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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 31,1998 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 1, 1999 as reported on The Nasdaq Stock Market, was approximately
$486,000,000.
The number of shares outstanding of the registrant's Common Stock on
March 1, 1999, was 54,515,592.
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 14, 1999 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, 1998
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........ 36
Item 8. Financial Statements and Supplementary Data....................... 36
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.......................................... 36
PART III
Item 10. Directors and Executive Officers of the Registrant................ 37
Item 11. Executive Compensation............................................ 37
Item 12. Security Ownership of Certain Beneficial Owners and Management.... 37
Item 13. Certain Relationships and Related Transactions.................... 37
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.. 38
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PART I
ITEM 1. BUSINESS.
Tekelec (the "Company") designs, manufactures and markets innovative
switching solutions and diagnostic systems for the global communications
marketplace. Tekelec's solutions enable both traditional carriers and new
emerging carriers to rapidly deliver advanced communications products and
services in order to compete in today's fast-evolving public communications
network environment.
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). Derived from
the EAGLE switching platform, the Company's IP7(TM) suite of products enables
traditional carriers and new entrants to pursue cost-reduced and
performance-enhanced network architectures based on Internet Protocol (IP),
Asynchronous Transfer Mode (ATM) or other "packet" technologies.
The Company's switching products have been sold primarily to U.S.
Regional Bell Operating Companies (RBOCs), competitive local exchange carriers
(CLECs), interexchange carriers (IXCs), PCS and cellular operators,
international Postal Telephone and Telegraph Companies (PTTs) and independent
telephone companies (ITCs).
Switching products have been sold primarily through the Company's U.S.
direct sales force. In order to pursue emerging opportunities in Europe, the
Company established in 1998 a sales, marketing and support office in London. In
addition to the Company's direct sales efforts, the Company markets its
switching products through reference relationships with the Company's diagnostic
distributor base, and to a lesser extent through various third-party
distribution and marketing relationships.
The Company's MGTS and Chameleon diagnostic product lines enable
carriers and communications equipment suppliers to ensure conformance to
specifications and to evaluate network performance in controlled environments,
without subjecting "live" networks to risk. Introduced in 1998, the MGTS
Sentinel(TM) enables carriers to monitor the performance of in-service networks.
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. The MGTS, MGTS
Sentinel and Chameleon products are sold through the Company's direct sales
force and through its global distributor network.
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INDUSTRY BACKGROUND
The telecommunications industry has experienced and is continuing to
experience rapid and dynamic changes resulting from deregulation and, more
importantly, significant advances in switching technologies that, until
recently, were applied only in data networks. The migration of these data
technologies to the Public Switched Telecommunications Network (PSTN) is
commonly referred to as "convergence", and frequently includes a reference to
voice telephony over Internet Protocol or voice telephony over Asynchronous
Transfer Mode.
Convergence generally includes telecommunications carriers' objective
to channel traditional circuit-based voice switching technologies over more
technologically efficient and cost-effective packet-switched technologies.
Ideally, true convergence would allow carriers to use identical network
architectures and infrastructure to accommodate traditional voice traffic and
rapidly growing data payloads.
For more than a century, engineering the PSTN has revolved primarily
around voice call statistics. Measurements such as average call duration,
percentage of local calls versus long distance, and the distribution of calls
throughout each day have historically determined the size of switching devices
and the transmission paths to facilitate them. A measurable change in any of
these statistics would significantly affect the capability of the network to
perform as expected.
The vast majority of PSTN communications paths in today's network are
circuit-oriented. Consequently, for the duration of the call dialogue, the
circuit connecting users of the network is considered dedicated to that dialogue
and a certain unit of bandwidth is consumed for the duration of the call. This
model is known as circuit-switched communications, wherein a physical circuit is
completely dedicated to the transmission.
An alternative model of communications is the "packet switched" model.
Under this model, communications are packaged in discrete units and routed on a
packet-by-packet basis. Packet switching is significantly more cost- and
material-efficient than circuit switching in that packets are not exchanged when
the dialogue is not active. Industry research suggests that transmitting the
same amount of "data" via packet-switching technologies would prove more
efficient than traditional circuit switching by at least one order of magnitude.
Even though the core of some voice transmission networks is "packet
oriented," these networks still do not benefit from the full advantages of
completely packetized networks. The maximum benefit of end-to-end packet
switching will only be realized when the switching components (versus the
transmission components) in today's networks are migrated from circuit switch
technology to packet switch technology.
While the critical elements of the future converged voice and data
networks have yet to be defined, most industry experts expect a highly complex
protocol called Common Channel Signaling System #7 ("SS7") to play a key
enabling role in their deployment.
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Intelligent Network and Advanced Intelligent Network Switching
The Intelligent Network (IN) utilizes 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 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) - Traditionally, an SCP has been a
computer database that is accessed by STPs or SSPs for customer call routing and
other special information required for AIN services. The Company has developed
applications that integrate SCP functionality into the EAGLE STP, such as the
Company's EAGLE STP / LNP product.
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, administration and management.
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. The growth of the Internet has also increased the need for SS7 to
provide signaling connectivity for
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evolving networks based on Internet Protocol (IP) and Asynchronous Transfer Mode
(ATM) and to implement internet offload solutions to carry internet traffic more
efficiently.
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 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 telecommunications network service providers.
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, enable AIN applications, or offer integrated,
multi-service platforms such as the EAGLE STP / LNP solution, 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, PCS and cellular operators
and IP-based carriers. 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 buses 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 capability enabling Service
Provider Local Number Portability on the EAGLE allows carriers to eliminate the
need for significant numbers of dedicated Service Control Point (SCP) general
purpose computers.
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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., IP, 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., IP,
ATM, Frame Relay, SS7, ISDN and BERT).
- 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.
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The Company's principal intelligent network diagnostic products are
described below.
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 geographical areas.
MGTS Companion(TM). The compact and portable MGTS Companion takes the
power and capabilities of the lab-based MGTS to the field. It is used by field
technicians in first office application testing, equipment installation
acceptance testing and complex signaling systems integration. MGTS companion
also enables sophisticated field-based troubleshooting of installed signaling
products. With PASM, MGTS Companion enables field technicians to either develop
custom test scenarios, or use scenarios that were designed in the lab, to
simulate or test intelligent network services for wireline and wireless
networks. MGTS Companion is also used to test roaming and other GSM network
services.
MGTS Sentinel(TM). Introduced in mid-1998, MGTS Sentinel is a complete
network maintenance and diagnostic system that provides telephony operators
total visibility of and access to their SS7 networks. MGTS Sentinel includes
network surveillance capabilities and fault-management functions. It provides a
combination of passive monitoring and proactive testing capabilities that enable
service providers to perform problem detection and analysis as well as verify
fixes from a centralized location on a single platform. In addition to reducing
operations costs, MGTS Sentinel enables network operators to enhance the quality
of the services they provide. It also has an open interface to accommodate
additional applications such as those used for fraud prevention, billing
verification, and quality of service measurement.
The Company's principal data network diagnostic products are described
below.
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 product operates with the same hardware and
software packages, and thus provides customers with the most flexible test
applications for portability and remote testing.
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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.
List prices for the Company's principal diagnostic products for
equipment design and test range from approximately $50,000 to $200,000,
depending on configuration. List prices for the Company's principal diagnostic
products for network monitoring and maintenance range from approximately $50,000
to $2,000,000, 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, IP 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 or new features 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
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Company engages in development projects for special applications for customers.
The Company typically retains the right to use such technology in future
products that are not competitive with the specific application for which the
development work was performed.
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 $26.4
million, $21.0 million and $17.1 million in 1998, 1997 and 1996, 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, Washington and Japan. As of March 1, 1999, the Company had 243 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.
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 traditional circuit-based
telephony markets and to expand into the emerging packet-based telephony
networks with new products and applications. The Company also intends to expand
its international presence through additional sales personnel and
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product enhancements targeted to the international market. 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 MGTS Sentinel
product is to focus on sales to the traditional circuit-based telephony markets
and to expand into the emerging packet-based telephony networks with new
products and applications. The Company also intends to expand its international
presence through additional sales personnel and product enhancements targeted to
the international market.
The Company's sales and marketing strategy for its other 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 to a lesser extent, through strategic relationships with various
third-parties. The Company's direct sales forces operate out of the Company's
headquarters in Calabasas, California and its regional offices located in
Colorado, Illinois, 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 30
distributors and a wholly owned subsidiary in Japan. The Company's Japanese
subsidiary, which presently sells only diagnostic products, generated
approximately 12%, 13% and 22% of the Company's revenues for 1998, 1997 and
1996, respectively. During 1998, the Company formed a subsidiary in the United
Kingdom to conduct sales and marketing activities primarily for switching
products.
