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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 COMMISSION FILE NUMBER 0-15135
TEKELEC
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-2746131
(State or other jurisdiction of (I.R.S.Employer
incorporation or organization) Identification Number)
26580 WEST AGOURA ROAD, CALABASAS, CALIFORNIA 91302
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 880-5656
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, WITHOUT PAR VALUE
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates
of the registrant, based upon the last reported sale price of the Common Stock
on March 2, 1998 as reported on the Nasdaq National Market, was approximately
$744,000,000.
The number of shares outstanding of the registrant's Common Stock on
March 2, 1998, was 26,433,576.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement to be delivered
to shareholders in connection with their Annual Meeting of Shareholders to be
held on May 15, 1998 are incorporated by reference into Part III of this Annual
Report.
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TEKELEC
INDEX TO ANNUAL REPORT ON FORM 10-K
For the fiscal year ended December 31, 1997
Page
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PART I
Item 1. Business.................................................................................... 3
Item 2. Properties.................................................................................. 23
Item 3. Legal Proceedings........................................................................... 23
Item 4. Submission of Matters to a Vote of Security Holders......................................... 23
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................................................... 24
Item 6. Selected Consolidated Financial Data........................................................ 25
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................................... 26
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.................................. 34
Item 8. Financial Statements and Supplementary Data................................................. 34
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................................................... 35
PART III
Item 10. Directors and Executive Officers of the Registrant.......................................... 36
Item 11. Executive Compensation...................................................................... 36
Item 12. Security Ownership of Certain Beneficial Owners and Management.............................. 36
Item 13. Certain Relationships and Related Transactions.............................................. 36
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................ 37
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PART I
ITEM 1. BUSINESS.
Tekelec (the "Company") designs, manufactures and markets innovative
network switching solutions and diagnostic systems for the global communications
marketplace. Tekelec's products enable communications infrastructure suppliers
and network providers to rapidly deliver advanced communications products and
services. The Company's EAGLE(R) STP switching platform enables operators of
wireline and wireless networks to deliver Intelligent Network (IN) and Advanced
Intelligent Network (AIN) services such as Caller ID, voice messaging, personal
number calling, Service Provider Local Number Portability and customized routing
and billing as well as digital wireless services such as Personal Communications
Systems (PCS) and Global Systems for Mobile (GSM). Tekelec's diagnostic systems
are used in the design, installation and maintenance of a broad range of
communications equipment and networks.
The Company's switching products have been sold primarily to U.S.
independent telephone companies (ITCs), PCS and cellular operators,
interexchange carriers (IXCs), competitive access providers (CAPs) and local
exchange carriers. In 1997, the Company entered the Regional Bell Operating
Company (RBOC) market with sales of its EAGLE STPs to NYNEX and to Bell Atlantic
Corporation. The two companies subsequently merged into Bell Atlantic
Corporation. Switching products have been sold primarily through the Company's
direct sales force and also through distribution and marketing relationships
with Daewoo Telecom, Ltd. (Daewoo), Lucent Technologies, Inc. (Lucent) and
Stratus Computer, Inc. (Stratus). In 1997, Daewoo became the Company's exclusive
Korean distributor of the EAGLE STP.
The Company sells its diagnostic systems worldwide to long distance
carriers, telephone operating companies, communications equipment manufacturers,
wireless and cellular network operators and government agencies.
INDUSTRY BACKGROUND
Deregulation and privatization worldwide have intensified competition
among existing operators of public communications networks and encouraged the
entrance of new service providers. At the same time, the convergence of
telephony and computing is resulting in end users demanding new and enhanced
high-quality communications services at lower cost. As a result, network
operators are increasingly pressured to reduce the time and expense required to
introduce such services. Together, these forces are creating the need for new
equipment and infrastructure for both wireline and wireless networks.
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Public Networks: Increased Competition and Complexity
In the U.S., long distance carriers, RBOCs and new competitive service
providers that have entered the local and long-distance markets are competing
with one another to offer enhanced products and services to their customers. The
passage of the Telecommunications Act of 1996 and subsequent orders and rulings
in 1997 continued their profound competitive impact on all domestic carriers.
The rapid growth of cellular and wireless networks continues to further increase
the number of communications alternatives offered to end users. For the first
time, real local choice became available to consumers in most metropolitan
areas. In response to this environment, operators of public networks are seeking
to lower their costs and differentiate themselves by rapidly introducing new
services. These include high-speed data services such as Asynchronous Transfer
Mode (ATM) and Frame Relay, AIN services such as Caller ID, voice messaging,
Service Provider Local Number Portability and customized routing and billing as
well as digital wireless services such as PCS and GSM. Globally, state-owned
Post Telephone and Telegraph Administrations (PTTs) are being liberalized and
privatized, resulting in some of the industry's most deregulated and competitive
marketplaces. The European Union, following the lead of the Federal
Communications Commission (FCC), is establishing pan-European standards for
Local Number Portability (LNP) based on Common Channel Signaling System No. 7
(SS7) with the objective of implementing such requirements by the year 2000.
While communications markets are becoming increasingly competitive, a
proliferation of standards and protocols is making the design and operation of
communications networks more complex. Demand for high-speed communications
integrating voice, data and video is growing rapidly. Services based on emerging
technologies, such as ATM, Frame Relay, xDSL, digital video and Fast Ethernet,
are being deployed while Integrated Services Digital Network (ISDN) is
increasingly available to provide end-user access to combined voice and data
services, particularly for Internet services. With the explosive growth of the
Internet comes the need for high-capacity, high-speed, flexible data products
and services. In addition, network operators must also support these standards
and protocols in an increasing number of Local Area Networks (LANs),
Metropolitan Area Networks (MANs), Wide Area Networks (WANs) and Global Area
Networks (GANs).
As a result, network operators have become more demanding of
communications equipment suppliers to provide cost effective solutions that
enable operators to increase the overall capabilities of their networks while
maintaining the highest network integrity.
Intelligent Network and Advanced Intelligent Network Switching
The Intelligent Network (IN) utilizes a highly complex protocol called
SS7 to provide the basis for virtually all new telecommunications services. The
IN architecture uses two separate but parallel paths; one to handle the voice or
data traffic and a second to carry the signaling
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information for call set up and routing. Network operators utilize the IN
architecture to increase the efficiency of their networks by offloading
signaling traffic onto the SS7 network, thus freeing up trunk line capacity
needed for revenue generating traffic.
A second generation Intelligent Network called the Advanced Intelligent
Network (AIN) is used by carriers and service providers seeking to differentiate
themselves by offering advanced voice and data communications services. The AIN
is a network architecture and a set of standards designed to allow network
operators to create, deploy and modify these services quickly and economically.
AIN services represent the merging of telephony with database information
through SS7 signaling. Such services include Caller ID, voice messaging,
personal number calling, Service Provider Local Number Portability and
customized routing and billing as well as digital wireless services such as PCS
and GSM.
Network operators are increasingly using SS7 networks as a source of
competitive advantage to introduce new services through software changes in IN
elements rather than in central office switches. The key network elements in the
IN and AIN architecture are as follows:
Signal Transfer Point (STP) - An STP is a switch that handles the
signaling messages used to set up telephone calls, queries external databases
for routing and processing information and dispatches call handling
instructions.
Service Switching Point (SSP) - An SSP is a component of the
central office switch that sets up trunk connections. When an SSP identifies an
AIN call, it routes a signaling message to the STP and awaits further
instructions for call processing.
Service Control Point (SCP) - An SCP is a computer database that
is accessed by STPs for customer call routing and other special information
required for AIN services.
Additional components of the AIN architecture include Service Creation
Environments (SCE) used to create new software-based services and Service
Management Systems (SMS) used for billing and administration.
While SS7 has been available since the 1980s, to date it has been used
principally to support intelligent services such as call set-up, 800 number
calling and calling card verification. AIN standards and services have only
recently emerged and the number and complexity of these services continue to
grow. Services such as Caller ID, voice messaging, personal number calling,
Service Provider Local Number Portability and customized routing and billing as
well as digital wireless services such as PCS and GSM all require SS7 networking
technology. ISDN, driven by the growth of the Internet and telecommuting, is
also increasing the need for SS7 to provide the signaling connectivity for ISDN
applications.
The accelerating rate of introduction of these new enhanced services
enabled by SS7 has placed increasing demand for functionality and capacity on
the installed base of older generation STPs. These devices are, in most cases,
modified central office digital switches that
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fundamentally were not optimized for AIN purposes. In addition, the
telecommunications industry is evolving towards an architecture of more
intelligent distributed switching in which software will allow for third party
developers to be involved in creating applications.
The FCC's June 1996 order requiring that Incumbent Local Exchange
Carriers (ILECs) provide competitors with the ability to transition customers to
their networks without changing the customer's existing telephone number (i.e.,
Service Provider Local Number Portability) is having a dramatic impact upon the
SS7 network and all ILECs.
With competition among network operators accelerating the deployment of
AIN services, the strategic and economic value of sophisticated switching
equipment optimized for SS7 applications is rapidly increasing. In addition, the
importance of SS7 network-to-network operators mandates extremely high
reliability and fault tolerance from the equipment as well as higher throughput
and scaleability to support the rapid and unpredictable growth in enhanced AIN
services. Companies that offer SS7-based products that are built on scaleable,
open distributed architectures and enable AIN applications can benefit from this
industry shift.
Diagnostic Tools
The proliferation of standards and protocols, growth of the Internet
and Intranet and the increasing complexity of communications equipment and
networks are creating a need for new, more sophisticated diagnostic systems
capable of simultaneously testing multiple existing and emerging technologies.
Network operators use diagnostic tools to efficiently monitor network
performance, simulate network services and test interoperability of equipment.
In an increasingly competitive environment, network operators need diagnostic
systems that can reduce time to market by shortening the testing cycles
necessary to model and implement new services. In addition, network operators
require advanced diagnostic solutions that verify reliability of network
elements, offer flexibility to support new standards and protocols as they
emerge and enable them to centralize the testing expertise within their
organizations.
Equipment manufacturers use diagnostic tools to design and test their
products, such as switches, hubs and routers, for conformance to new and
existing standards and to simulate network operating conditions. Manufacturers
seek diagnostic tools that enable them to shorten their product development
cycles and reduce their testing costs as these elements are principal
contributors to product development time and expense. Furthermore, diagnostic
tools with a flexible architecture are necessary to accommodate the rapid
changes in technology.
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PRODUCTS
Network Switching Products
EAGLE STP. The Company introduced the EAGLE STP in early 1992. The
EAGLE STP is designed to meet the demands of SS7 switching and features a fully
distributed, standards-based open architecture. Its distributed open
architecture, high capacity and throughput are tailored to the SS7 switching
needs of common carriers, local exchange carriers and PCS and cellular
operators. The EAGLE STP is economically scaleable in configurations from 2 to
500 links. Ongoing software releases provide continual product improvement to
meet the evolving needs of end users. As is required in SS7 networks, the EAGLE
is sold and deployed in pairs, for redundancy. The EAGLE has the following
features:
Designed for SS7 Standards. The EAGLE STP is designed to exceed the
requirements for STPs as defined by Bell Communications Research (Bellcore) and
presently supports both American National Standards Institute (ANSI) and
International Telephone and Telegraph Consultative Commission (CCITT) SS7
standards. Bellcore defines the standards used primarily by the RBOCs for
equipment used in their networks. See "Sales, Marketing and Support."
Powerful, Distributed Architecture. The EAGLE STP features a fully
distributed, open architecture, utilizing Intel x86 microprocessors. The
performance of the product results from its uniquely distributed architecture
and the elimination of central processors. In the EAGLE STP, all SS7 network
intelligence, including SS7 routing information, is distributed among up to 250
signaling interface processors. Each interface is interconnected via a
high-speed, redundant bus subsystem. The bus subsystem utilizes two
counter-rotating 125 Mbps busses and features proprietary switching and
buffering algorithms, which minimize collision and guarantee message delivery
between all attached interfaces. All interfaces attached to the bus subsystem
are hot-swappable, so that interface repair or replacement does not affect
system operation.
Software Architecture. The EAGLE STP's software is fully modular and
written entirely in industry-standard programming languages. All software is
released in complete versions, eliminating the need for interim patching and
minimizing the potential for errors. EAGLE STP software is optimized for the
capacity and redundancy features of the host hardware.
Open Software Interfaces. Users of the EAGLE STP can rapidly add new
functionality and value-added services to their network, utilizing the EAGLE
STP's open software interfaces. Features enabling these open interfaces include:
STP LAN, which allows users to attach inexpensive general purpose computers to
the EAGLE for network analysis; Database Transport Access, which allows users to
change the behavior of protocols in their network without relying on the
vendor's development cycles; and X.25 to SS7/IS.41 Protocol Conversion which
allows first-generation legacy cellular switches to interwork with the more
advanced SS7 cellular network. A significant new capability enabling Service
Provider Local Number Portability on
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the EAGLE allows carriers to eliminate the need for significant numbers of
dedicated Service Control Point (SCP) general purpose computers.
Ease of Operation and Maintenance. EAGLE STP installations generally do
not require any enhancements to the central office's power supply, cooling
system or flooring and require less than 36 square feet of space. An EAGLE STP
can usually be installed in less than one week. No scheduled maintenance is
required to support the EAGLE STP, eliminating the requirement for on-site
personnel.
Prices for a pair of EAGLE STPs typically range from approximately
$250,000 to $5,000,000, depending on configuration and associated software
applications.
Network Diagnostics Products
Equipment manufacturers and network service providers utilize Tekelec's
diagnostic products to perform a wide variety of test applications that
simulate, monitor and analyze network communications infrastructures. The
Company's proprietary simulation language enables the controlled imitation of
communications devices and nodes in conjunction with variable traffic loads. Its
analysis software packages support full-rate monitoring, selective capture and
triggering of digitized pulses transmitted through a network. Uses of the
Company's diagnostic products include the following:
- Designing Communications Equipment. By simulating existing and
emerging communications devices and nodes (e.g., digital switches, STPs, SCPs,
routers and intelligent hubs) and protocols (e.g., ATM, High-Speed Frame Relay,
SS7, Fast Ethernet, SMDS, ISDN, FDDI, BERT and Token Ring), the Company's
products enable engineers to quickly design communications devices that will
transition seamlessly into emerging network infrastructures, minimizing
potential breakdowns of network components deployed throughout the network.
