-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AlrHAJaIJzCO0hUUQ2OD2gEL5I5SbaRLz6mHZvoH4dm2IJGuLwSlwXvN1mzkwyXa i6jVJOvaw4OLg/K1NzX1Wg== 0000891554-02-001638.txt : 20020415 0000891554-02-001638.hdr.sgml : 20020415 ACCESSION NUMBER: 0000891554-02-001638 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TEKELEC CENTRAL INDEX KEY: 0000790705 STANDARD INDUSTRIAL CLASSIFICATION: RADIO & TV BROADCASTING & COMMUNICATIONS EQUIPMENT [3663] IRS NUMBER: 952746131 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-15135 FILM NUMBER: 02592672 BUSINESS ADDRESS: STREET 1: 26580 W AGOURA RD CITY: CALABASAS STATE: CA ZIP: 91302 BUSINESS PHONE: 8188805656 MAIL ADDRESS: STREET 1: 26580 W AGOURA RD CITY: CALABASAS STATE: CA ZIP: 91302 10-K 1 d50056_10-k.txt FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 Commission file number 0-15135 TEKELEC (Exact name of registrant as specified in its charter) California 95-2746131 (State or other jurisdiction of (I.R.S.Employer incorporation or organization) Identification Number) 26580 West Agoura Road, Calabasas, California 91302 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (818) 880-5656 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, without par value 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 [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the last reported sale price of the Common Stock on March 1, 2002 as reported on The Nasdaq Stock Market, was approximately $564,582,428. The number of shares outstanding of the registrant's Common Stock on March 1, 2002 was 60,154,372. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive Proxy Statement to be delivered to shareholders in connection with their Annual Meeting of Shareholders to be held on May 10, 2002 are incorporated by reference into Part III of this Annual Report. TEKELEC INDEX TO ANNUAL REPORT ON FORM 10-K For the fiscal year ended December 31, 2001 Page ---- PART I Item 1. Business........................................................... 3 Item 2. Properties......................................................... 32 Item 3. Legal Proceedings.................................................. 32 Item 4. Submission of Matters to a Vote of Security Holders................ 33 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................................................ 34 Item 6. Selected Consolidated Financial Data............................... 35 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................... 35 Item 7A. Quantitative and Qualitative Disclosures about Market Risk......... 48 Item 8. Financial Statements and Supplementary Data........................ 48 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........................................... 48 PART III Item 10. Directors and Executive Officers of the Registrant................. 48 Item 11. Executive Compensation............................................. 49 Item 12. Security Ownership of Certain Beneficial Owners and Management..... 49 Item 13. Certain Relationships and Related Transactions..................... 49 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K... 50 2 PART I Item 1. BUSINESS Overview Tekelec (the "Company") designs, manufactures, markets and supports network systems products, diagnostics systems and selected service applications for telecommunications networks and contact centers. The Company's customers include telecommunications carriers, network service providers, equipment manufacturers and contact center operators. The Company's network systems products help direct and control voice and data communications. They enable carriers to control, establish and terminate calls. They also enable carriers to offer intelligent services, which include any services other than the call or data transmission itself. Examples include familiar products such as call waiting, caller ID, voice messaging, toll free calls (e.g., "800" calls), prepaid calling cards, text messaging and local number portability. Some of the Company's network systems products also allow the monitoring and surveillance of network elements while the network is in operation and deliver revenue assurance features such as fraud protection. The Company believes that voice and data networks will increasingly interoperate, or converge. Network convergence should provide opportunities for the Company to expand sales of its network systems products and service applications, several of which are designed specifically for converged networks. The Company's diagnostics products simulate a controlled network environment, which allows telecommunications equipment manufacturers, and to a lesser extent, carriers, to test products to ensure that products conform to specifications and to evaluate network performance without risking the failure or outage of an in-service network. The Company's contact center products provide workforce management and intelligent call routing systems for single and multiple site contact centers. The Company sells its contact center products primarily to customers in industries with significant contact center operations such as financial services, telecommunications and retail. Industry Background Usage of communications networks has expanded rapidly in recent years. Driving this trend has been the growth in demand for data communications and wireless connectivity, deregulation and the emergence of new competitors, services and technologies. Growth in data traffic has been most visibly driven by the increase in the number of businesses and consumers that use the Internet. According to International Data Corp., an independent market research firm, the number of people accessing the Internet was approximately 142 million in 1998 and is expected to grow to 502 million by 2003. The number of wireless subscribers has also grown rapidly in recent years, doubling from 1998 levels to 650 million subscribers worldwide in 2000, according to Dataquest. 3 The increase in data traffic, combined with the inherent efficiency of packet switched networks, have led many carriers to build new packet networks and to seek ways to enable existing circuit switched networks to interface reliably and efficiently with these new packet switched networks. Deregulation has played a key role in the emergence of new competitive service providers in recent years. In addition, technological developments such as DSL, cable modems and broadband wireless have enabled alternative access technologies and fostered new types of service providers. As competition has grown in recent years, per-minute revenue from basic telephony service has declined significantly. As a result, intelligent services have become core competitive features of a network, providing incremental revenues to service providers and offering more service choices to subscribers. As these services have become less expensive and more widely accessible, customer demand for them has grown. Deregulation has also spurred the offering of intelligent services. The Telecommunications Act of 1996 mandates that subscribers of U.S. telephone service be given the option of changing their local service provider while retaining their local phone number. Several European and Asian countries have also recently adopted or are considering adopting similar number portability requirements to allow subscribers to retain their telephone numbers while changing service providers. Current FCC regulations require that wireless customers in the U.S. be offered this same option in November 2002. Recent Changes in Telecommunications Operating Environment Throughout the late 1990's, capital investment in telecommunications equipment grew rapidly before experiencing moderating growth in the second half of 2000. In 2001, telecom capital investment declined for the first time in several years as telecommunications industry fundamentals deteriorated. The industry's growth prior to the second half of 2000 was driven principally by significant capital investment by new types of service providers, such as competitive local exchange carriers (CLECs) formed after industry deregulation, and by substantial growth in capital spending from wireless operators to support the expansion of mobile networks. In addition, capital investment from incumbent carriers, such as Regional Bell Operating Companies (RBOCs), increased in response to the new threat of competition from CLECs and other new entrants. Adding to the favorable environment for telecom capital investment prior to mid-2000, capital markets were extremely active and institutional investors were willing to fund many new and established telecommunications service providers alike. The healthy capital markets and favorable valuations for telecommunications service providers led carriers to re-invest higher than normal percentages of their revenue into capital equipment purchases because new capital was perceived to be readily available. Beginning in 2000 and increasingly in 2001, capital available from equity markets declined significantly and the emerging competitive carriers began to experience difficulty attracting new funding. In many cases, the emerging carriers had accumulated considerable debt loads that required new capital to service their interest payments. In addition, economic weakness, particularly in the US, also impacted the market for telecommunications services, and particularly impacted the competitive carriers, many of which had been targeting businesses. As a result of these trends, competitive carriers have sharply reduced their capital spending, and several have filed for bankruptcy protection as a means to restructure their debt obligations. In 4 addition, while the capital spending by wireless service providers continued to increase in 2001 given the continuing rapid growth of their businesses, capital investment by incumbent carriers declined in 2001 in part due to the reduced threat from competitive carriers. Across all carrier types, the limited availability in the capital markets and reduced valuations in the equity markets, has created a new focus on operating measures such as cash flow, which has led service providers to conserve cash and reduce capital investment whenever possible. While future capital spending trends are difficult to predict, industry analysts expect capital spending on telecommunications equipment to decline in 2002 from 2001 levels across virtually every type of service provider segment; however capital spending on wireless equipment is expected to outperform other communications sectors, on a relative basis, due to expectations for increased traffic on mobile networks. Challenges Service Providers Face To compete in today's competitive environment, service providers are seeking to differentiate their products and services while lowering their costs. This has increased demand for technologies that enable the rapid creation and delivery of innovative services on existing and converged networks. Some of the key challenges that service providers face in expanding their network systems include: o expanding and/or upgrading their signaling network systems to support new and enhanced services, and rapidly-growing volumes of signaling traffic, particularly on signaling-intensive wireless networks which generate several times the amount of signaling traffic as wireline networks; o building and managing networks that can cost-effectively support circuit and packet network convergence; and o testing new network elements and monitoring increasingly complex networks. Similarly, telecommunications equipment manufacturers and network operators need advanced and flexible ways to test and monitor equipment in existing and converged networks in a cost efficient manner. Signaling and Intelligent Services Traditional voice telephone networks consist of two basic elements -- switching and signaling. The switching portion of a network carries and routes the actual voice or data comprising a "call." The signaling portion of a network instructs the switching portion how to do its job. Signaling messages are carried on a different logical transmission path than the actual call itself. Signaling is responsible for establishing and terminating a call. The signaling portion of the network also enables service providers to offer intelligent services such as call waiting, caller ID and voice messaging. The signaling portions of existing voice telephone networks in most of the world are based upon a set of complex standards known as Signaling System #7, or SS7. The primary network elements within a traditional circuit network architecture based on SS7 are as follows: 5 Signal Transfer Point (STP) -- A signal transfer point is a packet switch for the signaling portion of the network. It controls and directs the signaling messages used to establish and terminate telephone calls and to coordinate the provision of intelligent services. Service Switching Point (SSP) -- A service switching point (often called a Class 4 or Class 5 switch, depending on its location in the network) is a carrier's switch that connects to the SS7 network and serves as the origination and termination points for the SS7 messages in a network. In this capacity, the service switching point, via signaling transfer points, sends and processes the signaling messages used to establish and terminate telephone calls. When a service switching point identifies a call requiring instructions for intelligent services, it sends a signaling message to a signal transfer point and awaits further routing or call processing instructions. Service Control Point (SCP) -- A service control point is a specialized database containing network and customer information. It is queried by service switching points via signaling transfer points for information required for the delivery of intelligent services. Different service control points contain the information used by the SS7 network to perform different types of functions. Signaling Links -- A signaling link is a physical or logical connection or channel between any two different parts of the signaling portion of the network, or a connection or channel between the signaling part of the network and the switching part of the network. To create additional network capacity to accommodate increases in signaling traffic, additional links must be added to signal transfer points, or new signal transfer points must be added. Traditionally, signaling links have operated on dedicated circuit facilities. New network architectures support signaling over packet transmission technologies such as IP or ATM. The market for SS7 equipment is driven by growth in network traffic and by demand for intelligent services. Carriers and service providers must increase the performance and capacity of their signaling networks in order to increase call processing capacity or to offer intelligent services. Because of its role in providing reliability and features to a voice network, STPs must deliver high performance and reliability. Typically, STPs need to deliver 99.999% reliability, or less than three minutes of unscheduled downtime per year. Service providers also require an SS7 solution that is scalable -- that is, a solution that can initially be matched to support a carrier's current capacity but with the capability to have its capacity increased to support the carrier's growth without requiring the replacement of certain network elements. Unique Signaling Requirements of Wireless Networks Wireless networks generate substantially more signaling traffic than fixed line networks due to additional SS7 features inherent in wireless telephony such as mobile registrations, roaming, and handoffs between cellular equipment. As a result, wireless operators generally invest in SS7 related equipment, such as signal transfer points, more frequently than fixed line carriers to accommodate the unique signaling demands of mobile telephony. In addition, rapid growth in wireless minutes of use and increased popularity of wireless services enabled by signaling networks such as voice mail and text messaging have led to a significant increase in SS7 traffic on mobile networks in recent years, which has created a need for high capacity signaling infrastructure. Driving the higher usage in wireless networks, particularly in the United States, are flat rate pricing plans that feature no additional charges for long distance calls. Wireless usage is expected to continue to increase in the coming years, which will create further demand for signaling infrastructure. According to a recent report issued by The Yankee Group, a 6 research consultancy firm, wireless telephony is expected to account for 40% of total conversation minutes in the United States by 2005, up from 10% in 2000, as additional subscribers are added and existing subscribers continue to increase their usage of wireless phones. Supporting Voice and Data Convergence Currently, virtually all networks which carry both voice and data communications rely on a technology called circuit switching. Another technology, packet switching, has been used almost exclusively for data-only networks. Circuit switching and packet switching are fundamentally different technologies. While circuit switching has offered reliable and high quality voice communications, packet switching is inherently more efficient and cost effective. Industry sources estimate that the cost of a transmission minute is as much as 25% to 50% less for a packet network than for a circuit network. The cost and performance superiority of packet switching has led many incumbent and new carriers to build packet networks to handle data traffic. It has also led carriers to explore the transmission of voice communications over packet networks. This requires circuit networks and packet networks to seamlessly interconnect. To support voice and data communications, packet networks need signaling to provide the same reliability and quality of transmissions as circuit networks and to provide the intelligent services consumers have come to expect and demand. Because SS7 is the global industry standard for voice networks, the Company believes that signaling for the converged circuit and packet networks will be based upon SS7 or its derivatives as well. This allows new carriers with packet networks to more easily interconnect with existing circuit networks and would allow incumbent carriers to leverage their investment in their existing networks even as they build out their data networks. Tekelec believes that the primary network elements of converged circuit and packet networks, including signaling, call control and switching technologies, are as follows: Signal Transfer Point -- As in the present circuit networks, a signal transfer point relays messages needed to establish and terminate telephone calls and to coordinate the provision of intelligent services. It can relay messages within the circuit network, between circuit and packet networks, and possibly within some forms of packet networks. Service Control Point-- As in the present circuit networks, a service control point is a specialized database containing information used to deliver intelligent services. Service control points in converged networks may support packet-based signaling interfaces. Signaling Gateway -- A signaling gateway receives signaling messages from signal transfer points, reformats these messages and presents them to one or more media gateway controllers. Media Gateway Controller-- A media gateway controller, frequently called a softswitch or call agent, is a specialized computer that provides the intelligence, or call control to direct switching. It controls one or more voice/data switches called media gateways. 7 Media Gateway -- A media gateway is a voice/data switch that receives the message part of a call and redirects it as specified by the media gateway controller to a single destination or to multiple destinations. If necessary, a media gateway can translate the actual call from a packet switching format to a circuit switching format and vice versa. Application Server -- Similar to a service control point, an application server is a specialized database that contains information to deliver certain intelligent services in packet networks, interacting with the Media Gateway Controller via IP-based protocols such as Session Initiation Protocol (SIP). SIP Server -- A SIP server is a session control platform for voice-over-packet networks. Interoperating with media gateway controllers, the SIP server provides the foundation for initiating and terminating sessions as well as service delivery within a pure-packet, signaling network. The primary difference between the converged architecture and the circuit architecture described above is the use of the signaling gateway, media gateway controller and media gateway to perform the same switch functions as are currently performed by certain service switching points in circuit networks. However, industry experts believe it will take decades to replace all of the existing service switching points with packet switching technologies. In the Company's view of the converged architecture, these three switch components do not all have to be made and sold in one integrated product by a single equipment manufacturer. Instead, any of these switch components can be bundled and sold with switch components made by different manufacturers generally with one vendor serving as the primary supplier responsible for delivering, integrating and servicing the comprehensive packet telephony solution. The Company has developed partnerships with several vendors of media gateways and feature servers to enable Tekelec to offer a complete solution for packet telephony deployments. The Company believes carriers are seeking fully featured packet telephony solutions that can facilitate the convergence of circuit and packet networks, without compromising functionality, reliability, scalability, support and flexibility. The Company also believes that other equipment manufacturers may be looking for signaling and/or call control products which they can easily bundle and sell with their own switch components. The Tekelec Solution The Company is a leading designer and developer of telecommunications signaling infrastructure, packet telephony solutions, diagnostic tools and service applications. The Company's solutions are widely deployed in traditional and next-generation, or "converged" wireline and wireless networks and contact centers worldwide. The Company's systems and diagnostics products assist its customers in meeting their primary challenges in the competitive telecommunications environment: differentiating their offerings and lowering network costs. The Company offers signaling and packet telephony systems and services to enable the delivery of intelligent services and facilitate convergence of voice and data networks. The Company believes that its open, standards-based solutions are highly reliable and enable operators to more cost-effectively manage their networks and offer intelligent services. The Company's Eagle 5 SAS (the latest release of the Company's STP product), and previous versions of the Eagle STP, have been widely deployed and, according to market research firms, has achieved leading market share in North America. The Company is expanding 8 its international operations to increase its market share in international markets within Europe, Latin America, Asia and in other parts of the world. The Eagle 5 SAS offers high capacity and throughput, reliability and efficiency that support the growth of traffic and demand for intelligent services in service provider networks. The reliability of the Company's products enables it to offer service providers product solutions that reduce their total cost of ownership of network systems products. The Company's Eagle and IP7 products meet industry standards for 99.999% reliability and less than 3 minutes of unscheduled downtime per year. The Company also offers a feature of Eagle that allows Eagle 5 that allows support of SS7 signaling into Internet Protocol networks to realize substantial efficiencies inherent in IP networks. During the past few years, the Company has developed and introduced a suite of products created specifically for converged circuit and packet networks. These products include the IP7 Secure Gateway and the VXi Media Gateway Controller, two of the three components comprising a switch in converged circuit and packet networks. The Company's products are designed so that they may be purchased in combination with switch components made by other manufacturers, or purchased separately, depending on the customer's preference. In the Company's effort to offer its customers a complete switching solution, it has become an established reseller of media gateways manufactured by Cisco Systems and Alcatel, and applications servers manufactured by BroadSoft, with which the Company's solutions are interoperable. Use of the Company's SS7-over-IP solutions results in a substantial increase in signaling efficiency by enabling SS7 signaling over IP at faster rates than traditional SS7 signaling. Customers may choose to deploy the IP7 Secure Gateway or the Eagle 5 ("SAS") with SS7-over-IP capability to gain signaling efficiencies, among other benefits, as a precursor to deploying a complete packet telephony switch as a circuit switch replacement. In addition, customers of the Company's SS7 products may upgrade their existing solutions to enable SS7 signaling over IP. The upgrade enables them to preserve the value of their existing SS7 infrastructure and makes them fully capable of functioning in converged networks. The Company's approach to packet telephony solutions offers carriers more flexibility and lower costs than a fully integrated switch. Carriers can choose to purchase from among multiple vendors each of the switch components that offers the optimal performance for their needs. They can also potentially upgrade or expand a packet telephony switch by selectively replacing components, instead of having to replace the entire switch. The ability to upgrade media gateways without changing the signaling and call control elements of a converged switch is especially relevant due to continuous gains in packet switching efficiency, which by some estimates, doubles in performance every 18 months. The Company also believes that its approach is more scalable than a fully integrated packet telephony switch. 9 Business Strategy The Company's objective is to be the premier supplier of signaling and call control network systems and selected service applications, and diagnostics products, to existing and emerging communications markets. Key elements of the Company's strategy to achieve this objective include: Maintaining Technology Leadership. The Company believes that one of its core competitive strengths is the breadth of its knowledge and expertise in communications technologies, particularly in SS7 and related signaling technologies. The Company has developed this expertise over more than two decades. The Company intends to enhance its existing products and to develop new products by continuing to make significant investments in research and development. As part of its commitment to technology leadership, the Company has developed the Transport Adapter Layer Interface (TALI), an Internet Protocol signaling interface which enables the transport of signaling messages using the Internet Protocol. The Company has made available the TALI source code free of charge to the industry, and has entered into TALI licensing agreements with more than 200 companies, several of which are using the interface in live networks. Tekelec also supports other IP signaling protocols, including the Internet Engineering Task Force SIGTRAN suite of signaling protocols for next-generation network connectivity. The Company has also assumed a leadership role within the Softswitch Consortium, an industry organization created for global cooperation and coordination in the development of open standards and interoperability for packet networks. Targeting the Convergence of Voice and Data Networks. The Company is continuing to invest significantly to develop signaling and call control products and features that enable the convergence of circuit and packet networks. The Company introduced the IP7 product line, the VXi Media Gateway Controller and the SXi 500 SIP Server to target this convergence market. In addition, the Company has established reseller partnerships with vendors of media gateways and application servers, complementary products for converged voice and data networks. The Company believes its pursuit of this new market opportunity leverages its expertise in signaling and call control and will enhance the market potential for the Company's traditional solutions by ensuring customers that investments in Tekelec equipment can be upgraded to perform in converged networks. Expanding Internationally. The Company is increasingly pursuing international opportunities, primarily through its European sales and support office in the United Kingdom and through the Company's Japanese subsidiary. The Company also intends to open a sales office in Latin America during 2002. The Company's European sales efforts have resulted in significant expansion in the customer base, including Orange Personal Communications Systems, Bouygues Telecom and France Telecom, Cable & Wireless, British Telecom, and Vodafone. Recent mandates in certain European countries, including Spain, Holland and France, and a similar mandate in Australia provide that telecommunications service providers should offer number portability. The increasing implementation of number portability in Europe and other regions is expected to result in increasing demand for SS7 network elements such as signal transfer points to accommodate the increase in signaling traffic, and number portability solutions, such as those offered by the Company, to facilitate the deployment of number portability. Pursuing Additional Strategic Relationships, OEM Partners and Acquisitions. The Company intends to seek additional strategic relationships, including original equipment 10 manufacturer partners, referral arrangements, distribution agreements and acquisition candidates. The Company's existing strategic relationships include technology development and OEM relationships with Davox Corporation, Cisco Systems, Alcatel and BroadSoft, a technology development and marketing relationships with Telcordia and Nortel, collaboration agreements with Cisco Systems, Alcatel and Illuminet and distribution relationships with Lucent, Mercury (formerly Daewoo), Unisys and numerous other product distributors. See "Customers". Pursuing New Market Segments. The Company intends to continue its strategy of internally developing and acquiring products in order to enter new market segments. A number of products currently under development will enable the Company to serve new markets, including packet switching for wireless networks and diagnostics for packet networks using voice over Internet protocols and new mobile technologies. Seeking Additional Opportunities to Provide Upgrades, Extensions and Service Agreements. The Company intends to leverage its strong customer relationships to seek opportunities to better serve its customers' needs in the future. In particular, the Company will continue to develop and market software upgrades, link extensions, extended service agreements and other enhancements as a means to pursue repeat business opportunities. Such products and services accounted for approximately 50% of revenues in its Network Systems Division in 2001. Products The Company currently offers products in three broad categories: network systems products, network diagnostics products and contact center products. Network Systems Products The Company's network systems products enable telecommunications service providers to create, enhance and customize the intelligent services they offer. The Company's principal network systems products are described below: Product Description Eagle 5 Signaling The Company's Eagle 5 Signaling Application System Application System .......... ("SAS") is a highly reliable signal transfer point which is tailored to the SS7 switching needs of carriers, network service providers and wireless operators, among others. It offers high capacity and throughput, features a fully distributed, standards-based, open architecture and is scalable from 2 to 2000 links. It is sold in pairs for redundancy. It offers several optional features not typically available on signal transfer points including support for SS7 over IP signaling, integrated Sentinel for surveillance, monitoring and revenue assurance capabilities, and the delivery of service applications that are commonly hosted on service control points. 11 ASi 4000 Service Control The Company's ASi 4000 Service Control Point is a Point ....................... specialized database that contains network and customer information needed to process calls requiring special treatment, such as credit card calls or other intelligent services. This product supports interfaces to the products of most major switch vendors. Its graphical user interface enables the development, testing and deployment of intelligent services. IP7 Secure Gateway .......... The Company's IP7 Secure Gateway is a highly scalable signaling gateway that can provide signaling information to media gateway controllers and IP-signaling enabled SCPs in multiple locations. It can deliver these services in multi-protocol, multi-vendor converged networks or in circuit switched networks that deploy signaling over IP primarily to realize economic benefits. VXi Media Gateway The Company's VXi Media Gateway Controller is a Controller .................. media gateway controller that is highly scalable and can control media gateways in multiple locations. It interfaces to both asynchronous transfer mode and Internet protocol networks via proprietary and standards-based interfaces. SXi 500 SIP Server .......... The Company's SXi 500 product establishes and terminates sessions, and enables services in a packet switching network environment. Interworking with Media Gateway Controllers, the SXi 500 is an IP signaling foundation for service delivery in packet networks. Sentinel .................... The Company's Sentinel product is a network maintenance, surveillance and revenue assurance solution that enables service providers to ensure the reliability of telecommunication products and services implemented across their SS7/IP networks. Sentinel also enables revenue assurance features such as fraud prevention and billing verification. Sentinel can be deployed on a standalone basis or as an integrated feature of the Eagle 5 SAS. Network Diagnostics Products Equipment manufacturers, and to a lesser extent, network service providers utilize the Company's diagnostics products to perform a wide variety of test applications that simulate and analyze network communications network systems. The Company's customers use its diagnostics products for: o Designing Communications Equipment. By simulating existing and emerging communications devices, nodes and protocols, the Company's products enable engineers to quickly design communications devices that will transition into emerging network systems, minimizing potential breakdowns of network components deployed throughout the network. 12 o Ensuring Product Reliability. By simulating actual network conditions within an operating environment, including protocol errors and other network failures, the Company's products can help ensure that communications equipment manufacturers produce devices that will operate error-free, thus accelerating time to market and potentially reducing costly failures after installation. o Verifying Certification. By executing conformance and performance test suites, network operators and manufacturers use the Company's products to rapidly verify that communication devices meet specified standards. o Load generation. By simulating a traffic "load" of many simultaneous users of advanced features within a controlled environment, the Company's diagnostic products allow engineers to submit a product under development to stress testing to ensure that it can withstand the traffic demands of live networks. The Company's principal network diagnostics products are described below: Product Description - ------- ----------- MGTS ........................ The Company's MGTS is a signaling diagnostics system designed to provide a diagnostics and test platform for research and development, laboratory and telecommunications service provider environments. The MGTS supports various protocols, including SS7 and personal communications systems, permits the design of customized testing scenarios and can be used with multiple user groups and geographic locations. MGTS i3000 .................. The Company's MGTS i3000 is a complete diagnostics system for converged network technologies. The diagnostics applications built on the Company's i3000 platform address wireline and wireless communications equipment manufacturers' convergence test and verification needs. MGTS i3000 enables users to build and reuse test scenarios spanning multiple technologies, including SS7, GPRS, UMTS and IP. Contact Center Products The Company's contact center products provide planning, management and call routing and control tools for single contact centers and for complex, multiple site contact center environments. These tools help contact center managers maximize contact center productivity, achieve service level targets and reduce costs. The Company's principal contact center products are described below: 13 Product Description - ------- ----------- TotalView ................... The Company's TotalView Workforce Management Solution for single and multiple site contact centers generates staff schedules based on contact center workload and the availability and skills of contact center staff. It performs real-time monitoring and analysis of contact center operations. TotalView also provides detailed, customized reports to assist in optimizing contact center performance and forecasting contact center staffing requirements. TotalNet .................... The Company's TotalNet Call Routing Solution for multiple site contact centers routes calls to multiple locations as if they were a single contact center and balances workload across contact center sites based on staffing levels, call volume and caller requirements. TotalNet also maintains contact center statistics and analyzes contact center operations. Product Development The communications market is characterized by rapidly changing technology, evolving industry standards and frequent new product introductions. Standards for new technologies and services such as third generation wireless, softswitching, signaling for packet networks, internet protocol and asynchronous transfer mode are still evolving. As these standards evolve and the demand for services and applications increases, the Company intends to adapt and enhance its products and develop and support new products. The Company solicits product development input through discussions with its customers and participation in various industry organizations and standards committees, such as the Telecommunications Industry Association, the Internet Engineering Task Force, the Softswitch Consortium and the Asynchronous Transfer Mode Forum, and by closely monitoring the activities of the International Telecommunications Union, the European Telecommunications Standards Institute, the International Organization for Standardization and Telcordia. The Company's network systems product development group is principally focused on addressing the requirements of the converged voice and data networks and on the release of new software versions to incorporate enhancements or new features or functionality desired by customers. This group also focuses on compliance with standards to enable the Eagle solutions to address additional domestic and international markets. In addition, the Company plans continued improvement of hardware components to improve their performance and capabilities. The Company's diagnostics product development activities are principally focused on expanding the capabilities of the MGTS, and MGTS i3000 products, including their interfaces, software modules and protocol capabilities for emerging technologies such as broadband wireless and packet telephony, and adapting these products for the network operations market. From time to time the Company engages in development projects for special applications requested by its customers. The Company typically retains the right to use the developed technology in future products that are not competitive with the specific application for which the development work was performed. 14 The Company's contact center product development activities are principally focused on expanding the capabilities of the contact center products, including the skills and multimedia scheduling capabilities of the TotalView Workforce Management product and the functionality of the TotalNet Call Routing product. Sales and Marketing The Company's sales and marketing strategies include selling through the Company's direct sales forces, indirectly through distributors and other resellers, entering into strategic alliances and targeting certain markets and customers. To promote awareness of Tekelec and the Company's products, the Company also advertises in trade journals, exhibits at trade shows, maintains a presence on the Internet, uses direct mail and many of its employees author, from time to time, articles for trade journals. Distribution. The Company sells its network systems, network diagnostics and contact center products in the U.S. principally through the Company's separate direct sales forces and, for the Eagle 5 SAS and certain other network systems products indirectly through strategic relationships with various third parties. The Company's direct sales forces operate out of the Company's headquarters in Calabasas, California and the Company's regional offices located in Colorado, Georgia, Illinois, New Jersey, North Carolina, Virginia and Texas. The Company sells its network systems products internationally through the Company's direct sales force and distribution relationships with Mercury, Lucent and Unisys and the Company's wholly owned subsidiary in the United Kingdom. The Company sells its diagnostics products internationally through a network of approximately 21 distributors and the Company's wholly owned subsidiaries in Japan and the United Kingdom. The Company's Japanese subsidiary, which presently primarily sells diagnostics products, generated approximately 9% of the Company revenues for 2001, 8% for 2000 and 10% for 1999. Independent companies distribute the Company's products in other Western European countries, the Far East (other than Japan), Australia, Mexico, Puerto Rico, New Zealand, Latin America, the Middle East and South Africa. Distributors typically purchase products directly from Tekelec pursuant to agreements that are exclusive for a particular territory and are cancelable by either party upon 90 days notice. Export sales through international distributors accounted for approximately 7% of the Company's revenues for 2001, 5% for 2000 and 6% for 1999. Strategic Relationships. The Company believes that its current and future strategic relationships with leading communications equipment suppliers will improve market penetration and acceptance for the Company's network systems products. These suppliers have long-standing relationships with public telecommunications carriers and provide a broad range of services to these carriers through their existing sales and support networks. Tekelec seeks strategic relationships that: o enhance the Company's presence and strengthen the Company's competitive position in its target markets; o offer products that complement the Company's network systems solutions to provide value-added networking solutions; and 15 o leverage the Company's core technologies to enable communications equipment suppliers to develop enhanced products with market differentiation that can be integrated with Tekelec's solutions. The Company's strategic relationships include: o an agreement with Cisco Systems, whereby Tekelec will market and resell certain of Cisco's media gateways with its VXi Media Gateway Controller and IP7 Secure Gateway. o an agreement with Alcatel, whereby Tekelec will market and resell certain of Alcatel's media gateways with its VXi Media Gateway Controller and IP7 Secure Gateway. o an agreement with BroadSoft, whereby Tekelec will market and resell BroadSoft's application server product with its VXi Media Gateway Controller and IP7 Secure Gateway. o a non-exclusive distribution agreement with Lucent under which Lucent distributes the Company's Eagle STP; o a non-exclusive international distribution agreement with Unisys under which Unisys distributes the Company's network systems products; o an exclusive distribution and OEM agreement with Mercury under which Mercury distributes the Company's Eagle STP in South Korea; o an OEM and distribution agreement with Davox Corporation under which Davox will sell on an OEM basis the Company's TotalNet Call Routing products and the Company will distribute Davox's Ensemble call center solution; o an alliance with Nortel Networks in which Tekelec and Nortel Networks cooperatively market Nortel Networks' Symposium Call Center Server with TotalNet Call Routing and TotalView Workforce Management. The Company believes that its strategic third party relationships provide the Company with additional opportunities to penetrate the network systems markets and demonstrate the Company's strategic partners' recognition of the technical advantages of the Company's network products. Through the Company's relationships with, among others, Cisco Systems, Alcatel, BroadSoft, Lucent, Unisys, and Mercury, the Company is enhancing its market presence and the ability to access leading network service providers. In general, these agreements can be terminated by either party on limited notice and, except for the Company's agreement with Mercury, do not require minimum purchases. Cisco Systems, Unisys, and Davox also are not precluded from selling products that are competitive with the Company's products. Although the Company's current sales through these relationships are not significant, a termination of the Company's relationship with, or the sale of competing products by, any of these strategic partners could adversely affect the Company's business and operating results. 16 Service, Support and Warranty The Company believes that customer service, support and training are important to building and maintaining strong customer relationships. The Company services, repairs and provides technical support for the Company's products. Support services include 24-hour technical support, remote access diagnostics and servicing capabilities, extended maintenance and support programs, comprehensive technical customer training, extensive customer documentation, field installation and emergency replacement. The Company also offers to its customers and certain resellers of the Company's products training with respect to the proper use, support and maintenance of the Company's products. The Company maintains an in-house repair facility and provides ongoing training and telephone assistance to customers and international distributors and other resellers from the Company headquarters in Calabasas, California, certain U.S. regional offices and the Company's Japanese subsidiary. The Company's technical assistance centers in Morrisville, North Carolina and Egham, United Kingdom, support the Company's network systems products on a 24 hour-a-day, seven day-a-week basis. The Company's technical assistance center in Richardson, Texas, supports the Company's contact center products and certain of the Company's network systems products. The Company also offers network implementation services in connection with its effort to supply a complete solution for packet telephony deployments, including products from its vendor partners. In such instances, the Company will offer specific service contracts to support the needs of its carrier customers that choose to migrate their network to packet technologies. The Company typically warrants its products against defects in materials and workmanship for one year after the sale and thereafter offers extended service warranties. Customers The Company's customers include end users and marketing intermediaries. End users for the Company network systems products consist primarily of network service providers, wireless network operators, interexchange carriers, competitive access providers, local exchange carriers and Regional Bell Operating Companies. Wireless service providers accounted for more than 50% of the Company's Network Systems revenue in 2001. End users for the Company's diagnostic products primarily include communications equipment manufacturers, and to a lesser extent, network service providers and government agencies. The Company's contact center solutions have been sold primarily to Fortune 500 companies, financial services companies and telecommunications carriers. The Company anticipates that its operating results in any given period will continue to depend to a significant extent upon revenues from a small percentage of the Company's customers. Backlog Backlog for the Company's network systems products typically consists of contracts or purchase orders for both product delivery scheduled within the next 12 months and extended service warranty to be provided over periods of up to three years. Backlog for the Company's diagnostic and contact center products typically consists of products and services ordered for delivery within the next 12 months. Primarily because of variations in the size and duration of 17 orders received by Tekelec and customer delivery requirements, which may be subject to cancellation or rescheduling by the customer, the Company's backlog at any particular date may not be a meaningful indicator of future financial results. At December 31, 2001, the Company's backlog amounted to approximately $189.3 million, of which $85.8 million related to network systems service warranties. This compared to a backlog of approximately $197.2 million at December 31, 2000, of which $71.1 million related to network systems service warranties. The Company regularly reviews its backlog to ensure that its customers continue to honor their purchase commitments and have the financial means to purchase and deploy the Company's products and services in connection with their purchase contracts. Competition Network Systems Products. The market for the Company's network systems products is intensely competitive and has been highly concentrated among a limited number of dominant suppliers. The Company presently competes in the network systems market with, among others, Alcatel, Nortel, Cisco Systems, Telcordia, Sonus Networks, Ericsson, Lucent Technologies, Inet and Siemens. The Company expects competition to increase in the future from existing and new competitors. The Company believes that the principal competitive factors in the network systems products market are product performance, scalability and functionality, product quality and reliability, customer service and support, price and the supplier's financial resources and marketing and distribution capability. The Company anticipates that responsiveness in adding new features and functionality will become an increasingly important competitive factor. While some of the Company's competitors have greater financial resources, the Company believes that it competes favorably in other respects. New entrants or established competitors may, however, offer products which are superior to the Company's products in performance, quality, service and support and/or are priced lower than the Company's products. Some of the Company's competitors, including Lucent, Nortel and Sonus Networks manufacture and offer fully integrated network systems products for converged networks. These products include an SS7 signaling gateway, a media gateway controller and a media gateway. The Company's strategy, however, is to develop and provide the SS7 signaling gateway and the media gateway controller elements of network systems solutions for converged circuit and packet networks. This means that it will be necessary for the Company's products to be combined with the media gateways of other vendors to constitute a complete network systems switch for a converged network. To date, the Company has established relationships with Cisco Systems and Alcatel to offer a complete switch. Some customers may prefer to purchase fully integrated network systems switches from the Company's competitors rather than purchase the Company's network systems products because they may conclude that the fully integrated switch is superior. The Company's ability to compete in the market for network systems switches will also be limited if media gateway manufacturers develop fully integrated switches and cease selling media gateways on a non-integrated basis or bundled with the Company's convergence products. The Company believes that its ability to compete successfully in the network systems market also depends in part on the Company's distribution and marketing relationships with leading communications equipment suppliers and resellers. If the Company cannot successfully enter into 18 these relationships on terms that are favorable to the Company or if the Company cannot maintain these relationships, the Company's business may suffer. Diagnostics Products. The communications diagnostics market is intensely competitive and subject to rapid technological change and evolving industry standards. The Company competes primarily in the high performance segment of this market, and the Company's principal competitors are Catapult Communications and Acterna. The Company also competes with a number of other manufacturers, some of which have greater financial, marketing, manufacturing and technological resources than Tekelec. The Company believes that its long-term success will depend in part on its ability to be a leader in offering diagnostics products that address new emerging industry standards. The Company believes that the principal competitive factors in the communications diagnostics market in which it competes are product and price performance, functionality and reliability, timely introduction of new products, marketing and distribution capability and customer service and support. Although the Company believes that it competes favorably, new or established competitors could offer products which are superior to or cost less than the Company's products. Contact Center Products. The market for contact center products is extremely competitive. The Company competes principally with Aspect Communications and Blue Pumpkin Software in the market for workforce management solutions and with Cisco and Alcatel in the market for call routing solutions. The Company also competes to a lesser extent in these markets with a number of other manufacturers, some of which have greater financial, marketing, manufacturing and other resources than Tekelec. The Company believes that the success of its TotalView product will depend in part on its ability to offer competitive prices and to further develop its workforce management scheduling and other technologies and its international distribution channels. The Company believes that the success of the TotalNet product will depend to a significant degree on its ability to develop market penetration and to improve product functionality through strategic partnering with third parties. Intellectual Property The Company's success depends to a significant degree on its proprietary technology and other intellectual property. The Company relies on a combination of patents, copyrights, trademarks, trade secrets, confidentiality agreements and contractual restrictions to establish and protect the Company's proprietary rights both in the United States and abroad. The Company has been issued a number of patents and has a number of patent applications pending. These measures, however, afford only limited protection and may not prevent third parties from misappropriating the Company's technology or other intellectual property. In addition, the laws of certain foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States and thus make the possibility of misappropriation of the Company's technology and other intellectual property more likely. If the Company fails to successfully enforce or defend its intellectual property rights or if the Company fails to detect misappropriation of the Company's proprietary rights, its ability to effectively compete could be seriously impaired. The Company's pending patent and trademark registration applications may not be allowed and the Company's competitors may challenge the validity or scope of its patent or trademark registration applications. In addition, the Company may face challenges to the validity or 19 enforceability of its proprietary rights and litigation may be necessary to enforce and protect the Company's rights, to determine the validity and scope of the Company's proprietary rights and the rights of others, or to defend against claims of infringement or invalidity. Any such litigation would be expensive and time consuming, would divert the Company's management and key personnel from business operations and would likely harm the Company's business and operating results. The communications industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights to technologies that are important to Tekelec. From time to time, the Company receives notices from or is sued by third parties regarding patent claims. Any claims made against the Company regarding patents or other intellectual property rights could be expensive and time consuming to resolve or defend, would divert the Company's management and key personnel from its business operations and may require the Company to modify or cease marketing its products, develop new technologies or products, acquire licenses to proprietary rights that are the subject of the infringement claim or refund to the Company's customers all or a portion of the amounts paid for infringing products. If such claims are asserted, there can be no assurances that the dispute could be resolved without litigation or that the Company would prevail or be able to acquire any necessary licenses on acceptable terms, if at all. In addition, the Company may be requested to defend and indemnify certain of its customers and resellers against claims that the Company's products infringe the proprietary rights of others. The Company may also be subject to potentially significant damages or injunctions against the sale of certain products or use of certain technologies. See "Legal Proceedings" in Part I, Item 3, of its Annual Report on Form 10K. Employees At March 1, 2002, the Company had 1,057 employees, comprising 420 in sales, marketing and support, 84 in manufacturing, 412 in research, development and engineering and 141 in management, administration and finance. Virtually all of the Company's employees hold stock options and/or participate in the Company employee stock purchase plan. None of the Company's employees is represented by a labor union, and the Company has not experienced any work stoppages. The Company believes that its relations with its employees is excellent. Business Risk Factors The statements that are not historical facts contained in this Annual Report on Form 10-K are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect the current belief, expectations or intent of the Company's management and are subject to and involve certain risks and uncertainties. Many of these risks and uncertainties are outside of the Company's control and are difficult for the Company to forecast or mitigate. In addition to the risks described elsewhere in this Annual Report on Form 10-K and in certain of the Company's other Securities and Exchange Act Commission filings, the following important factors, among others, could cause the Company's actual results to differ materially from those expressed or implied by the Company in any forward-looking statement contained herein or made elsewhere by or on behalf of the Company. 20 Because the Company's quarterly operating results are difficult to predict and may fluctuate, the market price for the Company's stock may be volatile. The Company's quarterly operating results are difficult to predict and may fluctuate significantly. The Company has failed to achieve its revenue and net income expectations for certain prior periods, and it is possible that the Company will fail to achieve such expectations in the future. Fluctuations in the Company's quarterly operating results may contribute to the volatility in its stock price. A number of factors, many of which are outside the Company's control, can cause these fluctuations, including among others: o overall telecommunications spending; o changes in general consumer conditions and specific market conditions in the telecommunications industry; o the size, timing, terms and conditions of orders and shipments; o the lengthy sales cycle of the Company's network systems products and the reduced visibility into our customers' spending plans; o the progress and timing of the convergence of voice and data networks and other convergence-related risks described below; o the ability of carriers to utilize excess capacity of signaling infrastructure and related products in the network; o the capital spending patterns of customers, including deferrals or cancellations of purchases by customers; o the dependence on wireless customers for a significant percentage of the Company's revenue streams; o the success or failure of strategic alliances and acquisitions; o unanticipated delays or problems in releasing new products or services; o the mix of products and services that the Company sells; o the geographic mix of the Company's revenues and the associated impact on gross margins; o the introduction and market acceptance of new products and technologies; o the timing of the deployment by the Company's intelligent network services and new technologies; o the ability of our customers to obtain financing or to fund capital expenditures; 21 o the timing and level of the Company's research and development expenditures and other expenses; and o the expansion of the Company's marketing and support operations, both domestically and internationally. The Company's product sales in any quarter depend largely on orders booked and shipped in that quarter. A significant portion of the Company's product shipments in each quarter occurs at or near the end of the quarter. Since individual orders can represent a meaningful percentage of the Company's revenues and net income in any quarter, the deferral of or failure to close a single order in a quarter can result in a revenue and net income shortfall that causes the Company to fail to meet securities analysts' expectations for that period. The Company bases its current and future expense levels on its internal operating plans and sales forecasts, and its operating costs are to a large extent fixed. As a result, the Company may not be able to sufficiently reduce its costs in any quarter to compensate for an unexpected near-term shortfall in revenues, and even a small shortfall could disproportionately and adversely affect the Company's operating results for that quarter. The factors described above are difficult to forecast and could have a material adverse effect on the Company's business, operating results and financial condition. There can be no assurances that the Company will not experience a shortfall in the future, which would adversely affect the Company's operating results. Accordingly, the results of any one quarter should not be relied upon as an indication of the Company's future performance. The Company is exposed to general economic and market conditions The Company's business is subject to the effects of general economic conditions in the United States and globally, and, in particular, market conditions in the telecommunications industry. In recent quarters, the Company's operating results have been adversely affected as a result of unfavorable economic conditions and reduced capital spending in the United States, Europe, Latin America and Asia. In particular, sales to network carriers in the United States have been adversely affected during 2001. If the economic conditions in the United States and globally do not improve, or if there is a worsening in the global economic slowdown, the Company may continue to experience material adverse impacts on its business, operating results and financial condition. The Company has limited product offerings, and its revenues may suffer if demand for any of its products declines or fails to develop as it expects. The Company derives a substantial portion of its revenues from Network Systems products. During each of 1999, 2000 and 2001, the Company's Eagle and IP7 signaling products and related services generated over 50% of its revenues, and the Company expects that these products and services and its other network systems products will continue to account for a substantial majority of the Company's revenues for the foreseeable future. As a result, factors adversely affecting the pricing of or demand for these products, such as competition, technological change or a slower than anticipated rate of deployment of new technologies, could cause a decrease in the Company's revenues and profitability. Therefore, continued and widespread market acceptance of these products is critical to the Company's future success. Moreover, the Company's future financial performance will depend in significant part on the successful and timely development, introduction and customer acceptance of new and enhanced 22 versions of the Company's Eagle and IP7 products and other Network Systems products. There are no assurances that the Company will continue to be successful in developing and marketing its network systems products and related services. If wireless carriers do not continue to buy the Company's Network Systems products and services, the Company's Network Systems business would be harmed. The success of the Company's Network Systems business will depend in large part on the continued growth of the wireless network operators and their purchases of the Company's products and services. The Company derives a substantial portion of its revenues from the sale of Network Systems products and services to wireless networks operators. In 2001, sales to the wireless market accounted for approximately 50% of the Company's revenues. The Company expects that its sales of Network Systems products and services to wireless companies will continue to account for a substantial percentage of the Company's revenues for the foreseeable future. The continued growth of the domestic and international wireless markets is subject to a number of risks that could adversely affect the Company's revenues and profitability, including weakness in the domestic or global economy, a slowdown in capital spending by the wireless network operators, adverse changes in the debt and equity markets and the ability of wireless carriers to obtain financing on favorable terms, delays or scaling back of plans for the deployment by wireless network operators of new wireless broadband technologies, and slowing wireless network subscriber growth. Consequently, there can be no assurances that the wireless network carriers will continue to purchase the Company's Network Systems products and services for the build out or expansion of their networks. Risks related to the potential convergence of voice and data networks Currently, voice conversations are carried primarily over circuit switched networks. Another type of network, packet switched networks, carries primarily data. Circuit and packet networks use fundamentally different technologies. Although the Company expects a substantial portion of any increases in its future sales of network systems products to result from the interconnection, or convergence, of circuit and packet networks, the Company cannot accurately predict when such convergence will occur. Therefore, this convergence presents several significant and related risks to the Company's business. If the convergence of circuit and packet networks does not occur, or takes longer than anticipated, sales of the Company's network infrastructure products, and the Company's profitability, could be adversely affected. Any factor which might prevent or slow the convergence of circuit and packet networks could materially and adversely affect growth opportunities for the Company's business. Such factors include: o the failure to solve or difficulty in solving certain technical obstacles to the transmission of voice conversations over a packet network; o delays in the formulation of standards for the transmission of voice conversations over a packet network; and o the imposition on packet network operators of access fees, which they currently do not pay. 23 It may be difficult or impossible to solve certain technical obstacles to the transmission of voice conversations over a packet network with the same quality and reliability of a circuit network. For example, delays or gaps in the timing of a message are typically not as critical to data transmissions as they are to voice conversations. The nature of packet switching makes it difficult to prevent such delays or gaps as well as to repair such defects in a way that does not degrade the quality of a voice conversation. If this problem is not solved, the convergence of circuit and packet networks may never fully occur or may occur at a much slower rate than the Company anticipates. It may also be difficult or time-consuming for the industry to agree to standards incorporating any one solution to such technical issues if such a solution does exist. Without uniform standards, substantial convergence of circuit and packet networks may not occur. The Company cannot accurately predict when these technical problems will be solved, uniform standards agreed upon or when market acceptance of such solutions will occur. However, convergence may well take much longer or, as noted above, not fully occur at all. Moreover, uncertainty regarding the technology or standards employed in converged networks may cause carriers to delay their purchasing plans. Finally, the imposition of access fees on packet networks might slow the convergence of circuit and packet networks. Today, federal regulation requires an operator of a long distance circuit network to pay an access fee to the local phone company serving the recipient of a long distance call. Packet network operators do not currently pay such access fees. In the future, access fees may be imposed on carriers using packet networks to transmit voice calls. These access fees might also be imposed on the termination of "pure" data messages by operators of packet networks. The imposition of these access fees would reduce the economic advantages of using packet networks for voice and other transmissions, which may slow the convergence of circuit and packet networks. Customers may prefer fully integrated switching solutions offered by the Company's competitors. The Company's product strategy is to develop and provide only certain parts of a network switch which would be used in converged circuit and packet networks. This means that the Company's new IP7 Secure Gateway and VXi Media Gateway Controller will need to be deployed with the products of other manufacturers in order to constitute a complete switching solution for a converged network. Some of the Company's competitors, including Lucent, Nortel and Sonus Networks, manufacture fully integrated switches for converged networks that would not require any of the Company's products. Some or all of the Company's customers or potential customers may prefer to purchase such a fully integrated switching product rather than purchasing the Company's convergence switching products. They may prefer a fully integrated switch, even if the Company's convergence switching products are offered with the switch components made by others. Customers may choose this option because they believe that the fully integrated products are superior. If a significant number of the Company's potential customers prefer a fully integrated solution made entirely by one manufacturer, the Company's strategy could fail because its products do not achieve broad market acceptance for converged networks, and its business could suffer. 