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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. Twenty four 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 7%, 10% and 13% of
revenues in 1998, 1997 and 1996, 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, D
and M 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 strategic marketing and sales
alliance with Bellcore under which the Company and Bellcore will jointly market
each other's products and also exchange interfaces and potentially other product
specifications to allow the interworking of the Company's EAGLE IP7 Gateway and
Bellcore's ISCP(R) System. The Company believes that these relationships
demonstrate recognition of the technical advantages of the EAGLE STP and IP7
products, and that these agreements provide the Company with additional
opportunities to penetrate the SS7 network switching marketplace and the
convergence market. Through the Company's relationships with Lucent, Daewoo and
Bellcore, 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, except for Daewoo, do not require minimum
purchases. Furthermore, Lucent and Bellcore are not precluded from selling
products that are competitive with the Company's products. Although the
Company's current
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sales through its relationships with Lucent and Bellcore are not significant, a
termination of the Company's relationship with Lucent or Bellcore, or the sale
of competing products by Lucent or Bellcore, 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 1998, the Company shipped approximately 62 pairs of EAGLE STPs
to 35 customers worldwide and 780 units of its diagnostic products to over 190
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. No customer accounted for more than 10% of
the Company's revenues in 1998.
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 Company's largest customers in 1998 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
14
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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 within 15 to 30 days after 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 by the customer, the Company's backlog at any particular date may
not be a meaningful indicator of future financial results. At December 31, 1998,
the Company's backlog amounted to approximately $72.8 million, of which $45.3
million related to EAGLE STP service warranty. This compared to a backlog of
$59.0 million at December 31, 1997, of which $28.7 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.
The Company has a computerized manufacturing inventory control system
that 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 operations in 1996 and for
its intelligent network diagnostics operations in 1997.
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The Company has obtained CE Mark registration for its principal
diagnostic products and for its EAGLE STP 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 that 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 Alcatel Alstom S.A. and
Northern Telecom Ltd. 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, both domestically
and internationally, offer products with the best price/performance profile and
be responsive to customers' needs for new features and services.
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.
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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 patent, trade secret, copyright
and trademark laws and contractual restrictions to establish and protect
proprietary rights in 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 use 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 misappropriation of
the Company's technologies 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 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
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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 1, 1999, the Company had 581 employees, comprising 203 in
sales, marketing and support, 71 in manufacturing, 243 in research, development
and engineering and 64 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. Virtually all of the Company's
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 that
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.
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.
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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.
SMS (Service Management System)................ A proprietary application that 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
that 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.
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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 world- wide
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.
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.
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ITEM 2. PROPERTIES.
The Company's executive offices, as well as its principal manufacturing
operations, are located in an approximate 58,000 square-foot facility in
Calabasas, California, under a lease that expires in November 2004 with an
option to extend for an additional five years.
The Company also occupies two facilities comprising 98,000 square feet
in Morrisville, North Carolina, under leases expiring in March and September,
2003, primarily for engineering, product development, customer support and
regional sales activities for its network switching and intelligent network
diagnostics products. In November 1998, the Company agreed to lease a 152,000
square-foot facility in Morrisville, North Carolina. Under the terms of this
lease, the Company will terminate its current leases in North Carolina without
penalty. The Company intends to occupy the new facility and terminate its
current leases upon completion of construction of the new facility currently
scheduled for November 1999. The Company also has five regional sales offices
occupying an aggregate of approximately 9,000 square feet under leases expiring
between 1999 and 2001 in Campbell, California; Aurora, Colorado; Lombard,
Illinois; Tinton Falls, New Jersey and Irving, Texas. Additionally, the Company
has a research and development facility in Woodinville, Washington occupying
approximately 2,100 square feet under a lease expiring in November 1999. The
Company's Japanese subsidiary occupies approximately 10,600 square feet in Tokyo
under leases expiring between April 1999 and November 1999. The Company's
subsidiary in the United Kingdom occupies approximately 300 square feet in
London under a month-to-month lease. The Company believes that its existing
facilities will be adequate to meet its needs at least through 1999, and that 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
Stock Market 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 Stock
Market. As of March 1, 1999, there were 238 record holders of the Company's
Common Stock and approximately 9,000 beneficial holders based on information
provided by the Company's transfer agent and proxy solicitation agent.
High Low
----------- -----------
1997
First Quarter ................................. $ 5.74 $ 4.13
Second Quarter ................................ 9.44 4.75
Third Quarter ................................. 19.85 8.82
Fourth Quarter ................................ 23.57 13.97
1998
First Quarter ................................. $ 22.69 $ 14.05
Second Quarter ................................ 25.13 19.94
Third Quarter ................................. 24.63 13.75
Fourth Quarter ................................ 22.25 10.63
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, 1998, 1997 and
1996 and the balance sheet data set forth below at December 31, 1998 and 1997
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,
1995 and 1994 and the balance sheet data set forth below at December 31, 1996,
1995 and 1994 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, 1998 1997 1996 1995 1994
---------------------------------------------------------------------
(thousands, except per-share data)
STATEMENT OF OPERATIONS DATA:
Revenues ........................................ $176,669 $125,140 $ 72,126 $ 75,276 $ 61,189
Income (Loss) before provision
for income taxes .............................. 55,551 29,741 (284) 8,450 5,711
Net income (loss) ............................... 39,209 28,996 (2,511) 6,311 4,460
Earnings (Loss) per share(1):
Basic ....................................... $ 0.73 $ 0.58 $ (0.05) $ 0.15 $ 0.13
Diluted ..................................... 0.67 0.51 (0.05) 0.13 0.12
Weighted average number of shares outstanding(1):
Basic ....................................... 53,518 50,408 47,100 42,116 34,736
Diluted ..................................... 58,708 56,842 47,100 48,207 37,259
BALANCE SHEET DATA (at December 31):
Cash and investments ............................ $113,774 $ 70,518 $ 44,244 $ 43,609 $ 7,653
Working capital ................................. 108,762 86,354 44,688 56,983 13,466
Total assets .................................... 210,242 136,465 82,518 80,488 34,409
Long-term liabilities ........................... 2,252 2,839 1,061 380 654
Shareholders' equity ............................ 165,777 107,877 61,751 63,607 18,720
- -----------------
(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 July 6, 1998.
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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 currently organized into two divisions: Network Switching
and Intelligent Network Diagnostics. In January 1999, the Company scaled down
its Data Network Diagnostics Division and integrated this division into its
Intelligent Network Diagnostics Division. The Company's most successful data
network diagnostics efforts have been in the high speed links environment such
as for SS7 over ATM and High Speed Frame Relay. These programs are synergistic
with the Company's intelligent network diagnostics programs. By combining these
programs, the Company believes it can better focus on future opportunities for
its diagnostic products.
The Network Switching Division develops and markets products, features
and applications based on the Company's EAGLE platform, a high-capacity packet
switch supporting a variety of advanced switching technologies including SS7,
IP, ATM and others, enabling traditional circuit-based operators and new,
packet-based operators to offer value-added services to their respective
customers.
The Intelligent Network Diagnostics Division develops and markets
diagnostic products for the communications marketplace. These products,
principally the MGTS products for intelligent network diagnostics and the
Chameleon family of data network diagnostics products, 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,
----------------------------------
1998 1997 1996
----------------------------------
Revenues ...................................... 100.0% 100.0% 100.0%
Cost of goods sold ........................ 33.3 33.2 37.0
------ ------ ------
Gross profit .................................. 66.7 66.8 63.0
Research and development .................. 14.9 16.8 23.7
Selling, general and administrative ....... 22.9 27.9 41.4
Restructuring ............................. -- -- 0.4
------ ------ ------
Income (Loss) from operations ................. 28.9 22.1 (2.5)
Interest and other income, net ............ 2.6 1.7 2.1
------ ------ ------
Income (Loss) before provision for income taxes 31.5 23.8 (0.4)
Provision for income taxes ................ 9.3 0.6 3.1
------ ------ ------
Net income (loss) ....................... 22.2% 23.2% (3.5)%
====== ====== ======
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,
--------------------------------
1998 1997 1996
--------------------------------
Network switching ................. 66% 58% 35%
Intelligent network diagnostics ... 26 29 36
Data network diagnostics .......... 8 13 29
----- ----- -----
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,
------------------------------------
1998 1997 1996
------------------------------------
North America .. 69% 73% 58%
Japan .......... 12 13 22
Europe ......... 4 5 9
Rest of World .. 15 9 11
------ ------ ------
Total .... 100% 100% 100%
====== ====== ======
27
28
1998 COMPARED WITH 1997
Revenues
The Company's revenues increased by $51.5 million, or 41%, during 1998
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 62%, or $44.3 million, to
$116.3 million due primarily to increased EAGLE STP market acceptance worldwide
as reflected by higher international sales, increased sales of upgrades and
software enhancements to the Company's larger EAGLE STP installed base and
higher sales of Local Number Portability (LNP) and Local Service Management
System (LSMS) features. In 1998, the Company sold 62 pairs of EAGLE STPs
compared with 45 pairs in 1997.
