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FORM 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)

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

For the quarterly period ended December 31, 2002

OR

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

Commission file number 0-24701

CATAPULT COMMUNICATIONS CORPORATION

160 South Whisman Road
Mountain View, California 94041

(650) 960-1025

(Address, including zip code, and telephone number, including
area code, of principal executive offices)

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

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x    No

     As of January 31, 2003, there were 13,070,513 shares of the Registrant’s Common Stock, $0.001 par value, outstanding.

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CATAPULT COMMUNICATIONS CORPORATION
FORM 10-Q

INDEX

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Part I. Financial Information

Item 1. Financial Statements

CATAPULT COMMUNICATIONS CORPORATION

     The accompanying notes are an integral part of these condensed consolidated financial statements.

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CATAPULT COMMUNICATIONS CORPORATION

     The accompanying notes are an integral part of these condensed consolidated financial statements.

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CATAPULT COMMUNICATIONS CORPORATION

     The accompanying notes are an integral part of these condensed consolidated financial statements.

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CATAPULT COMMUNICATIONS CORPORATION

NOTE 1—THE COMPANY AND BASIS OF PRESENTATION

          Catapult Communications Corporation (the “Company”) designs, develops, manufactures, markets and supports an advanced software-based test system offering an integrated suite of testing applications for the global telecommunications industry. The Company’s advanced test systems assist its customers in the design, integration, installation and acceptance testing of a broad range of digital telecommunications equipment and services. The Company was founded in 1986 and has been incorporated in Nevada since June 19, 1998. The Company has operations in the United States, Canada, the United Kingdom and Europe, Australia and Japan. The Company conducts its business within one industry segment.

          On August 30, 2002, the Company purchased certain assets and assumed certain liabilities of the Network Diagnostics Business (“NDB”) of Tekelec. The assets acquired included the shares of Tekelec’s Japanese subsidiary, Tekelec Limited. The total purchase price of $69.4 million consisted of a cash payment of $42.5 million, two 2% convertible subordinated notes in the aggregate principal amount of $17.3 million maturing on August 30, 2004, an independent valuation premium of $0.8 million ascribed to the convertible notes payable, transaction costs of $4.3 million and a net working capital adjustment in the estimated amount of $4.5 million pursuant to the terms of the Asset Purchase Agreement payable following the completion of a closing date balance sheet audit. The amount of this adjustment has not yet been agreed or paid and the amounts included in these condensed consolidated financial statements relating to the purchase price and the assets and liabilities acquired are preliminary estimates subject to the networking capital adjustment.

          The accompanying unaudited interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. These condensed financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Report on Form 10-K for the year ended September 30, 2002, and filed with the Securities and Exchange Commission. The unaudited financial statements as of December 31, 2002, and for the three months ended December 31, 2002 and 2001, reflect, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial information set forth herein. The results of operations for the interim periods are not necessarily indicative of the results to be expected for any subsequent interim period or for an entire year. The September 30, 2002 balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES

          The Company has identified the policies below as critical to its business operations and the understanding of its results of operations. The impact and any associated risks related to these policies on its business operations are discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect the Company’s reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 in the Notes to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K.

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Revenue Recognition

          Sales of the Company’s product arrangements normally include hardware and software. Certain of the Company’s sales may also include installation. The Company also offers training and maintenance services. The Company recognizes revenue on system sales upon shipment or when installed, if installation services are purchased, provided collection is reasonably assured. Training and maintenance revenues are based on the Company’s established history of separate sales of training and maintenance. Revenues allocated to training are recognized at the time the training is complete. Revenues allocated to maintenance are recognized ratably over the term of the maintenance contract.

Foreign Currency Translations

          Certain of the Company’s foreign subsidiaries use their respective local currencies as their functional currencies because the majority of their revenues, expenses, assets and liabilities are denominated in those local currencies. In consolidation, assets and liabilities are translated at period-end currency exchange rates and revenue and expense items are translated at average currency exchange rates prevailing during the period. Gains and losses from foreign currency translation are recorded in accumulated other comprehensive income, which is a component of stockholders’ equity. Only gains and losses resulting from foreign currency transactions are included in the consolidated statement of income.

