UTSTARCOM HOLDINGS CORP. - Quarter Report: 2008 June (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)
x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2008
OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from to

 

COMMISSION FILE NUMBER 000-29661

 

UTSTARCOM, INC.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (510) 864-8800

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

As of July 30, 2008 there were 125,655,244 shares of the registrant’s common stock outstanding, par value $0.00125.

 

 

Table of Contents

 

TABLE OF CONTENTS

 

PART I—FINANCIAL INFORMATION	2
ITEM 1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)	2
ITEM 2—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	28
ITEM 3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS	47
ITEM 4—CONTROLS AND PROCEDURES	48
PART II—OTHER INFORMATION	51
ITEM 1—LEGAL PROCEEDINGS	51
ITEM 1A—RISK FACTORS	52
ITEM 2—UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	53
ITEM 3—DEFAULTS UPON SENIOR SECURITIES	53
ITEM 4—SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	54
ITEM 5—OTHER INFORMATION	55
ITEM 6—EXHIBITS	55
SIGNATURES	56

 

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PART I—FINANCIAL INFORMATION

 

ITEM 1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

UTSTARCOM, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In thousands, except share data)

 

		June 30,			December 31,
		2008			2007
ASSETS
Current assets:
Cash and cash equivalents		$	253,901		$	437,449
Short-term investments		889			65,629
Accounts receivable, net of allowances for doubtful accounts of $49,589 and $45,728 at June 30, 2008 and December 31, 2007, respectively		130,830			304,654
Accounts receivable, related parties		13,972			26,256
Notes receivable		8,643			12,615
Inventories		196,053			334,467
Deferred costs		146,905			190,260
Deferred tax assets		1,157			1,157
Restricted cash		17,394			6,442
Assets held for sale		373,929			—
Prepaids and other current assets		120,636			114,037
Total current assets		1,264,309			1,492,966
Property, plant and equipment, net		207,259			209,094
Long-term investments		16,211			16,667
Intangible assets, net		5,472			24,809
Long-term deferred costs		161,919			164,766
Long-term deferred tax assets		56,181			46,277
Other long-term assets		24,225			30,009
Total assets		$	1,735,576		$	1,984,588
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	179,984		$	148,440
Short-term debt		29,158			322,829
Income taxes payable		5,943			1,174
Customer advances		192,331			229,050
Deferred revenue		111,219			100,502
Deferred tax liabilities		49,687			53,922
Liabilities held for sale		154,953			—
Other current liabilities		175,303			247,299
Total current liabilities		898,578			1,103,216
Long-term deferred revenue		229,241			236,033
Long-term debt		—			333
Other long-term liabilities		19,124			23,325
Total liabilities		1,146,943			1,362,907
Commitments and contingencies (Note 14)
Minority interest in consolidated subsidiaries		796			3,705
Stockholders’ equity:
Common stock: $0.00125 par value; 750,000,000 authorized shares; 125,643,769 and 123,467,204 issued and outstanding at June 30, 2008 and December 31, 2007, respectively		152			152
Additional paid-in capital		1,227,729			1,216,691
Accumulated deficit		(704,593		)	(691,170		)
Accumulated other comprehensive income		64,549			92,303
Total stockholders’ equity		587,837			617,976
Total liabilities, minority interest and stockholders’ equity		$	1,735,576		$	1,984,588

 

See accompanying notes to the condensed consolidated financial statements.

 

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UTSTARCOM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In thousands, except per share data)

 

		Three months ended June 30,						Six months ended June 30,
		2008			2007			2008			2007
Net sales
Unrelated party		$	623,388		$	518,014		$	1,197,583		$	980,799
Related party		9,368			20,231			21,162			33,347
		632,756			538,245			1,218,745			1,014,146
Cost of net sales
Unrelated party		544,523			441,954			1,031,676			833,804
Related party		6,285			16,561			13,042			25,328
Gross profit		81,948			79,730			174,027			155,014
Operating expenses:
Selling, general and administrative		72,010			88,865			151,754			168,701
Research and development		39,286			42,158			80,686			85,819
Amortization of intangible assets		1,730			4,046			3,554			8,092
Total net operating expenses		113,026			135,069			235,994			262,612
Operating loss		(31,078		)	(55,339		)	(61,967		)	(107,598		)
Interest income		1,290			3,395			4,107			8,304
Interest expense		(3,457		)	(7,321		)	(9,528		)	(14,046		)
Other income (expense), net		(920		)	158			53,050			4,129
Loss before income taxes and minority interest		(34,165		)	(59,107		)	(14,338		)	(109,211		)
Income tax (expense) benefit		(4,625		)	(3,298		)	395			(7,640		)
Minority interest in losses of consolidated subsidiaries		10			698			520			1,161
Net loss		$	(38,780	)	$	(61,707	)	$	(13,423	)	$	(115,690	)
Loss per share - Basic and Diluted		$	(0.31	)	$	(0.51	)	$	(0.11	)	$	(0.96	)
Weighted average shares used in per-share calculation - Basic and Diluted		123,119			120,982			122,608			120,941

 

See accompanying notes to the condensed consolidated financial statements.

 

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UTSTARCOM, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

 

		Six months ended June 30,
		2008			2007
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss		$	(13,423	)	$	(115,690	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		19,904			29,737
Gain on sale of investments and liquidation of ownership interest in a variable interest entity		(48,375		)	(366		)
Net gain on sale of fixed assets		(85		)	(2,629		)
Stock-based compensation expense		9,844			4,939
Provision for doubtful accounts		2,722			2,370
Provision for (recovery of) deferred costs		9,089			(8,136		)
Deferred income taxes		(11,541		)	1,267
Other		2,185			(366		)
Changes in operating assets and liabilities:
Accounts receivable		65,081			84,696
Inventories		(69,513		)	(19,369		)
Deferred costs		42,747			31,563
Other assets		(5,513		)	(28,637		)
Accounts payable		116,453			(89,502		)
Income taxes payable		3,800			6,801
Customer advances		(16,503		)	27,141
Deferred revenue		(7,025		)	(23,982		)
Other current liabilities		(39,986		)	(49,135		)
Net cash provided by (used in) operating activities		59,861			(149,298		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment		(10,271		)	(15,425		)
(Purchase of) proceeds from the disposition of an investment interest		(2,244		)	1,800
Proceeds from repayment of loan by a variable interest entity		7,728			—
Change in restricted cash		(6,506		)	6,615
Purchase of short-term investments		(8,567		)	(21,735		)
Proceeds from sale of short-term investments		66,580			13,484
Other		143			(230		)
Net cash provided by (used in) investing activities		46,863			(15,491		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings		50,000			64,621
Payments on borrowings		(346,017		)	(64,732		)
Other		(3,637		)	4,728
Net cash (used in) provided by financing activities		(299,654		)	4,617
Effect of exchange rate changes on cash and cash equivalents		9,382			7,972
Net decrease in cash and cash equivalents		(183,548		)	(152,200		)
Cash and cash equivalents at beginning of period		437,449			661,623
Cash and cash equivalents at end of period		$	253,901		$	509,423
Supplemental disclosure of cash flow information:
Non-cash operating activity:
Accounts receivable transferred to notes receivable		$	9,278		$	11,462

 

See accompanying notes to the condensed consolidated financial statements.

