UTSI

Operator

Good afternoon. At this time I would like to welcome everyone to the UTStarcom first quarter 2006 earnings conference call. (Operator Instructions) At this time I would like to turn the call over to Fran Barton, CFO. Thank you, you may begin. Fran Barton: Thank you, Jamie. Good afternoon and thank you for joining UTStarcom's first quarter 2006 earnings conference call. I'm Fran Barton, UTStarcom's CFO, and I'm pleased to host today's call with our CEO, Hong Lu. I'd like to remind everyone that some of the information we'll discuss today constitutes forward-looking statements. Actual results could differ materially from our current expectations. To understand the risks that could cause results to differ, please refer to the risk factors identified in our latest annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, which are filed with the Securities and Exchange Commission. With that, I'll turn the call over to Hong.

Hong Lu

Thank you, Fran. Thank you, everybody for joining us this afternoon. Let me begin by providing a brief summary of our first quarter financial results. UTStarcom had a solid first quarter, exceeding guidance on a number of our key metrics. Our total revenue for the quarter was $597 million, which came in above our guidance range of $505 million to $535 million. Our loss per share was also favorable to guidance and came in at $0.09 loss, compared to guidance of a loss of $0.65 to $0.75 loss. We also generated positive cash flow from operations of approximately $54 million as compared to previously expected breakeven. Our strong first quarter performance is attributed to the higher-than-anticipated sales from our PCD and PAS handset divisions, as well as improved gross margin across all the business units. Fran will give more detail on first quarter results and the business units update later on in the call. From an operations perspective, I also believe we have a solid first quarter. During the quarter, we continued building presence in our strategic target markets. Let me quickly run through our target list of addressable markets which consist of ongoing business and future growth drivers. The ongoing business category includes: Our future growth drivers includes: The transition we are making to our future growth drivers is evidenced by recent contract wins in IPTV, NGN and FMC in multiple regions globally. Some examples of these wins includes the recent announcement of our first FMC trial with Brazil Telecom. In addition, we have also recently won a contract with a PODT in the Philippines to build out their next generation network. This is the first win for UTStarcom in their country, and in which we beat out major incumbent suppliers. Finally, I am especially pleased by our recent announcement of the two large-scale IPTV deployments in China with China Telecom and China Netcom; and our announcement this week of the partnership with the Kapsch CarrierCom to bring IPTV to Central and Eastern Europe. We remain committed to our strategy of a targeted diversification and expected to announce more execution milestones through 2006. Internally we made further progress in building out the Company's infrastructure. This initiative is crucial for UTStarcom. I believe that further success requires solid, efficient infrastructure. We accomplished a lot on this front in 2005 and made additional steps in Q1 2006. This includes the completion of our global order management systems, which are designed to automate our finance, supply chain and sales operation processes. Improvements to the supply chain includes a continued reduction in the number of suppliers, as well as improvement to current parts policies, all with the aim of increasing efficiency and improved gross margin. Going forward, infrastructure enhancement will remain a top priority for UTStarcom. Now let me address the leadership transition. As most of you know, last month I announced my decision to step down as Chairman and CEO of UTStarcom as of December 31 , 2006. This was a hard decision to make. For over ten years, I have been fortunate to work with a great team of the people at UTStarcom and saw the business grow into a multi-billion dollar company. I believe that now is the right time for me to pass the Company's leadership to a new management team that can take UTStarcom to the next level. Ying Wu, COO of China, will assume the CEO position beginning January 2007. Ying has been with the Company since the inception of UTStarcom. He possesses an adept understanding of the telecom markets and strong leadership skills. I will remain CEO through the end of the year and will serve as an advisor to the Company thereafter. We have also initiated a search for the chief operating officers who will be responsible for overseeing UTStarcom's worldwide operations. Additional steps to increase the depth of our senior management team include two important hires in the first quarter, which were Senior VP of the sales and