TEKELEC - 10-Q Quarterly Report

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 þ No o

Indicate by check mark whether the registrant is an accelerated filer. Yes þ No o

As of April 22, 2004, there were 62,323,737 shares of the registrant’s common stock, without par value, outstanding.

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

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

We conduct business in a number of foreign countries. We expect international sales to account for a significant portion of our revenues in future periods. Accordingly, we have identified four geographic territories for analyzing and reporting sales data. The four territories are: (1) North America, comprised of the United States and Canada, (2) “EMEA” comprised of Europe, the Middle East and Africa, (3) “CALA” comprised of the Caribbean and Latin America including Mexico, and (4) Asia Pacific, comprised of Asia and the Pacific region including China. These territories are presented for the three months ended March 31, 2004, with comparative information reclassified for the three months ended March 31, 2003.

We operate under a thirteen-week calendar quarter. For financial statement presentation purposes, however, the reporting periods are referred to as ended on the last calendar day of the quarter. The accompanying consolidated financial statements for the three months ended March 31, 2004 and 2003 are for the thirteen weeks ended April 2, 2004 and March 28, 2003, respectively.

These consolidated financial statements should be read in conjunction with the consolidated financial statements for the year ended December 31, 2003 and the notes thereto in our Annual Report on Form 10-K for the year ended December 31, 2003.

In November 2003, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-10, “Application of EITF 02-16 by Resellers to Sales Incentives Offered to Consumers by Manufacturers.” EITF No. 03-10 addresses the accounting for manufacturer sales incentives offered directly to consumers, including manufacturer coupons. EITF No. 03-10 is effective for the first interim period beginning after November 25, 2003. Because we do not offer manufacturer sales incentives, adoption of the provisions of EITF No. 03-10 did not have a material impact on our financial position, results of operations or cash flows.

In December 2003, the Financial Accounting Standards Board (“FASB”) revised Statement of Financial Accounting Standards (“SFAS”) No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” Revised SFAS No. 132 affects employers’ required disclosures about pension plans and other postretirement benefit plans. It does not change the measurement or recognition of those plans required by SFAS No. 87, “Employers’ Accounting for Pensions,” SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits” and SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” Revised SFAS 132 requires disclosures in addition to those in the original SFAS No. 132. Revised SFAS No. 132 is effective for financial statements with fiscal years ending after December 15, 2003. The interim-period disclosures required by Revised Statement 132 are effective for interim periods beginning after December 15, 2003. Because we do not offer pension or other postretirement benefits, adoption of Revised SFAS No. 132 beginning in the first quarter of 2004 did not have a material impact on our financial position, results of operations or cash flows.

In March 2004, the EITF reached a consensus on Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments.” EITF No. 03-1 requires disclosures on investments in an unrealized loss position. The disclosures are designed to help financial statement users analyze a company’s unrealized losses and to enable them to better understand the basis for any management conclusion that the impairment is temporary. Quantitative and qualitative disclosures for investments accounted for under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” are effective for the first annual reporting period ending after December 15, 2003. All new disclosures related to cost method investments are effective for the annual reporting periods ending after June 15, 2004. Comparative information for the periods prior to the period of initial application is not required. We will begin to make these required disclosures in our Annual Report on Form 10-K for the fiscal year ending December 31, 2004. Adoption of EITF No. 03-1 will not have a material impact on our financial position, results of operations or cash flows.

On February 12, 2004, the FASB issued FASB Staff Position (“FSP”) FIN 46(R)-1 “Reporting Variable Interests in Specified Assets of Variable Interest Entities under Paragraph 13 of FASB Interpretation No. 46 (Revised December 2003) (“FIN 46(R)”), Consolidation of Variable Interest Entities” to replace FIN 46-2 as a result of the release of FIN 46R in December 2003. The FSP states that a specified asset of a variable interest entity and the liability secured by that asset should not be deemed a separate variable interest entity. The effective date for this FSP follows the effective date and transition guidance specified in FIN 46R. Adoption of Fin 46(R)-1 will not have a material impact on our financial position, results of operations or cash flows.

In April 2004, the FASB issued FSP 129-1, “Disclosure Requirements under FASB Statement No. 129, Disclosure of Information about Capital Structure, Relating to Contingently Convertible Financial Instruments,” (“FSP 129-1”). FSP 129-1 states that SFAS No. 129 “Disclosure of Information about Capital Structure” applies to all contingently convertible securities, including those containing contingent conversion requirements that have not been met and are not otherwise required to be included in the computation of diluted earnings per share in accordance with SFAS No. 128, “Earnings per Share.” Paragraph 4 of SFAS No. 129 requires the disclosure of significant terms of the conversion features of the contingently convertible security to enable users of financial statements to understand the circumstances of the contingency and the potential impact of conversion. Disclosures are to indicate whether the shares that would be issued if the contingently convertible securities were converted are included in the calculation of diluted earnings per share, and the reasons why or why not. The guidance in FSP 129-1 is effective immediately upon posting of the final FSP 129-1 to the FASB website and applies to all existing and newly created securities. We have included these required disclosures in Note L “Earnings Per Share” of the Notes to Condensed Consolidated Financial Statements in this Form 10-Q.

On June 10, 2003, we acquired a 51.6% controlling voting ownership interest (57.5% on an as converted basis) in Santera in exchange for cash contribution of $28.0 million and the contribution of the business operations and certain assets and liabilities of our Packet Telephony Business Unit (“PTBU”). As part of the acquisition and combination, Santera was recapitalized and we contributed the $28.0 million in cash to Santera in exchange for 28,000 shares of Santera Series B Preferred Stock. In addition, we received 38,000 shares of Santera Series A Preferred Stock and one share of Santera common stock in exchange for the PTBU. Santera’s existing stockholders received 62,000 shares of Series A Preferred Stock in exchange for their existing shares in Santera and a cash contribution to Santera of $12.0 million. Each share of Santera’s Series B Preferred Stock has a liquidation preference equal to $2,000 and is convertible into 1.63 shares of Santera’s common stock. Each share of Santera’s Series A Preferred Stock has a liquidation preference equal to $1,000 and is convertible into one share of Santera common stock. Under terms of the original purchase agreement, we made an additional cash investment of $6.0 million in Santera during March 2004, in exchange for 6,000 shares of Santera Series B Preferred Stock. As a result of this cash investment, our ownership

percentage increased to 53.7% (60.1% on an as converted basis). In accordance with generally accepted accounting principles, the capital structure of Santera has been eliminated in consolidation and the minority stockholders’ interest in Santera is reflected in our consolidated balance sheet as minority interest. The minority stockholders’ interest in Santera is reflected at the fair value of the Santera assets acquired on the date of acquisition. Santera develops, markets and sells solutions for carrier-class, next-generation switches.

