##### Table of Contents



FORM 10-Q UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2005 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 Commission file number 0-24701 CATAPULT COMMUNICATIONS CORPORATION  Nevada
    
    77-0086010(State or other jurisdiction of
    
    (I.R.S. EmployerIncorporation or organization)
    
    Identification Number)
 160 South Whisman Road
Mountain View, California 94041 (650) 960-1025 (Address, including zip code, and telephone number, including
area code, of principal executive offices) Indicate by check mark whether the registrant (1) has filed all reports to be filed by
Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). Yes þ No o As of April 22, 2005, there were 14,700,274 shares of the Registrants Common Stock, $0.001
par value, outstanding.




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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION
FORM 10-Q INDEX  
 PagePart IFinancial InformationItem 1. Financial StatementsUnaudited Condensed Consolidated Balance Sheets at March 31, 2005
and September 30, 2004
    
    
    3Unaudited Condensed Consolidated Statements of Income for the three months and
six months ended March 31, 2005 and 2004
    
    
    4Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended
March 31, 2005 and 2004
    
    
    5Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    13Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    28Item 4. Controls and Procedures
    
    
    29Part IIOther InformationItem 1. Legal Proceedings
    
    
    29Item 4. Submission of Matters to a Vote of Security Holders
    
    
    29Item 6. Exhibits
    
    
    30Signatures
    
    
    30EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32
 2




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Part I. Financial Information 
 Item 1. Financial Statements CATAPULT COMMUNICATIONS CORPORATION 
 UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
  March 31,
    
    
    September 30,2005
    
    
    2004ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    25,743
    
    
    $
    20,108Short-term investments
    
    
    38,941
    
    
    
    32,562Accounts receivable, net
    
    
    12,623
    
    
    
    10,110Inventories
    
    
    2,550
    
    
    
    2,380Deferred income taxes
    
    
    989
    
    
    
    985Prepaid expenses and other current assets
    
    
    1,518
    
    
    
    1,638Total current assets
    
    
    82,364
    
    
    
    67,783Property and equipment, net
    
    
    2,234
    
    
    
    2,640Goodwill
    
    
    49,394
    
    
    
    49,394Other intangible assets, net
    
    
    4,561
    
    
    
    5,072Other assets
    
    
    3,299
    
    
    
    3,382Total assets
    
    $
    141,852
    
    
    $
    128,271LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Accounts payable
    
    $
    1,134
    
    
    $
    1,502Accrued liabilities
    
    
    5,916
    
    
    
    5,546Deferred revenue
    
    
    7,425
    
    
    
    5,388Total current liabilities
    
    
    14,475
    
    
    
    12,436Deferred revenue long term portion
    
    
    373
    
    
    
    70Total liabilities
    
    
    14,848
    
    
    
    12,506Stockholders Equity:Common stock
    
    
    15
    
    
    
    15Additional paid-in capital
    
    
    48,188
    
    
    
    46,297Deferred stock-based compensation
    
    
    (21
    )
    
    
    (39
    )Accumulated other comprehensive income
    
    
    747
    
    
    
    660Retained earnings
    
    
    78,075
    
    
    
    68,832Total stockholders equity
    
    
    127,004
    
    
    
    115,765Total liabilities and stockholders equity
    
    $
    141,852
    
    
    $
    128,271
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 3




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CATAPULT COMMUNICATIONS CORPORATION 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
  Three months ended
    
    
    Six months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Revenues:Products
    
    $
    15,095
    
    
    $
    13,931
    
    
    $
    27,468
    
    
    $
    22,352Services
    
    
    3,955
    
    
    
    3,311
    
    
    
    7,453
    
    
    
    5,939Total revenues
    
    
    19,050
    
    
    
    17,242
    
    
    
    34,921
    
    
    
    28,291Cost of revenues:Products
    
    
    1,429
    
    
    
    1,565
    
    
    
    2,671
    
    
    
    2,566Services
    
    
    852
    
    
    
    911
    
    
    
    1,673
    
    
    
    1,631Amortization of purchased technology
    
    
    172
    
    
    
    172
    
    
    
    343
    
    
    
    343Total cost of revenues
    
    
    2,453
    
    
    
    2,648
    
    
    
    4,687
    
    
    
    4,540Gross profit
    
    
    16,597
    
    
    
    14,594
    
    
    
    30,234
    
    
    
    23,751Operating expenses:Research and development
    
    
    3,211
    
    
    
    3,068
    
    
    
    6,182
    
    
    
    5,720Sales and marketing
    
    
    4,802
    
    
    
    4,661
    
    
    