Foreign Exchange Risk and Derivative Financial Instruments

          The Company’s foreign subsidiaries operate and sell the Company’s products in various global markets. As a result, the Company is exposed to changes in exchange rates on foreign currency denominated sales made to foreign subsidiaries. The Company utilizes foreign currency forward exchange contracts and options to mitigate the risk of future movements in foreign exchange rates that affect certain foreign currency denominated inter-company receivables. The Company attempts to match the forward contracts with specific underlying receivables in terms of currency, amount and maturity. The Company does not use derivative financial instruments for speculative or trading purposes.

Use of estimates; allowance for doubtful accounts

          The preparation of financial statements requires the Company to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. The Company specifically analyzes accounts receivable, historical bad debt experience, customer concentration, customer credit-worthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts.

Accounting for income taxes

          As part of the process of preparing consolidated financial statements, the Company is required to estimate income taxes in each of the jurisdictions in which it operates. This process involves estimating the Company’s actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within its consolidated balance sheet. The Company must then assess the likelihood that its deferred tax assets will be recovered from future taxable income and to the extent it believes that recovery is not likely, it must establish a valuation allowance. To the extent it establishes a valuation allowance or increases this allowance in a period, it must include an expense within the tax provision in the statement of operations.

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Recent Accounting Pronouncements

          In November 2002, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entity’s product warranty liabilities. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company believes that the adoption of this standard will have no material impact on its financial statements.

          The following table represents the activity in Warranty Accrual for the three months ended December 31, 2002 (in thousands):

          In December 2002, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition and annual disclosure requirements of SFAS No. 148 are effective for fiscal years ending after December 15, 2002. The interim disclosure requirements are effective for interim periods commencing after December 15, 2002. The Company believes that the adoption of this standard will have no material impact on its financial statements.

NOTE 3—BASIC AND DILUTED EARNINGS PER SHARE

          Basic earnings per share are computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share include the effect of dilutive potential common shares (options) issued during the period using the treasury stock method.

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NOTE 4 – GOODWILL AND OTHER INTANGIBLE ASSETS

          In July 2001, the FASB issued SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 provides specific criteria for determining which intangible assets acquired in a business combination should be reported separately from goodwill. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB No. 17, “Intangible Assets.” It changes the accounting for goodwill from an amortization method to an impairment-only approach. This pronouncement also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives and reviewed for impairment in accordance with SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and For Long-Lived Assets to be Disposed of.”

          The Company adopted the provisions of SFAS No.142 effective October 1, 2002. As of October 1, 2002, approximately $49.8 million of goodwill will no longer be amortized but will be tested annually for impairment in accordance with the requirements of SFAS No. 142. The Company performed its annual impairment test on October 1, 2002, showing no impairment of goodwill. As such, there was no writedown of the goodwill balance.

          As required by SFAS No. 142, the results for the prior year’s quarter have not been restated. Had SFAS No. 142 been adopted on October 1, 2001, the Company would have reported no difference in its reported net income and net income per share for the three months ended December 31, 2001.

          Between October 1, 2002 and December 31, 2002, there were no changes to the Company s goodwill balance. Goodwill information is as follows (in millions):

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          Intangible assets subject to amortization consist of technology and non-compete agreements that are being amortized over a period of seven to eight years. The components of intangible assets, excluding goodwill, are as follows (in thousands):

          The estimated future amortization expense of purchased intangible assets as of December 31, 2002 was as follows:

NOTE 5 — DISCONTINUED OPERATIONS

          Effective September 30, 2002, the Company discontinued the distribution and consulting businesses engaged in by Tekelec Limited in Japan. The assets and liabilities of the discontinued operations are segregated in the condensed consolidated balance sheet. The pre-tax loss attributable to discontinued operations was incurred and recognized in September 2002.

NOTE 6 — RESTRUCTURING OF ACQUIRED BUSINESS

          Prior to the effective date of the acquisition, the Company developed a formal plan to restructure NDB by reducing the staff complement of the acquired business by 66 employees, or approximately 39%, and by closing the Tokyo office of Tekelec Limited due to redundancy with the Company’s previously established Tokyo office. A summary of the movements in the restructuring accrual is as follows (in millions):

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NOTE 7 —COMPREHENSIVE INCOME

          The components of comprehensive income, net of tax, are as follows:

NOTE 8—INVENTORIES

NOTE 9 – CONVERTIBLE NOTES PAYABLE

          In connection with the acquisition of NDB described in Note 2, the Company’s Irish subsidiary issued two convertible notes to Tekelec in the principal amounts of $10.0 million and $7.3 million, respectively. These notes have been guaranteed by the Company, bear interest at 2% and are due and payable on or before August 30, 2004. The notes are convertible at the option of the holder into 1,081,250 shares of the Company’s common stock (subject to adjustment for certain events) between August 30, 2003 and the maturity date. The Company also granted Tekelec certain rights to require the Company to register with the Securities and Exchange Commission for resale by Tekelec any common stock acquired by Tekelec upon conversion of the notes.