marketing, David King; and the Chief Information Officer, Ari Bose. Let me finish by saying that I remain a great believer in UTStarcom and think the Company has a strong growth potential despite the short-term challenges that it has experienced over the past year. I look forward to the Company's continued positive momentum and the return to growth and profitability. I believe that the best is still yet to come for UTStarcom and now I will turn the call over to Fran, who will provide more detail on the operation and financial performance in Q1. Fran Barton: Thank you, Hong. Now, let me go over the performance of our business units in greater detail. PCD. The personal communications division had a strong quarter, generating $323 million in revenues, driven by stronger than anticipated shipments of our high-end 6700 series PDA phones to Verizon and Sprint. Total PCD shipments for the quarter were 1.65 million units, with an ASP of $182. Shipments of UT-manufactured handsets also continued to ramp in the quarter. In Q1 we sold more than 250,000 UTStarcom manufactured units, as compared to about 200,000 units for the full year of 2005. During the quarter, UTStarcom introduced two new internally designed models: the CDM 7025, which we began shipping to Sprint; and the CDM 7075. I believe that PCD is on its way in replacing Curitel with our own handsets and those of our suppliers such as Sharp, HTC, Casio, KTFT and others. However, I will remind you that the transition process is still expected to affect this year's sales, especially in the second quarter, when we expect sales to be down slightly relative to our stronger than anticipated Q1 levels. PAS. Now let me give you a quick update on our PAS business. In Q1, approximately 3.2 million, or 75%, of the 4.2 million PAS subscriber additions in the quarter were on UTStarcom's PAS networks throughout China. This brings the cumulative number of PAS subscribers on UTStarcom's networks to 50.6 million. Total cumulative PAS subscribers in China reached 89.5 million in the first quarter. During the quarter, UTStarcom shipped 2.4 million handsets with an ASP of $58. Approximately 70% of shipped handsets included the new ASIC from UTStarcom and Atheros, thus reducing overall handset costs. In Q1 we also introduced four new handset models. Our PAS handset market share remains stable at 50%. We continue to believe that spending for PAS in China will decline over the next several years, with the current expectation that it could be down as much as 10% to 15% in 2006 versus 2005. We will continue to give you updates on this outlook as we receive more data. Outside of China, we announced the launch of an IPAS network by Telefonica del Sur in Chile in the quarter. del Sur will deploy our IPAS wireless telephony solution to expand their next generation voice and data services. In our other wireless businesses, we continue to build momentum for our moving media 2000 IP CDMA technology, showcasing the industry's first live video transmission using EVDO RevA at the CTIA wireless show in Las Vegas. We also announced our partnership with Qualcomm to offer our mobile CDMA communications solutions for emergency, first response, and defense applications in the U.S. In another of our strategic growth markets, fixed mobile convergence, UTStarcom announced a joint development, licensing and supply agreement with ARIS. Under this agreement we will license our fixed mobile software and supply the hardware to ARIS for its solution targeting cable companies. The ARIS FMC solution allows customers with a Wi-Fi enabled handset to seamlessly roam between their cellular and Wi-Fi connections. We also announced our first major FMC trial with Brazil Telecom, a tier one carrier offering both fixed line and wireless services to over 12 million subscribers in Brazil. We believe these are all meaningful first steps in building our leadership in the burgeoning fixed mobile convergence market. Turning to our broadband business. During the quarter, UTStarcom reached a milestone of 1 million DSLAM ports deployed in Europe, spanning France, Italy, Benelux, Austria and the Czech Republic. Another important milestone for us was the announcement of two major deployments in IPTV, which is a key strategic market for UTStarcom. In February we won a contract with China Telecom to deploy our end-to-end IPTV solutions in two cities in Fujian Province. China Telecom is targeting 50,000 IPTV users in the City of Fuzhou and 80,000 users in the Quanzhou by the end of 2006. In April, we announced the deployment of IPTV in Harbin Province for China Netcom. This deal represents the single largest commercial IPTV deployment in China to date. According to our data, there are currently approximately 90,000 commercial IPTV subscribers in China, of which about 81,000 are on UTStarcom's networks. A final note on IPTV. On Tuesday, we announced our partnership with Kapsch CarrierCom to bring our IPTV solutions to Central and Eastern