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

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

Based on the purchase price allocation, $2.9 million of the purchase price represented acquired in-process research and development (“IPRD”) that had not yet reached technological feasibility and had no alternative future use. IPRD was valued using a discounted cash flow approach commonly known as the “excess earnings” approach. The IPRD amount was recorded as an expense in the second quarter of 2003. The identifiable assets created as a result of the acquisition will be amortized over their estimated useful lives of 15 years, with the exception of acquired backlog, which has an estimated life of one year. Amortization expense of purchased technology and other intangible assets of Santera, including the intangible assets contributed by PTBU, amounted to $1.9 million for the three months ended March 31, 2004.

The following table shows our pro forma revenue, net income and net income per share giving effect to the Santera acquisition as of the beginning of 2003:

The net income and losses of Santera are allocated between Tekelec and the minority stockholders based on their relative interests in the equity of Santera and the related liquidation preferences. This approach requires net losses to be allocated first to the Series A Preferred Stock until fully absorbed and then to the Series B Preferred Stock. Subsequent net income will be allocated first to the Series B Preferred Stock to the extent of previously recognized net losses allocated to Series B Preferred Stock. Additional net income will then be allocated to the Series A Preferred Stock to the extent of previously recognized losses allocated to Series A Preferred Stock and then to Common Stock in proportion to their relative ownership interests in the equity of Santera. The loss allocated to minority interest of Santera for the three months ended March 31, 2004 was computed as follows (dollars in thousands):

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

On August 30, 2002, we completed the sale of NDD to Catapult Communications Corporation (“Catapult”) for $59.8 million, consisting of cash in the amount of $42.5 million and convertible subordinated promissory notes (the “Notes”) issued by Catapult’s wholly owned Irish subsidiary and guaranteed by Catapult in the total principal amount of $17.3 million.

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

The Notes were initially reflected in the consolidated balance sheet at their estimated fair value with the assistance of a third party appraisal. The fair value was computed by discounting the face value amount to present value using a fair value rate of interest and then determining the fair value of the conversion option using the Black-Scholes valuation model. The carrying value of the Notes is being adjusted to the redemption

amount at maturity based on an effective interest amortization method, with periodic charges to interest. The carrying values of the Notes and the conversion option are as follows:

In January 2004, we announced a cost reduction initiative that is expected to result in employee terminations and relocations. The cost reduction initiative resulted in restructuring charges of $942,000 for the three months ended March 31, 2004, including $874,000 in severance costs, $25,000 in retention bonuses and $43,000 in relocation costs. These restructuring costs relate to the implementation of a global strategic manufacturing plan which includes the outsourcing of the majority of our manufacturing operations and the relocation of our remaining signaling product manufacturing operations from Calabasas, California to our facilities in Morrisville, North Carolina which is expected to be complete by the end of 2004.

For the restructuring charges related to relocation costs and retention bonuses, we have applied the provisions of SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” The principal difference between SFAS No. 146 and previous accounting standards relates to the timing of when restructuring charges are recorded. Under SFAS No. 146, restructuring charges are recorded as liabilities are incurred. Under prior accounting standards, restructuring related liabilities were recorded at the time we committed to a restructuring plan. Retention bonuses are being recognized proratably over the service period. We have applied the provisions of SFAS 112, “Employers’ Accounting for Postemployment Benefits” for severance costs because the severance benefits provided as part of this restructuring were part of an ongoing benefit arrangement and we accrued a liability for the severance costs.

The restructuring activity has resulted in the following accrual as of March 31, 2004:

As of March 31, 2004, total restructuring liabilities amounted to $899,000 and are included in accrued expenses and accrued payroll and related expenses in the accompanying balance sheet. Additional restructuring charges estimated at approximately $900,000 in total are likely to be incurred throughout the second, third and fourth quarters of 2004 as a result of the global strategic manufacturing plan and other consolidation activities.

We use derivative instruments, such as forward contracts, to manage our exposure to market risks such as interest rate and foreign exchange risks. We record derivative instruments as assets or liabilities on the Consolidated Balance Sheet, measured at fair value.

Corresponding gains and losses on these contracts, as well as gains and losses on the items being hedged, are included as a component of other income and expense in our consolidated statement of operations. When we elect not to designate a derivative instrument and hedged item as a fair value hedge at inception of the hedge, or the relationship does not qualify for fair value hedge accounting, the full amount of changes in the fair value of the derivative instrument will be recognized in the consolidated financial statements.

As of March 31, 2004, we had one foreign currency forward contract outstanding to sell approximately 2.4 million Euros in order to hedge certain receivable balances denominated in this currency. This contract had an expiration date of April 6, 2004, and did not meet specific hedge accounting requirements.

As of March 31, 2003, we had two foreign currency forward contracts outstanding to sell approximately 800,000 Euros and 759,000 Canadian Dollars in order to hedge certain receivable balances denominated in those currencies. These contracts had an expiration date of April 4, 2003, and did not meet specific hedge accounting requirements.

Corresponding gains and losses on these contracts, as well as gains and losses on the items being hedged, are included as a component of other income and expense in our consolidated statement of operations. For the three months ended March 31, 2004 and 2003, our net loss from foreign currency forward contracts was $42,477 and $159,000, respectively.

