Tekelec - Form 10-Q

-----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, UHyKdJuat8iz08N7CY4UQU9rg9VHcdrlJ8Ahu/eqZ1JfvdejtXxn423Pfro7ywTz IFGGffzuqR6ETdnyWfu6tQ== 0000950148-03-002716.txt : 20031113 0000950148-03-002716.hdr.sgml : 20031113 20031113160935 ACCESSION NUMBER: 0000950148-03-002716 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20030930 FILED AS OF DATE: 20031113 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-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-15135 FILM NUMBER: 03998267 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-Q 1 v92665e10vq.htm FORM 10-Q Tekelec - Form 10-Q

FORM 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)


[X]		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2003


[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-15135

TEKELEC

(Exact name of registrant as specified in its charter)


California (State or other jurisdiction of incorporation or organization)		95-2746131 (I.R.S. Employer Identification No.)

26580 W. Agoura Road, Calabasas, California 91302
(Address and zip code of principal executive offices)

(818) 880-5656
(Registrant’s telephone number, including area code)

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 whether the registrant is an accelerated filer. Yes [X] No [ ]

As of November 7, 2003, there were 61,520,692 shares of the registrant’s common stock, without par value, outstanding.

TABLE OF CONTENTS


PART I — FINANCIAL INFORMATION
	Item 1. Consolidated Financial Statements
		Consolidated Balance Sheets
		Consolidated Statements of Operations
		Consolidated Statements of Comprehensive Income
		Consolidated Statements of Cash Flows
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Controls and Procedures
PART II — OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 2. Changes in Securities and Use of Proceeds
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
EXHIBIT 10.1
EXHIBIT 10.2
EXHIBIT 10.3
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

TABLE OF CONTENTS
TEKELEC
FORM 10-Q
INDEX


		Page

Part I – Financial Information
Item 1.	Consolidated Financial Statements
	Consolidated Balance Sheets at September 30, 2003 and December 31, 2002	3
	Consolidated Statements of Operations for the three and nine months ended September 30, 2003 and 2002	4
	Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2003 and 2002	5
	Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and 2002	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	25
Item 4.	Controls and Procedures	25
Part II – Other Information
Item 1.	Legal Proceedings	26
Item 2.	Changes in Securities and Use of Proceeds	27
Item 6.	Exhibits and Reports on Form 8-K	28
Signatures		29

PART I — FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Tekelec
Consolidated Balance Sheets


			September 30,		December 31,
			2003		2002

			(thousands, except share data)
			(unaudited)
Assets
Current assets:
	Cash and cash equivalents		$	161,707	$	167,283
	Short-term securities, at fair value			10,493		14,289
	Accounts and notes receivable, less allowances of $2,454 and $4,860, respectively			33,330		44,061
	Current portion of convertible notes receivable ($17,300 principal amount)			17,681		—
	Inventories			19,142		10,560
	Deferred income taxes, net			12,992		13,806
	Prepaid expenses and other current assets			17,138		16,491

		Total current assets		272,483		266,490
Long-term securities, at fair value				167,592		128,258
Property and equipment, net				23,244		21,387
Investments in privately-held companies				16,525		16,525
Deferred income taxes, net				10,583		11,502
Other assets				6,080		2,263
Long-term convertible notes receivable ($17,300 principal amount)				—		17,987
Goodwill				70,775		44,942
Intangible assets, net				37,726		16,329

		Total assets	$	605,008	$	525,683

Liabilities and Shareholders’ Equity
Current liabilities:
	Trade accounts and notes payable		$	7,576	$	6,674
	Accrued expenses			31,552		31,011
	Accrued payroll and related expenses			16,533		11,360
	Current portion of deferred revenues			40,256		28,355
	Income taxes payable			228		1,178

		Total current liabilities		96,145		78,578
Notes payable				4,344		—
Long-term convertible debt				125,000		126,973
Deferred income taxes				10,775		14,493
Long-term portion of deferred revenues				2,015		3,632

		Total liabilities		238,279		223,676

Minority Interest				48,480		—

Commitments and Contingencies (Note H)
Shareholders’ equity:
	Common stock, without par value, 200,000,000 shares authorized; 61,363,468 and 60,892,730 shares issued and outstanding, respectively			186,897		182,277
	Retained earnings			130,617		119,443
	Accumulated other comprehensive income			735		287

		Total shareholders’ equity		318,249		302,007

		Total liabilities and shareholders’ equity	$	605,008	$	525,683

See notes to consolidated financial statements.

Tekelec
Consolidated Statements of Operations
(unaudited)


				Three Months Ended						Nine Months Ended
				September 30,						September 30,

				2003			2002			2003			2002

				(thousands, except per share data)
Revenues				$	70,747		$	73,544		$	188,675		$	201,918
Cost of sales:
	Cost of goods sold				14,488			16,479			44,009			52,298
	Amortization of purchased technology				2,964			2,476			8,102			7,663

		Total cost of sales			17,452			18,955			52,111			59,961

		Gross profit			53,295			54,589			136,564			141,957

Operating expenses:
	Research and development				20,696			16,251			51,183			45,149
	Selling, general and administrative				28,344			22,654			74,681			68,878
	Acquired in-process research and development				—			—			2,900			—
	Amortization of intangible assets				543			400			1,368			1,200

		Total operating expenses			49,583			39,305			130,132			115,227

Income from operations					3,712			15,284			6,432			26,730
Other income (expense):
	Interest income				1,479			1,496			4,528			4,854
	Interest expense				(2,783	)		(2,305	)		(7,675	)		(6,865	)
	Other, net				(279	)		(391	)		(290	)		301

			Total other income (expense)		(1,583	)		(1,200	)		(3,437	)		(1,710	)

Income from continuing operations before provision for income taxes					2,129			14,084			2,995			25,020
Provision for income taxes					4,987			4,760			7,634			8,448

			Net income (loss) before minority interest		(2,858	)		9,324			(4,639	)		16,572
Minority interest					8,015			—			12,520			—

Income from continuing operations					5,157			9,324			7,881			16,572
Loss from discontinued operation, net of benefit for income taxes of $1,533 and $2,707 for the three and nine months ended September 30, 2002, respectively					—			(1,898	)		—			(3,308	)
Gain on disposal of discontinued operation, net of provision for income taxes of $13,345 for the three and nine months ended September 30, 2002					3,293			28,312			3,293			28,312

		Net income		$	8,450		$	35,738		$	11,174		$	41,576

Earnings per share from continuing operations:
	Basic			$	0.09		$	0.15		$	0.13		$	0.27
	Diluted				0.08			0.16			0.12			0.31
Loss per share from discontinued operation:
	Basic			$	—		$	(0.03	)	$	—		$	(0.05	)
	Diluted				—			(0.03	)		—			(0.05	)
Earnings per share from gain on disposal of discontinued operation:
	Basic			$	0.05		$	0.47		$	0.05		$	0.47
	Diluted				0.05			0.41			0.05			0.41
Earnings per share:
	Basic			$	0.14		$	0.59		$	0.18		$	0.69
	Diluted				0.13			0.54			0.17			0.67
Weighted average number of shares outstanding:
	Basic				61,206			60,407			61,057			60,249
	Diluted				69,915			68,793			68,848			68,987

See notes to consolidated financial statements.

Tekelec
Consolidated Statements of Comprehensive Income
(unaudited)


		Three Months Ended					Nine Months Ended
		September 30,					September 30,

		2003			2002		2003			2002

		(thousands)
Net income		$	8,450		$	35,738	$	11,174		$	41,576
Other comprehensive income:
	Foreign currency translation adjustments		(352	)		352		(322	)		1,687
	Net unrealized gain (loss) on available-for-sale securities		(197	)		—		770			—

Comprehensive income		$	7,901		$	36,090	$	11,622		$	43,263

See notes to consolidated financial statements.

Tekelec
Consolidated Statements of Cash Flows
(unaudited)


				Nine Months Ended
				September 30,

				2003			2002

				(thousands)
Cash flows from operating activities:
Net income				$	11,174		$	41,576
Adjustments to reconcile net income to net cash provided by operating activities:
	Minority interest				(12,520	)		—
	Net gain on disposal of discontinued operation				(3,293	)		(28,312	)
	Net loss from discontinued operation				—			3,308
	Allowance for doubtful accounts				—			(197	)
	Depreciation				10,894			12,121
	Amortization				13,090			8,929
	Amortization of deferred financing costs				1,843			615
	Convertible debt accretion				2,335			2,960
	Deferred income taxes				(1,986	)		(996	)
	Stock-based compensation				328			246
	Tax benefit related to stock options exercised				791			341
	Changes in operating assets and liabilities, net of the effects of the acquisition:
		Accounts and notes receivable			12,907			8,802
		Inventories			(2,969	)		3,292
		Prepaid expenses and other current assets			2,122			5,748
		Trade accounts payable			(5,181	)		(4,808	)
		Accrued expenses			(9,843	)		1,636
		Accrued payroll and related expenses			5,173			7,458
		Deferred revenues			4,670			(12,958	)
		Income taxes payable			(953	)		(1,754	)

			Total adjustments		17,408			6,431

			Net cash provided by operating activities		28,582			48,007

Cash flows from investing activities:
	Proceeds from maturity of available-for-sale securities				267,176			229,036
	Purchase of available-for-sale securities				(301,944	)		(203,425	)
	Purchase of property and equipment				(4,007	)		(4,187	)
	Cash acquired from acquisition of Santera				12,335			—
	Purchase of technology				(3,166	)		137
	Change in other assets				(71	)		(313	)
	Proceeds from disposal of discontinued operation, net of cash expenditures				1,033			37,883

			Net cash provided by (used in) investing activities		(28,644	)		59,131

Cash flows from financing activities:
	Payments on notes payable				(557	)		—
	Retirement of convertible debt				(129,307	)		—
	Proceeds from issuance of convertible debt				125,000			—
	Debt issuance costs				(3,816	)		—
	Proceeds from issuance of common stock				3,501			2,008

			Net cash provided by (used in) financing activities		(5,179	)		2,008

Effect of exchange rate changes on cash					(335	)		502

Net cash flows from discontinued operation					—			2,007

	Net change in cash and cash equivalents				(5,576	)		111,655
Cash and cash equivalents at beginning of period					167,283			87,148

Cash and cash equivalents at end of period				$	161,707		$	198,803

See notes to consolidated financial statements.