Europe. Kapsch CarrierCom has more than 20 years of providing fixed, mobile and data networks in such countries as Austria, Hungary and the Czech Republic, among others. This represents our first move into the Central and Eastern European regions. In addition to IPTV, we've also continued to sign new customers and new regions for our broadband access equipment. As Hong mentioned, we began a deployment of our iANA 8000 NGN equipment with PLDT, the leading carrier in the Philippines, offering both fixed and wireless solutions. Using our equipment, PLDT is offering voice and DSL to both their consumer and enterprise customers. This is our first contract in the Philippines, and there are currently approximately 10,000 subscribers in the network. As you can see, we had a number of important contract wins since our last conference call, and we expect that revenues associated with these wins will ramp throughout this and the coming years, supporting our revenue diversification initiative. Now, let me turn to the financials. As Hong mentioned, we exceeded our guidance for the first quarter with sales of $597 million. This was driven primarily by stronger than anticipated revenues in our PCD and PAS handset segments during the quarter. By business segment, PCD division sales were $323 million in the quarter, which exceeded our expectations by over $45 million. This upside was driven by higher than anticipated PDA sales in the U.S. Sales for the non-PCD handset business were approximately $99 million, which exceeded our guidance by approximately $20 million, as previous component shortages were resolved. Wireless infrastructure sales were approximately $100 million, which were in line with the guidance given for the quarter. Sales for the broadband business were approximately $57 million in the quarter, which were in line with guidance and included order cancellation fees of approximately $22 million from two customers in Japan. Finally, our services revenues were approximately $17 million in the quarter, slightly below our guidance for the quarter. By geography, sales in China represented approximately 33% of total sales in the first quarter. Gross margins also exceeded expectations in the first quarter, with total gross margins of 20.5% of sales. This compares favorably to margin guidance of 14% to 16%. While we saw improvements to gross margins across business segments, the primary driver of our higher gross margins in the first quarter were the $22 million order cancellation fees received from two customers in Japan. This brought our overall gross margins in the broadband business to 40% for the quarter. For the remainder of our segments, gross margin for the first quarter came in as follows: Total operating expenses for the first quarter were $134 million, which reflects some pick-ups such as lower than anticipated stock compensation expenses of $4 million and the reversal of some deferred compensation expenses associated with the divestiture. These were offset by an asset impairment of approximately $4.7 million associated with the writedown of our joint venture assets in Mongolia. SG&A expenses, inclusive of stock compensation, were approximately $83 million or 14% of sales in the quarter. This number includes approximately $4 million in incremental legal and audit expenses related to the audit committee investigation, which was concluded last month. This also included the $4.7 million Mongolia asset impairment mentioned above. R&D expenses were approximately $46 million or 8% of sales in the quarter. Net interest and other income for the first quarter was income of approximately $4 million, primarily reflecting a gain of approximately $3 million on foreign exchange. Income tax expense was $2.8 million for the quarter, which reflects our taxable profits in certain jurisdictions. Our total net loss for the first quarter was $10.6 million or a $0.09 per share loss, as compared to guidance of a loss of $0.65 to $0.75 per share. Transitioning the discussion to the balance sheet now, I'm once again pleased with our balance sheet performance, as we show continued improvements to such items as cash, accounts receivable, and short-term debt. As of March 31, our cash and short-term investments totaled $684 million, an increase of approximately $26 million from December 31, 2005. Our accounts receivable balance at the end of March was approximately $495 million, which represents a reduction of approximately $28 million from Q4 levels. This is the result of continued strong collections of over $700 million during the quarter. Our DSO was 75 days, which compares to 70 days in the fourth quarter, and is reflective of higher than anticipated revenues during this quarter. Our inventory levels remained relatively flat in the first quarter and came in at approximately $671 million. Given our strong collections and the reduction in receivables, we achieved approximately $54 million of positive cash flow from operations in the first