    9,505
    
    
    
    8,611General and administrative
    
    
    2,026
    
    
    
    1,779
    
    
    
    3,932
    
    
    
    3,455Total operating expenses
    
    
    10,039
    
    
    
    9,508
    
    
    
    19,619
    
    
    
    17,786Operating income
    
    
    6,558
    
    
    
    5,086
    
    
    
    10,615
    
    
    
    5,965Interest income
    
    
    289
    
    
    
    185
    
    
    
    513
    
    
    
    379Interest expense
    
    
    
    
    
    
    (87
    )
    
    
    
    
    
    
    (175
    )Other income (expense), net
    
    
    (144
    )
    
    
    58
    
    
    
    (137
    )
    
    
    162Income before income taxes
    
    
    6,703
    
    
    
    5,242
    
    
    
    10,991
    
    
    
    6,331Provision for income taxes
    
    
    1,273
    
    
    
    712
    
    
    
    1,748
    
    
    
    886Net income
    
    $
    5,430
    
    
    $
    4,530
    
    
    $
    9,243
    
    
    $
    5,445Net income per share:Basic
    
    $
    0.37
    
    
    $
    0.35
    
    
    $
    0.63
    
    
    $
    0.42Diluted
    
    $
    0.36
    
    
    $
    0.32
    
    
    $
    0.61
    
    
    $
    0.39Shares used in per share calculation:Basic
    
    
    14,676
    
    
    
    13,000
    
    
    
    14,637
    
    
    
    12,952Diluted
    
    
    15,103
    
    
    
    14,570
    
    
    
    15,129
    
    
    
    14,425
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 4




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CATAPULT COMMUNICATIONS CORPORATION 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
  Six months endedMarch 31,2005
    
    
    2004Cash flows from operating activities:Net income
    
    $
    9,243
    
    
    $
    5,445Adjustments to reconcile net income to net cash provided by operating
activities:Depreciation and amortization
    
    
    892
    
    
    
    892Amortization of deferred stock-based compensation
    
    
    18
    
    
    
    18Amortization of intangible assets
    
    
    511
    
    
    
    510Provision for doubtful accounts
    
    
    40
    
    
    
    104Deferred income taxes
    
    
    62
    
    
    
    Amortization of premium on note payable
    
    
    
    
    
    
    (204
    )Change in assets and liabilities:Accounts receivable
    
    
    (2,575
    )
    
    
    (2,514
    )Inventories
    
    
    (156
    )
    
    
    (538
    )Prepaid expenses and other current assets
    
    
    146
    
    
    
    (1,055
    )Other assets
    
    
    23
    
    
    
    5Accounts payable
    
    
    (405
    )
    
    
    25Accrued liabilities
    
    
    338
    
    
    
    2,666Deferred revenue
    
    
    2,340
    
    
    
    890Net cash provided by operating activities
    
    
    10,477
    
    
    
    6,244Cash flows from investing activities:Sales and maturities of short-term investments
    
    
    20,341
    
    
    
    17,157Purchases of short-term investments
    
    
    (26,758
    )
    
    
    (23,082
    )Purchases of property and equipment
    
    
    (467
    )
    
    
    (346
    )Net cash used in investing activities
    
    
    (6,884
    )
    
    
    (6,271
    )Cash flows from financing activities:Proceeds from issuance of common stock
    
    
    1,890
    
    
    
    1,392Net cash provided by financing activities
    
    
    1,890
    
    
    
    1,392Effect of exchange rate changes on cash and cash equivalents
    
    
    152
    
    
    
    231Increase in cash and cash equivalents
    
    
    5,635
    
    
    
    1,596Cash and cash equivalents, beginning of period
    
    
    20,108
    
    
    