          The fair value of the notes, as determined by an independent valuation, was $18.1 million, which has been recorded in the balance sheet. The premium of $0.8 million is being amortized to interest income over the term of the notes using the effective interest method with a credit to interest income of $102,000 recorded in the quarter.

          On the maturity date of the $10.0 million note, the Company is entitled to pay the principal balance in any combination of cash and/or common stock, provided that the common stock shall be at a value of 82.5% of the fair market value of the stock, determined pursuant to a formula set forth in the note.

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NOTE 10 — SEGMENT REPORTING

          The Company is organized to operate and service a single industry segment: the design, development, manufacture, marketing and support of advanced software-based test systems globally.

          The Company’s principal geographical areas of operations, revenues and net income for the three month periods ended December 31, 2002 and 2001 and long-lived assets by region at December 31, 2002 and September 30, 2002 were as follows (in thousands):

          The results of operations by geographic region include significant sales principally from the United States to the Company’s foreign locations at agreed upon transfer prices.

NOTE 11 – CONTINGENCIES

          A lawsuit was instituted in October 2002 against the Company and one of its subsidiaries, Catapult Communications International Limited, an Irish corporation, in the Antwerp Commercial Court, Antwerp, Belgium, by Tucana Telecom NV, a Belgian company (“Tucana”). Tucana has been a distributor of products for Tekelec, the company from which NDB was acquired in August 2002. The writ alleges that the defendants improperly terminated an exclusive distribution agreement with Tucana following the acquisition of NDB and seeks damages of 12,461,000 euros plus costs. A preliminary hearing on the matter has been scheduled for March 6, 2003 at which time the Company expects that a trial date will be established. The Company strongly believes that it properly terminated any contract it had with Tucana and that Tucana is not entitled to any damages in this matter. The Company intends to defend itself vigorously. The Company anticipates that it would seek indemnification from Tekelec for any damages assessed against it in this matter under the terms of the Asset Purchase Agreement it entered into with Tekelec.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

          The following discussion and analysis should be read in conjunction with “Selected Consolidated Financial Data” and the Company’s Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K for 2002.

Forward-looking Statements

          The following discussion contains statements that are not historical facts but are forward-looking statements. Such statements are generally identified by the use of forward-looking words and phrases, such as “intended,” “expects,” “anticipates” and “is (or are) expected (or anticipated).” These forward-looking statements include but are not limited to those identified in this report with an asterisk (*) symbol. Actual results may differ materially from those discussed in such forward-looking statements, and the Company’s stockholders should carefully review the cautionary statements set forth in this report on Form 10-Q, including those set forth under the caption “Factors That May Affect Future Results.”

          The Company may from time to time make additional written and oral forward-looking statements, including statements contained in the Company’s filings with the Securities and Exchange Commission and in its reports to Stockholders. The Company does not undertake to update any forward-looking statements that may be made in this Form 10-Q and from time to time or on behalf of the Company.

Overview

          Catapult Communications Corporation (“Catapult,” the “Company” or the “Registrant”) designs, develops, manufactures, markets and supports advanced software-based test systems offering integrated suites of testing applications for the global telecommunications industry. Catapult’s DCT and MGTS products are digital communications test systems designed to enable equipment manufacturers and network operators to deliver complex digital telecommunications equipment and services more quickly and cost-effectively, while helping to ensure interoperability and reliability. The Company’s advanced software and hardware assist customers in the design, integration, installation and acceptance testing of a broad range of digital telecommunications equipment and services. The DCT and MGTS products perform a variety of test functions, including simulation, load and stress testing, feature verification, conformance testing and monitoring. The Company maintains an extensive library of software modules that support a large number of industry standard protocols and variants thereon. In addition, the Company offers customer support under software support contracts, as well as installation and training services.

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Results of Operations

          The following table sets forth, for the periods indicated, the percentage relationship of certain items from the Company’s consolidated statements of income to total revenues.

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Comparison of the Three Month Periods Ended December 31, 2002 and 2001

          Revenues, cost of revenues and expenses for the three months ended December 31, 2002 include the results of the continuing operations of NDB, which was acquired by the Company on August 30, 2002 as described in more detail in Note 1 to the Condensed Consolidated Financial Statements.