 

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UTSTARCOM, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

NOTE 1 - BASIS OF PRESENTATION AND LIQUIDITY

 

The accompanying unaudited condensed consolidated financial statements include the accounts of UTStarcom, Inc. (“Company”) and its wholly and majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in the preparation of the condensed consolidated financial statements. The minority interest in consolidated subsidiaries is shown separately in the condensed consolidated financial statements.

 

The accompanying unaudited condensed consolidated financial statements as of June 30, 2008 and for the three and six months ended June 30, 2008 and 2007 have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The December 31, 2007 balance sheet was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. These condensed consolidated financial statements should be read in conjunction with the Company’s December 31, 2007 financial statements, including the notes thereto, and the other information set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts of assets, liabilities, revenue, costs, expenses and gains and losses not affecting retained earnings that are reported in the consolidated financial statements and accompanying disclosures.  Actual results may be different.  See the Company’s 2007 Annual Report for discussions of the Company’s critical accounting policies and estimates.

 

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting of only normal recurring adjustments) considered necessary for a fair statement of the Company’s financial condition, the results of its operations and its cash flows for the periods indicated. The results of operations for the three and six months ended June 30, 2008 are not necessarily indicative of the operating results for the full year.

 

The Company had an operating loss of $62.0 million and a net loss of $13.4 million for the six months ended June 30, 2008. At June 30, 2008, the Company had an accumulated deficit of $704.6 million.  Cash provided from operations was $59.9 million during the six months ended June 30, 2008, primarily the result of management of working capital, in part, necessitated by the repayment of the convertible subordinated notes due March 1, 2008. At June 30, 2008, the Company had cash and cash equivalents of $253.9 million, of which $157.7 million was held by its China subsidiaries and continues to be subject to currency exchange controls on transfers of funds from China.

 

The Company reported net losses of $195.6 million, $117.3 million and $532.6 million for the years ended December 31, 2007, 2006 and 2005, respectively. At December 31, 2007, the Company’s accumulated deficit aggregated $691.2 million. During the year ended December 31, 2007, the Company used $218.2 million of cash in operations. At December 31, 2007, the Company had cash and cash equivalents of $437.4 million of which $289.5 million was used to repay the convertible subordinated notes due on March 1, 2008 (the “Notes”). This amount included a principal payment of $274.6 million and $14.9 million in accrued interest. At December 31, 2007, $322.4 million of the Company’s cash and cash equivalents were held by its subsidiaries in China and China imposes currency exchange controls on transfers of funds outside of China. Additionally, the available lines of credit in China are significantly less than what has been available to the Company historically and the existing credit facilities in China expire during the fourth quarter of 2008. These factors raised substantial doubt as to the Company’s ability to continue as a going concern.

 

On June 30, 2008, the Company entered into an agreement to sell UTStarcom Personal Communications LLC, a wholly-owned subsidiary of the Company (“PCD”) for a total purchase consideration of approximately $240 million and has classified PCD’s assets and liabilities as held for sale in the June 30, 2008 condensed consolidated balance sheet. The transaction closed on July 1, 2008 (See Note 22). As a result of this transaction, management believes the Company has

 

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sufficient liquidity to finance its anticipated working capital and capital expenditure requirements for the next twelve months.  In an effort to further improve the Company’s profitability and cash flows, management continues to re-examine all aspects of the Company’s business for areas of improvement and continues to focus on the Company’s fixed cost base and improving the working capital position to better align with operations, market demand and current sales levels. However, if projected sales do not materialize, management may need to further reduce expenses. In addition, the Company may require additional equity or debt financing. If future funds are raised through issuance of stock or debt, these securities could have rights, privileges or preference senior to those of the Company’s common stock and debt covenants could impose restrictions on the Company’s operations. The sale of additional equity securities or debt financing could result in additional dilution to the Company’s current shareholders. There can be no assurance that additional financing, if required, will be available on terms satisfactory to the Company.

 

NOTE 2 – RECENT ACCOUNTING PRONOUNCEMENTS

 

Adoption of New Accounting Standards

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements,” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of this standard apply to current accounting pronouncements that require or permit fair value measurements. Upon adoption, the provisions of SFAS 157 are to be applied prospectively with limited exceptions.  Effective January 1, 2008, the Company adopted the measurement and disclosure requirements of SFAS 157 as it relates to financial assets and financial liabilities measured at fair value on a recurring basis. The adoption of SFAS No. 157 for these financial assets and financial liabilities did not have a material impact on the Company’s financial condition or results of operations in the first six months of 2008. The new disclosures required by SFAS 157 are included in Note 6. In February 2008, the FASB issued FASB Staff Position No. 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”), which delays the effective date of SFAS 157 for non-financial assets and non-financial liabilities except those recorded or disclosed at fair value on a recurring basis.  Therefore, the Company has delayed application of SFAS 157 to those non-financial assets and non-financial liabilities until January 1, 2009.  The Company is currently evaluating the impact of SFAS 157 on those non-financial assets and non-financial liabilities on the Company’s financial position and results of operations.  While the Company does not expect the adoption of this statement to have a material impact on its consolidated financial statements in subsequent reporting periods, the Company continues to monitor any additional implementation guidance that is issued that addresses the fair value measurements for non-financial assets and non-financial liabilities not disclosed at fair value in the consolidated financial statement on at least an annual basis.

 

In February 2007, the FASB issued Statement of Financial Accounting Standard No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). This statement permits, but does not require, companies to report at fair value the majority of recognized financial assets, financial liabilities and firm commitments. Under this standard, unrealized gains and losses on items for which the fair value option is elected are reported in earnings at each subsequent reporting date. The Company adopted SFAS 159 during the first quarter of 2008. The Company has chosen not to elect the fair value option for any items that are not already required to be measured at fair value in accordance with accounting principles generally accepted in the United States. As such, the adoption of SFAS 159 did not have an impact on the Company’s financial position or results of operations.

 

Standards Issued But Not Yet Effective

 

In December 2007, the FASB issued Statement No. 141 (revised), “Business Combinations” (“SFAS 141(R)”). The standard changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for preacquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  The Company will assess the impact of SFAS 141(R) if and when a future acquisition occurs.

 

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In December 2007, the FASB issued Statement No. 160, “Non-controlling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS 160”). The standard changes the accounting for non-controlling (minority) interests in consolidated financial statements including the requirements to classify non-controlling interests as a component of consolidated stockholders’ equity, and the elimination of “minority interest” accounting in results of operations with earnings attributable to non-controlling interests reported as part of consolidated earnings. Additionally, SFAS 160 revises the accounting for both increases and decreases in a parent’s controlling ownership interest. SFAS 160 is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. The Company is currently evaluating the impact of the pending adoption of SFAS 160 on its consolidated financial statements.