    8,769Cash and cash equivalents, end of period
    
    $
    25,743
    
    
    $
    10,365
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 5




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CATAPULT COMMUNICATIONS CORPORATION 
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 1THE COMPANY AND BASIS OF PRESENTATION Catapult Communications Corporation and its subsidiaries (we or the Company) design,
develop, manufacture, market and support advanced software-based test systems offering integrated
suites of testing applications for the global telecommunications industry. Our advanced test
systems assist our customers in the design, integration, installation and acceptance testing of a
broad range of digital telecommunications equipment and services. The Company was incorporated in
California in 1985, was reincorporated in Nevada in 1998 and has operations in the United States,
Canada, the United Kingdom, Europe, Japan, China and Australia. Management has determined that we
conduct our business within one global industry segment: the design, development, manufacture,
marketing and support of advanced software-based telecommunications test systems. The accompanying unaudited interim condensed consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).
Certain information and footnote disclosures normally included in the financial statements prepared
in accordance with accounting principles generally accepted in the United States of America have
been condensed or omitted pursuant to such rules and regulations. These unaudited condensed
consolidated financial statements should be read in conjunction with the audited consolidated
financial statements and notes thereto included in the Companys Annual Report on Form 10-K for the
year ended September 30, 2004, and filed with the SEC on December 10, 2004. The unaudited condensed
consolidated financial statements as of March 31, 2005, and for the three and six months ended
March 31, 2005 and 2004, reflect, in the opinion of management, all adjustments, consisting only of
normal recurring adjustments, necessary to state fairly the financial information set forth herein.
The results of operations for the interim periods are not necessarily indicative of the results to
be expected for any subsequent interim period or for an entire year. The September 30, 2004 balance
sheet was derived from audited financial statements at that date, but does not include all
disclosures required by accounting principles generally accepted in the United States of America. NOTE 2 RECENT ACCOUNTING PRONOUNCEMENTS In December 2004, the Financial Accounting Standards Board (FASB) issued Statement Number
123 (revised 2004), SFAS No. 123(R), Share-Based Payment. SFAS No. 123(R) requires all entities
to recognize compensation expense in an amount equal to the fair value of share-based payments,
such as stock options granted to employees. On April 14, 2005, the SEC approved a new rule that for
public companies delays the effective date of SFAS No. 123(R) to annual, rather than interim,
periods that begin after June 15, 2005. We may elect to apply SFAS No. 123(R) using the modified
prospective application method, under which we would record compensation expense (as previous
awards continue to vest) for the unvested portion of previously granted awards that remain
outstanding at the date of adoption, without restating prior periods. Alternatively, we may elect
to apply the modified retrospective application method, under which financial statements for prior
periods would be adjusted on a basis consistent with the pro forma disclosures required for those
periods by SFAS No. 123. We expect the adoption of SFAS No.
123(R) may have a material adverse effect on our reported net income
per share. We are currently evaluating the extent of that impact and
we have not made an election with respect to application method. In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43,
Chapter 4. This Statement requires abnormal amounts of idle facility expense, freight, handling
costs, and wasted material be recognized as current-period charges regardless of whether they meet
the criterion of so abnormal. In addition, this Statement requires that allocation of fixed
production overhead to the costs of conversion be based on the normal capacity of the production
facilities. The provisions of this Statement are effective for inventory costs incurred during
fiscal years beginning after June 15, 2005. However, as we do not include amounts of idle facility
expense, freight, handling costs and wasted material in our inventory, the adoption of SFAS No. 151
is not expected to have a material impact on our financial position or results of operations. 6




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In October 2004, the American Jobs Creation Act of 2004 (the Act), was signed into law,
allowing U.S. companies to repatriate accumulated income from abroad by providing a one-time
deduction of 85% for certain dividends from controlled foreign corporations. The deduction is
subject to certain limitations, and numerous provisions of the Act contain uncertainties that
require interpretation and evaluation. We are currently evaluating whether, and to what extent, to
repatriate accumulated income from abroad under the provisions of the Act. Until such evaluation is
complete, we have not accrued income taxes on the accumulated undistributed earnings of our Irish
subsidiary, as these earnings are currently expected to be reinvested indefinitely. NOTE 3 STOCK-BASED COMPENSATION We currently account for stock-based employee compensation arrangements in accordance with
provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, as interpreted by FASB Interpretation No. 44 Accounting for Certain Transactions
Involving Stock Compensation, an Interpretation of Opinion No. 25. We also comply with the
disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation and SFAS No. 148,
Accounting for Stock-Based Compensation, Transition and Disclosure. Under APB Opinion No. 25,
compensation cost is recognized over the vesting period based on the difference, if any, on the
date of grant between the fair value of our stock and the amount an employee must pay to acquire
the stock. The changes that will be required by SFAS No. 123(R) are discussed in Note 2 above. Had compensation expense been determined based on the fair value at the grant dates for the
awards under these plans using the Black-Scholes option pricing model prescribed by SFAS No. 123,
our pro forma net income and pro forma basic and diluted earnings per share would have been as set
forth in the table below. Such pro forma disclosures may not be representative of future
compensation expense because options vest over several years and additional grants are made each
year. Three monthsended
    
    
    Six months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004(in thousands, except per share data)Net income, as
reported
    
    $
    5,430
    
    
    $
    4,530
    
    
    $
    9,243
    
    
    $
    5,445Add: Interest on
convertible notes
payable, net of
related tax
effects
    