quarter. This exceeded our expectation of breakeven cash flow for the quarter, and marked the fourth quarter in a row we've generated positive cash flow from operations. We will continue to focus on reductions and overall AR and inventory levels over the coming quarters. Our total short-term debt balance at the end of the first quarter was approximately $172 million. During this quarter we repaid approximately $27 million in short-term debt. We continue to have lines of credit totaling approximately $800 million globally, with various maturity dates over the next 12 months. As these lines become due, we expect to renew them as we have done historically. Before I give guidance for Q2, I'd like to quickly discuss the recent conclusion of the audit committee investigation. As you know, last month we concluded our audit committee investigation. As a result, the Company has restated its revenues and earnings for the fiscal years 2003 and 2004, and for the first three quarters of 2005. The aggregate impact of the restatements is a $49.5 million reduction in revenues and an $11.9 million reduction in net income. Subsequent to completing the investigation, UTStarcom filed its 10-K report for the fiscal year 2005. We expect to file our 10-Q for the first quarter of 2006 by the 22nd of June, which is tomorrow. This will bring us back into full compliance with the SEC reporting requirements and the NASDAQ listing requirements. Now, on to guidance. I'd like to begin by giving you my thoughts on the full year 2006. As discussed on the Q4 call, we continue to expect that 2006 will be a year of transition for UTStarcom. We believe that revenues in 2006 could be down by as much as 10% to 15% from 2005 levels. In addition, we believe that we will have a net loss for the year. We expect to demonstrate positive cash flows from operations for both the first half and the full year of 2006, but, of course, this could fluctuate on an individual quarterly basis. From a quarterly perspective, as Q1 came in significantly above our expectations across the board, we believe that Q2 will be down slightly; however, we do continue to believe that you should see gradual improvements to revenues and profitability each quarter thereafter. We continue to work towards returning to profitability and expect it to happen by the first half of 2007. In terms of guidance for Q2, for the second quarter of 2006, revenue should be approximately $545 million to $575 million. By segment, revenues should be as follows: Moving on to backlog, in the first quarter our book-to-bill ratio was just above one, which represents backlog of over $1 billion at the end of the first quarter. Gross margins. In Q2, consolidated gross margins should be approximately 15% to 17%. By business unit, gross margins should be as follows: Operating expenses should be in the low $140 million range, and will include approximately $4 million in expense associated with stock compensation. Our Q2 tax expense should be approximately $3 million. On the bottom line, our GAAP EPS guidance for Q2 is a loss of approximately $0.45 to $0.55. We're not currently planning any impairment or restructuring charges or other one-time events in the second quarter. With respect to cash flows in the second quarter, given our strong collections in the first quarter, coupled with our expected loss in the second quarter, we're targeting cash flow from operations to be approximately breakeven to slightly negative; but, again, we do expect to have positive cash flow for both the first half and full year of 2006. In summary, we're still progressing through the transition process that we shared with you at the beginning of the year. Despite the fact that the PAS market is declining, we are improving gross margins for PAS even faster than we had anticipated, making it a more profitable business. With respect to PCD, although challenges still exist, we are expanding PCD's footprint into new regions and with new UTStarcom designed product. Although our new businesses can't instantly solve our revenue problem, we are continuing to grow the international businesses with exciting new products such as IPTV, IP CDMA and fixed mobile convergence. These solutions, plus our broadband access products, will be our driver of future growth. In addition, we will continue to reduce operating expenses over the next several quarters, even while investing in the future. Despite our short-term losses, we have a net cash position of over $235 million greater than our debt. Although it will take time, we are adding the management talent and business processes necessary to run a growing and profitable Company. In short, we know what we're facing and we're taking the necessary steps to be successful. We've overcome a lot of adversity recently and I believe that that has made us a much stronger organization. We have many reasons to be optimistic about our future. With that, I'd like to turn the call over to question and answers.