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”), which amends and expands the disclosure requirements of FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities”  (“SFAS 133”), with the intent to provide users of financial statements with an enhanced understanding of:  (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows.  SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative instruments.  This statement applies to all entities and all derivative instruments.  SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.   Since SFAS 161 only provides for additional disclosure requirements, there will be no impact on the Company’s financial position or results of operations.

 

In April 2008, the FASB issued FASB Staff Position (“FSP”) No. 142-3, “Determination of the Useful Life of Intangible Assets”. FSP 142-3 amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under FASB Statement No. 142, “Goodwill and Other Intangible Assets”. This new guidance applies prospectively to intangible assets that are acquired individually or with a group of other assets in business combinations and asset acquisitions. FSP 142-3 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. Early adoption is prohibited. The Company is currently evaluating the impact that FSP 142-3 will have on its consolidated financial statements.

 

In May 2008, the FASB issued Staff Position No. APB 14-1, “Accounting for Convertible Debt Instruments that May be Settled in Cash Upon Conversion.” APB 14-1 requires that the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) be separately accounted for in a manner that reflects an issuer’s nonconvertible debt borrowing rate. The resulting debt discount is amortized over the period the convertible debt is expected to be outstanding as additional non-cash interest expense. APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Retrospective application to all periods presented is required except for instruments that were not outstanding during any of the periods that will be presented in the annual financial statements for the period of adoption but were outstanding during an earlier period. The Company does not anticipate the adoption of this position to have a material impact on its financial condition, results of operations and cash flows based on its existing debt securities.

 

NOTE 3 - STOCK-BASED COMPENSATION

 

During the three and six months ended June 30, 2008, the Company granted equity awards including restricted stock, restricted stock units and stock options. Such awards generally vest over a period of one to four years from the date of grant.  Restricted stock has the voting rights of common stock and the shares underlying restricted stock are issued and outstanding.

 

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In November 2007, the Compensation Committee granted 962,249 shares of performance-based restricted stock units to certain senior executive officers.  On February 26, 2008, the Committee determined, based on the Company’s and each executive officer’s level of performance during the Company’s 2007 fiscal year, that 783,324 shares underlying the previously granted performance-based restricted stock units had been earned, with 50% vesting immediately and 50% vesting on February 28, 2009.  Each performance-based restricted stock unit has a fair value of $2.99 per share, which equals the closing price of the Company’s common stock on the NASDAQ Stock Market on the measurement date of February 26, 2008.  In February 2008, the Compensation Committee also granted an additional 1,073,333 performance-based awards to certain senior executive officers, subject to the attainment of goals determined by the Compensation Committee.  The Company may be subject to variable levels of expense related primarily to the varying levels of performance, as well as for fluctuations in the Company’s stock price as these awards are “marked to market” periodically prior to the date of the Compensation Committee’s determination on performance.

 

The total stock-based compensation expense recognized in the condensed consolidated statements of operations is as follows:

 

		Three months ended June 30,						Six months ended June 30,
		2008			2007			2008			2007
		(in thousands)
Cost of net sales		$	334		$	119		$	594		$	243
Selling, general and administrative		4,029			1,159			8,026			2,864
Research and development		686			906			1,224			1,832
Total		$	5,049		$	2,184		$	9,844		$	4,939

 

The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option valuation model and the weighted average assumptions in the following table. The expected term of options granted is derived from historical data on employee exercise and post-vesting employment termination behavior. The risk free interest rate is based on the zero coupon U.S. Treasury securities with an equivalent remaining term. Expected volatility is based on the historical volatility of the Company’s stock. The weighted-average per share fair value of stock options granted and the assumptions used, are as follows:

 

		Three months ended June 30,					Six months ended June 30,
		2008			2007 (1)		2008			2007 (1)
Weighted-average per share fair value of grants		$	1.72		—		$	1.51		—
Expected remaining term in years		4.1			—		4.3			—
Weighted average risk-free interest rate		2.77		%	—		2.38		%	—
Expected dividend rate		0.00		%	—		0.00		%	—
Volatility		63		%	—		63		%	—

 

(1) No stock options were granted during the three and six months ended June 30, 2007.

 

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Option activity as of June 30, 2008 and changes during the six months ended June 30, 2008 are as follows:

 

		Number of shares outstanding (in thousands)		Weighted average exercise price
Options outstanding, December 31, 2007		17,647		$	13.91
Options granted		510		2.95
Options exercised		(50	)	1.90
Options forfeited or expired		(3,212	)	16.86
Options outstanding, June 30, 2008		14,895		$	12.94

 

Nonvested restricted stock and restricted stock units as of June 30, 2008, and changes during the six months ended June 30, 2008, are as follows:

 

		Shares (in thousands)		Weighted average grant date fair value
Nonvested at December 31, 2007		6,370		$	3.09
Granted		5,367		2.88
Vested		(1,256	)	2.87
Forfeited		(765	)	2.88
Nonvested at June 30, 2008		9,716		$	3.02

 

At June 30, 2008, there was approximately $36.6 million of total unrecognized compensation cost, related to non-vested stock options, restricted stock and restricted stock units, adjusted for forfeitures, which is expected to be recognized over a weighted average period of 2.3 years. For additional information regarding the Company’s stock-based compensation plans, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

 

NOTE 4 - LOSS PER SHARE

 

Basic earnings per share (“EPS”) is computed by dividing net loss available to common stockholders by the weighted average number of shares of the Company’s common stock outstanding during the period, which excludes nonvested restricted stock. Diluted EPS presents the amount of net loss available to each share of common stock outstanding during the period plus each share of common stock that would have been outstanding assuming the Company had issued shares of common stock for all dilutive potential common shares outstanding during the period. The Company’s potentially dilutive common shares include convertible subordinated notes prior to their maturity, outstanding stock options, nonvested restricted stock and restricted stock units and Employee Stock Purchase Plan (“ESPP”) shares.