Revenues from intelligent network diagnostics products increased by 27%,
or $9.7 million, to $46.3 million. This increase was primarily driven by higher
sales of development services in Japan and the addition of sales of the
Company's MGTS Sentinel product domestically, partially offset by lower MGTS
product sales in Japan.
Revenues from data network diagnostics products decreased by 15%, or
$2.5 million, to $14.1 million primarily due to lower sales of the Company's
Chameleon products in all markets, partially offset by increased sales of
third-party data diagnostics products in Japan by the Company's Japanese
subsidiary.
Revenues in North America increased by $29.9 million, or 33%, as a
result of higher switching and MGTS product sales, partially offset by lower
Chameleon product sales. Revenues in Japan increased by $5.6 million, or 34%,
due primarily to higher sales of MGTS-related development services and
third-party data diagnostics products, partially offset by lower Chameleon and
MGTS product sales. Revenues in Europe increased by $1.1 million, or 16%, due to
higher switching product sales. Other international revenues increased by $15.0
million, 141%, primarily due to higher switching product sales including a large
sale in South Africa.
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 $1.5 million, or 1%, 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 products and related applications,
the MGTS Sentinel, and market acceptance of the Company's recently introduced
EAGLE IP7 and FALCON product lines. In 1998, the Company experienced significant
revenue growth, particularly in switching products. The Company expects that
switching product sales will continue to grow in 1999, both in dollars and as a
percentage of total revenues, although at a lower percentage rate of growth than
in 1998.
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29
Gross Profit
Gross profit as a percentage of revenues was essentially flat at 67%.
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 $5.4 million, or
25%, such expenses decreased as a percentage of revenues from 17% in 1997 to 15%
in 1998. The dollar increase was attributable primarily to ongoing development
expenses in the Network Switching Division with respect to development of new
features for the EAGLE products and consisted principally of expenses incurred
in connection with the hiring of additional personnel and higher depreciation
expense resulting from equipment acquisitions.
The Company intends to continue to make substantial investments in
product and technology development and believes that its future success depends
in large part upon its ability to continue to enhance existing products and to
develop or acquire new products that maintain its technological competitiveness.
Selling, General and Administrative
Although selling, general and administrative expenses increased by $5.5
million, or 16%, such expenses decreased as a percentage of revenues from 28% in
1997 to 23% in 1998. The increase in dollars was attributable primarily to
increased infrastructure costs required to meet the needs of the growing EAGLE
installed base and to support higher sales levels of switching and intelligent
network diagnostics products. Sales, general and administrative expenses were
reduced in 1998 by the proceeds from the settlement of an insurance claim in the
amount of approximately $1.7 million, net of applicable costs.
Income Taxes
During 1998, the Company recorded tax benefits of $3.7 million resulting
from a reduction of its valuation allowance for deferred taxes, and tax benefits
associated with research and development tax credits. 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 Company's
ability to utilize certain research and development tax credit carryforwards.
For the year ended December 31, 1998, excluding the one-time tax benefits, the
Company had a tax provision of $20.0 million, resulting in an effective tax rate
of 36%. For 1997, the Company had an effective tax rate of 33% excluding a
one-time tax benefit of $9.0 million resulting from a reduction of its valuation
allowance for deferred taxes.
Interest, Net
Net interest income increased by $2.4 million primarily as a result of
higher average investment balances in 1998.
29
30
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 184%, or $46.6 million, to
$71.9 million due primarily to increased EAGLE STP market acceptance principally
in the U.S., and the addition of sales of the Company's LNP and related 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 pairs in 1996.
Revenues from intelligent network diagnostics products increased by 43%,
or $11.0 million, to $36.6 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 21%, or
$4.6 million, to $16.6 million primarily due to lower sales in all markets for
both the Chameleon Open and the Company's older Chameleon products.
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.
30
31
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.
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.
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 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.
LIQUIDITY AND CAPITAL RESOURCES
During 1998, cash and cash equivalents decreased by $6.8 million to
$31.9 million, after a net purchase of approximately $50.1 million of short-term
and long-term investments. Operating activities, including the effects of
exchange rate changes on cash, provided $44.5 million. Financing activities,
which represented proceeds from the issuance of Common Stock upon the exercise
of options and warrants, provided $7.6 million and investing activities,
excluding purchases of short-term and long-term investments, used $8.9 million.
31
32
Accounts receivable at December 31, 1998, including amounts due from
related parties, increased by 80% compared to December 31, 1997, due primarily
to increased sales levels and a higher concentration of sales at the end of the
fourth quarter of 1998 compared to 1997. Inventories increased by 14% during
1998 primarily to support the increased sales levels and the expanded breadth of
the Company's products. Trade accounts payable and accrued expenses increased by
122% and 86%, respectively, primarily due to the timing of purchases and
increased level of operating expenses incurred by the Company primarily to
support higher sales levels and the Company's product development programs.
Deferred revenues increased by 21% primarily as a result of increased extended
warranty service revenues that are recognized ratably over the warranty period
and the timing of installation activities.
Capital expenditures were $8.7 million during 1998 and represented the
planned acquisition of equipment principally for research and development,
manufacturing operations and facility expansion. The Company expects capital
expenditures will increase significantly in 1999, principally for the
acquisition of equipment for research and development, sales demonstration and
manufacturing operations to support the Company's planned growth.
Net cash provided by financing activities in 1998 was $7.6 million,
which represented proceeds from the issuance of Common Stock upon the exercise
of options and warrants.
In July 1998, the Company renewed its credit facility with a U.S. bank
and increased the maximum line of credit available thereunder from $10.0 million
to $15.0 million. The Company also has lines of credit aggregating $3.9 million
available to its Japanese subsidiary from various Japan-based banks.
The Company's $15.0 million credit facility is collateralized by
substantially all of the Company's assets, bears interest at, or in some cases
below, the lender's prime rate (7.75% at December 31, 1998), and expires on June
30, 2000, 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 $3.9 million with interest at the Japanese prime
rate (1.5% at December 31, 1998) plus 0.125% per annum, which expire between
August 5, 1999, and March 31, 2000, if not renewed.
There were no borrowings by the Company under the lines of credit
described above or any other lines of credit in 1998 or 1997.
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 1999. 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.
32
33
Foreign Exchange
International operations are subject to certain opportunities and risks,
including currency fluctuations. In 1998, 1997 and 1996, the percentages by
which weighted average exchange rates for the Japanese yen weakened against the
U.S. dollar were 7%, 9% and 18%, respectively.
The change in cumulative translation adjustments in 1998 was due
primarily to the strengthening of the Japanese yen against the U.S. dollar when
comparing the exchange rate at December 31, 1998, to that of December 31, 1997.
Realized exchange gains (losses) are recorded in the period when incurred, and
amounted to $56,000, $(273,000) and $(180,000) in 1998, 1997 and 1996,
respectively. Exchange gains and losses include the remeasurement of certain
currencies into functional currencies and the settlement of intercompany
balances.
Readiness for Year 2000
Background. As the year 2000 approaches, a critical issue has emerged
regarding how existing application software programs, operating systems and
embedded computer chips can accommodate the year 2000 date value. The Company
has a year 2000 project team in place with overall responsibility for the
Company's year 2000 compliance programs. In addition, executive management
regularly monitors the status of the Company's year 2000 remediation plans.
Project. The Company has identified potential year 2000 risks in four
categories: software and system products the Company sells to customers;
internal business software and information technology systems; systems other
than information technology systems ("Non-IT systems"); and third-party
suppliers to the Company. The Company's year 2000 project includes the following
phases for the first three categories above: (1) identifying year 2000 risks;
(2) assigning priorities to identified risks; (3) testing year 2000 compliance
for risks determined to be material to the Company; (4) correcting problems
determined to be material and not year 2000 compliant; (5) retesting corrections
that have been implemented; and (6) developing contingency plans. With respect
to the Company's third-party suppliers, the Company's year 2000 project consists
of the following phases: (1) contacting suppliers for information concerning
their year 2000 readiness; (2) prioritizing suppliers as to relative importance;
(3) validating supplier responses regarding year 2000 compliance; and (4)
developing contingency plans in the event that one or more suppliers fail to
achieve year 2000 compliance.