    
    
    
    
    
    78
    
    
    
    
    
    
    
    152Add: Stock-based
employee
compensation expense
included in reported
net income, net of
related tax
effects
    
    
    7
    
    
    
    8
    
    
    
    15
    
    
    
    16Deduct: Total
stock-based employee
compensation expense
determined under
fair-value-based
method for all
awards, net of
related tax
effects
    
    
    (612
    )
    
    
    (541
    )
    
    
    (1,290
    )
    
    
    (1,137
    )Pro forma net
income, for basic
earnings per share
    
    $
    4,825
    
    
    $
    3,997
    
    
    $
    7,968
    
    
    $
    4,324Pro forma net
income, for diluted
earnings per share
    
    $
    4,825
    
    
    $
    4,075
    
    
    $
    7,968
    
    
    $
    4,476Net income per share:Basic, as
reported
    
    $
    0.37
    
    
    $
    0.35
    
    
    $
    0.63
    
    
    $
    0.42Basic, pro
forma
    
    $
    0.33
    
    
    $
    0.31
    
    
    $
    0.54
    
    
    $
    0.33Diluted, as
reported
    
    $
    0.36
    
    
    $
    0.32
    
    
    $
    0.61
    
    
    $
    0.39Diluted, pro
forma
    
    $
    0.32
    
    
    $
    0.28
    
    
    $
    0.53
    
    
    $
    0.31
 7




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The fair value of each option is estimated on the date of grant using the Black-Scholes
option-pricing model with the assumptions set out in the table below. Employee Stock Option Plans
    
    
    Employee Stock Option PlanThree months ended
    
    
    Six months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Expected life of option
    
    2.68 years
    
    2.70 years
    
    2.67 years
    
    2.70 yearsRisk-free interest rate
    
    
    3.56
    %
    
    
    2.85
    %
    
    
    3.39
    %
    
    
    2.85
    %Expected volatility
    
    
    80.9
    %
    
    
    90.1
    %
    
    
    81.8
    %
    
    
    90.1
    %
 Employee Stock Purchase Plans
    
    
    Employee Stock Purchase PlanThree months ended
    
    
    Six months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Expected life of option
    
    0.5 years
    
    0.5 years
    
    0.5 years
    
    0.5 yearsRisk-free interest rate
    
    
    2.48
    %
    
    
    1.15
    %
    
    
    2.48
    %
    
    
    1.15
    %Expected volatility
    
    
    47.0
    %
    
    
    71.3
    %
    
    
    47.0
    %
    
    
    71.3
    %
 NOTE 4BASIC AND DILUTED NET INCOME PER SHARE Basic net income per share is computed using the weighted average number of common shares
outstanding during the period. Diluted net income per share includes the effect of dilutive
potential common shares issued during the period from the exercise of options using the treasury
stock method. Three months ended
    
    
    Six months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004(in thousands, except per share data)Net income
    
    $
    5,430
    
    
    $
    4,530
    
    
    $
    9,243
    
    
    $
    5,445Interest on note payable, net of
taxes
    
    
    0
    
    
    
    78
    
    
    
    0
    
    
    
    152Net Income, for diluted earnings per share
    
    $
    5,430
    
    
    $
    4,608
    
    
    $
    9,243
    
    
    $
    5,597Weighted average shares outstanding
    
    
    14,676
    
    
    
    13,000
    
    
    
    14,637
    
    
    
    12,952Dilutive options
    
    
    427
    
    
    
    489
    
    
    
    492
    
    
    
    392Convertible notes payable
    
    
    0
    
    
    
    1,081
    
    
    
    0
    
    
    
    1,081Weighted average shares assuming
dilution
    
    
    15,103
    
    
    
    14,570
    
    
    
    15,129
    
    
    
    14,425Net income per share:Basic
    
    $
    0.37
    
    
    $
    0.35
    
    
    $
    0.63
    
    
    $
    0.42Diluted
    
    $
    0.36
    
    
    $
    0.32
    
    
    $
    0.61
    
    
    $
    0.39
 Diluted net income per share does not include the effect of the following anti-dilutive
potential common shares: Three months ended
    
    
    Six months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Common stock options
    
    
    300
    
    
    
    149
    
    
    
    228
    
    
    