 

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The following is a summary of the calculation of basic and diluted loss per share:

 

		Three months ended June 30,						Six months ended June 30,
		2008			2007			2008			2007
		(in thousands except per share data)
Numerator
Net loss		$	(38,780	)	$	(61,707	)	$	(13,423	)	$	(115,690	)
Denominator
Weighted-average shares outstanding		123,119			120,982			122,608			120,941
Loss per share - basic and diluted		$	(0.31	)	$	(0.51	)	$	(0.11	)	$	(0.96	)

 

For the three and six months ended June 30, 2008 and 2007, no potential common shares were dilutive because of the net loss in each of these periods.  The following table summarizes the total potential shares of common stock that were excluded from the diluted per share calculation:

 

		Three months ended June 30,				Six months ended June 30,
		2008		2007		2008		2007
		(in thousands)
Stock options and ESPP shares		17,034		18,302		17,105		18,812
Assumed conversion of convertible subordinated notes		—		11,543		3,805		11,543
Nonvested restricted stock and restricted stock units		9,977		516		8,982		575
		27,011		30,361		29,892		30,930

 

NOTE 5 - COMPREHENSIVE LOSS

 

The reconciliation of net loss to comprehensive loss for the three and six months ended June 30, 2008 and 2007 is as follows:

 

		Three months ended June 30,						Six months ended June 30,
		2008			2007			2008			2007
		(in thousands)
Net loss		$	(38,780	)	$	(61,707	)	$	(13,423	)	$	(115,690	)
Unrealized gain (loss) on investments, net of tax		(273		)	52,141			(1,723		)	48,271
Reclassification adjustment related to realization of previously unrealized gains, net of tax		—			—			(38,302		)	—
Foreign currency translation		4,507			7,241			12,271			11,908
Total comprehensive loss		$	(34,546	)	$	(2,325	)	$	(41,177	)	$	(55,511	)

 

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The components of accumulated other comprehensive income reported in the condensed consolidated balance sheets are as follows:

 

		June 30,			December 31,
		2008			2007
		(in thousands)
Unrealized (loss) gain on available-for-sale securities, net of tax		$	(2,699	)	$	35,949
Foreign currency translation		67,248			56,354
Accumulated other comprehensive income		$	64,549		$	92,303

 

NOTE 6 - CASH, CASH EQUIVALENTS, INVESTMENTS AND FAIR VALUE MEASUREMENTS

 

Cash and cash equivalents are recorded at cost. Short-term investments, consisting of bank notes and available-for-sale securities, were $0.9 million and $65.6 million at June 30, 2008 and December 31, 2007, respectively.   Short-term investments decreased at June 30, 2008 from December 31, 2007 primarily due to the sale of investments with a carrying value of $42.4 million at December 31, 2007.  The available-for-sale securities investments are recorded at fair value (see below).  Any unrealized holding gains or losses are reported as a component of other comprehensive income, net of related income tax effects. Realized gains and losses are reported in earnings.  At June 30, 2008, the long-term investments included $2.7 million of unrealized holding loss which was recorded in accumulated other comprehensive income. There was no unrealized holding gain or loss in short-term investments.   At December 31, 2007, the long-term and short-term investments included $1.0 million of unrealized holding loss and $36.9 million of unrealized holding gain, respectively.

 

The Company accepts bank notes receivable with maturity dates of between three and six months from its customers in China in the normal course of business.  The Company may discount these bank notes with banking institutions in China. The Company sold $7.7 million and $30.5 million of bank notes, and recorded costs of $0.1 million and $0.4 million as a result of discounting the notes, during the three and six months ended June 30, 2008, respectively.  There were no bank notes sold during the three and six months ended June 30, 2007.

 

The following table shows the break-down of the Company’s total investments at June 30, 2008 and December 31, 2007:

 

		June 30,			December 31,
		2008			2007
		(in thousands)
Equity Securities
Gemdale Company, Ltd		$	—		$	30,595
Infinera		—			11,759
Global Asia Partners L.P.		2,211			2,113
Cortina		3,348			3,013
MRV		1,808			3,523
GCT SemiConductor, Inc.		3,000			3,000
Xalted Networks		3,302			3,302
Others		2,542			1,716
Bank Notes		889			23,275
Total investments		$	17,100		$	82,296
Short-term investments		889			65,629
Long-term investments		16,211			16,667

 

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Gemdale

 

Gemdale Co., Ltd (“Gemdale”) is a real estate company that invests and develops properties in China, primarily in Shanghai, Beijing, Shenzhen and Wuhan.  During the first quarter of 2008, the Company sold its remaining investment for approximately $32.9 million cash and recorded a gain of $32.4 million in other income (expense), net.

 

Infinera

 

Infinera Corporation (“Infinera”) develops optical telecommunications systems using photonic integrated circuits.  Infinera became a public company as a result of its initial public offering in June 2007.  During the first quarter of 2008, the Company sold all of its investment in Infinera for total proceeds of $9.2 million and recognized a gain of $7.3 million in other income (expense), net.

 

MRV

 

On July 1, 2007, Fiberxon, an investment in which the Company had a 7% ownership interest, completed a merger with MRV Communications (“MRV”), which is a publicly-traded company in an active market. In exchange for the Company’s interest in Fiberxon, the Company was entitled to receive $1.5 million in cash, 1,519,365 shares of MRV common stock valued at approximately $4.5 million and deferred consideration of approximately $2.7 million. The deferred consideration becomes payable upon the completion of certain milestones and may be reduced by legitimate claims of MRV for certain matters related to the merger. In the third quarter of 2007, the Company was paid the cash consideration of $1.5 million and received 1,519,365 shares of MRV common stock and recognized a gain on investment of $2.9 million. During the three and six months ended June 30, 2008, the Company recorded an unrealized loss of $0.3 million and $1.7 million, respectively, in other comprehensive income, representing the change in fair value of the investment during the period.  The accumulated unrealized loss at June 30, 2008 was $2.7 million, representing the difference between the fair value of the investment on June 30, 2008 and the initial amount recorded of $4.5 million when the MRV shares were received in 2007.  Because the Company has the ability and intent to hold this investment until a recovery of fair value, the Company does not consider this investment to be other-than-temporarily impaired. At June 30, 2008, MRV is the only investment accounted for under SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities”.

 

Fair Value Measurements

 

As discussed in Note 2, effective January 1, 2008, the Company adopted SFAS 157 as it relates to financial assets and liabilities that are being measured and reported at fair value on a recurring basis.  Although the adoption of SFAS 157 did not materially impact its financial condition, results of operations, or cash flows, the Company is now required to provide additional disclosures as part of its financial statements.  In accordance with FSP 157-2, the Company deferred adoption of SFAS 157 as it relates to non-financial assets and liabilities measured at fair value on a nonrecurring basis.

 

SFAS No. 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, SFAS No. 157 establishes a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs other than the quoted prices in active markets that are observable either directly or indirectly, or quoted prices in less active markets; and (Level 3) unobservable inputs in which there is little or no market data, which require us to develop our own assumptions. This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. On a recurring basis, the Company measures certain financial assets at fair value, including its marketable securities.

 

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At June 30, 2008, the Company’s investment in MRV is an available-for-sale security recorded at fair value, classified within Level 1 of the fair value hierarchy.  The Company has no other financial assets or liabilities that are being measured at fair value at June 30, 2008.

 

NOTE 7 - RESTRICTED CASH

 

At June 30, 2008, the Company had short-term restricted cash of $17.4 million, and had long-term restricted cash of $15.8 million included in other long-term assets. At December 31, 2007 the Company had short-term restricted cash of $6.4 million, and had long-term restricted cash of $20.2 million included in other long-term assets. These amounts primarily collateralize the Company’s issuances of standby and commercial letters of credit.