24 The Company's dependence on strategic relationships with manufacturers of other products makes it potentially vulnerable to the actions and performance of other manufacturers. Because the Company's IP7 Secure Gateway and VXi Media Gateway Controller will need to be bundled with the products of other manufacturers in order to constitute a switch in converged circuit and packet networks, the Company may be adversely affected by the actions of the manufacturers of the other necessary switch elements. First, these manufacturers may not choose to make their product designs compatible with the Company's products. Second, those manufacturers who do choose to make their products compatible with the Company's products may not develop or deliver their products on a timely basis, or may not develop products which perform as expected or are priced competitively. Third, manufacturers of these products may also subsequently change the design of their products in a manner which makes it difficult or impossible to make the Company's products compatible. Fourth, manufacturers of these products may decide to develop a fully integrated network switch for converged networks and may cease selling non-integrated switching products. Finally, because the Company intends to market a product which incorporates network switching products made by others, any other manufacturer who markets the Company's products together with its products may terminate or cease to fully support its efforts to sell the Company's products. All of these actions will be outside of the Company's control. Any of these actions could materially and adversely affect the Company's business and profitability. If the Company's products do not satisfy customer demand for performance or price, the Company's customers could purchase products from its competitors. If the Company is not able to compete successfully against its current and future competitors, its current and potential customers may choose to purchase similar products offered by the Company's competitors, which would negatively affect the Company's revenues. The Company faces formidable competition from a number of companies offering a variety of network systems, diagnostics or contact center products. The markets for the Company's products are subject to rapid technological changes, evolving industry standards and regulatory developments. The Company's competitors include many large domestic and international companies as well as many smaller established and emerging technology companies. The Company competes principally on the basis of: o product performance and functionality; o product quality and reliability; o customer service and support; and o price. Many of the Company's competitors have substantially greater financial resources, product development, marketing, distribution and support capabilities, name recognition and other resources than the Company. The Company anticipates that competition will continue to intensify with the anticipated convergence of voice and data networks. The Company may not be able to compete effectively or to maintain or capture meaningful market share, and the Company's business could be harmed, if the Company's competitors' solutions provide higher performance, offer additional features and functionality or are more reliable or less expensive 25 than the Company's products. Increased competition could force the Company to lower its prices or take other actions to differentiate its products, which could adversely affect its operating results. The Company depends on a limited number of customers, and the loss of any of these customers could adversely affect the Company's operating results. Historically, a limited number of customers has accounted for a significant percentage of the Company's revenues in each fiscal quarter. Less than 10% of the Company's customers accounted for approximately 70% of the Company's revenues in each of 2000 and 2001. The Company anticipates that its operating results in any given period will continue to depend to a significant extent upon revenues from a small number of customers. In addition, the Company anticipates that the mix of customers in each fiscal period will continue to vary. In order to increase its revenues, the Company will need to attract additional significant customers on an ongoing basis. Its failure to sell a sufficient number of products or to obtain a sufficient number of significant customers during a particular period could adversely affect its operating results. If the Company fails to develop or introduce new products in a timely fashion, its business will suffer. If the Company fails to develop or introduce on a timely basis new products or product enhancements or features that achieve market acceptance, its business will suffer. The markets for the Company's network systems and diagnostics products are characterized by rapidly changing technology, frequent new product introductions, short product life cycles and enhancements and evolving industry standards. The Company's success will depend to a significant extent upon its ability to accurately anticipate the evolution of new products, technologies and market trends and to enhance its existing products. It will also depend on the Company's ability to timely develop and introduce innovative new products that gain market acceptance. Finally, sales of both the Company's network systems and its diagnostics products depend in part on the continuing development and deployment of emerging standards and our ability to offer new products and services that comply with these standards. There can be no assurances that the Company will be successful in selecting, developing, manufacturing and marketing new products or enhancing its existing products on a timely or cost-effective basis. Moreover, the Company may encounter technical problems in connection with its product development that could result in the delayed introduction of new products or product enhancements. In addition, products or technologies developed by others may render the Company's products noncompetitive or obsolete. Litigation related to product liability claims could be expensive and could negatively affect the Company's profitability. Products as complex as the Company's may contain undetected errors when first introduced or as new versions are released. Such errors, particularly those that result in a failure of the Company's switching products or telecommunications networks, could harm the Company's customer relationships, business and reputation. While the Company's products have earned a reputation for reliability and performance, there can be no assurances that the Company's products will not have errors in the future. A product liability claim brought against the Company could result in costly, protracted, highly disruptive and time consuming litigation, which would harm the Company's business. In addition, the Company may be subject to claims arising from its failure to properly service or maintain its products or to adequately remedy 26 defects in its products once such defects have been detected. The Company's agreements with its customers typically contain provisions designed to limit its exposure to potential product liability claims. However, it is possible that the limitation of liability provisions contained in the Company's agreements may not be effective under the laws of some jurisdictions, particularly since the Company has significant international sales. Although the Company maintains product liability insurance, it may not be sufficient to cover all claims to which the Company may be subject. The successful assertion against the Company of one or a series of large uninsured claims would harm the Company's business. Although the Company has not experienced any significant product liability claims to date, the Company's sale and support of products may entail the risk of these types of claims, and subject the Company to such claims in the future. In August 2000, Alcatel USA, Inc. and Alcatel USA Sourcing, L.P. (collectively, "Alcatel") filed a complaint against Tekelec alleging that Tekelec manufactures and sells products that infringe two patents owned by Alcatel USA Sourcing, L.P. The patents at issue relate to a system and method for application location register routing in a telecommunications network. Although the Company believes that it has defenses to Alcatel's claims on the ground of invalidity, noninfringement and inequitable conduct by Alcatel, there can be no assurance that the Company will be successful in this action. See "Legal Proceedings", Item 3. If customers do not continue to purchase test systems, the Company's diagnostics business would be harmed. The future success of the Company's diagnostics business will depend on continued growth in the market for telecommunications test systems and services and the continued commercial acceptance of the Company's diagnostics products as solutions to address the testing requirements of telecommunications equipment manufacturers, to a lesser extent, and network operators. While most of the Company's existing and potential customers have the technical capability and financial resources to produce their own test systems and perform test services internally, many have chosen to purchase a substantial portion of their test equipment needs. There can be no assurances that the Company's customers will continue to purchase their test systems from third parties or that potential new customers will purchase test equipment. Even if they do, they may choose the diagnostics products and services offered by the Company's competitors. Certain of the Company's customers in the diagnostics market also manufacture network systems products that compete or may compete with the Company's current or future network systems products. Increasing competition in the network systems market may cause these customers to reduce their purchases of the Company's diagnostics products. The Company is dependent on relationships with strategic partners and distributors and other resellers. The Company believes that its ability to compete successfully against other network systems product manufacturers depends in part on distribution and marketing relationships with leading communications equipment suppliers. If the Company cannot successfully enter these types of relationships on favorable terms to the Company or maintain these relationships, the Company's business may suffer. In addition, the Company expects to increasingly rely on the deployment of its products with those of other manufacturers, systems integrators and other resellers, both domestically and 27 internationally. To the extent the Company's products are so incorporated, the Company depends on the timely and successful development of those other products. Although the Company currently has a network of distributors for its diagnostics products and uses distributors only to a limited extent or not at all with respect to its other product lines, the Company may expand its distribution activities with respect to its other products, including network infrastructure products. The Company's compliance with telecommunications regulations and standards may be difficult and costly, and if the Company fails to comply, its product sales would decrease. In order to maintain market acceptance, the Company's products must continue to meet a significant number of regulations and standards. In the United States, the Company's products must comply with various regulations defined by the Federal Communications Commission and Underwriters Laboratories as well as standards established by Telcordia (formerly Bell Telecommunications Research). Internationally, the Company's products must comply with standards established by telecommunications authorities in various countries as well as with recommendations of the International Telecommunications Union. As these standards evolve, the Company will be required to modify its products or develop and support new versions of its products. The failure of the Company's products to comply, or delays in compliance, with the various existing and evolving industry standards could delay introduction of its products, which could harm the Company's business. In order to penetrate the Company's target markets, it is important that the Company ensures the interoperability of its products with the operations, administration, maintenance and provisioning systems used by the Company's customers. To ensure this interoperability, the Company periodically submits its products to technical audits. The Company's failure or delay in obtaining favorable technical audit results could adversely affect its ability to sell products to some segments of the communications market. Government regulatory policies are likely to continue to have a major impact on the pricing of existing as well as new public network services and, therefore, are expected to affect demand for such services and the communications products, including the Company's products, that support such services. Tariff rates, whether determined autonomously by carriers or in response to regulatory directives, may affect cost effectiveness of deploying public network services. Tariff policies are under continuous review and are subject to change. User uncertainty regarding future policies may also affect demand for communications products, including the Company's products. In addition, the convergence of circuit and packet networks could be subject to governmental regulation. Regulatory initiatives in this area could adversely affect the Company's business. The Company has significant international sales, and international markets have inherent risks. International sales are subject to inherent risks, including unexpected changes in regulatory requirements and tariffs, difficulties in staffing and managing foreign operations and distributors, longer payment cycles, greater difficulty in accounts receivable collection and potentially adverse tax consequences. Doing business overseas is generally more costly than doing business in the United States. The Company sells its products worldwide through its direct sales forces, distributors and other resellers and wholly owned subsidiaries in Japan and the United Kingdom. International sales accounted for 23% in 1999, 29% in 2000 and 27% in 2001. 28 The Company's sales through its Japanese subsidiary, and to a limited extent, other sales, are denominated in local currencies while other international sales are U.S. dollar-denominated. The Company expects that international sales will continue to account for a significant portion of its revenues in future periods. Exchange rate fluctuations on foreign currency transactions and translations arising from international operations may contribute to fluctuations in the Company's business and operating results. Fluctuations in exchange rates could also affect demand for the Company's products. If, for any reason, exchange or price controls or other restrictions in foreign countries are imposed, the Company's business and operating results could suffer. In addition, any inability to obtain local regulatory approvals in foreign markets on a timely basis could harm the Company's business. In particular, if the Company is not able to manage its continuing expansion into Europe and planned expansion into Latin America, the Company's business may suffer. In addition, the Company is relatively unknown in Europe and Latin America, and the Company may have difficulty establishing relationships or building name recognition, which could adversely affect its performance in these markets. Moreover, European telecommunications networks generally have a different structure, and the Company's products may not be completely compatible with this different structure. As a result, the Company's products may not be competitive with those of its competitors in Europe. Access to foreign markets is often difficult due to the established relationships between a government-owned or controlled communications operating company and its traditional indigenous suppliers of communications equipment. These foreign communications networks are in many cases owned or strictly regulated by government. There can be no assurances that the Company will be able to successfully penetrate these markets, particularly for its switching products. The Company's loss of services of key personnel or failure to attract and retain additional key personnel could adversely affect the Company's business. The Company depends to a significant extent upon the continuing services and contributions of its senior management team and other key personnel, particularly Michael L. Margolis, its Chief Executive Officer and President; Fred Lax, its Chief Operating Officer and Executive Vice President, Lori Craven, its Vice President and General Manager, Network Systems Division; Lee Smith, its Vice President and General Manager, Network Diagnostics Division; and Debbie May, its Vice President and General Manager, Contact Center Division. The Company does not have long-term employment agreements or other arrangements with its employees which would prevent them from leaving Tekelec. The Company's future success also depends upon its ongoing ability to attract and retain highly skilled personnel. The Company's business could suffer if it were to lose any key personnel and not be able to find appropriate replacements in a timely manner or if it were unable to attract and retain additional highly skilled personnel. There can be no assurances that the Company's measures to protect its proprietary technology and other intellectual property rights are adequate. The Company's success depends to a significant degree on its proprietary technology and other intellectual property. Although the Company regards its technology as proprietary, it has 29 sought only limited patent protection. The Company relies on a combination of patents, copyrights, trademarks, trade secrets, confidentiality agreements and contractual restrictions to establish and protect its proprietary rights. These measures, however, afford only limited protection and may not prevent third parties from misappropriating the Company's technology or other intellectual property. In addition, the laws of certain foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States, which makes misappropriation of the Company's technology and other intellectual property more likely. It is possible that others will independently develop similar products or design around the Company's patents and other proprietary rights. If the Company fails to successfully enforce or defend its intellectual property rights or if it fails to detect misappropriation of its proprietary rights, the Company's ability to effectively compete could be seriously impaired. The Company's pending patent and trademark registration applications may not be allowed, and the Company's competitors may challenge the validity or scope of the Company's patent or trademark registration applications. In addition, the Company from time to time faces challenges to the validity or enforceability of its proprietary rights and litigation may be necessary to enforce and protect its rights, to determine the validity and scope of its proprietary rights and the rights of others, or to defend against claims of infringement or invalidity. Any such litigation would be expensive and time consuming, would divert the Company's management and key personnel from business operations and would likely harm its business and operating results. If third parties claim that the Company is infringing their intellectual property, the Company may be prevented from selling certain products and incur significant expenses to resolve these claims. The Company receives from time to time claims of infringement from third parties or otherwise becomes aware of relevant patents or other intellectual property rights of third parties that may lead to disputes and litigation. Any claims made against the Company regarding patents or other intellectual property rights could be expensive and time consuming to resolve or defend and could have a material adverse effect on the Company's business. In addition, any such claims would divert the Company's management and key personnel from its business operations and may require the Company to modify or cease marketing its products, develop new technologies or products, acquire licenses to proprietary rights that are the subject of the infringement claim or refund to its customers all or a portion of the amounts they paid for infringing products. If such claims are asserted, there can be no assurances that the Company would prevail or be able to acquire any necessary licenses on acceptable terms, if at all. In addition, the Company may be requested to defend and indemnify certain of its customers and resellers against claims that its products infringe the proprietary rights of others. The Company may also be subject to potentially significant damages or injunctions against the sale of certain products or use of certain technologies. There can be no assurances whether litigation can be avoided or successfully concluded. Although the Company believes that its intellectual property rights are sufficient to allow it to sell its existing products without violating the valid proprietary rights of others, there can be no assurances that the Company's technologies or products do not infringe on the proprietary rights of third parties or that such parties will not initiate infringement actions against the Company. If the Company is unable to procure some of its subsystems and components from other manufacturers, the Company may not be able to obtain substitute subsystems or components on terms that are as favorable. 30 Certain of the Company's products contain subsystems or components acquired from other OEMs. These OEM products are often available only from a limited number of manufacturers. In the event that an OEM product becomes unavailable from a current OEM vendor, second sourcing would be required. This sourcing may not be available on reasonable terms, if at all, and could delay customer deliveries, which could adversely affect the Company's business. The Company is exposed to the credit risk of some of its customers and to credit exposures in weakened markets. Due to the current slowdown in the economy, the credit risks relating to Tekelec's customers have increased. Although the Company has programs in place to monitor and mitigate the associated risk, there can be no assurance that such programs will be effective in reducing the Company's credit risks. The Company also continues to monitor credit exposure from weakened financial conditions in certain geographic regions, and the impact that such conditions may have on the worldwide economy. The Company has experienced losses due to customers' failing to meet their obligations. Although these losses have not been significant, future losses, if incurred, could harm the Company's business and have a material adverse effect on its operating results and financial condition. Substantial future sales of the Company's Common Stock or sales by its directors and officers in the public market may depress the Company's stock price. Sales of a substantial number of shares of the Company's Common Stock in the future could cause the Company's stock price to fall. All of the Company's directors and executive officers own or have options to acquire shares of Tekelec Common Stock and sales by these individuals could be perceived negatively by investors and could cause the market price of the Common Stock to drop. The Company's shareholder rights plan may make it more difficult for a third party to acquire us, despite the possible benefits to our shareholders. The Company's shareholder rights plan may have the effect of delaying, deferring or preventing a change in control of the Company despite possible benefits to its shareholders, may discourage bids at a premium over the market price of Tekelec Common Stock and may harm the market price of the Common Stock. Tekelec's stock price may be volatile. The market price for Tekelec Common Stock has experienced price volatility and may continue to be volatile and subject to fluctuations in response to factors including those set forth in this Annual Report. The stock markets in general, and The Nasdaq Stock Market and technology and telecommunications companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to companies' operating performances. These broad market and industry factors, as well as general economic and political conditions, may materially adversely impact the market price of Tekelec Common Stock in the future, regardless of the Company's actual operating performance. 31 Item 2. PROPERTIES The Company's executive offices and principal manufacturing operations are located in Calabasas, California in facilities consisting of approximately 77,000 square feet. The Company leases the facility under a lease expiring in November 2004, subject to a five-year renewal option. The Company also occupies a 155,000 square-foot facility in Morrisville, North Carolina under a lease expiring in November 2009. This facility is used primarily for engineering, product development, customer support and regional sales activities for the Company's network systems products. In July 2000, the Company agreed to lease an additional 161,000 square-foot facility in Morrisville, North Carolina, to be constructed in three phases. Phase one was completed in July 2001, and approximately 57,000 square feet are occupied by the Company. Construction of the entire facility is scheduled to be completed by May 2003. This facility is used primarily for engineering, product development, customer support and regional sales activities for the Company's network diagnostics products. The Company's IEX subsidiary leases a facility consisting of approximately 95,000 square feet in Richardson, Texas under a lease expiring in May 2003, subject to a five-year renewal option. The IEX facility is used for engineering, product development, customer support, and general administrative and sales activities for certain of the Company's network systems products and the Company's contact center products. The Company also has seven regional sales offices occupying an aggregate of approximately 12,000 square feet under leases expiring between 2002 and 2005 in Englewood, Colorado; Duluth, Georgia; Lombard, Illinois; Mt. Laurel, New Jersey; Irving, Texas; Sunset Hills, Virginia; and Amsterdam, the Netherlands. The Company's Japanese subsidiary occupies approximately 14,000 square feet in Tokyo under leases expiring between April 2002 and November 2003. The Company's subsidiary in the United Kingdom occupies approximately 20,000 square feet in Egham under a lease expiring in March 2016. The Company believes that its existing facilities will be adequate to meet the Company's needs at least through 2002, and that the Company will be able to obtain additional space when, where and as needed on acceptable terms. Item 3. LEGAL PROCEEDINGS Alactel USA, Inc. and Alcatel USA Sourcing, L.P. vs. Tekelec In August 2000, Alcatel USA, Inc. and Alcatel USA Sourcing, L.P. (collectively, "Alcatel") filed a complaint against Tekelec in the United States District Court for the Eastern District of Texas, Sherman Division. The complaint alleges that Tekelec makes and sells products that infringe two patents owned by Alcatel Sourcing. The patents at issue relate to a system and method for application location register routing in a telecommunications network. Alcatel's allegations relate to three particular software applications offered by Tekelec as features on its EAGLE STP for routing query messages in wireless networks. Alcatel seeks a permanent injunction enjoining the Company from infringing the patents at issue, unspecified general and exemplary damages, and an award of costs. 32 In September 2000, Tekelec filed an answer and counterclaim to Alcatel's complaint denying Alcatel's claims of infringement and raising several affirmative defenses. Tekelec has also asserted several counterclaims against Alcatel seeking declaratory relief that Tekelec has not infringed the Alcatel patents and that such patents are invalid and unenforceable. Tekelec believes that it has strong defenses to Alcatel's claims on the grounds of invalidity, noninfringement and inequitable conduct by Alcatel, and is defending the action vigorously. The parties are currently completing pre-trial discovery. A trial date has been scheduled for June of 2002. IEX Corporation vs. Blue Pumpkin Software, Inc. In January 2001, IEX Corporation, a wholly owned subsidiary of Tekelec ("IEX"), filed suit against Blue Pumpkin Software, Inc., in the United States District Court for the Eastern District of Texas, Sherman Division. In its complaint, IEX asserts that certain of Blue Pumpkin's products and services infringe United States Patent No. 6,044,355 held by IEX. In the suit, IEX seeks damages and an injunction prohibiting Blue Pumpkin's further infringement of the patent. In February 2001, Blue Pumpkin responded to IEX's suit denying that Blue Pumpkin infringes IEX's patent and asserting that such patent is invalid. IEX intends to vigorously prosecute this action and to protect its intellectual property. Lemelson Medical, Education and Research Foundation, Limited Partnership vs. Tekelec In March 2002, the Lemelson Medical, Education & Research Foundation, Limited Partnership ("Lemelson") filed a complaint against thirty defendants, including Tekelec, in the United States District Court for the District of Arizona. The complaint alleges that all defendants make, offer for sale, sell, import, or have imported products that infringe eighteen patents assigned to Lemelson, and the complaint also alleges that the defendants use processes that infringe the same patents. The patents at issue relate to computer image analysis technology and automatic identification technology. Lemelson has not identified the specific Tekelec products or processes that allegedly infringe the patents at issue, and Tekelec is currently investigating which products and/or processes might be subject to the lawsuit. Several other Arizona lawsuits involving the same patents have been stayed pending a non-appealable resolution of a lawsuit involving the same patents in the United States District Court for the District of Nevada. Tekelec believes that the same stay may apply to this lawsuit as well. Tekelec currently believes that the ultimate outcome of the lawsuit will not have a material adverse effect on its financial condition or overall results of operations. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Inapplicable 33 PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's Common Stock is traded on The Nasdaq Stock Market under the symbol TKLC. The following table sets forth the range of high and low closing sales prices for the Common Stock for the periods indicated. As of March 1, 2002, there were 242 record shareholders of the Company's Common Stock. High Low ------- ------- 2000 First Quarter........................... $ 52.19 $ 23.88 Second Quarter.......................... 48.19 27.38 Third Quarter........................... 48.13 28.88 Fourth Quarter.......................... 39.69 24.06 2001 First Quarter........................... $ 30.50 $ 16.88 Second Quarter.......................... 35.56 16.13 Third Quarter........................... 26.35 11.79 Fourth Quarter.......................... 21.56 12.06 The Company has never paid a cash dividend on its Common Stock. It is the present policy of the Company to retain earnings to finance the growth and development of its business and, therefore, the Company does not anticipate paying cash dividends on its Common Stock in the foreseeable future. On November 2, 1999, the Company issued $135,000,000 principal amount at maturity of its 3.25% Convertible Subordinated Discount Notes due 2004 (the "Notes") in a private placement and without registration in reliance on Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"). The issue price of the Notes was 85.35% of the principal amount at maturity, and the total gross proceeds to the Company were $115,227,900 before discounts and expenses. The Notes are convertible into Common Stock of the Registrant at any time on or after January 31, 2000, unless previously redeemed or otherwise repurchased by the Registrant. The conversion rate of the Notes is 56.3393 shares of Common Stock per $1,000 principal amount at maturity, subject to adjustment in certain events. The Company sold the Notes to Deutsche Bank Securities Inc. and Warburg Dillon Read LLC as the initial purchasers, and the initial purchasers have advised the Company that they resold the Notes only to "Qualified Institutional Buyers" (as defined in Rule 144A under the Securities Act) in compliance with Rule 144A and, outside of the United States, to investors that were not "United States persons" as defined in Rule 902 of Regulation S under the Securities Act. In February 2000, the Company registered for resale the Notes and the shares of Common Stock issuable upon conversion thereof under the Securities Act of 1933. The notes are callable after three years from issuance. 34 Item 6. SELECTED CONSOLIDATED FINANCIAL DATA. The statement of operations data included in the selected consolidated financial data set forth below for the years ended December 31, 2001, 2000 and 1999 and the balance sheet data set forth below at December 31, 2001 and 2000 are derived from, and are qualified in their entirety by reference to, the Company's audited consolidated financial statements and notes thereto included in this Annual Report on Form 10-K. The statement of operations data set forth below for the years ended December 31, 1998 and 1997 and the balance sheet data set forth below at December 31, 1999, 1998 and 1997 are derived from audited consolidated financial statements of the Company, which are not included herein. Five-Year Selected Financial Data
For the Years Ended December 31, 2001 2000 1999 1998 1997 ---------- ---------- ---------- ---------- ---------- (thousands, except per share data) Statement of Operations Data: Revenues ......................................................... $ 312,451 $ 314,334 $ 226,068 $ 176,669 $ 125,140 Income (Loss) before provision for income taxes ............................................ (816) 29,622 10,229 55,551 29,741 Net income (loss) ................................................ (6,899) 12,896 444 39,209 28,996 Earnings (Loss) per share: Basic ....................................................... $ (0.12) $ 0.22 $ 0.01 $ 0.73 $ 0.58 Diluted ..................................................... (0.12) 0.20 0.01 0.67 0.51 Weighted average number of shares outstanding: Basic ....................................................... 59,574 57,823 54,931 53,518 50,408 Diluted ..................................................... 59,574 64,123 58,690 58,708 56,842 Balance Sheet Data (at December 31): Cash and liquid investments ...................................... $ 230,980 $ 159,413 $ 106,664 $ 113,774 $ 70,518 Working capital .................................................. 185,168 218,935 127,702 108,762 86,354 Total assets ..................................................... 484,404 458,524 394,434 210,210 136,465 Long-term liabilities ............................................ 137,929 136,050 137,552 2,252 2,839 Shareholders' equity ............................................. 248,822 237,597 176,595 165,777 107,877