- Ensuring Product Reliability. By simulating actual network conditions
within an operating environment, including protocol errors and other network
failures, the Company's products can help ensure that communications equipment
manufacturers produce devices that will operate error-free, thus accelerating
time to market and potentially reducing costly failures after installation.
- Verifying Certification. By executing conformance and performance
test suites, network operators and manufacturers use the Company's products to
rapidly verify that communication devices meet specified standards (e.g., ATM,
Frame Relay, SS7, ISDN and BERT).
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- Monitoring Networks. By collecting and analyzing traffic, the
Company's products can monitor the health of networks on a continuous basis and
provide advance notice of potential system failures, allowing quicker service
restoration or even service failure prevention.
- Troubleshooting. By identifying the specific location and type of
communication error, the Company's products can isolate which network device has
failed (e.g., router, intelligent hub, switch port, edge switch). The Company's
products help technicians and engineers repair devices and networks promptly and
minimize expensive downtime associated with service failure.
The Company's principal intelligent network diagnostics product is the
MGTS. The MGTS system is used primarily for SS7-based device simulation, load
generation and network monitoring. In its fully configured form, the system
includes Tekelec's proprietary programming tool, PASM, that can be used to
design customized testing scenarios. The MGTS software runs on Sun Microsystems
and Hewlett-Packard UNIX operating systems with an X-Windows, Motif graphical
user interface. The MGTS system supports a number of protocols, including SS7,
AIN, GSM, IS.41, CDMA and PCS. The system is scaleable and can support any
number of links with multiple systems and can be networked over large geographic
areas.
The Company's principal data network diagnostics products are:
Chameleon(R) Open. The Chameleon Open is a multiprotocol communications
analyzer that features a flexible modular architecture, multiple LAN, MAN, WAN
and GAN technologies and protocols, simultaneous interoperability between
different technologies, and full bandwidth capabilities from low data
transmission rates to high-speed optical interfaces. Technologies supported
include ATM, SMDS, High-Speed Frame Relay, FDDI, ISDN, WAN DS-1/E1, Fast
Ethernet, Ethernet, BERT and Token Ring. The Chameleon Open's user-friendly
interface allows customers to quickly diagnose their network or switch
performance and detect any upper layer violations within the protocol stack
utilized within the network or switch fabric. The Chameleon Open's products are
available in two configuration options: portable 6 slot test application
(Chameleon Open) or the rack-mounted 12 slot test application (Chameleon
Open-X). Each Chameleon Open operates with the same hardware and software
packages, thus providing our customers with the most flexible test applications
for portability and remote testing.
Chameleon 32+. The Chameleon 32+ protocol analyzer supports a variety
of protocols and technologies including SS7, ISDN, IS-41, X.25/X.75, SNA and
Frame Relay enabling network operators as well as equipment manufacturers to
perform active network diagnostics, troubleshoot network or device problems on
existing network equipment, and validate new equipment being developed. The
Chameleon 32+ can be utilized for extensive monitoring and simulation testing
for a wide-array of protocols and interfaces including: X.25, X.75, QLC, PSH,
SNA, Async, Bisync, ISDN, SS7, IS-41, OSI, DPNSS, DASS 2, DMI, V.120, DDCMP, U
Interface, Frame Relay, ASAI, SCAI, Digital Test Access and BERT.
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List prices for the Company's principal diagnostic products range from
approximately $14,000 to $150,000 depending on configuration.
Compliance with Industry Standards
The Company's products are designed to meet a significant number of
standards and regulations, some of which are evolving as new technologies are
deployed. In the United States, the Company's products must comply with various
regulations defined by the FCC and Underwriters Laboratories as well as
standards established by Bellcore and the ANSI. Internationally, the Company's
products must comply with standards established by telecommunications
authorities in various countries as well as with recommendations of the CCITT
and the International Standards Organization (ISO). The failure of the Company's
products to comply, or delays in compliance, with the various existing and
evolving standards could have a material adverse effect on the Company's
business and operating results.
PRODUCT DEVELOPMENT
The communications market is characterized by rapidly changing
technology, evolving industry standards and frequent new product introductions.
Standards for new services such as AIN, PCS and ATM are still evolving. As these
standards and the demand for services and applications evolve, the Company
intends to adapt its products or develop and support new products. The Company
solicits product development input through discussions with users of the
Company's products and participation in industry organizations and international
standards committees, such as the Telecommunications Industry Association (TIA)
and the ATM Forum, and by closely monitoring the activities of the ITU, ETSI,
ISO and Bellcore.
The Company's network switching product development group is
principally focused on the release of new software versions to incorporate
enhancements desired by customers and compliance with standards to enable EAGLE
to address additional domestic and international markets. In addition, the
Company plans continued improvement of hardware components to improve
performance and capabilities.
The Company's diagnostic product development activities are principally
focused on expanding the capabilities of the MGTS and Chameleon products,
including their interfaces, software modules and protocol capabilities for
emerging technologies such as AIN and ATM, and adapting these products for the
emerging network operations market. From time to time the Company engages in
development projects for special applications for customers. The Company is
usually free to use such technology in future products which are not competitive
with the specific application for which the development work was performed.
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The Company utilizes a common standards-based open architecture
approach in the design of its products. This approach facilitates and
accelerates the development of new applications and products and permits the
Company to enhance existing products by substituting new hardware or software
modules. This modular approach also helps to extend the life cycles of the
Company's products, ensure compatibility among successive generations of
products and simplify manufacturing.
The Company's success depends, to a substantial degree, upon its
ability to respond rapidly to changes in technology, industry standards and
customer requirements. This requires the timely selection, development and
marketing of enhancements and new products on a cost-effective basis. The
Company has invested and expects to continue to invest substantial resources in
the development of new products and technology and product enhancements. There
can be no assurance that the Company's product development efforts will result
in commercially successful new or enhanced products or that the Company's
products will not be rendered obsolete or noncompetitive by changing technology
or new competitive products.
Products as complex as those offered by the Company may contain
undetected errors or failures when first introduced or as new versions are
released. Such errors have occurred in the past. Although the Company's products
have not experienced any significant errors, such errors, particularly those
that result in a failure of the Company's switching products, could have a
material adverse effect on the Company's customer relationships, business and
operating results. There can be no assurance that, despite thorough testing by
the Company and by customers, errors will not be found in the Company's
products.
Product development includes expenditures for research and development,
new product design, enhancement of existing products and selective acquisition
of technology. Research and development expenses amounted to approximately $21.0
million, $17.1 million and $15.1 million in 1997, 1996 and 1995, respectively.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The Company's development facilities are located in California, North
Carolina and Japan. As of March 2, 1998, the Company had 170 persons engaged
full time in product development. The Company believes that recruiting and
retaining highly skilled engineering personnel is essential to its success. To
the extent that the Company is not successful in attracting and retaining its
technical staff, its business and operating results would be adversely affected.
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SALES, MARKETING AND SUPPORT
The Company's sales and marketing strategy for its EAGLE switching
product is to continue to focus on sales to the U.S. ITC, cellular and RBOC
markets and to pursue new customer relationships and international
opportunities. Current and future strategic alliances will continue to be an
integral component of the strategy to reach broader markets and attain greater
market presence. The network switching sales cycle typically ranges from three
to 18 months depending on the complexity of a customer's planning, bidding and
implementation requirements.
RBOCs and other large service providers require their suppliers to
continuously participate in Bellcore Technical Auditing programs as new hardware
and software features are introduced. Bellcore provides Technical Auditing
Services ("technical audits") to suppliers of network equipment assessing the
supplier's conformance to certain Bellcore standards which have been adopted by
RBOCs and other service providers. Ongoing technical audits of the EAGLE STP are
conducted by Bellcore and the results of these audits are available to the
Company and its customers. Bellcore does not endorse or certify any product or
service or guarantee its performance. Failure or delay in obtaining favorable
technical audit results could have a material adverse effect on the Company's
ability to sell its EAGLE STP to this large segment of the communications
carrier market.
The Company's sales and marketing strategy for its diagnostic products
is to initially target customers' research and development departments designing
the next generation of communications equipment and then to target the
manufacturing groups and ultimate users in network operations as equipment is
manufactured, certified and installed. This strategy permits the Company to gain
expertise in testing emerging technologies in the early stages of their life
cycles.
Domestic Distribution. The Company sells its switching and diagnostic
products in the U.S. principally through separate direct sales forces and, for
the EAGLE STP, also through strategic relationships with Lucent and Stratus. The
Company's direct sales forces operate out of the Company's headquarters in
Calabasas, California and its regional offices located in Illinois, New
Hampshire, New Jersey, North Carolina, Northern California and Texas.
International Distribution. The Company sells its switching products
internationally through its direct sales force and a distributor in Korea. The
Company sells its diagnostic products internationally through a network of 25
distributors and a wholly owned subsidiary in Japan. The Company's Japanese
subsidiary, which presently sells only diagnostic products, generated
approximately 13%, 22% and 22% of the Company's revenues for 1997, 1996 and
1995, respectively.
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Tekelec-Airtronic, S.A., an affiliate of the Company, and its wholly
owned subsidiaries are the distributors of the Company's diagnostic products in
France, Italy, Germany, the Netherlands, Belgium, Luxembourg, Portugal, Spain
and China. Nineteen additional independent companies distribute the Company's
products in other Western European countries, the Far East (other than Japan),
Australia, Mexico, Puerto Rico, New Zealand, Latin America, the Middle East and
South Africa. Distributors typically purchase products directly from the Company
pursuant to agreements that are exclusive for a particular territory and are
cancelable by either party upon 90 days notice. Export sales through
international distributors accounted for approximately 10%, 13% and 17% of
revenues in 1997, 1996 and 1995, respectively.
The Company typically invoices export sales in U.S. dollars and its
foreign subsidiary invoices sales in its local currency. International sales are
subject to inherent risks, including longer payment cycles, unexpected changes
in regulatory requirements and tariffs, difficulties in staffing and managing
foreign operations and distributors, greater difficulty in accounts receivable
collection and potentially adverse tax consequences. Additionally, exchange rate
fluctuations on foreign currency transactions and translations arising from
international operations may contribute to fluctuations in the Company's
business and operating results. Fluctuations in exchange rates could also affect
demand for the Company's products. In addition, due to the technical nature of
the Company's products, certain of the Company's export sales must be licensed
by the Office of Export Administration of the U.S. Department of Commerce. The
Company's products are subject, in certain international jurisdictions, to
reduced protection for the Company's copyrights and trademarks. See Notes A, E
and N to consolidated financial statements.
Strategic Relationships. The Company believes that it can improve
market penetration and acceptance for its EAGLE products through strategic
relationships with leading communications equipment suppliers. These suppliers
have long-standing relationships with public carriers and provide a broad range
of services to these carriers through their existing sales and support networks.
Tekelec seeks strategic relationships that (i) enhance the Company's presence in
its target markets, (ii) offer products that complement the EAGLE to provide
value-added networking solutions and (iii) leverage the Company's core
technologies enabling the communications equipment suppliers to develop enhanced
products with market differentiation that can be integrated with the EAGLE
platform.
The Company has a non-exclusive distribution agreement with Lucent, an
exclusive distribution agreement with Daewoo and a marketing agreement with
Stratus for the EAGLE STP. The Company believes that these relationships
demonstrate recognition of the technical advantages of the EAGLE STP. The
Company believes that these agreements provide the Company with additional
opportunities to penetrate the SS7 network switching marketplace. Through the
Company's relationships with Lucent, Daewoo and Stratus, the Company has
enhanced its market presence and its ability to access leading telephone
companies. In general, these agreements can be terminated by either party on
limited notice and,
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except for Daewoo, do not require minimum purchases. Furthermore, Lucent is not
precluded from selling products that are competitive with the Company's
products. A termination of the Company's relationship with Lucent or the sale of
competing products by Lucent could adversely affect the Company's business and
operating results.
Advertising and Promotion. The Company uses advertising in trade
journals, exhibitions at trade shows, a presence on the Internet via the World
Wide Web and direct mail to promote awareness of the Company and its products.
The Company has been most successful in generating sales through demonstrations
of its products and, therefore, focuses its advertising and promotional
activities on generating opportunities for demonstrations. The Company also
provides extensive training for, and merchandising aids to, its direct sales
force and distributors. These include sales brochures, demonstration systems and
promotional product literature.
Services, Support and Warranty. The Company believes that customer
service, support and training are important to building and maintaining strong
customer relationships. The Company services, repairs and provides technical
support for its products. The Company maintains an in-house repair facility and
provides ongoing training and telephone assistance to customers and
international distributors from its headquarters in Calabasas, California,
certain U.S. regional offices and its Japanese subsidiary. The Company's
Technical Assistance Center in Morrisville, North Carolina, supports the
Company's switching products on a 24 hour-a-day, seven day-a-week basis. Support
services include 24-hour technical support, remote access diagnostic and
servicing capabilities, extended maintenance and support programs, comprehensive
technical customer training, extensive customer documentation, field
installation and emergency replacement. The Company typically warrants its
products against defects in materials and workmanship for one year after the
sale and thereafter offers extended service warranties. To date, warranty
expenses have been within management's expectations.
CUSTOMERS
During 1997, the Company shipped approximately 45 pairs of EAGLE STPs
to 25 customers worldwide and 900 units of its diagnostic products to over 220
customers worldwide. The Company's customers include end users and marketing
intermediaries. End users for the Company's EAGLE STP consist primarily of U.S.
ITCs, PCS and cellular operators, interexchange carriers, competitive access
providers, local exchange carriers and RBOCs. End users for the Company's
diagnostic products include long-distance carriers, telephone operating
companies, communications equipment manufacturers, wireless and cellular network
operators and government agencies. Sales to Bell Atlantic Corporation, which
consisted primarily of switching products, accounted for 23% of the Company's
1997 revenues. No other customer accounted for more than 10% of the Company's
revenues in 1997.
The Company's diagnostic business is substantially dependent on repeat
business and, therefore, customer satisfaction and loyalty are crucial to its
long-term success. Many of the
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Company's largest customers in 1997 were purchasers of the Company's diagnostic
systems in prior years.
Federal and state agencies, including the FCC, regulate many of the
Company's domestic customers. The FCC and a majority of the states have enacted
or are considering regulations based upon alternative pricing methods.