Revenues

          Revenues decreased by approximately 5% from $10.9 million for the three months ended December 31, 2001 to $10.4 million for the three months ended December 31, 2002. Over the same period, product revenues decreased by approximately 16% from $9.5 million to $8.0 million. The decrease in product revenues was attributable to reduced demand for the Company’s DCT test systems due to reductions in research and development spending on the part of most of its major customers, largely offset by the presence in the latter period of revenues from the Company’s MGTS products acquired with NDB. Services revenues increased 76.9% from $1.4 million to $2.4 million. The increase in services revenues was due to the addition of the service revenue stream from the MGTS installed base acquired with NDB.

Cost of Revenues

          Cost of product revenues consists of the costs of board assembly by independent contractors, purchased components, payroll and benefits for personnel in product testing, purchasing, shipping and inventory management, as well as supplies, media and freight. In addition, in the three months ended December 31, 2002, cost of product revenues included fees paid to Tekelec for the manufacture of the MGTS products under a transitional services agreement that expires February 28, 2003. Cost of product revenues increased approximately 124% from $614,000 for the three months ended December 31, 2001 to $1.4 million for the three months ended December 31, 2002 and gross margin on product revenues decreased from 94% to 83% due to the inclusion of MGTS product, which has lower margins than the Company’s DCT products, and to $440,000 in manufacturing fees paid under the transitional services agreement. The Company expects cost of product revenues to decrease and gross margin on product revenues to increase with the expiry of the transitional services agreement.*

          Cost of services revenues consists primarily of the costs of payroll and benefits for customer support, installation and training personnel. Cost of services revenues increased by approximately 165% from $263,000 for the three months ended December 31, 2001 to $697,000 for the three months ended December 31, 2002 and gross margin on services revenues decreased from 81% to 71% due to a 120% increase in the number of customer service personnel as a result of the NDB acquisition.

Research and Development

          Research and development expenses consist primarily of the costs of payroll and benefits for engineers, materials, equipment and consulting services. To date, all software development costs have been charged to research and development expenses as incurred. Research and development expenses increased by approximately 106% from $1.6 million for the three months ended December 31, 2001 to $3.4 million for the three months ended December 31, 2002 due to a 102% increase in the number of research and development personnel and to an increased use of contract developers as a result of the NDB acquisition. As a percentage of total revenues, research and development expenses increased from 15% to 32% over the same period. The Company expects research and development expenses to decrease by approximately $300,000 per quarter in the remainder of the fiscal year ending September 30, 2003 due to a reduction in contract development expense.*

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Sales and Marketing

          Sales and marketing expenses consist primarily of the costs of payroll, benefits, commissions and bonuses, occupancy costs, travel and promotional expenses, such as product brochures and trade show costs. Sales and marketing expenses increased by approximately 27% from $2.8 million for the three months ended December 31, 2001 to $3.5 million for the three months ended December 31, 2002 due primarily to a 30% increase in the number of sales and marketing personnel as a result of the NDB acquisition. As a percentage of total revenues, sales and marketing expenses increased from 26% to 34% over the same period. The company expects sales and marketing expenses to increase as additional sales support personnel are hired in Europe.*

General and Administrative

          General and administrative expenses include costs associated with the Company’s general and risk management, public reporting, employee recruitment and retention, investor relations and finance functions, as well as amortization of intangible assets acquired with NDB in 2002. General and administrative expenses increased approximately 85% from $1.2 million for the three months ended December 31, 2001 to $2.2 million for the three months ended December 31, 2002 due primarily to a 50% increase in the number of administrative personnel as a result of the NDB acquisition and to the inclusion of $455,000 in amortization expense. As a percentage of total revenues, general and administrative expenses increased from 11% to 21% over the same period. The Company expects general and administrative expenses to decrease by approximately $200,000 per quarter in the remainder of the fiscal year ending September 30, 2003 due to a reduction in amortization expense.*

Interest Income (Expense), net

          Interest income (expense), net consists of interest earned on cash and cash equivalents and short-term investments and amortization of the valuation premium attributed to the convertible notes payable, net of interest charges on those notes. Interest income decreased from $433,000 for the three months ended December 31, 2001 to $199,000 for the three months ended December 31, 2002. The decrease is due to a 51% reduction in cash and short-term investments as a result of the NDB acquisition and to a decrease in interest rates. The $102,000 in amortization of the valuation premium on the convertible notes payable offset the $87,000 in interest payable on those notes.