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and the notes thereto included in this Annual Report on Form 10-K. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods. The Tekelec logo and Eagle are registered trademarks of Tekelec. Tekelec IP7 Secure Gateway, ASi 4000, VXi, MGTS i3000, TotalView and TotalNet are trademarks of Tekelec. OVERVIEW The Company's product offerings are currently organized along three distinct product lines: network systems, network diagnostics and contact center. Network Systems Products. The Company's network systems product line consists principally of the Eagle 5 SAS and related products, features and applications based on the Eagle platform, including the IP7 Secure Gateway and the Company's local number portability solution, the ASi 4000 Service Control Point, the VXi Media Gateway Controller and other convergence 35 products. During 2000, the Company's business segments were reorganized to include the Sentinel network surveillance system in the network systems products segment. Network Diagnostics Products. This product line consists principally of the MGTS and MGTS i3000 families of diagnostics products. Contact Center Products. The Company's IEX contact center products provide planning, management and call routing and control tools for single contact centers and for complex, multiple site contact center environments. This product line includes the TotalView Workforce Management and TotalNet Call Routing solutions. In 2000, the IEX Call Center Division was renamed the Contact Center Division due to the evolution of that division's products to support multimedia contact centers. Critical Accounting Policies and Estimates Management's discussion and analysis of financial condition and results of operations were based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires making estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, estimates are evaluated, including those related to revenue recognition, allowance for doubtful accounts, inventories, investments, deferred taxes, impairment of long-lived assets, product warranty, and contingencies and litigation. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. The Company applies the following critical accounting policies in the preparation of the consolidated financial statements: o Revenue Recognition Policy. Revenues are derived from sales of network systems products, diagnostics products and contact center products. Revenues are recognized upon the transfer of title, generally at the time of shipment to the customer's final site and satisfaction of related Company obligations, if any, provided that persuasive evidence of an arrangement exists, the fee is fixed and determinable and collectability is deemed probable. For certain products, the Company's sales arrangements include acceptance provisions which are based on the Company's published specifications and are accounted for as warranty, provided that the Company has previously demonstrated that the product meets the specified criteria and has established a history with substantially similar transactions. Revenue is deferred for sales arrangements which include customer-specific acceptance provisions where the Company is unable to reliably demonstrate that the delivered product meets all of the specified criteria until customer acceptance is obtained. Revenues associated with multiple-element arrangements are allocated to each element based on vendor specific objective evidence of fair value. Revenues associated with installation services, if provided, are deferred based on the fair value of such services and are recognized upon completion. Revenue is recognized for maintenance agreements ratably over the contract term. Significant management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period. Material differences may result in the amount and timing of our revenue for any period if management made different judgments or utilized different estimates. 36 o Allowance for Doubtful Accounts. An allowance for doubtful accounts is maintained for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. o Inventories. Inventory levels are based on projections of future demand and market conditions. Any sudden decline in demand and/or rapid product improvements and technological changes can result in excess and/or obsolete inventories. On an ongoing basis inventories are reviewed and written down for estimated obsolescence or unmarketable inventories equal to the difference between the costs of inventories and the estimated net realizable value based upon forecasts for future demand and market conditions. If actual market conditions are less favorable than our forecasts, additional inventory reserves may be required. Estimates could be influenced by sudden decline in demand due to economic downturn, rapid product improvements and technological changes. o Investments. An impairment charge is recorded when an asset has experienced a decline in value that is other than temporary. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment's current carrying value, thereby possibly requiring an impairment charge in the future. o Deferred Taxes. A valuation allowance is recorded to reduce deferred tax assets to the amount that is more likely than not to be realized. The Company has evaluated its deferred tax assets and liabilities and has determined that no valuation allowance is necessary. Should it be determined that the Company would not be able to realize all or part of the net deferred tax asset in the future, an adjustment to the deferred tax asset would reduce income in the period such determination was made. o Impairment of Long-Lived Assets. The Company evaluates the recoverability of its identifiable intangible assets, goodwill and other long-lived assets in accordance with SFAS No. 121, which generally requires assessing these assets for recoverability when events or circumstances indicate a potential impairment by estimating the undiscounted cash flows to be generated from the use and ultimate disposition of these assets. Upon implementation of SFAS No. 142 on January 1, 2002, the fair value method will be used to assess goodwill on at least an annual basis and the undiscounted cash flows method will continue to be used for qualifying identifiable intangible assets and other long-lived assets. As discussed in the "Recent Accounting Pronouncements" section, the Company is currently evaluating the provisions of SFAS No. 142 and its impact on the Company's consolidated financial statements. o Product Warranty. Our warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting product failures. Should actual product failure rates, material usage or service delivery costs differ from our estimates, revisions to the estimated warranty liability would be required. 37 o Commitments and Contingencies. We evaluate contingent liabilities including threatened or pending litigation in accordance with SFAS No. 5, "Accounting for Contingencies" and record accruals when the outcome of these matters is deemed probable and the liability is reasonably estimable. We make these assessments based on the facts and circumstances and in some instances based in part on the advice of outside legal counsel. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentages that statement of operations items bear to total revenues:
Percentage of Revenues For the Years Ended December 31, ---------------------------------------- 2001 2000 1999 -------- -------- -------- Revenues ..................................................... 100.0% 100.0% 100.0% Cost of goods sold ...................................... 33.0 34.4 34.3 Amortization of purchased technology .................... 3.3 3.2 2.8 -------- -------- -------- Gross Profit ................................................. 63.7 62.4 62.9 Research and development ................................ 23.0 17.3 18.7 Selling, general and administrative ..................... 33.8 28.3 28.4 Amortization of goodwill and other intangibles .......... 6.9 7.0 7.0 Acquired in-process research and development and other acquisition-related charges .................... -- -- 3.0 Restructuring ........................................ -- -- 0.8 -------- -------- -------- Income from operations ....................................... 0.0 9.8 5.0 Interest and other expense, net ....................... (0.3) (0.4) (0.5) -------- -------- -------- Income (Loss) before provision for income taxes .............. (0.3) 9.4 4.5 Provision for income taxes ................................... 1.9 5.3 4.3 -------- -------- -------- Net income (loss) ..................................... (2.2%) 4.1% 0.2% ======== ======== ========
The following table sets forth, for the periods indicated, the revenues by principal product line as a percentage of total revenues:
Percentage of Revenues For the Years Ended December 31, ---------------------------------------- 2001 2000 1999 -------- -------- -------- Network Systems .............................................. 68% 70% 66% Network Diagnostics .......................................... 20 20 25 Contact Center ............................................... 12 10 9 -------- -------- -------- Total ................................................. 100% 100% 100% ======== ======== ========
38 The following table sets forth, for the periods indicated, the revenues by geographic territory as a percentage of total revenues:
Percentage of Revenues For the Years Ended December 31, ---------------------------------------- 2001 2000 1999 -------- -------- -------- North America ................................................ 73% 71% 77% Japan ........................................................ 9 8 10 Europe ....................................................... 7 11 4 Rest of World ................................................ 11 10 9 -------- -------- -------- Total ................................................. 100% 100% 100% ======== ======== ========
2001 Compared with 2000 Revenues. The Company's revenues decreased by $1.9 million, or 1%, during 2001 due primarily to lower sales of network systems products and services partially offset by higher sales of contact center products. Revenues from network systems products decreased by $9.2 million, or 4%, due primarily to lower sales of the Company's IP7 and Sentinel products offset by higher sales of Eagle STP and local number portability products. Revenues from network diagnostics products increased by $1.4 million, or 2%, due primarily to higher sales of MGTS-related development services and secondarily to higher subcontracting revenues. Revenues from contact center products increased by $5.9 million, or 18%, due primarily to increased sales of the TotalView product and secondarily to higher TotalNet sales. Revenues in North America increased by $4.0 million, or 2%, due primarily to higher sales of Eagle STP products. Sales in Japan increased $1.4 million, or 5%, as a result of higher sales of MGTS-related development services and higher subcontracting revenues. Revenues in Europe decreased by $11.7 million, or 35%, due to lower network systems product sales. Rest of world revenues increased by $4.4 million, or 14%, due to higher contact center sales. The impact of exchange rate fluctuations on currency translations decreased revenues by $3.5 million, or 1%, and did not have a material effect on net loss. The Company believes that its future revenue growth depends in large part upon a number of factors, including the continued market acceptance, both domestically and internationally, of the Company's products, particularly the Eagle products and related applications as well as the Company's suite of products for converged circuit and packet networks, including the IP7 Secure Gateway and VXi Media Gateway Controller network systems products and the MGTS i3000 diagnostics product. Gross Profit. Gross profit as a percentage of revenues increased to 63.7% in 2001 compared with 62.4% in 2000. The increase in gross margin was primarily due to the Company recording a non-recurring charge of $2.9 million to write-down inventory related to the IEX network switch product line in 2000. Excluding the write-down of inventory in 2000, gross profit as a percentage of sales was essentially flat at 63.7% in 2001 compared to 63.3% in 2000. 39 Changes in the following factors, among others, may affect gross profit: product and distribution channel mix; competition; customer discounts; supply and demand conditions in the electronic components industry; internal manufacturing capabilities and efficiencies; foreign currency fluctuations; and general economic conditions. Research and Development. Research and development expenses increased overall by $17.4 million, or 32%, and increased as a percentage of revenues to 23.0% in 2001 from 17.3% in 2000. The increase was attributable principally to increased expenses incurred in connection with the hiring of additional personnel for product development and enhancements for network systems, primarily related to the development of products to address the Internet Protocol ("IP")/Signaling System #7 ("SS7") and media gateway controller, or "softswitch" markets, and Third Generation wireless ("3G") network diagnostic products. The Company intends to continue to make substantial investments in product and technology development and believes that its future success depends in large part upon its ability to continue to enhance existing products and to develop or acquire new products that maintain the Company's technological competitiveness. Selling, General and Administrative. Selling, general and administrative expenses increased by $16.6 million, or 19%, and increased as a percentage of revenues to 33.8% in 2001 from 28.3% in 2000. The dollar increase was primarily due to increased personnel and infrastructure-related expenses incurred to support the Company's installed base and an increase in the allowance for doubtful accounts. Charges to the allowance for doubtful accounts amounted to $4.4 million in 2001 compared to $3.0 million in 2000. Selling, general and administrative expenses also included a charge of $750,000 in connection with the settlement of a legal dispute in 2000. Amortization of Goodwill and Other Intangibles. Amortization of goodwill and intangible assets decreased by $256,000, and decreased slightly as a percentage of revenue at 6.9% in 2001 as compared to 7.0% in 2000. Interest and Other Income (Expense), net. Interest expense was $9.0 million in 2001, compared to $8.7 million in 2000. Interest income increased by $808,000 in 2001, or 10%, due to higher invested cash balances in 2001 compared to 2000, partially offset by lower interest rates. Income Taxes. The income tax provision for 2001 was $6.1 million and reflected the effect of non-deductible acquisition-related costs, partially offset by a benefit of $4.6 million from the utilization of deferred tax liabilities related to certain of these acquisition-related costs. Excluding the effect of these acquisition-related items, an estimated effective tax rate of 35% was applied and represented federal, state and foreign taxes on the Company's income, reduced primarily by research and development and foreign tax credits, compared to an effective tax rate of 35% for 2000. The Company expects that its effective tax rate, excluding the effect of acquisition-related items, will remain relatively consistent with and within the range of the effective tax rates in prior years. Changes in the tax rate can be affected by changes in the mix of international sales and changes in the amount of the research and development credits. 40 2000 Compared with 1999 Revenues. The Company's revenues increased by $88.3 million, or 39%, during 2000 due primarily to higher sales of network systems products and services and secondarily to the inclusion of post-acquisition sales of IEX contact center products for the full year and higher sales of network diagnostics products. Revenues from network systems products increased by $70.8 million, or 48%, due primarily to higher sales of the Company's Eagle STP and local number portability products, increased upgrade and extensions sales, and higher sales of the Company's IP7 products. Revenues from network diagnostics products increased by $6.2 million, or 11%, due to higher sales of the Company's MGTS i3000 diagnostic system. Revenues from contact center products increased by $11.2 million, or 53%, compared to 1999, which only included sales following the May 1999 acquisition, and increased sales on a full-year comparison basis of TotalView Workforce Management products. Revenues in North America increased by $50.1 million, or 29%, due primarily to higher sales of Eagle STP products and IP7 Secure Gateway product sales. Sales in Japan increased $3.6 million, or 16%, as a result of higher sales of MGTS and third-party data diagnostics products. Revenues in Europe increased by $23.8 million, or 245%, due to higher network systems product sales. Rest of world revenues increased by $10.7 million, or 52%, due to increased Eagle STP sales. The impact of exchange rate fluctuations on currency translations increased revenues by $1.6 million, or 1%, and did not have a material effect on net income. Gross Profit. Gross profit as a percentage of revenues decreased to 62.4% in 2000 compared with 62.9% in 1999. The decrease in gross margin was primarily due to the increase in amortization of purchased technology, primarily in connection with the acquisition of IEX, for twelve months in 2000 compared to eight months of such amortization in 1999. Excluding the amortization of purchased technology related to the IEX acquisition, gross profit as a percentage of sales was essentially flat at 65.6% in 2000 compared to 65.7% in 1999. In 2000, the Company also recorded a non-recurring charge of $2.9 million to write-down inventory related to the IEX network switch product line. Research and Development. Research and development expenses increased overall by $12.2 million, or 29%, and decreased as a percentage of revenues to 17.3% in 2000 from 18.7% in 1999. The dollar increase was attributable principally to increased expenses incurred in connection with the hiring of additional personnel for product development and enhancements for both network systems and network diagnostics products, primarily related to the Company's continued development of products to address the IP/SS7 and Media Gateway Controller, or "softswitch," markets. 41 Selling, General and Administrative. Selling, general and administrative expenses increased by $24.7 million, or 38%, and decreased slightly as a percentage of revenues to 28.3% in 2000 from 28.4% in 1999. The dollar increase was primarily due to increased personnel and infrastructure-related expenses incurred to support the Company's installed base and anticipated higher sales levels. Selling, general and administrative expenses for 2000 include a $2.3 million charge to record an allowance for doubtful accounts related to outstanding receivables from a customer which filed for bankruptcy protection under Chapter 11 in March 2001 and a charge of $750,000 in connection with the settlement of a legal dispute. Amortization of Goodwill and Other Intangibles. Amortization of goodwill and intangible assets increased by $6.1 million, but stayed flat as a percentage of revenue at 7.0% in 2000 and 1999. The dollar increase was due to the amortization of goodwill and intangibles, primarily in connection with the acquisition of IEX, for the full year in 2000 compared to eight months in 1999. Interest and Other Income (Expense), net. Interest expense was $8.7 million in 2000, compared to $4.9 million in 1999. The $3.8 million increase was primarily due to a full year of interest expense in 2000 for the Company's convertible notes, compared to approximately eight months of interest expense in 1999 for short-term notes issued by the Company in May 1999 in connection with the acquisition of IEX, and interest for the convertible notes issued in November 1999 to retire the short-term notes. Interest income increased $3.9 million, or 91%, due to higher invested cash balances in 2000 compared to 1999. Income Taxes. The income tax provision for 2000 was $16.7 million and reflected the effect of non-deductible acquisition-related costs, partially offset by a benefit of $4.7 million from the utilization of deferred tax liabilities related to certain of these acquisition-related costs. Excluding the effect of these acquisition-related items, an estimated effective tax rate of 35% was applied and represented federal, state and foreign taxes on the Company's income, reduced primarily by research and development and foreign tax credits, compared to an effective tax rate of 35% for 1999. Liquidity and Capital Resources General During 2001, cash and cash equivalents increased by $26.5 million to $92.2 million, after $45.1 million net purchases of short-term and long-term investments, other than investments in privately-held companies. Operating activities, net of the effects of exchange rate changes on cash, provided $96.4 million. Financing activities, which represented proceeds from the issuance of Common Stock upon the exercise of options and warrants, provided $12.8 million, and investing activities, excluding net purchases of short-term and long-term investments other than equity investments in privately-held companies, used $37.6 million primarily for capital expenditures and investments in privately-held companies. During 2001 and 2000, the Company financed net working capital and capital expenditure requirements principally from operations, available cash and proceeds from the issuance of Common Stock upon the exercise of options and warrants. Cash flow from operating activities was comprised mainly of net loss adjusted for depreciation, amortization and tax benefits related to stock options exercised, a decrease in accounts receivable and an increase in deferred revenue. Net accounts receivables decreased by 42 34% during 2001 due primarily to a decrease in revenues in the fourth quarter of 2001 compared to 2000 and strong collections activity. Capital expenditures of $20.5 million during 2001 represented the planned addition of equipment principally for research and development, manufacturing operations and a Company wide information system. The Company has a $20.0 million line of credit with a U.S. bank and lines of credit aggregating $2.3 million available to the Company's Japanese subsidiary from various Japan-based banks. The Company's $20.0 million credit facility is collateralized by substantially all of the Company's assets, bears interest at or, in some cases, below the lender's prime rate (4.75% at December 31, 2001), and expires on October 31, 2002, if not renewed. Under the terms of this facility, the Company is required to maintain certain financial ratios and meet certain net worth and indebtedness covenants. The Company believes it is in compliance with these requirements. There have been no borrowings under this credit facility. The Company's Japanese subsidiary has collateralized yen-denominated lines of credit with Japan-based banks, primarily available for use in Japan, amounting to the equivalent of $2.3 million with interest at Japan's prime rate (1.375% at December 31, 2001) plus 0.125% per annum, which expire between February 2002 and August 2002, if not renewed. There have been no borrowings under these lines of credit. In November 1999, the Company completed the private placement of $135.0 million principal amount at maturity of 3.25% convertible subordinated discount notes due in 2004 (the "Notes"), issued at 85.35% of their face amount (equivalent to gross proceeds of approximately $115.2 million at issuance before discounts and expenses). The Notes are callable after three years from issuance. In November 1999, the Company used a portion of the net proceeds from the Notes to retire all of the $100 million in short-term notes issued in May 1999 in connection with the acquisition of IEX Corporation. During 2001, a significant portion of our cash inflows were generated by our operations. Because our operating results may fluctuate significantly, as a result of decrease in customer demand or decrease in the acceptance of our future products, our ability to generate positive cash flow from operations may be jeopardized. 43 Future payments due under debt and lease obligations as of December 31, 2001 (in thousands): 3.25% Convertible Non Subordinated Cancelable Notes due Operating 2004 (1) Leases Total ---------- ---------- ---------- 2002 $ -- $ 6,910 $ 6,910 2003 -- 7,382 7,382 2004 135,000 5,760 140,760 2005 -- 4,678 4,678 2006 -- 4,758 4,758 2007 and thereafter -- 20,655 20,655 ---------- ---------- ---------- $ 135,000 $ 50,143 $ 185,143 ========== ========== ========== (1) In 2002, 2003 and 2004 the Company will make interest payments of $4.4 million, $4.4 million and $3.7 million, respectively. The Company believes that its existing working capital, funds generated through operations, and its current bank lines of credit will be sufficient to satisfy operating requirements for at least the next twelve months. Nonetheless, the Company may seek additional sources of capital as necessary or appropriate to fund acquisitions or to otherwise finance the Company's growth or operations; however, there can be no assurance that such funds, if needed, will be available on favorable terms, if at all. Foreign Exchange International operations are subject to certain opportunities and risks, including currency fluctuations. In 2001, 2000, and 1999, the percentages by which weighted average exchange rates for the Japanese yen strengthened (weakened) against the U.S. dollar were (11%), (3%) and 15%, respectively. The change in cumulative translation adjustments in 2001 was due primarily to the weakening of the Japanese yen against the U.S. dollar when comparing the exchange rate at December 31, 2001, to that of December 31, 2000. Realized exchange gains (losses) are recorded in the period when incurred, and amounted to ($849,000), ($492,000) and $79,000 in 2001, 2000, and 1999, respectively. Exchange gains and losses include foreign currency transactions and the settlement of intercompany balances. Financial Risk The Company's international sales are predominantly denominated in U.S. dollars, and therefore exposure to foreign currency exchange fluctuations on international sales is limited. In certain instances where the Company has entered into contracts which are denominated in foreign currencies, the Company has obtained foreign currency forward and option contracts, principally denominated in Euros or British pounds, to offset the impact of currency rates on accounts receivable. The Company had no forward or option contracts outstanding as of December 31, 2001. The notional amount of the forward and option contracts outstanding was $10.0 million at December 31, 2000. The fair value of the forward contracts and options and 44 premiums paid for the options were not material. The Company does not enter into derivative instrument transactions for trading or speculative purposes. The Company does not hedge foreign currencies in a manner that would entirely eliminate the effects of the changes in foreign currency rates on the Company's consolidated net income. The Company does not typically hedge its exposure to the Japanese Yen, which is the functional currency for the Company's Japanese subsidiary. Fixed income securities are subject to interest rate risk. The fair value of the Company's investment portfolio would not be significantly impacted by either a 100 basis point increase or decrease in interest rates due mainly to the short-term nature of the major portion of the Company's investment portfolio. The portfolio is diversified and consists primarily of investment grade securities to minimize credit risk. There have been no borrowings under the Company's variable rate credit facilities. All of the Company's outstanding long-term debt is fixed rate and not subject to interest rate fluctuation. With respect to trade receivables, the Company sells network systems, communications diagnostic systems and contact center systems worldwide primarily to telephone operating companies, equipment manufacturers and corporations that use its systems to design, install, maintain, test and operate communications equipment and networks. Credit is extended based on an evaluation of each customer's financial condition, and generally collateral is not required. Generally, payment terms stipulate payment within 90 days of shipment and currently, the Company does not engage in leasing or other customer financing arrangements. Many of the Company's international sales are secured with import insurance or letters of credit to mitigate credit risk. Although the Company has processes in place to monitor and mitigate credit risk, there can be no assurance that such programs will be effective in eliminating such risk. Historically, credit losses have been within management's expectations and relatively insignificant. The Company's exposure to credit risk has increased as a result of weakened financial conditions in certain market segments such as the Competitive Local Exchange Carrier segment. Credit losses for such customers have been provided for in the financial statements. Future losses, if incurred, could harm the Company's business and have a material adverse effect on the Company's financial position, results of operations or cash flows. Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 133 "Accounting for Derivative Instruments and Hedging Activities." The statement requires the recognition of all derivatives as either assets or liabilities on the balance sheet and the measurement of those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the planned use of the derivative and the resulting designation. The Company implemented SFAS No. 133 in the first quarter of 2001 and the adoption of SFAS No. 133 did not have a material impact on the Company's financial position, results of operations or cash flows. In June 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 establishes new standards for accounting and reporting requirements for business combinations initiated after June 30, 2001 and prohibits the use of the pooling-of-interests method for combinations initiated after June 30, 2001. SFAS No. 142 changes the accounting for goodwill from an amortization method to an 45 impairment-only approach. Upon adoption of SFAS No. 142 on January 1, 2002, goodwill will be tested at the reporting unit annually and whenever events or circumstances occur indicating that goodwill might be impaired. Amortization of goodwill, including goodwill recorded in past business combinations, will cease. Amortization of goodwill in 2001 was $19.1 million and the unamortized balance of goodwill was $44.7 million as of December 31, 2001. The Company is currently evaluating the provisions of SFAS No. 142 and their potential impact on the Company's consolidated financial statements. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. This Statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." This Statement also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for segments of a business to be disposed of. This Statement also amends ARB No. 51, "Consolidated Financial Statements," to eliminate the exception to consolidation for a temporarily controlled subsidiary. The adoption date for SFAS No. 144 was effective January 1, 2002 and its impact will be evaluated in conjunction with SFAS No. 142 as discussed above. 46 "Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995 The statements that are not historical facts contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Annual Report on Form 10-K are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that reflect the current belief, expectations or intent of the Company's management. These statements are subject to and involve certain risks and uncertainties including, but not limited to, timing of significant orders and shipments and the resulting fluctuation of the Company's operating results; changes in customer product mix; customer acceptance of the Company's products; capital spending patterns of customers; the Company's limited product offerings; risks relating to the convergence of voice and data networks; competition and pricing; the Company's relatively limited number of customers; new product introductions by the Company or its competitors; product liability risks; the continued growth in third party purchases of diagnostics systems; uncertainties relating to the Company's international operations; intellectual property protection; carrier deployment of new technologies and intelligent network services; the level and timing of research and development expenditures; regulatory changes; general economic conditions; and other risks described in this Annual Report on Form 10-K and in certain of the Company's other Securities and Exchange Commission filings. Many of these risks and uncertainties are outside of the Company's control and are difficult for the Company to forecast or mitigate. Actual results may differ materially from those expressed or implied in such forward-looking statements. The Company is not responsible for updating or revising these forward-looking statements. Undue emphasis should not be placed on any forward-looking statements contained herein or made elsewhere by or on behalf of the Company. See also "Business - Business Risk Factors." 47 Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company's international sales are predominantly denominated in U.S. dollars, and therefore exposure to foreign currency exchange fluctuations on international sales is limited. In certain instances where the Company has entered into contracts which are denominated in foreign currencies, the Company has obtained foreign currency forward and option contracts, principally denominated in Euros or British pounds, to offset the impact of currency rates on accounts receivable. The Company had no forward or option contracts outstanding as of December 31, 2001. The notional amount of the forward and option contracts outstanding was $10.0 million at December 31, 2000. The fair value of the forward contracts and options and premiums paid for the options were not material. The Company does not enter into derivative instrument transactions for trading or speculative purposes. The Company does not hedge foreign currencies in a manner that would entirely eliminate the effects of the changes in foreign currency rates on the Company's consolidated net income. The Company does not typically hedge its exposure to the Japanese Yen, which is the functional currency for the Company's Japanese subsidiary. Fixed income securities are subject to interest rate risk. The fair value of the Company's investment portfolio would not be significantly impacted by either a 100 basis point increase or decrease in interest rates due mainly to the short-term nature of the major portion of the Company's investment portfolio. The portfolio is diversified and consists primarily of investment grade securities to minimize credit risk. There have been no borrowings under the Company's variable rate credit facilities. All of the Company's outstanding long-term debt is fixed rate and not subject to interest rate fluctuation. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. See the consolidated financial statements of the Company and its subsidiaries included herein and listed in Item 14(a) of this Annual Report on Form 10-K. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information required by this Item is incorporated by reference to the sections of the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on May 10, 2002, entitled "Election of Directors," "Executive Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance" to be filed with the Commission. 48 Item 11. EXECUTIVE COMPENSATION. The information required by this Item is incorporated by reference to the sections of the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on May 10, 2002, entitled "Election of Directors - Compensation of Directors," "Executive Compensation and Other Information," "Board of Directors and Compensation Committee Reports on Executive Compensation" and "Performance Graph," to be filed with the Commission. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this Item is incorporated by reference to the section of the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on May 10, 2002, entitled "Common Stock Ownership of Principal Shareholders and Management," to be filed with the Commission. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this Item is incorporated by reference to the section of the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on May 10, 2002, entitled "Certain Relationships and Related Transactions," to be filed with the Commission. 