Operator

(Operator Instructions) Your first question comes from Mike Ounjian - Credit Suisse.

Mike Ounjian

Thank you. Hong, could you talk a little bit about the timing of some of these IPTV deployments? How quickly should we expect them to rollout, in particular the two in China that you walked through and the one in Central Europe? Fran, any color you can give us on the mechanics around recognizing revenue on these deployments?

Hong Lu

Hi, Mike. Regarding the IPTV in China, we have been operational since the latter part of last year, and we also are getting some pay customers, so we feel comfortable that commercial trial is going to open up more cities. There are only two authorized cities in China. One is in Harbin, which is operated China Netcom, and the other one is in Shanghai, operated by China Telecom. We are the major supplier in Shanghai. We had split that originally with Siemens and in the second half, we were just awarded by them again and another one was shared by BTE. So those are the two official ones but we do have a contract that we had signed and I am expecting that official license will be given. Those are things we are expecting for the second half, more activity, and we hope we will start making more positive announcements on those. And then the European, as well as the others, we have a good approach in India, which we made an announcement in Bharat, so that is a pay trial. We also have the pay trial in Brazil, and I don't think we can announce the name yet but we have one major carrier in Brazil that had also given us the pay trial, as well. So, I'm more confident that our product has been sustained going through our commercialization, and we are competing against many, many other major companies. So far we feel very good about our competition and relating to our stability of the products. So I hope more activity will come in the second half of the year from business perspectives. Fran Barton: Yes, Mike, the mechanics vary from time to time, but generally the mechanics would be similar to other infrastructure sales mechanics. So, if you'll recall, the order we sold last year in Japan, we sold the carrier all our infrastructure products, but it took a couple of quarters to rollout because of first time installation, its a new application and new testing and so fourth. There's probably a good -- oh, pick a number -- six-month lag or something, could even be a nine-month lag, possibly, in a new country first time around. Over time, that should shorten up a little bit, but there'll always be some sort of lag. I can take you through more detail offline, but that's the short answer.

Mike Ounjian

Okay, that's helpful. In terms of your comments on the full year outlook, sort of a 10% to 15% revenue decline, if I'm recalling correctly, the last time you'd made comments along those lines it was more of a 5% to 10% decline. It appears the first half, I mean, the Q1 numbers obviously stronger than your guidance; with Q2 down maybe collectively, it appears the first half id at least in line with what you're expecting. So is the more cautious comment here on the second half really coming from timing issues, or is there something you're seeing in terms of market dynamics that's getting you to be a bit more cautious? Fran Barton: Okay, yes, good question and good memory, too, yes. We had been talking in the 5% up to 10% we had said before, and now we're saying possibly a little over 10%. There's probably two small dynamics. One has to do with PCD in the short-term, which is just a lifting-off in this difficult market, transitioning, again, from Curitel to us. Although, as you said, Q1 was very good , Q2 they're going to probably have a smaller revenue number than Q1. The first half will be a good number, nevertheless, so we're generally optimistic there. The second area that we also need to be cautious is probably in China with the PAS handset business that the handsets are coming under a lot of pressure from the mobile suppliers, and we'll have to ensure that our customers, China Netcom and China Telecom, continue to be aggressive in that market. So we're just being a little bit cautious probably with those two particular areas, and everything else is pretty much as we had thought it would be.

Mike Ounjian

I just had a few housekeeping questions. First to make sure I heard it right, could you remind me again what the mix of business in China was in Q1? Fran Barton: Well, I didn't say what the mix of business was.

Mike Ounjian

Oh, okay. Did you give a comment on geographic mix for the quarter? Fran Barton: I said that China as a percent of corporate total was 33%.

Mike Ounjian

Yes, that's what I meant. Okay, 33%. I'm sorry I didn't phrase that well. And then as I'm thinking about the wire line margins for Q1, is it fair just to back out the order cancellation fee for the full $22 million from the revenue and the gross profit and think about the adjusted number as under 3% for the rest of the business? Or is there something else I should do there? Fran Barton: Well, two things. One is the math. It's probably closer to 10% when all is said and done. It would probably cost about three margin points on a corporate level, but the broadband business unit itself will drop from 40% to about 10%, just rough numbers. The complexity of that particular thing is that that was some business that customers had basically over-ordered for, but since they ordered, we ended up completing the contract. So it's business that we would have had in another time, maybe with a different set of margins. But the math you mentioned is correct, Mike, if that answered your question.

Mike Ounjian

Okay. The last question was on the PAS handset margins and just how we should think about those. I mean, it sounded like there was a lot of the improvement with the new ASIC and inventory management, but it's going to be down sequentially in Q2. I guess what's the reason for that? Fran Barton: Yes. I think what'll happen we've got a big one-time catch up on cost as the market, the prices have continually declined almost linearly over time. I think the price declines will continue into Q2, Q3 and Q4. The cost improvements will not match the pace of that, at least from a planning perspective for the next quarter, so we'll have a small erosion, but it'll still be good margins.