 

NOTE 8 - NOTES RECEIVABLE AND RECEIVABLES PURCHASE AGREEMENT

 

Commercial notes receivable available for sale were $8.6 million and $12.6 million at June 30, 2008 and December 31, 2007, respectively. The Company may discount these commercial notes with banking institutions in China. A sale of these notes is reflected as a reduction of notes receivable and the proceeds of the settlement of these notes are included in cash flows from operating activities in the consolidated statement of cash flows. There were no commercial notes receivable sold during the three and six months ended June 30, 2008 and 2007.

 

In August 2005, the Company entered into a Committed Receivables Purchase Agreement (“Agreement”) with a financial institution, whereby the Company could sell up to $100.0 million of its eligible accounts receivable, as defined in the Agreement.  In March 2008, the Company terminated the Agreement. No receivables were sold pursuant to this arrangement and no premiums or penalties were incurred by the Company in connection with the termination of this credit facility.

 

NOTE 9 - INVENTORIES

 

As of June 30, 2008 and December 31, 2007, total inventories consisted of the following:

 

		June 30,			December 31,
		2008			2007
		(in thousands)
Raw materials		$	24,039		$	34,413
Work-in-process		31,615			35,853
Finished goods		140,399			264,201
Total Inventories		$	196,053		$	334,467

 

At June 30, 2008, the Company had inventories of approximately $208.0 million included in assets held for sale, see Note 10.

 

NOTE 10 – ASSETS HELD FOR SALE

 

Beginning in the fourth quarter of 2007, the Company launched a number of initiatives, including potential divestitures of non-core assets, to focus on its core growth technologies, including IPTV, IP-based softswitch and broadband devices. On June 30, 2008, the Company entered into an agreement to sell UTStarcom Personal Communications LLC, a wholly-owned subsidiary of the Company (“PCD”) to an entity controlled by AIG Global Investment Group and certain other investors. The transaction closed on July 1, 2008 (See Note 22).  Previously, PCD was a reportable segment of the Company.

 

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As of June 30, 2008, the Company determined that the “held for sale” criteria in FASB Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (“SFAS 144”) had been met for the PCD assets and liabilities. As the sale of PCD is anticipated to result in a gain to be recorded in the third quarter of 2008, no adjustments to the carrying values of the net assets were made. Assets and liabilities for PCD are included in assets held for sale and liabilities held for sale in the condensed consolidated balance sheet as of June 30, 2008.  The following table summarizes the net assets held for sale as of June 30, 2008 (in thousands):

 

Accounts receivable, net		$	125,783
Inventories, net		208,042
Deferred costs		13,652
Prepaids and other current assets		9,019
Property, plant and equipment, net		1,611
Intangible assets, net		15,783
Other assets		39
Assets held for sale		$	373,929
Accounts payable		$	89,856
Customer advances		18,262
Deferred revenue		7,379
Accrued liabilities and other		39,456
Liabilities related to assets held for sale		$	154,953
Net assets held for sale		$	218,976

 

In accordance with SFAS 144, the Company ceased depreciation on the assets to be sold upon executing the agreement to sell PCD. The operations and cash flows of the PCD business will not be accounted for and presented as a discontinued operation because of expected significant continuing direct cash flows pursuant to a three-year supply agreement whereby the Company will continue to sell handset products to the divested entity.

 

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NOTE 11 - INTANGIBLE ASSETS

 

As of June 30, 2008 and December 31, 2007, intangible assets consisted of the following:

 

		June 30, 2008									December 31, 2007
		Gross						Net			Gross									Net
		Carrying			Accumulated			Carrying			Carrying			Impairment			Accumulated			Carrying
		Amount			Amortization			Amount			Amount			Charges			Amortization			Amount
		(in thousands)
Amortized intangible assets:
Existing technology		$	—		$	—		$	—		$	39,530		$	(5,214	)	$	(33,843	)	$	473
Customer relationships		11,128			(5,656		)	5,472			57,220			(10,458		)	(24,676		)	22,086
Trade names		—			—			—			4,940			—			(4,940		)	—
Non-compete agreement		—			—			—			10,800			—			(8,550		)	2,250
		$	11,128		$	(5,656	)	$	5,472		$	112,490		$	(15,672	)	$	(72,009	)	$	24,809

 

Amortization expense was $1.7 million and $4.0 million for the three months ended June 30, 2008 and 2007, respectively, and was $3.6 million and $8.1 million for the six months ended June 30, 2008 and 2007, respectively. In the fourth quarter of 2007, the Company determined that the undiscounted cash flows are not sufficient to recover the carrying value of the customer relationships and technology intangible assets within the Other segment and recorded an intangible asset impairment charge of $15.7 million.

 

The estimated aggregate amortization expense for intangibles for the remainder of 2008 and each of the next four years and thereafter is as follows:

 

		(in thousands)
Remainder of 2008		$	556
2009		1,113
2010		1,113
2011		1,113
2012		1,113
Thereafter		464
		$	5,472

 

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NOTE 12 - DEBT

 

The following represents the outstanding borrowings at June 30, 2008 and December 31, 2007:

 

		June 30,			December 31,
		2008			2007
		(in thousands)
Bank loans		$	29,158		$	47,981
Capital lease obligations, at 4.7%-10.0%, due through 2011		—			581
Convertible subordinated notes, due March 1, 2008		—			274,600
Total Debt		$	29,158		$	323,162
Long-term debt		—			333
Short-term debt		$	29,158		$	322,829

 

At June 30, 2008, the Company had $29.2 million of bank loans with interest rates ranging 6.3% to 6.6% per annum. These bank loans mature during 2008 and are included in short-term debt. There are no significant covenants associated with these loans.

 

At June 30, 2008, the Company had credit facilities totaling $161.8 million, of which $43.7 million was for working capital purposes and the remaining $118.1 million was for use in support of letters of credits and corporate guarantees.  As of June 30, 2008, $153.8 million of the total credit facilities remained available. All of these facilities expire in late 2008.  As of June 30, 2008, the Company had not guaranteed any debt not included in the condensed consolidated balance sheet.

 

On March 21, 2008, the Company entered into a credit agreement providing for a $75.0 million secured revolving credit facility that was subject to an accounts receivable and inventory borrowing base formula and was used during the second quarter of 2008 to fund the Company’s general working capital requirements.  During the quarter, the Company repaid all outstanding borrowings under this arrangement. On June 30, 2008, in connection with the entry into an agreement for the sale of the PCD segment (see Note 22), the Company terminated the commitments under the credit agreement. Upon termination of the credit agreement, the Company expensed the remaining unamortized debt issuance costs of approximately $1.1 million.

 

On March 12, 2003, the Company completed an offering of $402.5 million of 7/8% convertible subordinated notes due March 1, 2008 to qualified buyers pursuant to Rule 144A under the Securities Act of 1933.  In 2007, the Company and holders of the remaining $274.6 million of convertible subordinated notes entered into two supplemental indentures waiving certain provisions of the original agreement and providing for an increase in the interest rate. The notes were convertible into the Company’s common stock, under certain conditions, at a conversion price of $23.79 per share and were subordinated to all present and future senior debt of the Company.  On March 3, 2008, the Company repaid the convertible subordinated notes of $289.5 million which included a principal payment of $274.6 million and the accrued interest of $14.9 million.