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

The income tax provision from continuing operations for the three months ended March 31, 2004 and 2003 was $6.3 million and $632,000, respectively. Our provision for income taxes does not include any benefit from the losses generated by Santera because our ownership interest in Santera does not meet the threshold to consolidate under income tax rules and regulations. Therefore, Santera losses are not reported on our consolidated federal tax return. A full valuation allowance is provided on the tax benefits generated by Santera as a result of its historical operating losses. In addition, the tax provision also reflects the effect of non-deductible acquisition-related costs, partially offset by benefits of $557,000 and $1.1 million, respectively, from the utilization of deferred tax liabilities related to certain of these acquisition-related costs.

Excluding the effect of acquisition-related items and Santera’s operating results, an effective tax rate of 35% and 34% was applied to continuing operations for the three month period ended March 31, 2004 and 2003, respectively, and represented federal, state and foreign taxes on our income, reduced primarily by research and development credits, foreign tax credits, and other benefits from foreign sourced income.

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

As a result of the Santera transaction (see Note B — Acquisition of Majority Interest in Santera), we have two notes payable to U.S. financial institutions with monthly installments of principal and interest. One of the notes has an outstanding balance of $2.6 million and is collateralized by the assets purchased under the note, bears interest at 10% and matures in February 2005. The second note for $3.0 million is collateralized by the assets purchased under the note and substantially all of Santera’s assets, excluding the assets secured under the $2.6 million note, bears interest at 6.36% and matures in November 2005. Under the terms of this facility, we are required to maintain certain financial reporting covenants. We believe we are in compliance with these requirements.

In June 2003, we issued and sold $125.0 million principal amount of our 2.25% Senior Subordinated Convertible Notes due 2008 (the “Notes”). The Notes were issued in a private offering in reliance on Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”). The initial purchaser of the Notes was Morgan Stanley & Co. Incorporated, which resold the Notes to qualified institutional buyers pursuant to Rule 144A promulgated under the Securities Act. The aggregate offering price of the Notes was $125.0 million and the aggregate proceeds to Tekelec were approximately $121.2 million after expenses. The Notes mature on June 15, 2008, and are convertible prior to the close of business on their final maturity date into shares of our common stock at a conversion rate of 50.8906 shares per $1,000 principal amount of the Notes, subject to adjustment in certain circumstances. There are no financial covenants related to the Notes, and there are no restrictions on us paying dividends, incurring debt or issuing or repurchasing securities.

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

From time to time, various claims and litigation are asserted or commenced against us arising from or related to contractual matters, intellectual property matters, product warranties and personnel and employment disputes. As to such claims and litigation, including those matters discussed below, we can give no assurance that we will prevail. While we currently do not believe that the ultimate outcome of these matters, individually or in the aggregate, will have a material adverse effect on our business or consolidated financial position, litigation is subject to inherent uncertainties. An unfavorable outcome in any of these matters could have a material adverse effect on our business, or our consolidated financial position, results of operations or cash flows in the quarter or annual period in which one or more of these matters are resolved.

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. Several Arizona lawsuits, including the lawsuit in which Tekelec is a named defendant, involve the same patents and 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. On January 23, 2004, the Court in the District of Nevada case issued an Order finding that certain Lemelson patents covering bar code technology and machine vision technology were: (1) unenforceable under the doctrine of prosecution laches; (2) not infringed by any of the accused products sold by any of the eight plaintiffs; and (3) invalid for lack of written description and enablement. Tekelec currently believes that the ultimate outcome of the lawsuit will not have a material adverse effect on our financial position, results of operations or cash flows.

In January 2002, Syndia Corporation (“Syndia”) sent a letter to Tekelec accusing Tekelec of infringing two patents and offering to license these and other patents to Tekelec. The patents at issue relate to integrated circuit technology. Syndia has not identified the specific Tekelec products or processes that allegedly infringe the patents at issue. Tekelec currently believes that the ultimate outcome of the lawsuit will not have a material adverse effect on our financial position, results of operations or cash flows.

On August 14, 2003, Tekelec filed a complaint against Telica, Inc. (“Telica”) in the United States District Court for the Central District of California. The complaint alleges that Telica failed and refused to provide to Tekelec certain financial statements, documents and information required to be provided under the Second Amended and Restated Stockholders’ Agreement, dated as of October 4, 2001, as amended by Amendment No. 1 thereto (as so amended, the “Stockholders Agreement”). Tekelec contends, among other things, that Telica’s failure and refusal to deliver the required financial statements, documents and information has injured Tekelec, including by interfering with Tekelec’s ability to monitor its investment in certain preferred stock of Telica, which Tekelec purchased from Telica on December 19, 2001, for approximately $10 million. In the complaint, Tekelec alleges claims for breach of contract and specific performance and seeks, among other things, compensatory damages, costs, interest and an order and injunction compelling Telica to deliver all financial statements, documents and information required to be delivered under the Stockholders Agreement. On September 15, 2003, Tekelec filed its First Amended Complaint, adding certain individuals as defendants and adding claims for breach of the implied covenant of good faith and fair dealing and breach of fiduciary duty.

On November 7, 2003, Telica filed a Counterclaim against Tekelec, alleging purported claims for breach of contract, breach of the covenant of good faith and fair dealing, fraud, and intentional interference with prospective economic advantage. Telica contends, among other things, that Tekelec misused certain documents and information purportedly provided by Telica. Telica seeks an unspecified amount of compensatory damages, punitive damages, attorneys’ fees, costs and interest. On December 5, 2003, Tekelec filed its Reply to the Counterclaim, denying each and every purported claim therein and asserting various affirmative defenses.

The parties have commenced the discovery phase of the case. A trial date of June 8, 2004 has been set by the Court. Tekelec currently believes that the ultimate outcome of the lawsuit will not have a material adverse effect on its financial position, results of operations or cash flows.

As of March 31, 2004, we have five stock-based employee compensation plans. We account for employee stock option plans in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and the related FASB interpretation FIN No. 44, “Accounting for Certain Transactions Involving Stock Compensation.” Accordingly, compensation expense related to employee stock options is recorded, if on the date of the grant, the fair value of the underlying stock exceeds the exercise price.

We also have 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 1.8 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.