49 PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) The following documents are filed as part of this Report: Page 1. Consolidated Financial Statements ---- o Report of Independent Accountants F-1 o Consolidated Statements of Operations for each of the three years in the period ended December 31, 2001 F-2 o Consolidated Balance Sheets as of December 31, 2001 and 2000 F-3 o Consolidated Statements of Cash Flow for each of the three years in the period ended December 31, 2001 F-4 o Consolidated Statements of Shareholders' Equity for each of the three years in the period ended December 31, 2001 F-6 o Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2001 F-7 o Notes to Consolidated Financial Statements F-8 2. Consolidated Financial Statement Schedule o Report of Independent Accountants on Financial Statement Schedule S-1 o Schedule II Valuation and Qualifying Accounts and Reserves for each of the three year in the period ended December 31, 2001 S-2 Schedules which are not listed above have been omitted because they are not applicable or the information required to be set forth therein is included in the consolidated financial statements or notes thereto. 3. List of Exhibits Exhibit Number Exhibit ------ ------- 3.1 Amended and Restated Articles of Incorporation(1) 3.2 Bylaws, as amended(2) 4.1 Rights Agreement dated as of August 25, 1997 between the Registrant and U.S. Stock Transfer Corporation as Rights Agent(3) 50 4.2 Indenture dated as of November 2, 1999 between the Registrant and Bankers Trust Company as Trustee, including form of the Registrant's 3.25% Convertible Subordinated Discount Notes due 2004(4) 4.3 Registration Rights Agreement dated as of November 2, 1999 among the Registrant, Deutsche Bank Securities Inc. and Warburg Dillon Read LLC(4) 10.1 Amended and Restated 1984 Stock Option Plan, including forms of stock option agreements(5) (6) 10.2 Amended and Restated Non-Employee Director Equity Incentive Plan, including form of nonstatutory stock option agreement(5), as amended February 21, 1996(6) (7) 10.3 1994 Stock Option Plan, including forms of stock option agreements(8), as amended February 4, 1995(9), March 3, 1995(9), January 27, 1996(7), February 26, 1997(10), March 19, 1997(10), March 20, 1998(11), March 19, 1999(12), March 23, 2000 (13) and May 18, 2001 (6) (14) 10.4 Form of Indemnification Agreement between the Registrant and all directors of the Registrant(6) (15) 10.5 Lease Agreement dated as of February 8, 1988 between the Registrant and State Street Bank and Trust Company of California, N.A., not individually, but solely as an Ancillary Trustee for State Street Bank and Trust Company, a Massachusetts banking corporation, not individually, but solely as Trustee for the AT&T Master Pension Trust, covering the Company's principal facilities in Calabasas, California(16) 10.6 Officer Severance Plan, including form of Employment Separation Agreement(17), as amended March 8, 1999( 18 ) and February 4, 2000(6) (19) 10.7 Employee Stock Purchase Plan, including form of subscription agreement (7), as amended May 18, 2001 (6) (14) 10.8 Warrants to purchase shares of the Registrant's Common Stock and Schedule of Warrantholders(6) (20) 10.9 Stock Award Agreement dated February 17, 1998 between the Registrant and Michael Margolis(6) (21) 10.10 Lease Agreement dated as of November 6, 1998 between the Registrant and Weeks Realty, L.P., covering certain of the Registrant's facilities in Morrisville, North Carolina(18) as amended by First Amendment thereto dated May 27, 1999, Second Amendment thereto dated October 1, 1999, Third Amendment thereto dated November 30, 1999, and Fourth Amendment thereto dated July 19, 2000 (22) 51 10.11 Loan Agreement and Promissory Note dated October 31, 2001 between the Registrant and Union Bank of California 10.12 Lease Agreement as of July 19, 2000 between the Registrant and Duke Construction Limited Partnership covering certain of the Company's facilities in Morrisville, North Carolina (22) 10.13 Nonstatutory Stock Option Agreement dated February 1, 2001 between the Registrant and Frederick M. Lax (6) (23) 10.14 Stock Award Agreement dated February 1, 2001 between the Registrant and Frederick M. Lax (6) (23) 10.15 Employment Offer Letter dated November 15, 2001 between the Registrant and Lori A. Craven 10.16 Employment Offer Letter dated November 15, 2001 between the Registrant and Daniel B. Walters 21.1 Subsidiaries of the Registrant 23.1 Consent of PricewaterhouseCoopers LLP - --------------------- (1) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (File No. 0-15135) for the quarter ended June 30, 1998. (2) Incorporated by reference to the Registrant's Annual Report on Form 10-K (File No. 0-15135) for the year ended December 31, 1996. (3) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (File No. 0-15135) for the quarter ended September 30, 1997. (4) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q (File No. 0-15135) for the quarter ended September 30, 1999. (5) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (Registration No. 33-48079) filed with the Commission on May 22, 1992. (6) Constitutes a management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K. (7) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (Registration No. 333-05933) filed with the Commission on June 13, 1996. (8) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (Registration No. 33-82124) filed with the Commission on July 28, 1994. 52 (9) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (Registration No. 33-60611) filed with the Commission on June 27, 1995. (10) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (Registration No. 333-28887) filed with the Commission on June 10, 1997. (11) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (Registration No. 333-71261) filed with the Commission on January 27, 1999. (12) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (File No. 0-15135) for the quarter ended June 30, 1999. (13) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (Registration Statement No. 333-39588) filed with the Commission on June 19, 2000. (14) Incorporate by reference to the Registrant's Quarterly Report on Form 10-Q (File No. 0-15135) for the quarter ended June 30, 2001. (15) Incorporated by reference to the Registrant's Annual Report on Form 10-K (File No. 0-15135) for the year ended December 31, 1987. (16) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (File No. 0-15135) for the quarter ended June 30, 1988. (17) Incorporated by reference to the Registrant's Annual Report on Form 10-K (File No. 0-15135) for the year ended December 31, 1993. (18) Incorporated by reference to the Registrant's Annual Report on Form 10-K (File No. 0-15135) for the year ended December 31, 1998. (19) Incorporated by reference to the Registrant's Annual Report on Form 10-K (File No. 0-15135) for the year ended December 31, 1999. (20) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (Registration No. 333-37843) filed with the Commission on October 14, 1997. (21) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (File No. 0-15135) for the quarter ended March 31, 1998. (22) Incorporated by reference to the Registrant's Annual Report on Form 10-K (File No. 0-15135) for the year ended December 31, 2000. (23) Incorporated by reference to the Registrant's Quarterly Report on 10-Q (File No. 0-15135) for the quarter ended March 31, 2001. 53 (b) Reports on Form 8-K No reports on Form 8-K were filed by the Registrant during the quarter ended December 31, 2001. (c) Exhibits See the list of Exhibits under Item 14(a) 3 of this Annual Report on Form 10-K. (d) Financial Statement Schedules See the Schedule under Item 14(a) 2 of this Annual Report on Form 10-K. 54 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. TEKELEC By: /s/ Michael L. Margolis -------------------------------------- Michael L. Margolis, President and Chief Executive Officer Dated: March 28, 2002 Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- /s/ Jean-Claude Asscher Chairman of the Board March 28, 2002 - ------------------------- Jean-Claude Asscher /s/ Michael L. Margolis President, Chief Executive March 28, 2002 - ------------------------- Officer and Director Michael L. Margolis /s/ Robert V. Adams Director March 28, 2002 - ------------------------- Robert V. Adams /s/ Daniel L. Brenner Director March 28, 2002 - ------------------------- Daniel L. Brenner /s/ Howard Oringer Director March 28, 2002 - ------------------------- Howard Oringer /s/ Jon F. Rager Director March 28, 2002 - ------------------------- Jon F. Rager /s/ Paul J. Pucino Vice President and Chief March 28, 2002 - ------------------------- Financial Officer Paul J. Pucino (Principal Financial and Chief Accounting Officer) 55 REPORT OF INDEPENDENT ACCOUNTANTS TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF TEKELEC In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, cash flows, shareholders' equity, and comprehensive income (loss) present fairly, in all material respects, the financial position of Tekelec and its subsidiaries (the "Company") at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. /s/ PricewaterhouseCoopers LLP Los Angeles, California January 29, 2002 F-1 Tekelec Consolidated Statements of Operations
For the Years Ended December 31, -------------------------------------------- 2001 2000 1999 -------------------------------------------- Revenues .................................................... $ 312,451 $ 314,334 $ 226,068 Cost of Sales: Cost of goods sold ..................................... 103,043 108,001 77,389 Amortization of purchased technology ................... 10,324 10,135 6,397 ---------- ---------- ---------- Total cost of sales ................................ 113,367 118,136 83,786 ---------- ---------- ---------- Gross profit ....................................... 199,084 196,198 142,282 ---------- ---------- ---------- Operating expenses: Research and development ............................... 71,851 54,466 42,289 Selling, general and administrative .................... 105,620 89,043 64,294 Amortization of goodwill and other intangibles ......... 21,664 21,920 15,863 Acquired in-process research and development and other acquisition-related charges ................. -- -- 6,830 Restructuring .......................................... -- -- 1,800 ---------- ---------- ---------- Total operating expenses ............................ 199,135 165,429 131,076 ---------- ---------- ---------- Income (Loss) from operations .............................. (51) 30,769 11,206 Interest and other income (expense): Interest income ........................................ 8,893 8,085 4,230 Interest expense ....................................... (8,955) (8,739) (4,914) Other, net ............................................. (703) (493) (293) ---------- ---------- ---------- Total other income (expense) ........................ (765) (1,147) (977) ---------- ---------- ---------- Income (Loss) before provision for income taxes ............. (816) 29,622 10,229 Provision for income taxes ............................. 6,083 16,726 9,785 ---------- ---------- ---------- Net income (loss) ................................... $ (6,899) $ 12,896 $ 444 ========== ========== ========== Earnings (Loss) per share: Basic .................................................. $ (0.12) $ 0.22 $ 0.01 Diluted ................................................ (0.12) 0.20 0.01 Weighted average number of shares outstanding: Basic .................................................. 59,574 57,823 54,931 Diluted ................................................ 59,574 64,123 58,690
See notes to consolidated financial statements F-2 Tekelec Consolidated Balance Sheets
December 31, -------------------------- 2001 2000 -------------------------- (thousands) Assets Current assets: Cash and cash equivalents ............................................... $ 92,172 $ 65,690 Short-term investments, at fair value ................................... 68,608 81,723 Accounts and notes receivable, less allowances 2001 - $5,349; 2000 - $4,287 .......................................... 68,467 104,506 Inventories ............................................................. 21,317 25,868 Deferred income taxes, net .............................................. 15,840 14,429 Prepaid expenses and other current assets ............................... 16,417 11,596 ---------- ---------- Total current assets .................................................. 282,821 303,812 Long-term investments, at fair value ......................................... 70,200 12,000 Property and equipment, net .................................................. 34,759 31,700 Investments in privately-held companies ...................................... 16,500 -- Deferred income taxes ........................................................ 4,350 2,964 Other assets ................................................................. 3,482 3,825 Intangible assets ............................................................ 72,292 104,223 ---------- ---------- Total assets .......................................................... $ 484,404 $ 458,524 ========== ========== Liabilities and Shareholders' Equity Current liabilities: Trade accounts payable .................................................. $ 16,903 $ 16,750 Accrued expenses ........................................................ 22,583 22,784 Accrued payroll and related expenses .................................... 9,986 12,063 Current portion of deferred revenues .................................... 46,587 31,832 Income taxes payable .................................................... 1,594 1,448 ---------- ---------- Total current liabilities ............................................. 97,653 84,877 Long-term convertible debt ................................................... 122,992 119,269 Deferred income taxes ........................................................ 9,983 14,558 Long-term portion of deferred revenues ....................................... 4,954 2,223 ---------- ---------- Total liabilities ..................................................... 235,582 220,927 ---------- ---------- Commitments and contingencies (Note M) Shareholders' equity: Common stock, without par value, 200,000,000 shares authorized; issued and outstanding 2001-60,107,087; 2000-58,896,708 ............... 171,846 151,830 Retained earnings ....................................................... 78,525 85,424 Accumulated other comprehensive income (loss) ........................... (1,549) 343 ---------- ---------- Total shareholders' equity ............................................ 248,822 237,597 ---------- ---------- Total liabilities and shareholders' equity ............................ $ 484,404 $ 458,524 ========== ==========
See notes to consolidated financial statements F-3 Tekelec Consolidated Statements of Cash Flows
For the Years Ended December 31, ------------------------------------------ 2001 2000 1999 ------------------------------------------ (thousands) Cash flows from operating activities: Net income (loss) .................................................... $ (6,899) $ 12,896 $ 444 Adjustments to reconcile net income to net cash provided by operating activities: Allowance for doubtful accounts ...................................... 4,412 2,968 265 Inventory provision .................................................. 3,448 4,393 760 Depreciation ......................................................... 17,315 11,846 8,519 Amortization ......................................................... 31,989 32,056 22,128 Amortization of deferred financing costs ............................. 819 812 132 Write-offs of acquired in-process research and development ........................................................ -- -- 6,000 Non-cash portion of restructuring charge ............................. -- -- 800 Convertible debt accretion ........................................... 3,723 3,483 558 Deferred income taxes ................................................ (7,478) (11,008) (4,742) Stock-based compensation ............................................. 310 121 121 Tax benefits related to stock options exercised ...................... 6,943 22,457 2,009 Changes in assets and liabilities: (excluding the effect of acquisition) Accounts and notes receivable ...................................... 30,537 (22,860) (18,722) Inventories ........................................................ 596 (6,260) (6,084) Income taxes receivable ............................................ -- -- 3,478 Prepaid expenses and other current assets .......................... (4,844) (6,472) (1,182) Trade accounts payable ............................................. 803 1,195 3,383 Accrued expenses ................................................... (16) 3,749 5,798 Accrued payroll and related expenses ............................... (2,010) 3,187 (4,442) Deferred revenues .................................................. 17,486 (3,812) 11,328 Income taxes payable ............................................... 229 879 149 ---------- ---------- ---------- Total adjustments ................................................ 104,262 36,734 30,256 ---------- ---------- ---------- Net cash provided by operating activities ........................ 97,363 49,630 30,700 ---------- ---------- ---------- Cash flows from investing activities: Purchase of available-for-sale securities ............................ (257,472) (115,964) (52,737) Proceeds from maturity of available-for-sale securities ......................................................... 212,387 82,234 81,842 Purchase of investments in privately-held companies .................. (16,500) -- -- Payments in connection with acquisition, net of cash acquired ........................................................... -- -- (49,087) Purchase of property and equipment ................................... (20,473) (21,990) (13,948) Purchase of technology ............................................... (59) (573) (1,561) Increase in other assets ............................................. (530) (399) (3,615) ---------- ---------- ---------- Net cash used in investing activities ............................ (82,647) (56,692) (39,106) ---------- ---------- ---------- Cash flows from financing activities: Repayments of short-term notes ....................................... -- -- (100,000) Net proceeds from issuance of convertible debt ....................... -- -- 115,228 Proceeds from issuance of common stock ............................... 12,763 27,867 6,452 ---------- ---------- ---------- Net cash provided by financing activities ........................ 12,763 27,867 21,680 ---------- ---------- ---------- Effect of exchange rate changes on cash ................................... (997) (1,786) 1,465 ---------- ---------- ---------- Net increase in cash and cash equivalents .................................................... 26,482 19,019 14,739 ---------- ---------- ---------- Cash and cash equivalents at beginning of the year ........................ 65,690 46,671 31,932 ---------- ---------- ---------- Cash and cash equivalents at end of the year .............................. $ 92,172 $ 65,690 $ 46,671 ========== ========== ==========
See notes to consolidated financial statements F-4 Tekelec Consolidated Statements of Cash Flows (Continued)
For the Years Ended December 31, ---------------------------------------------- 2001 2000 1999 ---------------------------------------------- (thousands) Supplemental disclosure of cash flow information: Cash paid during the year for: Interest ............................................ $ 4,398 $ 4,420 $ 3,471 Income taxes ........................................ 6,210 7,140 8,248 Supplemental disclosure of non-cash flow activity: Notes payable issued in connection with acquisition ........ -- -- 100,000 Assets and liabilities recognized in connection with acquisition: Accounts receivable ................................. -- -- 9,957 Other current assets ................................ -- -- 13,261 Investments ......................................... -- -- 7,255 Property and equipment .............................. -- -- 3,490 Other assets ........................................ -- -- 169 Intangibles ......................................... -- -- 61,000 Goodwill ............................................ -- -- 95,274 Accounts payable .................................... -- -- 1,515 Other current liabilities ........................... -- -- 22,929 Deferred income tax liability ....................... -- -- 22,875
See notes to consolidated financial statements F-5 Tekelec Consolidated Statements of Shareholders' Equity
Common Stock Accumulated ----------------------- Other Total Number Retained Comprehensive Shareholders' of Shares Amount Earnings Income (Loss) Equity - ------------------------------------------------------------------------------------------------------------------------------------ (thousands) - ------------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1998 54,329 $ 92,803 $ 72,084 $ 890 $ 165,777 Exercise of stock options and warrants and issuance of shares under employee stock purchase plan 1,384 6,452 -- -- 6,452 Issuance of restricted stock, net of unearned compensation -- 121 -- -- 121 Stock option tax benefits -- 2,009 -- -- 2,009 Translation adjustment -- -- -- 1,792 1,792 Net income -- -- 444 -- 444 - ------------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1999 55,713 $ 101,385 $ 72,528 $ 2,682 $ 176,595 Exercise of stock options and warrants and issuance of shares under employee stock purchase plan 3,184 27,867 -- -- 27,867 Compensation related to vesting of restricted stock -- 121 -- -- 121 Stock option tax benefits -- 22,457 -- -- 22,457 Translation adjustment -- -- -- (2,339) (2,339) Net income -- -- 12,896 -- 12,896 - ------------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 2000 58,897 $ 151,830 $ 85,424 $ 343 $ 237,597 Exercise of stock options and warrants and issuance of shares under employee stock purchase plan 1,180 12,763 -- -- 12,763 Compensation related to vesting of restricted stock 30 310 -- -- 310 Stock option tax benefits -- 6,943 -- -- 6,943 Translation adjustment -- -- -- (1,892) (1,892) Net loss -- -- (6,899) -- (6,899) - ------------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 2001 60,107 $ 171,846 $ 78,525 $ (1,549) $ 248,822 ====================================================================================================================================
See notes to consolidated financial statements F-6 Tekelec Consolidated Statements of Comprehensive Income (Loss)
For the Years Ended December 31, -------------------------------------- 2001 2000 1999 -------------------------------------- (thousands) Net income (loss) .................................... $ (6,899) $ 12,896 $ 444 Other comprehensive income (loss): Foreign currency translation adjustments ........ (1,892) (2,339) 1,792 -------- -------- -------- Comprehensive income (loss) .......................... $ (8,791) $ 10,557 $ 2,236 ======== ======== ========
See notes to consolidated financial statements F-7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business The Company designs, manufactures and markets network systems products and diagnostics systems for telecommunications networks. The Company's customers include telecommunications carriers, network service providers and equipment manufacturers. The Company also develops and sells management software to operators of contact centers. Principles of Consolidation and Presentation The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions are eliminated. Certain items shown in the December 31, 2000 and 1999 financial statements have been reclassified to conform with the current period presentation. Estimates The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and revenues and expenses during the reporting periods. Actual results could differ from those estimates. Cash and Cash Equivalents The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Investments The Company's marketable securities are classified as available-for-sale securities and are accounted for at their fair value, and unrealized gains and losses on these securities are reported as a separate component of shareholders' equity. At December 31, 2001 and 2000, net unrealized gains or losses on available-for-sale securities were not significant. The Company utilizes specific identification in computing realized gains and losses on the sale of investments. Realized gains and losses are reported in other income and expense, and were not significant for 2001, 2000 and 1999. The Company also invests in equity instruments of privately-held companies for business and strategic purposes. These investments are classified as long-term assets and are accounted for under the cost method as the Company does not have the ability to exercise significant influence over operations. The Company monitors its investments for impairment and records reductions in carrying values when necessary. Inventories Inventories are stated at the lower of cost (first in, first out) or market. F-8 Property and Equipment Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method. The estimated useful lives are: Manufacturing and development equipment 3-5 years Furniture and office equipment 5 years Demonstration equipment 3 years Leasehold improvements The shorter of useful life or lease term Software Developed for Internal Use The Company capitalizes costs of software, consulting services, hardware and payroll-related costs incurred to purchase or develop internal-use software. The Company expenses costs incurred during preliminary project assessment, research and development, re-engineering, training and application maintenance. Software Development Costs The Company provides for capitalization of certain software development costs once technological feasibility is established. The costs so capitalized are amortized on a straight-line basis over the estimated product life (generally eighteen months to three years), or on the ratio of current revenue to total projected product revenues, whichever is greater. To date, the establishment of technological feasibility of the Company's products and general release have substantially coincided. As a result, the Company has not capitalized any internal software development costs as costs qualifying for such capitalization have not been significant. Intangible Assets Intangible assets consist of goodwill, purchased technology and other intangible assets, all of which are generally amortized over periods ranging from three to five years. Intangible assets are stated at cost, less accumulated amortization. Long-Term Assets The Company identifies and records impairment on long-lived assets, including goodwill that is not identified with an impaired asset, when events and circumstances indicate that such assets have been impaired. Events and circumstances that may indicate that an asset is impaired include: significant decreases in the fair market value of an asset, a change in the extent or manner in which an asset is used, shifts in technology, loss of key management or personnel, changes in the operating model or strategy and competitive forces. If events and circumstances indicate that that the carrying amount of an asset may not be recoverable and the expected undiscounted future cash flows attributable to the asset is less than the carrying amount of the asset, an impairment loss equal to the excess of the asset's carrying value over its fair value is recorded. Fair value is determined based on the present value of estimated expected future cash flows using a discount rate commensurate with the risks involved, quoted market prices or appraised values, depending on the nature of the assets. To date, no such impairment has been recorded. Product Warranty Costs The Company generally warrants its products against defects in materials and workmanship for one year after sale and provides for estimated future warranty costs at the time F-9 revenue is recognized. At December 31, 2001 and 2000, accrued product warranty costs amounted to $5.5 million and $3.4 million, respectively, and are included in accrued expenses. Revenue Recognition Revenues from sales of network systems products, diagnostic products and contact center products are recognized upon the transfer of title, generally at the time of shipment to the customer's final site and satisfaction of related Company obligations, if any, provided that persuasive evidence of an arrangement exists, the fee is fixed and determinable and collectability is deemed probable. For certain products, the Company's sales arrangements include acceptance provisions which are based on the Company's published specifications and are accounted for as warranty, provided that the Company has previously demonstrated that the product meets the specified criteria and has established a history with substantially similar transactions. Revenue is deferred for sales arrangements which include customer-specific acceptance provisions where the Company is unable to reliably demonstrate that the delivered product meets all of the specified criteria until customer acceptance is obtained. Revenues associated with multiple-element arrangements are allocated to each element based on vendor specific objective evidence of fair value. Revenues associated with installation services, if provided, are deferred based on the fair value of such services and are recognized upon completion. Installation services are accounted for as a separate element based on the customer's obligation to pay the contract price upon shipment of the related equipment and the fact that such services are not essential to the functionality of the related equipment, are available from other vendors and can be purchased unaccompanied by other elements. Extended warranty service revenues are recognized ratably over the warranty period. Engineering service revenues are recognized on delivery or as the services are performed. Development contract revenues are recognized using the percentage-of-completion method based on the costs incurred relative to total estimated costs. Provisions for anticipated losses, if any, on development contracts are recognized in income currently. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 provides guidance for revenue recognition under certain circumstances. The Company's existing revenue recognition policies are in accordance with Statement of Position (SOP) 97-2, "Software Revenue Recognition" and the adoption of SAB No. 101 in 2000 did not have a significant impact on the Company's financial position, results of operations or cash flows. Income Taxes Income tax expense is the tax payable for the period and the change during the period in non-capital-related deferred tax assets and liabilities. Deferred income taxes are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted rates in effect during the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Advertising Advertising costs are expensed as incurred and amounted to $1.1 million, $1.6 million and $1.4 million for 2001, 2000 and 1999, respectively. Stock-Based Compensation The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees," and complies with the disclosure provisions of F-10 Statement of Financial Accounting Standard ("SFAS") No. 123, "Accounting for Stock-Based Compensation." Under APB No. 25, compensation expense is recognized over the vesting period based on the difference, if any, on the date of grant between the fair value of the Company's stock and the exercise price on the date of grant. The Company accounts for stock issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force ("EITF") 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods and Services." See Note Q. Foreign Currency Translation of foreign currencies is accounted for using the local currency as the functional currency of the Company's foreign subsidiaries. All assets and liabilities are translated at exchange rates in effect on the balance sheet dates while revenues and expenses are translated at average rates in effect for the period. The resulting gains and losses are included in a separate component of shareholders' equity. Realized gains (losses) on foreign currency transactions are reflected in net income (loss) and amounted to ($849,000), ($492,000), and $79,000 for 2001, 2000 and 1999, respectively. Earnings Per Share Earnings per share are computed using the weighted average number of shares outstanding and dilutive Common Stock equivalents (options and warrants), in accordance with SFAS No. 128, "Earnings per Share." Comprehensive Income Comprehensive income generally represents all changes in shareholders' equity during the period except those resulting from investments by, or distributions to, shareholders. Segment Information The Company uses the "management approach" in determining reportable business segments. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 133 "Accounting for Derivative Instruments and Hedging Activities." The statement requires the recognition of all derivatives as either assets or liabilities on the balance sheet and the measurement of those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the planned use of the derivative and the resulting designation. The Company implemented SFAS No. 133 in the first quarter of 2001 and the adoption of SFAS No. 133 did not have a material impact on the Company's financial position, results of operations or cash flows. In June 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 establishes new standards for accounting and reporting requirements for business combinations initiated after June 30, 2001 and prohibits the use of the pooling-of-interests method for combinations initiated after June 30, 2001. SFAS No. 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Upon adoption of SFAS No. 142 on January 1, 2002, goodwill will be tested at the reporting unit annually and whenever events or circumstances occur indicating F-11 that goodwill might be impaired. Amortization of goodwill, including goodwill recorded in past business combinations, will cease. Amortization of goodwill in 2001 was $19.1 million and the unamortized balance of goodwill was $44.7 million as of December 31, 2001. The Company is currently evaluating the provisions of SFAS No. 142 and their potential impact on the Company's consolidated financial statements. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. This Statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." This Statement also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for segments of a business to be disposed of. This Statement also amends ARB No. 51, "Consolidated Financial Statements," to eliminate the exception to consolidation for a temporarily controlled subsidiary. The adoption date for SFAS No. 144 was effective January 1, 2002 and its impact will be evaluated in conjunction with SFAS No. 142 as discussed above. NOTE B - ACQUISITION OF IEX CORPORATION On May 7, 1999, the Company acquired all of the outstanding stock of IEX Corporation ("IEX") for $163 million, consisting of $63 million in cash and $100 million in short-term notes that were refinanced with convertible notes in November 1999 (See Note L). IEX develops, markets and sells solutions for intelligent networks, contact centers and other telecommunications markets. The transaction has been accounted for under the purchase method of accounting, and resulted in net goodwill and other intangibles of approximately $133.4 million, with an average amortization period of five years. The total purchase price, including acquisition expenses of $2.0 million, was allocated among the assets acquired and liabilities assumed based on their estimated fair values as follows: (thousands) In-process research and development ....................... $ 6,000 Developed and existing technology ......................... 48,000 Other intangibles ......................................... 13,000 Goodwill .................................................. 95,274 Tangible assets acquired .................................. 50,045 Deferred income tax liabilities associated with certain intangible assets ............................... (22,875) Liabilities assumed ....................................... (24,444) --------- $ 165,000 ========= Based on a third party appraisal, management determined that $6.0 million of the purchase price represented acquired in-process research and development that had not yet reached technological feasibility and had no alternative future use. This amount was recorded as a non-recurring expense in the second quarter of 1999. Amortization expense of purchased technology and other intangible assets resulting from the acquisition amounted to $26.7 million and $26.8 million, net of amortization of associated deferred income tax liabilities of $4.6 million and $4.7 million, for 2001 and 2000, respectively. F-12 NOTE C -- FAIR VALUE OF INVESTMENTS The Company had short-term investments in corporate debt securities with original maturities of less than 90 days whose carrying amounts approximate their fair values because of their short maturities. These short-term investments are included in cash and cash equivalents, are classified as held-to-maturity securities and amounted to $53.4 million at December 31, 2000. The Company did not have any of these types of securities at December 31, 2001. The Company also had investments classified as available-for-sale securities included in short-term and long-term investments, categorized as follows:
December 31, ---------------------- 2001 2000 ---------------------- (thousands) Type of Security: Corporate debt securities with maturities of less than one year ................. $ 68,608 $ 59,723 U.S. government securities with maturities of less than one year ................ -- 22,000 -------- -------- Total short-term investments .................................................... 68,608 81,723 U.S. government securities with maturities of between one and three years ....... 70,200 12,000 -------- -------- $138,808 $ 93,723 ======== ========
NOTE D -- BUSINESS AND CREDIT RISK Financial instruments, which potentially subject the Company to concentration of credit risk, consist principally of cash, investments and trade receivables. The Company invests its excess cash in interest-bearing deposits with major banks, United States government securities, high-quality commercial paper and money market funds. At times the Company's cash balances may be in excess of the FDIC insurance limits. With respect to trade receivables, the Company sells network systems, communications diagnostic systems and contact center systems worldwide primarily to telephone operating companies, equipment manufacturers and corporations that use its systems to design, install, maintain, test and operate communications equipment and networks. Credit is extended based on an evaluation of each customer's financial condition, and generally collateral is not required. Generally, payment terms stipulate payment within 90 days of shipment and currently, the Company does not engage in leasing or other customer financing arrangements. Many of the Company's international sales are secured with import insurance or letters of credit to mitigate credit risk. Although the Company has processes in place to monitor and mitigate credit risk, there can be no assurance that such programs will be effective in eliminating such risk. Historically, credit losses have been within management's expectations and relatively insignificant. The Company's exposure to credit risk has increased as a result of weakened financial conditions in certain market segments such as the Competitive Local Exchange Carrier segment. Credit losses for such customers have been provided for in the financial statements. Future losses, if incurred, could harm the Company's business and have a material adverse effect on the Company's financial position, results of operations or cash flows. The Company's international sales are predominantly denominated in U.S. dollars, and therefore exposure to foreign currency exchange fluctuations on international sales is limited. In certain instances where the Company has entered into contracts which are denominated in foreign currencies, the Company has obtained foreign currency forward and option contracts, principally denominated in Euros or British pounds, to offset the impact of currency rates on accounts receivable. The Company had no forward or option contracts outstanding as of F-13 December 31, 2001. The notional amount of the forward and option contracts outstanding was $10.0 million at December 31, 2000. The fair value of the forward contracts and options and premiums paid for the options were not material. The Company does not enter into derivative instrument transactions for trading or speculative purposes. The Company does not hedge foreign currencies in a manner that would entirely eliminate the effects of the changes in foreign currency rates on the Company's consolidated net income. The Company does not typically hedge its exposure to the Japanese Yen, which is the functional currency for the Company's Japanese subsidiary. Fixed income securities are subject to interest rate risk. The fair value of the Company's investment portfolio would not be significantly impacted by either a 100 basis point increase or decrease in interest rates due mainly to the short-term nature of the major portion of the Company's investment portfolio. The portfolio is diversified and consists primarily of investment grade securities to minimize credit risk. There have been no borrowings under the Company's variable rate credit facilities. All of the Company's outstanding long-term debt is fixed rate and not subject to interest rate fluctuation. NOTE E -- RELATED PARTY TRANSACTIONS As of December 31, 2001, the Company's principal shareholder and the Company's Chairman (the "Chairman") of the Board of Directors and his family owned an aggregate of approximately 24% of the Company's outstanding stock. The following is a summary of transactions and balances with foreign affiliates controlled by the Chairman. In April 2000, these foreign affiliates were sold to an unrelated company. Sales transacted subsequent to the sale of the former affiliates and amounts due are no longer considered related party transactions: 2001 2000 1999 ------ ------ ------ (thousands) Product sales ........................... $ -- $ 918 $3,319 Director's fees and expenses ............ 51 55 66 Due from affiliates ..................... -- -- 1,847 The amounts due from affiliates were non-interest bearing. The Company's Japanese subsidiary purchases, for resale, products under a distribution arrangement from an affiliate controlled by a director. The following is a summary of transactions and balances with an affiliated company controlled by a director: 2001 2000 1999 ------ ------ ------ (thousands) Purchases from related party ............ $2,165 $1,581 $ 443 Due to related party .................... 168 11 19 F-14 NOTE F - RESTRUCTURING During the first quarter of 1999, the Company announced its plan to scale down its Data Network Diagnostics Division and integrate the division into its Intelligent Network Diagnostics Division. In connection with this restructuring, the Company recorded a restructuring charge of $1.8 million consisting of cash severance costs for 27 terminated employees in management, research and development, support and administrative functions, and non-cash charges consisting of the write-down of certain assets to their net realizable value. The costs consisted of the following: (thousands) Severance pay ........................... $ 700 Other accrued expenses .................. 300 Inventory ............................... 350 Fixed assets ............................ 200 Other assets ............................ 250 ------ $1,800 ====== At December 31, 1999, all 27 employees had been terminated, and all severance costs and other accrued expenses had been paid. NOTE G -- INCOME TAXES The provision for income taxes consists of the following: For the Years Ended December 31, ------------------------------------ 2001 2000 1999 ------------------------------------ (thousands) Current: Federal ......................... $ 10,219 $ 22,057 $ 9,991 State ........................... 1,882 5,175 2,683 Foreign ......................... 1,353 460 454 Deferred: Federal ......................... (6,732) (11,152) (2,981) State ........................... (623) 124 (414) Foreign ......................... (16) 62 52 -------- -------- -------- $ 6,083 $ 16,726 $ 9,785 ======== ======== ======== F-15 The components of temporary differences that gave rise to deferred taxes at December 31, 2001 and 2000 are as follows: December 31, -------------------- 2001 2000 -------------------- (thousands) Deferred tax assets: Allowance for doubtful accounts .................. $ 2,069 $ 1,646 Inventory adjustments ............................ 1,315 3,181 Depreciation and amortization .................... 503 (74) Research and development credit carryforward ..... 4,428 3,738 Net operating loss carryforward .................. -- 70 Accrued liabilities .............................. 8,856 6,981 Warranty accrual ................................. 2,317 1,466 Other ............................................ 702 385 -------- -------- Total deferred tax asset ......................... 20,190 17,393 Current portion ....................................... 15,840 14,429 -------- -------- Long-term portion ..................................... $ 4,350 $ 2,964 ======== ======== Deferred tax liability: Acquisition-related intangible assets ............ $ 9,983 $ 14,558 Current portion ....................................... -- -- -------- -------- Long term portion ..................................... $ 9,983 $ 14,558 ======== ======== The Company has not provided a valuation allowance for its deferred tax assets, based on management's assessment of the Company's ability to utilize its deferred tax assets. Realization of the deferred tax assets of $20.2 million is dependent on the extent of the Company's income in carryback years and on the Company generating sufficient taxable income in the future. Although realization is not assured, the Company believes it is more likely than not that the deferred tax assets will be realized. The amount of the deferred tax assets considered realizable, however, could be reduced in the future if estimates of future taxable income are reduced. In connection with the acquisition of IEX in 1999, the Company recorded deferred income tax liabilities of $22.9 million associated with certain intangible assets. These deferred income tax liabilities are amortized on a straight-line basis and amounted to $10.0 million at December 31, 2001. The provision for income taxes differs from the amount obtained by applying the federal statutory income tax rate to income before provision for income taxes as follows:
For the Years Ended December 31, ---------------------------------------- 2001 2000 1999 ---------------------------------------- (thousands) Federal statutory provision ................................ $ (285) $ 10,368 $ 3,580 State taxes, net of federal benefit ........................ 1,122 2,922 1,474 Research and development credits ........................... (1,844) (1,647) (1,531) Nontaxable foreign source income ........................... (322) (1,281) (507) Acquisition-related intangible assets, net of related deferred income tax liability ........................... 6,367 6,360 6,204 Foreign taxes and other .................................... 1,045 4 565 -------- -------- -------- Actual income tax provision ................................ $ 6,083 $ 16,726 $ 9,785 ======== ======== ======== Effective tax rate ......................................... (748.2%) 56.5% 95.7%
At December 31, 2001, the Company had available federal research and development credit carryforwards of $3.2 million, which will begin to expire, if unused, in the year 2019 and F-16 $1.2 million of state research and development credit carryforwards which will begin to expire, if unused, in the year 2003. The Company has not provided for federal income taxes on $12.3 million of undistributed earnings of its foreign subsidiaries that have been reinvested in their operations. NOTE H -- INVENTORIES The components of inventories are: December 31, ---------------------- 2001 2000 ---------------------- (thousands) Raw materials ........................................ $ 8,490 $ 10,701 Work in process ...................................... 2,530 2,497 Finished goods ....................................... 10,297 12,670 --------- --------- $ 21,317 $ 25,868 ========= ========= In 2000, the Company wrote-down $2.9 million of potentially obsolete inventory related to its IEX network switch product line. NOTE I -- PROPERTY AND EQUIPMENT Property and equipment consist of the following: December 31, ---------------------- 2001 2000 ---------------------- (thousands) Manufacturing and development equipment .............. $ 52,674 $ 43,507 Furniture and office equipment ....................... 27,990 21,084 Demonstration equipment .............................. 5,053 3,213 Leasehold improvements ............................... 8,525 7,026 --------- --------- 94,242 74,830 Less, accumulated depreciation and amortization . (59,483) (43,130) --------- --------- $ 34,759 $ 31,700 ========= ========= NOTE J - INTANGIBLE ASSETS Intangible assets consist of the following: December 31, ---------------------- 2001 2000 ---------------------- (thousands) Goodwill ............................................. $ 95,274 $ 95,274 Purchased technology ................................. 50,193 50,285 Other ................................................ 13,000 13,000 --------- --------- 158,467 158,559 Less, accumulated amortization .................. (86,175) (54,336) --------- --------- Intangible assets, net ................. $ 72,292 $ 104,223 ========= ========= F-17 NOTE K -- LINES OF CREDIT AND BORROWINGS The Company has a $20.0 million line of credit with a U.S. bank and lines of credit aggregating $2.3 million available to the Company's Japanese subsidiary from various Japan-based banks. The Company's $20.0 million credit facility is collateralized by substantially all of the Company's assets, bears interest at or, in some cases, below the lender's prime rate (4.75% at December 31, 2001), and expires on October 31, 2002, if not renewed. Under the terms of this facility, the Company is required to maintain certain financial ratios and meet certain net worth and indebtedness covenants. The Company believes it is in compliance with these requirements. There have been no borrowings under this credit facility. The Company's Japanese subsidiary has collateralized yen-denominated lines of credit with Japan-based banks, primarily available for use in Japan, amounting to the equivalent of $2.3 million with interest at Japan's prime rate (1.375% at December 31, 2001) plus 0.125% per annum, which expire between February 2002 and August 2002, if not renewed. There have been no borrowings under these lines of credit. NOTE L - CONVERTIBLE DEBT On November 2, 1999 the Company completed a private placement of $135.0 million aggregate principal amount at maturity of 3.25% convertible subordinated discount notes due 2004. The notes were issued at 85.35% of their face amount (equivalent to gross proceeds at issuance of approximately $115.2 million before discounts and expenses). The gross proceeds at issuance before discounts and expenses included approximately $15.2 million from the sale of notes issued upon the initial purchasers' exercise in full of their over-allotment option. The notes are convertible at any time after January 31, 2000 into Tekelec Common Stock, unless the notes have been previously redeemed or otherwise purchased, at a conversion rate of 56.3393 shares per $1,000 principal amount at maturity (approximately 7.6 million shares in total) which represents a redemption price of $15.15 per share of Common Stock. The notes can be redeemed by the Company at any time after November 2, 2002 at the redemption price together with accrued but unpaid interest. The notes were issued with a 14.65% discount and carry a cash interest (coupon) rate of 3.25%, payable on May 2 and November 2 of each year, commencing on May 2, 2000. The payment of the principal amount of the notes at maturity together with cash interest paid over the term of the notes represents a yield to maturity of 6.75% per year, computed on a semi-annual bond equivalent basis. Interest expense is computed based on the accretion of the discount, the accrual of the cash interest payment and the amortization of expenses related to the offering of these notes on a straight-line basis, and amounted to $8.9 and $8.7 million for 2001 and 2000, respectively, and approximately $1.4 million for the period of November 2, 1999 through December 31, 1999. F-18 NOTE M -- COMMITMENTS AND CONTINGENCIES The Company leases its office and manufacturing facilities together with certain office equipment under operating lease agreements. Lease terms generally range from one to ten years; certain building leases contain options for renewal for additional periods and are subject to increases up to 10% every 24 months. Total rent expense was $6.4 million, $5.7 million and $4.0 million for 2001, 2000 and 1999, respectively. Minimum annual noncancelable lease commitments at December 31, 2001 are: For the Years Ending December 31, (thousands) 2002.............................................. $ 6,910 2003.............................................. 7,382 2004.............................................. 5,760 2005.............................................. 4,678 2006.............................................. 4,758 Thereafter........................................ 20,655 --------- $ 50,143 ========= NOTE N -- STOCK OPTIONS AND EMPLOYEE BENEFIT PLANS The Company has various stock option plans with maximum terms of ten years under which 40.5 million shares of the Company's Common Stock have been authorized and reserved for issuance. The terms of options granted under these option plans are determined at the time of grant, generally vest ratably over a one- to five-year period, and in any case the option price may not be less than the fair market value per share on the date of grant. Both incentive stock options and nonstatutory stock options can be issued under the option plans. The Company also has an Employee Stock Purchase Plan (ESPP), with a maximum term of ten years, the latest of which expires in the year 2006, and under which one million shares of the Company's Common Stock have been authorized and reserved for issuance. Eligible employees may authorize payroll deductions of up to 10% of their compensation to purchase shares of Common Stock at 85% of the lower of the market price per share at the beginning or end of each six-month offering period. Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123), encourages but does not require companies to record compensation cost for stock-based employee compensation plans at fair value for awards granted subsequent to December 31, 1995. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, no compensation expense has been recognized for the Company's stock option and purchase plans. Had compensation costs under these plans been determined based upon the methodology prescribed under SFAS 123, the Company's net income (loss) and diluted earnings (loss) per share would approximate the following proforma amounts (in thousands, except per-share data): F-19 As Reported Proforma ----------- ---------- Year Ended December 31, 2001: Net loss ...................................... $ (6,899) $ (41,484) Loss per share ................................ (0.12) (0.70) Year Ended December 31, 2000: Net income (loss) ............................. $ 12,896 $ (7,737) Earnings (Loss) per share (diluted) ........... 0.20 (0.13) Year Ended December 31, 1999: Net income .................................... $ 444 $ (11,864) Earnings (Loss) per share (diluted) ........... 0.01 (0.22) The effects of applying SFAS 123 in this proforma disclosure are not indicative of future amounts, and additional awards in future years are anticipated. A summary of the status of the Company's stock options, as of December 31, 2001, 2000 and 1999, and the changes during the year ended on those dates are presented below (shares in thousands):
2001 2000 1999 --------------------------------------------------------------------- Wgtd. Avg. Wgtd. Avg. Wgtd. Avg. Shares Exer. Price Shares Exer. Price Shares Exer. Price --------- --------- --------- --------- --------- --------- Outstanding at beginning of year ........................ 11,600 $ 18.88 10,949 $ 10.79 8,438 $ 8.90 Granted - price equals fair value ....................... 4,546 24.86 4,769 30.70 4,932 12.07 Granted - price greater than fair value ................. -- -- 123 16.44 Exercised ............................................... 1,013 9.33 2,950 8.00 1,187 3.72 Cancelled ............................................... 778 24.21 1,168 18.81 1,357 10.39 --------- --------- --------- Outstanding at year-end ................................. 14,355 21.17 11,600 18.88 10,949 10.79 ========= ========= ========= Options exercisable at year-end ......................... 6,169 3,813 4,063 Options available for future grant ...................... 3,869 4,022 4,823 Weighted average fair value of options granted during the year: Exercise price equals fair value at grant date ..... $ 17.42 $ 21.42 $ 8.40 Exercise price greater than fair value at grant date ......................................... -- -- 10.88
The following table summarizes information about stock options outstanding at December 31, 2001 (shares in thousands):
Options Outstanding Options Exercisable -------------------------------------- --------------------------- Wgtd. Avg. Number Remaining Wgtd.Avg. Number Wgtd. Avg. Outstanding Contractual Exercise Outstanding Exercise Range of Exercise Price at 12/31/01 Life Price at 12/31/01 Price - ---------------------------------------------------------------------------------------------------------- $ 0.75 to $ 3.13 431 3.96 $ 2.52 431 $ 2.52 3.19 to 7.09 1,298 4.85 4.88 1,222 4.85 8.19 to 14.94 2,714 6.93 12.31 1,332 12.43 15.00 to 25.88 7,394 8.22 23.11 2,464 22.62 27.56 to 39.50 2,059 8.73 33.82 537 35.18 45.75 to 52.19 459 8.34 48.51 183 48.59 ------ ------ 0.75 to 52.19 14,355 7.61 21.17 6,169 17.28 ====== ======
The fair value of options granted during 2001, 2000 and 1999 is estimated as $52.0 million, $66.8 million and $24.7 million, respectively, on the dates of grant using the Black-Scholes option-pricing model with the following assumptions: (i) dividend yield of 0%, (ii) expected volatility of 92%, 89% and 79%, respectively, for 2001, 2000 and 1999, (iii) weighted F-20 average risk-free interest rates of 4.8%, 6.5% and 5.3% for 2001, 2000 and 1999, respectively, (iv) weighted average expected option lives of 4.5, 4.4 and 5.1 years for 2001, 2000 and 1999, respectively, and (v) assumed forfeiture rate of 34%, 35% and 42% for 2001, 2000 and 1999, respectively. During 2001, 2000 and 1999, approximately 165,000, 110,000 and 198,000 shares, respectively, were purchased under the Company's ESPP at weighted average exercise prices of $18.95, $23.30 and $10.27, respectively. At December 31, 2001, 2000 and 1999, there were approximately 154,000, 119,000 and 229,000 shares, respectively, available for future grants. The weighted average fair values of ESPP shares granted in 2001, 2000 and 1999 were $9.23, $14.27 and $5.15 per share, respectively. The Company has a 401(k) tax-deferred savings plan under which eligible employees may authorize from 2% to 12% of their compensation to be invested in employee-elected investment funds managed by an independent trustee and under which the Company may contribute matching funds of up to 50% of the employees' payroll deductions. During 2001, 2000 and 1999, the Company's contributions amounted to $2.7 million, $2.4 million and $1.8 million respectively. NOTE O -- EARNINGS PER SHARE The following table provides a reconciliation of the numerators and denominators of the basic and diluted per-share computations for the years ended December 31, 2001, 2000 and 1999:
Net Income Shares Per-Share (Numerator) (Denominator) Amount -------------------------------------------- For the Year Ended December 31, 2001: (thousands except per-share amounts) Basic loss per share ............................... $ (6,899) 59,574 $ (0.12) Effect of Dilutive Securities - Stock Options and Warrants .......................... -- -- -------- -------- Diluted loss per share ............................. $ (6,899) 59,574 $ (0.12) ======== ======== ======== For the Year Ended December 31, 2000: Basic earnings per share ........................... $ 12,896 57,823 $ 0.22 Effect of Dilutive Securities - Stock Options and Warrants .......................... -- 6,300 -------- -------- Diluted earnings per share ......................... $ 12,896 64,123 $ 0.20 ======== ======== ======== For the Year Ended December 31, 1999: Basic earnings per share ........................... $ 444 54,931 $ 0.01 Effect of Dilutive Securities - Stock Options and Warrants .......................... -- 3,759 -------- -------- Diluted earnings per share ......................... $ 444 58,690 $ 0.01 ======== ======== ========
The computation of diluted number of shares excludes unexercised stock options and warrants and potential shares issuable upon conversion of the Company's convertible subordinated discount notes that are anti-dilutive. The numbers of such shares excluded were 14.6 million, 8.2 million and 11.5 million for the years ended December 31, 2001, 2000 and 1999, respectively. F-21 There were no transactions subsequent to December 31, 2001, which, had they occurred prior to January 1, 2002, would have changed materially the number of shares in the basic or diluted earnings per share computations. NOTE P -- OPERATING SEGMENT INFORMATION The Network Systems operating segment develops, markets and sells the Company's Eagle STP products based on the Company's high capacity packet switching platform; the IP7 Secure Gateway, an SS7/IP gateway for signaling in converged networks, and other IP7 convergence products; and network systems products resulting from the Company's acquisition of IEX, including ASi 4000 Service Control Point, an advanced database server used for the provisioning of telephony applications, and VXi Media Gateway Controller, a controller for converged networks. During 2000, the Company's business segments were reorganized to include the Sentinel network surveillance system in the Network Systems product segment. Prior periods have been restated to reflect this reorganization. The Network Diagnostics operating segment develops, markets and sells diagnostic products, including MGTS, a diagnostic tool used primarily by equipment suppliers for research and development, and i3000, a diagnostic tool for converged and third generation wireless networks. The Japan Diagnostics operating segment sells the Company's and third parties' diagnostic products to customers in Japan. At the end of 2000, the IEX Call Center business was renamed Contact Center in order to reflect the products' evolution to support multimedia contact centers. The Contact Center operating segment develops, markets and sells software-based solutions for call centers, including TotalView Workforce Management and TotalNet Call Routing. Transfers between operating segments are made at prices reflecting market conditions. The allocation of revenues from external customers by geographical area is determined by the destination of the sale. F-22 The Company's operating segments and geographical information are as follows (in thousands): Operating Segments
Net Sales ----------------------------------------------------- 2001 2000 1999 ----------------------------------------------------- Network Systems .................................. $ 210,467 $ 219,892 $ 148,814 Network Diagnostics .............................. 40,163 44,847 36,177 Contact Center ................................... 38,231 32,344 21,128 Japan Diagnostics ................................ 27,309 26,513 21,890 Intercompany Eliminations ........................ (3,719) (9,262) (1,941) Total net sales ............................. $ 312,451 $ 314,334 $ 226,068
Operating Income ----------------------------------------------------- 2001 2000 1999 ----------------------------------------------------- Network Systems(1) ............................... $ 46,206 $ 64,364 $ 38,552 Network Diagnostics(2) ........................... (353) 9,112 4,921 Contact Center ................................... 16,986 12,088 9,068 Japan Diagnostics ................................ 788 2,515 2,352 Intercompany Eliminations ........................ 677 (2,424) 114 General Corporate(3) ............................. (64,355) (54,886) (43,801) --------- --------- --------- Total operating income (loss) ............... $ (51) $ 30,769 $ 11,206 ========= ========= =========
- ---------- (1) Network Systems operating segment includes charges recorded in 2000 of $2,880 for the write-down of inventory related to the IEX network switch product line (See Note H), and $2,332 to record an allowance for doubtful accounts related to a bankruptcy filing by a certain customer. (2) Network Diagnostics operating segment reflects the $1,800 restructuring charge recorded in 1999 (See Note F). (3) General Corporate includes a non-recurring charge of $750 in connection with the settlement of a legal dispute in 2000 and acquisition-related charges and amortization of $31,264, $31,520 and $28,970 for 2001, 2000 and 1999 respectively. Enterprise Wide Disclosures The following table sets forth, for the periods indicated, revenues from external customers by principal product line (in thousands):
2001 2000 1999 ----------------------------------------------------- Network Systems .................................. $ 210,390 $ 219,554 $ 148,745 Network Diagnostics .............................. 63,830 62,436 56,195 Contact Center ................................... 38,231 32,344 21,128 --------- --------- --------- Total revenues from external customers ...... $ 312,451 $ 314,334 $ 226,068 ========= ========= =========
The following table sets forth, for the periods indicated, revenues from external customers by geographic territory (in thousands):
2001 2000 1999 ----------------------------------------------------- North America .................................... $ 227,743 $ 223,694 $ 173,590 Japan ............................................ 27,030 25,663 22,034 Europe ........................................... 21,796 33,509 9,717 Rest of World .................................... 35,882 31,468 20,727 --------- --------- --------- Total revenues from external customers ...... $ 312,451 $ 314,334 $ 226,068 ========= ========= =========
F-23 The following table sets forth, for the periods indicated, long-lived assets by geographic area in which the Company holds assets (in thousands):
2001 2000 1999 ----------------------------------------------------- United States .................................... $ 112,478 $ 138,393 $ 160,109 Japan ............................................ 1,454 1,024 1,175 Other ............................................ 951 331 385 --------- --------- --------- Total long-lived assets ..................... $ 114,883 $ 139,748 $ 161,669 ========= ========= =========
Sales to one customer accounted for 14% of the revenues for the year ended December 31, 2001 and included sales from all three operating segments. There were no customers accounting for 10% or more of revenues in 2000 and 1999. NOTE Q -- COMMON STOCK Warrants: At December 31, 2001 and 2000, the Company had warrants outstanding to purchase an aggregate of 195,000 shares of its Common Stock, as more fully discussed below. In July 1997, the Company issued warrants to purchase a total of 360,000 shares of its Common Stock to five directors and one corporate officer at $14.08 per share. These warrants vest and become exercisable in 12 equal quarterly installments beginning on September 30, 1997. During 2001, none of these warrants were exercised and warrants to purchase 195,000 were outstanding at December 31, 2001. During 2000, warrants to purchase 124,000 shares were exercised, and warrants to purchase 195,000 shares were outstanding at December 31, 2000. Restricted Stock: In February 1998, the Company granted a restricted stock award of 30,000 shares of its Common Stock to a director and corporate officer in connection with the commencement of his employment. The restricted shares vest in five equal annual installments beginning in February 1999. This award was valued at $607,000, which is being recognized as stock-based compensation expense over the term of the award. In February 2001, the Company granted a restricted stock award of 30,000 shares of its Common Stock to a corporate officer in connection with the commencement of his employment. The restricted shares vest in four equal annual installments beginning in February 2001. This award was valued at $827,000, which is being recognized as stock-based compensation expense over the term of the award. F-24 NOTE R -- QUARTERLY FINANCIAL SUMMARY (UNAUDITED)
Quarters For the Years Ended December 31, First Second Third Fourth -------------------------------------------------------------- (thousands, except per-share data) 2001 Revenues ................................................... $ 84,315 $ 70,882 $ 77,475 $ 79,779 Gross profit ............................................... 55,042 47,089 47,216 49,737 Income (Loss) before provision for income taxes ...................................................... 4,555 (4,552) (1,442) 623 Net income (loss) .......................................... 1,369 (4,551) (2,530) (1,187) Earnings (Loss) per share: Basic ................................................. $ 0.02 $ (0.08) $ (0.04) $ (0.02) Diluted ............................................... 0.02 (0.08) (0.04) (0.02) 2000 Revenues ................................................... $ 60,062 $ 74,148 $ 83,755 $ 96,369 Gross profit ............................................... 37,769 46,594 53,912 57,923 Income (Loss) before provision for income taxes ...................................................... (213) 5,790 12,230 11,815 Net income (loss) .......................................... (1,802) 2,036 6,158 6,504 Earnings (Loss) per share: Basic ................................................. $ (0.03) $ 0.04 $ 0.11 $ 0.11 Diluted ............................................... (0.03) 0.03 0.10 0.10
Typically a substantial portion of the Company's revenues in each quarter result from orders received in that quarter. Further, Tekelec typically generates a significant portion of its revenues for each quarter in the last month of the quarter. Tekelec establishes its expenditure levels based on its expectations as to future revenues, and if revenue levels were to fall below expectations this would cause expenses to be disproportionately high. Therefore, a drop in near-term demand would significantly affect revenues, causing a disproportionate reduction in profits or even losses in a quarter. Tekelec's quarterly operating results may fluctuate as a result of a number of factors, including general economic and political conditions (such as recessions in the U.S., Japan and Europe), capital spending patterns of Tekelec's customers, increased competition, variations in the mix of sales, fluctuation in proportion of foreign sales, and announcements of new products by Tekelec or its competitors. F-25 REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF TEKELEC Our audits of the consolidated financial statements referred to in our report dated January 29, 2002 appearing in the Annual Report to Shareholders of Tekelec (which report and consolidated financial statements are included in this Annual Report on Form 10-K) also included an audit of the financial statement schedule appearing on page S-2 of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ PricewaterhouseCoopers LLP Los Angeles, California March 28, 2002 S-1 TEKELEC VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