 

NOTE 13 - WARRANTY OBLIGATIONS AND OTHER GUARANTEES

 

The Company provides a warranty on its equipment and handset sales for a period generally ranging from one to two years from the time of final acceptance. At times, the Company has entered into arrangements to provide limited warranty services for periods longer than two years. The Company provides for the expected cost of product warranties at the time that revenue is recognized based on an assessment of past warranty experience and when specific circumstances dictate. From time to time, the Company may be subject to additional costs related to non-standard warranty claims from its customers. If and when this occurs, the Company estimates additional accruals based on historical experience, communication with its customers and various assumptions that the Company believes to be reasonable under the circumstances. Such additional warranty accruals are recorded in the period in which the additional costs are identified.

 

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Warranty obligations, included in other current liabilities, are as follows:

 

		Three months ended June 30,						Six months ended June 30,
		2008			2007			2008			2007
		(in thousands)
Balance at beginning of period		$	49,572		$	59,819		$	52,734		$	66,408
Accruals for warranties issued during the period		4,354			7,769			11,587			11,066
Settlements made during the period		(8,222		)	(11,464		)	(18,617		)	(21,350		)
Warranty obligations related to PCD reclassified to liabilities held for sale		(10,124		)	—			(10,124		)	—
Balance at end of period		$	35,580		$	56,124		$	35,580		$	56,124

 

Certain of the Company’s sales contracts include provisions under which customers would be indemnified by the Company in the event of, among other things, a third-party claim against the customer for intellectual property rights infringement related to the Company’s products.  There are no limitations on the maximum potential future payments under these guarantees.  The Company has not accrued any amount in relation to these provisions as no such claims have developed into assertable claims and the Company believes it has defensible rights to the intellectual property embedded in its products.

 

NOTE 14 - COMMITMENTS AND CONTINGENCIES

 

Litigation

 

Securities Class Action Litigation

 

Beginning in October 2004, several shareholder class action lawsuits alleging federal securities violations were filed against the Company and various officers and directors of the Company. The actions have been consolidated in United States District Court for the Northern District of California under the caption In re UTStarcom, Inc. Securities Litigation, Master File No. C-04-4908-JW (PVT). The lead plaintiffs in the case filed a First Amended Consolidated Complaint on July 26, 2005. The First Amended Complaint alleged violations of the Securities Exchange Act of 1934, and was brought on behalf of a putative class of shareholders who purchased the Company’s stock after April 16, 2003 and before September 20, 2004. On April 13, 2006, the lead plaintiffs filed a Second Amended Complaint adding new allegations and extending the end of the class period to October 6, 2005. In addition to the Company defendants, the plaintiffs are also suing Softbank. Plaintiffs’ complaint seeks recovery of damages in an unspecified amount.

 

On June 2, 2006, the Company and the individual defendants filed a motion to dismiss the Second Amended Complaint. On March 21, 2007, the Court granted defendants’ motion and dismissed plaintiffs’ Second Amended Complaint. The Court granted plaintiffs leave to file a Third Amended Complaint, which plaintiffs filed on May 25, 2007. On July 13, 2007, the Company and the individual defendants filed a motion to dismiss and a motion to strike the Third Amended Complaint. On March 14, 2008, the Court granted defendants’ motion and dismissed plaintiffs’ Third Amended Complaint.  The Court granted plaintiffs leave to file a Fourth Amended Complaint, which plaintiffs filed on May 14, 2008.  On June 13, 2008, consistent with the Court’s March 14, 2008 dismissal order, the Company and the individual defendants filed objections to the form and content of the Fourth Amended Complaint.  On July 24, 2008, the Court overruled the objections, but stated that the Company and the individual defendants would be permitted to file a motion to dismiss and a motion to strike the Fourth Amended Complaint.

 

On September 4, 2007, a second shareholder class action complaint captioned Peter Rudolph v. UTStarcom, et al., Case No. C-07-4578 SI, was filed in the United States District Court for the Northern District of California against the Company and some of its current and former directors and officers. The complaint alleges violations of the Securities Exchange Act of 1934 through undisclosed improper accounting practices concerning the Company’s historical equity award

 

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grants. Plaintiff seeks unspecified damages on behalf of a purported class of purchasers of the Company’s common stock between July 24, 2002 and September 4, 2007. On December 14, 2007, the Court appointed James R. Bartholomew lead plaintiff. On January 25, 2008, the lead plaintiff filed an amended complaint.  On April 14, 2008, the Court granted defendants’ motion to dismiss the amended complaint.  The Court granted the lead plaintiff leave to file a second amended complaint no later than May 16, 2008 which was filed by the lead plaintiff on May 16, 2008.  On June 6, 2008, defendants filed a motion to dismiss the second amended complaint.

 

Due to the preliminary status of these lawsuits and uncertainties related to litigation, management is unable to evaluate the likelihood of either a favorable or unfavorable outcome. Accordingly, management is unable at this time to estimate the effects of these complaints on the Company’s financial position, results of operations, or cash flows.

 

Governmental Investigations

 

On May 1, 2008, the U.S. Securities and Exchange Commission (the “SEC”) announced a final settlement agreement with the Company in connection with an investigation commenced by the SEC in September 2005.  The investigation involved the Company’s financial disclosures during prior reporting periods, historic option grant awards practices, certain historical sales contracts in China and other matters. Without admitting or denying the allegations in the SEC’s complaint, the Company consented to a permanent injunction against any future violations of certain books-and-records and internal control provisions of the federal securities laws. No monetary penalties were assessed against the Company.  In connection with the same investigation, Mr. Lu, the Company’s Chief Executive Officer at the time of the settlement and the current Chairman of the Board of Directors, individually entered into a settlement agreement with the SEC. Without admitting or denying the allegations in the SEC’s complaint, Mr. Lu agreed to pay a civil penalty of $100,000 and consented to a permanent injunction on similar terms as the Company.

 

In December 2005, the U.S. Embassy in Mongolia informed the Company that it had forwarded to the Department of Justice (the “DOJ”) allegations that an agent of the Company’s Mongolia joint venture had offered payments to a Mongolian government official in possible violation of the Foreign Corrupt Practices Act (the “FCPA”). The Company, through its Audit Committee, authorized an independent investigation into possible violations of the FCPA, and it has been in contact with the DOJ and SEC regarding the investigation. The investigation has identified possible FCPA violations in Mongolia, Southeast Asia, India, and China, as well as possible violations of U.S. immigration laws. The DOJ has requested that the Company voluntarily produce documents related to the investigation, the SEC has subpoenaed the Company for documents, and the Company has received a Grand Jury Subpoena requiring the production of documents related to one aspect of the DOJ investigation, that is, training programs the Company had sponsored. The Company has executed tolling agreements extending the statute of limitations for the FCPA issues under investigation by the DOJ. Such proceedings may result in criminal or civil sanctions, penalties and disgorgements against the Company. If it is probable that an obligation of the Company exists and will result in an outflow of resources, a provision will be recorded if the amount can be reasonably estimated. Regulatory and legal proceedings as well as government investigation often involve complex legal issues and are subject to substantial uncertainties. Accordingly, management exercises considerable judgment in determining whether it is probable that such a proceeding will result in outflow of resources and whether the amount of the obligation can be reasonably estimated. The Company periodically reviews the status of these proceedings and these judgments are subject to change as new information becomes available. At this time, the Company cannot predict when any inquiry will be completed or what the outcome of any inquiry will be. The Company is unable to reasonably estimate the total amount of loss, if any, associated with the proceedings. A judgment against the Company may have a material adverse effect on the Company’s financial position, results of operations and cash flows.