Assessment. The software and systems products that the Company sells to
customers consist of internally developed software, third-party software
licensed by the Company for use in or with the Company's products, hardware
systems designed and manufactured by the Company and hardware systems designed
and manufactured by third parties. The Company has identified priorities,
completed the initial testing phase and begun offering solutions to its
customers. The Company believes that its current product offerings are year 2000
compliant. For past product offerings that the Company is still supporting, the
Company is offering releases that should make such products year 2000 compliant.
However, failure to achieve year 2000 compliance for any products could
materially adversely affect sales in 1999. Additionally, if any of the Company's
mission critical products were to fail in the field as a result of year 2000
noncompliance, such failure could result in substantial liability to the Company
and have a material adverse effect on the Company's financial results, business,
market position, reputation and prospects.
33
34
Internal business software and systems consist primarily of the Company's
business information systems in the United States and at the Company's Japanese
subsidiary. The Company has completed its initial year 2000 project phases with
respect to its business systems, and is in the process of developing,
implementing and testing the necessary modifications. The Company believes that
its internal business software and systems will be year 2000 compliant. However,
if the Company's business systems are not year 2000 compliant, the Company could
experience interruptions to its production process, development programs and
general business operations.
The Company has been advised by the suppliers of its Non-IT systems, which
consist primarily of environmental systems such as fire suppression and security
systems in the various buildings the Company occupies, that such systems are
year 2000 compliant.
Third-party suppliers provide component parts, purchased assemblies and contract
manufacturing services incorporated by the Company into the products and systems
it sells. The Company is requiring that each of its key suppliers certify
whether they are year 2000 compliant. The Company has also prioritized its
suppliers by level of criticality to the Company's business. Based on
information received from its suppliers, the Company estimates that
approximately 41% of its critical suppliers are presently year 2000 compliant.
The Company plans to monitor its critical suppliers and either develop alternate
sources or increase inventory levels prior to the year 2000 for those vendors
considered to be at risk of not timely achieving year 2000 compliance. However,
there can be no assurance that such alternate sources will be available or that
adequate inventory levels will be attainable if necessary, and the Company could
experience parts shortages and production interruptions if one or more key
third-party suppliers experience year 2000 problems.
Costs. Incremental costs of the Company's year 2000 project have
consisted of the hiring of two contractors to assist with administrative duties
related to the year 2000 project, consulting by PricewaterhouseCoopers LLP at
the initial stages of the project and a third-party audit team, which provides
year 2000 compliance test audit reports. Such costs in the aggregate have not
been material to the Company's financial position, results of operations or cash
flows. The balance of the effort for the Company's year 2000 project has been by
employees whose costs for this project are not tracked separately. The Company
believes that costs for the remainder of the year 2000 project will not be
material to the Company's financial position, results of operations or cash
flows.
Risks. The Company's results of operations, financial condition and cash
flows could be materially adversely affected if the Company or any of its key
suppliers or customers do not achieve year 2000 compliance. Although the
Company's year 2000 project is expected to minimize the Company's risks of
experiencing a year 2000 problem, inherent risks and uncertainties exist despite
the Company's efforts. There can be no assurance that a failure on the part of
the Company, its products, its key suppliers or its customers will not be
disruptive to the Company's business. As a result of these uncertainties the
Company is unable to determine at this time whether the consequences of year
2000 failures will have a material effect on the Company's results of
operations, financial condition or cash flows.
34
35
Reorganization
In January 1999, the Company announced its decision to scale down its
Data Network Diagnostics Division and integrate the division into its
Intelligent Network Diagnostics Division. In connection with this activity, the
Company will record a charge of approximately $1.8 million in the first quarter
of 1999, which represents a workforce reduction of 25 employees and the
write-off of certain assets related to the Data Network Diagnostics Division.
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995
The statements that are not historical facts contained in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations and other sections of this Annual Report on Form 10-K are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 that reflect the current belief, expectations or
intent of the Company's management. These statements are subject to and involve
certain risks and uncertainties including, but not limited to, timing of
significant orders and shipments, changes in customer product mix, customer
acceptance of the Company's products, capital spending patterns of customers,
including shifts in such patterns as a result of customers' deferral of product
purchases until the year 2000, competition and pricing, new product
introductions by the Company or its competitors, carrier deployment of
intelligent network services, the level and timing of research and development
expenditures, regulatory changes, readiness for the year 2000 by the Company,
its customers and its suppliers, general economic conditions and other risks
described in this Annual Report on Form 10-K and in certain of the Company's
other Securities and Exchange Commission filings. Many of these risks and
uncertainties are outside of the Company's control and are difficult for the
Company to forecast or mitigate. Actual results may differ materially from those
expressed or implied in such forward-looking statements.
35
36
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 on
Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Inapplicable.
36
37
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 14, 1999, 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 14, 1999, 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 14, 1999, 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 14, 1999, entitled "Certain Relationships and
Related Transactions," to be filed with the Commission.
37
38
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, 1998 F-2
- Consolidated Balance Sheets as of December 31, 1998 and 1997 F-3
- Consolidated Statements of Cash Flow for each of the
three years in the period ended December 31, 1998 F-4
- Consolidated Statements of Shareholders' Equity for each of
the three years in the period ended December 31, 1998 F-5
- Consolidated Statements of Comprehensive Income for each
of the three years in the period ended December 31, 1998 F-6
- Notes to Consolidated Financial Statements F-7
- Report of Independent Accountants on Financial Statement
Schedule S-1
- Schedule II Valuation and Qualifying Accounts and Reserves
for each of the three years in the period ended
December 31, 1998 S-2
Schedules which are not listed above have been omitted because they are
not applicable or the information required to be set forth therein is included
in the consolidated financial statements or notes thereto.
LIST OF EXHIBITS
3.1 Amended and Restated Articles of Incorporation(1)
3.2 Bylaws, as amended(2)
4.1 Rights Agreement dated as of August 25, 1997 between the
Registrant and U.S. Stock Transfer Corporation as Rights
Agent(3)
38
39
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), March 19,
1997(9), and March 20, 1998(5)(10)
10.4 Retirement Pension Rules of Tekelec, Ltd.(5)(11)
10.5 Form of Indemnification Agreement between the Registrant and all
directors of the Registrant(5)(12)
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(13)
10.7 Form of International Distributor Agreement(14) and Schedule of
Distributors
10.8 Officers Severance Plan, including form of Employment Separation
Agreement (5)(15), as amended March 8, 1999
10.9 Employee Stock Purchase Plan, including form of subscription
agreement(5)(7)
10.10 Credit Agreement dated October 22, 1996 between the Registrant
and Imperial Bank, together with Promissory Note of the
Registrant dated October 22, 1996(2), amended by First Amendment
to Credit Agreement dated July 15, 1998, together with
Promissory Note of the Registrant dated July 15, 1998(1)
10.11 General Security Agreement dated October 22, 1996 between the
Registrant and Imperial Bank(2)
10.12 Agreement dated September 9, 1997 between the Registrant and
Shigeru Suzuki(3), as amended by Agreement dated January 6,
1998(16)
10.13* Distribution and OEM Agreement dated as of June 1, 1997 between
the Registrant and Daewoo Telecom, Ltd.(3)
10.14 Warrants to purchase shares of the Company's Common Stock and
Schedule of Warrantholders(5)(17)
39
40
10.15 Stock Award Agreement dated February 17, 1998 between the
Registrant and Michael Margolis(16)
10.16 Lease dated as of November 6, 1998 between the Registrant and
Weeks Realty, L.P., covering the Company's facilities in
Morrisville, North Carolina
10.17 Employment Offer Letter dated January 13, 1999 between the
Registrant and Teresa Pippin
21.1 Subsidiaries of the Registrant
23.1 Consent of PricewaterhouseCoopers LLP
27.1 Financial Data Schedule for the year ended December 31, 1998
- ----------------------
* 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, 1998.
(2) Incorporated by reference to the Registrant's Annual Report on Form 10-K
(File No. 0-15135) for the year ended December 31, 1996.
(3) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q (File No. 0-15135) for the quarter ended September 30, 1997.