    559
 8




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NOTE 5GOODWILL AND INTANGIBLE ASSETS We performed our most recent annual impairment test on September 30, 2004, and determined that
there was no impairment of goodwill. As such, there was no write-down of the goodwill balance.
Between
October 1, 2004 and March 31, 2005, there were no changes to the Companys goodwill balance of
$49.4 million or indicators of impairment. Intangible assets subject to amortization consist of purchased technology, trade names and
customer relationships that are being amortized over a period of seven years, non-compete
agreements that are being amortized over a period of eight years, and backlog that was amortized
over a period of six months, as follows (in thousands): As of September 30, 2004
    
    
    As of March 31, 2005Gross
    
    
    
    
    
    
    Net
    
    
    Gross
    
    
    
    
    
    
    NetCarrying
    
    
    Accumulated
    
    
    Carrying
    
    
    Carrying
    
    
    Accumulated
    
    
    CarryingAmount
    
    
    Amortization
    
    
    Amount
    
    
    Amount
    
    
    Amortization
    
    
    AmountPurchased Technology
    
    $
    4,800
    
    
    $
    (1,428
    )
    
    $
    3,372
    
    
    $
    4,800
    
    
    $
    (1,772
    )
    
    $
    3,028Trade names
    
    
    1,000
    
    
    
    (298
    )
    
    
    702
    
    
    
    1,000
    
    
    
    (369
    )
    
    
    631Customer relationships
    
    
    1,000
    
    
    
    (298
    )
    
    
    702
    
    
    
    1,000
    
    
    
    (369
    )
    
    
    631Non-compete agreements
    
    
    400
    
    
    
    (104
    )
    
    
    296
    
    
    
    400
    
    
    
    (129
    )
    
    
    271System backlog
    
    
    400
    
    
    
    (400
    )
    
    
    
    
    
    
    400
    
    
    
    (400
    )
    
    
    Total
    
    $
    7,600
    
    
    $
    (2,528
    )
    
    $
    5,072
    
    
    $
    7,600
    
    
    $
    (3,039
    )
    
    $
    4,561
 The estimated future amortization expense of purchased intangible assets as of March 31, 2005
was as follows: AmountFiscal Year
    
    (in millions)2005 (remaining 6 months)
    
    $
    0.52006
    
    
    1.02007
    
    
    1.02008
    
    
    1.0Thereafter
    
    
    1.1Total
    
    $
    4.6
 NOTE 6WARRANTY ACCRUAL The following table represents the activity in warranty accrual for the six months ended March
31, 2005 and 2004 (in thousands): 2005
    
    
    2004Balance at beginning of period
    
    $
    69
    
    
    $
    60Warranty accrual used during the period
    
    
    (41
    )
    
    
    (34
    )Accruals for warranties issued during the period
    
    
    48
    
    
    
    42Balance at end of period
    
    $
    76
    
    
    $
    68
 9




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NOTE 7COMPREHENSIVE INCOME The components of comprehensive income, net of tax, are as follows: Three months ended
    
    
    Six months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004(in thousands)Net income
    
    $
    5,430
    
    
    $
    4,530
    
    
    $
    9,243
    
    
    $
    5,445Currency translation adjustment
    
    
    (59
    )
    
    
    82
    
    
    
    124
    
    
    
    185Unrealized gains (losses) on investments, net
    
    
    (21
    )
    
    
    3
    
    
    
    (37
    )
    
    
    (4
    )Comprehensive income
    
    $
    5,350
    
    
    $
    4,615
    
    
    $
    9,330
    
    
    $
    5,626
 NOTE 8INVENTORIES March 31,
    
    
    September 30,2005
    
    
    2004(in thousands)Raw materials
    
    $
    2,147
    
    
    $
    1,908Work-in-process
    
    
    283
    
    
    
    298Finished goods
    
    
    120
    
    
    
    174$
    2,550
    
    
    $
    2,380
 NOTE 9CONVERTIBLE NOTES PAYABLE In connection with the acquisition of the Network Diagnostic Business (NDB) from Tekelec in
August 2002, our Irish subsidiary issued two convertible notes to Tekelec in the principal amounts
of $10.0 million and $7.3 million, respectively. These notes were guaranteed by us, bore interest
at 2% per annum and were due and payable on or before August 30, 2004. The two notes were converted
by Tekelec in September 2004 into 1,081,250 shares of our common stock. The fair value of the notes was $18.1 million, which was recorded on the balance sheet as at
the date they were issued. The valuation premium of $0.8 million was amortized to interest income
over the term of the notes on an effective interest method. NOTE 10ISSUANCE OF COMMON STOCK In September 2004, as part of our public offering under our previously filed shelf
Registration Statement on Form S-3 (File No. 333-112610) which was declared effective by the
Securities and Exchange Commission on March 31, 2004, we issued 200,000 shares of our common stock
at a public offering price of $18.97 per share. After underwriting discounts and commissions of
approximately $190,000 and capitalized external incremental costs of approximately $602,000, the
net proceeds to us were approximately $3,002,000. Also sold under the public offering were 300,000
outstanding shares held by certain selling stockholders and 1,081,250 shares that were registered
upon conversion of the notes issued to Tekelec described in Note 9 above. NOTE 11REPURCHASE OF COMMON STOCK In December 1999, our Board of Directors authorized a stock repurchase program of up to
2,000,000 shares of its common stock. Depending on market conditions and other factors, repurchases
can be made from time to time in the open market and in negotiated transactions, including block
transactions, and this program may be discontinued at any time. In the year ended September 30,
2003, 10