Uncertainty regarding future pricing policies and the cost effectiveness of
deploying public network services may affect demand for communications products,
including the Company's products. However, the Company believes that
deregulation of the telecommunications market and new methods of price
regulation as evidenced by the passage of the Telecommunications Act of 1996
could increase the demand for products such as those offered by the Company
which enhance the efficiency of the network or allow the expedited introduction
of new revenue-producing services.
BACKLOG
Backlog for switching products typically consists of contracts or
purchase orders for both product delivery scheduled within the next 12 months
and EAGLE STP extended service warranty to be provided over the next five years.
Orders for the Company's diagnostic products are usually placed by customers on
an as-needed basis, and the Company has typically been able to ship these
products in 15 to 30 days after the acceptance of the purchase order. Because of
variations in the magnitude and duration of orders received by the Company, and
customer delivery requirements, which may be subject to cancellation or
rescheduling, the Company's backlog at any particular date may not be a
meaningful indicator of future financial results. At December 31, 1997, the
Company's backlog amounted to approximately $59.0 million, of which $28.7
million related to EAGLE STP service warranty. This compared to $28.0 million at
December 31, 1996, of which $16.6 million related to EAGLE STP service warranty.
MANUFACTURING
The Company's manufacturing operations consist of the procurement and
inspection of components, final assembly, burn-in, quality control testing and
packaging. Printed circuit boards, chassis and most of the other major
components used in the Company's products are subassembled to the Company's
specifications by independent contractors with whom the Company generally has
had long-standing working relationships. The assembled components are then
delivered to the Company's production facilities for final assembly, quality
control testing and product configuration, including software installation. The
Company's products incorporate the Company's proprietary software as well as
software licensed from third parties. The Company believes that its use of
independent contractors for subassembly coupled with in-house final assembly
improves production planning, increases efficiency, reduces costs and improves
quality.
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The Company has a computerized manufacturing inventory control system
which integrates and monitors purchasing, inventory control and production. The
Company's quality control process tests for reliability and conformance with
product specifications and utilizes certain automated software test procedures.
The Company received ISO 9002 certification from Bellcore in 1995, ISO 9001
certification from Bellcore for its network switching operation in 1996 and for
its intelligent network diagnostics operation in 1997 and is currently
undergoing the processes for ISO 9001 certification for its remaining
operations.
The Company has obtained CE Mark registration for its principal
diagnostic products to meet EC regulations for shipment of products into Europe.
As new hardware and software features or new products are introduced, the
Company routinely engages in the process of obtaining CE Mark registration as
needed. Failure or delay in the Company's ability to obtain CE Mark registration
for its products could have a material impact on future sales in Europe.
The Company generally uses industry standard components for its
products which are available from multiple sources; however, a few key
components, such as certain microprocessors, video displays and power supplies,
are currently only available from single suppliers. Vendor supply agreements
often include provisions requiring the vendor to maintain a specified level of
key components. The Company believes that inventory levels of key components,
including those maintained by vendors, are adequate. In addition, should any
components become unavailable the Company believes that functionally similar, if
not identical, components could be obtained, and any necessary internal redesign
accomplished, without materially adversely impacting the Company. To date, the
Company has not experienced any significant delays in obtaining components from
its suppliers and independent contractors. However, the electronics industry is
subject to rapid technological change. Components become obsolete and are
discontinued by manufacturers as new succeeding generations are introduced. An
inability to obtain essential components, if prolonged, could materially
adversely affect the Company's business and operating results and damage
customer relationships.
COMPETITION
Network Switching Products. The market for STPs is highly competitive
and has been highly concentrated among a limited number of dominant suppliers.
The Company expects competition to increase in the future from existing and new
competitors. The Company presently competes with DSC Communications Corp. and to
a lesser extent with a limited number of other manufacturers, all of which have
significantly greater financial, marketing, manufacturing and other resources
and larger installed customer bases than the Company. The Company believes that
its long-term success will depend on its ability to further penetrate the major
telephone companies, including the RBOCs, offer products with the best
price/performance profile and be responsive to customers' needs for new features
and services.
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The Company believes that the principal competitive factors in the
network switching products market are product price/performance characteristics
and reliability, customer service and support and the supplier's financial
resources, marketing and distribution capability. The Company anticipates that
responsiveness in adding new features will become an increasingly important
competitive factor. While the Company's competitors have greater financial
resources, the Company believes it competes favorably in other respects.
However, there can be no assurance that new entrants or established competitors
with greater financial resources have not or will not offer products superior in
performance, quality, service and support to, and/or lower in price than, those
of the Company.
Diagnostic Products. The communications diagnostic market is intensely
competitive and subject to rapid technological change and evolving industry
standards. The Company primarily competes in the high performance segment of the
market. Its principal competitor is Hewlett-Packard. The Company also competes
with a number of other manufacturers, some of which have greater financial,
marketing, manufacturing and technological resources than the Company. The
Company believes that its long-term success will depend in part on its ability
to be a leader in offering products that address new emerging industry standards
and to offer a broad line of integrated applications.
The Company believes that the principal competitive factors in the
communications diagnostic market in which the Company competes are product/price
performance, functionality and reliability, timely introduction of new products,
breadth of integrated product applications, marketing and distribution
capability and customer service and support. The Company believes that it
competes favorably, although there can be no assurance that new or established
competitors will not offer products superior to or lower in price than those of
the Company.
INTELLECTUAL PROPERTY
The Company relies on a combination of trade secret, copyright and
trademark laws and contractual restrictions to establish and protect proprietary
rights in its products. The Company generally does not hold patents with respect
to its products. The Company has entered into confidentiality and invention
assignment agreements with its employees, and enters into non-disclosure
agreements with its suppliers, distributors and appropriate customers among
others so as to limit access to and disclosure of its proprietary information.
There can be no assurance that these statutory and contractual arrangements will
prove sufficient to deter misappropriation of the Company's technologies or
independent third-party development of similar technologies. The laws of certain
foreign countries in which the Company's products are or may be developed,
manufactured or sold may not protect the Company's products or intellectual
property rights to the same extent as do the laws of the United States and thus
make the possibility of piracy of the Company's technology and products more
likely. The Company believes that, because of the rapid pace of technological
change in the communications market, legal protections for its products are less
significant factors in the Company's success than the
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knowledge, ability and experience of the Company's employees, the frequency and
timely introduction of product enhancements and the quality of support services
provided by the Company.
The communications industry is characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. From time to time, third parties may assert exclusive patent,
copyright, trademark and other intellectual property rights to technologies that
are important to the Company. There are no currently pending material claims
that the Company's products, trademarks or other proprietary rights infringe the
proprietary rights of third parties. However, there can be no assurance that the
Company will not receive communications from third parties in the future
asserting that the Company's products infringe or may infringe the proprietary
rights of third parties. In its distribution agreements and certain of its major
customer agreements, the Company agrees to indemnify its customers for any
expenses or liabilities resulting from claimed infringements of patents,
trademarks or copyrights of third parties. In the event of litigation to
determine the validity of any third-party claims, such litigation, whether or
not determined in favor of the Company, could result in significant expense to
the Company and divert the efforts of the Company's technical and management
personnel from productive tasks. In the event of an adverse ruling in such
litigation, the Company might be required to discontinue the use and sale of
infringing products, expend significant resources to develop non-infringing
technology or obtain licenses from third parties. There can be no assurance that
licenses from third parties would be available on reasonable commercial terms,
if at all. In the event of a successful claim against the Company and the
failure of the Company to develop or license a substitute technology, the
Company's business and operating results would be materially adversely affected.
EMPLOYEES
At March 2, 1998, the Company had 442 employees, comprising 156 in
sales, marketing and support, 65 in manufacturing, 170 in research, development
and engineering and 51 in management, administration and finance. The Company
believes that its future success will depend in part on its ability to attract,
motivate and retain highly qualified personnel. Most employees hold stock
options and/or participate in an employee stock purchase plan. None of the
Company's employees is represented by a labor union, and the Company has not
experienced any work stoppages. The Company believes that its employee relations
are excellent.
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GLOSSARY
AIN (Advanced Intelligent Network)............. Bellcore's set of standards for advanced intelligent
services for the telephone networks of Regional Bell
Operating Companies.
ANSI (American National Standards
Institute).................................. The coordinating body for voluntary standards groups
within the United States. ANSI is a member of the
International Organization for Standardization (ISO).
ATM (Asynchronous Transfer Mode)............... A broadband, low-delay, packet-based switching and
multiplexing technique. Usable capacity is segmented into
fixed-size cells, consisting of header and information
fields, allocated to services on demand.
BRI (Basic Rate Interface)..................... One interface type used to access the Integrated
Services Digital Network. The BRI allows two simultaneous
calls across a single pair of copper wires.
CCITT (International Telephone and
Telegraph Consultative Committee)........... A United Nations organization which establishes
international telecommunications standards.
El ............................................ The European telecommunications standard defining
circuits that operate at speeds of 2.048 Mbps, similar to
T1 lines in the United States.
Ethernet....................................... A standard set of specifications for a particular type of
LAN that employs baseband signaling (single signal on a
cable) and has a transmission rate of 10 Mbps.
Fast Ethernet.................................. 100 Mbps' technology for workstation LANs from
the eponymous Fast Ethernet Alliance, which includes 3Com and
SynOptics. It has been adopted by the IEEE as the basis
for the 100BaseT Ethernet standard.
FDDI (Fiber Distributed Data
Interface).................................. A standard for operating fiber optic-based LANs at 110
Mbps used for high speed and backbone applications.
Frame Relay.................................... A variable length packet-based transmission technology
that is used to transmit data at speeds up to 2 Mbps.
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GAN (Global Area Network)...................... A network of computers connected across countries.
GSM (Global Systems for Mobile)................ The standard for a set of protocols for digital
wireless initially deployed in Europe.
IN (Intelligent Network)....................... An out-of-band, packet switched overlay network to the
in-band Public Switched Telephone Network (PSTN). The
Intelligent Network minimally consists of SS7-equipped
Central Offices (Service Switching Points, or SSPs),
packet switches (Signal Transfer Points, or STPs) and
databases (Service Control Points, or SCPs).
Internet....................................... The worldwide system of linked networks that is capable
of exchanging mail and data through a common addressing and
naming system based on TCP/IP protocols.
Intranet....................................... A private network that uses Internet software and
standards.
ISDN (Integrated Services Digital
Network).................................... Public digital communications services supporting a wide
range of data, voice and image services accessed by
standard interfaces integrated with customer control.
IS.41.......................................... One of the Interim Standards for North American mobile
applications for digital cellular.
LAN (Local Area Network)....................... A type of high-speed data communications arrangement in
which multiple computer and related products in an office or
campus environment are connected by means of a
standard transmission medium (typically coaxial
cable, twisted-pair wire or optical fiber).
MAN (Metropolitan Area Network)................ A high-speed network designed to link together sites
in a metropolitan or campus area. The IEEE has defined its
802.6 standard for MANs based on the Distributed Queue
Dual Bus technology.
Mbps (Megabits per second)..................... A measurement unit, equal to 1,048,576 bits per second,
used to describe data transfer rates as a function of time.
MSC (Mobile Switching Center).................. A switch that coordinates trunk call set-up to and
from users in a digital cellular network.
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Packet Switching............................... A data transmission technique whereby user
information is segmented and routed in discrete data
envelopes called packets, each with its own appended control
information for routing, sequencing and error checking.
PCS (Personal Communications
Systems).................................... A set of evolving standards and protocols
providing for the concept of one number per user and
associated advanced intelligent services regardless of
location primarily involving mobile communications.
PDC (Personal Digital
Communications)............................. A set of protocol standards for Japanese digital
cellular mobile network promulgated by NEC.
Primary Rate Interface (PRI)................... A T1 or E1 circuit used to carry 23 or 30 ISDN calls,
respectively. In an ISDN PRI, a single channel is used
for signaling for calls placed on all of the other channels
in the T1 or E1 circuit.
protocol....................................... A formal set of standards governing the establishment of
a communications link and controlling the format and timing
of transmissions between two devices.
RBOCs (Regional Bell Operating
Companies).................................. Telephone companies created in 1984 as a result of the
break-up of AT&T.
signaling...................................... The process by which digital information is
exchanged to establish, control and manage connections in a
network.
SCE (Service Creation Environments)............ An application in the Advanced Intelligent Network
which allows for the development and customization of new
telephone services, utilizing Advanced Intelligent
Network (AIN) "building blocks". Using customized Service
Information Blocks (SIBs) and "triggers", users
describe services such as time-of-day routing.
These descriptions are loaded into Service
Control Points (SCPs) or Service Nodes (SNs) for
execution in the network.
SCP (Service Control Point).................... A computer database that is accessed by STPs for
customer call routing information and other special
information required for AIN services.
SMDS (Switched Multi-megabit Data
Service).................................... A communications service providing high speed,
connectionless data transport.
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SMS (Service Management System)................ A proprietary application which provides the user with a
maintenance and administration interface to various IN and
AIN network elements.
SP-LNP (Service Provider Local
Number Portability)......................... A capability mandated by the Federal Communications
Commission in June, 1996 which allows telephone
customers to change their local service provider
without changing their telephone number. Adding SP-LNP
capabilities to the Public Switched Telephone Network
requires the introduction of three new network elements
and new software capabilities in virtually every
existing network element.
SS7 (Common Channel Signaling
System No. 7)............................... A complex protocol which governs signaling between
certain devices in a digital telephone network.
SSP (Service Switching Point).................. An SSP is a component of the central office switch that
sets up trunk connections. When an SSP identifies an
AIN call, it routes a signaling message to the STP and
awaits further instructions for call processing.
STP (Signal Transfer Point).................... An STP is a switch that handles the signaling messages
used to set up telephone calls, queries external
databases for routing and processing information and
dispatches call handling instructions.
T1 ............................................ The North American telecommunications standard
defining a circuit that multiplexes and switches 24
channels and operates at speeds of 1.544 Mbps (T3 is the
equivalent of 27 T1 circuits).
TCP/IP (Transmission Control
Protocol/Internet Protocol)................. The common name for the suite of protocols developed by
the U.S. Department of Defense in the 1970s to support
the construction of worldwide internetworks. TCP and
IP are the two best-known protocols in the suite. TCP
corresponds to Layer 4 (the transport layer) of the OSI
reference model. It provides reliable transmission of
data. IP corresponds to layer 3 (the network layer) of
the OSI reference model and provides connectionless
datagram service.