(4) Incorporated by reference to 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.
(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.
40
41
(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 Registration Statement on
Form S-8 (Registration No. 333-71261) filed with the Commission on
January 27, 1999.
(11) Incorporated by reference to the Registrant's Annual Report on Form 10-K
(File No. 0-15135) for the year ended December 31, 1994.
(12) Incorporated by reference to the Registrant's Annual Report on Form 10-K
(File No. 0-15135) for the year ended December 31, 1987.
(13) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q (File No. 0-15135) for the quarter ended June 30, 1988.
(14) 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.
(15) Incorporated by reference to the Registrant's Annual Report on Form 10-K
(File No. 0-15135) for the year ended December 31, 1993.
(16) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q (Filed No. 0-15135) for the quarter ended March 31, 1998.
(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, 1998.
(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.
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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 29, 1999
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 29, 1999
- -------------------------------
Jean-Claude Asscher
/s/ Michael L. Margolis President, Chief Executive March 29, 1999
- ------------------------------- Officer and Director
Michael L. Margolis
/s/ Robert V. Adams Director March 29, 1999
- -------------------------------
Robert V. Adams
/s/ Daniel L. Brenner Director March 29, 1999
- -------------------------------
Daniel L. Brenner
/s/ Howard Oringer Director March 29, 1999
- -------------------------------
Howard Oringer
/s/ Jon F. Rager Director March 29, 1999
- -------------------------------
Jon F. Rager
/s/ Gilles C. Godin Vice President, Finance and March 29, 1999
- ------------------------------- Chief Financial Officer
Gilles C. Godin
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43
REPORT OF INDEPENDENT ACCOUNTANTS
To The Shareholders And Board Of Directors Of Tekelec
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, cash flow, shareholders' equity, and
comprehensive income present fairly, in all material respects, the financial
position of Tekelec and its subsidiaries (the "Company") at December 31, 1998
and 1997, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/
PricewaterhouseCoopers LLP
Woodland Hills, California
February 2, 1999
F-1
44
TEKELEC
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1998 1997 1996
-----------------------------------------------------
(thousands, except per-share data)
REVENUES ........................................... $ 176,669 $ 125,140 $ 72,126
COSTS AND EXPENSES:
Cost of goods sold ............................. 58,902 41,524 26,682
Research and development ....................... 26,371 21,019 17,076
Selling, general and administrative ............ 40,458 34,971 29,842
Restructuring .................................. -- -- 327
----------- ----------- -----------
Total costs and expenses ..................... 125,731 97,514 73,927
----------- ----------- -----------
Income (Loss) from operations ...................... 50,938 27,626 (1,801)
Other income (expense):
Interest, net .................................. 4,785 2,378 1,693
Other, net ..................................... (172) (263) (176)
----------- ----------- -----------
Total other income ........................... 4,613 2,115 1,517
Income (Loss) before provision for income taxes .... 55,551 29,741 (284)
----------- ----------- -----------
Provision for income taxes ..................... 16,342 745 2,227
----------- ----------- -----------
NET INCOME (LOSS) ............................ $ 39,209 $ 28,996 $ (2,511)
=========== =========== ===========
EARNINGS (LOSS) PER SHARE(1):
Basic ........................................ $ 0.73 $ 0.58 $ (0.05)
Diluted ...................................... 0.67 0.51 (0.05)
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING(1):
Basic ........................................ 53,518 50,408 47,100
Diluted ...................................... 58,708 56,842 47,100
- --------------
(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 July 6, 1998.
See notes to consolidated financial statements
F-2
45
TEKELEC
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-------------------------------
1998 1997
-------------------------------
(thousands, except share data)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .......................................... $ 31,932 $ 38,748
Short-term investments, at fair value .............................. 37,704 19,773
Accounts and notes receivable, less allowances
1998 -- $763; 1997 -- $469 ..................................... 54,606 29,141
Inventories ........................................................ 12,872 11,281
Amounts due from related parties ................................... 1,896 2,286
Income taxes receivable ............................................ 32 805
Deferred income taxes, net ......................................... 8,616 8,309
Prepaid expenses and other current assets .......................... 3,317 1,760
----------- -----------
Total current assets ............................................. 150,975 112,103
Long-term investments, at fair value ................................... 44,138 11,997
Property and equipment, net ............................................ 12,859 9,841
Deferred income taxes, net ............................................. 1,514 1,999
Other assets ........................................................... 756 525
----------- -----------
Total assets ..................................................... $ 210,242 $ 136,465
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable ............................................. $ 10,904 $ 4,919
Accrued expenses ................................................... 10,932 5,862
Accrued payroll and related expenses ............................... 5,660 6,846
Current portion of deferred revenues ............................... 10,480 7,693
Income taxes payable ............................................... 4,237 429
----------- -----------
Total current liabilities ........................................ 42,213 25,749
Long-term portion of deferred revenues ................................. 2,252 2,839
----------- -----------
Total liabilities ................................................ 44,465 28,588
----------- -----------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY(1):
Common stock, without par value, 200,000,000 shares authorized;
issued and outstanding 1998 -- 54,328,512; 1997 -- 52,252,086 .... 92,803 75,627
Retained earnings .................................................. 72,084 32,875
Accumulated other comprehensive income (loss) ...................... 890 (625)
----------- -----------
Total shareholders' equity ....................................... 165,777 107,877
----------- -----------
Total liabilities and shareholders' equity ....................... $ 210,242 $ 136,465
=========== ===========
- -----------------------
(1) Number of shares outstanding have been retroactively adjusted to reflect the
two-for-one stock split effected July 6, 1998.
See notes to consolidated financial statements
F-3
46
TEKELEC
CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1998 1997 1996
-----------------------------------------------------
(thousands)
CASH FLOW FROM OPERATING ACTIVITIES:
Net income (loss) ................................ $ 39,209 $ 28,996 $ (2,511)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization .................... 5,795 4,790 3,842
Deferred income taxes ............................ 276 (82) (80)
Stock-based compensation ......................... 343 -- --
Changes in assets and liabilities:
Accounts and notes receivable .................. (24,873) (12,537) 1,810
Inventories .................................... (1,507) (3,299) (1,840)
Amounts due from related parties ............... 389 93 672
Income taxes receivable ........................ 775 (857) --
Prepaid expenses and other current assets ...... (1,548) (266) (564)
Trade accounts payable ......................... 5,660 (412) 1,776
Accrued expenses ............................... 4,955 (49) 1,645
Accrued payroll and related expenses ........... (1,225) 2,842 755
Deferred revenues .............................. 2,200 6,766 870
Income taxes payable ........................... 12,800 (849) 370
----------- ----------- -----------
Total adjustments ............................ 4,040 (3,860) 9,256
----------- ----------- -----------
Net cash provided by operating activities ... 43,249 25,136 6,745
----------- ----------- -----------
CASH FLOW FROM INVESTING ACTIVITIES:
Purchase of available-for-sale securities ........ (107,272) (22,737) (45,033)
Proceeds from maturity of available-for-sale
securities ................................... 57,200 18,000 18,000
Purchase of property and equipment ............... (8,702) (6,552) (6,008)
(Increase) Decrease in other assets .............. (195) 46 63
----------- ----------- -----------
Net cash (used in) investing activities ...... (58,969) (11,243) (32,978)
----------- ----------- -----------
CASH FLOW FROM FINANCING ACTIVITIES:
Repayments of short-term borrowings .............. -- -- (570)
Repayment of long-term debt ...................... -- -- (380)
Repayments of other obligations .................. -- -- (31)
Proceeds from issuance of common stock ........... 7,634 8,759 2,050
----------- ----------- -----------
Net cash provided by financing activities .... 7,634 8,759 1,069
----------- ----------- -----------
Effect of exchange rate changes on cash .............. 1,270 (1,115) (1,234)
----------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents ................................. (6,816) 21,537 (26,398)
----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR ... 38,748 17,211 43,609
----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF THE YEAR ......... $ 31,932 $ 38,748 $ 17,211
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
CASH PAID DURING THE YEAR FOR:
Interest ....................................... $ -- $ -- $ 98
Income taxes ................................... 2,297 2,408 1,970
SUPPLEMENTAL DISCLOSURE OF NON-CASH FLOW ACTIVITY:
Tax benefit related to stock options ........... 9,199 9,819 63
See notes to consolidated financial statements
F-4
47
TEKELEC
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK ACCUMULATED
-------------------------- OTHER TOTAL
NUMBER RETAINED COMPREHENSIVE SHAREHOLDERS'
OF SHARES(1) AMOUNT EARNINGS INCOME (LOSS) EQUITY
---------------------------------------------------------------------------------
(thousands)
- -----------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1995 ............. 46,396 $ 54,936 $ 6,390 $ 2,281 $ 63,607
Exercise of stock options
and warrants ..................... 1,644 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 ............. 48,040 57,049 3,879 823 61,751
Exercise of stock options
and warrants ..................... 4,212 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 ............. 52,252 75,627 32,875 (625) 107,877
Exercise of stock options
and warrants ..................... 2,032 7,634 -- -- 7,634
Issuance of restricted stock,
net of unearned compensation ..... 45 343 -- -- 343
Stock option tax benefits .......... -- 9,199 -- -- 9,199
Translation adjustment ............. -- -- -- 1,515 1,515
Net income ......................... -- -- 39,209 -- 39,209
- -----------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 ............. 54,329 $ 92,803 $ 72,084 $ 890 $ 165,777
=============================================================================================================================
- --------------
(1) Number of shares of Common Stock have been retroactively adjusted to reflect
the two-for-one stock split effected July 6, 1998.