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

A. Basis of Presentation

The consolidated financial statements are unaudited, other than the consolidated balance sheet at December 31, 2002, and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of our financial condition, operating results and cash flows for the interim periods. The consolidated financial statements include the accounts and operating results of our wholly owned subsidiaries and our majority owned subsidiary, Santera, less minority interest from the acquisition date of June 10, 2003. See note B — Acquisition of Majority Interest in Santera.

As more fully described in Note C – Disposition of Network Diagnostics Business, we sold our Network Diagnostics Division (“NDD”) effective August 30, 2002. Accordingly, comparative 2002 financial results and notes have been restated to reflect NDD as a discontinued operation. All significant intercompany balances and transactions have been eliminated in consolidation.

The results of operations for the current interim periods are not necessarily indicative of results to be expected for the current year. Certain items shown in the prior financial statements have been reclassified to conform with the presentation of the current period.

We operate under a thirteen-week calendar quarter. For financial statement presentation purposes, however, the reporting periods are referred to as ended on the last calendar day of the quarter. The accompanying consolidated financial statements for the three and nine months ended September 30, 2003 and 2002 are for the thirteen and thirty-nine weeks ended September 26, 2003 and September 27, 2002, respectively.

These consolidated financial statements should be read in conjunction with the consolidated financial statements for the year ended December 31, 2002 and the notes thereto in our Annual Report on Form 10-K for the year ended December 31, 2002.

Recent Accounting Pronouncements

In February 2003, the Financial Accounting Standards Board (“FASB”) issued Emerging Issues Task Force (“EITF”) Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 requires revenue arrangements with multiple deliverables to be divided into separate units of accounting. If the deliverables in the arrangement meet certain criteria, arrangement consideration should be allocated among the separate units of accounting based on their relative fair values. Applicable revenue recognition criteria should be considered separately for separate units of accounting. The guidance in EITF Issue No. 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. Adoption of EITF Issue No. 00-21 did not have a material impact on our financial position, results of operations or cash flows.

In April 2003, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies the accounting guidance on derivative instruments (including certain derivative instruments embedded in other contracts) and hedging activities that fall within the scope of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 is effective for all contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. The guidance is to be applied prospectively. Currently, we do not enter into these types of transactions and therefore this pronouncement did not have an impact on our financial position, results of operations or cash flows.

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

guidance could be classified as equity, or “mezzanine” equity, by now requiring those instruments to be classified as liabilities in the statement of financial position. Further, SFAS No. 150 requires disclosure regarding the terms of those instruments and settlement alternatives. SFAS No. 150 was generally effective for all financial instruments entered into or modified after May 31, 2003, and was otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material impact on our financial position, results of operations, or cash flows.

In January 2003, FASB issued Interpretation (“FIN”) No. 46, “Consolidation of Variable Interest Entities-an Interpretation of ARB No. 51.” The Interpretation clarified the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of this Interpretation are effective for all enterprises with variable interest entities created after January 31, 2003. On October 8, 2003, the FASB deferred the implementation date of Interpretations No. 46 from the third quarter of 2003 to the fourth quarter of 2003. The adoption of Interpretation No. 46 will not have a material impact on our financial position, results of operations, or cash flows.

B. Acquisition of Majority Interest in Santera

On June 10, 2003, we acquired a 51.6% controlling voting ownership interest (57.5% on an as converted basis) in Santera in exchange for cash contribution of $28.0 million and the contribution of the business operations and certain assets and liabilities of Tekelec’s Packet Telephony Business Unit (“PTBU”). As part of the acquisition and combination, Santera was recapitalized and Tekelec contributed the $28.0 million in cash to Santera in exchange for 28,000 shares of Santera’s Series B Preferred Stock. In addition, Tekelec received 38,000 shares of Santera’s Series A Preferred Stock and one share of Santera’s common stock in exchange for the PTBU. Santera’s existing shareholders received 62,000 shares of Series A Preferred Stock in exchange for their existing shares in Santera and made an additional cash contribution to Santera of $12.0 million. Each share of Santera’s Series B Preferred Stock has a liquidation preference equal to $2,000 and is convertible into 1.63 shares of Santera’s common stock. Each share of Santera’s Series A Preferred Stock has a liquidation preference equal to $1,000 and is convertible into one share of Santera’s common stock. In accordance with consolidation accounting, the capital structure of Santera has been eliminated in consolidation and the minority shareholders’ interest in Santera is reflected in our consolidated balance sheet as minority interest. The minority shareholders’ interest in Santera is reflected at the fair value of the Santera assets acquired. Santera develops, markets and sells solutions for carrier-class, next-generation switches.

The transaction has been accounted for using the purchase method of accounting, and resulted in a step-up of approximately $56.9 million of Santera’s assets and liabilities to fair value as follows:


	(thousands)
Fair value of Santera	$	61,000
Direct acquisition costs		3,700
Less: Santera tangible net assets acquired		(7,767	)

Fair value step up	$	56,933

The total purchase price step-up were allocated among the Santera assets acquired and liabilities assumed based on their estimated fair values determined by a third party appraisal as follows:


	(thousands)
In-process research and development	$	2,900
Goodwill		25,835
Identifiable intangible assets		27,200
Acquired backlog		500
Inventory fair value step-up		498

	$	56,933

The PTBU assets and liabilities contributed remain at historical cost.

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

Based on the purchase price allocation, $2.9 million of the purchase price represented acquired in-process research and development (“IPRD”) that had not yet reached technological feasibility and had no alternative future use. This amount was recorded as an expense in the second quarter of 2003. The identifiable intangible assets created as a result of the acquisition will be amortized over their estimated useful lives of 15 years, with the exception of acquired backlog which has an estimated life of one year. Amortization expense of purchased technology and other intangible assets of Santera, including the intangible assets contributed by PTBU, amounted to $1.9 million and $2.2 million for the three and nine months ended September 30, 2003, respectively.

The following table shows our pro forma revenue, net income and net income per share giving effect to the Santera acquisition as of the beginning of 2002, excluding the impact of the one-time IPRD charge:


		Nine Months Ended September 30,

		2003		2002

		(thousands, except per share
		amounts)

Revenues		$	194,485	$	204,194
Net income			6,926		28,948
Net income per share:
	Basic	$	0.11	$	0.48
	Diluted		0.10		0.42

The net income and losses of Santera are allocated between us and minority interest based on the relative interest in the equity of Santera and the related liquidation preferences. This approach requires net losses to be allocated first to the Series A Preferred Stock until fully absorbed and then to the Series B Preferred Stock. Subsequent net income will be allocated first to the Series B Preferred Stock to the extent of previously recognized net losses allocated to Series B Preferred Stock. Additional net income will then be allocated to the Series A Preferred Stock to the extent of previous recognized losses allocated to Series A Preferred Stock and then to Series A and B Preferred Stock in proportion to relative ownership. The loss allocated to minority interest of Santera for the period of June 10, 2003 through September 30, 2003 was computed as follows (dollars in thousands):


Santera net loss (includes amortization of intangibles and IPRD charges of $2,191 and $2,900, respectively)	$	20,194
Percentage of losses attributable to the minority interest based on capital structure and liquidation preferences		62	%

Net loss allocated to minority interest	$	12,520

In addition to the initial ownership interest, we have the right to increase our ownership to up to 56.0% of Santera’s outstanding shares (62.5% on an as converted basis) for a per share purchase price equal to the per share purchase price of our original investment. We also have certain rights, exercisable during the period from July 1, 2005 through December 31, 2007, to acquire the remaining outstanding shares of Santera from the holders thereof at a price determined in accordance with the terms of the definitive agreements (the “Tekelec Option Price”). In addition, the other shareholders of Santera will have the right, exercisable during the period from January 2006 through February 2008, to require us to purchase their shares at a price equal to 80% of the Tekelec Option Price, provided Santera has been profitable for the two calendar quarters preceding such exercise.

C. Disposition of Network Diagnostics Business

On August 30, 2002, we completed the sale of NDD to Catapult Communications Corporation (“Catapult”) for $59.8 million, consisting of cash in the amount of $42.5 million and convertible subordinated promissory notes (the “Notes”) issued by Catapult’s wholly owned Irish subsidiary and guaranteed by Catapult in the total principal amount of $17.3 million. The sale resulted in a pre-tax gain of approximately $41.7 million ($28.3 million after taxes) in 2002. During the third quarter of 2003, an additional $3.3 million gain on the sale was recognized based on post closing adjustments, including working capital, resulting from the final settlement with Catapult in accordance with the asset purchase

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

agreement. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the sale of the NDD business segment has been presented as a discontinued business and our historical financial results for periods prior to disposition have been revised to reflect NDD as a discontinued operation. Accordingly, the revenues, costs and expenses, assets and liabilities, and cash flows of NDD have been condensed in the accompanying consolidated statements of operations, balance sheets and cash flows.

Revenues and loss from our discontinued operation were as follows:


	Three Months Ended			Nine Months Ended
	September 30, 2002			September 30, 2002

	(thousands)
Revenues	$	2,221		$	26,556
Loss from discontinued operations		(1,898	)		(3,308	)

The Notes have a principal amount of $17.3 million bearing interest at 2% per annum and are due on August 30, 2004. We have the option of converting the Notes into Catapult common stock after August 30, 2003 through maturity at a conversion rate (subject to certain adjustments) of 62.50 shares of Catapult common stock per $1,000 in principal (approximately 1.1 million shares). Catapult also has the option of repaying one of the Notes at maturity in the principal amount of $10.0 million by delivery of shares of Catapult common stock valued at a 17.5% discount from trading prices at the time of repayment.

