| TEKELEC Item 1A Risk Factors The statements that are not historical facts contained in this Annual Report on Form 10-K are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 |
| These statements reflect the current belief, expectations, estimates, forecast or intent of our management and are subject to and involve certain risks and uncertainties |
| Many of these risks and uncertainties are outside of our control and are difficult for us to forecast or mitigate |
| In addition to the risks described elsewhere in this Annual Report on Form 10-K and in certain of our other Securities and Exchange Act Commission filings, the following risks and uncertainties, among others, could cause our actual results to differ materially from those contemplated by us or by any forward-looking statement contained herein |
| Prospective and existing investors are strongly urged to carefully consider the various cautionary statements and risks set forth in this Annual Report and our other public filings |
| Our operating results may fluctuate in future periods, which may adversely affect our stock price |
| Our quarterly and annual operating results are difficult to predict and may fluctuate significantly |
| We have failed to achieve our revenue and net income expectations for certain prior periods, and it is possible that we 19 _________________________________________________________________ [74]Table of Contents will fail to achieve such expectations in the future |
| A number of factors, many of which are outside our control, can cause fluctuations in our quarterly and annual operating results, including among others: • our judgments as to whether an arrangement includes multiple elements and if so, whether vendor specific objective evidence of fair value exists for those elements, which judgments impact the amount of product and service revenue recognized; • fluctuations in demand for our products and services, especially with respect to telecommunications service providers, in part due to a changing global economic environment; • price and product competition in the telecommunications industry which can change rapidly due to technological innovation; • the success or failure of our strategic alliances and acquisitions; • the introduction and market acceptance of our and our competitors’ new products, services and technologies; • the timing of the deployment by our customers of new technologies and services, including VoIP; • changes in accounting rules, such as recently issued pronouncements regarding stock-based compensation (ie, requiring the expensing of employee stock option grants) and tax accounting pronouncements; • changes in general economic conditions and specific market conditions in the telecommunications industry; • fluctuations in demand for our products and the size, timing, terms and conditions of orders and shipments; • sudden or unanticipated shortages of components provided by our vendors; • the lengthy sales cycle of our signaling, switching solutions and communications software solutions products, especially with respect to our international customers, and the reduced visibility into our customers’ spending plans for those products and associated revenue; • the progress and timing of the convergence of voice and data networks and other convergence-related risks described below; • the ability of carriers to utilize excess capacity of signaling infrastructure and related products in their networks; • the capital spending patterns of our customers, including deferrals or cancellations of purchases by customers; • the trend toward industry consolidation among our customers and our competitors; • our ability to achieve targeted cost and expense reductions; • manufacturing and customer lead times; • our dependence on wireless carriers for a significant percentage of our revenues; • unanticipated delays or problems in developing or releasing new products or services; • variations in sales channels, product costs, or mix of products sold; • the geographic mix of our revenues and the associated impact on margins; • the mix of our product sales across product lines (ie, between our higher margin NSG products and lower margin SSG products), which can have significant impact on our gross margins; • foreign currency exchange rate fluctuations; 20 _________________________________________________________________ [75]Table of Contents • actual events, circumstances, outcomes, and amounts differing from judgments, assumptions, and estimates used in determining the values of certain assets (including the amounts of related valuation allowances), liabilities, and other items reflected in our consolidated financial statements; • the ability of our customers to obtain financing or to otherwise fund capital expenditures; • the timing and level of our research and development expenditures and other expenditures; • the expansion of our marketing and support operations, both domestically and internationally; • changes in our pricing policies and those of our competitors; • worldwide economic or political instability; and • failure of certain customers to successfully and timely reorganize their operations, including emerging from bankruptcy |
| Our product sales in any quarter depend largely on orders booked and shipped in that quarter |
| A significant portion of our product shipments in each quarter occurs at or near the end of the quarter |
| Since individual orders can represent a meaningful percentage of our revenues and net income in any quarter, the deferral or cancellation of or failure to ship an entire order in a quarter can result in a revenue and net income shortfall that causes us to fail to meet securities analysts’ expectations or our business plan for that period |
| We base our current and future expense levels on our internal operating plans and sales forecasts, and our operating costs are to a large extent fixed |