Other Income (Expense), net

          Other income (expense), net primarily represents gains and losses from fluctuations in exchange rates on transactions denominated in foreign currencies and income from miscellaneous refunds. Other income increased by $896,000 from an expense of $178,000 for the three months ended December 31, 2001 to an income of $718,000 for the three months ended December 31, 2002 due to a Japanese consumption tax refund of approximately $695,000 recorded in the latter period and to the absence in the latter period of foreign exchange losses recorded in the earlier period.

Provision for income taxes

          Provision for income tax consists of federal, state and international income taxes. The Company’s effective tax rate was 28.0% for the three months ended December 31, 2002 and 2001, respectively. The Company expects that its future tax rate may vary depending in part on the relative income contribution by its domestic and foreign operations.

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Liquidity and Capital Resources

          Historically, the Company has financed its operations primarily through cash generated from operations and from the proceeds of its initial public offering completed on February 11, 1999. The proceeds to the Company from the offering, net of underwriter fees and other expenses, were approximately $19.2 million.

          The Company’s purchase of NDB was additionally financed through the issuance of two convertible notes in the aggregate principal amount of $17.3 million. The convertible notes were issued by the Company’s Irish subsidiary and are guaranteed by the Company. The notes are convertible at the option of the holder into an aggregate of 1,081,250 shares of the Company’s common stock (subject to adjustment for certain events) between August 30, 2003 and the maturity date. The Company is entitled to pay the principal and accrued interest on one of the notes in the principal amount of $10.0 million in cash or, in whole or in part, by issuing its common stock at a value of 82.5% of the fair market value of the stock determined by a formula set forth in the note.

          The Company’s operating activities used cash of $3.7 million in the three month period ended December 31, 2002 and provided cash of $1.2 million in the three month periods ended December 31, 2001. The cash used by the Company’s operations for the three months ended December 31, 2002 was attributable to a decrease in accounts payable and accrued liabilities of $7.0 million, partially offset by a realization of $1.8 million on the assets of discontinued operations net of liabilities paid, an increase of $666,000 in deferred revenue and non-cash depreciation and amortization charges of $834,000. The cash provided by the Company’s operations for the three months ended December 31, 2001 was primarily attributable to net income and partially offset by an increase in accounts receivable that reflected primarily timing of invoicing. Investing activities, consisting primarily of purchases and sales of short-term investments and to a lesser extent additions to property and equipment, provided cash of $6.4 million in the three months ended December 31, 2002 compared to $667,000 in the three months ended December 31, 2001. Cash flows from financing activities for the three months ended December 31, 2002 and 2001 were attributable to exercises of employee stock options and the purchase of shares under the employee stock purchase plan in both periods.

          As of December 31, 2002, the Company had working capital of $29.3 million, cash and cash equivalents of $15.7 million, short-term investments of $16.1 million and no bank indebtedness. As of December 31, 2002, the Company had the following contractual obligations, in millions:

     The Company expects that capital expenditures will total approximately $1.2 million in fiscal 2003.*

     The Company believes that cash and cash equivalents, short-term investments and funds generated from operations will provide the Company with sufficient funds to finance its operations for at least the next 12 months.* The Company may require additional funds to support its working capital requirements or for other purposes. There can be no assurance that additional financing will be available or that, if available, such financing will be obtainable on terms favorable to the Company or its stockholders.

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Factors That May Affect Future Results

Fluctuations in Quarterly Operating Results; Lengthy Sales Cycle

          The Company has experienced, and anticipates that it will continue to experience, significant fluctuations in quarterly revenues and operating results. The Company’s revenues and operating results are relatively difficult to forecast for a number of reasons, including (i) the variable size and timing of individual purchases by customers, (ii) seasonal factors that may affect capital spending by customers, such as the varying fiscal year ends of customers and the reduction in business during the summer months, particularly in Europe, (iii) the relatively long sales cycles for the Company’s products, (iv) the timing of hiring sales and technical personnel, (v) changes in timing and amount of sales incentive compensation, (vi) competitive conditions in the Company’s markets, (vii) exchange rate fluctuations, (viii) changes in the mix of products sold, (ix) the timing of the introduction and market acceptance of new products or product enhancements by the Company, its customers, competitors or suppliers, (x) costs associated with developing and introducing new products, (xi) product life cycles, (xii) changes in the level of operating expenses relative to revenues, (xiii) software defects and other product quality problems, (xiv) customer order deferrals in anticipation of new products, (xv) delays in purchasing decisions or customer orders due to customer consolidation, (xvi) supply interruptions, (xvii) changes in the regulatory environment and (xviii) changes in global or regional economic conditions or in the telecommunications industry.