Hong Lu

Maybe I can add a little color for that. Buying from Atheros and our own design, but then consequently, we have sold that business to Marvell. Our exclusivity are about ready to expire, but those are the ones that we also have added to the formula. On top of it, we have a continuation from the other Company 's competition. They have inventory and so fourth, so they are trying to get rid of the inventory. I would see that more people would be aggressively approached in the market and, therefore, that's also caused some of the decline in our margin too.

Mike Ounjian

Got it. Well thank you very much. Fran Barton: Thanks, Mike.

Operator

Our next question comes from Jeff Kvaal - Lehman Brothers.

Jeff Kvaal

Thanks very much. My first question is on PCD. It sounds as though we should be expecting a fairly sizeable drop off in revenues next quarter. If it's only going to be half of revenues, then somewhere in the zone of -- well, a fairly sizeable drop off. Is that a fair statement and could you go into why that is? Fran Barton: Well, I think what we said was that they would be 50% of our range of 545-575, and I think we also said that they would have a drop off. The reason that I eluded to earlier Jeff, was the fact that in this transition period as Curitel is ramping down and we're ramping up, the two lines are sort of crossing and there's a blip in there that they're not matching one for one. There's a second factor, actually, which is a market factor that this razor product that has been coming out has been really hot for the past maybe month or so, so we're also trying to be cautious on that. Every so often, something that looks good catches fire, catches the imagination. So we're keeping an eye on that, as well. Ultimately it'll be measured on its performance, not on its looks, but right now its got a lot of attention in the market.

Hong Lu

So, Jeff, I think when you say that 50%, I think your math doesn't work if it's at 230.

Jeff Kvaal

No, no, no, you're right. It's 320 this quarter, right, and then -- Fran Barton: So it's going to be down. And then next quarter.

Hong Lu

That is as you have earlier mentioned, so about that range is what we expecting.

Jeff Kvaal

Okay, alright. One might expect if your supply arrangements are coming together that they would come together in a fairly smooth pattern; and that you wouldn't necessarily have a surge in availability and demand for phones in one quarter and then sequentially lower in another. Is there something that I'm misunderstanding here about that migration?

Hong Lu

Yes. I think the migration is definitely -- some of them it could be prevented and some of them it's harder to prevent. In our second quarter, we do have a very high demand for UTStarcom's product but, unfortunately, our supply chain -- because of our new demand that it's very difficult for us to catch up to buy all of those right components in time. Just relatively speaking, it's a very big ramp for any company to start out with the size and number of shipments that we are expected to do. That has actually reduced some of the revenue in Q2. Another part is the approval process, particularly with the Sidekick product that has been delayed in the latter part of Q2, so we missed out a bigger opportunity. So those two have negatively impact our PCD sales, so otherwise it would be probably coming in very close to what originally we had planned. Fran Barton: And as Mike had just pointed out, remember we did go $45 million over PCD in Q1, so we did have an over the top and a little bit under, and you're right. You'd think it would be smoother. It doesn't seem to work out that way.

Jeff Kvaal

Okay. Secondly, Fran, I'm wondering if you could give us some thoughts on the trajectory of OpEx into the second half of this year? Or if not, the trajectory, at least some of the moving parts. That would be kind of you. Thank you. Fran Barton: Sure, sure. Thanks, Jeff. Well, the trajectory is to be down, so we would like to see Q3 below Q2 and Q4 below that. So we can't say for sure what -- we're not going to be into guiding a couple quarters out right now, but the answer to your question, the trajectory will be down. The OpEx will not be growing. It'll be declining.

Jeff Kvaal

Okay, fantastic. Thank you very much. Fran Barton: Okay.

Operator

Your next question comes from the line of Larry Harris - Oppenheimer.

Larry Harris

Yes, thank you. I just wanted to get a better handle here with respect to Marvell. Was there a gain recorded in this quarter on the Marvell transaction? Fran Barton: No. Because of the nature of the contract, there's a number of performance criteria and supply agreements and so forth attached, Larry, so as they play out and milestones are met and so forth, those gains will show up in future time periods.