| As a result, we may not be able to sufficiently reduce our costs in any quarter to adequately compensate for an unexpected near-term shortfall in revenues, and even a small shortfall could disproportionately and adversely affect our operating results for that quarter |
| The factors described above are difficult to forecast and could have a material adverse effect on our business, operating results and financial condition |
| We may experience a shortfall in revenues or an increase in operating expenses in the future, which would adversely affect our operating results |
| As a consequence, operating results for a particular period are difficult to predict, and, therefore, prior results are not necessarily indicative of results to be expected in future periods |
| Any of the foregoing factors, or any other factors discussed elsewhere herein, could have a material adverse effect on our business, results of operations, and financial condition that could adversely affect our stock price |
| Our operating results may be adversely affected by unfavorable economic and market conditions and the uncertain geopolitical environment |
| Economic conditions worldwide have contributed to slowdowns in the telecommunications industry and may impact our business resulting in: • reduced demand for our products as a result of continued constraints on capital expenditures by our customers; • increased price competition for our products, • risk of excess and obsolete inventories; and • higher overhead costs as a percentage of revenue |
| Recent turmoil in the geopolitical environment in many parts of the world, including terrorist activities and military actions, particularly the continuing tension in and around Iraq, and changes in energy, natural resources and precious metal costs may continue to put pressure on global economic conditions |
| If the economic and market conditions in the United States or internationally deteriorate, we may experience material impacts on our business, operating results, and financial condition |
| 21 _________________________________________________________________ [76]Table of Contents We expect our margins to vary over time, and our recent level of gross margins and operating margins may not be sustainable |
| Our recent level of operating margins may not be sustainable and may continue to be adversely affected by numerous factors, including: • increased price competition, including competitors from Asia, especially China; • changes in customer, geographic, or product mix, including mix of configurations within each product group; • an increase in revenues from sales of our Switching Solutions Group products (which typically carry lower margins than sales of our Network Signaling Group products) as a percentage of total revenues; • introduction of new products; • our ability to reduce and control production costs; • entry into new markets, including markets with different pricing and cost structures; • sales discounts; • increases in material or labor costs; • excess inventory and inventory holding costs; • obsolescence charges; • changes in shipment volume; • reductions in cost savings due to changes in component pricing or charges incurred due to inventory holding periods if parts ordering does not correctly anticipate product demand; • changes in distribution channels; • losses on customer contracts; • increased warranty costs; and • our ability to execute our strategy and operating plans |
| Changes in service margins may result from various factors such as changes in the mix between extended warranty services and advanced services, as well as the timing of extended warranty contract initiations and renewals and the addition of personnel and other resources to support higher levels of service business in future periods |
| The markets in which we compete are intensely competitive, which could adversely affect our revenue and net income growth |
| For information regarding our competition and the risks arising out of the competitive environment in which we operate, see the section entitled “Competition” contained in Item 1 of this report |
| We have limited product offerings, and our revenues may suffer if demand for any of our products declines or fails to develop as we expect, if we are not able to develop and market additional and enhanced product offerings or if we consummate the sale of our IEX Contact Center Group |
| We derive a substantial portion of our revenues from sales of our Network Signaling Group’s products |
| In each of 2005, 2004 and 2003, our EAGLE products and related services generated over 50prca of our revenues, and we expect that these products and services and our other products of our Network Signaling Group will continue to account for a majority of our revenues for the foreseeable future |
| As a result, factors adversely affecting the pricing of or demand for these products, such as competition, technological change or a slower than anticipated rate of development or deployment of new products, features and technologies, could cause a significant decrease in our revenues and profitability |
| Continued and widespread market acceptance of these 22 _________________________________________________________________ [77]Table of Contents products is therefore critical to our future success |
| Moreover, our future financial performance will depend in significant part on the successful and timely development, introduction and customer acceptance of new and enhanced versions of our EAGLE product line as well as other Network Signaling Group products and Switching Solutions Group products |
| Introducing new and enhanced products such as these requires a significant commitment to research and development that may not result in success |