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##### Table of Contents



we repurchased 257,400 shares at a cost of approximately $1.8 million. The shares repurchased
were
restored to the status of authorized but unissued stock. In the same period, treasury stock with a
carrying value of $300,000 that had previously been repurchased was restored to the status of
authorized but unissued stock. In the years ended September 30, 2002 and 2004 and the six months
ended March 31, 2005, we repurchased no shares. As of March 31, 2005, we are authorized to
repurchase an additional 1,742,600 shares of our common stock under the stock repurchase program. NOTE 12INCOME TAXES Our provision for income taxes consists of federal, state and foreign taxes. We recorded a tax
provision of $1.3 million and $712,000 in the three months ended March 31, 2005 and March 31, 2004,
respectively and $1.7 million and $886,000 in the six months ended March 31, 2005 and March 31,
2004, respectively. The provision in the six months ended March 31, 2005 reflected a $0.1 million
benefit from additional research and development tax benefits claimed with respect to a prior year
and a $0.2 million benefit from the retroactive impact of the reinstitution of the research and
development tax credit program. NOTE 13GEOGRAPHIC INFORMATION We are organized to operate in and service a single global industry segment: the design,
development, manufacture, marketing and support of advanced software-based telecommunications test
systems. Although we operate in one geographic segment, our chief decision makers evaluate net revenues
by customer location based on four geographic regions, as follows: North
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    ConsolidatedAmerica
    
    
    Europe
    
    
    Japan
    
    
    Rest of World
    
    
    Total(in thousands)Six months Ended March 31, 2005Revenues from unaffiliated customers
    
    $
    10,473
    
    
    $
    9,524
    
    
    $
    11,604
    
    
    $
    3,320
    
    
    $
    34,921As of March 31, 2005Goodwill
    
    $
    22,896
    
    
    $
    26,498
    
    
    $
    
    
    
    $
    
    
    
    $
    49,394Long-lived assets
    
    
    1,480
    
    
    
    470
    
    
    
    284
    
    
    
    
    
    
    
    2,234Six months Ended March 31, 2004Revenues from unaffiliated customers
    
    $
    6,920
    
    
    $
    5,947
    
    
    $
    14,697
    
    
    $
    727
    
    
    $
    28,291As of September 30, 2004Goodwill
    
    $
    22,896
    
    
    $
    26,498
    
    
    $
    
    
    
    $
    
    
    
    $
    49,394Long-lived assets
    
    
    2,034
    
    
    
    339
    
    
    
    267
    
    
    
    
    
    
    
    2,640
 Revenues are segmented based on the location of the end customer and exclude all inter-company
sales. Revenues in the United States represented 26% and 20% of our total revenues in the six months
ended March 31 2005 and 2004, respectively, and revenues from Germany accounted for 10% of our
consolidated net revenues from unaffiliated customers for the six months ended March 31, 2005.
Operations in Ireland accounted for 32% and 39% of our consolidated identifiable assets at March
31, 2005 and 2004, respectively. 11




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NOTE 14CUSTOMER INFORMATION We currently sell our products to a small number of customers. Customers representing 10% or
more of our accounts receivable balances as of March 31, 2005 or September 2004, or 10% or more of
our revenues for the three months or six months ended March 31,
2005 or 2004 were as follows: Percentage of AccountsReceivable as of
    
    
    
    
    
