Back to GetFilings.com

Table of Contents

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 June 30, 2003
		OR
[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-15135

TEKELEC

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

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

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

     Indicate by check mark whether the registrant is an accelerated filer. Yes [X] No [   ]

     As of August 8, 2003, there were 61,239,541 shares of the registrant’s common stock, without par value, outstanding.

Table of Contents

TEKELEC
FORM 10-Q
INDEX

						Page
Part I — Financial Information
Item 1.		Consolidated Financial Statements
		Consolidated Balance Sheets at June 30, 2003 and December 31, 2002					3
		Consolidated Statements of Operations for the three and six months ended June 30, 2003 and 2002					4
		Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2003 and 2002					5
		Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002					6
		Notes to Consolidated Financial Statements					7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations					20
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 4.		Submission of Matters to a Vote of Security Holders					31
Item 6.		Exhibits and Reports on Form 8-K					32
Signatures							34

2

Table of Contents

PART I — FINANCIAL INFORMATION

Tekelec
Consolidated Balance Sheets

See notes to consolidated financial statements.

3

Table of Contents

Tekelec
Consolidated Statements of Operations
(unaudited)

See notes to consolidated financial statements.

4

Table of Contents

Tekelec
Consolidated Statements of Comprehensive Income
(unaudited)

See notes to consolidated financial statements.

5

Table of Contents

Tekelec
Consolidated Statements of Cash Flows
(unaudited)

See notes to consolidated financial statements.

6

Table of Contents

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

A. Basis of Presentation

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

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

     We operate under a thirteen-week calendar quarter. For financial statement presentation purposes, however, the reporting periods are referred to as ended on the last calendar day of the quarter. The accompanying consolidated financial statements for the three and six months ended June 30, 2003 and 2002 are for the thirteen and twenty-six weeks ended June 27, 2003 and June 28, 2002, respectively.

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

Recent Accounting Pronouncements

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

     In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies the accounting guidance on derivative instruments (including certain derivative instruments embedded in other contracts) and hedging activities that fall within the scope of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 is effective for all contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. The guidance is to be applied prospectively.

7

Table of Contents

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

Currently, we do not enter into these types of transactions and therefore we do not expect this pronouncement to have an impact on our financial position, results of operations or cash flows.

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

     In January 2003, FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities—an Interpretation of ARB No. 51.” The Interpretation clarified the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of this Interpretation are effective for all enterprises with variable interest entities created after January 31, 2003 and is required to be fully implemented no later than the third quarter of 2003. We are currently assessing the impact, if any, this interpretation will have on our financial position, results of operations, or cash flows.

B. Acquisition of Majority Interest in Santera

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

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

     The Packet Telephony Business Unit assets and liabilities contributed remain at historical cost.

8

Table of Contents

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

     Based on the purchase price allocation, $2.9 million of the purchase price represented acquired in-process research and development (“IPRD”) that had not yet reached technological feasibility and had no alternative future use. This amount was recorded as a non-recurring expense in the second quarter of 2003. The identifiable intangible assets created as a result of the acquisition will be amortized over their estimated useful lives of 15 years, with the exception of acquired backlog which has an estimated life of one year. Amortization expense of purchased technology and other intangible assets resulting from the acquisition amounted to $97,000, for the three and six months ended June 30, 2003.

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

     The profits and losses of Santera are allocated between us and the minority interest based on the relative interest in the equity of Santera and the related liquidation preferences. This requires losses to be allocated first to the Series A Preferred Stock until fully absorbed and then to the Series B Preferred Stock. Subsequent profits will be allocated first to the Series B Preferred Stock until the previously recognized losses are recovered to the extent of the original Series B Preferred Stock investment balance. Profits will then be allocated to the Series A Preferred Stock. The minority interest in the losses of Santera for the period of June 10, 2003 through June 30, 2003 was computed as follows (thousands, except percentages):

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

C. Disposition of Network Diagnostics Business

     On August 30, 2002, we completed the sale of NDD to Catapult Communications Corporation (“Catapult”) for $59.8 million, consisting of $42.5 million in cash and convertible subordinated promissory notes (the “Notes”) issued by Catapult’s wholly owned Irish subsidiary and guaranteed by Catapult in the total amount of $17.3 million, subject to certain adjustments. The sale resulted in a pre-tax gain of approximately $41.7 million ($28.3 million after taxes). This gain is subject to future adjustment depending on the final resolution of certain contingencies under the asset purchase agreement. Any differences between these estimates and their actual settlement will change the gain accordingly. In accordance with SFAS No. 144, “Accounting for

9

Table of Contents

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

the Impairment or Disposal of Long-Lived Assets,” the sale of the NDD business segment has been presented as a discontinued business and our historical financial results for periods prior to disposition have been revised to reflect NDD as a discontinued operation. Accordingly, the revenues, costs and expenses, assets and liabilities, and cash flows of NDD have been condensed in the accompanying consolidated statements of operations, balance sheets and cash flows.

     Revenues and loss from our discontinued operation were as follows:

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

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

10

Table of Contents

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

D. Certain Balance Sheet Items

E. Financial Instruments

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

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

     As of June 30, 2003, we had no foreign currency forward contracts outstanding.

     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

11

Table of Contents

Tekelec
Notes to Consolidated Financial Statements
(unaudited)

statement of operations. For the three and six months ended June 30, 2003, our net loss from foreign currency forward contracts was $466,000 and $625,000, respectively. We did not enter into forward contracts for the three and six months ended June 30, 2002.

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

F. Income Taxes

     The income tax provisions from continuing operations for the three and six months ended June 30, 2003 were $2.0 million and $2.6 million, respectively, and reflected the effect of non-deductible acquisition-related costs, partially offset by benefits of $969,000 and $2.0 million, respectively, from the utilization of deferred tax liabilities related to certain of these acquisition-related costs.

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

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

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

     We have a $20.0 million line of credit with a U.S. bank. Our $20.0 million credit facility is collateralized by substantially all of our assets excluding the assets of Santera, bears interest at or, in some cases, below the lender’s prime rate (4.0% at June, 2003) and expires on August 31, 2004. Under the terms of this 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 also have two notes with U.S. financial institutions. One of the notes has an outstanding balance of $4.3 million and is secured by the assets purchased under the note, bears interest at 10% and expires in February 2005. The second note for $3.7 million is secured by the assets purchased under the note and substantially all of Santera’s assets, excluding the assets secured under the $4.3 million note, bears interest at a variable rate based on the two-year treasury note rate (6.36% at June 30, 2003) and expires in November 2005. Under the terms of this facility, we are required to maintain certain financial reporting covenants. We believe we are in compliance with these requirements.

     In November 1999, we completed the private placement of $135.0 million principal amount at maturity of 3.25% convertible subordinated discount 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 Notes were called and subsequently redeemed on July 19, 2003. See Note L-Subsequent Event.

     In June 2003, we completed the private placement of $125.0 million principal amount of 2.25% senior subordinated convertible notes due in 2008.

12

Table of Contents