WAN (Wide Area Network)........................ A network that extends beyond the distance that can be
accommodated by local cabling methods. A WAN typically
utilizes public carrier services to connect sites,
which may span a city, state, country or the world.
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xDSL........................................... Another name for an ISDN BRI channel. Operated at the
Basic Rate Interface (with two 64 kbps circuit switched
channels), the DSL can carry both voice and data signals
at the same time, in both directions, as well as the
signaling data used for call information and customer
data.
X.25........................................... A protocol for transfer of information across packet
data networks. X.25 was the first packet data
technology to be widely implemented.
ITEM 2. PROPERTIES.
The Company's executive offices, as well as its principal manufacturing
and data network diagnostics product engineering and marketing operations, are
located in an approximate 58,000 square-foot facility in Calabasas, California,
under a lease which expires in November 2004 with an option to extend for an
additional five years.
The Company also occupies a 68,000 square-foot facility in Morrisville,
North Carolina, under a lease expiring in March 2003, primarily for engineering,
product development, customer support and regional sales activities for its
network switching and intelligent network diagnostics products. The Company also
has five regional sales offices occupying an aggregate of approximately 8,300
square feet under leases expiring between 1998 and 2000 in Campbell, California;
Lombard, Illinois; Bedford, New Hampshire; Iselin, New Jersey and Irving, Texas.
The Company's Japanese subsidiary occupies approximately 10,600 square feet in
Tokyo under leases expiring between April 1998 and November 1998. The Company
believes that its existing facilities will be adequate to meet its needs at
least through 1998. The Company believes it will be able to obtain additional
space when and as needed on acceptable terms.
ITEM 3. LEGAL PROCEEDINGS.
Inapplicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Inapplicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is traded over-the-counter on the Nasdaq
National Market System under the symbol TKLC. The following table sets forth the
high and low closing sales prices for the Common Stock, as reported on the
Nasdaq National Market System. As of March 2, 1998, there were 210 record
holders and approximately 10,000 beneficial holders of the Company's Common
Stock based on information provided by the Company's transfer agent and proxy
solicitation agent.
High Low
---- ---
1996
----
First Quarter.................................... $ 7.19 $ 4.75
Second Quarter................................... 8.75 6.31
Third Quarter.................................... 7.38 4.50
Fourth Quarter................................... 8.63 6.00
1997
----
First Quarter.................................... $ 11.47 $ 8.25
Second Quarter................................... 18.88 9.50
Third Quarter.................................... 39.69 17.63
Fourth Quarter................................... 47.13 27.94
The Company has never paid a cash dividend. It is the present policy of
the Company to retain earnings to finance the growth and development of its
business and, therefore, the Company does not anticipate paying cash dividends
on its Common Stock in the foreseeable future.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
The statement of operations data included in the selected consolidated
financial data set forth below for the years ended December 31, 1997, 1996 and
1995 and the balance sheet data set forth below as of December 31, 1997 and 1996
are derived from, and are qualified in their entirety by reference to, the
Company's audited consolidated financial statements and notes thereto. The
statement of operations data set forth below for the years ended December 31,
1994 and 1993 and the balance sheet data set forth below as of December 31,
1995, 1994 and 1993 are derived from audited consolidated financial statements
of the Company which are not included herein.
FIVE-YEAR SELECTED FINANCIAL DATA
FOR THE YEARS ENDED DECEMBER 31, ................ 1997 1996 1995 1994 1993
---------------------------------------------------------------
(thousands, except per-share data)
STATEMENT OF OPERATIONS DATA:
Revenues ........................................ $125,140 $ 72,126 $75,276 $61,189 $ 46,856
Income (Loss) before provision
for income taxes ............................. 29,741 (284) 8,450 5,711 (17,101)
Net income (loss) ............................... 28,996 (2,511) 6,311 4,460 (18,543)
Earnings (Loss) per share(1):
Basic ...................................... $ 1.15 $ (0.11) $ 0.30 $ 0.26 $ (1.12)
Diluted .................................... 1.02 (0.11) 0.26 0.24 (1.12)
Weighted average number of shares outstanding(1):
Basic ...................................... 25,204 23,550 21,058 17,368 16,628
Diluted .................................... 28,421 23,550 24,104 18,629 16,628
BALANCE SHEET DATA (at December 31):
Cash and investments ............................ $ 70,518 $ 44,244 $43,609 $ 7,653 $ 3,669
Working capital ................................. 86,354 44,688 56,983 13,466 3,215
Total assets .................................... 136,465 82,518 80,488 34,409 28,139
Long-term liabilities ........................... 2,839 1,061 380 654 323
Shareholders' equity ............................ 107,877 61,751 63,607 18,720 11,693
(1) Earnings (Loss) per share and weighted average number of shares outstanding
have been retroactively adjusted to reflect the two-for-one stock splits
effected August 22, 1997 and March 17, 1995, and have been computed under the
provisions of SFAS No. 128 "Earnings Per Share." See Note M to consolidated
financial statements.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion should be read in conjunction with, and is
qualified in its entirety by, the consolidated financial statements and the
notes thereto included in this Annual Report on Form 10-K. Historical results
and percentage relationships among any amounts in the financial statements are
not necessarily indicative of trends in operating results for any future
periods.
CORPORATE ORGANIZATION
The Company is organized into three divisions: Network Switching,
Intelligent Network Diagnostics and Data Network Diagnostics.
The Network Switching Division develops and supplies the Company's
EAGLE product, a high-capacity packet switching platform enabling wireline and
wireless network operators to deliver intelligent network services.
The Intelligent Network Diagnostics Division and Data Network
Diagnostics Division develop and supply diagnostic products for the
communications marketplace. These products, principally the MGTS products for
the Intelligent Network Diagnostics Division and the Chameleon family of
products for the Data Network Diagnostics Division, have been the foundation of
the Company's business and the source of the technology and expertise that has
facilitated the Company's entry into other markets.
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RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the
percentages that statement of operations items bear to total revenues:
PERCENTAGE OF REVENUES
FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
---- ---- ----
Revenues ...................................... 100.0% 100.0% 100.0%
Cost of goods sold ....................... 33.2 37.0 33.3
------ ------ ------
Gross profit .................................. 66.8 63.0 66.7
Research and development ................. 16.8 23.7 20.0
Selling, general and administrative ...... 27.9 41.4 36.7
Restructuring ............................ -- 0.4 --
------ ------ ------
Income (Loss) from operations ................. 22.1 (2.5) 10.0
Interest and other income, net ........... 1.7 2.1 1.2
------ ------ ------
Income (Loss) before provision for income taxes 23.8 (0.4) 11.2
Provision for income taxes ............... 0.6 3.1 2.8
------ ------ ------
Net income (loss) ...................... 23.2% (3.5)% 8.4%
====== ====== ======
The following table sets forth, for the periods indicated, the revenues
by principal product line as a percentage of total revenues:
PERCENTAGE OF REVENUES
FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
---- ---- ----
Network switching ............. 59% 38% 32%
Intelligent network diagnostics 27 33 27
Data network diagnostics ...... 14 29 41
--- -- --
Total .................. 100% 100% 100%
=== === ===
The following table sets forth, for the periods indicated, the revenues
by geographic territory as a percentage of total revenues:
PERCENTAGE OF REVENUES
FOR THE YEARS ENDED DECEMBER 31,
1997 1996 1995
----------------------------
North America 73% 59% 59%
Japan ....... 13 22 22
Europe ...... 5 9 9
Rest of World 9 10 10
--- --- ---
Total 100% 100% 100%
=== === ===
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1997 COMPARED WITH 1996
Revenues
The Company's revenues increased by $53.0 million, or 73%, during 1997
due to higher sales of switching products and intelligent network diagnostics
products. Sales of data network diagnostics products decreased both in dollars
and as a percentage of total sales.
Revenues from switching products increased by 173%, or $47.1 million,
to $74.3 million due primarily to increased EAGLE STP market acceptance
principally in the U.S., and the addition of sales of the Company's Local Number
Portability (LNP) and related Local Service Management System (LSMS) features.
Additionally, the EAGLE STP average selling price increased as a result of the
Company's sales of larger systems to the Regional Bell Operating Company (RBOC)
market. In 1997, 45 pairs of EAGLE STPs were sold compared with 26 in 1996.
Revenues from intelligent network diagnostics products increased by
40%, or $9.4 million, to $33.1 million. This increase was primarily driven by
strong demand for the Company's MGTS products in all geographic markets,
particularly North America.
Revenues from data network diagnostics products decreased by 16%, or
$3.5 million, to $17.7 million primarily due to lower sales in all markets for
both the Chameleon Open and the Company's older Chameleon products. The Company
has taken steps to expand its Chameleon products' reach into the network
operator market including the introduction of software applications addressing
specific needs of this market which could provide additional sales
opportunities, initially in the domestic market.
Revenues in North America increased by $49.5 million, or 118%, as a
result of higher switching and MGTS product sales, partially offset by lower
Chameleon product sales. Revenues in Japan increased by $638,000, or 4%, due
primarily to higher sales of MGTS products partially offset by the impact of
exchange rate fluctuations on currency translations in 1997. Other international
revenues increased by $2.8 million, or 19%, primarily due to higher switching
product sales in the rest of the world and higher MGTS product sales in Europe.
The impact of exchange rate fluctuations on currency translations,
which consisted primarily of the translation of Japanese yen into U.S. dollars,
decreased revenues by approximately $1.9 million, or 2%, and did not have a
significant impact on net income.
The Company believes that its future revenue growth depends in large
part upon a number of factors, including the continued market acceptance of the
Company's products, particularly the EAGLE STP product, and new applications
such as the Company's LNP and related LSMS features for its EAGLE STP. In 1997,
the Company experienced significant revenue growth, particularly in its
switching products, in part because of the initial success of its STP product in
the RBOC market and the market acceptance of its LNP and LSMS solutions.
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The Company expects that switching product sales will continue to grow in 1998
both in dollars and as a percentage of total revenues, although at a lower
percentage rate of growth than in 1997.
Gross Profit
Gross profit as a percentage of revenues increased from 63% in 1996 to
67% in 1997, due primarily to the addition of sales of higher margin LNP and
LSMS features and improved manufacturing efficiencies due to higher sales
volumes. Changes in the following factors, among others, may affect gross
profit: product and distribution channel mix, competition, customer discounts,
supply and demand conditions in the electronic components industry, internal
manufacturing capabilities and efficiencies, foreign currency fluctuations and
general economic conditions.
Research and Development
Although research and development expenses increased by $3.9 million,
or 23%, such expenses decreased as a percentage of revenues from 24% in 1996 to
17% in 1997. The dollar increase was attributable primarily to ongoing
development expenses in the Network Switching Division with respect to the
Company's LNP and LSMS features for the EAGLE STP product, and consisted
principally of expenses incurred in connection with the hiring of additional
personnel and higher depreciation expense resulting from equipment acquisitions.
Additionally, research and development expenses increased as a result of the
accrual of certain costs for performance-related award programs.
The Company intends to continue to make substantial investments in
product and technology development and believes that its future success depends
in large part upon its ability to continue to enhance existing products and
develop new products that maintain its technological competitiveness.
Selling, General and Administrative
Although selling, general and administrative expenses increased by $5.1
million, or 17%, such expenses decreased as a percentage of revenues from 41% in
1996 to 28% in 1997. The increase in dollars was attributable primarily to
increased infrastructure costs to meet the needs of the growing EAGLE installed
base and to support higher sales levels of switching and intelligent network
diagnostics products, and the accrual of certain costs for performance-related
award programs.
Income Taxes
During 1997, the Company recorded a tax benefit of $9.0 million
resulting from a reduction of its valuation allowance for deferred taxes. The
reduction in the valuation allowance was based on the Company's improved income
trend and management's assessment of various uncertainties related to the future
realization of its deferred tax benefits. For the year ended December 31, 1997,
excluding the one-time tax benefit, the Company had a tax provision of $9.7
million, resulting in an effective tax rate of 33%. Although the Company's 1996
pretax results showed a loss, the Company had a tax provision of $2.2 million,
which consisted principally of
29
30
foreign taxes on the income of the Company's Japanese subsidiary and reflected
the Company's then inability to recognize a benefit for its U.S. loss and
credits carryforwards.
Interest, Net
Net interest income increased by $685,000 primarily as a result of
higher average investment balances in 1997.
1996 COMPARED WITH 1995
Revenues
The Company's revenues decreased by $3.2 million, or 4%, during 1996
due to lower sales of data network diagnostics products, partially offset by
higher sales of switching and intelligent network diagnostics products.
Revenues from data network diagnostics products decreased by 32%, or
$9.8 million, to $21.2 million, primarily due to lower sales in all markets for
both the Chameleon Open and the Company's older Chameleon products.
Revenues from intelligent network diagnostics products increased by
15%, or $3.1 million, to $23.7 million. This increase was primarily driven by
strong demand for the Company's MGTS products in North America and Japan.
Revenues from switching products increased by 15%, or $3.5 million, to
$27.2 million due primarily to increased EAGLE STP sales worldwide, particularly
internationally. This increase was lower than anticipated principally due to
delays in RBOC's SS7 network replacement and expansion. In 1996, 26 pairs of
EAGLE STPs were sold compared with 28 in 1995. The increased revenues despite
lower unit sales were due to larger average system sizes, combined with
increased service revenues due to growth of the EAGLE installed base.
Revenues in North America decreased by $1.4 million, or 3%, as a result
of lower Chameleon product sales, partially offset by higher MGTS and switching
product sales. Revenues in Japan decreased by $938,000, or 6%, due to lower
sales of Chameleon products and the impact of exchange rate fluctuations on
currency translations in 1996, partially offset by strong MGTS product sales.
Other international revenues decreased by $862,000, or 6%, primarily due to
lower sales of both diagnostic product lines, partially offset by higher
switching product sales.
The impact of exchange rate fluctuations on currency translations
decreased revenues by approximately $2.4 million, or 3%, and increased net loss
by $257,000, or 11%.
30
31
Gross Profit
Gross profit as a percentage of revenues decreased from 67% in 1995 to
63% in 1996, due primarily to increased competition in the EAGLE product market
and lower sales of higher margin diagnostic products.