The Notes were initially reflected in the consolidated balance sheet at their estimated fair value using a third party appraisal which computed the fair value by discounting the face amount to present value using a fair value rate of interest and then determining the fair value of the conversion option using the Black-Scholes valuation model. The fair value of the Notes is being adjusted to the redemption amount at maturity based on an effective interest amortization method, with periodic charges to interest. The fair values of the Notes and the conversion option are as follows:


		September 30,			December 31,
		2003			2002

		(thousands)
Notes: fair value at $17,300			14,869			14,869
Fair value of conversion option feature		$	3,246		$	3,246

	Fair value of Notes at August 30, 2002		18,115			18,115
Less, accumulated amortization			(434	)		(128	)

	Carrying value of Notes	$	17,681		$	17,987

D. Certain Balance Sheet Items


		September 30,			December 31,
		2003			2002

		(thousands)
Inventories consist of the following:
Raw materials		$	13,192		$	4,777
Work in process			660			179
Finished goods			5,290			5,604

	Inventories	$	19,142		$	10,560

Property and equipment consist of the following:
Manufacturing and development equipment		$	61,188		$	47,074
Furniture and office equipment			30,454			26,819
Demonstration equipment			2,429			3,711
Leasehold improvements			9,296			8,382

			103,367			85,986
Less accumulated depreciation			(80,123	)		(64,599	)

	Property and equipment, net	$	23,244		$	21,387

Tekelec
Notes to Consolidated Financial Statements
(unaudited)


		September 30,			December 31,
		2003			2002

		(thousands)
Intangible assets consist of the following:
Purchased technology		$	79,162		$	49,995
Other			14,600			10,000

			93,762			59,995
Less accumulated amortization			(56,036	)		(43,666	)

	Intangible assets, net	$	37,726		$	16,329

E. Financial Instruments

We conduct business in a number of foreign countries, with certain transactions denominated in local currencies. During the nine months ended September 30, 2003, we entered into forward contracts to mitigate exposures associated with sale contracts denominated in currencies other than the U.S. dollar. These contracts are used to reduce our risk associated with exchange rate movements, as gains and losses on these contracts are intended to offset exchange losses and gains on underlying exposures. Changes in the fair value of these forward contracts are recorded immediately in earnings.

The purpose of our foreign currency management policy is to minimize the effect of exchange rate fluctuations on certain foreign denominated anticipated cash flows. The terms of currency instruments used for hedging purposes are consistent with the timing of the transactions being hedged. We do not use derivative financial instruments for trading or speculative purposes.

As of September 30, 2003, we had one foreign currency forward contract outstanding to sell approximately 2,800,000 Euros in order to hedge certain receivables denominated in those currencies. These contracts had an expiration date of October 3, 2003 and did not meet specific hedge accounting requirements.

Corresponding gains and losses on these contracts, as well as gains and losses on the items being hedged, are included as a component of other income and expense in our consolidated statement of operations. For the three and nine months ended September 30, 2003, our income (loss), net from foreign currency forward contracts was $10,000 and ($412,000), respectively. We did not enter into forward contracts for the three and nine months ended September 30, 2002.

We may continue to use foreign currency forward contracts to manage foreign currency exchange risks in the future.

F. Income Taxes

The income tax provisions from continuing operations for the three and nine months ended September 30, 2003 were $5.0 million and $7.6 million, respectively, and reflected the effect of non-deductible acquisition-related costs, partially offset by benefits of $557,000 and $2.6 million, respectively, from the utilization of deferred tax liabilities related to certain of these acquisition-related costs.

The provision for income taxes does not include any benefit from the losses generated by Santera due to their losses not being included on our federal consolidated tax return because our ownership interest in Santera does not meet the threshold to consolidate under income tax rules and regulations and a full valuation is provided on the tax benefits generated by Santera as a result of their historical operating losses.

Excluding the effect of acquisition-related items and Santera’s operating results, an effective tax rate of 34% and 35% was applied to continuing operations for the three and nine-month periods ended September 30, 2003 and 2002, respectively, and represented federal, state and foreign taxes on our income, reduced primarily by research and development credits, foreign tax credits, and other benefits from foreign sourced income.

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

G. Lines of Credit, Notes Payable and Long-Term Convertible Debt

We have a $20.0 million line of credit with a U.S. bank. Our $20.0 million credit facility is collateralized by substantially all of our assets, excluding the assets of Santera, bears interest at or, in some cases, below the lender’s prime rate (4.0% at September 30, 2003) and expires on August 31, 2004, if not renewed. Under the terms of this credit facility, we are required to maintain certain financial ratios and meet certain net worth and indebtedness covenants. We believe we are in compliance with these requirements. There have been no borrowings under this credit facility.

As a result of the Santera transaction (see note B — Acquisition of Majority Interest in Santera), we have two notes payable to U.S. financial institutions. One of the notes has an outstanding balance of $3.7 million and is secured by the assets purchased under the note, bears interest at 10% and matures in February 2005. The second note for $3.5 million is secured by the assets purchased under the note and substantially all of Santera’s assets, excluding the assets secured under the $3.7 million note, bears interest at 6.36% and matures in November 2005. Under the terms of this facility, we are required to maintain certain financial reporting covenants. We believe we are in compliance with these requirements.

In November 1999, we completed the private placement of $135.0 million principal amount at maturity of 3.25% convertible subordinated discounted notes due in 2004, issued at 85.35% of their face amount (equivalent to gross proceeds of approximately $115.2 million at issuance before discounts and expenses). The discounted notes were called and subsequently redeemed on July 19, 2003.

In June 2003, we completed the private placement of $125.0 million principal amount of 2.25% Senior Subordinated Convertible notes due in 2008.

H. Commitments and Contingencies

Legal Claims

Alcatel 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 alleged 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 a particular software application offered by Tekelec as a feature on its STP for routing query messages in wireless networks. Alcatel sought a permanent injunction enjoining the Company from infringing the patents at issue, unspecified general and exemplary damages, and an award of costs.

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 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 defended the action vigorously, asserting defenses to Alcatel’s claims on the grounds of invalidity, non-infringement and inequitable conduct by Alcatel.

In April 2002, Tekelec filed a motion for summary judgment for non-infringement and Alcatel filed a motion for summary judgment for infringement. The Court referred both motions to the Magistrate Judge for consideration. After a hearing on both motions before the Magistrate Judge, in May 2002 the Magistrate Judge issued a report and recommendation of non-infringement in favor of Tekelec. After a hearing held in May 2003, the District Judge partially upheld and partially overruled the Magistrate Judge’s recommendation. By letter, the Judge indicated he would find summary judgment of non-infringement for Tekelec on some claims of the patents, but would deny summary judgment on other claims. The Court also indicated it would deny Alcatel’s Motion for Summary Judgment of infringement.

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

In August 2003, the Magistrate Judge heard and subsequently denied cross-motions for summary judgment filed by Alcatel and Tekelec on the Company’s defenses of invalidity and inequitable conduct.

In September 2003, Tekelec and Alcatel reached a settlement under which Tekelec received from Alcatel, in exchange for the payment by Tekelec of a lump sum, a license under the patents-in-suit and under other related patents, as well as a covenant not to sue for other unrelated patents which had been asserted against an affiliate of Tekelec. The lawsuit has been dismissed with prejudice. The terms of the settlement are confidential.

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 us, 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 we are currently investigating which products and/or processes might be subject to the lawsuit. At present, the lawsuit is stayed pending a non-appealable resolution of a lawsuit involving the same patents that is pending in the United States District Court for the District of Nevada. We currently believe that the ultimate outcome of the lawsuit will not have a material adverse effect on our financial condition, results of operations or cash flows.

Syndia Corporation

In January 2002, Syndia Corporation (“Syndia”) sent a letter to us accusing Tekelec of infringing two patents and offering to license these and other patents to us. The patents at issue relate to integrated circuit technology. Syndia has not identified the specific Tekelec products or processes that allegedly infringe the patents at issue, and we are currently investigating which products and/or processes might be subject to Syndia’s claims.

Indemnities, Commitments and Guarantees

In the normal course of our business, we make certain indemnities, commitments and guarantees under which we may be required to make payments in relation to certain transactions. These indemnities, commitments and guarantees include, among others, intellectual property indemnities to our customers in connection with the sale of our products and licensing of our technology, indemnities for liabilities associated with the infringement of other parties’ technology based upon our products and technology, guarantees of timely performance of our obligations, and indemnities to our directors and officers to the maximum extent permitted by law. The duration of these indemnities, commitments and guarantees varies, and, in certain cases, is indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments that we could be obligated to make. We have not recorded a liability for these indemnities, commitments or guarantees in the accompanying balance sheets because future payment is not probable.

I. Stock-Based Compensation

As of September 30, 2003, we have five stock-based employee compensation plans. We account for employee stock option plans in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and the related FASB interpretation FIN No. 44, “Accounting for Certain Transactions Involving Stock Compensation.” Accordingly, compensation expense related to employee stock options is recorded, if on the date of the grant, the fair value of the underlying stock exceeds the exercise price.

To date, options have been granted at exercise prices that equal or exceed market value of the underlying common

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

stock on the grant date. However, we have modified certain option grants that did require remeasurement on the modification date and accordingly have resulted in stock-based compensation because the exercise prices were below the fair market value on the date of the modification. We account for stock issued to non-employees in accordance with the provisions of SFAS No. 123 and EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods and Services.”

SFAS No. 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. We have chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in related interpretations. However, in accordance with the disclosure only requirements of SFAS No. 123, we have computed the fair value of our stock option grants using the Black-Scholes option-pricing model with the following assumptions: (i) dividend yield of 0%, (ii) expected volatility of 85% and 90%, respectively, for 2003 and 2002, (iii) weighted average risk-free interest rates of 2.2% and 3.7% for 2003 and 2002, respectively, (iv) weighted average expected option lives of 5.0 and 4.9 years for 2003 and 2002, respectively, and (v) assumed forfeiture rate of 47% and 50% for 2003 and 2002, respectively.