See notes to consolidated financial statements
F-5
48
TEKELEC
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Years Ended December 31,
-----------------------------------------
1998 1997 1996
-----------------------------------------
(thousands)
Net income (loss) ............................... $ 39,209 $ 28,996 $ (2,511)
Other comprehensive income (loss):
Foreign currency translation adjustments .... 1,515 (1,448) (1,458)
-------- -------- --------
Comprehensive income (loss) ..................... $ 40,724 $ 27,548 $ (3,969)
======== ======== ========
See notes to consolidated financial statements
F-6
49
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, 1997 and
1996 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
LONG-TERM ASSETS
The Company identifies and records impairment on long-lived assets when
events and circumstances indicate that such assets have been impaired. The
Company periodically evaluates the recoverability of its long-lived assets based
on expected nondiscounted cash flows, and recognizes impairment, if any, based
on expected discounted cash flows.
F-7
50
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, 1998 and 1997, accrued product warranty costs amounted to $2.3
million and $1.2 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 Company obligations, if any. Revenues associated with multiple-element
arrangements (products, upgrades, enhancements and post-contract customer
support) are allocated to each element based on the relative fair value.
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. Development contract revenues are recognized using the
percentage-of-completion method based on the costs incurred relative to total
estimated costs. Provisions for anticipated losses, if any, on development
contracts are recognized in income currently.
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 $781,000,
$669,000 and $620,000 for 1998, 1997 and 1996, 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 exchange rates in effect on the balance
sheet dates while revenues and expenses are translated at average rates in
effect for the period. The resulting gains and losses are included in a separate
component of shareholders' equity. Realized gains (losses) on foreign currency
transactions are reflected in net income (loss) and amounted to $56,000,
$(273,000) and $(180,000) for 1998, 1997 and 1996, respectively.
EARNINGS (LOSS) PER SHARE
Earnings (Loss) per share are computed using the weighted average number
of shares outstanding and dilutive Common Stock equivalents (options and
warrants), in accordance with Statement of Financial Accounting Standards (SFAS)
No. 128 "Earnings per Share."
F-8
51
COMPREHENSIVE INCOME
In 1998, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 130, "Reporting Comprehensive Income," and accordingly has included a
separate Statement of Comprehensive Income. Comprehensive income generally
represents all changes in shareholders' equity during the period except those
resulting from investments by, or distributions to, shareholders.
SEGMENT INFORMATION
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments
of a Business Enterprise and Related Information." SFAS No. 131 supersedes SFAS
No. 14, "Financial Reporting for Segments of a Business Enterprise," replacing
the "industry segment" approach with the "management" approach. The management
approach designates the internal organization that is used by management for
making operating decisions and assessing performance as the source of the
Company's reportable segments. SFAS No. 131 also requires disclosures about
products and services, geographic areas and major customers. The adoption of
SFAS No. 131 did not affect results of operations or financial position but did
affect the disclosure of segment information. See Note M.
NOTE B -- 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 $19.4 million and $25.3 million at
December 31, 1998, and December 31, 1997, 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,
-------------------------
1998 1997
-------------------------
(thousands)
TYPE OF SECURITY:
Corporate debt securities with maturities of less than one year ........... $ 25,704 $ 10,745
U.S. government securities with maturities of less than one year .......... 12,000 9,028
---------- ----------
Total short-term investments .............................................. 37,704 19,773
U.S. government securities with maturities of between one and two years .. 44,138 11,997
---------- ----------
$ 81,842 $ 31,770
========== ==========
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, 1998 and 1997, net unrealized
gains or losses on available-for-sale securities were not significant. The
Company utilizes specific identification in computing realized gains and losses
on the sale of investments. Realized gains and losses are reported in other
income and expense, and were not significant for 1998, 1997 and 1996.
F-9
52
NOTE C -- 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 D -- RELATED PARTY TRANSACTIONS
As of December 31, 1998, the Company's principal shareholder, a director
and his family, and a foreign-affiliated company controlled by the director
owned an aggregate of approximately 27% of the Company's outstanding stock.
The following is a summary of transactions and balances with these
affiliates:
1998 1997 1996
---------- ---------- ----------
(thousands)
Product sales ..................... $ 4,269 $ 4,471 $ 4,130
Purchases of inventory ............ -- 212 125
Director's fees and expenses ...... 51 104 59
Due from affiliates ............... 1,896 2,286 2,381
Due to affiliates ................. -- -- 145
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 120,000 shares of the Company's Common Stock. This agreement
terminated December 31, 1996.
F-10
53
NOTE E -- 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.
NOTE F -- INCOME TAXES
The provision for income taxes consists of the following:
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------
1998 1997 1996
----------- ----------- -----------
(thousands)
CURRENTLY PAYABLE:
Federal ............. $ 10,736 $ 5,394 $ --
State ............... 3,500 1,554 1
Foreign ............. 1,794 390 2,392
DEFERRED:
Federal ............. 2,134 (5,974) --
State ............... (1,338) (745) --
Foreign ............. (484) 126 (166)
----------- ----------- -----------
$ 16,342 $ 745 $ 2,227
=========== =========== ===========
F-11
54
The primary components of temporary differences that gave rise to deferred taxes
at December 31, 1998 and 1997 are as follows:
DECEMBER 31,
1998 1997
---------------------------
(thousands)
DEFERRED TAX ASSETS:
Net operating loss carryforward .... $ -- $ 3,319
Foreign tax credit carryforward .... -- 247
Allowance for doubtful accounts .... 258 257
Inventory adjustments .............. 1,708 1,715
Depreciation and amortization ...... 188 223
Research and development
credit carryforward ............ 4,447 2,756
Accrued liabilities ................ 2,191 3,154
Warranty accrual ................... 885 515
Other .............................. 453 370
----------- -----------
Total deferred tax asset ........... 10,130 12,556
Less, valuation allowance .......... -- (2,248)
----------- -----------
TOTAL NET DEFERRED TAX ASSET ....... 10,130 10,308
----------- -----------
CURRENT PORTION ........................ 8,616 8,309
----------- -----------
LONG-TERM PORTION ...................... $ 1,514 $ 1,999
=========== ===========
The valuation allowance for deferred taxes decreased by approximately $2.2
million during the year ended December 31, 1998. 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 Company's ability to utilize
certain research and development tax credit carryforwards. Realization of the
net deferred tax assets of $10.1 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 future if estimates of future taxable income
are reduced.
F-12
55
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,
-----------------------------------------------
1998 1997 1996
-----------------------------------------------
(thousands)
Federal statutory provision (benefit) ........... $ 19,443 $ 10,112 $ (97)
State taxes, net of federal benefit ............. 1,530 534 --
Foreign taxes ................................... 335 226 785
Reduction in valuation allowance ................ (2,248) (8,960) --
Utilization of operating loss carryforwards ..... -- (499) --
Research and development credits ................ (2,111) (723) --
Nontaxable FSC income ........................... (865) -- --
Loss for which no tax benefit was recorded ...... -- -- 1,182
Temporary differences for which no
tax benefit was recorded .................... -- -- 252
Other ........................................... 258 55 105
----------- ----------- -----------
Actual income tax provision ..................... $ 16,342 $ 745 $ 2,227
----------- ----------- -----------
Effective tax rate .............................. 29.4% 2.5% 784.0%
At December 31, 1998, the Company had available research and development credit
carryforwards of $4.4 million, which will begin to expire in the year 2007.