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

SFAS No. 123 encourages but does not require companies to record compensation cost for stock-based employee compensation plans at fair value for awards granted subsequent to December 31, 1995. We have chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in related interpretations. However, in accordance with the disclosure only requirements of SFAS No. 123, we have computed the fair value of our stock option grants using the Black-Scholes option-pricing model with the following assumptions: (i) dividend yield of 0%, (ii) expected volatility of 80% and 86%, respectively, for 2004 and 2003, (iii) weighted average risk-free interest rates of 2.4% and 2.6% for 2004 and 2003, respectively, (iv) weighted average expected option lives of 4.0 and 5.8 years for 2004 and 2003, respectively, and (v) assumed forfeiture rate of 49% and 41% for 2004 and 2003, respectively.

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

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

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

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

Transfers between operating segments are made at prices reflecting markets conditions. The allocation of revenues from external customers by geographical area is determined by the destination of the sale.

States and Canada, (2) “EMEA” comprised of Europe, the Middle East and Africa (3) “CALA” comprised of the Caribbean and Latin America including Mexico, and (4) Asia Pacific, comprised of Asia and the Pacific region including China. These territories are presented for the three months ended March 31, 2004, with comparative information reclassified for the three months ended March 31, 2003.

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


(1)	General Corporate includes acquisition-related charges and amortization of $3,364 and $2,800 for the three months ended March 31, 2004 and 2003, respectively, as well as other corporate expenses not specifically allocated to the operating segments or specifically used by operating segment management to evaluate segment performance.

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

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

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

Sales to one customer accounted for 10% of revenues for the three months ended March 31, 2004, and included sales from the network signaling and contact center operating systems.

Sales to two customers individually accounted for 15% and 14% of revenues for the three months ended March 31, 2003, and included sales from the network signaling and contact center operating segments.

The following table provides a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations for the three months ended March 31, 2004 and 2003:

The computation of diluted number of shares for the three months ended March 31, 2004 excludes unexercised stock options and warrants and potential shares issuable upon conversion of our convertible subordinated discount notes that are anti-dilutive. The numbers of such shares excluded were 14.5 million for the three months ended March 31, 2004.

On April 8, 2004, we completed the acquisition of all of the outstanding shares of capital stock of privately held Taqua, Inc., a Delaware corporation (“Taqua”). The acquisition was accomplished by means of a reverse triangular merger of a new wholly owned subsidiary of Tekelec (“Merger Sub”), with and into Taqua (the “Acquisition”). As a result of the Acquisition, Taqua is the surviving corporation and a wholly owned subsidiary of Tekelec.

We paid an aggregate cash amount of approximately $84.4 million (the “Purchase Price”) to the common and preferred stockholders and warrant holders of Taqua in exchange for their interests in Taqua. By virtue of the Acquisition, we assumed any unexercised outstanding options to purchase shares of common stock of Taqua, and the assumed options were converted, based on exchange ratios specified in the Merger Agreement, into options to purchase an aggregate of approximately 500,000 shares of our Common Stock valued at approximately $9.0 million using the Black Scholes option pricing model. In addition, we have incurred approximately $4.4 million in direct acquisition related costs, including $1.8 million paid on behalf of Taqua upon the closing. These direct acquisition costs consist of investment banking, legal, accounting and other related fees that will be included in the purchase price of Taqua.

The acquisition will be accounted for using the purchase method of accounting. The financial results of Taqua subsequent to the acquisition will be included in the operating results of our next-generation switching operating segment.

Taqua offers a portfolio of circuit and IP voice switching products and services, including next-generation packet Class 5 switches, intelligent line access gateways, application servers, and an element management system. In addition, Taqua offers a suite of professional services including network design and capacity planning, as well as installation and cutover services.

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

The following discussion should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and the notes thereto included in Item 1 of this Quarterly Report and the Consolidated Financial Statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2003. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.

Our logo, IEX, TALI, and Eagle are registered trademarks of Tekelec, IP7, IP7 Secure Gateway, Asi 4000, Vxi, TekWare, TekServer, TotalView, and TotalNet are trademarks of Tekelec. Santera and SanteraOne are registered trademarks of Santera, our majority owned subsidiary. BOX and OFX are trademarks of Santera.

In June 2003, we acquired a 51.6% controlling voting ownership interest (57.5% on an as converted basis) in Santera in exchange for a cash contribution of $28.0 million and the contribution of the business operations and certain assets and liabilities of our Packet Telephony Business Unit (“PTBU”). As part of the acquisition, Santera was recapitalized and we contributed the $28.0 million in cash to Santera in exchange for 28,000 shares of Santera Series B Preferred Stock. In addition, we received 38,000 shares of Santera Series A Preferred Stock and one share of Santera common stock in exchange for the PTBU. Santera’s existing stockholders received 62,000 shares of Series A Preferred Stock in exchange for their existing shares in Santera and made an additional cash contribution to Santera of $12.0 million. Each share of Santera Series B Preferred Stock has a liquidation preference equal to $2,000 and is convertible into 1.63 shares of Santera common stock. Each share of Santera Series A Preferred Stock has a liquidation preference equal to $1,000 and is convertible into one share of Santera common stock. Under terms of the original purchase agreement, we made an additional cash investment of $6.0 million in Santera during March 2004, in exchange for 6,000 shares of Santera Series B Preferred Stock. As a result of this cash investment, our ownership percentage increased to 53.7% (60.1% on an as converted basis.) In accordance with generally accepted accounting principles, the capital structure of Santera has been eliminated in consolidation and the minority stockholders’ interest in Santera is reflected in our consolidated balance sheet as minority interest. The minority stockholders’ interest in Santera is reflected at the fair value of the Santera assets on the date of acquisition. Santera develops, markets and sells solutions for carrier-class, next-generation switches.

On April 8, 2004, we completed our acquisition of Taqua, Inc., a privately held provider of next-generation Class 5 packet switching systems, located in Richardson, Texas. The purchase price was approximately $84.4 million cash, plus the assumption of outstanding stock options valued at approximately $9.0 million using the Black Scholes model. Additionally, we incurred approximately $4.4 million in direct acquisition related costs, including $1.8 million paid on behalf of Taqua upon the close of the transaction. The direct acquisition related costs consist of investment banking, legal, accounting and other related fees. See Note M — Subsequent Event. Taqua offers a portfolio of circuit and IP voice switching products and services, including next-generation packet Class 5 switches, intelligent line access gateways, application servers, and an element management system. In addition, Taqua offers a suite of professional services including network design and capacity planning, as well as installation and cutover services. Taqua will become part of our next-generation switching product line in the second quarter of 2004.