The following table illustrates the effect on stock-based compensation, net income (loss) in total and per share if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.


			Three Months Ended				Nine Months Ended
			September 30,				September 30,

			2003		2002		2003			2002

			(thousands, except per share data)
Stock-based compensation, net of tax benefit:
	As reported		$	87	$	53	$	216		$	159
	Additional stock-based compensation expense determined under the fair value method			3,649		4,785		13,106			13,896

	Pro forma		$	3,736	$	4,838	$	13,322		$	14,055

Net income (loss):
	As reported		$	8,450	$	35,738	$	11,174		$	41,576
	Less: additional stock-based compensation expense determined under the fair value method, net of tax benefit			3,649		4,785		13,106			13,896

	Pro forma		$	4,801	$	30,953	$	(1,932	)	$	27,680

Net income (loss) per share-basic:
	As reported		$	0.14	$	0.59	$	0.18		$	0.69
	Less: per share effect of additional stock-based compensation expense determined under the fair value method, net of tax			0.06		0.08		0.21			0.23

	Pro forma		$	0.08	$	0.51	$	(0.03	)	$	0.46

Net income (loss) per share-diluted:
	As reported		$	0.13	$	0.54	$	0.17		$	0.67
	Less: per share effect of additional stock-based compensation expense determined under the fair value method, net of tax			0.05		0.07		0.20			0.20

	Pro forma		$	0.08	$	0.47	$	(0.03	)	$	0.47

Weighted average number of shares outstanding:
		Basic		61,206		60,407		61,057			60,249
		Diluted		69,915		68,793		68,848			68,987

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

J. Operating Segment Information

The Network Signaling (formerly Network Systems) operating segment develops, markets and sells our Eagle signaling products based on our high capacity Eagle 5 Signaling Application System (SAS) platform that has been expanded to include TekWare and TekServer architecture, a high-density, high-speed processing platform that is compatible with existing technology; the IP7 Secure Gateway, an SS7/IP gateway for signaling in converged networks, and other IP7 convergence products; Sentinel, a complete network monitoring and revenue assurance system; and network signaling products resulting from our acquisition of IEX, including the ASi 4000 Service Control Point, an advanced database server used for the provisioning of telephony applications.

The Contact Center operating segment develops, markets and sells software-based solutions for call centers, including TotalView Workforce Management and TotalNet Call Routing.

The Next-Generation Switching operating segment comprises Santera, a majority owned subsidiary of Tekelec. See Note B — Acquisition of Majority Interest in Santera. Santera develops next-generation switching technologies for network service providers. Santera’s portfolio of switching solutions allows network service providers to migrate their network infrastructure from circuit-based technology to packet-based technology. Santera’s product portfolio includes SanteraOne, a carrier-grade, integrated voice and data switching solution which delivers applications like IXC tandem, Class 4/5, PRI offload, packet/cell switching and Voice over Broadband services.

As discussed in Note C — Disposition of Network Diagnostics Business, we sold the Network Diagnostics operating segment and the Japan Diagnostics operating segment, (collectively “NDD”) in August 2002. NDD is reflected as a discontinued operation and accordingly the historical operating segment data has been restated to exclude the discontinued operation.

Our operating segments and geographical information are as follows (in thousands):

Operating Segments


		Revenues

		Three Months Ended				Nine Months Ended
		September 30,				September 30,

		2003		2002		2003		2002

Network Signaling		$	56,823	$	62,815	$	156,349	$	171,958
Contact Center			9,350		10,729		26,529		29,960
Next-Generation Switching(1)			4,574		—		5,797		—

	Total revenues	$	70,747	$	73,544	$	188,675	$	201,918


		Income from Operations

		Three Months Ended						Nine Months Ended
		September 30,						September 30,

		2003			2002			2003			2002

Network Signaling		$	22,734		$	20,993		$	47,156		$	47,618
Contact Center			3,662			4,664			9,397			12,018
Next-Generation Switching(1)			(9,960	)		—			(13,976	)		—
General Corporate(2)			(12,724	)		(10,373	)		(36,145	)		(32,906	)

	Total income from operations	$	3,712		$	15,284		$	6,432		$	26,730

(1)		Results for Next-Generation Switching are for the period subsequent to June 10, 2003, the acquisition date of Santera.




(2)		General Corporate includes acquisition-related charges and amortization of $3,364 and $2,800 for the three months ended September 30, 2003 and 2002, respectively, and $11,961 and $8,400 for the nine months ended September 30, 2003 and 2002, respectively.

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

Enterprise-Wide Disclosures

The following table sets forth, for the periods indicated, revenues from external customers by principal product line:


		Three Months Ended				Nine Months Ended
		September 30,				September 30,

		2003		2002		2003		2002

Network Signaling		$	56,823	$	62,815	$	156,349	$	171,958
Contact Center			9,350		10,729		26,529		29,960
Next-Generation Switching			4,574		—		5,797		—

	Total	$	70,747	$	73,544	$	188,675	$	201,918

The following table sets forth, for the periods indicated, revenues from external customers by geographic territory:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,

	2003		2002		2003		2002

North America	$	60,620	$	53,012	$	156,143	$	164,649
Europe		3,752		15,371		12,182		21,662
Rest of World		6,375		5,161		20,350		15,607

Total revenues from external customers	$	70,747	$	73,544	$	188,675	$	201,918

The following table sets forth, for the periods indicated, long-lived assets by geographic area in which we hold assets:


		September 30,		December 31,
		2003		2002

United States		$	153,311		84,064
Other			1,039		857

	Total long-lived assets	$	154,350		84,921

Sales to one customer accounted for 11% of revenues for the three and nine months ended September 30, 2003 and included sales from all operating segments. Sales to another other customer accounted for 11% of the revenues for the nine months ended September 30, 2003 and included sales from both the network signaling and contact center operating segments. A third customer accounted for 15% of revenue for the three months ended September 30, 2003 and included sales from the network signaling and contact center operating segments.

Sales to two customers individually accounted for 12% and 10% of revenues for the three months ended September 30, 2002 and included sales from the network signaling and contact center operating segments. There were no customers accounting for 10% or more of revenues for the nine months ended September 30, 2002.

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

K. Earnings Per Share

The following table provides a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations for the three and nine months ended September 30, 2003 and 2002:


	Net Income		Shares		Per Share
	(Numerator)		(Denominator)		Amount

	(thousands, except per share data)
For the Three Months Ended September 30, 2003:
Basic EPS	$	8,450		61,206	$	0.14
Effect of Dilutive Securities — Stock Options and Warrants		—		2,348
Effect of “if-converted” method applied to Convertible Note		591		6,361

Diluted EPS	$	9,041		69,915	$	0.13

For the Three Months Ended September 30, 2002:
Basic EPS	$	35,738		60,407	$	0.59
Effect of Dilutive Securities — Stock Options and Warrants		—		780
Effect of “if-converted” method applied to Convertible Note		1,498		7,606

Diluted EPS	$	37,236		68,793	$	0.54

For the Nine Months Ended September 30, 2003:
Basic EPS	$	11,174		61,057	$	0.18
Effect of Dilutive Securities — Stock Options and Warrants		—		1,430
Effect of “if-converted” method applied to Convertible Note		684		6,361

Diluted EPS	$	11,858		68,848	$	0.17

For the Nine Months Ended September 30, 2002:
Basic EPS	$	41,576		60,249	$	0.69
Effect of Dilutive Securities — Stock Options and Warrants		—		1,132
Effect of “if-converted” method applied to Convertible Note		4,463		7,606

Diluted EPS	$	46,039		68,987	$	0.67

For the three and nine months ended September 30, 2003, the calculation of earnings per share includes, for the purposes of the calculation, the add-back to net income of $591 and $684, respectively, for assumed after-tax interest cost related to the convertible debt using the “if-converted” method of accounting for diluted earnings per share. The weighted average number of shares outstanding for the three and nine months ended September 30, 2003 includes 6,361 shares related to the convertible debt using the “if-converted” method.

For the three and nine months ended September 30, 2002, the calculation of earnings per share includes, for the purposes of the calculation, the add-back to net income of $1,498 and $4,463, respectively, for assumed after-tax interest cost related to the convertible debt using the “if-converted” method of accounting for diluted earnings per share. The weighted average number of shares outstanding for the three and nine months ended September 30, 2002 includes 7,606 shares related to the convertible debt using the “if-converted” method.

Item 2. 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 Item 1 of this Quarterly Report and the Consolidated Financial Statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2002. 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.

Our logo, IEX, and Eagle are registered trademarks of Tekelec. Tekelec, IP7, IP7 Secure Gateway, ASi 4000, VXi, TekWare, TekServer, TotalView, and TotalNet are trademarks of Tekelec. SanteraOne is a registered trademark of Santera, our majority owned subsidiary.

Overview

Our product offerings are currently organized into three distinct product lines: network signaling, contact center, and next-generation switching.

Network Signaling (formerly Network Systems). Our network signaling product line consists principally of the Eagle 5 SAS and products, features and applications based on the Eagle platform, including TekWare and TekServer, the IP7 Secure Gateway and our local number portability solution, Sentinel, ASi 4000 Service Control Point and other convergence products.

Contact Center. Our 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.

Next-Generation Switching. Santera’s portfolio of switching solutions allows network service providers to migrate their network infrastructure from circuit-based technology to packet-based technology. Santera’s product portfolio includes SanteraOne, a carrier-grade, integrated voice and data switching solution which delivers applications like IXC tandem, Class 4/5, PRI offload, packet/cell switching and Voice over Broadband services.