Research and Development
Research and development expenses increased by $2.0 million, or 13%,
and represented 24% of revenues in 1996, compared to 20% in 1995. The increase
was attributable primarily to the hiring of additional personnel in the Network
Switching Division, expenses incurred in connection with the Bellcore technical
audits of the Company's EAGLE product and higher depreciation expense as a
result of equipment acquisitions for EAGLE research and development.
Selling, General and Administrative
Selling, general and administrative expenses increased by $2.2 million,
or 8%, and represented 41% of revenues in 1996, compared to 37% in 1995. The
increase was attributable primarily to severance charges, recruiting activity
and relocation expenses incurred in connection with personnel changes.
Restructuring
During the third quarter of 1996, the Company recorded restructuring
charges amounting to $327,000 which represent severance pay, benefit costs and
other costs related to the consolidation of the Company's Ohio research facility
into the Company's North Carolina facility. See Note F to consolidated financial
statements.
Income Taxes
Although the Company's pretax results showed a loss in 1996, the
Company had a tax provision of $2.2 million, compared to $2.1 million and an
effective tax rate of 25% in 1995. The provisions for both periods were
principally foreign taxes on the income of the Company's Japanese subsidiary.
The 1996 provision was impacted by the Company's then inability to recognize a
benefit for its U.S. loss and credits carryforwards, which remained available to
reduce future U.S. taxes. In 1995, the Company was able to utilize a portion of
its prior years' U.S. loss carryforwards, and consequently provided for taxes on
its U.S. taxable income at the federal alternative minimum tax rate and
applicable state tax rates.
Interest, Net
Net interest income increased by $554,000 primarily as a result of
higher average investment balances in 1996.
31
32
LIQUIDITY AND CAPITAL RESOURCES
During 1997, cash and cash equivalents increased by $21.5 million to
$38.7 million, after a net transfer of approximately $4.7 million to short-term
and long-term investments. Operating activities, net of the effects of exchange
rate changes on cash, provided $24.0 million, financing activities provided $8.8
million and $6.6 million was used for capital expenditures.
Accounts receivable, including amounts due from related parties,
increased by 62% during 1997 due primarily to increased sales levels.
Inventories increased by 39% during 1997 primarily to support the increased
sales levels and the expanded breadth of the Company's products, particularly
the new LNP and LSMS features for the EAGLE STP platform. Accrued payroll and
related expenses increased by 70% due to the accrual of certain costs for
performance-related award programs. Deferred revenues increased by 179%
primarily as a result of increased extended warranty service revenues which are
recognized ratably over the warranty period.
Capital expenditures were $6.6 million during 1997 and represented the
planned acquisition of equipment principally for research and development,
manufacturing operations and facility expansion. There are currently no
significant commitments for capital expenditures; however, the Company expects
capital expenditures will be at least at a comparable level in 1998, principally
for the acquisition of equipment for research and development, sales
demonstration and manufacturing operations.
Net cash provided by financing activities in 1997 was $8.8 million,
which represented proceeds from the issuance of Common Stock upon the exercise
of options and warrants.
The Company has a $10 million line of credit with a U.S. bank,
collateralized by substantially all of the Company's assets and bearing interest
at, or in some cases below, the U.S. prime rate (8.5% at December 31, 1997).
There have been no borrowings under this credit facility, which expires June 30,
1998 if not renewed. Under the terms of this facility, the Company is required
to maintain certain financial ratios and meet certain net worth and indebtedness
tests for which the Company is in compliance.
The Company's Japanese subsidiary has collateralized yen-denominated
lines of credit with Japan-based banks, primarily available for use in Japan,
amounting to the equivalent of $2.7 million with interest at the Japanese prime
rate (1.625% at December 31, 1997) plus 0.125% per annum which expire between
August 5, 1998, and March 31, 1999, if not renewed. There have been no
borrowings under these lines of credit.
Upon the expiration of the above-described credit facilities, the
Company believes that, if necessary, it would be able to arrange for credit
facilities on terms generally no less favorable than those described above.
32
33
There were no borrowings by the Company in 1997. The Company's weighted
average short-term borrowing rate in 1996 was 11.6%.
The Company believes that existing working capital, funds generated
from operations and its current bank lines of credit are sufficient to satisfy
anticipated operating requirements at least through 1998. Nonetheless, the
Company may seek additional sources of capital as necessary or appropriate to
fund acquisitions or to otherwise finance the Company's growth or operations;
however, there can be no assurance that such funds, if needed, will be available
on favorable terms, if at all.
Foreign Exchange
International operations are subject to certain opportunities and
risks, including currency fluctuations. In 1997, 1996 and 1995, the percentages
by which weighted average exchange rates for the Japanese yen strengthened
(weakened) against the U.S. dollar were (9%), (18%) and 9%, respectively.
The change in cumulative translation adjustments in 1997 was due
primarily to the weakening of the Japanese yen against the U.S. dollar when
comparing the exchange rate at December 31, 1997 to that of December 31, 1996.
Realized exchange gains (losses) are recorded in the period when incurred, and
amounted to $(273,000), $(180,000) and $(210,000) in 1997, 1996 and 1995,
respectively. Exchange gains and losses include the remeasurement of certain
currencies into functional currencies and the settlement of intercompany
balances.
Statements of Financial Accounting Standards Not Yet Adopted
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." This statement establishes standards for the reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements. Comprehensive income generally represents all changes in
shareholders' equity during the period except those resulting from investments
by, or distributions to, shareholders. SFAS No. 130 is effective for fiscal
years beginning after December 15, 1997 and requires restatement of earlier
periods presented. The Company believes that comprehensive income in future
periods will fluctuate as a result of changes in the cumulative translation
account, which is a component of comprehensive income. Net unrealized gains and
losses on the Company's available-for-sale securities, which have not been
significant, are also a component of comprehensive income.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 131 establishes standards
for public enterprises' reporting of information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. SFAS No. 131 is effective for fiscal years beginning after
December 15, 1997 and requires restatement of earlier periods presented.
Management is currently evaluating the requirements of SFAS No. 131.
33
34
In October 1997, Statement of Position (SOP) 97-2, "Software Revenue
Recognition" was issued, which addresses software revenue recognition under
generally accepted accounting principles, and which is effective for fiscal
years beginning after December 15, 1997. The Company believes it is currently in
compliance with SOP 97-2 and does not anticipate any changes in the Company's
revenue recognition practices.
Readiness for Year 2000
As the year 2000 approaches, a critical industrywide issue has emerged
regarding how existing application software programs and operating systems can
accommodate the year 2000 date value. The Company is currently in the
preliminary stages of conducting a comprehensive review of its computer systems,
products and significant vendors to identify the systems and products which
could be affected by this issue. Based on the results of the review conducted to
date, management does not anticipate that the Company will incur significant
operating expenses or be required to invest heavily in computer system or
product improvements to be year 2000 compliant. To the extent the Company's
products or systems are not fully Year 2000 compliant, there can be no assurance
that potential product failures, systems interruptions or the cost necessary to
update software would not have a material adverse effect on the Company's
business, financial condition, results of operations, cash flows and business
prospects.
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995
The statements which are not historical facts contained in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations and other sections of this Annual Report on Form 10-K are
forward-looking statements that involve certain risks and uncertainties
including, but not limited to, timing of significant orders and shipments,
product mix, customer acceptance of the Company's products, capital spending
patterns of customers, competition and pricing, new product introductions by the
Company or its competitors, carrier deployment of intelligent network services,
the timing of research and development expenditures, regulatory changes, general
economic conditions and other risks described in this Annual Report on Form 10-K
and in the Company's other Securities and Exchange Commission filings.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.
Inapplicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See the consolidated financial statements of the Company and its
subsidiaries included herein and listed in Item 14 (a) of this Annual Report.
34
35
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
Inapplicable.
35
36
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item is incorporated by reference to
the sections of the Company's definitive Proxy Statement for the Annual Meeting
of Shareholders to be held on May 15, 1998, entitled "Election of Directors" and
"Executive Officers" to be filed with the Commission.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item is incorporated by reference to
the sections of the Company's definitive Proxy Statement for the Annual Meeting
of Shareholders to be held on May 15, 1998, entitled "Election of Directors -
Compensation of Directors," "Executive Compensation and Other Information,"
"Board of Directors and Compensation Committee Reports on Executive
Compensation" and "Performance Graph," to be filed with the Commission.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference to
the section of the Company's definitive Proxy Statement for the Annual Meeting
of Shareholders to be held on May 15, 1998, entitled "Common Stock Ownership of
Principal Shareholders and Management," to be filed with the Commission.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference to
the section of the Company's definitive Proxy Statement for the Annual Meeting
of Shareholders to be held on May 15, 1998, entitled "Certain Relationships and
Related Transactions," to be filed with the Commission.
36
37
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K.
(a) The following documents are filed as part of this Report:
CONSOLIDATED FINANCIAL STATEMENTS PAGE
----
Report of Independent Accountants F-1
Consolidated Statements of Operations for each of the
three years in the period ended December 31, 1997 F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996 F-3
Consolidated Statements of Cash Flow for each of the
three years in the period ended December 31, 1997 F-4
Consolidated Statements of Shareholders' Equity for each of
the three years in the period ended December 31, 1997 F-5
Notes to Consolidated Financial Statements F-6
- -----------------------------
PAGE
----
CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
Schedule II Valuation and Qualifying Accounts and Reserves
for each of the three years in the period ended
December 31, 1997 S-1
Schedules which are not listed above have been omitted because they are
not applicable or the information required to be set forth therein is included
in the consolidated financial statements or notes thereto.
LIST OF EXHIBITS
3.1 Amended and Restated Articles of Incorporation(1)
3.2 Bylaws, as amended(2)
37
38
4.1 Rights Agreement dated as of August 25, 1997 between the
Registrant and U.S. Stock Transfer Corporation as Rights
Agent(3)
10.1 Amended and Restated 1984 Stock Option Plan, including forms
of stock option agreements(4)(5)
10.2 Amended and Restated Non-Employee Director Equity Incentive
Plan, including forms of stock award certificate and
nonstatutory stock option agreements(6), as amended February
21, 1996(5)(7)
10.3 1994 Stock Option Plan, including forms of stock option
agreements(6), as amended February 4, 1995(8), March 3, 1995
(8), January 27, 1996(7), February 26, 1997(9), and March 19,
1997(5)(9)
10.4 Retirement Pension Rules of Tekelec Ltd.(5)(10)
10.5 Form of Indemnification Agreement between the Registrant and
all directors of the Registrant(5)(11)
10.6 Lease dated as of February 8, 1988 between the Registrant and
State Street Bank and Trust Company of California, N.A., not
individually, but solely as an Ancillary Trustee for State
Street Bank and Trust Company, a Massachusetts banking
corporation, not individually, but solely as Trustee for the
AT&T Master Pension Trust, covering the Company's principal
facilities in Calabasas, California(12)
10.7 Form of International Distributor Agreement(13) and Schedule
of Distributors
10.8 Officer Severance Plan, including form of Employment
Separation Agreement(5)(14)
10.9 Agreement dated March 26, 1997 between the Registrant and
Allan Toomer(2)(5)
10.10 Employee Stock Purchase Plan, including form of subscription
agreement(5)(7)
10.11 Consulting Agreement dated August 1, 1996 between the
Registrant and Howard Oringer, including forms of Warrant and
Confidentiality Agreement(16), and Amendment No. 1 thereto
dated November 30, 1996(2)
10.12 Credit Agreement dated October 22, 1996 between the Registrant
and Imperial Bank, together with Promissory Note of the
Registrant dated October 22, 1996(2)
10.13 General Security Agreement dated October 22, 1996 between the
Registrant and Imperial Bank(2)
38
39
10.14 Agreement dated September 9, 1997 between the Registrant and
Shigeru Suzuki(3), as amended by Agreement dated January 6,
1998(5)
10.15* Distribution and OEM Agreement dated as of June 1, 1997
between the Registrant and Daewoo Telecom, Ltd.(3)
10.16 Warrants issued to Allan Toomer to purchase 80,600 shares of
the Company's Common Stock(5)(9)
10.17 Warrants to purchase shares of the Company's Common Stock and
Schedule of Warrantholders(5)(17)
10.18 Description of the Company's Officer Bonus Plan for the year
ended December 31, 1997(5)
10.19 Description of the Company's Officer Bonus Plan for the year
ended December 31, 1998(5)
21.1 Subsidiaries of the Registrant
23.1 Consent of Coopers & Lybrand L.L.P.
27.1997 Financial Data Schedule for the year ended December 31, 1997
27.1996 Restated Financial Data Schedule for the year ended
December 31, 1996
27.1995 Restated Financial Data Schedule for the year ended
December 31, 1995
27.1997.1Q Restated Financial Data Schedule for the quarter ended
March 31. 1997
27.1997.2Q Restated Financial Data Schedule for the quarter ended
June 30, 1997
27.1997.3Q Restated Financial Data Schedule for the quarter ended
September 30, 1997
27.1996.1Q Restated Financial Data Schedule for the quarter ended
March 31, 1996
27.1996.2Q Restated Financial Data Schedule for the quarter ended
June 30, 1996
27.1996.3Q Restated Financial Data Schedule for the quarter ended
September 30, 1996
- -----------------------------
* Confidential treatment has been granted with respect to portions of
this exhibit, and such confidential portions have been deleted and
filed with the Commission pursuant to Rule 24b-2 promulgated under the
Securities Exchange Act of 1934.
(1) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q (File No. 0-15135) for the quarter ended June 30, 1997.
(2) Incorporated by reference to the Registrant's Annual Report on Form
10-K (File No. 0-15135) for the year ended December 31, 1996.
(3) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q (File No. 0-15135) for the quarter ended September 30, 1997.
(4) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Registration No. 33-48079) filed with the Commission on May
22, 1992.
(5) Constitutes a management contract or compensatory plan or arrangement
required to be filed as an exhibit to this Annual Report on Form 10-K.
(6) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Registration No. 33-82124) filed with the Commission on July
28, 1994.
39
40
(7) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Registration No. 333-05933) filed with the Commission on June
13, 1996.
(8) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Registration No. 33-60611) filed with the Commission on June
27, 1995.
(9) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Registration No. 333-28887) filed with the Commission on June
10, 1997.