 

Shareholder Litigation

 

On November 17, 2006, a shareholder derivative complaint captioned Ernesto Espinoza v. Ying Wu et al., Case No. RG06298775, was filed against certain of the Company’s current and former officers and directors in the Superior Court of the County of Alameda, California. The complaint alleges that the individual defendants, among other things, breached their duties, were unjustly enriched, and violated the California Corporations Code in connection with the timing of stock option grants. The complaint names the Company as a nominal defendant and seeks unspecified monetary damages against the

 

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individual defendants and various forms of injunctive relief. On February 2, 2007, the Company and the individual defendants filed demurrers against the complaint. On April 11, 2007, the Court sustained the individual defendants’ demurrer, overruled the Company’s demurrer, ordered the plaintiff to file an amended complaint, and ordered the Company to answer the original complaint. The plaintiff filed an amended complaint and the Company has filed an answer to the amended complaint. On August 21, 2007, the individual defendants filed demurrers against the amended complaint. The Court sustained the individual defendants’ demurrers and ordered the plaintiff to file a second amended complaint. The plaintiff has until September 5, 2008 to file his second amended complaint.

 

Due to the preliminary status of this complaint and uncertainties related to litigation, management of the Company is unable to evaluate the likelihood of either a favorable or unfavorable outcome. Accordingly, management of the Company is unable at this time to estimate the effects of this complaint on the Company’s financial position, results of operations, or cash flows.

 

IPO Allocation

 

On October 31, 2001, a complaint was filed in United States District Court for the Southern District of New York against the Company, some of the Company’s directors and officers and various underwriters for the Company’s initial public offering. Substantially similar actions were filed concerning the initial public offerings for more than 300 different issuers, and the cases were coordinated as In re Initial Public Offering Securities Litigation, 21 MC 92 for pretrial purposes. In April 2002, a consolidated amended complaint was filed in the matter against the Company, captioned In re UTStarcom, Initial Public Offering Securities Litigation, Civil Action No. 01-CV-9604. Plaintiffs allege violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 through undisclosed improper underwriting practices concerning the allocation of IPO shares in exchange for excessive brokerage commissions, agreements to purchase shares at higher prices in the aftermarket and misleading analyst reports. Plaintiffs seek unspecified damages on behalf of a purported class of purchasers of the Company’s common stock between March 2, 2000 and December 6, 2000. The Company’s directors and officers have been dismissed without prejudice pursuant to a stipulation. On February 19, 2003, the Court granted in part and denied in part a motion to dismiss the claims brought by defendants including the Company. The order dismissed all claims against the Company except for a claim brought under Section 11 of the Securities Act of 1933, which alleges that the registration statement filed in accordance with the IPO was misleading. In June 2004, a stipulation of settlement and release of claims against the issuer defendants, including the Company, was submitted to the court for approval. The terms of the settlement, if approved, would have dismissed and released all claims against the participating defendants (including the Company). In August 2005, the Court preliminarily approved the settlement. In December 2006, the Court of Appeals for the Second Circuit reversed the Court’s October 2004 order certifying a class in six test cases that were selected by the underwriter defendants and plaintiffs in the coordinated proceedings. The Company’s case is not one of the test cases. Because class certification was a condition of the settlement, it was unlikely that the settlement would receive final Court approval. On June 25, 2007, the Court entered an order terminating the proposed settlement based on a stipulation among the parties to the settlement. Plaintiffs have filed amended master allegations and amended complaints and moved for class certification in the six test cases, which the defendants in those cases have opposed. On March 26, 2008, the Court largely denied the defendants’ motion to dismiss the amended complaints.  It is unclear whether there will be any revised or future settlement. If the litigation proceeds, management of the Company believes that the Company has meritorious defenses and management of the Company intends to defend the action vigorously. The total amount of the loss associated with the above litigation is not determinable at this time. Therefore, management of the Company is unable to currently estimate the loss, if any, associated with the litigation.

 

UTStarcom, Inc. v. Starent Patent Infringement Litigations

 

On February 16, 2005, the Company filed a suit against Starent for patent infringement in the U.S. District Court for the Northern District of California. In the Complaint, the Company asserted that Starent infringes UTStarcom patent U.S. Reg. No. 6,829,473 (“the ‘473 patent”) through Starent’s development and testing of a software upgrade for its customer’s installed ST-16 Intelligent Mobile Gateways. The Company seeks declaratory and injunctive relief. Starent subsequently filed its answer and counterclaims, and the Company then filed a motion to dismiss Starent’s counterclaim. On July 19, 2005, the parties stipulated that Starent would file an amended answer and counterclaim and the Company then responded to Starent’s

 

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amended counterclaim. In early December 2006, the Company filed a reissue application for the ‘473 patent with the United States Patent and Trademark Office. Starent has also filed for reexamination of the ‘473 patent. The reexamination and reissue are currently co-pending. The litigation is still in a preliminary stage, and is stayed pending the outcome of the reissue. The litigation and its outcome cannot be predicted, although management of the Company believes the litigation has merit. Nonetheless, management of the Company believes that any adverse judgment on Starent’s counterclaims will not have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.

 

On May 8, 2007, the Company filed an additional suit against Starent and sixteen individual defendants (who were all former employees of 3Com’s CommWorks division, of which the Company acquired certain assets in May of 2003) in the Northern District of Illinois. The causes of action include claims for patent infringement, misappropriation of trade secrets, intentional interference with business relations and prospective economic advantage and declarations of ownership of certain patent rights. The Company seeks compensatory damages, punitive damages and injunctive relief. After the court denied the defendant’s motion to dismiss the misappropriation of trade secrets claims, on August 30, 2007, Starent answered the Company’s complaint, denying the Company’s allegations and asserting a number of affirmative defenses and counterclaims. The Company has filed an Amended Complaint to allege additional related causes of action. Starent moved to dismiss certain causes of action of the Amended Complaint. The Court has appointed a special master to handle discovery and issues related to identification of the trade secrets. On May 30, 2008, the Company amended its complaint to remove from suit U.S. patent 6,978,128, and to add additional factual allegations relating to all defendants in the case. On July 23, 2008, the Court struck the Company’s trade secret and contract-based counts.  The Company is asking the Court to clarify that ruling and has simultaneously filed a motion for leave to file a Fourth Amended Complaint.  Discovery and motion practice is ongoing. The Company believes that any adverse judgment on Starent’s counterclaims will not have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.