    
    Percentage of RevenueThree months ended
    
    
    Six months endedMarch 31,
    
    
    September 30,
    
    
    March 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004Customer A
    
    
    <10
    %
    
    
    <10
    %
    
    
    <10
    %
    
    
    33
    %
    
    
    <10
    %
    
    
    21
    %Customer B
    
    
    23
    %
    
    
    14
    %
    
    
    15
    %
    
    
    <10
    %
    
    
    16
    %
    
    
    <10
    %Customer C
    
    
    <10
    %
    
    
    12
    %
    
    
    11
    %
    
    
    24
    %
    
    
    <10
    %
    
    
    16
    %Customer D
    
    
    18
    %
    
    
    <10
    %
    
    
    12
    %
    
    
    <10
    %
    
    
    <10
    %
    
    
    <10
    %Customer E
    
    
    <10
    %
    
    
    <10
    %
    
    
    18
    %
    
    
    <10
    %
    
    
    12
    %
    
    
    <10
    %Customer F
    
    
    <10
    %
    
    
    <10
    %
    
    
    <10
    %
    
    
    <10
    %
    
    
    <10
    %
    
    
    10
    %
 NOTE 15RECLASSIFICATION Certain auction rate securities have been reclassified from cash equivalents to short-term
investments in prior periods. Auction rate securities are variable rate bonds tied to short-term
interest rates with maturities on the face of the securities in excess of 90 days. Auction rate
securities have interest rate resets through a modified Dutch auction, at pre-determined short-term
intervals, usually every 7, 28 or 35 days. They trade at par and are callable at par on any
interest payment date at the option of the issuer. Interest paid during a given period is based
upon the interest rate determined during the prior auction. Although these securities are issued and rated as long-term bonds, they are priced and traded
as short-term instruments because of the liquidity provided through the interest rate reset. Based
on our ability either to liquidate our holdings or to roll our investment over to the next reset
period, we had historically classified some or all of these instruments as cash equivalents if the
period between interest rate resets was 90 days or less. We account for our marketable securities in accordance with SFAS No. 115, Accounting for
Certain Investments in Debt and Equity Securities. Such investments are classified as available
for sale and are reported at fair value in the Companys balance sheets. The short-term nature and
structure, the frequency with which the interest rate resets and the ability to sell auction rate
securities at par and at our discretion indicates that such securities should more appropriately be
classified as short-term investments with the intent of meeting the Companys short-term working
capital requirements. Certain variable rate demand and pre-refunded securities have been reclassified from
short-term investments to cash equivalents in prior periods. Like auction rate securities, variable
rate demand and pre-refunded securities are issued and rated as long term bonds but, unlike auction
rate securities, variable rate demand and pre-refunded securities are subject to a redemption
requirement on the part of the issuer prior to the originally established maturity dates. For this
reason, variable rate demand and pre-refunded securities with required redemption dates within 90
days of the date purchased are more appropriately classified as cash equivalents. Based upon our re-evaluation of these securities, we have reclassified as short-term
investments any auction rate securities previously classified as cash equivalents in each of the
accompanying consolidated balance sheets. We have also reclassified as cash equivalents any
variable rate demand and pre-refunded securities previously classified as short-term investments.
This resulted in a reclassification from short-term investments to cash and cash equivalents of
$1.8 million on the September 30, 2004 balance sheet. In addition, purchases of short-term and
long-term investments and sales of short-term investments included in the accompanying consolidated
statements of cash flows have been revised to reflect the purchase and sale of 12