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

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

Contact Center. Our IEX contact center products provide planning, management and call routing and control tools for single contact centers and for complex, multiple site contact center environments. This product line includes the TotalView Workforce Management and TotalNet Call Routing solutions.

Next-Generation Switching. Santera’s portfolio of switching solutions allows network service providers to migrate their network infrastructure from circuit-based technology to packet-based technology. Santera’s product portfolio includes SanteraOne, a carrier-grade, integrated voice and data switching solution which delivers applications like IXC tandem, Class 4/5, PRI offload, packet/cell switching and Voice over Broadband services. Taqua will become part of our next-generation switching product line in the second quarter of 2004.

Our revenues are currently organized into four distinct geographical territories: North America, EMEA, CALA and Asia/ Pacific. North America is comprised of the United States and Canada. EMEA is comprised of Europe, the Middle East and Africa. CALA is comprised of the Caribbean and Latin America including Mexico. Asia Pacific is comprised of Asia and the Pacific region including China. These territories are presented for the three months ended March 31, 2004, with comparative information reclassified for the three months ended March 31, 2003.

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

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

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

Revenues. Our revenues increased by $23.9 million, or 43%, during the first quarter of 2004 compared to the first quarter of 2003 due primarily to higher sales in our network signaling operating segment and the addition of sales from our next-generation switching operating segment.

Revenues from network signaling products increased by $17.3 million, or 38%, in the first quarter of 2004 compared to the first quarter of 2003 due to higher sales of Eagle STP systems and higher sales of extensions.

Revenues from contact center products increased by $205,000, or 2%, as a result of increased sales of IEX’s TotalView products.

Revenues from next-generation switching products during the first quarter of 2004 were $6.4 million, reflecting the addition of sales of next-generation switching products following the June 2003 acquisition of our majority interest in Santera. Taqua will become part of our next-generation switching product line in the second quarter of 2004.

Revenues in North America increased by $21.1 million, or 45%, in the first quarter of 2004 compared to the first quarter of 2003 due primarily to higher sales of Eagle STP systems and secondarily to the addition of sales from our next-generation switching operating segment as well as higher sales of local number portability products. EMEA revenues decreased by $3.4 million, or 57%, due primarily to lower sales of Eagle STP systems and secondarily to lower sales of local number portability products. CALA revenues increased by $4.9 million, or 454%, to higher sales of Eagle STP systems. Revenues in the Asia Pacific region increased by $1.2 million, or 79%, due to higher sales of Eagle STP systems. The percentage of revenues that were from outside the United States for the three months ended March 31, 2004 and 2003 were 23.3% and 17.9%, respectively.

A significant portion of our revenues in each quarter results from orders that are received in that quarter, and are difficult to predict. Further, we typically generate a significant portion of our revenues for each quarter in the last month of the quarter. We establish our expenditure levels based on our expectations as to future revenues, and if revenue levels were to fall below our expectations, then such shortfall would cause expenses to be disproportionately high. Therefore, a drop in near-term demand would significantly affect revenues, causing a disproportionate reduction in profits or even losses in a quarter.

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

Gross Profit. Gross profit as a percentage of revenues remained relatively the same at 71.5% in the first quarter of 2004 compared to 71.6% in the first quarter of 2003.

Research and Development. Research and development expenses increased overall by $6.4 million, or 45%, and increased slightly as a percentage of revenues to 26.1% in the first quarter of 2004 from 25.8% in the first quarter of 2003. The dollar amount increase was due primarily to an increase in salary and related expenses attributable to additional personnel as a result of our acquisition of a majority interest in Santera (See Note B — Acquisition of a Majority Interest in Santera).

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

Selling, General and Administrative. Selling, general and administrative expenses increased by $10.3 million, or 47%, and increased as a percentage of revenues to 40.9% in the first quarter of 2004 from 39.9% in the first quarter of 2003. The increases were due primarily to our acquisition of a majority interest in Santera (See Note B — Acquisition of a Majority Interest in Santera) and secondarily to increases in consulting services related to Santera integration activities as well as higher salaries and related expenses.

Amortization of Intangible Assets. Amortization of intangible assets in the first quarter of 2004 increased by $132,000 to $532,000, and remained flat as a percentage of revenues for the first quarter of 2004.

Restructuring Charges: In January 2004, we announced a cost reduction initiative that resulted in restructuring charges of $942,000 for the three months ended March 31, 2004, including $874,000 in termination costs, $25,000 in retention bonuses, and $43,000 in relocation costs. These charges relate to our implementation of a global strategic manufacturing plan which includes outsourcing a majority of our manufacturing operations and relocating our remaining signaling product manufacturing operations from Calabasas, California to our facilities in Morrisville, North Carolina. Additional restructuring charges are likely to be incurred in the second, third and fourth quarters of 2004 as a result of these actions and relate to general corporate expenses (See Note D — Restructuring Costs).

Interest and Other Income (Expense), net. Interest expense decreased by $1.2 million, or 53%, due to the June 2003 issuance of our convertible debt that carries an interest rate of 2.25% compared to the former convertible debt interest rate of 6.75%. The former convertible debt was redeemed in July 2003. Interest income remained relatively the same compared to 2003.

Income Taxes. The income tax provisions from operations for the three months ended March 31, 2004 and 2003 were $6.3 million and $632,000, respectively, and reflect the effect of non-deductible acquisition-related costs, partially offset by benefits of $557,000 and $1.1 million for the first quarter of 2004 and 2003, respectively. Our provision for income taxes does not include any benefit from the losses generated by Santera because our ownership interest in Santera does not meet the threshold to consolidate under income tax rules and regulations. Therefore, Santera losses are not reported on our consolidated federal tax return. A full valuation allowance is provided on the tax benefits generated by Santera as a result of their historical operating losses. Excluding the effect of acquisition-related items and Santera’s operating results, estimated effective tax

rates of 35% and 34% were applied for the three-month periods ended March 31, 2004 and 2003, respectively, and represented federal, state and foreign taxes on our income, reduced primarily by research and development credits, foreign tax credits and other benefits from foreign sourced income.