(10) Incorporated by reference to the Registrant's Annual Report on Form
10-K (File No. 0-15135) for the year ended December 31, 1994.
(11) Incorporated by reference to the Registrant's Annual Report on Form
10-K (File No. 0-15135) for the year ended December 31, 1987.
(12) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q (File No. 0-15135) for the quarter ended June 30, 1988.
(13) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (Registration No. 33-4123) filed with the Commission on March
19, 1986.
(14) Incorporated by reference to the Registrant's Annual Report on Form
10-K (File No. 0-15135) for the year ended December 31, 1993.
(15) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q (File No. 0-15135) for the quarter ended September 30, 1994.
(16) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q (File No. 0-15135) for the quarter ended September 30, 1996.
(17) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (Registration No. 333-37843) filed with the Commission on
October 14, 1997.
(B) REPORTS ON FORM 8-K
No reports on Form 8-K were filed or required to be filed by the
Registrant during the quarter ended December 31, 1997.
40
41
(C) EXHIBITS
See the list of Exhibits under Item 14(a)3 of this Annual Report on
Form 10-K.
(D) FINANCIAL STATEMENT SCHEDULES
See the Schedule under Item 14(a)2 of this Annual Report on Form 10-K.
41
42
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
TEKELEC
By:/s/ Michael L. Margolis
--------------------------
Michael L. Margolis, President and
Chief Executive Officer
Dated: March 31, 1998
Pursuant to the requirements of the Securities Act of 1934, this report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Jean-Claude Asscher Chairman of the Board March 31, 1998
- ------------------------------------
Jean-Claude Asscher
/s/ Michael L. Margolis President, Chief Executive March 31, 1998
- ------------------------------------ Officer and Director
Michael L. Margolis
Director March , 1998
- -----------------------------------
Robert V. Adams
/s/ Daniel L. Brenner Director March 31, 1998
- -----------------------------------
Daniel L. Brenner
/s/ Howard Oringer Director March 31, 1998
- -----------------------------------
Howard Oringer
/s/ Jon F. Rager Director March 31, 1998
- -----------------------------------
Jon F. Rager
/s/ Allan J. Toomer Director March 31, 1998
- -----------------------------------
Allan J. Toomer
/s/ Gilles C. Godin Vice President, Finance and March 31, 1998
- ----------------------------------- Chief Financial Officer
Gilles C. Godin
43
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF TEKELEC
We have audited the accompanying consolidated balance sheets of Tekelec
and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of operations, shareholders' equity, and cash flow, and the financial
statement schedule for each of the three years in the period ended December 31,
1997. These financial statements and the financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Tekelec and Subsidiaries as of December 31, 1997 and 1996, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles. In addition, in our opinion, the financial statement
schedule referred to above, when considered in relation to the basic financial
statements taken as a whole, presents, in all material respects, the information
required to be included therein.
/s/
Coopers & Lybrand L.L.P.
Woodland Hills, California
February 5, 1998
F-1
44
TEKELEC
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
------------------------------------
(thousands, except per-share data)
REVENUES (including sales to related parties of
1997 - $4,471; 1996 - $4,130; 1995 - $5,305) $ 125,140 $ 72,126 $ 75,276
COSTS AND EXPENSES:
Cost of goods sold ......................... 41,524 26,682 25,035
Research and development ................... 21,019 17,076 15,054
Selling, general and administrative ........ 34,971 29,842 27,653
Restructuring .............................. -- 327 --
--------- -------- --------
Total costs and expenses ................. 97,514 73,927 67,742
Income (Loss) from operations ................... 27,626 (1,801) 7,534
Other income (expense):
Interest, net .............................. 2,378 1,693 1,139
Other, net ................................. (263) (176) (223)
--------- -------- --------
Total other income ....................... 2,115 1,517 916
--------- -------- --------
Income (Loss) before provision for income taxes . 29,741 (284) 8,450
Provision for income taxes ................. 745 2,227 2,139
--------- -------- --------
NET INCOME (LOSS) ........................ $ 28,996 $ (2,511) $ 6,311
========= ======== ========
EARNINGS (LOSS) PER SHARE(1):
Basic .................................... $ 1.15 $ (0.11) $ 0.30
Diluted .................................. 1.02 (0.11) 0.26
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING(1):
Basic .................................... 25,204 23,550 21,058
Diluted .................................. 28,421 23,550 24,104
(1)Earnings (Loss) per share and weighted average number of shares outstanding
have been retroactively adjusted to reflect the two-for-one stock split effected
August 22, 1997.
See notes to consolidated financial statements
F-2
45
TEKELEC
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
------------
1997 1996
---------------------
(thousands, except share data)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ..................................... $ 38,748 $17,211
Short-term investments, at fair value ......................... 19,773 17,913
Accounts and notes receivable, less allowances
1997 -- $469; 1996 -- $368 ................................ 29,141 17,026
Inventories ................................................... 11,281 8,116
Amounts due from related parties .............................. 2,286 2,381
Income taxes receivable ....................................... 805 --
Deferred income taxes, net .................................... 8,309 242
Prepaid expenses and other current assets ..................... 1,760 1,505
--------- -------
Total current assets ........................................ 112,103 64,394
Long-term investments, at fair value ............................... 11,997 9,120
Property and equipment, net ........................................ 9,841 8,174
Deferred income taxes, net ......................................... 1,999 207
Other assets ....................................................... 525 623
--------- -------
Total assets ................................................ $ 136,465 $82,518
========= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable ........................................ $ 4,919 5,631
Accrued expenses .............................................. 5,862 5,989
Accrued payroll and related expenses .......................... 6,846 4,027
Current portion of deferred revenues .......................... 7,693 2,717
Income taxes payable .......................................... 429 1,342
--------- -------
Total current liabilities ................................... 25,749 19,706
Long-term portion of deferred revenues ............................. 2,839 1,061
--------- -------
Total liabilities ........................................... 28,588 20,767
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY(1):
Common stock, without par value, 100,000,000 shares authorized;
issued and outstanding 1997 -- 26,126,043; 1996 -- 24,020,198 75,627 57,049
Retained earnings ............................................. 32,875 3,879
Cumulative translation adjustments ............................ (625) 823
--------- -------
Total shareholders' equity .................................. 107,877 61,751
--------- -------
Total liabilities and shareholders' equity .................. $ 136,465 $82,518
========= =======
(1)Number of shares outstanding have been retroactively adjusted to reflect the
two-for-one stock split effected August 22, 1997.
See notes to consolidated financial statements
F-3
46
TEKELEC
CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------------------------------------
(thousands)
CASH FLOW FROM OPERATING ACTIVITIES:
Net income (loss) ............................. $ 28,996 $ (2,511) $ 6,311
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ................. 4,790 3,842 3,643
Deferred income taxes ......................... (82) (80) (369)
Changes in assets and liabilities:
Accounts and notes receivable ............... (12,537) 1,810 (5,022)
Inventories ................................. (3,299) (1,840) (2,079)
Amounts due from related parties ............ 93 672 (1,515)
Income taxes receivable ..................... (857) -- --
Prepaid expenses and other current assets ... (266) (564) (567)
Trade accounts payable ...................... (412) 1,776 (188)
Accrued expenses ............................ (49) 1,645 1,346
Accrued payroll and related expenses ........ 2,842 755 (865)
Deferred revenues ........................... 6,766 870 1,496
Income taxes payable ........................ (849) 370 912
-------- -------- --------
Total adjustments ......................... (3,860) 9,256 (3,208)
-------- -------- --------
Net cash provided by operating activities 25,136 6,745 3,103
-------- -------- --------
CASH FLOW FROM INVESTING ACTIVITIES:
Decrease in restricted cash ................... -- -- 1,000
Purchase of available-for-sale securities ..... (22,737) (45,033) --
Proceeds from maturity of available-for-sale
securities ................................ 18,000 18,000 --
Purchase of property and equipment ............ (6,552) (6,008) (4,530)
Decrease in other assets ...................... 46 63 64
-------- -------- --------
Net cash (used in) investing activities ... (11,243) (32,978) (3,466)
-------- -------- --------
CASH FLOW FROM FINANCING ACTIVITIES:
Repayments of short-term borrowings ........... -- (570) (796)
Repayment of long-term debt ................... -- (380) (240)
Repayments of other obligations ............... -- (31) (323)
Proceeds from issuance of common stock ........ 8,759 2,050 38,894
-------- -------- --------
Net cash provided by financing activities . 8,759 1,069 37,535
-------- -------- --------
Effect of exchange rate changes on cash ............ (1,115) (1,234) (216)
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents ............................. 21,537 (26,398) 36,956
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR . 17,211 43,609 6,653
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF THE YEAR ....... $ 38,748 $ 17,211 $ 43,609
======== ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
CASH PAID DURING THE YEAR FOR:
Interest .................................... $ -- $ 98 $ 231
Income taxes ................................ 2,408 1,970 1,543
SUPPLEMENTAL DISCLOSURE OF NON-CASH FLOW ACTIVITY:
Tax benefit related to stock options ........ $ 9,819 $ 63 $ 102
See notes to consolidated financial statements
F-4
47
TEKELEC
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK
---------------------- CUMULATIVE TOTAL
NUMBER RETAINED TRANSLATION SHAREHOLDERS'
OF SHARES(1) AMOUNT EARNINGS ADJUSTMENTS EQUITY
-------------------------------------------------------------------------
(thousands)
BALANCE, DECEMBER 31, 1994 18,046 $ 15,940 $ 79 $ 2,701 $ 18,720
Issuance of common stock 4,026 36,520 -- -- 36,520
Exercise of stock options
and warrants 1,126 2,374 -- -- 2,374
Stock option tax benefits -- 102 -- -- 102
Translation adjustment -- -- -- (420) (420)
Net income -- -- 6,311 -- 6,311
- ------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1995 23,198 54,936 6,390 2,281 63,607
Exercise of stock options
and warrants 822 2,050 -- -- 2,050
Stock option tax benefits -- 63 -- -- 63
Translation adjustment -- -- -- (1,458) (1,458)
Net loss -- -- (2,511) -- (2,511)
- -------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 24,020 57,049 3,879 823 61,751
Exercise of stock options
and warrants 2,106 8,759 -- -- 8,759
Stock option tax benefits -- 9,819 -- -- 9,819
Translation adjustment -- -- -- (1,448) (1,448)
Net income -- -- 28,996 -- 28,996
- ------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 26,126 $ 75,627 $ 32,875 $ (625) $ 107,877
==================================================================================================================
(1)Number of shares of Common Stock have been retroactively adjusted to reflect
the two-for-one stock split effected August 22, 1997.
See notes to consolidated financial statements
F-5
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION AND PRESENTATION
The consolidated financial statements include the accounts of the
Company and its subsidiaries. All significant intercompany accounts and
transactions are eliminated. Certain items shown in the December 31, 1996 and
1995 financial statements have been reclassified to conform with the current
period presentation.
ESTIMATES
The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the dates of
the financial statements and revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid debt instruments purchased with
an original maturity of three months or less to be cash equivalents.
INVENTORIES
Inventories are stated at the lower of cost (first in, first out) or
market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated
depreciation and amortization. Depreciation and amortization are provided using
the straight-line method. The estimated useful lives are:
Manufacturing and
development equipment 3-5 years
Furniture and office equipment 5 years
Demonstration equipment 3 years
Leasehold improvements The shorter of useful
life or lease term
F-6
49
LONG-TERM ASSETS
The carrying value of long-term assets is periodically reviewed by
management, and impairment losses, if any, are recognized when the expected
nondiscounted future operating cash flows derived from such assets are less than
their carrying value.
PRODUCT WARRANTY COSTS
The Company generally warrants its products for one year after sale and
provides for estimated future warranty costs at the time revenue is recognized.
At December 31, 1997 and 1996, accrued product warranty costs amounted to $1.2
million and $1.6 million, respectively, and are included in accrued expenses.
REVENUE RECOGNITION
Revenues from sales of diagnostic products are generally recognized
when products are shipped. Revenues from sales of switching products are
recognized upon shipment to the customer's final site and satisfaction of
related significant Company obligations, if any. Revenues associated with
installation are realized upon completion. Extended warranty service revenues
are recognized ratably over the warranty period. Engineering service revenues
are recognized on delivery or as the services are performed.
INCOME TAXES
Income tax expense is the tax payable for the period and the change
during the period in non-capital-related deferred tax assets and liabilities.
Deferred income taxes are determined based on the difference between the
financial reporting and tax bases of assets and liabilities using enacted rates
in effect during the year in which the differences are expected to reverse.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized.
ADVERTISING
Advertising costs are expensed as incurred and amounted to $669,000,
$620,000 and $625,000 for 1997, 1996 and 1995, respectively.
TRANSLATION OF FOREIGN CURRENCIES
Translation of foreign currencies is accounted for using the local
currency as the functional currency of the Company's foreign subsidiaries. All
assets and liabilities are translated at current exchange rates while revenues
and expenses are translated at average rates in effect for the period. The
resulting gains and losses are included in a separate component of shareholders'
equity. Realized gains (losses) on foreign currency transactions are reflected
in net income (loss) and amounted to $(273,000), $(180,000) and $(210,000) for
1997, 1996 and 1995, respectively.
F-7
50
EARNINGS (LOSS) PER SHARE
In 1997, the Company adopted Statement of Financial Accounting
Standards No. 128 "Earnings per Share" ("SFAS 128"). This statement requires
dual presentation of newly defined basic and diluted earnings per share ("EPS"),
which are computed using the weighted average number of shares outstanding and
dilutive Common Stock equivalents (options and warrants), on the face of the
income statement for all entities with complex capital structures. See note M.
STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS NOT YET ADOPTED
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." This statement establishes standards for the reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements. Comprehensive income generally represents all changes in
shareholders' equity during the period except those resulting from investments
by, or distributions to, shareholders. SFAS No. 130 is effective for fiscal
years beginning after December 15, 1997 and requires restatement of earlier
periods presented. The Company believes that comprehensive income in future
periods will fluctuate as a result of changes in the cumulative translation
account, which is a component of comprehensive income. Net unrealized gains and
losses on the Company's available-for-sale securities, which have not been
significant, are also a component of comprehensive income.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 131 establishes standards
for public enterprises' reporting of information about operating segments in
annual financial statements, and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. SFAS No. 131 is effective for fiscal years beginning after
December 15, 1997 and requires restatement of earlier periods presented.