Results of Operations

The following table sets forth, for the periods indicated, the percentages that certain income statement items bear to total revenues:


		Percentage of Revenues

		Three Months Ended						Nine Months Ended
		September 30,						September 30,

		2003			2002			2003			2002

Revenues			100.0	%		100.0	%		100.0	%		100.0	%
Cost of goods sold			20.5			22.4			23.3			25.9
Amortization of purchased technology			4.2			3.4			4.3			3.8

Gross profit			75.3			74.2			72.4			70.3

Research and development			29.2			22.1			27.1			22.4
Selling, general and administrative			40.0			30.8			39.6			34.1
Acquired in-process research and development			—			—			1.6			—
Amortization of intangible assets			0.8			0.5			0.7			0.6

Total operating expenses			70.0			53.4			69.0			57.1

Income from operations			5.3			20.8			3.4			13.2
Interest and other income (expense), net			(2.3	)		(1.6	)		(1.8	)		(0.8	)

Income from continuing operations before provision for income taxes			3.0			19.2			1.6			12.4
Provision for income taxes			7.0			6.5			4.1			4.2

Income (Loss) from continuing operations before minority interest			(4.0	)		12.7			(2.5	)		8.2
Minority interest			11.3			—			6.7			—

Income from continuing operations			7.3			12.7			4.2			8.2
Loss from discontinued operation			—			(2.6	)		—			(1.6	)
Gain from sale of discontinued operation			4.6			38.5			1.7			14.0

	Net income		11.9	%		48.6	%		5.9	%		20.6	%

The following table sets forth, for the periods indicated, the revenues by principal product line as a percentage of total revenues:


		Percentage of Revenues

		Three Months Ended						Nine Months Ended
		September 30,						September 30,

		2003			2002			2003			2002

Network Signaling			80	%		85	%		83	%		85	%
Contact Center			13			15			14			15
Next-Generation Switching			7			—			3			—

	Total		100	%		100	%		100	%		100	%

The following table sets forth for the periods indicated, the revenues by geographic territories as a percentage of total revenues:


		Percentage of Revenues

		Three Months Ended						Nine Months Ended
		September 30,						September 30,

		2003			2002			2003			2002

North America			86	%		72	%		83	%		81	%
Europe			5			21			6			11
Rest of World			9			7			11			8

	Total		100	%		100	%		100	%		100	%

Three Months Ended September 30, 2003 Compared with the Three Months Ended September 30, 2002

Revenues. Our revenues decreased by $2.8 million, or 4%, during the third quarter of 2003 due to lower sales in both our network signaling and contact center operating segments.

Revenues from network signaling products decreased by $6.0 million, or 10%, due to lower revenues primarily from Eagle STP systems and secondarily to lower local number portability products, partially offset by higher sales of Eagle STP upgrades and extensions.

Revenues from contact center products decreased by $1.4 million, or 13%, as a result of decreased sales of all contact center products.

Revenues from next-generation switching products during the third quarter of 2003 were $4.6 million, reflecting the addition of sales of next-generation products following the June 2003 closing of our acquisition of a majority interest in Santera.

Revenues in North America increased by $7.6 million, or 14%, due to higher sales of Eagle STP systems. Revenues in Europe decreased by $11.6 million, or 76%, due to lower Eagle STP product sales. Rest of world revenues increased by $1.2 million, or 24%, due primarily to higher Eagle STP product sales and secondarily to higher Sentinal product sales.

A significant portion of our revenues in each quarter results from orders that are received in that quarter, and are difficult to predict. Further, we typically generate a significant portion of our revenues for each quarter in the last month of the quarter. We establish our expenditure levels based on our expectations as to future revenues, and if revenue levels were to fall below our expectations, then such shortfall 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.

We believe that our future revenue growth depends in large part upon a number of factors, including the continued market acceptance, both domestically and internationally, of our products, particularly the Eagle products including TekWare and TekServer and related applications as well as our suite of products for converged circuit and packet networks, including the IP7 Secure Gateway and SanteraOne next-generation switching products.

Gross Profit. Gross profit as a percentage of revenues increased to 75.3% in the third quarter of 2003 compared to 74.2% in the third quarter of 2002. The increase in gross profit in the third quarter of 2003 as compared to the third quarter 2002 was due primarily to a higher proportion of sales of Eagle STP upgrades and extensions and service agreements, which typically carry higher margins than our other signaling products.

Research and Development. Research and development expenses increased overall by $4.4 million, or 27.0%, and increased as a percentage of revenues to 29.2% in the third quarter of 2003 from 22.1% in the third quarter of 2002. These increases were due primarily to an increase in salary and related expenses attributable to additional personnel and our acquisition of a majority interest in Santera (See Note B — Acquisition of a Majority Interest in Santera).

We intend to continue to make substantial investments in product and technology development and believe that our future success depends in large part upon our ability to continue to enhance existing products and to develop or acquire new products that maintain our technological competitiveness.

Selling, General and Administrative. Selling, general and administrative expenses increased by $5.7 million, or 25%, and increased as a percentage of revenues to 40.0% in the third quarter of 2003 from 30.8% in the third quarter of 2002. The increases were due primarily to our acquisition of a majority interest in Santera (See Note B — Acquisition of a Majority Interest in Santera) and secondarily to an increase in facility costs, consulting services related to Santera integration activities, and higher legal fees.

Amortization of Intangible Assets. Amortization of intangible assets in the third quarter of 2003 increased by $143,000 to $543,000, and increased as a percentage of revenues to 0.8% for the third quarter of 2003 from 0.5% for the third quarter of 2002.

Interest and Other Income (Expense), net. Interest expense decreased by $478,000, or 21%, due primarily to the June 2003 issuance of our convertible debt which carries an interest rate of 2.25% compared to the former convertible debt interest rate of 6.75%.

The former convertible debt was redeemed in July 2003. Interest income decreased $17,000 or 1% due to lower interest rates in 2003 compared to 2002.

Income Taxes. The income tax provisions from continuing operations for the three months ended September 30, 2003 and 2002 were $2.1 million and $14.1 million, respectively, and reflected the effect of non-deductible acquisition-related costs, partially offset by benefits of $557,000 and $1.1 million for the third quarter of 2003 and 2002, respectively. Excluding the effect of acquisition-related items and Santera’s 2003 operating results, estimated effective tax rates of 34% and 35% were applied for the three-month periods ended September 30, 2003 and 2002, respectively, and represented federal, state and foreign taxes on our income, reduced primarily by research and development credits, foreign tax credits and other benefits from foreign sourced income.

Minority Interest. Minority interest represents the losses of Santera allocable to Santera’s minority shareholders.

Nine Months Ended September 30, 2003 Compared with the Nine Months Ended September 30, 2002

Revenues. Our revenues decreased by $13.2 million, or 7%, during the nine months ended September 30, 2003 due to lower sales in both our network signaling and contact center operating segments.

Revenues from network signaling products decreased by $15.6 million, or 9%, due primarily to lower sales of Eagle STP products and secondarily to lower sales of Sentinel products partially offset by higher revenues from Eagle STP upgrades and extensions and customer service agreements.

Revenues from contact center products decreased by $3.4 million, or 12%, as a result of decreased sales of all contact center products.

Revenues from next-generation switching products were $5.8 million reflecting the addition of sales of next-generation switching products following the June 2003 closing of our acquisition of a majority interest in Santera.

Revenues in North America decreased by $8.5 million, or 5%, due to lower sales of all products other than network signaling and contact center customer extended warranties. Revenues in Europe decreased by $9.5 million, or 44%, due primarily to lower sales of Eagle STP products. Rest of world revenues increased by $4.7 million, or 30%, due primarily to higher sales of Eagle STP products.

Gross Profit. Gross profit as a percentage of revenues increased to 72.4% in the nine months ended September 30, 2003 compared to 70.3% in the nine months ended September 30, 2002. The increase in gross margins in 2003 as compared to 2002 was due primarily to a higher proportion of 2003 sales of Eagle STP upgrades and extensions and service agreements in 2003, which typically carry higher margins than sales of our other signaling products.

Research and Development. Research and development expenses increased overall by $6.0 million, or 13.4%, and increased as a percentage of revenues to 27.1% in the nine months ended September 30, 2003 from 22.4% in the nine months ended September 30, 2002. The increase in 2003 was due primarily to an increase in salary and related expenses attributable to additional personnel as well as our acquisition of a majority interest in Santera (See Note B — Acquisition of a Majority Interest in Santera).

Selling, General and Administrative. Selling, general and administrative expenses increased by $5.8 million, or about 8.4%, and increased as a percentage of revenues to 40.0% in the nine months ended September 30, 2003 from 39.6% in the nine months ended September 30, 2002. The increase in 2003 was due primarily to our acquisition of a majority interest in Santera (See Note B — Acquisition of a Majority Interest in Santera) and secondarily to increased facility costs and higher insurance premiums incurred in 2003.

Acquired In-Process Research and Development. Acquired in-process research and development expense of $2.9 million in the first nine months of 2003 represents the write-off in the second quarter of acquired in-process research and development related to the Santera acquisition. See Note B — Acquisition of Majority Interest in Santera.

Amortization of Intangible Assets. Amortization of intangible assets increased by $168,000 to $1.4 million, and increased as a percentage of revenues to 0.7% for the nine months ended September 30, 2003 from 0.6% for the nine months ended September 30, 2002.

Interest and Other Income (Expense), net. Interest expense increased by $810,000, or 11.8%, for the nine months ended September 30, 2003 compared to 2002, due primarily to the June 2003 issuance of our convertible debt that was outstanding concurrently with

our former convertible debt that was redeemed in July 2003. Interest income decreased by $326,000, or 6.7%, due to lower interest rates in 2003 compared to 2002.