During the three months ended March 31, 2004, cash and cash equivalents increased by $72.9 million to $118.1 million, including net sales of $69.9 million of short-term and long-term available-for-sale securities. Operating activities, net of the effects of exchange rate changes on cash, provided $2.1 million. Financing activities, which primarily represented proceeds from the issuance of our common stock upon the exercise of options and warrants provided $6.3 million and investing activities, excluding the net purchases of short-term and long-term available-for-sale securities used $5.4 million primarily due to capital expenditures.

Cash flows from operating activities decreased $4.4 million, or 67% during the first quarter of 2004 compared to the first quarter of 2003 due primarily to our minority interest in Santera and secondarily to an increase in accounts receivable. Cash flows from operating activities were comprised mainly of net income adjusted for depreciation and amortization, an increase in accounts receivable, an increase in accounts payable, an increase income taxes payable and an increase in deferred revenue. Net accounts receivable increased by 25% during the first three months of 2004 primarily due to high sales activity. Deferred revenue increased by 13% during the three months ended March 31, 2004 primarily due to an increase in transactions pending completion of acceptance or delivery requirements and higher extended warranty service billings, which are deferred and recognized ratably over the warranty period.

Cash flows from investing activities increased $56.4 million, or 695% during the first quarter of 2004 compared to the first quarter of 2003 due to proceeds from maturity of available-for-sale securities of $367,000. Net capital expenditures of $4.5 million during the first three months of 2004 represented the planned addition of equipment principally for research and development and manufacturing operations.

Cash flows from financing activities increased $6.0 million, or 223% during the first quarter of 2004 compared to the first quarter of 2003 due to proceeds from the issuance of our common stock upon the exercise of options and warrants of $7.2 million.

As a result of the Santera transaction (see Note B — Acquisition of Majority Interest in Santera), we have two notes payable to U.S. financial institutions with monthly installments of principal and interest. One of the notes has an outstanding balance of $2.6 million and is collaterized by the assets purchased under the note, bears interest at 10% and matures in February 2005. The second note for $3.0 million is collaterized by the assets purchased under the note and substantially all of Santera’s assets, excluding the assets secured under the $2.6 million note, bears interest at 6.36% and matures in November 2005. Under the terms of this facility, we are required to maintain certain financial reporting covenants. We believe we are in compliance with these requirements.

On April 8, 2004, we completed the acquisition of all of the outstanding shares of capital stock of privately held Taqua, Inc., a Delaware corporation (“Taqua”). We paid an aggregate cash amount of approximately $84.4 million (the “Purchase Price”) to the common and preferred stockholders and warrant holders of Taqua in exchange for their interests in Taqua. By virtue of the Acquisition, we assumed any unexercised outstanding options to purchase shares of common stock of Taqua, and the assumed options were converted, based on exchange ratios specified in the Merger Agreement, into options to purchase an aggregate of approximately 500,000 shares of Tekelec Common Stock valued at $9.0 million using the Black Scholes

model. Additionally, we have incurred approximately $4.4 million in direct acquisition related costs, including $1.8 million paid on behalf of Taqua upon closing.

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

In June 2003, we completed the private placement of $125.0 million principal amount of 2.25% Senior Subordinated Convertible Notes (“Notes”) due in 2008. The Notes are convertible into 50.8906 shares of common stock per $1,000 principal amount, subject to certain adjustments, on their final maturity. There are no financial covenants related to the notes and there are no restrictions on us paying dividends, incurring debt or issuing or repurchasing securities.

We expect to absorb losses generated from the next-generation switching operating segment throughout 2004. We believe that existing working capital, funds generated through operations, proceeds from the issuance of stock upon the exercise of options, and our current bank credit facility will be sufficient to satisfy operating requirements for at least the next twelve months. Nonetheless, we may seek additional sources of capital as necessary or appropriate to fund acquisitions or to otherwise finance our growth or operations; however, there can be no assurance that such funds, if needed, will be available on favorable terms, if at all.

The statements that are not historical facts contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Quarterly Report on Form 10-Q are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect the current belief, expectations, estimates, forecasts or intent of our management and are subject to, and involve certain risks and uncertainties. As discussed in our Annual Report on Form 10-K for 2003 and other filings with the SEC, our future operating results are difficult to predict and subject to significant fluctuations. Factors that may cause future results to differ materially from the Company’s current expectations include, among others: overall telecommunications spending, changes in general economic conditions, the timing of significant orders and shipments, the lengthy sales cycle for the Company’s products, the timing of the convergence of voice and data networks, the success or failure of strategic alliances or acquisitions including the success or failure of the integration of Santera’s and Taqua’s operations with the those of the Company, the ability of carriers to utilize excess capacity of signaling infrastructure and related products in the network, the capital spending patterns of customers, the dependence on wireless customers for a significant percentage and growth of the Company’s revenues, the timely development and introduction of new products and services, product mix, the geographic mix of the Company’s revenues and the associated impact on gross margins, market acceptance of new products and technologies, carrier deployment of intelligent network services, the ability of our customers to obtain financing, the level and timing of research and development expenditures, regulatory changes, and the expansion of the Company’s sales, marketing and support organizations, both domestically and internationally, and other risks described in this Quarterly Report, our Annual Report on Form 10-K for 2003 and in certain of our other Securities and Exchange Commission filings. Many of these risks and uncertainties are outside of our control and are difficult for us to forecast or mitigate. Actual results may differ materially from those expressed or implied in such forward-looking statements. We are not responsible for updating or revising these forward-looking statements. Undue emphasis should not be placed on any forward-looking statements contained herein or made elsewhere by or on behalf of us.

There have been no material changes in our market risks during the three-month period ended March 31, 2004.

We conduct business in a number of foreign countries, with certain transactions denominated in local currencies. In certain instances where we have entered into contracts that are denominated in foreign currencies, we have obtained foreign currency forward contracts, principally denominated in Euros or British Pounds, to offset the impact of currency rates on accounts receivable. These contracts are used to reduce our risk associated with exchange rate movements, as gains and losses on these contracts are intended to offset exchange losses and gains on underlying exposures. Changes in the fair value of these forward contracts are recorded immediately in earnings.