Management is currently evaluating the requirements of SFAS No. 131.
In October 1997, Statement of Position (SOP) 97-2, "Software Revenue
Recognition" was issued, which addresses software revenue recognition under
generally accepted accounting principles, and which is effective for fiscal
years beginning after December 15, 1997. The Company believes it is currently in
compliance with SOP 97-2 and does not anticipate any changes in the Company's
revenue recognition practices.
NOTE B -- RESTRICTED CASH
At December 31, 1994, the Company's Japanese subsidiary had $1.0
million of restricted cash included in current assets, which represented cash on
deposit at a bank in Japan as collateral for outstanding short-term borrowings
in the U.S. under a $2.0 million line of credit. Upon expiration of this
facility during 1995, the outstanding loan balance of $1.0 million was paid in
full and the line of credit was not renewed.
F-8
51
NOTE C -- FAIR VALUE OF INVESTMENTS
The Company has short-term investments in corporate debt securities
with original maturities of less than 90 days whose carrying amounts approximate
their fair values because of their short maturities. These short-term
investments are included in cash and cash equivalents, are classified as
held-to-maturity securities and amounted to $25.3 million and $3.0 million at
December 31, 1997 and December 31, 1996, respectively.
The Company also had investments classified as available-for-sale
securities included in short-term and long-term investments, categorized as
follows:
DECEMBER 31,
------------
1997 1996
-----------------
(thousands)
TYPE OF SECURITY:
- -----------------
Corporate debt securities with maturities of less than one year.............. $10,745 $11,915
U.S. Treasury Notes with maturities of less than one year .................... 9,028 5,998
------- -------
Total short-term investments ................................................. 19,773 17,913
U.S. Treasury Notes with maturities of between one and two years ............. 11,997 9,120
------- -------
$31,770 $27,033
======= =======
These available-for-sale securities are accounted for at their fair value, and
unrealized gains and losses on these securities are reported as a separate
component of shareholders' equity. At December 31, 1997 and 1996, net unrealized
gains or losses on available-for-sale securities were not significant.
NOTE D -- BUSINESS AND CREDIT RISK
Financial instruments, which potentially subject the Company to
concentration of credit risk, consist principally of cash, investments and trade
receivables. The Company invests its excess cash in interest-bearing deposits
with major banks, United States government securities, high-quality commercial
paper and money market funds. At times the Company's cash balances may be in
excess of the FDIC insurance limits. With respect to trade receivables, the
Company sells network switching and communications diagnostic systems worldwide
primarily to telephone operating companies, equipment manufacturers and
corporations that use its systems to design, install, maintain, test and operate
communications equipment and networks. Credit is extended based on an evaluation
of each customer's financial condition, and generally collateral is not
required. Credit losses, if any, have been provided for in the financial
statements and to date have been within management's expectations.
NOTE E -- RELATED PARTY TRANSACTIONS
As of December 31, 1997, the Company's principal shareholder, a
director and his family, and a foreign-affiliated company controlled by the
director owned an aggregate of approximately 28% of the Company's outstanding
stock.
F-9
52
The following is a summary of transactions and balances with these
affiliates:
1997 1996 1995
---- ---- ----
(thousands)
Product sales.......................................... $ 4,471 $ 4,130 $ 5,305
Purchases of inventory................................. 212 125 321
Director's fees and expenses........................... 104 59 32
Due from affiliates.................................... 2,286 2,381 3,053
Due to affiliates...................................... -- 145 254
The amounts due from and to the affiliates are non-interest bearing.
In August 1996, the Company entered into a consulting agreement with a
director, pursuant to which such director earned $30,000 and received a warrant
to purchase 60,000 shares of the Company's Common Stock. This agreement
terminated December 31, 1996. See Note Q.
NOTE F -- RESTRUCTURING
During the third quarter of 1996, the Company recorded restructuring
charges amounting to $327,000 which represent severance pay and benefit costs
for eight terminated employees in research and development and support
functions, and other costs related to the consolidation of the Company's Ohio
research facility into the Company's North Carolina facility. The costs
consisted of the following:
(thousands)
Severance pay.......................................................... $ 250
Other accrued expenses................................................. 57
Property and equipment write-down...................................... 20
---------
$ 327
At December 31, 1997, all identified employees had been terminated, and
all severance costs and other accrued expenses had been paid.
F-10
53
NOTE G -- INCOME TAXES
The provision for income taxes consists of the following:
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
----------------------------------
(thousands)
CURRENTLY PAYABLE:
Federal ....................................................... $ 5,394 $ -- $ 88
State ......................................................... 1,554 1 228
Foreign ....................................................... 390 2,392 2,258
DEFERRED:
Federal ....................................................... (5,974) -- --
State ......................................................... (745) -- --
Foreign ....................................................... 126 (166) (435)
------- ------- -------
$ 745 $ 2,227 $ 2,139
======= ======= =======
The primary components of temporary differences which gave rise to
deferred taxes at December 31, 1997 and 1996 are as follows:
DECEMBER 31,
---------------------
1997 1996
---------------------
(thousands)
DEFERRED TAX ASSETS:
Net operating loss carryforward .. $ 3,319 $ 9,174
Foreign tax credit carryforward .. 247 918
Allowance for doubtful accounts .. 257 126
Inventory adjustments ............ 1,715 1,029
Depreciation and amortization .... 223 205
Deferred product development costs -- 100
Research and development
credit carryforward ............ 2,756 2,033
Accrued liabilities .............. 3,154 1,059
Warranty accrual ................. 515 629
Other ............................ 370 166
-------- --------
Total deferred tax asset ......... 12,556 15,439
Less, valuation allowance ........ (2,248) (14,990)
-------- --------
TOTAL NET DEFERRED TAX ASSET ..... 10,308 449
-------- --------
CURRENT PORTION ....................... 8,309 242
-------- --------
LONG-TERM PORTION ..................... $ 1,999 $ 207
======== ========
The valuation allowance for deferred taxes decreased by approximately
$12.7 million during the year ended December 31, 1997. The reduction in the
valuation allowance is based on the Company's improved income trend and
management's assessment of various uncertainties related to the future
realization of its deferred tax benefits. The remaining valuation allowance of
F-11
54
$2.2 million is attributable to research and development and foreign tax credits
carryforwards which may expire before the Company can utilize them.
Realization of the remaining net deferred tax assets of $10.3 million
is dependent on the Company generating sufficient taxable income in the future.
Although realization is not assured, the Company believes it is more likely than
not that the deferred tax assets will be realized. The amount of the deferred
tax assets considered realizable, however, could be reduced in the near term if
estimates of future taxable income are reduced.
The provision for income taxes differs from the amount obtained by
applying the federal statutory income tax rate to income before provision for
income taxes as follows:
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------------------------------------
(thousands)
Federal statutory provision
(benefit) at 34% ........................................... $ 10,112 $ (97) $ 2,873
State taxes,
net of federal benefit ..................................... 534 -- 152
Foreign taxes ................................................... 226 785 465
Reduction in valuation allowance ................................ (8,960) -- --
Utilization of operating
loss carryforwards ......................................... (499) -- (1,437)
Research and development credits ................................ (723) -- --
Loss for which no tax benefit
was recorded ............................................... -- 1,182 --
Temporary differences for which
no tax benefit was recorded ................................ -- 252 --
Other ........................................................... 55 105 86
-------- ------- -------
Actual income tax provision ..................................... $ 745 $ 2,227 $ 2,139
-------- ------- -------
Effective tax rate .............................................. 2.5% 784.0% 25.3%
At December 31, 1997, the Company had available federal net operating
loss carryforwards of $9.4 million, foreign tax credit carryforwards of $247,000
and research and development credit carryforwards of $2.8 million which will
generally expire beginning in the years 2009, 2003 and 2008, respectively.
The Company has not provided for federal income taxes on $11.8 million
of undistributed earnings of its foreign subsidiaries which have been reinvested
in their operations. If these earnings were distributed, net operating loss
carryforwards and foreign tax credits available under current law would
eliminate the resulting federal income tax liability.
F-12
55
NOTE H -- INVENTORIES
The components of inventories are:
DECEMBER 31,
------------
1997 1996
----------------------
(thousands)
Raw materials.......................................... $ 2,779 $ 2,825
Work in process........................................ 2,448 1,869
Finished goods......................................... 6,054 3,422
-------- ----------
$ 11,281 $ 8,116
======== ==========
NOTE I -- PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
DECEMBER 31,
------------
1997 1996
----------------------
(thousands)
Manufacturing and
development equipment............................. $17,645 $ 13,520
Furniture and office equipment......................... 7,773 7,300
Demonstration equipment................................ 3,964 4,055
Leasehold improvements................................. 1,397 1,118
------ -------
30,779 25,993
Less, accumulated depreciation and amortization........ (20,938) (17,819)
------- --------
$ 9,841 $ 8,174
======= ========
NOTE J -- BORROWINGS
The Company has a $10 million line of credit with a U.S. bank,
collateralized by substantially all of the Company's assets and bearing interest
at, or in some cases below, the U.S. prime rate (8.5% at December 31, 1997).
There have been no borrowings under this credit facility, which expires June 30,
1998 if not renewed. Under the terms of this facility, the Company is required
to maintain certain financial ratios and meet certain net worth and indebtedness
tests for which the Company is in compliance.
The Company's Japanese subsidiary has collateralized yen-denominated
lines of credit with Japan-based banks, primarily available for use in Japan,
amounting to the equivalent of $2.7 million with interest at the Japanese prime
rate (1.625% at December 31, 1997) plus 0.125% per annum which expire between
August 5, 1998 and March 31, 1999, if not renewed. There have been no borrowings
under these lines of credit.
There were no borrowings by the Company in 1997. The Company's weighted
average short-term borrowing rate was 11.6% in 1996.
F-13
56
NOTE K -- COMMITMENTS AND CONTINGENCIES
The Company leases its office and manufacturing facilities together
with certain office equipment under operating lease agreements. Lease terms
generally range from one to ten years; certain building leases contain options
for renewal for additional periods and are subject to increases up to 10% every
24 months.
Total rent expense was $2.5 million, $2.4 million and $2.4 million for
1997, 1996 and 1995, respectively.
Minimum annual noncancelable lease commitments at December 31, 1997
are:
For the Years Ending December 31,
- ---------------------------------
(thousands)
1998.............................................. $ 1,869
1999.............................................. 1,657
2000.............................................. 1,587
2001.............................................. 1,498
2002.............................................. 1,507
Thereafter........................................ 1,798
-------
$ 9,916
=======
NOTE L -- STOCK OPTIONS AND EMPLOYEE BENEFIT PLANS
The Company has various stock option plans with maximum terms of ten
years under which 13.5 million shares of the Company's Common Stock have been
issued or reserved for issuance. The terms of options granted under these option
plans are determined at the time of grant, generally vest ratably over a three-
to five-year period, and in any case the option price may not be less than the
fair market value per share on the date of grant. Both incentive stock options
and nonstatutory stock options can be issued under the Option Plans.
The Company also has Employee Stock Purchase Plans ("ESPP"), with
maximum terms of ten years, the latest of which expires in the year 2006 and
under which 400,000 shares of the Company's Common Stock have been authorized
and reserved for issuance. Eligible employees may authorize payroll deductions
of up to 10% of their compensation to purchase shares of Common Stock at 85% of
the lower of the market price per share at the beginning or end of each
six-month offering period.
Statement of Financial Accounting Standards No. 123 "Accounting for
Stock-Based Compensation" ("SFAS 123") encourages but does not require companies
to record compensation cost for stock-based employee compensation plans at fair
value. The Company has chosen to continue to account for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees," and
related interpretations. Accordingly, no compensation expense has been
recognized for the Company's stock-based compensation plans. Had compensation
costs for the
F-14
57
Company's stock option and purchase plans been determined based upon the
methodology prescribed under SFAS 123, the Company's net income (loss) and
diluted earnings (loss) per share would approximate the following pro forma
amounts (in thousands except per-share data):
As Reported Pro Forma
YEAR ENDED DECEMBER 31, 1997: ----------- ---------
Net income............................. $28,996 $26,646
Earnings per share (diluted)........... 1.02 0.95
Year Ended December 31, 1996:
Net loss............................... $(2,511) $(3,777)
Loss per share (diluted)............... (0.11) (0.16)
Year Ended December 31, 1995:
Net income............................. $6,311 $5,672
Earnings per share (diluted)........... 0.26 0.24
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts. SFAS 123 does not apply to awards prior to 1995,
and additional awards in future years are anticipated.
A summary of the status of the Company's stock options, as of December
31, 1997, 1996 and 1995, and the changes during the year ended on those dates is
presented below (shares in thousands):
1997 1996 1995
----------------------------------------------------------------
Wgtd. Avg. Wgtd. Avg. Wgtd. Avg.
Shares Exer. Price Shares Exer. Price Shares Exer. Price
Outstanding at beginning of year................ 4,836 $4.87 4,676 $4.14 4,496 $2.16
Granted - price equals fair value............... 1,361 14.54 1,223 6.71 1,270 9.23
Granted - price greater than fair value......... 170 20.66 1,369 7.11 24 11.25
Exercised....................................... 1,889 3.73 690 1.99 940 1.88
Cancelled....................................... 329 7.43 1,742 7.11 174 2.89
------- ------ ------
Outstanding at year-end......................... 4,149 9.00 4,836 4.87 4,676 4.14
======= ====== ======
Options exercisable at year-end................. 1,137 1,959 1,412
Options available for future grant.............. 1,757 996 2,176
Weighted average fair value of options granted
during the year:
Exercise price equals fair value at grant date $ 10.47 $ 4.84 $ 6.65
Exercise price greater than fair value at
grant date.................................... $ 13.78 $ 2.16 $ 6.53
F-15
58
The following table summarizes information about stock options
outstanding at December 31, 1997 (shares in thousands):
Options Outstanding Options Exercisable
------------------------------------- -----------------------------
Wgtd. Avg.
Number Remaining Wgtd.Avg. Number Wgtd. Avg.