| There are no assurances that we will continue to be successful in developing and marketing our Network Signaling Group, Switching Solutions Group, Communications Software Solutions Group or IEX Contact Center Group products and related services |
| Our revenues and operating income will also decline if our previously disclosed sale of our IEX Contact Center Group is consummated |
| If wireless carriers do not continue to grow and to buy our Network Signaling Group products and services, our network signaling related business would be harmed |
| The success of our Network Signaling Group’s business will depend in large part on the continued growth of wireless network operators and their purchases of our products and services |
| We derive a substantial portion of our revenues from the sale of our Network Signaling Group’s products and services to wireless network operators |
| In each of 2005, 2004 and 2003, sales to the wireless market accounted for more than 50prca of our Network Signaling Group’s revenues |
| We expect that our sales of Network Signaling Group’s products and services to wireless companies will continue to account for a substantial majority of our Network Signaling Group’s revenues for the foreseeable future |
| The continued growth of the domestic and international wireless markets is subject to a number of risks that could adversely affect our revenues and profitability, including: • a downturn in the domestic or global economy; • a slowdown in capital spending by wireless network operators; • adverse changes in the debt and equity markets and in the ability of wireless carriers to obtain financing on favorable terms; • delays or scaling back of plans for the deployment by wireless network operators of new wireless broadband technologies and applications; and • slowing growth of wireless network subscribers, minutes of use or adoption of new services |
| Consequently, there can be no assurances that the wireless network carriers will continue to purchase our Network Signaling products or services for the build-out or expansion of their networks |
| Our business is subject to risks related to the potential convergence of voice and data networks |
| Currently, voice conversations are carried primarily over circuit switched networks |
| Another type of network, packet switched networks, carries primarily data |
| Circuit and packet networks use fundamentally different technologies |
| Although we expect a substantial portion of any increases in our future sales of Switching Solutions Group products to result from the interconnection, or convergence, of circuit and packet networks, we cannot accurately predict when such convergence will occur or whether it will fully occur |
| Therefore, this convergence presents several significant and related risks to our business |
| If the convergence of circuit and packet networks does not fully occur or takes longer than anticipated, sales of our network infrastructure products, and our profitability, would be adversely affected |
| Any factor that might prevent or slow the convergence of circuit and packet networks could materially and adversely affect growth opportunities for our business |
| Such factors include: • the failure to solve or difficulty in solving certain technical obstacles to the transmission of voice conversations over a packet network; • delays in the formulation of standards for the transmission of voice conversations over a packet network; and • the imposition on packet network operators of access fees, which are not currently charged |
| 23 _________________________________________________________________ [78]Table of Contents It may be difficult or impossible to solve certain technical obstacles to the transmission of voice conversations over a packet network with the same quality and reliability of a circuit network |
| For example, delays or gaps in the timing of a message are typically not as critical to data transmissions as they are to voice conversations |
| The nature of packet switching makes it difficult to prevent such delays or gaps as well as to repair such defects in a way that does not degrade the quality of a voice conversation |
| If this problem is not solved, the convergence of circuit and packet networks may never fully occur or may occur at a much slower rate than we anticipate |
| It may also be difficult or time-consuming for the industry to agree to standards incorporating any one solution addressing any such technical issues, if such a solution exists |
| Without uniform standards, substantial convergence of circuit and packet networks may not occur or may take longer than anticipated |
| We cannot accurately predict when these technical problems will be solved, when uniform standards will be agreed upon or when market acceptance of such products and services will occur |
| Convergence may, however, take much longer than we expect or, as noted above, not fully occur at all |
| Moreover, uncertainty regarding the technology or standards to be employed in converged networks may cause carriers to delay their purchasing plans |
| Today, federal regulation requires an operator of a long distance circuit network to pay an access fee to the local phone company serving the recipient of a long distance call |
| Packet network operators do not currently pay such access fees |
| These access fees might also be imposed on the termination of “pure” data messages by operators of packet networks |
| The imposition of these access fees would reduce the economic advantages of using packet networks for voice and other transmissions, which may slow the convergence of circuit and packet networks |
| The restatement of our consolidated financial statements and related events could have a material adverse effect on us |
| As discussed in Note 2 of the “Notes to Consolidated Financial Statements” contained in Item 15 of this Annual Report on Form 10-K, we have restated our consolidated financial statements to correct certain errors in our prior period financial statements |