          The Company’s revenues in any period generally have been, and are likely to continue to be, derived from relatively small numbers of sales and service transactions with relatively high average revenues per order. Therefore, the loss of any orders or delays in closing such transactions could have a more significant impact on the Company’s quarterly revenues and results of operations than on those of companies with relatively high volumes of sales or low revenues per order. See “Dependence on Limited Number of Customers” below. The Company’s products generally are shipped within 15 to 30 days after orders are received and revenues are recognized upon shipment or, if installation services are purchased, when installed, provided collection is probable. As a result, the Company generally does not have a significant backlog of orders, and revenues in any quarter are substantially dependent on orders booked, shipped and installed in that quarter.

          The Company’s expectations for future revenues are predicated, to a large extent, on the recruitment and hiring of a significant number of employees, particularly experienced sales and technical personnel. Failure to hire, or delays in hiring, sufficient sales and technical personnel could have a material adverse effect on the Company’s results of operations for any period.

          Due to the relatively fixed nature of most of the Company’s costs, including personnel and facilities costs, and because operating expenses are based on anticipated revenue, a decline in revenue from even a limited number of transactions, failure to achieve expected revenue in any fiscal quarter or unanticipated variations in the timing of recognition of specific revenues can cause significant variations in operating results from quarter to quarter and may in some future quarter result in losses or have a material adverse effect on the Company’s business, financial condition and results of operations. The Company believes, therefore, that period-to-period comparisons of its operating results should not be relied upon as an indication of future performance.

          For all of the foregoing factors, as well as other unanticipated factors, it is possible that in some future quarter, the Company’s results of operations could fail to meet the expectations of public market analysts or investors. In such event, or in the event that adverse conditions prevail or are perceived to prevail generally or with respect to the Company’s business, the price of the Company’s common stock will likely be materially adversely affected.

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Dependence on Limited Number of Customers

          The Company’s customer base is highly concentrated, and a relatively small number of companies have accounted for substantially all of the Company’s revenues to date. In the fiscal year ended September 30, 2002, the Company’s top five customers represented approximately 64% of total revenues. The Company expects that it will continue to depend upon a relatively limited number of customers for substantially all of its revenues in future periods, although no customer is presently obligated either to purchase a specific amount of products or to provide the Company with binding forecasts of purchases for any period. The loss of a major customer or the reduction, delay or cancellation of orders from one or more of the Company’s significant customers could materially adversely affect the Company’s business, financial condition and results of operations.

Risks Relating to Acquisitions

          As part of its business strategy, the Company acquired NDB on August 30, 2002 and may make further acquisitions of, or significant investments in, companies, products or technologies that it believes are complementary, although no such acquisitions or investments are currently pending. The NDB acquisition and any such future transactions would be accompanied by the risks commonly encountered in making acquisitions of companies, products and technologies. Such risks include, among others, the difficulties associated with assimilating the personnel and operations of acquired companies, the potential disruption of the Company’s ongoing business, the distraction of management and other resources, the integration of personnel and technology of an acquired Company, difficulties in evaluating the technology of a potential target, inability to motivate and retain new personnel, the maintenance of uniform standards, controls, procedures and policies and the impairment of relationships with employees and clients as a result of the integration of new management personnel. The Company has no experience in assimilating acquired companies or product lines into its operations. There can be no assurance that the Company will be successful in overcoming these risks or any other problems encountered in connection with the NDB acquisition or any such future acquisitions. Furthermore, future acquisitions by the Company could result in the issuance of dilutive equity securities, the incurrence of debt or contingent liabilities or amortization expenses related to goodwill and other intangible assets, any of which could have a material adverse effect on the Company’s business, financial condition and results of operation or on the market price of the Company’s common stock.