 

Telemetrix, Inc. Arbitration

 

On October 19, 2006, Telemetrix, Inc. (“Telemetrix”) filed a formal Request for Arbitration against the Company to the World Intellectual Property Organization (“WIPO”) in Geneva, Switzerland. The Request for Arbitration sought unspecified damages arising from a contract between Telemetrix and Telos Technology, Inc., dated October 22, 2003. The Company assumed Telos’ rights and obligations under this contract pursuant to the Company’s purchase of Telos’ assets on May 19, 2004. Telemetrix alleged nine causes of action, including breach of contract, fraud, negligent misrepresentation, interference with contractual relations, and interference with prospective economic advantage. In December 2006, the Company filed a formal response to the Request for Arbitration, denying all material factual allegations asserted by Telemetrix. An arbitrator was selected by the parties, and, on August 2, 2007, the arbitrator granted a pleading motion in favor of the Company due to Telemetrix’s failure to allege sufficient facts in support of a majority of its causes of action. On August 17, 2007, Telemetrix filed an Amended Statement of Claim, alleging six causes of action, including breach of contract and fraud. Telemetrix seeks damages totaling approximately $750,000 plus costs and attorneys’ fees.  The evidentiary hearing occurred on July 28-30, 2008.  The matter has been submitted to the Arbitrator.

 

Other Litigation

 

The Company is a party to other litigation matters and claims that are normal in the course of operations, and while the results of such litigation matters and claims cannot be predicted with certainty, management of the Company believes that the final outcome of such matters will not have a material adverse impact on the Company’s financial position, results of operations or cash flows.

 

Uncertain Tax Positions

 

Effective January 1, 2007, the Company adopted the provisions of FIN 48.  As of June 30, 2008, the Company had $82.8 million of gross unrecognized tax benefits. If recognized, the portion of gross unrecognized tax benefits that would decrease the provision for income taxes and increase the Company’s net income is $9.1 million. The impact on net income reflects the gross unrecognized tax benefits net of certain deferred tax assets and the federal tax benefit of state income tax items totaling $73.7 million.

 

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Letters of credit

 

The Company issues standby letters of credit primarily to support international sales activities outside of China.  When the Company submits a bid for a sale, often the potential customer will require that the Company issue a bid bond or a standby letter of credit to demonstrate its commitment through the bid process.  In addition, the Company may be required to issue standby letters of credit as guarantees for advance customer payments upon contract signing or performance guarantees.  The standby letters of credit usually expire without being drawn by the beneficiary thereof.  Finally, the Company may issue commercial letters of credit in support of purchase commitments.  As of June 30, 2008 the Company had outstanding letters of credit approximating $59.3 million.

 

NOTE 15 - SEGMENT REPORTING

 

During the fourth quarter of 2007, the Company announced a new organization structure to align the business units with its corporate strategy. This new organization structure changed the reporting segments on which the Company measures performance and allocates resources. Effective October 1, 2007, the new reporting segments are as follows:

 

·                  Broadband Infrastructure—Focused on the Company’s world class portfolio of broadband products.

 

·                  Multimedia Communications—Focused on development and market opportunities in IPTV solutions and Wireless infrastructure technologies.

 

·                  Personal Communications Division (PCD)—Focused on distribution of mobile handsets, mainly in the United States.  On July 1, 2008 the Company sold PCD (See Note 22).

 

·                  Handsets—Focused on mobile phone business with continued focus on the PAS and CDMA handset market, as well as data cards markets.

 

·                  Services—Focused on providing services and support of our Broadband Infrastructure and Multimedia Communications product lines.

 

·                  Other—includes Mobile Solutions which focused on development, sales and services for the IPCDMA market; and Custom Solutions which focused on customized telecommunication solution.

 

The Company’s management makes financial decisions based on information it receives from its internal management system and currently evaluates the operating performance of and allocates resources to the reporting segments based on segment revenue and gross profit. Cost of sales and direct expenses in relation to production are assigned to the reporting segments.  The accounting policies used in measuring segment assets and operating performance are the same as those used at the consolidated level.

 

Summarized below are the Company’s segment net sales, gross profit and segment margin for the three and six months ended June 30, 2008 and 2007 based on the current reporting segment structure.  The Company has reclassified its previously reported segment information for the three and six months ended June 30, 2007 to conform to the current segment presentation.

 

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		Three months ended June 30,										Six months ended June 30,
		2008			% of net sales		2007			% of net sales		2008			% of net sales		2007			% of net sales
		(in thousands)
Net Sales by Segment
Broadband Infrastructure		$	35,888		6	%	$	38,237		7	%	$	61,479		5	%	$	64,781		6	%
Multimedia Communication		74,018			12	%	63,439			12	%	141,464			12	%	135,994			14	%
PCD		448,864			71	%	357,797			66	%	879,588			72	%	646,127			64	%
Handsets		49,461			8	%	62,177			12	%	93,484			8	%	131,896			13	%
Services		15,884			2	%	11,106			2	%	26,975			2	%	23,665			2	%
Other		8,641			1	%	5,489			1	%	15,755			1	%	11,683			1	%
		$	632,756		100	%	$	538,245		100	%	$	1,218,745		100	%	$	1,014,146		100	%

 

		Three months ended June 30,										Six months ended June 30,
		2008			Gross Profit %		2007			Gross Profit %		2008			Gross Profit %		2007			Gross Profit %
		(in thousands)
Gross profit by Segment
Broadband Infrastructure		$	1,669		5	%	$	10,105		26	%	$	3,890		6	%	$	14,314		22	%
Multimedia Communication		28,818			39	%	27,616			44	%	61,974			44	%	50,410			37	%
PCD		36,169			8	%	15,922			4	%	69,005			8	%	32,767			5	%
Handsets		6,781			14	%	22,396			36	%	22,996			25	%	47,443			36	%
Services		4,794			30	%	98			1	%	7,113			26	%	730			3	%
Other		3,717			43	%	3,593			65	%	9,049			57	%	9,350			80	%
		$	81,948		13	%	$	79,730		15	%	$	174,027		14	%	$	155,014		15	%

 

		Three months ended June 30,						Six months ended June 30,
		2008			2007			2008			2007
		(in thousands)
Segment Margin and Operating Loss
Broadband Infrastructure		$	(4,715	)	$	2,832		$	(8,941	)	$	(1,407	)
Multimedia Communication		16,262			9,540			32,457			14,883
PCD		28,612			7,873			53,576			16,079
Handsets		(6,443		)	9,138			(5,422		)	22,902
Services		3,849			(1,036		)	4,795			(1,257		)
Other		(6,185		)	(5,347		)	(10,343		)	(8,999		)
Total segment margin		31,380			23,000			66,122			42,201
General and Corporate		(62,458		)	(78,339		)	(128,089		)	(149,799		)
Operating Loss		$	(31,078	)	$	(55,339	)	$	(61,967	)	$	(107,598	)

 

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