| These errors principally related to (i) our application of Statement of Position 97-2 “Software Revenue Recognition” (“SOP 97-2”), (ii) the misclassification of costs, specifically the classification of certain customer service costs as costs of sales, in accordance with Article 5 of Regulation S-X and (iii) our accounting, presentation and disclosure of certain financial statement items such as deferred income taxes in accordance with Statement of Financial Accounting Standards Nodtta 109 “Accounting for Income Taxes” and certain prior period purchase accounting entries |
| We have corrected these errors through a restatement in this Annual Report of our previously issued financial statements for (i) the year ended December 31, 2003, (ii) the year ended December 31, 2004 and the unaudited quarterly financial data for each of the quarters therein, and (iii) the unaudited quarterly financial data for each of the quarters in the nine months ended September 30, 2005 (the “Restatement”) |
| The need for the Restatement resulted in delays in the filing of this Annual Report and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 |
| For more information on the Restatement, see (i) Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations, (ii) Item 9A — Controls and Procedures and (iii) Note 2 to our consolidated financial statements included in Item 15 of this Annual Report on Form 10-K As a result of the Restatement, we have become subject to the following risks |
| Each of these risks could have a material adverse effect on our business, results of operations, financial condition and liquidity |
| • We could be subject to civil litigation, including class action shareholder actions, which if decided against us, could require us to pay substantial judgments, settlements or other penalties |
| • Negative publicity relating to the Restatement may adversely affect our business and the market price of our publicly traded securities |
| 24 _________________________________________________________________ [79]Table of Contents • The delayed filing of this Annual Report caused us to be in violation of (i) certain covenants under our credit facility and (ii) the indenture related to our 2dtta25prca Senior Subordinated Convertible Notes due 2008 |
| We received an extension until June 30, 2006 for the delivery of our audited 2005 financial statements and unaudited financial information for the first quarter of 2006 required under our credit facility from the lender under that facility |
| With respect to our 2dtta25prca Senior Subordinated Convertible Notes due 2008, had we been unable to file this Annual Report by May 31, 2006, an Event of Default would have occurred, and either the Trustee or the holders of 25prca in aggregate principal of the notes could then have declared the notes to be currently due and payable |
| As a result of the delay in filing our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 by the close of business on May 25, 2006, we were not in compliance with our obligation to deliver our Quarterly Report on Form 10-Q to the Trustee under the indenture governing the notes |
| As such, it is possible that the Trustee or the holders of the notes may seek to accelerate the repayment of that debt if they give us a notice of default after May 25, 2006, and the default is not cured within 60 days thereafter |
| In addition, it is possible that we will not have completed our financial statements for the quarter ended March 31, 2006 by June 30, 2006, and that the lender under our credit facility will not grant us a further extension of the deadline for delivering those financial statements |
| • We have identified a material weakness related to our internal control over financial reporting and concluded that our internal control over financial reporting is ineffective as of December 31, 2005, which has its own risks as discussed below |
| • Should we be unable to file our Form 10-Q for the first quarter of 2006 by July 17, 2006, the extended deadline provided by the Nasdaq, the Nasdaq could delist Tekelec’s common shares |
| • If our Common Stock is delisted as a result of any failure to file our Form 10-Q for the first quarter of 2006 by Nasdaq’s extended deadline of July 17, 2006, then any holder of our 2dtta25prca Senior Subordinated Convertible Notes due 2008 may require us to redeem the holder’s notes and we will also be in default under our credit facility |
| • Due to the negative publicity with respect to the Restatement and the associated uncertainty in the equity markets, we may be unable to attract or retain the personnel necessary to achieve our business objectives |
| • Management’s focus on achieving our business objectives has and may continue to be diverted to addressing (i) the Restatement effort, (ii) customers’, employees’, investors’ and regulators’ questions and concerns regarding the Restatement, (iii) improvements in Tekelec’s public image, which may have been negatively impacted by the Restatement, with its customers and in the financial markets, and (iv) any subsequent litigation that may result from the Restatement |
| • The SEC may review the Restatement and require further amendment of our public filings |
| • We have incurred and may continue to incur significant expenses and costs associated with the Restatement and each of the above items |
| We have identified a material weakness in our disclosure controls and procedures and our internal control over financial reporting, which, if not remediated effectively, could have an adverse effect on the trading price of our Common Stock and otherwise seriously harm our business |
| In connection with the documentation, testing and assessment of our internal control over financial reporting pursuant to the rules promulgated by the |