Income Taxes. The income tax provisions for the nine months ended September 30, 2003 and 2002 were $7.6 million and $8.4 million, respectively, and reflected the effect of non-deductible acquisition-related costs and amortization, partially offset by a benefit of $2.6 million and $3.2 million, respectively, from the utilization of deferred tax liabilities related to certain of these acquisition-related costs. Excluding the effect of acquisition-related items and Santera’s 2003 operating results, estimated effective tax rates of 34% and 35% were applied for the nine-month periods ended September 30, 2003 and 2002, respectively, and represented federal, state and foreign taxes on our income, reduced primarily by research and development credits, foreign tax credits and other benefits from foreign sourced income.

Minority Interest. Minority interest represents the losses of Santera allocable to Santera’s minority shareholders.

Liquidity and Capital Resources

During the nine months ended September 30, 2003, cash and cash equivalents increased by $5.6 million to $167.7 million, including net purchases of $34.8 million of short-term and long-term available-for-sale securities. Operating activities, net of the effects of exchange rate changes on cash, provided $28.2 million. Financing activities, which represented proceeds from the issuance of our common stock upon the exercise of options and warrants, the issuance of our convertible notes and the retirement of our former convertible notes, used $5.2 million, and investing activities, excluding the net purchases of short-term and long-term available-for-sale securities, provided $6.1 million primarily due to cash included in the assets of Santera, partially offset by capital expenditures.

Cash flows from operating activities were comprised mainly of net income adjusted for depreciation and amortization, a decrease in accounts receivable and an increase in deferred revenue. Net accounts receivable decreased by 28% during the first nine months of 2003 primarily due to strong collections activity. Deferred revenue increased by 12% during the nine months ended September 30, 2003 primarily due to an increase in transactions pending completion of acceptance or delivery requirements and higher extended warranty service billings, which are deferred and recognized ratably over the warranty period.

Net capital expenditures of $4.0 million during the first nine months of 2003 represented the planned addition of equipment principally for research and development and manufacturing operations.

We have a $20.0 million line of credit that is collateralized by substantially all of our assets, excluding the assets of Santera, bears interest at or, in some cases, below the lender’s prime rate (4.0% at June 30, 2003), and expires on August 31, 2004, if not renewed. Under the terms of this credit facility, we are required to maintain certain financial ratios and meet certain net worth and indebtedness tests. We believe we are in compliance with these requirements. There have been no borrowings under this credit facility.

As a result of the Santera transaction (see note B — Acquisition of Majority Interest in Santera) we have two notes payable to U.S. financial institutions. One of the notes has an outstanding balance of $3.7 million and is secured by the assets purchased under the note, bears interest at 10% and matures in February 2005. The second note for $3.5 million is secured by the assets purchased under the note and substantially all of Santera’s assets, excluding the assets secured under the $3.7 million note, bears interest at 6.36% and matures in November 2005. Under the terms of this facility, we are required to maintain certain financial reporting covenants. We believe we are in compliance with these requirements.

In November 1999, we completed the private placement of $135.0 million principal amount at maturity of 3.25% Convertible Subordinated Discounted notes due in 2004, issued at 85.35% of their face amount (equivalent to gross proceeds of approximately $115.2 million at issuance before discounts and expenses). The discounted notes were called and subsequently redeemed on July 19, 2003.

In June 2003, we completed the private placement of $125.0 million principal amount of 2.25% Senior Subordinate Convertible notes due in 2008.

We believe that our existing working capital, funds generated through operations, and our current bank lines of credit will be sufficient to satisfy our operating requirements for at least the next twelve months. Nonetheless, we may seek additional sources of capital as necessary or appropriate to fund acquisitions or to otherwise finance our growth or operations; however, there can be no assurance that such funds, if needed, will be available on favorable terms, if at all.

Recent Accounting Pronouncements

In April 2003, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging.Activities.” SFAS No. 149 amends and clarifies the accounting guidance on derivative instruments (including certain derivative instruments embedded in other contracts) and hedging activities that fall within the scope of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 is effective for all contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. The guidance is to be applied prospectively. Currently, we do not enter into these types of transactions and therefore this pronouncement did not have an impact on our financial position, results of operations or cash flows.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 changes the accounting for certain financial instruments that under previous guidance could be classified as equity, or “mezzanine” equity, by now requiring those instruments to be classified as liabilities in the statement of financial position. Further, SFAS No. 150 requires disclosure regarding the terms of those instruments and settlement alternatives. SFAS No. 150 is generally effective for all financial instruments entered into or modified after May 31, 2003, and was otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material impact on our financial position, results of operations, or cash flows.

In January 2003, FASB issued Interpretation (“FIN”) No. 46, “Consolidation of Variable Interest Entities — an Interpretation of ARB No. 51.” The Interpretation clarified the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of this Interpretation are effective for all enterprises with variable interest entities created after January 31, 2003. On October 8, 2003, the FASB deferred the implementation date of Interpretation No. 46 from the third quarter of 2003. The adoption of Interpretation No. 46 will not have a material impact on our financial position, results of operations, or cash flows.

“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 Quarterly Report on Form 10-Q are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect the current belief, expectations, estimates, forecasts or intent of our management and are subject to, and involve certain risks and uncertainties. As discussed in our 2002 Annual Report on Form 10-K and other filings with the SEC, our future operating results are difficult to predict and subject to significant fluctuations. Factors that may cause future results to differ materially from the Company’s current expectations include, among others: overall telecommunications spending, changes in general economic conditions, the timing of significant orders and shipments, the lengthy sales cycle for the Company’s products, the timing of the convergence of voice and data networks, the success or failure of strategic alliances or acquisitions including the success or failure of the integration of Santera’s operations with the those of the Company, the ability of carriers to utilize excess capacity of signaling infrastructure and related products in the network, the capital spending patterns of customers, the dependence on wireless customers for a significant percentage and growth of the Company’s revenues, the timely development and introduction of new products and services, product mix, the geographic mix of the Company’s revenues and the associated impact on gross margins, market acceptance of new products and technologies, carrier deployment of intelligent network services, the ability of our customers to obtain financing, the level and timing of research and development expenditures, regulatory changes, and the expansion of the Company’s marketing and support organizations, both domestically and internationally and other risks described in this Quarterly Report, our Annual Report on Form 10-K for 2002 and in certain of our other Securities and Exchange Commission filings. Many of these risks and uncertainties are outside of our control and are difficult for us to forecast or mitigate. Actual results may differ materially from those expressed or implied in such forward-looking statements. We are 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 us.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes for the nine-month period ended September 30, 2003. For a further discussion of the quantitative and qualitative disclosures about market risk, reference is made to our Annual Report on Form 10-K for the year ended December 31, 2002.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Chief Financial Officer, of the effectiveness, as of the end of the fiscal quarter covered by this report, of the design and operation of our “disclosure controls and procedures” as defined in Exchange Act Rule 13a-14 promulgated by the SEC under the Exchange Act. Based upon that evaluation, our President and Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures, as of the end of the fiscal quarter, were adequate and effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

(b) Changes in Internal Controls

There have not been any significant changes in our internal controls over financial reporting or in other factors that could significantly affect our internal controls over financial reporting subsequent to the date of the evaluation referred to above.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

The Company is a party to various legal proceedings that are discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 (the “Annual Report”) and Quarterly Reports on Form 10-Q for the quarters ended March 31, 2003 and June 30, 2003 (the “Quarterly Reports”). The following information supplements the information concerning the Company’s legal proceedings disclosed in the Annual Report and the Quarterly Reports:

Alcatel USA, Inc. and Alcatel USA Sourcing, L.P. vs Tekelec

In August 2003, the Magistrate Judge heard and subsequently denied cross-motions for summary judgment filed by Alcatel and Tekelec on the Company’s defenses of invalidity and inequitable conduct.

IEX Corporation vs. Blue Pumpkin Software, Inc.

In January 2001, IEX Corporation, our wholly owned subsidiary (“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 asserted that certain of Blue Pumpkin’s products and services infringe United States Patent No. 6,044,355 (the “’355 Patent”) 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. Blue Pumpkin filed a motion for summary judgment in April 2003. In July 2003, a magistrate judge recommended that the District Court enter summary judgment in favor of Blue Pumpkin. On October

10, 2003, the District Court adopted the recommendation of the magistrate judge and granted summary judgment that Blue Pumpkin’s products do not infringe the ‘355 Patent. On November 5, 2003, IEX filed its notice of appeal of the summary judgment to the Federal Circuit Court of Appeals. Tekelec currently believes that the ultimate outcome of the lawsuit will not have a material adverse effect on its financial position, results of operations or cash flows.

Item 2. Changes in Securities and Use of Proceeds

In June 2003, we issued and sold $125,000,000 principal amount of our 2.25% Senior Subordinated Convertible Notes due 2008 (the “Notes”). The Notes were issued in a private offering in reliance on Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”). The initial purchaser of the Notes was Morgan Stanley & Co. Incorporated, which resold the Notes to qualified institutional buyers pursuant to Rule 144A promulgated under the Securities Act. The aggregate offering price of the Notes was $125,000,000, and the aggregate proceeds to Tekelec were $121,562,500 before expenses. The Notes mature on June 15, 2008, and are convertible prior to the close of business on their final maturity date into shares of our common stock at a conversion rate of 50.8906 shares per $1,000 principal amount of the Notes, subject to adjustment in certain circumstances.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits


10.1		Santera Systems Inc. 2003 Employee Bonus Plan
10.2		Employment Offer Letter dated August 1, 2003 between the Registrant and Monty Johnson.
10.3		Amended 2003 Executive Officer Bonus Plan
31.1		Certification of President and Chief Executive Officer of Registrant pursuant to Rule 13a-14(a) under the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Vice President and Chief Financial Officer of Registrant pursuant to Rule 13a-14(a) under the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of President and Chief Executive Officer and Vice President and Chief Financial Officer of Registrant pursuant to Rule 13a-14(b) under the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b) Reports on From 8-K

(i) On July 29, 2003, Registrant filed a Current Report of Form 8-K with the Commission with respect to its issuance of a press release announcing the Registrant’s 2003 second quarter financial results.