Column A Column B Column C Column D Column E - ----------------------------------------------------------------------------------------------------------------------------------- Additions Balance at Charged to Charged to Deductions Balance at Beginning Costs and Other and other End of Description of Period Expenses Accounts Adjustments Period - ----------------------------------------------------------------------------------------------------------------------------------- (thousands) Year ended December 31, 1999: - ----------------------------- Allowance for doubtful accounts $ 763 $ 265 $ 495 $ 45 $1,478 Product warranty 2,343 1,395 -- 985 2,753 Inventory provision 1,740 760 -- 328 2,172 Year ended December 31, 2000: - ----------------------------- Allowance for doubtful accounts $1,478 $2,968 $ -- $ 159 $4,287 Product warranty 2,753 1,986 -- 1,305 3,434 Inventory provision 2,172 4,393 -- 3,590 2,975 Year ended December 31, 2001: - ----------------------------- Allowance for doubtful accounts $4,287 $4,412 $ -- $3,350 $5,349 Product warranty 3,434 3,965 -- 1,937 5,462 Inventory provision 2,975 3,448 -- 2,096 4,327
S-2 EXHIBIT INDEX Sequentially Exhibit Numbered Number Description Page - ------ ----------- ---- 10.11 Loan Agreement and Promissory Note dated October 31, 2001 between the Registrant and Union Bank of California............................................. 10.15 Employment Offer Letter dated November 13, 2001 between the Registrant and Lori A. Craven...................... 10.16 Employment Offer Letter dated November 13, 2001 between the Registrant and Daniel B. Walters................... 21.1 Subsidiaries of the Registrant......................... 23.1 Consent of PricewaterhouseCoopers LLP.................. EX-10.11 3 d50056_ex10-11.txt LOAN AGREEMENT AND PROMISSORY NOTE EXHIBIT 10.11 LOAN AGREEMENT THIS LOAN AGREEMENT ("Agreement") is made and entered into as of October 31, 2001, by and between TEKELEC, a California corporation ("Borrower"), and UNION BANK OF CALIFORNIA, N.A., a national banking association ("Bank"). SECTION 1. THE LOAN 1.1 The Revolving Loan. Bank will loan to Borrower an amount not to exceed Twenty Million Dollars ($20,000,000) outstanding in the aggregate at any one time (the "Revolving Loan"). Borrower may borrow, repay and reborrow all or part of the Revolving Loan in amounts of not less than Five Hundred Thousand Dollars ($500,000) in accordance with the terms of the Revolving Note (as such term is defined herein below). All borrowings of the Revolving Loan must be made before October 31, 2002 (the "Revolving Loan Termination Date"), at which time all unpaid principal of and accrued but unpaid interest on the Revolving Loan shall be due and payable. The Revolving Loan shall be evidenced by a promissory note (the "Revolving Note") on the standard form used by Bank to evidence its commercial loans. Bank shall enter each amount borrowed and repaid in Bank's records and such entries shall be deemed to be the amount of the Revolving Loan outstanding. The omission of Bank to make any such entries shall not discharge Borrower of its obligation to repay in full with interest all amounts borrowed. 1.1.1 The L/C Line. Bank shall issue, for the account of Borrower, one or more irrevocable commercial or standby letters of credit (individually, an "L/C" and collectively, the "L/Cs") and in the case of commercial L/Cs, calling for drafts at sight covering the importation or purchase of goods required in the normal course of business. Each L/C shall be drawn on such terms and conditions as are acceptable to Bank and shall be governed by the terms of (and Borrower agrees to execute) Bank's standard form for L/C application and reimbursement agreement. The aggregate amount available to be drawn under all outstanding L/Cs and the aggregate amount of unpaid reimbursement obligations under drawn L/Cs shall not exceed Five Million Dollars ($5,000,000) and shall reduce, dollar for dollar, the maximum amount available under the Revolving Loan. No L/C shall have an expiration date more than 365 days from its date of issuance. No L/C shall expire after the Revolving Loan Termination Date. 1.2 Terminology. As used herein, the following terms shall have the following meanings: (a) "Loan" shall mean, collectively, all of the credit facilities described above. (b) "Loan Documents" shall mean all documents, instruments and agreements executed in connection with this Agreement. (c) "Note" shall mean, collectively, all of the promissory notes described above. 1.3 Purpose of Loan. The proceeds of the Revolving Loan shall be used for Borrower's general corporate purposes and working capital. EXHIBIT 10.11 1.4 Interest. The unpaid principal balance of the Loan shall bear interest at the rate or rates provided in the Note and selected by Borrower. The Loan may be prepaid in full or in part only in accordance with the terms of the Note and any such prepayment shall be subject to the prepayment fee provided for therein. 1.5 Commitment/Documentation Fee. Borrower shall pay a commitment/documen-tation fee to Bank in the sum of Fifty Thousand Dollars ($50,000) on or before October 31, 2001. In the event that Borrower does not pay such commitment fee to Bank before October 31, 2001, then Bank shall autocharge Borrower's operating account with Bank for the amount of such commitment fee. No portion of such commitment fee shall be reimbursable. 1.6 Unused Commitment Fee. On the last calendar day of the third month following the execution of this Agreement and on the last calendar day of each three (3) month period thereafter until the Revolving Loan Termination Date, or on the earlier termination of the Loan, Borrower shall pay to Bank a fee of thirty one-hundredths percent (.30%) per annum on the average unused portion of the Loan for the preceding three (3) month period, computed on the basis of actual days elapsed of a year of 360 days. 1.7 Balances. Borrower shall maintain its major depository accounts with Bank until the Note and all other sums payable pursuant to this Agreement have been paid in full. 1.8 Disbursement. Bank shall disburse the proceeds of the Loan as provided for in Bank's standard form Authorization to Disburse executed by Borrower. 1.9 Security. Prior to any disbursement of the Loan, Borrower shall have executed a security agreement, on Bank's standard form, and a financing statement, suitable for filing in the office of the Secretary of State of the State of California and any other state designated by Bank, granting to Bank a first priority security interest in such of Borrower's property as is described in said security agreement. Exceptions to Bank's first priority, are permitted as shown in Exhibit A to this Agreement. At Bank's request, Borrower will also obtain executed landlord's and mortgagee's waivers on Bank's form covering all of Borrower's property located on leased or encumbered real property. 1.10 Controlling Document. In the event of any inconsistency between the terms of this Agreement and the Note or any of the other Loan Documents, the terms of the Note or such other Loan Documents will prevail over the terms of this Agreement. SECTION 2. CONDITIONS PRECEDENT Bank shall not be obligated to disburse all or any portion of the proceeds of the Loan unless at or prior to the time for the making of such disbursement, the following conditions have been fulfilled to Bank's satisfaction: 2.1 Compliance. Borrower shall have performed and complied with all terms and conditions required by this Agreement to be performed or complied with prior to or at the date of the making of such disbursement and shall have executed and delivered to Bank the Note and the other Loan Documents. 2.2 Guaranties. IEX Corporation, a Nevada corporation ("Guarantor"), shall have executed and delivered to Bank a continuing guaranty in form and amount satisfactory to Bank. EXHIBIT 10.11 In addition, any and all future domestic subsidiaries of Borrower shall promptly execute and deliver to Bank continuing guaranties in form and amount satisfactory to Bank. 2.3 Borrowing Resolution. Borrower shall have provided Bank with certified copies of resolutions duly adopted by the board of directors of Borrower, authorizing the execution, delivery and performance of this Agreement and the Loan Documents. Such resolutions shall also designate the persons who are authorized to act on Borrower's behalf in connection with this Agreement and to do the things required of Borrower pursuant to this Agreement. 2.4 Termination Statements. Borrower shall have provided Bank with UCC-3 termination statements executed by such secured creditors as may be required by Bank suitable for filing with the Secretary of State in each state designated by Bank. 2.5 Continuing Compliance. At the time any disbursement is to be made, there shall not exist any event, condition or act which constitutes an Event of Default under Section 6 hereof or any event, condition or act which with notice, lapse of time or both would constitute an Event of default; nor shall there be any such event, condition, or act immediately after the disbursement were it to be made. SECTION 3. REPRESENTATIONS AND WARRANTIES Borrower represents and warrants that: 3.1 Business Activity. The principal business of Borrower is the design, manufacture, and support of network system products, diagnostic systems and selected service applications for telecommunications networks and call centers. 3.2 Affiliates and Subsidiaries. Borrower's affiliates and subsidiaries (those entities in which Borrower has either a controlling interest or at least a 25% ownership interest) and their addresses, and the names of Borrower's principal shareholders, are as provided on a schedule delivered to Bank on or before the date of this Agreement. 3.3 Authority to Borrow. The execution, delivery and performance of this Agreement, the Note and all other Loan Documents are not in contravention of any of the terms of any indenture, agreement or undertaking to which Borrower is a party or by which it or any of its property is bound or affected. 3.4 Financial Statements. The financial statements of Borrower and its subsidiaries on Form 10Q, including both a consolidated balance sheet at June 30, 2001, together with supporting schedules, and a consolidated income statement for the three (3) months ended June 30, 2001, have heretofore been furnished to Bank, and are true and complete and fairly represent the financial condition of Borrower and its subsidiaries during the period covered thereby. Since June 30, 2001, there has been no material adverse change in the financial condition or operations of Borrower or any of its subsidiaries. 3.5 Title. Except for assets which may have been disposed of in the ordinary course of business, Borrower and its subsidiaries have good and marketable title to all of the property reflected in the financial statements of Borrower and its subsidiaries delivered to Bank and to all property acquired by Borrower and its subsidiaries since the date of such financial statements, free and clear of all liens, encumbrances, security interests and adverse claims (collectively, EXHIBIT 10.11 "Liens"), except for Liens incurred in the ordinary course of business which do not result in a material adverse effect on the financial condition of Borrower or any of its subsidiaries. 3.6 Litigation. There is no litigation or proceeding pending or threatened against Borrower or any of its subsidiaries, or any of their respective properties, which is reasonably likely to result in a material adverse effect on the financial condition, property or business of Borrower or any of its subsidiaries or result in liability in excess of Borrower's or any such subsidiary's insurance coverage. 3.7 Default. Borrower is not now in default in the payment of any of its material obligations, and there exists no event, condition or act which constitutes an Event of Default under Section 6 hereof and no condition, event or act which with notice or lapse of time, or both, would constitute an Event of Default. 3.8 Organization. Borrower is duly organized and existing under the laws of the State of California, and has the power and authority to carry on the business in which it is engaged and/or proposes to engage. 3.9 Power. Borrower has the power and authority to enter into this Agreement and to execute and deliver the Note and all of the other Loan Documents. 3.10 Authorization. This Agreement and all things required by this Agreement have been duly authorized by all requisite corporate action of Borrower. 3.11 Qualification. Borrower is duly qualified and in good standing in any jurisdiction where such qualification is required. 3.12 Compliance With Laws. Borrower is in compliance with all applicable laws, rules, ordinances and regulations which materially affect the operations or financial condition of Borrower. 3.13 ERISA. All defined benefit pension plans (as such term is defined in the Employee Retirement Income Security Act of 1974, as amended ("ERISA")) of Borrower meet, as of the date hereof, the minimum funding standards of Section 302 of ERISA, and no Reportable Event or Prohibited Transaction as defined in ERISA has occurred with respect to any such plan. 3.14 Regulation U. No action has been taken or is currently planned by Borrower, or any agent acting on its behalf, which would cause this Agreement or the Note to violate Regulation U or any other regulation of the Board of Governors of the Federal Reserve System or to violate the Securities and Exchange Act of 1934, in each case as in effect now or as the same may hereafter be in effect. Borrower is not engaged in the business of extending credit for the purpose of purchasing or carrying margin stock as one of its important activities and none of the proceeds of the Loan will be used directly or indirectly for such purpose. 3.15 "Senior Indebtedness" as Defined in the Indenture Dated as of November 2, 1999 between Borrower and Bankers Trust Company ("indenture"). The obligations and liabilities of Borrower to Bank thereunder shall constitute "senior Indebtedness," as such term is defined in the Indenture. EXHIBIT 10.11 3.16 Continuing Representations. These representations shall be con- sidered to have been made again at and as of the date of each disbursement of the Loan and shall be true and correct as of such date or dates. SECTION 4. AFFIRMATIVE COVENANTS Until the Note and all sums payable pursuant to this Agreement and the Loan Documents have been paid in full, unless Bank otherwise consents in writing, Borrower agrees that: 4.1 Use of Proceeds. Borrower will use the proceeds of the Revolving Loan only as provided in subsection 1.3 hereof. 4.2 Payment of Obligations. Borrower will pay and discharge promptly all taxes, assessments and other governmental charges and claims levied or imposed upon it or its property, or any part thereof; provided, however, that Borrower shall have the right in good faith to contest any such taxes, assessments, charges or claims and, pending the outcome of such contest, to delay or refuse payment thereof provided that adequately funded reserves are established by it to pay and discharge any such taxes, assessments, charges and claims. 4.3 Maintenance of Existence. Borrower will maintain and preserve its existence and assets and all rights, franchises, licenses and other authority necessary for the conduct of its business and will maintain and preserve its property, equipment and facilities in good order, condition and repair. Bank may, at reasonable times, visit and inspect any of the properties of Borrower. 4.4 Records. Borrower will keep and maintain full and accurate accounts and records of its operations according to generally accepted accounting principles and will permit Bank to have access thereto, to make examination and photocopies thereof, and to make audits during regular business hours. Costs for such audits shall be paid by Borrower. 4.5 Information Furnished. Borrower will furnish to Bank: (a) Within forty-five (45) days after the close of each fiscal quarter, except for the final fiscal quarter of each fiscal year, the unaudited, consolidated balance sheet of Borrower and its subsidiaries on Form 10Q as of the close of such fiscal quarter, including at least the unaudited, consolidated income and expense statement of Borrower and its subsidiaries with supportive schedules for such fiscal quarter, prepared in accordance with generally accepted accounting principles; (b) Within one hundred twenty (120) days after the close of each fiscal year, a copy of its statement of financial condition on Form 10K, including at least the consolidated balance sheet of Borrower and its subsidiaries as of the close of such fiscal year and the consolidated income and expense statement of Borrower and its subsidiaries for such fiscal year, examined and prepared on an audited basis by independent certified public accountants selected by Borrower and reasonably satisfactory to Bank, in accordance with generally accepted accounting principles applied on a basis consistent with that of the previous fiscal year; (c) Such other financial statements and information relating to Borrower and it subsidiaries as Bank may reasonably request from time to time; EXHIBIT 10.11 (d) In connection with each financial statement provided hereunder, a statement executed by a responsible officer of Borrower, certifying that no Event of Default has occurred and no event exists which with notice or the lapse of time, or both, would result in an Event of Default hereunder; (e) In connection with each fiscal year end statement required hereunder, any management letter of Borrower's independent certified public accountants as requested by Bank; (f) Within forty-five (45) days after the close of each fiscal quarter and within one-hundred twenty (120) days after each fiscal year end, a certification of compliance with all covenants under this Agreement, executed by Borrower's chief financial officer or other duly authorized officer of Borrower, in form acceptable to Bank; (g) Prompt written notice to Bank of all Events of Default under any of the terms or provisions of this Agreement or of any event of default under any other agreement, contract, document or instrument entered into, or to be entered into, with Bank; and of any litigation which, if decided adversely to Borrower or any of its subsidiaries, would have a material adverse effect on the financial condition of Borrower or any of its subsidiaries; and of any other matter which has resulted in, or is likely to result in, a material adverse change in the financial condition or operations of Borrower or any of its subsidiaries; and (h) When possible, prior written notice to Bank of any changes in Borrower's chief executive officer, chief financial officer, senior director of finance or treasurer (or prompt written notice following any unanticipated and unexpected change in any of such officers); Borrower's name; or the location of Borrower's assets, principal place of business or chief executive office. 4.6 Liquid Assets. Borrower will at all times maintain Liquid Assets of not less than Forty Million Dollars ($40,000,000). As used herein, the term "Liquid Assets" shall mean cash and marketable securities (short-term and long-term) owned by Borrower. 4.7 Consolidated Total Debt to Consolidated Tangible Net Worth. Borrower will maintain at all times a ratio of Consolidated Total Debt to Consolidated Tangible Net Worth of not greater than 1.0 to 1.0 as at the end of each fiscal quarter. As used in this Agreement, "Total Debt" shall mean total liabilities of Borrower or any of its subsidiaries as defined by GAAP on a consolidated basis less indebtedness of Borrower or any of its subsidiaries subordinated to Bank. "Consolidated Tangible Net Worth" shall mean the net worth of Borrower and its subsidiaries, increased by indebtedness of Borrower or any of its subsidiaries subordinated to Bank and decreased by patents, licenses, trademarks, trade names, goodwill and other similar intangible assets of Borrower or any of its subsidiaries, organizational expenses and monies due from affiliates to Borrower or any of its subsidiaries (including the officers, shareholders and directors of any thereof). 4.8 Consolidated Rolling-Four Quarter EBITDA. Borrower will achieve consolidated rolling-four quarter EBITDA of not less than Forty Million Dollars ($40,000,000) for each fiscal quarter. "Consolidated Rolling-Four Quarter EBITDA" shall mean the net profit after taxes of Borrower and its subsidiaries for the preceding four (4) fiscal quarters, plus interest expense, taxes, depreciation and amortization for Borrower or any of its subsidiaries for such four (4) fiscal quarters, less interest income of Borrower and its subsidiaries for such four (4) fiscal quarters. EXHIBIT 10.11 4.9 Insurance. Borrower will keep all of its insurable property, whether real, personal or mixed, insured by companies and in amounts approved by Bank against fire and such other risks, and in such amounts, as is customarily obtained by companies conducting similar business with respect to like properties. Borrower will furnish to Bank statements of its insurance coverage, will promptly furnish other or additional insurance deemed necessary by and upon request of Bank to the extent that such insurance may be available and hereby assigns to Bank, as security for Borrower's obligations to Bank, the proceeds of any such insurance. Prior to any disbursement of the Loan, Bank will be named loss payee on all policies insuring collateral and such policies shall require at least ten (10) days' written notice to Bank before any policy may be altered or cancelled. Borrower will maintain adequate worker's compensation insurance and adequate insurance against liability for damage to persons or property. 4.10 Additional Requirements. Borrower will promptly, upon demand by Bank, take such further action and execute all such additional documents and instruments in connection with this Agreement as Bank in its reasonable discretion deems necessary, and promptly supply Bank with such other information concerning the affairs of Borrower and its subsidiaries as Bank may request from time to time. 4.11 Litigation and Attorneys' Fees. Borrower will pay promptly to Bank upon demand, reasonable attorneys' fees (including but not limited to the reasonable estimate of the allocated costs and expenses of in-house legal counsel and staff) and all costs and other expenses paid or incurred by Bank in collecting, modifying or compromising the Loan or in enforcing or exercising its rights or remedies created by, connected with or provided for in this Agreement or any of the Loan Documents, whether or not an arbitration, judicial action or other proceeding is commenced. If such proceeding is commenced, only the prevailing party shall be entitled to attorneys' fees and court costs. 4.12 Bank Expenses. Borrower will pay or reimburse Bank for all costs, expenses and fees incurred by Bank in preparing and documenting any and all amendments and modifications to this Agreement and the Loan Documents, including but not limited to attorneys' fees, including the reasonable estimate of the allocated costs and expenses of in-house legal counsel and staff. 4.13 Reports Under Pension Plans. Borrower will furnish to Bank, as soon as possible and in any event within fifteen (15) days after Borrower knows or has reason to know that any event or condition with respect to any defined benefit pension plans of Borrower described in subsection 3.13 hereof has occurred, a statement of an authorized officer of Borrower describing such event or condition and the action, if any, which Borrower proposes to take with respect thereto. SECTION 5. NEGATIVE COVENANTS Until the Note and all other sums payable pursuant to this Agreement and the Loan Documents have been paid in full, unless Bank otherwise consents in writing, Borrower agrees that: 5.1 Liens. Borrower will not, and will not permit any of its subsidiaries to create, assume or permit to exist any Lien on any of its property, whether real, personal or mixed, now owned or hereafter acquired, or upon the income or profits thereof, except for (a) Liens, if any, in EXHIBIT 10.11 favor of Bank, (b) Liens incurred in the ordinary course of business in connection with worker's compensation, unemployment insurance or similar legislation, (c) Liens created to secure indebtedness permitted by subsection 5.2(c) hereof, which is incurred solely for the purpose of financing the acquisition of such assets and incurred at the time of acquisition, so long as each such Lien shall at all times be confined solely to the asset or assets so acquired (and proceeds thereof), and refinancings thereof so long as any such Lien remains solely on the asset or assets acquired and the amount of such indebtedness related thereto is not increased, (d) minor encumbrances and easements on real property which do not affect its market value, (e) Liens for taxes not delinquent and for taxes and other items being contested in good faith, (f) Liens on personal property in existence on the date of this Agreement and (g) Liens in respect of judgments or awards for which appeals or proceedings for review are being prosecuted and in respect of which a stay of execution upon any such appeal or proceeding for review shall have been secured, provided that (i) Borrower or such subsidiary shall have established adequate reserves for such judgments or awards, (ii) such judgments or awards shall be fully insured and the insurer shall not have denied coverage, or (iii) such judgments or awards shall have been bonded to the satisfaction of Bank. 5.2 Indebtedness. Borrower will not sell, discount or otherwise transfer any account receivable or any note, draft or other evidence of indebtedness, except to Bank or except to a financial institution at face value for deposit or collection purposes only and without any fee other than fees normally charged by the financial institution for deposit or collection services. Borrower will not, nor shall it permit any subsidiary to create, assume, incur or otherwise become or remain obligated in respect of, or permit to be outstanding, or suffer to exist any indebtedness, except (a) indebtedness under this Agreement and the Loan Documents, (b) accounts payable and accrued liabilities incurred in the ordinary course of business, (c) indebtedness, including in respect of capitalized lease obligations, incurred to purchase, or to finance the purchase of, assets which constitute property, plant and equipment, in an aggregate principal amount not in excess of Five Million Dollars ($5,000,000), (d) interest hedging obligations under interest hedge agreements entered into with Bank or any other financial institution, (e) obligations under foreign exchange hedge agreements entered into with Bank or any other financial institution, (f) indebtedness existing on the date of this Agreement (including overdraft lines for Japanese subsidiary), or permitted to be incurred under agreements existing on the date of this Agreement, including renewals, replacements and refinancings (but no increases) thereof, (g) indebtedness in respect of endorsement of negotiable instruments in the ordinary course of business, (h) indebtedness owing to Borrower or any of its subsidiaries by any subsidiary of Borrower which has executed a continuing guaranty in favor of Bank as provided for herein, and (i) guaranties by subsidiaries of Borrower of indebtedness of Borrower or other subsidiaries of Borrower, to the extent such underlying indebtedness is permitted hereunder, 5.3 Sale of Assets. Borrower will not, and will not permit any of its subsidiaries to, sell, lease, transfer or otherwise dispose of, any of its assets except (a) inventory in the ordinary course of business, (b) obsolete or worn-out assets and (c) provided that no Event of Default or event which, with notice or lapse of time, or both, would become an Event of Default, exists or would exist immediately prior to or after giving effect thereto, sales of other assets, the fair market value of which shall not exceed One Million Dollars ($1,000,000) in aggregate amount during any fiscal year. 5.4 Liquidation or Merger. Borrower will not, and will not permit any of its subsidiaries to, at any time: EXHIBIT 10.11 (a) liquidate or dissolve itself (or suffer any liquidation or dissolution) or otherwise wind up, except that (i) a subsidiary of Borrower may liquidate or dissolve into Borrower, (ii) a subsidiary of Borrower may liquidate or dissolve into a domestic subsidiary, (iii) a foreign subsidiary of Borrower may liquidate or dissolve into another direct foreign subsidiary of Borrower or a domestic subsidiary; or (b) enter into any merger or consolidation unless (i) with respect to a merger or consolidation involving Borrower, Borrower shall be the surviving corporation, or if the merger or consolidation involves a subsidiary of Borrower and not Borrower, such subsidiary shall be the surviving corporation, in each case other than solely to effect a change of the jurisdiction of incorporation of Borrower or any of its subsidiaries, (ii) such transaction shall not be utilized to circumvent compliance with any term or provision hereof, (iii) no Event of Default shall then be in existence or occur as a result of such transaction and (iv) no domestic subsidiary shall be permitted to enter into any merger or consolidation with a foreign subsidiary unless such domestic subsidiary shall be the surviving corporation. 5.5 Acquisitions. Borrower will not, and shall not permit any of its subsidiaries to purchase all or any portion of the stock, equity interests or assets of any person or entity; provided, however, that Borrower or any of its subsidiaries may make any acquisition so long as (a) the board of the company to be acquired has approved the transaction; (b) the company to be acquired is in a line of business similar to Borrower's; (c) immediately prior to and after giving effect to the proposed acquisition as evidenced by a proforma compliance certificate provided to Bank there shall not exist an Event of Default hereunder, (d) the consideration payable or to be paid by Borrower or such subsidiary for such acquisition does not exceed Thirty Million Dollars ($30,000,000) per single acquisition or Ninety Million Dollars ($90,000,000) during any 12-month period for more than one acquisition and (e) in the case of any proposed acquisition Borrower shall have provided Bank with the pro forma financial statements of Borrower and its subsidiaries (including the person or entity so acquired) prior to the consummation of such acquisition. Acquisitions financed entirely with preferred and common stock (of which no more than 40% of the purchase price shall be preferred equity) can be completed without Bank approval. The Revolving Line shall not be used to finance acquisitions without prior Bank approval. 5.6 Investments. Borrower will not, and will not permit any subsidiary to, make any investment, except that Borrower and any of its subsidiaries may purchase or otherwise acquire and own (a) cash, cash equivalents, and marketable securities, (b) accounts receivable and notes receivable that arise in the ordinary course of business and are payable on standard terms, (c) investments in existence on the date of this Agreement, (d) investments in the form of interest hedge agreements permitted by subsection 5.2(d) hereof, (e) investments consisting of advances to employees in the ordinary course of business, (f) investments in existing domestic subsidiaries of Borrower, (g) investments made after the date of this Agreement in foreign subsidiaries of Borrower in an aggregate amount not to exceed Five Million Dollars ($5,000,000), (h) minority investments in other persons or entities, provided that each such person or entity is engaged primarily in the business of the manufacture and distribution of software and hardware for computer networking and activities directly related thereto and (i) other investments not to exceed Five Million Dollars ($5,000,000) in the aggregate at any time outstanding. 5.7 Restricted Payments. Borrower shall not, and shall not permit any of its subsidiaries to, directly or indirectly, declare, pay or make any Restricted Payments except for (a) Dividends payable to stockholders of Borrower, (b) Dividends payable by a subsidiary of Borrower to Borrower or to domestic subsidiary of EXHIBIT 10.11 Borrower, (c) provided that no Event of Default exists or will exist immediately prior to or after giving effect to such Restricted Payment, acquisition of shares of capital stock pursuant to employee stock purchase plans or agreements to repurchase directors' qualifying shares not to exceed One Million Dollars ($1,000,000) in aggregate amount during any fiscal year, and (d) provided that no Event of Default exists or will exist immediately prior to or after giving effect to such Restricted Payment and provided that Borrower provides Bank with a minimum seven (7) days written notice, redemption of Borrower's $135,000,000 3.25% Convertible Subordinated Discount Notes provided that the cash principal and interest payment for such redemption does not exceed $12,000,000. As used herein, the term "Restricted Payments" shall mean, collectively, (i) Dividends and (ii) any (A) payment or prepayment of principal, premium or penalty on any subordinated indebtedness of Borrower or any of its subsidiaries, or any defeasance, redemption, purchase, repurchase or other acquisition or retirement for value, in whole or in part, of any subordinated indebtedness (including, without limitation, the setting aside of assets of the deposit of funds therefore), other than the conversion thereof into capital stock, and (B) prepayment of interest on any subordinated indebtedness. As used herein, the term "Dividends" shall mean, as to Borrower or any of its subsidiaries, (i) any declaration or payment of any dividend (other than a stock dividend) on, or the making of any distribution, loan, advance or investment to or in any holder of, any shares of capital stock of, or other similar interest in, Borrower or such subsidiary and (ii) any purchase, redemption or other acquisition or retirement for value of any shares of capital stock of, or similar interest in, Borrower or such subsidiary. 5.8 Affiliate Transactions. Borrower will not transfer any property to its stockholders or any affiliate of its stockholders, except for value received in the normal course of business as business would be conducted with an unrelated or unaffiliated entity. 5.9 Capital Expenditures. Borrower will not make, and will not permit any of its subsidiaries to make, capital expenditures in excess of Thirty Million Dollars ($30,000,000) in the aggregate in any fiscal year; and shall only make such expenditures as are necessary for Borrower and its subsidiaries in the conduct of its ordinary course of business. Each capital expenditure shall be needed by Borrower or any of its subsidiaries in the ordinary course of its business. As used herein, the term "capital expenditures" shall include the current expense portion of all leases, whether or not capitalized, and shall also include the current portion of any indebtedness used to finance capital expenditures. SECTION 6. EVENTS OF DEFAULT The occurrence of any of the following events (collectively, "Events of Default") shall terminate any obligation on the part of Bank to make or continue the Loan and automatically, unless otherwise provided under the Note, shall make all sums of interest and principal and any other amounts owing under the Loan immediately due and payable, without notice of default, presentment or demand for payment, protest or notice of nonpayment or dishonor, or any other notices or demands: 6.1 Borrower shall default in the due and punctual payment of the principal of or the interest on the Note or any of the other Loan Documents; or 6.2 Any default shall occur under the Note; or EXHIBIT 10.11 6.3 Borrower shall default in the due performance or observance of any covenant or condition of the Loan Documents; or 6.4 Any guaranty or subordination required hereunder is breached or becomes ineffective, or any Guarantor or subordinated creditor shall die, disavow or attempt to revoke or terminate such guaranty or subordination. SECTION 7. MISCELLANEOUS PROVISIONS 7.1 Additional Remedies. The rights, powers and remedies given to Bank hereunder shall be cumulative and not alternative and shall be in addition to all rights, powers and remedies given to Bank by law against Borrower or any other person, including but not limited to Bank's rights of setoff or banker's lien. 7.2 Nonwaiver. Any forbearance or failure or delay by Bank in exercising any right, power or remedy hereunder shall not be deemed a waiver thereof and any single or partial exercise of any right, power or remedy shall not preclude the further exercise thereof. No consent or waiver shall be effective unless it is in writing and signed by an officer of Bank. 7.3 Inurement. The benefits of this Agreement shall inure to the successors and assigns of Bank and the permitted successors and assigns of Borrower, and any assignment by Borrower without Bank's consent shall be null and void. 7.4 Applicable Law. This Agreement and all other agreements and instruments required by Bank in connection therewith shall be governed by and construed in accordance with the laws of the State of California. 