Risk Associated with International Operations

          Company revenues from international customers were approximately 43% during the three months ended December 31, 2002. The Company expects that international sales will continue to account for a significant portion of its revenues in future periods.* The Company sells its products worldwide through its direct sales force. The Company has international offices located in Japan, Canada, the United Kingdom, Germany, France, Finland, and Australia and plans to add offices, staff and resources worldwide from time to time. International sales and operations are subject to inherent risks, including difficulties in staffing and managing foreign operations, longer customer payment cycles, greater difficulty in accounts receivable collection, changes in regulatory requirements or in economic or trade policy, costs related to localizing products for foreign countries, potentially weaker protection for intellectual property in certain foreign countries, the burden of complying with a wide variety of foreign laws and practices, tariffs and other trade barriers, and potentially adverse tax consequences, including restrictions on repatriation of earnings. During the last two fiscal years and during the three months ended December 31, 2002, a significant portion of the Company’s sales has been to customers in Japan. If economic conditions in Japan deteriorate to a significant extent, the Company’s business, financial condition and results of operations could be materially adversely affected. An inability to obtain necessary regulatory approvals in foreign markets on a timely basis could also have a material adverse effect on the Company’s business, financial condition and results of operations.

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          Many of the Company’s international sales, including its sales in Japan, are denominated in local currencies. Although the Company currently engages in hedging transactions with respect to certain receivables resulting from certain inter-company sales, there can be no assurance that the Company will continue to do so or that its hedging activities will be successful. Fluctuations in foreign currency exchange rates may contribute to fluctuations in the Company’s operating results. For example, changes in foreign currency exchange rates could adversely affect the revenues, net income, earnings per share and cash flow of the Company’s operations in affected markets. Similarly, such fluctuations may cause the Company to raise prices, which could affect demand for the Company’s products and services. In addition, if exchange or price controls or other restrictions are imposed in countries in which the Company does business, the Company’s business, financial condition and results of operations would be materially adversely affected.

Dependence on Rapidly Evolving Telecommunications Industry

          The Company’s future success is dependent upon the continued growth of the telecommunications industry. The global telecommunications industry is evolving rapidly, and it is difficult to predict its potential growth rate or future trends in technology development. There can be no assurance that the deregulation, privatization and economic globalization of the worldwide telecommunications market that have resulted in increased competition and escalating demand for new technologies and services will continue in a manner favorable to the Company or its business strategies. In addition, there can be no assurance that the growth in demand for Internet services and the resulting need for high speed or enhanced telecommunications equipment will continue at its current rate or at all.

          The Company’s future success is dependent upon the increased utilization of its test solutions by network operators and telecommunications equipment manufacturers. Industry-wide network equipment and infrastructure development driving the demand for the Company’s products and services may be delayed or prevented by a variety of factors, including cost, regulatory obstacles or the lack of or reduction in consumer demand for advanced telecommunications products and services. There can be no assurance that telecommunications equipment manufacturers and network operators will develop new technology or enhance current technology or, if developed, that such new technology or enhancements will create demand for the Company’s products or services.

Rapid Technological Change; Uncertainty of Acceptance of the Company’s Products and Services

          The market for telecommunications test systems and services is subject to rapid technological change, evolving industry standards, rapid changes in customer requirements and frequent product and service introductions and enhancements. The Company’s future success will depend in part on its ability to anticipate and respond to these changes by enhancing its existing products and services and by developing and introducing, on a timely and cost-effective basis, new products, features and services that address the needs of its customer base. There can be no assurance that the Company will be successful in identifying, developing and marketing new products, product enhancements and related services that respond to technological change

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or evolving industry standards or that adequately meet new market demands. In addition, because of the rapid technological change characteristic of the telecommunications industry, the Company may be required to support legacy systems used by its customers, which may place additional demands on the Company’s personnel and other resources and may require the Company to maintain an inventory of otherwise obsolete components.

          The Company’s test systems currently operate only on the UNIX operating system. The Company’s current and prospective customers may require other operating systems, such as Windows 2000 or Windows XP, to be used in their telecommunications test systems or may require the integration of other industry standards. There can be no assurance that the Company would be able to successfully adapt its products to such operating systems on a timely or cost-effective basis, if at all. The failure of the Company to respond to rapidly changing technologies and to develop and introduce new products and services in a timely manner would have a material adverse effect on the Company’s business, financial condition and results of operations.