We do not enter into derivative instrument transactions for trading or speculative purposes. The purpose of our foreign currency management policy is to minimize the effect of exchange rate fluctuations on certain foreign denominated anticipated cash flows. The terms of currency instruments used for hedging purposes are consistent with the timing of the transactions being hedged. We may continue to use foreign currency forward contracts to manage foreign currency exchange risks in the future.

Fixed income securities are subject to interest rate risk. The fair value of our 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 our investment portfolio. The portfolio is diversified and consists primarily of investment grade securities to minimize credit risk.

There have been no borrowings under our variable rate credit facilities. All of our outstanding long-term debt is fixed rate and not subject to interest rate fluctuation. The fair value of the long-term debt will increase or decrease as interest rates decrease or increase, respectively.

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

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

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

In January 2001, IEX Corporation, our wholly owned subsidiary (“IEX”), filed suit against Blue Pumpkin Software, Inc., in the United States District Court for the Eastern District of Texas, Sherman Division. In its complaint, IEX 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. Discovery in the case closed in December 2002. Blue Pumpkin filed a motion for summary judgment of non-infringement, and the Court granted that motion finding that Blue Pumpkin did not infringe the ’355 patent as a matter of law. IEX timely filed a notice of appeal and submitted its appellate brief to the Federal Circuit Court of Appeals in January 2004. Blue Pumpkin’s Response was filed April 9, 2004, and IEX will file a Reply brief May 19, 2004. We believe that the ultimate outcome of the lawsuit will not have a material adverse effect on our financial position, results of operations or cash flows.

2.1 Agreement and Plan of Merger dated as of February 25, 2004 by and among Tekelec, Buckaroo, Inc., Taqua, Inc. and, as representatives of the stockholders of Taqua, Inc., Bessemer Venture Partners V L.P. and Columbia Capital, L.L.C.⁽¹⁾

2.2 First Amendment to Agreement and Plan of Merger dated as of February 26, 2004 by and among Tekelec, Buckaroo, Inc., Taqua, Inc. and, as representatives of the stockholders of Taqua, Inc., Bessemer Venture Partners V L.P. and Columbia Capital, L.L.C.⁽²⁾

2.3 Indemnification Agreement dated as of February 25, 2004 by and among Tekelec, Buckaroo, Inc., Taqua, Inc. and certain stockholders of Taqua, Inc.⁽¹⁾

2.4 Escrow Agreement dated as of April 8, 2004 by and among Tekelec, Taqua, Inc. and, as representatives of the stockholders of Taqua, Inc., Bessemer Venture Partners V L.P. and Columbia Capital, L.L.C. and U.S. Bank National Association⁽²⁾

31.1 Certification of President and Chief Executive Officer of Registrant pursuant to Rule 13a-14(a) under the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2 Certification of Vice President and Chief Financial Officer of Registrant pursuant to Rule 13a-14(a) under the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1 Certification of President and Chief Executive Officer and Vice President and Chief Financial Officer of Registrant pursuant to Rule 13a-14(b) under the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


(1)	Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on March 4, 2004 (SEC File No. 0-15135).

(2)	Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on April 23, 2004 (SEC File No. 0-15135).

(i) On April 23, 2004, Registrant filed a Current Report on Form 8-K with the Commission with respect to its completion of the acquisition of Taqua, Inc.

(ii) On April 22, 2004, Registrant furnished a Current Report on Form 8-K with the Commission with respect to its issuance of a press release announcing the Registrants 2004 first quarter financial results.

(iii) On February 25, 2004, Registrant filed a Current Report on Form 8-K with the Commission with respect to its announcement to acquire all of the outstanding shares of Taqua, Inc.

(iv) On January 29, 2004, Registrant furnished a Current Report on Form 8-K with the Commission with respect to its issuance of a press release announcing the Registrant’s 2003 fiscal quarter and year-end financial results.

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	TEKELEC

	/s/ FREDERICK M. LAX

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

	/s/ PAUL J. PUCINO

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


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

		For the quarterly period ended March 31, 2004

OR

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


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


		Page

PART I — FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements
	Consolidated Balance Sheets at March 31, 2004 and December 31, 2003		3
	Consolidated Statements of Operations for the three months ended March 31, 2004 and 2003		4
	Consolidated Statements of Comprehensive Income for the three months ended March 31, 2004 and 2003		5
	Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003		6
	Notes to Consolidated Financial Statements		7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		21
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		29
Item 4.	Controls and Procedures		29

PART II — OTHER INFORMATION
Item 1.	Legal Proceedings		30
Item 6.	Exhibits and Reports on Form 8-K		31
Signatures			32
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1


			March 31,		December 31,
			2004		2003

			(Unaudited)

			(Thousands, except share
			data)
ASSETS
Current assets:
	Cash and cash equivalents		$	118,123	$	45,261
	Short-term investments, at fair value			66,948		83,800
	Accounts receivable, less allowances of $2,517 and $2,619, respectively			65,766		52,781
	Convertible notes receivable ($17,300 principal amount)			17,478		17,580
	Inventories			24,284		21,434
	Deferred income taxes, net			6,309		4,958
	Prepaid expenses and other current assets			25,358		22,088

		Total current assets		324,266		247,902
Long-term investments, at fair value				157,032		210,298
Property and equipment, net				23,392		22,172
Investments in privately-held companies				17,322		17,322
Deferred income taxes, net				9,419		7,876
Other assets				6,957		6,342
Goodwill				68,903		68,903
Intangible assets, net				30,524		34,118

		Total assets	$	637,815	$	614,933


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
	Trade accounts payable		$	16,349	$	8,974
	Accrued expenses			30,638		30,812
	Accrued payroll and related expenses			16,453		17,967
	Current portion of notes payable			3,337		3,934
	Current portion of deferred revenues			58,095		50,105
	Income taxes payable			7,882		1,071
	Deferred income tax			232		—

