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