          The Company’s success will depend in part on whether a large number of telecommunications equipment manufacturers and network operators purchase the Company’s products and services. Because the telecommunications market is rapidly evolving, it is difficult to predict the future success of products and services in this market. The customers in this market use products from a number of competing suppliers for various testing purposes, and there has not been broad adoption of the products of one company. There can be no assurance that the Company’s current or future products or services will achieve widespread acceptance among telecommunications equipment manufacturers, network operators or other potential customers or that solutions developed by competitors will not render the Company’s products obsolete or uncompetitive. In the event the telecommunications industry does not broadly adopt the Company’s products or services or does so less rapidly than expected by the Company, or in the event the Company’s products are rendered obsolete or uncompetitive by more advanced solutions, the Company’s business, financial condition and results of operations would be materially adversely affected.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Exchange Risk and Derivative Financial Instruments

          The Company’s foreign subsidiaries operate and sell the Company’s products in various global markets. As a result, the Company is exposed to changes in interest rates and foreign currency exchange rates on foreign currency denominated sales made to foreign subsidiaries. The Company utilizes foreign currency forward exchange contracts and options to mitigate the risk of future movements in foreign exchange rates that affect certain foreign currency denominated inter-company receivables. The Company attempts to match the forward contracts with specific underlying receivables in terms of currency, amount and maturity. The Company does not use derivative financial instruments for speculative or trading purposes. Because the impact of movements in currency exchange rates on forward contracts offsets the related impact on the associated exposures, these financial instruments do not subject the Company to speculative risk that would otherwise result from changes in currency exchange rates. Realized gains and losses on forward exchange contracts offset foreign exchange transaction gains or losses from revaluation of foreign currency denominated inter-company receivable balances which otherwise would be charged to other income (expense). To date, the Company has not fully mitigated all risk associated with its sales denominated in foreign currencies, and there can be no assurance that the Company’s foreign exchange risk management activities, if any, will be successful.

          At December 31, 2002 the Company had forward exchange contracts maturing in fiscal 2003 to sell approximately $3.7 million in Japanese Yen. The fair market value of these contracts at December 31, 2002 was not material.

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          The Company has evaluated the potential near-term losses in future earnings, fair values and cash flows from reasonably possible near-term changes in market rates or prices and believes that any such losses would not be material.*

          Additional factors that could affect future operating results or the price of the Common Stock are set forth under the caption “Factors That May Affect Future Results” in the Company’s Annual Report on Form 10-K for 2002.

Interest Rate Risk

          The Company’s exposure to market risk for changes in interest rates relates primarily to its short-term investment portfolio. As of December 31, 2002, short-term investments consisted of available-for-sale securities, including those classified as cash equivalents, of $24.6 million. These fixed income marketable securities included corporate bonds and government securities, all of which are of high investment grade. They are subject to interest rate risk and will decline in value if the market interest rates increase. If the market interest rates were to increase immediately and uniformly by 10% from levels as of December 31, 2002, the decline in the fair value of the portfolio would not be material to the Company’s financial position.

Part II. Other Information

Item 1. Legal Proceedings

          A lawsuit was instituted in October 2002 against the Company and one of its subsidiaries, Catapult Communications International Limited, an Irish corporation, in the Antwerp Commercial Court, Antwerp, Belgium, by Tucana Telecom NV, a Belgian company (“Tucana”). Tucana has been a distributor of products for Tekelec, the company from which NDB was acquired in August 2002. The writ alleges that the defendants improperly terminated an exclusive distribution agreement with Tucana following the acquisition of NDB and seeks damages of 12,461,000 euros plus costs. A preliminary hearing on the matter has been scheduled for March 6, 2003 at which time the Company expects that a trial date will be established. The Company strongly believes that it properly terminated any contract it had with Tucana and that Tucana is not entitled to any damages in this matter. The Company intends to defend itself vigorously. The Company anticipates that it would seek indemnification from Tekelec for any damages assessed against it in this matter under the terms of the Asset Purchase Agreement it entered into with Tekelec.

          Except for the aforementioned, the Company is not currently aware of any legal proceedings or claims that the Company believes are likely to have a material adverse effect on the Company’s financial position, results of operation or cash flows. From time to time we have been and expect to continue to be, subject to legal proceedings and claims by third parties in the ordinary course of business, including claims of alleged infringement of third party trademarks and other intellectual property rights against our licensees or us. Third party claims, like these, even if not meritorious, could result in the expenditure of significant financial and managerial resources and could materially affect our business, financial condition, results of operations and cash flows.

Item 2. Changes in Securities and Use of Proceeds

          Inapplicable

Item 3. Defaults Upon Senior Securities

          Inapplicable

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Item 4. Submission of Matters to a Vote of Security Holders

          Inapplicable

Item 5. Other Information

          Inapplicable

Item 6. Exhibits and Reports on Form 8-K.

(a)

Exhibits.

	99.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b)

Reports on Form 8-K.