		Total current liabilities		132,986		112,863
Notes payable				2,228		2,574
Long-term convertible debt				125,000		125,000
Deferred income taxes				—		790
Long-term portion of deferred revenues				2,487		3,687

		Total liabilities		262,701		244,914

Minority Interest				31,631		41,208

Commitments and Contingencies (Note I)
Shareholders’ equity:
	Common stock, without par value, 200,000,000 shares authorized; 62,261,466 and 61,625,518 shares issued and outstanding, respectively			198,997		189,908
	Retained earnings			143,744		137,895
	Accumulated other comprehensive income			742		1,008

		Total shareholders’ equity		343,483		328,811

		Total liabilities and shareholders’ equity	$	637,815	$	614,933



				Three Months Ended
				March 31,

				2004			2003


				(Unaudited)
				(Thousands, except
				per share data)
Revenues				$	78,870		$	55,006
Cost of sales:
	Cost of goods sold				19,385			13,081
	Amortization of purchased technology				3,064			2,531

		Total cost of sales			22,449			15,612

			Gross profit		56,421			39,394

Operating expenses:
	Research and development				20,619			14,213
	Selling, general and administrative				32,271			21,951
	Restructuring				942			—
	Amortization of intangible assets				532			400

		Total operating expenses			54,364			36,564

Income from operations					2,057			2,830
Other income (expense):
	Interest income				1,533			1,448
	Interest expense				(1,118	)		(2,355	)
	Other, net				53			223

		Total other income (expense)			468			(684	)

Income from operations before provision for income taxes					2,525			2,146
Provision for income taxes					6,253			632

		Net income (loss) before minority interest			(3,728	)		1,514
Minority interest					9,577			—

		Net income		$	5,849		$	1,514

Earnings per share:
	Basic			$	0.09		$	0.02
	Diluted				0.09			0.02
Weighted average number of shares outstanding:
	Basic				62,034			60,934
	Diluted				65,194			61,632

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		Three Months
		Ended March 31,

		2004			2003


		(Unaudited)
		(Thousands)
Net income		$	5,849		$	1,514
Other comprehensive income (loss):
	Foreign currency translation adjustments		(44	)		(246	)
	Net unrealized loss on available-for-sale securities		(222	)		—

Comprehensive income		$	5,583		$	1,268


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

Fair value step-up	$	56,933


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

	$	56,933


		Three Months Ended
		March 31, 2003

		(Thousands, except
		per share amounts)
Revenues			56,862
Net loss			(972	)
Net loss per share:
	Basic		(0.02	)
	Diluted		(0.02	)


Santera net loss	$	15,447
Percentage of losses attributable to the minority interest based on capital structure and liquidation preferences		62	%

Net loss allocated to minority interest	$	9,577


				Costs Incurred		Cumulative
				for the Three		Costs Incurred
		Total Costs		Months Ended		through
		Expected to be		March 31,		March 31,
		Incurred		2004		2004


		(Thousands)
Severance costs and retention bonuses		$	972	$	899	$	899
Employee relocation costs			550		43		43
Facility relocation costs			320		—		—

	Total	$	1,842	$	942	$	942


							Balance at
		Restructuring					March 31,
		Charges, Net		Payments			2004


		(Thousands)
Severance costs and retention bonuses		$	899	$	—		$	899
Employee relocation costs			43		(43	)		—

	Total	$	942	$	(43	)	$	899



		Income (Loss)
		from Operations


		Three Months Ended
		March 31,

		2004			2003

Network Signaling		$	24,963		$	9,711
Contact Center			3,076			3,339
Next-Generation Switching			(12,213	)		—
General Corporate(1)			(13,769	)		(10,220	)

	Total	$	2,057		$	2,830


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


	(Thousands, except per share data)
For the Three Months Ended March 31, 2004:
Basic EPS	$	5,849		62,034	$	0.09
Effect of Dilutive Securities — Stock Options and Warrants		—		3,160

Diluted EPS	$	5,849		65,194	$	0.09

For the Three Months Ended March 31, 2003:
Basic EPS	$	1,514		60,934	$	0.02
Effect of Dilutive Securities — Stock Options and Warrants		—		698

Diluted EPS	$	1,514		61,632	$	0.02



		Percentage of
		Revenues


		Three Months
		Ended
		March 31,

		2004			2003

Revenues			100.0	%		100.0	%
Cost of goods sold			24.6			23.8
Amortization of purchased technology			3.9			4.6

Gross profit			71.5			71.6

Research and development			26.1			25.8
Selling, general and administrative			40.9			39.9
Restructuring			1.2			—
Amortization of intangible assets			0.7			0.8

Total operating expenses			68.9			66.5

Income from operations			2.6			5.1
Interest and other income (expense), net			0.6			(1.2	)

Income from operations before provision for income taxes			3.2			3.9
Provision for income taxes			7.9			1.1

Net income (loss) from operations before minority interest			(4.7	)		2.8
Minority interest			12.1			—

	Net income		7.4	%		2.8	%


Item 1.	*Consolidated Financial Statements*


	*Recent Accounting Pronouncements*


			March 31,			December 31,
			2004			2003

			(Unaudited)

			(Thousands)
Inventories consist of the following:
	Raw materials		$	16,248		$	15,810
	Work in process			687			128
	Finished goods			7,349			5,496

		Inventories	$	24,284		$	21,434

Property and equipment consist of the following:
	Manufacturing and development equipment		$	66,654		$	61,400
	Furniture and office equipment			31,151			29,464
	Demonstration equipment			2,519			2,465
	Leasehold improvements			9,064			8,989

				109,388			102,318
	Less accumulated depreciation			(85,996	)		(80,146	)

		Property and equipment, net	$	23,392		$	22,172

Intangible assets consist of the following:
	Purchased technology		$	79,162			79,162
	Other			14,600			14,600

				93,762			93,762
	Less accumulated amortization			(63,238	)		(59,644	)

		Intangible assets, net	$	30,524		$	34,118


	*Indemnities, Commitments and Guarantees*


	*Three Months Ended March 31, 2004 Compared with the Three Months Ended March 31, 2003*


Item 3.	*Quantitative and Qualitative Disclosures About Market Risk*