The Company has not provided for federal income taxes on $13.1 million of
undistributed earnings of its foreign subsidiaries that have been reinvested in
their operations.
NOTE G -- INVENTORIES
The components of inventories are:
DECEMBER 31,
--------------------------
1998 1997
--------------------------
(thousands)
Raw materials ...... $ 3,830 $ 3,738
Work in process .... 2,064 2,448
Finished goods ..... 6,978 5,095
----------- -----------
$ 12,872 $ 11,281
=========== ===========
F-13
56
NOTE H -- PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
DECEMBER 31,
----------------------------
1998 1997
----------------------------
(thousands)
Manufacturing and development equipment .......... $ 23,024 $ 17,645
Furniture and office equipment ................... 9,677 7,773
Demonstration equipment .......................... 4,038 3,964
Leasehold improvements ........................... 1,953 1,397
----------- -----------
38,692 30,779
Less, accumulated depreciation and amortization .. (25,833) (20,938)
----------- -----------
$ 12,859 $ 9,841
=========== ===========
NOTE I -- LINES OF CREDIT
In July 1998, the Company renewed its credit facility with a U.S. bank
and increased the maximum line of credit available thereunder from $10.0 million
to $15.0 million. The Company also has lines of credit aggregating $3.9 million
available to its Japanese subsidiary from various Japan-based banks.
The Company's $15.0 million credit facility is collateralized by
substantially all of the Company's assets, bears interest at, or in some cases
below, the lender's prime rate (7.75% at December 31, 1998), and expires on June
30, 2000, 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. There have been no
borrowings under this credit facility.
The Company's Japanese subsidiary has collateralized yen-denominated
lines of credit with Japan-based banks, primarily available for use in Japan,
amounting to the equivalent of $3.9 million with interest at the Japanese prime
rate (1.5% at December 31, 1998) plus 0.125% per annum, which expire between
August 5, 1999 and March 31, 2000, if not renewed. There have been no borrowings
under these lines of credit.
NOTE J -- 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.
F-14
57
Total rent expense was $2.5 million, $2.5 million and $2.4 million for
1998, 1997 and 1996, respectively.
Minimum annual noncancelable lease commitments at December 31, 1998 are:
For the Years Ending December 31,
- --------------------------------- (thousands)
1999 ....................................................... $ 2,476
2000 ....................................................... 2,940
2001 ....................................................... 2,729
2002 ....................................................... 2,730
2003 ....................................................... 2,797
Thereafter ................................................. 13,427
-----------
$ 27,099
===========
NOTE K -- STOCK OPTIONS AND EMPLOYEE BENEFIT PLANS
The Company has various stock option plans with maximum terms of ten
years under which 29.1 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 800,000 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.
F-15
58
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), encourages but does not require
companies to record compensation cost for stock-based employee compensation
plans at fair value for awards granted subsequent to December 31, 1995. The
Company has chosen to continue to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, no compensation expense has been recognized for the Company's stock
option and purchase plans. Had compensation costs under these plans been
determined based upon the methodology prescribed under SFAS 123, the Company's
net income (loss) and diluted earnings (loss) per share would approximate the
following proforma amounts (in thousands except per-share data):
As Reported Proforma
---------- ----------
YEAR ENDED DECEMBER 31, 1998:
Net income ...................... $ 39,209 $ 32,836
Earnings per share (diluted) .... 0.67 0.56
Year Ended December 31, 1997:
Net income ...................... $ 28,996 $ 26,646
Earnings per share (diluted) .... 0.51 0.47
Year Ended December 31, 1996:
Net loss ........................ $ (2,511) $ (3,777)
Loss per share (diluted) ........ (0.05) (0.08)
The effects of applying SFAS 123 in this proforma disclosure are not
indicative of future amounts, and additional awards in future years are
anticipated.
A summary of the status of the Company's stock options, as of December
31, 1998, 1997 and 1996, and the changes during the year ended on those dates
are presented below (shares in thousands):
1998 1997 1996
--------------------------------------------------------------------------
Wgtd. Avg. Wgtd. Avg. Wgtd. Avg.
Shares Exer. Price Shares Exer. Price Shares Exer. Price
------ ----------- ------ ----------- ------ -----------
Outstanding at beginning of year ....... 8,298 $ 4.50 9,672 $ 2.43 9,352 $ 2.07
Granted - price equals fair value ...... 1,959 20.25 2,722 7.27 2,446 3.36
Granted - price greater than fair value 340 17.71 339 10.33 2,738 3.56
Exercised .............................. 1,838 2.88 3,777 1.87 1,380 1.00
Cancelled .............................. 321 8.15 658 3.72 3,484 3.56
----- ----- -----
Outstanding at year-end ................ 8,438 8.90 8,298 4.50 9,672 2.43
===== ===== =====
Options exercisable at year-end......... 2,550 2,273 3,918
Options available for future grant...... 3,528 3,513 1,992
Weighted average fair value of
options granted during the year:
Exercise price equals fair value
at grant date ...................... $13.92 $ 5.23 $ 2.42
Exercise price greater than fair
value at grant date................. 11.85 6.89 1.08
F-16
59
The following table summarizes information about stock options
outstanding at December 31, 1998 (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 12/31/98 Life Price at 12/31/98 Price
- ---------------------------------------------------------------------------------------------
$0.66 to $ 0.99 686 4.59 $ 0.86 609 $ 0.85
1.00 to 3.78 1,940 6.86 3.10 815 3.14
3.82 to 5.55 2,609 7.51 4.47 833 4.35
7.07 to 10.63 560 8.64 8.17 117 7.78
14.08 to 20.94 2,168 9.15 19.28 139 17.69
21.25 to 23.69 475 9.36 21.96 37 22.36
----- -----
0.66 to 23.69 8,438 7.72 8.90 2,550 4.27
===== =====
The fair value of options granted during 1998, 1997 and 1996 is
estimated as $15.7 million, $6.9 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 81%, 86% and
87%, respectively, for 1998, 1997 and 1996, (iii) weighted average risk-free
interest rates of 5.3%, 6.4% and 6.2% for 1998, 1997 and 1996, respectively,
(iv) weighted average expected life of 5.1 years, 5.1 years and 4.8 years for
1998, 1997 and 1996, respectively, and (v) assumed forfeiture rate of 50%, 58%
and 64%, respectively, for 1998, 1997 and 1996.
During 1998, 1997 and 1996, approximately 103,000, 161,000 and 247,000
shares, respectively, were purchased under the Company's ESPP at weighted
average exercise prices of $13.94, $5.07 and $2.40, respectively. At December
31, 1998, 1997 and 1996 there were approximately 427,000, 530,000 and 691,000
shares, respectively, available for future grants. The weighted average fair
values of ESPP shares granted in 1998, 1997 and 1996 were $7.37, $2.23 and $1.18
per share, respectively.
In 1997, the Company granted warrants to purchase 521,000 shares of
Common Stock. The grant date fair values of these warrants was $7.44 per share.
There were no warrants granted in 1998. See Note N.
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 1998,
1997 and 1996, the Company's contributions amounted to $654,000, $401,000 and
$187,000, respectively.
F-17
60
NOTE L --EARNINGS PER SHARE
The following table provides a reconciliation of the numerators and
denominators of the basic and diluted per-share computations for the years ended
December 31, 1998, 1997 and 1996:
NET INCOME (LOSS) SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
-----------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31, 1998: (thousands except per-share amount)
Basic EPS ........................... $ 39,209 53,518 $ 0.73
Effect of Dilutive Securities - Stock
Options and Warrants ............ -- 5,190
-------- --------
Diluted EPS ......................... $ 39,209 58,708 $ 0.67
======== ======== ========
FOR THE YEAR ENDED DECEMBER 31, 1997:
Basic EPS ........................... $ 28,996 50,408 $ 0.58
Effect of Dilutive Securities - Stock
Options and Warrants ............ -- 6,434
-------- --------
Diluted EPS ......................... $ 28,996 56,842 $ 0.51
======== ======== ========
FOR THE YEAR ENDED DECEMBER 31, 1996:
Basic EPS ........................... $ (2,511) 47,100 $ (0.05)
Effect of Dilutive Securities - Stock
Options and Warrants ............ -- --
-------- --------
Diluted EPS ......................... $ (2,511) 47,100 $ (0.05)
======== ======== ========
The computation of diluted number of shares excludes unexercised stock
options and warrants that are anti-dilutive. The numbers of such shares excluded
were 1.3 million, 89,000 and 9.9 million for the years ended December 31, 1998,
1997 and 1996, respectively.