Outstanding Contractual Exercise Outstanding Exercise
Range of Exercise Price at 12/31/97 Life Price at 12/31/97 Price
- ---------------------------------------------------------------------------------------------------------------
$1.31 to $ 1.97 654 5.53 $ 1.71 386 $ 1.70
2.00 to 7.13 1,258 7.67 6.14 382 6.18
7.25 to 10.88 1,641 8.40 8.76 329 8.53
10.94 to 14.13 253 9.34 13.36 24 13.38
18.38 to 28.16 109 9.51 21.52 9 20.33
32.63 to 41.88 234 9.79 35.90 7 34.12
------- -------
1.31 to 41.88 4,149 7.89 9.00 1,137 5.78
======= =======
The fair value of options granted during 1997, 1996 and 1995 is estimated
as $6.9 million, $3.6 million and $3.3 million, respectively, on the dates of
grants using the Black-Scholes option-pricing model with the following
assumptions: (i) dividend yield of 0%, (ii) expected volatility of 86%, 87% and
85%, respectively, for 1997, 1996 and 1995, (iii) weighted average risk-free
interest rates of 6.4%, 6.2% and 6.9% for 1997, 1996 and 1995, respectively,
(iv) weighted average expected life of 5.1 years, 4.8 years and 5.1 years for
1997, 1996 and 1995, respectively, and (v) assumed forfeiture rate of 58%, 64%
and 64%, respectively, for 1997, 1996 and 1995.
During 1997, 1996 and 1995, approximately 80,000, 124,000 and 68,000
shares, respectively, were purchased under the Company's ESPP at weighted
average exercise prices of $10.15, $4.80 and $5.48, respectively. At December
31, 1997, 1996 and 1995 there were approximately 265,000, 345,000 and 232,000
shares, respectively, available for future grants. The weighted average fair
values of ESPP options granted in 1997, 1996 and 1995 were $4.47, $2.36 and
$3.02 per share, respectively.
In 1997 and 1996, the Company granted warrants to purchase 261,000 and
60,000 shares of Common Stock, respectively. The grant date fair values of these
warrants for 1997 and 1996 were $14.88 and $4.90 per share, respectively. See
Note Q.
The Company has a 401(k) tax-deferred savings plan under which eligible
employees may authorize from 2% to 12% of their compensation to be invested in
employee-elected investment funds managed by an independent trustee. As
determined annually by the Board of Directors, the Company may contribute
matching funds of up to 50% of the employees' payroll deductions. During 1997,
1996 and 1995, the Company's contributions amounted to $401,000, $187,000 and
$167,000, respectively.
F-16
59
NOTE M -- EARNINGS PER SHARE
In 1997, the Company adopted Statement of Financial Accounting
Standards No. 128 "Earnings Per Share" ("SFAS 128"). This statement requires
dual presentation of newly defined basic and diluted earnings per share ("EPS")
on the face of the income statement for all entities with complex capital
structures. The following table provides a reconciliation of the numerators and
denominators of the basic and diluted per-share computations for the years ended
December 31, 1997, 1996 and 1995:
NET INCOME (LOSS) SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31, 1997: (thousands except per-share amount)
Basic EPS........................................ $ 28,996 25,204 $ 1.15
Effect of Dilutive Securities - Stock
Options and Warrants........................ -- 3,217
------- ------
Diluted EPS...................................... $ 28,996 28,421 $ 1.02
======= ======
FOR THE YEAR ENDED DECEMBER 31, 1996:
Basic EPS........................................ $ (2,511) 23,550 $ (0.11)
Effect of Dilutive Securities - Stock
Options and Warrants........................ -- --
------- ------
Diluted EPS...................................... $ (2,511) 23,550 $ (0.11)
======= ======
FOR THE YEAR ENDED DECEMBER 31, 1995:
Basic EPS........................................ $ 6,311 21,058 $ 0.30
Effect of Dilutive Securities - Stock
Options and Warrants........................ -- 3,046
------- ------
Diluted EPS...................................... $ 6,311 24,104 $ 0.26
======= ======
The computation of diluted number of shares excludes unexercised stock
options and warrants which are anti-dilutive. The number of such shares excluded
were 44,000, 4,955,000 and 325,000 for the years ended December 31, 1997, 1996
and 1995, respectively.
There were no transactions subsequent to December 31, 1997 which, had
they occurred prior to December 31, 1997, would have changed materially the
number of shares in the basic or diluted earnings per share computations.
F-17
60
NOTE N -- GEOGRAPHIC SEGMENTS AND FOREIGN OPERATIONS
The Company operates in one business segment. Transfers between
geographic areas are made at prices reflecting market conditions. Geographic
segment information including sales and transfers between geographic areas is
presented below:
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
------------------------------------
(thousands)
Revenues
United States ........................................ $ 108,757 $ 55,040 $ 55,801
Japan ................................................ 16,383 15,773 16,684
Other ................................................ -- 1,313 2,791
--------- -------- --------
Total ............................................ $ 125,140 $ 72,126 $ 75,276
========= ======== ========
Transfers between geographic areas
United States ........................................ $ 4,641 $ 5,197 $ 6,060
Japan ................................................ 154 -- --
Other ................................................ -- -- --
--------- -------- --------
Total ............................................ $ 4,795 $ 5,197 $ 6,060
========= ======== ========
Total revenues
United States ........................................ $ 113,398 $ 60,237 $ 61,861
Japan ................................................ 16,537 15,773 16,684
Other ................................................ -- 1,313 2,791
Intersegment eliminations ............................ (4,795) (5,197) (6,060)
-------- -------- --------
Total ............................................ $ 125,140 $ 72,126 $ 75,276
========= ======== ========
Income (Loss) from operations
United States ........................................ $ 24,047 $ (6,437) $ 3,441
Japan ................................................ 3,579 4,340 3,395
Other ................................................ -- 296 698
--------- -------- --------
Total ............................................ $ 27,626 $ (1,801) $ 7,534
========= ======== ========
Identifiable assets
United States ........................................ $ 121,343 $ 67,275 $ 69,741
Japan ................................................ 15,122 14,948 10,019
Other ................................................ -- 295 728
--------- -------- --------
Total ............................................ $ 136,465 $ 82,518 $ 80,488
========= ======== ========
U.S. export sales by destination of sale
Europe ............................................... $ 6,687 $ 6,498 $ 7,097
Other ................................................ 16,025 8,029 8,184
--------- -------- --------
Total ............................................ $ 22,712 $ 14,527 $ 15,281
========= ======== ========
F-18
61
NOTE O -- MAJOR CUSTOMERS
Sales to Bell Atlantic Corporation amounted to 23% of revenues in 1997.
Sales to Nippon Telegraph and Telephone amounted to 12% and 14% of revenues in
1996 and 1995, respectively, and sales to AT&T amounted to 12% of revenues in
1995.
NOTE P -- QUARTERLY FINANCIAL SUMMARY (UNAUDITED)
For the Years Ended December 31, QUARTERS
First Second Third Fourth
-----------------------------------------------------------
(thousands, except per-share data)
1997
- ----
Revenues....................................... $ 20,577 $ 25,077 $ 36,112 $ 43,374
Gross profit................................... 13,899 16,065 23,763 29,889
Income before provision for income
taxes......................................... 2,397 3,846 9,532 13,966
Net income..................................... 1,628 3,370 15,061 8,937
Earnings per share:
Basic..................................... $ 0.07 $ 0.14 $ 0.59 $ 0.34
Diluted................................... 0.06 0.12 0.52 0.31
1996
- ----
Revenues....................................... $ 11,860 $ 16,864 $ 19,396 $ 24,006
Gross profit................................... 7,265 10,123 11,986 16,070
Income (Loss) before provision for income
taxes....................................... (3,540) (1,151) 819 3,588
Net income (loss).............................. (3,968) (1,412) 275 2,594
Earnings (Loss) per share:
Basic..................................... $ (0.17) $ (0.06) $ 0.01 $ 0.11
Diluted................................... (0.17) (0.06) 0.01 0.10
Tekelec typically operates with a limited backlog, and most of its
revenues in each quarter result from orders received in that quarter. Further,
Tekelec typically generates a significant portion of its revenues for each
quarter in the last month of the quarter. Tekelec establishes its expenditure
levels based on its expectations as to future revenues, and if revenue levels
were to fall below expectations this would cause expenses to be
disproportionately high. Therefore, a drop in near-term demand would
significantly affect revenues, causing a disproportionate reduction in profits
or even losses in a quarter. Tekelec's quarterly operating results may fluctuate
as a result of a number of factors, including general economic and political
conditions (such as recessions in the U.S. and Japan), capital spending patterns
of Tekelec's customers, increased competition, variations in the mix of sales,
fluctuation in proportion of foreign sales, and announcements of new products by
Tekelec or its competitors.
F-19
62
NOTE Q -- COMMON STOCK
On August 22, 1997, the Company effected a two-for-one stock split. All
references to number of shares and per-share amounts have been restated to
reflect the stock split.
At December 31, 1997 and 1996, the Company had warrants outstanding to
purchase an aggregate of 204,367 and 80,000 shares of its Common Stock,
respectively, as more fully discussed as follows.
In July 1997, the Company issued warrants to purchase a total of
180,000 shares of its Common Stock to five directors and one corporate officer
at $28.16 per share. These warrants vest and become exercisable in 12 equal
quarterly installments beginning on September 30, 1997. During 1997, 2,500 of
these warrants were exercised, and 177,500 were outstanding at December 31,
1997.
In January 1997, the Company issued warrants to a director and
corporate officer to purchase 80,600 shares of its Common Stock at $9.31 per
share, all of which vested in 1997. During 1997, 53,733 of these warrants were
exercised, and 26,867 were outstanding at December 31, 1997.
In August 1996, pursuant to a consulting agreement between the Company
and a director, the Company issued warrants to purchase 60,000 shares of its
Common Stock at $4.75 per share to such director. These warrants vested during
1996, and were all outstanding at December 31, 1996. During 1997, all of these
warrants were exercised.
In 1992, the Company issued warrants to purchase a total of 40,000
shares of its Common Stock to two directors at $3.78 per share. These warrants
were repriced to $1.80 per share in 1993, and were exercisable in full at any
time prior to January 17, 1997. At December 31, 1996, 20,000 of these warrants
were outstanding. During 1997, the remaining 20,000 warrants were exercised.
On August 25, 1997, the Company adopted a shareholder rights plan to
protect shareholders against unsolicited attempts to acquire control of the
Company which do not offer what the Company believes to be an adequate price to
all shareholders. Under the plan, a dividend distribution of one right for each
outstanding share of Tekelec Common Stock was made to shareholders of record on
September 5, 1997, and such rights expire on September 5, 2007. Each right
entitles the registered holder to purchase from the Company one share of Common
Stock at a price of $180 per share, subject to adjustment (the "Purchase
Price").
The rights will be exercisable only if a person or group (except for
certain exempted persons or groups, including those shareholders of the Company
who at the time of adoption of the Plan beneficially owned more than 15% of
Tekelec Common Stock) acquires 15% or more of Tekelec's Common Stock or
announces a tender offer which would result in ownership of 15% or more of the
Common Stock.
F-20
63
Under the plan, if any person or group (other than the Company, any
subsidiary of the Company or any employee benefit plan of the Company or any
exempted person or group) acquires 15% or more of the Company's outstanding
voting stock without the prior written consent of the Company's Board of
Directors, each right, except those held by such acquiring persons or group,
would entitle each holder of a right to acquire such number of shares of the
Company's Common Stock as equals the result obtained by multiplying the then
current Purchase Price by the number of shares of Common Stock for which a right
is then exercisable and dividing the product by 50% of the then current
per-share market price of the Company's Common Stock.
The Company may redeem the rights at $0.01 per right at any time until
ten business days after a person or group acquires 15% or more of the Company's
outstanding shares. The Company also may, at any time after a person or group
acquires 15% or more, but less than 50%, of the Company's shares, exchange each
right for one share of Common Stock.
F-21
64
TEKELEC
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
Column A Column B Column C Column D Column E
- -------------------------------------------------------------------------------------------------------------------
Additions
Balance at Charged to Charged to Deductions Balance at
Beginning Costs and Other and other End of
Description of Period Expenses Accounts Adjustments Period
----------------------------------------------------------------------------------------------------------------
(thousands)
Year ended December 31, 1995:
- -----------------------------
Allowance for doubtful accounts $ 318 $ 120 $ -- $ 47 $ 391
Product warranty 827 581 -- 529 879
Inventory provision 1,089 315 -- 239 1,165
Deferred tax valuation allowance 9,496 775 -- -- 10,271
Year ended December 31, 1996:
- -----------------------------
Allowance for doubtful accounts $ 391 $ -- $ -- $ 23 $ 368
Product warranty 879 1,083 -- 407 1,555
Inventory provision 1,165 391 -- 241 1,315
Deferred tax valuation allowance 10,271 4,719 -- -- 14,990
Year ended December 31, 1997:
- -----------------------------
Allowance for doubtful accounts $ 368 $ 101 $ -- $ -- $ 469
Product warranty 1,555 655 -- 990 1,220
Inventory provision 1,315 775 -- 750 1,340
Deferred tax valuation allowance 14,990 -- -- 12,742 2,248
S-1 SCHEDULE II
65
EXHIBIT INDEX
Sequentially
Exhibit Numbered
Number Description Page
- ------- ----------- ------------
10.7 Schedule of Distributors........................
10.18 Description of the Company's Officer Bonus Plan
for the year ended December 31, 1997............
10.19 Description of the Company's Officer Bonus Plan
for the year ended December 31, 1998............
21.1 Subsidiaries of the Registrant..................
23.1 Consent of Coopers & Lybrand L.L.P. ............
27.1997 Financial Data Schedule for the year ended
December 31, 1997...............................
27.1996 Restated Financial Data Schedule for the year
ended December 31, 1996.........................
27.1995 Restated Financial Data Schedule for the year
ended December 31, 1995.........................
27.1997.1Q Restated Financial Data Schedule for the quarter
ended March 31, 1997............................
27.1997.2Q Restated Financial Data Schedule for the quarter
ended June 30, 1997.............................
27.1997.3Q Restated Financial Data Schedule for the quarter
ended September 30, 1997........................
27.1996.1Q Restated Financial Data Schedule for the quarter
ended March 31, 1996............................
27.1996.2Q Restated Financial Data Schedule for the quarter
ended June 30, 1996.............................
27.1996.3Q Restated Financial Data Schedule for the quarter
ended September 30, 1996........................