7.5 Severability. Should any one or more provisions of this Agreement be determined to be illegal or unenforceable, all other provisions nevertheless shall be effective. In the event of any conflict between the provisions of this Agreement and the provisions of the Note or any reimbursement agreement evidencing any indebtedness hereunder, the provisions of the Note or such reimbursement agreement shall prevail. 7.6 Integration Clause. Except for the Loan Documents, this Agreement constitutes the entire agreement between Bank and Borrower regarding the Loan and all prior communications, whether verbal or written, between Borrower and Bank shall be of no further effect or evidentiary value. 7.7 Construction. The section and subsection headings herein are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. 7.8 Amendments. This Agreement may be amended only in writing signed by all parties hereto. 7.9 Counterparts. Borrower and Bank may execute one or more counterparts to this Agreement, each of which shall be deemed an original, but when together shall be one and the same instrument. 7.10 Confidentiality. Bank agrees to hold any confidential information that it may receive from Borrower pursuant to this Agreement or the Loan Documents in confidence, except EXHIBIT 10.11 that Bank may disclose such confidential information (a) to affiliates of Bank, (b) to legal counsel and accountants for Borrower or Bank, (c) to other professional advisors to Borrower or Bank, provided that the recipient has accepted such confidential information subject to a confidentiality agreement substantially similar to this Section 7.10, (d) to regulatory officials having jurisdiction over Bank, (e) as required by law or legal process, provided that Bank agrees to notify Borrower of any such disclosures unless prohibited by applicable law, or in connection with any legal proceeding to which Bank and Borrower are adverse parties, and (f) to another financial institution in connection with a disposition or proposed disposition to that financial institution of all or part of Bank's interests hereunder or a participation interest in the Note, provided that the recipient has accepted such confidential information subject to a confidentiality agreement substantially similar to this Section 7.10. For purposes of the foregoing, "confidential information" shall mean any information respecting Borrower or any of its subsidiaries reasonably considered by Borrower to be confidential, other than (i) information previously filed with any governmental agency and available to the public, (ii) information previously published in any public medium from a source other than, directly or indirectly, Bank, and (iii) information previously disclosed by Borrower to any person or entity not associated with Borrower which does not owe a professional duty of confidentiality to Borrower or which has not executed an appropriate confidentiality agreement with Borrower. Nothing in this Section 7.10 shall be construed to create or give rise to any fiduciary duty on the part of Bank to Borrower. SECTION 8. NOTICES 8.1 Any notices or other communications provided for or allowed hereunder shall be effective only when given by one of the following methods and addressed to the respective party at its address given with the signatures at the end of this Agreement and shall be considered to have been validly given: (a) upon delivery, if delivered personally; (b) upon receipt, if mailed, first class postage prepaid, with the United States Postal Service; (c) on the next business day, if sent by overnight courier service of recognized standing; and (d) upon telephoned confirmation of receipt, if telecopied. 8.2 The addresses to which notices or demands are to be given may be changed from time to time by notice delivered as provided above. EXHIBIT 10.11 THIS AGREEMENT is executed on behalf of the parties by their duly authorized officers as of the date first above written. TEKELEC By_______________________ Title:___________________ By_______________________ Title:___________________ Address: Tekelec 26580 Aguora Road Calabasas, California 91302 Attention: Mr. Paul J. Pucino Vice President & Chief Financial Officer Telecopier No.: 818-880-0176 Telephone No.: 818-880-7921 UNION BANK OF CALIFORNIA, N.A. By_______________________ Title:___________________ Address: Union Bank of California, N.A. 445 South Figueroa Street, 10th Floor Los Angeles, California 90071 Attention: John Kase Vice President & Senior Credit Executive Telecopier No.: 213-236-7637 Telephone No.: 213-236-7329 EXHIBIT 10.11 PROMISSORY NOTE UNION BANK OF PROMISSORY NOTE CALIFORNIA BASE RATE BATIE/R/11198 - -------------------------------------------------------------------------------- Borrower Name TEKELEC - -------------------------------------------------------------------------------- Borrower Address Office Loan Number 30361 8903510826 0008-00-0-000 ---------------------------------------------------- 26580 W. AGOURA ROAD Maturity Date Amount CALABASAS, CA 91302 OCTOBER 31, 2002 $20,000,000.00 - -------------------------------------------------------------------------------- Date OCTOBER 31, 2001 $20,000,000.00 FOR VALUE RECEIVED, on OCTOBER 31, 2002 the undersigned ("Debtor") promises to pay to the order of UNION BANK OF CALIFORNIA, N.A. ("Bank"), as indicated below, the principal sum of TWENTY MILLION AND NO/100 Dollars ($20,000,000.00), or so much thereof as is disbursed, together with interest on the balance of such principal from time to time outstanding, at a per annum rate or rates and at the times set forth below. 1. INTEREST PAYMENTS. Debtor shall pay interest on the 30th day of each MONTH commencing NOVEMBER 30, 2001. Should interest not be paid when due, it shall become a part of the principal and thereafter bear interest as herein provided. All computations of interest under this note shall be made on the basis of a year of 360 days, for actual days elapsed. a. BASE INTEREST RATE. At Debtor's option, amounts outstanding hereunder in minimum amounts of at least $500,000.00 shall bear interest at a rate based on an index selected by Debtor, which is 1.500% per annum in excess of Bank's LIBOR Rate for the Interest Period selected by Debtor, acceptable to Bank. No Base Interest Rate may be changed, altered or otherwise modified until the expiration of the Interest Period selected by Debtor. The exercise of interest rate options by Debtor shall be as recorded in Bank's records, which records shall be prima facie evidence of the amount borrowed under either interest option and the interest rate; provided, however, that failure of Bank to make any such notation in its records shall not discharge Debtor from its obligations to repay in full with interest all amounts borrowed. In no event shall any Interest Period extend beyond the maturity date of this note. To exercise this option, Debtor may, from time to time with respect to principal outstanding on which a Base Interest Rate is not accruing, and on the expiration of any Interest Period with respect to principal outstanding on which a Base Interest Rate has been accruing, select an index offered by Bank for a Base Interest Rates Loan and an Interest Period by telephoning an authorized lending officer of Bank located at the banking office identified below prior to 10:00 a.m., Pacific time, on any Business Day and advising that officer of the selected index, the Interest Period and the Origination Date selected (which Origination Date, for a Base Interest Rate Loan based on the LIBOR Rate, shall follow the date of such selection by no more than two (2) Business Days). Bank will mail a written confirmation of the terms of the selection to Debtor promptly after the selection is made. Failure to send such confirmation shall not affect Bank's rights to collect interest at the rate selected. If, on the date of the selection, the index selected is unavailable for any reason, the selection shall be void. Bank reserves the right to fund the principal from any source of funds notwithstanding any Base Interest Rate selected by Debtor. b. VARIABLE INTEREST RATE. All principal outstanding hereunder which is not bearing interest at a Base Interest Rate shall bear interest at a rate per annum equal to the Reference Rate, which rate shall vary as and when the Reference Rate changes. If any interest rate defined in this note ceases to be available from Bank for any reason, then said interest rate shall be replaced by the rate then offered by Bank, which, in the sole discretion of Bank, most closely approximates the unavailable rate. At any time prior to the maturity of this note, subject to the provisions of paragraph 4, below, of this note, Debtor may borrow, repay and reborrow hereon so long as the total outstanding at any one time does not exceed the principal amount of this note. Debtor shall pay all amounts due under this note in lawful money of the United States at Bank's SAN FERNANDO VALLEY COMMERCIAL BANKING Office, or such other office as may be designated by Bank, from time to time. 2. LATE PAYMENTS. If any payment required by the terms of this note shall remain unpaid ten days after same is due, at the option of Bank, Debtor shall pay a fee of $100 to Bank. 3. INTEREST RATE FOLLOWING DEFAULT. In the event of default, at the option of Bank, and, to the extent permitted by law, interest shall be payable on the outstanding principal under this note at a per annum rate equal to FIVE AND NO/100 percent (5,000%) in excess of the interest rate specified in paragraph 1.b, above, calculated from the date of default until all amounts payable under this note are paid in full. 4. PREPAYMENT. a. Amounts outstanding under this note bearing interest at a rate based on the Reference Rate may be prepaid in whole or in part at any time, without penalty or premium. Debtor may repay amounts outstanding under this note bearing interest at a Base Interest Rate in whole or in part provided Debtor has given Bank not less than five (5) Business Days prior written notice of Debtor's intention to make such prepayment and pays to Bank the prepayment fee due as a result. The prepayment fee shall also be paid, if Bank, for any other reason, including acceleration or foreclosure, receives all or any portion of principal bearing interest at a Base Interest Rate prior to its scheduled payment date. The prepayment fee shall be an amount equal to the present value of the product of: (i) the difference (but not less than zero) between (a) the Base Interest Rate applicable to the principal amount which is being prepaid, and (b) the return which Bank could obtain if it used the amount of such prepayment of principal to purchase at bid price regularly quoted securities issued by the United States having a maturity date most closely coinciding with EXHIBIT 10.11 the relevant Base Rate Maturity Date and such securities were held by Bank until the relevant Base Rate Maturity Date ("Yield Rate"); (ii) a fraction, the numerator of which is the number of days in the period between the date of prepayment and the relevant Base Rate Maturity Date and the denominator of which is 360; and (iii) the amount of the principal so prepaid (except in the event that principal payments are required and have been made as scheduled under the terms of the Base Interest Rate Loan being prepaid, then an amount equal to the lesser of (A) the amount prepaid or (B) 50% of the sum of (1) the amount prepaid and (2) the amount of principal scheduled under the terms of the Base Interest Rate Loan being prepaid to be outstanding at the relevant Base Rate Maturity Date). Present value under this note is determined by discounting the above product to present value using the Yield Rate as the annual discount factor. b. In no event shall Bank be obligated to make any payment or refund to Debtor, nor shall Debtor be entitled to any setoff or other claim against Bank, should the return which Bank could obtain under this prepayment formula exceed the interest that Bank would have received if no prepayment had occurred. All prepayments shall include payment of accrued interest on the principal amount so prepaid and shall be applied to payment of interest before application to principal. A determination by Bank as to the prepayment fee amount, if any, shall be conclusive. c. Bank shall provide Debtor a statement of the amount payable on account of prepayment. Debtor acknowledges that (i) Bank establishes a Base Interest Rate upon the understanding that it apply to the Base Interest Rate Loan for the entire Interest Period, and (ii) Bank would not lend to Debtor without Debtor's express agreement to pay Bank the prepayment fee described above. Debtor initial here: /s/ ------------------------------ 5. DEFAULT AND ACCELERATION OF TIME FOR PAYMENT. Default shall include, but not be limited to, any of the following: (a) the failure of Debtor to make any payment required under this note when due; (b) any breach, misrepresentation or other default by Debtor, any guarantor, co-maker, endorser, or any person or entity other than Debtor providing security for this note (hereinafter individually and collectively referred to as the "Obligor") under any security agreement, guaranty or other agreement between Bank and any Obligor; (c) the insolvency of any Obligor or the failure of any Obligor generally to pay such Obligor's debts as such debts become due; (d) the commencement as to any Obligor of any voluntary or involuntary proceeding under any laws relating to bankruptcy, insolvency, reorganization, arrangement, debt adjustment or debtor relief; (e) the assignment by any Obligor for the benefit of such Obligor's creditors; (f) the appointment, or commencement of any proceeding for the appointment of a receiver, trustee, custodian or similar official for all or substantially all of any Obligor's property; (g) the commencement of any proceeding for the dissolution or liquidation of any Obligor; (h) the termination of existence or death of any Obligor; (i) the revocation of any guaranty or subordination agreement given in connection with this note; (j) the failure of any Obligor to comply with any order, judgement, injunction, decree, writ or demand of any court or other public authority; (k) the filing or recording against any Obligor, or the property of any Obligor, of any notice of levy, notice to withhold, or other legal process for taxes other than property taxes; (l) the default by any Obligor personally liable for amounts owed hereunder on any obligation concerning the borrowing of money; (m) the issuance against any Obligor, or the property of any Obligor, of any writ of attachment, execution, or other judicial lien; or (n) the deterioration of the financial condition of any Obligor which results in Bank deeming itself, in good faith, insecure. Upon the occurrence of any such default, Bank, in its discretion, may cease to advance funds hereunder and may declare all obligations under this note immediately due and payable; however, upon the occurrence of an event of default under d, e, f, or g, all principal and interest shall automatically become immediately due and payable. 6. ADDITIONAL AGREEMENTS OF DEBTOR. If any amounts owing under this note are not paid when due, Debtor promises to pay all costs and expenses, including reasonable attorneys' fees, incurred by Bank in the collection or enforcement of this note. Debtor and any endorsers of this note, for the maximum period of time and the full extent permitted by law, (a) waive diligence, presentment, demand, notice of nonpayment, protest, notice of protest, and notice of every kind; (b) waive the right to assert the defense of any statute of limitations to any debt or obligation hereunder; and (c) consent to renewals and extensions of time for the payment of any amounts due under this note. If this note is signed by more than one party, the term "Debtor" includes each of the undersigned and any successors in interest thereof; all of whose liability shall be joint and several. Any married person who signs this note agrees that recourse may be had against the separate property of that person for any obligations hereunder. The receipt of any check or other item of payment by Bank, at its option, shall not be considered a payment on account until such check or other item of payment is honored when presented for payment at the drawee bank. Bank may delay the credit of such payment based upon Bank's schedule of funds availability, and interest under this note shall accrue until the funds are deemed collected. In any action brought under or arising out of this note, Debtor and any Obligor, including their successors and assigns, hereby consent to the jurisdiction of any competent court within the State of California, as provided in any alternative dispute resolution agreement executed between Debtor and Bank, and consent to service of process by any means authorized by said state's law. The term "Bank" includes, without limitation, any holder of this note. This note shall be construed in accordance with and governed by the laws of the State of California. This note hereby incorporates any alternative dispute resolution agreement previously, concurrently or hereafter executed between Debtor and Bank. 7. DEFINITIONS. As used herein, the following terms shall have the meanings respectively set forth below: "Base Interest Rate" means a rate of interest based on the LIBOR Rate. "Base Interest Rate Loan" means amounts outstanding under this note that bear interest at a Base Interest Rate. "Base Rate Maturity Date" means the last day of the Interest Period with respect to principal outstanding under a Base Interest Rate Loan. "Business Day" means a day on which Bank is open for business for the funding of corporate loans, and, with respect to the rate of interest based on the LIBOR Rate, on which dealings in U.S. dollar deposits outside of the United States may be carried on by Bank. "Interest Period" means with respect to funds bearing interest at a rate based on the LIBOR Rate, any calendar period of one, three, six, nine or twelve months. In determining an Interest Period, a month means a period that starts on one Business Day in a month and ends on and includes the day preceding the numerically corresponding day in the next month. For any month in which there is no such numerically corresponding day, then as to that month, such day shall be deemed to be the last calendar day of such month. Any Interest Period which would otherwise end on a non-Business Day shall end on the next succeeding Business Day unless that is the first day of a month, in which event such Interest Period shall end on the next preceding Business Day. "LIBOR Rate" means a per annum rate of interest (rounded upward, if necessary, to the nearest 1/100 of 1%) at which dollar deposits, in immediately available funds and in lawful money of the United States would be offered to Bank, outside of the United States, for a term coinciding with the Interest Period selected by Debtor and for an amount equal to the amount of principal covered by Debtor's interest rate selection, plus Bank's costs, including the cost, if any, of reserve requirements. "Origination Date" means the first day of the Interest Period. "Reference Rate" means the rate announced by Bank from time to time at its corporate headquarters as its Reference Rate. The Reference Rate is an index rate determined by Bank from time to time as a means of pricing certain extensions of credit and is neither directly tied to any external rate of interest or index nor necessarily the lowest rate of interest charged by Bank at any given time. TEKELEC By: /s/ VP, Corporate Controller __________________________________________________________________ Title By: /s/ VP, Chief Financial Officer __________________________________________________________________ Title EX-10.15 4 d50056_ex10-15.txt EMPLOYMENT OFFER LETTER (CRAVEN) EXHIBIT 10.15 November 13, 2001 PERSONAL AND CONFIDENTIAL Via Federal Express Lori A. Craven 1111 Kenilworth Circle Naperville, IL 60540 Dear Lori: On behalf of Tekelec, I am pleased to offer you employment as Vice President and General Manager, Network Systems Division, on the terms and conditions set forth in this letter. As Vice President and General Manager, Network Systems Division, you will report directly to Tekelec's Executive Vice President and Chief Operating Officer, will be principally responsible for Tekelec's Network Systems Division and will have such other duties and responsibilities as may be delegated to you from time to time by the Executive Vice President and Chief Operating Officer and/or the Chief Executive Officer. You may choose your employment start date so long as it is on or before January 2, 2002. Your compensation and benefits will be as follows: 1. Your starting annual base salary will be $225,000 (i.e., $8,653.85 per bi-weekly period). 2. You will be eligible to participate in Tekelec's 2002 Officer Bonus Plan, under which you will be eligible to receive, in accordance with the terms of such Plan as approved by the Company's Board of Directors (which approval is expected prior to March 2002), up to 56% of your annual base salary earned during 2002 as a cash bonus based on certain financial milestones in 2002 and an annual bonus equal to 14% of your annual base salary earned during 2002 if you achieve certain individual objectives during 2002. For 2002, you will be guaranteed a minimum bonus of $39,375 which, if due, will be paid during the first quarter of 2003. This minimum bonus represents 25% of the maximum aggregate bonus for which you would be eligible under the 2002 Officer Bonus Plan. The terms of your participation in any officer bonus plans after 2002 will be subject to change and the approval of the Board of Directors of Tekelec. 3. You will be entitled to take four weeks personal time annually. 4. You will receive applicable benefits, including health, dental, vision, long-term disability and life insurance, as are generally provided to Tekelec's executive officers. 5. You will be offered the opportunity to participate in Tekelec's Employee Stock Purchase Plan and 401(k) Plan upon your satisfaction of the eligibility requirements for such plans. 6. You will be covered by Tekelec's Officer Severance Plan (a copy of which is enclosed). 7. The Compensation Committee of Tekelec will grant to you stock options (incentive stock options to the maximum extent permitted under law, with the balance being nonstatutory stock options) under Tekelec's 1994 Stock Option Plan (the "Plan") to purchase 200,000 EXHIBIT 10.15 shares of Tekelec Common Stock ("Options"), effective as of the later of your start date or the date of the Compensation Committee's action granting such options (the "grant date"). The exercise price of your Options will be equal to the closing price of Tekelec's Common Stock on the grant date (as reported in The Wall Street Journal on the first business day following the grant date). Your Options will vest to the extent of 50,000 shares on the one-year anniversary of your start date. The remaining 150,000 shares will vest and become exercisable cumulatively in 12 equal quarterly installments of 12,500 shares each, with the first installment vesting on the last day of the first full calendar quarter following your one-year anniversary of employment with the Company) and one additional installment vesting on the last day of each calendar quarter thereafter as long as you remain an employee of Tekelec. Your Options will expire, to the extent previously unexercised, upon the earlier of ten years from the date of grant or a date not less than three months after you cease to be a Tekelec employee as determined in accordance with the terms of the Plan. The Options will in all respects be subject to the terms and provisions of the Plan and the stock option agreement evidencing the grant of the Options. In addition to the foregoing grant, it is anticipated that the Compensation Committee will periodically, typically annually, consider whether additional options should be granted to you while you remain an officer of the Company. 8. Tekelec will pay you up to a maximum of $100,000 to reimburse you for your accountable costs incurred in relocating to North Carolina, including the anticipated commissions and fees for the sale of your current home, losses (if any) incurred on the sale of your current home, the closing costs you incur in connection with your purchase of a new home in North Carolina, your actual out-of-pocket travel, moving, rental and other expenses relating to your relocation, the costs of temporary housing in North Carolina pending your relocation and the reasonable transportation expense you incur traveling to such location and the associated income taxes payable by you with respect to your receipt of such reimbursement. In addition, Tekelec will reimburse you for the reasonable expenses of one house-hunting trip to North Carolina. You are aware that Tekelec prohibits employees from unlawfully using confidential or proprietary information belonging to any other person or entity. By signing the enclosed copy of this letter, you agree not to disclose or use or induce Tekelec or any of its employees to use any trade secrets or confidential or proprietary information belonging to any of your former employers. As a condition of commencing your employment with Tekelec, you will be required to sign Tekelec's standard "Confidentiality and Non-Disclosure Agreement and Assignment of Rights" (a copy of which is enclosed). As with every Tekelec employee, you reserve the right to terminate your employment at any time for any reason, and we similarly reserve the right to terminate your employment at any time, with or without cause. We hope and expect, however, that this will be a long and mutually beneficial relationship. This letter agreement contains our entire understanding with respect to your employment with Tekelec. The provisions of this letter may be amended only by a writing signed by you and Tekelec. If you have any questions about the meaning of any of the terms or provisions included herein, please let me know at your earliest convenience. This letter agreement shall be construed under the laws of California. EXHIBIT 10.15 Lori, we believe that Tekelec can provide you with opportunities for professional growth and financial return. We look forward to working with you and to a mutually fulfilling and rewarding relationship. If this letter agreement is acceptable to you, then please acknowledge your acceptance by signing and dating the enclosed copy of this letter agreement where indicated below and then faxing (fax number: 818.880.0176) and returning such signed copy to me for receipt no later than November 15, 2001. Sincerely, Fred Lax Executive Vice President and Chief Operating Officer Acknowledged and Accepted: /S/ Date: November 15, 2001 - --------------------- Lori A. Craven EX-10.16 5 d50056_ex10-16.txt EMPLOYMENT OFFER LETTER (WALTERS) EXHIBIT 10.16 November 13, 2001 PERSONAL AND CONFIDENTIAL Via Federal Express Daniel B. Walters 804 Hawksbill Island Drive Satellite Beach, FL 32937 Dear Daniel: On behalf of Tekelec, I am pleased to offer you employment as Vice President, Global Marketing and Sales, on the terms and conditions set forth in this letter. As Vice President, Global Marketing and Sales, you will report directly to Tekelec's Executive Vice President and Chief Operating Officer, will be principally responsible for Tekelec's Global Marketing and Sales and will have such other duties and responsibilities as may be delegated to you from time to time by the Executive Vice President and Chief Operating Officer and/or the Chief Executive Officer. You may choose your employment start date so long as it is between January 7 and 14, 2002. Your compensation and benefits will be as follows: 1. Your starting annual base salary will be $225,000 (i.e., $8,653.85 per bi-weekly period). 2. You will be eligible to participate in Tekelec's 2002 Officer Bonus Plan, under which you will be eligible to receive, in accordance with the terms of such Plan as approved by the Company's Board of Directors (which approval is expected prior to March 2002), up to 56% of your annual base salary earned during 2002 as a cash bonus based on certain financial and/or sales milestones in 2002 and an annual bonus equal to 14% of your annual base salary earned during 2002 if you achieve certain individual objectives during 2002. For 2002, you will be guaranteed a minimum bonus of $39,375 which, if due, will be paid during the first quarter of 2003. This minimum bonus represents 25% of the maximum aggregate bonus for which you would be eligible under the 2002 Officer Bonus Plan. The terms of your participation in any officer bonus plans after 2002 will be subject to change and the approval of the Board of Directors of Tekelec. 3. You will be entitled to take four weeks personal time annually. 4. You will receive applicable benefits, including health, dental, vision, long-term disability and life insurance, as are generally provided to Tekelec's executive officers. 5. You will be offered the opportunity to participate in Tekelec's Employee Stock Purchase Plan and 401(k) Plan upon your satisfaction of the eligibility requirements for such plans. 6. You will be covered by Tekelec's Officer Severance Plan (a copy of which is enclosed). 7. The Compensation Committee of Tekelec will grant to you stock options (incentive stock options to the maximum extent permitted under law, with the balance being nonstatutory stock options) under Tekelec's 1994 Stock Option Plan (the "Plan") to purchase 200,000 EXHIBIT 10.16 shares of Tekelec Common Stock ("Options"), effective as of the later of your start date or the date of the Compensation Committee's action granting such options (the "grant date"). The exercise price of your Options will be equal to the closing price of Tekelec's Common Stock on the grant date (as reported in The Wall Street Journal on the first business day following the grant date). Your Options will vest to the extent of 50,000 shares on the one-year anniversary of your start date. The remaining 150,000 shares will vest and become exercisable cumulatively in 12 equal quarterly installments of 12,500 shares each, with the first installment vesting on the last day of the first full calendar quarter following your one-year anniversary of employment with the Company) and one additional installment vesting on the last day of each calendar quarter thereafter as long as you remain an employee of Tekelec. Your Options will expire, to the extent previously unexercised, upon the earlier of ten years from the date of grant or a date not less than three months after you cease to be a Tekelec employee as determined in accordance with the terms of the Plan. The Options will in all respects be subject to the terms and provisions of the Plan and the stock option agreement evidencing the grant of the Options. In addition to the foregoing grant, it is anticipated that the Compensation Committee will periodically, typically annually, consider whether additional options should be granted to you while you remain an officer of the Company. 8. Tekelec will pay you up to a maximum of $100,000 to reimburse you for your accountable costs incurred in relocating to North Carolina, including the anticipated commissions and fees for the sale of your current home, losses (if any) incurred on the sale of your current home, the closing costs you incur in connection with your purchase of a new home in North Carolina, your actual out-of-pocket travel, moving, rental and other expenses relating to your relocation, the costs of temporary housing in North Carolina pending your relocation and the reasonable transportation expense you incur traveling to such location and the associated income taxes payable by you with respect to your receipt of such reimbursement. In addition, Tekelec will reimburse you for the reasonable expenses of one house-hunting trip to North Carolina. You are aware that Tekelec prohibits employees from unlawfully using confidential or proprietary information belonging to any other person or entity. By signing the enclosed copy of this letter, you agree not to disclose or use or induce Tekelec or any of its employees to use any trade secrets or confidential or proprietary information belonging to any of your former employers. As a condition of commencing your employment with Tekelec, you will be required to sign Tekelec's standard "Confidentiality and Non-Disclosure Agreement and Assignment of Rights" (a copy of which is enclosed). As with every Tekelec employee, you reserve the right to terminate your employment at any time for any reason, and we similarly reserve the right to terminate your employment at any time, with or without cause. We hope and expect, however, that this will be a long and mutually beneficial relationship. This letter agreement contains our entire understanding with respect to your employment with Tekelec. The provisions of this letter may be amended only by a writing signed by you and Tekelec. If you have any questions about the meaning of any of the terms or provisions included herein, please let me know at your earliest convenience. This letter agreement shall be construed under the laws of California. EXHIBIT 10.16 Daniel, we believe that Tekelec can provide you with opportunities for professional growth and financial return. We look forward to working with you and to a mutually fulfilling and rewarding relationship. If this letter agreement is acceptable to you, then please acknowledge your acceptance by signing and dating the enclosed copy of this letter agreement where indicated below and then faxing (fax number: 818.880.0176) and returning such signed copy to me for receipt no later than November 15, 2001. Sincerely, Fred Lax Executive Vice President and Chief Operating Officer Acknowledged and Accepted: /S/ Date: November 19, 2001 - -------------------- Daniel B. Walters EX-21.1 6 d50056_ex21-1.txt SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21.1 SUBSIDIARIES OF THE REGISTRANT STATE OR OTHER JURISDICTION OF NAME OF SUBSIDIARY INCORPORATION OR ORGANIZATION - ------------------ ----------------------------- Tekex Limited U.S. Virgin Islands Tekelec Ltd. Japan Tekelec Limited United Kingdom IEX Corporation Nevada Tekelec France France Tekelec Canada Inc. Canada Tekelec Germany GmbH Germany - ---------- * The subsidiaries of the Registrant do not do business under any name other than as listed above EX-23.1 7 d50056_ex23-1.txt CONSENT OF PRICEWATERHOUSECOOPERS LLP EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements of Tekelec on Form S-8 (Registration Nos. 33-48079, 33-82124, 33-60611, 333-05933, 333-28887, 333-37843, 333-71261, 333-86147 and 333-39588) and on Form S-3 (Registration No.333-95649) of our reports dated January 29, 2002, relating to consolidated financial statements and consolidated financial statement schedule which appear in this Annual Report on Form 10-K. /s/ PricewaterhouseCoopers LLP Los Angeles, California March 28, 2002 -----END PRIVACY-ENHANCED MESSAGE-----