(ii) On September 16, 2003, Registrant filed an amended Current Report on Form 8-K/A with the Commission that amended the Registrants Form 8-K filed with the Commission on June 11, 2003, to provide updated pro forma financial information for the six months ended June 30, 2003.

SIGNATURES

Pursuant to the requirements 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

November 13, 2003		/s/ Frederick M. Lax

		Frederick M. Lax President and Chief Executive Officer (Duly authorized officer)

		/s/ Paul J. Pucino

		Paul J. Pucino Vice President and Chief Financial Officer (Principal financial and chief accounting officer)

29 EX-10.1 3 v92665exv10w1.txt EXHIBIT 10.1 EXHIBIT 10.1 SANTERA SYSTEMS INC. 2003 EMPLOYEE BONUS PLAN The 2003 Employee Bonus Plan ("2003 Bonus Plan") is designed to motivate employees of Santera Systems Inc. ("Santera" or the "Company") and to reward them for their continuing contributions to the Company's business if Santera achieves certain financial results in the second half of 2003. The Company believes that the achievement of these results is essential for the Company's success. 2003 Bonus Plan: Each Eligible Employee (as defined below) who earns a bonus by virtue of his or her continuing employment with Santera will be eligible to receive a quarterly bonus ("Quarterly Bonus") based on the Company's financial performance as measured by the degree of the Company's attainment of a pre-set, Board of Directors' approved, non-GAAP "operating income before bonus" goal for each of the third and fourth calendar quarters of 2003. The Quarterly Bonuses payable to an Eligible Employee under the 2003 Bonus Plan will be calculated as a percentage of such employee's actual earnings paid during a calendar quarter, excluding certain compensation and payments (e.g., reimbursement for moving expenses, bonus payments received under this Plan or otherwise, stock option compensation, disability benefits, sign-on bonuses, vacation cash-outs, on call pay, and similar payments). Eligible Employees: All full-time and part-time (as defined in Santera's Human Resources policy) employees of Santera, other than Excluded Employees (as defined below), are Eligible Employees for purposes of the 2003 Bonus Plan. The following employees of Santera are Excluded Employees for purposes of the 2003 Bonus Plan: 1. Commissioned employees; 2. Employees who are expressly covered by another 2003 bonus plan of Santera or any of its affiliates; 3. Casual, co-op or temporary employees; and 4. Employees who are on a Performance Improvement Plan on the last day of a calendar quarter. In order to earn and be eligible to receive a Quarterly Bonus, a person must be employed by Santera as an Eligible Employee (i) throughout the entire calendar quarter for which the bonus is payable; and (ii) on the date on which such bonuses are paid, unless such requirements are waived in writing by the Chairman of the Board of Directors of the Company, in his sole discretion. An employee's eligibility under the 2003 Bonus Plan shall be determined on a quarter-by-quarter basis. An employee who is on an approved leave of absence from the Company during a calendar quarter will, for purposes of determining eligibility under the 2003 Bonus Plan, be treated as being employed by the Company during such leave of absence. Quarterly Bonuses: The Company's non-GAAP operating income before bonus (which excludes the effects of acquisition-related amortization and other merger-related charges) ("Operating Income before Bonus") for each of the third and fourth calendar quarters will be the financial measure for the Quarterly Bonuses. For purposes of the 2003 Bonus Plan, "Operating Income" means revenues less cost of goods sold and operating expenses. The amount of bonus payable as a Quarterly Bonus to an Eligible Employee will be calculated by multiplying (i) the product of such Eligible Employee's actual earnings paid in a calendar quarter and the Quarterly Bonus Percentage for such calendar quarter listed opposite such employee's grade in the Bonus Participation Table below by (ii) the applicable Bonus Factor (as determined in accordance with the matrix set forth in Schedule A attached hereto). Stated mathematically, the amount of a Quarterly Bonus equals (AxB)xC, where A = an Eligible Employee's actual earnings paid in a calendar quarter; B = the applicable Quarterly Bonus Percentage; and C = the applicable Bonus Factor. EXHIBIT 10.1 The amount of the Company's quarterly Operating Income before Bonus will determine the applicable Bonus Factor. As indicated on Schedule A, minimum quarterly Operating Income before Bonus will result in a Bonus Factor of 25%; mid-point Operating Income before Bonus will result in a Bonus Factor of 50%; and maximum quarterly Operating Income before Bonus will result in a maximum Bonus Factor of 100%. There will be a linear increase in the percentage amount of the Bonus Factor between (i) the minimum quarterly Operating Income before Bonus and the mid-point Operating Income before Bonus; and (ii) the mid-point Operating Income before Bonus and the maximum quarterly Operating Income before Bonus. Except as otherwise provided herein, the Quarterly Bonus will be payable in one lump sum (subject to applicable withholding taxes and other applicable deductions) within 30 days after the Company's quarterly results are publicly announced. An Eligible Employee who is on an approved leave of absence from the Company on the date on which Quarterly Bonuses are paid and thereafter returns to active status as an Eligible Employee upon the end of such leave of absence, will be paid a Quarterly Bonus to which he/she is otherwise entitled under this 2003 Bonus Plan within 30 days following his/her return to active status as an Eligible Employee. An Eligible Employee who is on an approved leave of absence from the Company on the date on which Quarterly Bonuses are paid and thereafter fails to return to active status as an Eligible Employee upon the end of such leave of absence, will forfeit his/her right to any Quarterly Bonus to which he/she may otherwise be entitled for such quarter. Bonus Participation Levels: For purposes of determining an Eligible Employee's Quarterly Bonus under the 2003 Bonus Plan, the Quarterly Bonus Percentages (by calendar quarter) shall be as follows:
Bonus Participation Table ------------------------- Quarterly Bonus Percentage -------------------------- Grade Q3 Q4 ----- -- -- E-22 72% 96% E-21 60 80 E-20 48 64 E-19 36 48 E-18 30 40 E-17 24 32 E-16 24 32 E-15 18 24 E-14 18 24 E-13 12 16 E-12 12 16 E-11 12 16 E-10 12 16 N-6 through N-13 12 16
EX-10.2 4 v92665exv10w2.txt EXHIBIT 10.2 EXHIBIT 10.2 August 1, 2003 Monty Johnson Via Fax (919.380.2063)and Federal Express 1250 Dogwood Drive Greensboro, GA 30642 Dear Monty: On behalf of Tekelec, I am pleased to offer you employment as President and General Manager of our Network Signaling Division, on the terms and conditions set forth in this letter. As President and General Manager, Network Signaling Division, you will report directly to Tekelec's President and Chief Executive Officer, will be principally responsible for Tekelec's Network Signaling Division and will have such other duties and responsibilities as may be delegated to you from time to time by the President and Chief Executive Officer. If you accept this offer, your appointment as President and General Manager, Network Signaling Division, will be effective August 11, 2003 ("start date"). Your compensation and benefits will be as follows: 1. Your 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 2003 Executive Officer Bonus Plan, under which you will be eligible to receive, in accordance with the terms of such Plan, (a) quarterly cash bonuses in amounts up to 57.6% of your salary paid during the 2003 third quarter and 76.8% of your salary paid during the 2003 fourth quarter (based in each quarter on the Company's achievement of certain financial milestones) and (b) an annual bonus equal to 12% of your annual base salary earned during 2003 if you achieve certain individual objectives during 2003. The terms of your participation in any bonus plans after 2003 will be subject to change and the approval of the Board of Directors of Tekelec. 3. You will receive applicable benefits, including personal time off, health, dental, vision, long-term disability and life insurance, as are generally provided to Tekelec's executive officers. 4. You will continue to be offered the opportunity to participate in Tekelec's Employee Stock Purchase Plan and 401(k) Plan. 5. You will be covered by Tekelec's Officer Severance Plan (a copy of which is enclosed). For purposes of Section 4(a) of the Officer Severance Plan and notwithstanding anything to the contrary therein, your office and title as President and General Manager, Network Signaling Division, will be treated as the equivalent of Vice President. 6. The Compensation Committee of Tekelec will grant to you nonstatutory stock options under Tekelec's 1994 Stock Option Plan (the "Plan") to purchase 100,000 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 EXHIBIT 10.2 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 and become exercisable cumulatively in 16 equal quarterly installments of 6,250 shares each, with the first installment vesting on December 31, 2003 and one additional installment vesting on the last day of each calendar quarter thereafter as long as you remain an employee of Tekelec. Each installment of your Options will expire, to the extent previously unexercised, upon the earlier of four years from the date of vesting 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. 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 as Tekelec's President and General Manager, Network Signaling Division. 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. Monty, we believe that Tekelec can provide you with opportunities for professional growth and financial return. We look forward to working with you in your new position 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 August 7, 2003. Sincerely, /s/ Fred Lax Fred Lax President and Chief Executive Officer Acknowledged and Accepted: /s/ Monty Johnson Date: August 6, 2003 - ---------------------------------- ------------------------ MONTY JOHNSON EX-10.3 5 v92665exv10w3.txt EXHIBIT 10.3 EXHIBIT 10.3 TEKELEC 2003 EXECUTIVE OFFICER BONUS PLAN (Amended 7/31/03) Tekelec ("Tekelec" or the "Company") believes that a portion of each executive officer's annual compensation should be directly related to the Company's financial performance and such officer's achievement of certain objectives. The 2003 Executive Officer Bonus Plan ("2003 Bonus Plan") is designed to motivate Tekelec's executive officers and to reward them for their continuing contributions to the Company's business if in 2003 the Company achieves certain financial results and/or such officers achieve certain individual, business or strategic objectives. The Company believes that the achievement of these results and objectives is essential for the Company's success and for the continued growth in shareholder value. 