There were no transactions subsequent to December 31, 1998, which, had
they occurred prior to December 31, 1998, would have changed materially the
number of shares in the basic or diluted earnings per share computations.
F-18
61
NOTE M --OPERATING SEGMENT INFORMATION
The Company has adopted Statement of Financial Accounting Standards
(SFAS) No. 131, "Disclosures about Segments of an Enterprise and Related
Information," which requires the reporting of certain financial information by
operating segment and geographical area. The Company's reportable operating
segments are strategic operating units that are managed separately due to their
different products or geographic location. The Network Switching operating
segment develops and supplies the Company's EAGLE product, a high-capacity
packet switching platform. The Intelligent Network Diagnostics operating segment
develops and supplies diagnostic products for intelligent networks. The Data
Network Diagnostics operating segment develops and supplies diagnostic products
for data networks (see Note P). The Japan Diagnostics operating segment sells
the Company's and third parties' diagnostic products to customers in Japan.
Transfers between operating segments are made at prices reflecting market
conditions. Geographic areas for which revenues from external customers are
reported are determined by the destination of the sale.
F-19
62
The Company's operating segments and geographical information are as follows (in
thousands):
OPERATING SEGMENTS
Net Sales
-------------------------------------------------------
1998 1997 1996
-------------------------------------------------------
(thousands)
Network Switching ................. $ 116,259 $ 71,941 $ 25,359
Intelligent Network Diagnostics ... 33,116 29,905 20,790
Data Network Diagnostics .......... 8,100 11,552 15,427
Japan Diagnostics ................. 21,981 16,384 15,746
Intercompany Eliminations ......... (2,787) (4,642) (5,196)
--------- --------- ---------
Total net sales ............... $ 176,669 $ 125,140 $ 72,126
========= ========= =========
Operating Income
----------------------------------------------------
1998 1997 1996
----------------------------------------------------
(thousands)
Network Switching ................. $ 47,186 $ 22,591 $ (598)
Intelligent Network Diagnostics ... 11,544 11,956 3,516
Data Network Diagnostics .......... (3,466) (2,196) (1,656)
Japan Diagnostics ................. 4,342 3,450 4,156
Intercompany Eliminations ......... 283 152 102
General Corporate ................. (8,951) (8,327) (7,321)
-------- -------- --------
Total operating income (loss) . $ 50,938 $ 27,626 $ (1,801)
======== ======== ========
ENTERPRISE WIDE DISCLOSURES
The following table sets forth, for the periods indicated, revenues from
external customers by principal product line:
1998 1997 1996
--------------------------------------------------
Network Switching ............................. $116,259 $ 71,941 $ 25,359
Intelligent Network Diagnostics ............... 46,305 36,570 25,586
Data Network Diagnostics ...................... 14,105 16,629 21,181
-------- -------- --------
Total revenues from external customers .... $176,669 $125,140 $ 72,126
======== ======== ========
The following table sets forth, for the periods indicated, revenues from
external customers by geographic territory:
1998 1997 1996
-------- -------- --------
North America ................................. $121,288 $ 91,404 $ 41,853
Japan ......................................... 21,981 16,384 15,746
Europe ........................................ 7,738 6,687 6,498
Rest of World ................................. 25,662 10,665 8,029
-------- -------- --------
Total revenues from external customers .... $176,669 $125,140 $ 72,126
======== ======== ========
F-20
63
The following table sets forth, for the periods indicated, long-lived assets by
geographic area in which the Company holds assets:
1998 1997 1996
-----------------------------------------------
United States ...... $12,348 $ 9,370 $ 7,375
Japan .............. 1,216 996 1,387
Other .............. 51 -- 35
------- ------- -------
Total Assets ... $13,615 $10,366 $ 8,797
======= ======= =======
There were no customers accounting for 10% or more of revenues in 1998. Sales to
one customer accounted for 23% of revenues in 1997 and included sales from the
Network Switching, Intelligent Network Diagnostics and Data Network Diagnostics
operating segments. Sales to one customer for the Japan Diagnostics operating
segment accounted for 12% of revenues in 1996.
NOTE N -- COMMON STOCK
On July 6, 1998, 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, 1998 and 1997, the Company had warrants outstanding to
purchase an aggregate of 319,000 and 409,000 shares of its Common Stock,
respectively, as more fully discussed as follows.
In July 1997, the Company issued warrants to purchase a total of 360,000
shares of its Common Stock to five directors and one corporate officer at $14.08
per share. These warrants vest and become exercisable in 12 equal quarterly
installments beginning on September 30, 1997. At December 31, 1997, 355,000 of
these warrants were outstanding. During 1998, 36,000 of these warrants were
exercised, and 319,000 were outstanding at December 31, 1998.
In January 1997, the Company issued warrants to a director and corporate
officer to purchase 161,000 shares of its Common Stock at $4.67 per share, all
of which vested in 1997. At December 31, 1997, 54,000 of these warrants were
outstanding, all of which were exercised during 1998.
In February 1998, the Company granted a restricted stock award of 30,000
shares of its Common Stock to a director and corporate officer in connection
with the commencement of his employment. The restricted shares vest in five
equal annual installments beginning in February 1999. This award was valued at
$607,000, which is being recognized as stock-based compensation expense over the
term of the award.
In January 1998, the Company granted a restricted stock award for an
aggregate of 15,000 shares of its Common Stock to its five non-employee
directors. The restricted shares became fully vested in January 1999. This award
was valued at $240,000, all of which was recognized as stock-based compensation
expense in 1998.
F-21
64
NOTE O -- QUARTERLY FINANCIAL SUMMARY (UNAUDITED)
For the Years Ended December 31, QUARTERS
First Second Third Fourth
----------------------------------------------------------------------
(thousands, except per-share data)
1998
Revenues ............................... $ 34,908 $ 42,949 $ 49,658 $ 49,154
Gross profit ........................... 23,503 28,818 32,998 32,448
Income before provision for income
taxes ................................. 10,735 13,488 16,734 14,594
Net income ............................. 6,656 8,365 10,372 13,816
Earnings per share:
Basic .............................. $ 0.13 $ 0.16 $ 0.19 $ 0.26
Diluted ............................ 0.11 0.14 0.18 0.24
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 .............................. $ 0.03 $ 0.07 $ 0.30 $ 0.17
Diluted ............................ 0.03 0.06 0.26 0.15
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, including shifts in such patterns as a result of
customers' deferral of product purchases until the year 2000, increased
competition, variations in the mix of sales, fluctuation in proportion of
foreign sales, and announcements of new products by Tekelec or its competitors.
NOTE P -- SUBSEQUENT EVENT
In January 1999, the Company announced a plan to scale down its Data
Network Diagnostics Division and integrate the division into its Intelligent
Network Diagnostics Division. In connection with this activity the Company will
record a charge of approximately $1.8 million in the first quarter of 1999,
which includes a workforce reduction of 25 employees and the write-off of
certain assets related to the Data Network Diagnostics Division.
F-22
65
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To The Shareholders And Board Of Directors Of Tekelec
Our report on the consolidated financial statements of Tekelec and its
subsidiaries is included on page F-1 of this Form 10-K. In connection with our
audits of such financial statements, we have audited the related financial
statement schedule at December 31, 1998, 1997 and 1996 and for each of the three
years in the period ended December 31, 1998, as included on page S-2 of this
Form 10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
/s/
PricewaterhouseCoopers LLP
Woodland Hills, California
February 2, 1999
S-1
66
SCHEDULE II
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, 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
Year ended December 31, 1998:
Allowance for doubtful accounts $ 469 $ 475 $ -- $ 181 $ 763
Product warranty ............... 1,220 2,388 -- 1,261 2,347
Inventory provision ............ 1,340 1,021 -- 621 1,740
Deferred tax valuation allowance 2,248 -- -- 2,248 --
S-2
67
EXHIBIT INDEX
Sequentially
Exhibit Numbered
Number Description Page
- ------ ----------- ----
10.7 Schedule of Distributors.................................
10.8 Amendment No. 1 to Tekelec Officer Severance Plan dated
March 8, 1999............................................
10.16 Lease dated as of November 6, 1998 between the Registrant
and Weeks Realty, L.P., covering the Company's facilities
in Morrisville, North Carolina...........................
10.17 Employment Offer Letter dated January 13, 1999 between
the Registrant and Teresa Pippin..........................
21.1 Subsidiaries of the Registrant...........................
23.1 Consent of PricewaterhouseCoopers LLP....................
27.1 Financial Data Schedule for the year ended
December 31, 1998........................................