Larry Harris

With respect to the product roadmap, because T-mobile has announced the Sidekick, could we see it in the third quarter maybe benefiting your results? Also, any updates on the 7075? Is it approved to any carriers yet? And the Casio water-resistant model?

Hong Lu

Now first the Sidekick, we have already started shipping; although we were expecting the earlier part of Q2, but it went into the second half of Q2. Therefore, it didn't benefit our Q2 results. But in Q3, we are expecting a good benefit. Particularly, we see the new model is very, very slick and much more attractive than the previous model and therefore, I think it will benefit us in the second half of the year. Regarding 7075, we have not yet received any approval from any carrier at this moment yet, but we are aggressively working to get approval, so we'll be benefiting in the second half.

Larry Harris

Understood. And the Casio water-resistant model?

Hong Lu

That one, we already have the orders in. We just need to be able to deliver, and I think that is our plan is in the second half of the year.

Larry Harris

Understood. Okay, thank you.

Hong Lu

Sure. Fran Barton: If there's anymore questions we'll take them. If not we'll close down.

Operator

Your next question comes from the line of Bill Choi - Jefferies.

Bill Choi

Okay, thank you. Hi, guys. On the wireless infrastructure, can you break that down between PAS and the non-PAS part? Fran Barton: The shortest answer is it's something like 90% PAS, so for all intents and purposes, it's nearly all PAS, and the rest of the stuff isn't all that meaningful. I can take you off line through it if you need, but it's predominantly PAS.

Bill Choi

Now, you guys were kind enough to give the overall PAS numbers for China, and recent reports are that there's been actual PAS subscriber declines in certain markets due to aggressive pricing from the mobile. Can you give some level of update on the overall PAS market as we look into Q2, at the end of Q2?

Hong Lu

Yes. Typically in China, they have a very heavy promotion during the Telecom Day, which was normally on May 17th. And this year, we see a lot of aggressive promotion from both China Mobile and China Unicom. Our fixed-line operator has been a little shy to put the same promotion during the same period of time. So, they're shifting that off a little bit. We still remain to see, the new subscriber from China Telecom and China Netcom's fixed line operators are heavily depending on our PAS, so it still recorded about 50% of their total new subscriber is due to PAS, as well as their total revenue income are coming in -- roughly 25% of the total income is due to the PAS. So it is still one of their major revenue sources. So I think that the Q2 was a disappointing number to all of us, but I think now we do plan to ramp it up in the second half of the year. Then just for information, normally Q3 is the slowest period in entire China, and that will start ramping up in the Q4. So I think Q4, we expect it to be a very good quarter for us.

Bill Choi

Any guess whether it will be actually able to hit $95 million to $100 million for the entire PAS market for the full year?

Hong Lu

Yes, I think it's a very strong -- well, I'm very optimistic about hitting $95 million, and north of the $95 million doesn't seems to be the issue. The first quarter we have over $4 million new subscribers, and that is about $90 million right there. So I think that no matter how we're looking at it, to have the three quarters do 5 million is very, very simple to me to achieve; there is very high probability we'll be seeing even an additional 10 million.

Bill Choi

Okay, one final question. On the services, gross margins were 23%, and based on your restatements, it was running in the high 40's, if not into the 50s -- and in one quarter, even into the 60s. Can you talk about gross margins in the services and what changed this year? Fran Barton: Yes. Roughly it's a classification difference. The profitability of the services are at their historical levels. We're just taking a sharper pencil as to what is cost of goods versus what is SG&A, so I wouldn't put a lot into that, Bill. Okay. Thanks.

Operator

Gentlemen, there are no further questions at this time. Are there any closing remarks? Fran Barton: No, I just want to thank everybody for attending, and we'll announce our next earnings call publicly. Thank you all for your attention and have a good day.

Operator

Ladies and gentlemen, today's conference will be available for replay today at 5:30 p.m. Eastern Standard Time through June 28, 2006 at midnight. To listen to the replay, please dial 1-800-642-1687; or internationally, 706-645-9291. Thank you. This concludes today's conference. You may now disconnect.