2003 Bonus Plan: Each Eligible Officer (as defined below) who earns a bonus by virtue of his or her continuing employment with Tekelec will be eligible to receive: (i) a quarterly bonus ("Quarterly Bonus") based on the Company's financial performance as measured by the degree of the Company's attainment of a pre-set, Board of Directors' approved, operating income before bonus goal for each calendar quarter during 2003; and (ii) an annual bonus ("Annual Bonus") based on his/her achievement in 2003 of individual, business or strategic objectives that the Company's Chief Executive Officer (in the case of the Chief Executive Officer, the Board of Directors) approves during the first quarter of 2003. The Quarterly Bonuses and Annual Bonus payable to an Eligible Officer under the 2003 Bonus Plan will be calculated as a percentage of such officer's actual earnings paid during a calendar quarter or the calendar year, as the case may be, excluding certain compensation and payments (e.g., reimbursement for moving expenses, bonus payments received under the 2002 or 2003 Bonus Plan, stock option compensation, disability benefits, sign-on bonuses, vacation cash-outs, on call pay, and similar payments). Eligible Officers: Unless additional officers are expressly designated as Eligible Officers under the 2003 Bonus Plan pursuant to a subsequent, duly adopted Board of Directors' resolution, only the following executive officers shall be eligible to participate in the 2003 Bonus Plan (all titles are positions with Tekelec unless otherwise specified): Chief Executive Officer Chief Operating Officer Chief Financial Officer Vice President and General Manager, Network Systems Division* Vice President and General Counsel Executive Vice President, Global Sales and Marketing Group President and General Manager, Network Signaling Division President and General Manager, IEX Corporation Vice President and General Manager, IEX Contact Center Division* Vice President, Corporate Development Vice President, Human Resources Vice President, Operations and Quality - ------------ * through 6/30/03 EXHIBIT 10.3 In order to earn and be eligible to receive a Quarterly or an Annual Bonus, an Eligible Officer must be employed by Tekelec or one of its subsidiaries as an Eligible Officer on the date on which such bonuses are paid, unless such requirement is waived in writing by the Company's Chief Executive Officer in the case of an Eligible Officer other than the Chief Executive Officer, or by the Board of Directors in the case of the Chief Executive Officer. An Eligible Officer who is on an approved leave of absence from the Company during a calendar quarter will, for purposes of determining eligibility under the 2003 Bonus Plan, be treated as being employed by the Company during such leave of absence. In the event that an Eligible Officer's title changes during a calendar quarter, the amount of Quarterly Bonus payable under the 2003 Bonus Plan to such Eligible Officer commencing with such quarter and the amount of Annual Bonus payable under the 2003 Bonus Plan to such Eligible Employee shall be determined by reference to such Eligible Officer's new title and corresponding Quarterly Bonus Percentage and Annual Bonus Percentage, as the case may be. Quarterly Bonuses: The Company's pro forma operating income before bonus (which excludes the effects of acquisition-related amortization and other merger-related charges) calculated on a consolidated basis ("Operating Income before Bonus") for each calendar quarter will be the financial measure for the Quarterly Bonuses. The amount of bonus payable as a Quarterly Bonus to an Eligible Officer will be calculated by multiplying (i) the product of such Eligible Officer's actual earnings paid in a calendar quarter and the Quarterly Bonus Percentage for such calendar quarter listed opposite such officer's title in the Bonus Participation Table below by (ii) the applicable Bonus Factor (as determined in accordance with the matrix set forth in Schedule A attached hereto). Stated mathematically, the amount of a Quarterly Bonus equals (AxB)xC, where A = an Eligible Officer's actual earnings paid in a calendar quarter; B = the applicable Quarterly Bonus Percentage; and C = the applicable Bonus Factor. The amount of the Company's quarterly Operating Income before Bonus will determine the applicable Bonus Factor. As indicated on Schedule A, minimum quarterly Operating Income before Bonus will result in a Bonus Factor of 25%; mid-point Operating Income before Bonus will result in a Bonus Factor of 50%; and maximum quarterly Operating Income before Bonus will result in a maximum Bonus Factor of 100%. There will be a linear increase in the percentage amount of the Bonus Factor between (i) the minimum quarterly Operating Income before Bonus and the mid-point Operating Income before Bonus; and (ii) the mid-point Operating Income before Bonus and the maximum quarterly Operating Income before Bonus. Except as otherwise provided herein, the Quarterly Bonus will be payable in one lump sum (subject to applicable withholding taxes and other applicable deductions) within 30 days after the Company's quarterly results are publicly announced. An Eligible Officer who is on an approved leave of absence from the Company on the date on which Quarterly Bonuses are paid by the Company and thereafter returns to active status as an Eligible Officer upon the end of such leave of absence, will be paid a Quarterly Bonus to which he/she is otherwise entitled under this 2003 Bonus Plan within 30 days following his/her return to active status as an Eligible Officer. An Eligible Officer who is on an approved leave of absence from the Company on the date on which Quarterly Bonuses are paid by the Company and thereafter fails to return to active status as an Eligible Officer upon the end of such leave of absence, will forfeit his/her right to any Quarterly Bonus to which he/she may otherwise be entitled for such quarter. EXHIBIT 10.3 Annual Bonuses: The percentage degree (0% to 100%) to which an Eligible Officer achieves his/her objectives for 2003 will be the measure for the Annual Bonus. The determination of the percentage degree to which an Eligible Officer (other than the Chief Executive Officer) achieves his/her objectives will be made by the Chief Executive Officer by February 15, 2004. The determination of the percentage degree to which the Chief Executive Officer achieves his objectives will be made by the Board of Directors by February 15, 2004. The amount of a bonus payable as an Annual Bonus to an Eligible Officer will be calculated by multiplying (i) the product of such officer's actual earnings paid in 2003 and the Annual Bonus Percentage listed opposite such officer's title in the Bonus Participation Table below by (ii) the percentage degree to which the Chief Executive Officer or the Board of Directors, as the case may be, determines that such Eligible Officer has achieved his/her objectives for 2003. Except as otherwise provided herein, the Annual Bonus will be payable in one lump sum (subject to applicable withholding taxes and other applicable deductions) within 30 days of the Chief Executive Officer's or Board of Directors' determination, as the case may be, of the percentage degree to which the Eligible Officer has achieved his/her objectives for 2003. An Eligible Officer who is on an approved leave of absence from the Company on the date on which Annual Bonuses are paid by the Company and thereafter returns to active status as an Eligible Officer upon the end of such leave of absence, will be paid an Annual Bonus to which he/she is otherwise entitled under this 2003 Bonus Plan within 30 days following his/her return to active status as an Eligible Officer. An Eligible Officer who is on an approved leave of absence from the Company on the date on which Annual Bonuses are paid by the Company and thereafter fails to return to active status as an Eligible Officer upon the end of such leave of absence, will forfeit his/her right to any Annual Bonus to which he/she may otherwise be entitled for 2003. Bonus Participation Levels: For purposes of determining an Eligible Officer's Quarterly or Annual Bonus under the 2003 Bonus Plan, the Quarterly Bonus Percentages (by calendar quarter) and the Annual Bonus Percentages for the Eligible Officers shall be as follows:
Bonus Participation Table Annual Bonus Title Quarterly Bonus Percentage Percentage ----- -------------------------- ---------- 2. Q1 Q2 Q3 Q4 -- -- -- -- 3. Chief Executive Officer 40.0% 80.0% 120.0% 160.0% 25% Chief Operating Officer 32.0 64.0 96.0 128.0 20 Chief Financial Officer 22.4 44.8 67.2 89.6 14 Vice President and General Manager, NSD 22.4 44.8 0.0 0.0 0 Vice President and General Counsel 22.4 44.8 67.2 89.6 14 Executive Vice President, Global Sales and Marketing Group 0.0 0.0 67.2 89.6 14 President and General Manager, Network Signaling Division 0.0 0.0 57.6 76.8 12 President and General Manager, IEX Corporation 0.0 0.0 57.6 76.8 12 Vice President and General Manager, IEX Contact Center Div 19.2 38.4 0.0 0.0 0 Vice President, Corporate Development 16.0 32.0 48.0 64.0 10 Vice President, Human Resources 16.0 32.0 48.0 64.0 10 Vice President, Operations and Quality 16.0 32.0 48.0 64.0 10 - ---------------
Discretionary Bonuses: Discretionary bonuses may also be paid under the 2003 Bonus Plan but only upon the express approval of the Board of Directors. * * * * * EX-31.1 6 v92665exv31w1.txt EXHIBIT 31.1 EXHIBIT 31.1 CERTIFICATION I, Frederick M. Lax, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Tekelec; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting ; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting , to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 13, 2003 /s/ Frederick M. Lax - ------------------------------------- President and Chief Executive Officer EX-31.2 7 v92665exv31w2.txt EXHIBIT 31.2 EXHIBIT 31.2 CERTIFICATION I, Paul J. Pucino, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Tekelec; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting ; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting , to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 13, 2003 /s/ Paul J. Pucino - ------------------------------------------ Vice President and Chief Financial Officer EX-32.1 8 v92665exv32w1.txt EXHIBIT 32.1 EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Tekelec (the "Company") on Form 10-Q for the period ending June 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), we, Frederick M. Lax, President and Chief Executive Officer of the Company and Paul J. Pucino, Vice President and Chief Financial Officer, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: 1) The Report fully complies with the requirement of section 13 (a) or 15 (d) of the Securities Exchange Act of 1934; and 2) The information contained in the Report fairly presents, in all material respects, the Company's consolidated financial position, results of operations and cash flows. /s/ Frederick M. Lax - ---------------------- President and Chief Executive Officer /s/ Paul J. Pucino - ---------------------- Vice President and Chief Financial Officer November 13, 2003 -----END PRIVACY-ENHANCED MESSAGE-----

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	(i)		On July 29, 2003, Registrant filed a Current Report of Form 8-K with the Commission with respect to its issuance of a press release announcing the Registrant’s 2003 second quarter financial results.
	(ii)		On September 16, 2003, Registrant filed an amended Current Report on Form 8-K/A with the Commission that amended the Registrants Form 8-K filed with the Commission on June 11, 2003, to provide updated pro forma financial information for the six months ended June 30, 2003.