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auction rate,
variable rate demand and pre-refunded securities in the appropriate categories during the periods
presented. NOTE 16 CONTINGENCIES A lawsuit was instituted in October 2002 against us and one of our subsidiaries, Catapult
Communications International Limited, an Irish corporation, in the Antwerp Commercial Court,
Antwerp, Belgium, by Tucana Telecom NV, a Belgian company. Tucana had been a distributor of
products for Tekelec, the company from which NDB was acquired in August 2002. The writ alleges that
the defendants improperly terminated an exclusive distribution agreement with Tucana following the
acquisition of NDB and seeks damages of 12,461,000 euros ($16,161,917 as at March 31, 2005) plus
legal costs. A trial date on the matter had been scheduled for January 16, 2004 but Tucana did not
appear. On March 14, 2005, Tucana filed a further brief with the
Belgian court. We are currently in
process of submitting a response. We strongly believe that we properly terminated any contract we
had with Tucana and that Tucana is not entitled to any damages in this matter. We intend to defend
ourselves vigorously. We may be able to seek indemnification from Tekelec for any damages assessed
against us in this matter under the terms of the Asset Purchase Agreement it entered into with
Tekelec, although there is no assurance that such indemnification would be available. From time to time, we may be involved in other lawsuits, claims, investigations and
proceedings, consisting of intellectual property, commercial, employment and other matters, which
arise in the ordinary course of business. In accordance with SFAS No. 5, Accounting for
Contingencies, we record a liability when it is both probable that a liability has been incurred
and the amount of the loss can be reasonably estimated. These provisions are reviewed at least
quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of
legal counsel and other information and events pertaining to a particular case. Litigation is
inherently unpredictable. However, we believe that we have valid defenses with respect to the legal
matters pending against us, as well as adequate provisions for any probable and estimable losses.
If an unfavorable ruling were to occur in any specific period, there exists the possibility of a
material adverse impact on the results of operations of that period. We believe that, given our
current liquidity and cash and investment balances, were we to receive an adverse judgment with
respect to litigation that we are currently a party to, such a judgment would not have a material
impact on liquidity. 
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis should be read in conjunction with Selected
Consolidated Financial Data and our Consolidated Financial Statements and Notes thereto included
in our Annual Report onForm 10-Kfor the year ended September 30, 2004, filed on December 10,
2004. Forward-looking Statements This report onForm 10-Qcontains statements that are not historical facts but are
forward-looking statements relating to such matters as anticipated financial performance and
involve known and unknown risks, uncertainties and other factors that may cause our business or our
industrys actual results, levels of activity, performance or achievements to be materially
different from those expressed or implied by any forward-looking statements. Such statements
include, in particular, statements about our plans, strategies, prospects, changes and trends in
our business and the markets in which we operate as described in this prospectus, the documents
incorporated herein by reference and any supplement to this prospectus. In some cases, you can
identify forward-looking statements by terminology such as may, will, could, would,
should, expect, plan, anticipate, intend, believe, estimate, forecast, predict,
propose, potential or continue or the negative of those terms or other comparable
terminology. These statements are only predictions. These forward-looking statements include but are not limited to those identified in this
report with an asterisk (*) symbol. Actual results may differ materially from those discussed in
such forward-looking statements, and you should carefully review the cautionary statements set
forth in this report onForm 10-Q, 13




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##### Table of Contents



including those set forth under the caption Risk Factors and
those set forth in our Annual Report on Form 10-K for the year ended September 30, 2004, filed on
December 10, 2004. We may from time to time make additional written and oral forward-looking statements,
including statements contained in our filings with the Securities and Exchange Commission and in
our reports to stockholders. We do not undertake to update any forward-looking statements that may
be made in thisForm 10-Qor from time to time by us or on our behalf. Overview Our Business and Products Catapult Communications Corporation (we, Catapult, the Company or the Registrant)
designs, develops, manufactures, markets and supports advanced software-based test systems offering
integrated suites of testing applications for the global telecommunications industry. We offer a single line of software-based telecommunications test products operating on a
common hardware platform range. This product line includes the DCT system, originally introduced in
1985 and since extensively enhanced; the MGTS system, acquired in 2002 in connection with the
acquisition of NDB; and the Chameleon protocol analyzer, released in the fourth calendar quarter of
2004. Our products perform a variety of test and analysis functions, including design and feature
verification, conformance testing, interoperability testing, load and stress testing, and
monitoring and analysis. We maintain an extensive library of software modules that provide test
support for a large number of industry standard protocols and variants thereon. Our emphasis is on
testing complex, high-level and emerging protocols, including:  
    Third and Fourth Generation Cellular (3G and 4G), including UMTS and cdma2000;
    General Packet Radio Service (GPRS);
    Global Systems for Mobile Communications (GSM);
    Code Division Multiple Access (CDMA);
    IP Telephony (Voice over IP or VoIP);
    Asynchronous Transfer Mode (ATM); and
    Signaling System #7 (SS7). Our extensive technical know-how and proprietary software development tools enable us to
implement test support for new protocols and protocol variants rapidly in response to customer
needs. With their extensive libraries of software protocol test modules, large selection of
proprietary hardware physical interfaces and versatile range of hardware platforms, our products
are easily configured to support a wide variety of digital testing functions, thereby reducing
customers needs for multiple test systems. In addition, our test systems multi-protocol,
multi-user capabilities allow multiple complex testing operations to be performed simultaneously,
helping our customers to accelerate their product development cycles. Our products consist of advanced proprietary software running on third-party Sun Microsystems
Solaris UNIX-based workstations or Linux-based computers together with our proprietary hardware
interfaces. When acquiring a system, customers typically license one or more software modules and
purchase hardware and ongoing software support. Customers may upgrade their systems by purchasing
additional software protocol test modules and additional hardware interfaces to meet future testing
needs. Prices for our products vary from approximately $30,000 to over $250,000 depending upon the
overall system configuration, including the number and type of software protocol modules and the
number of hardware interfaces required by the customer. 14




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Conditions and Trends in Our Industry Over the course of our last fiscal year ended September 30, 2004, there was increasing
evidence that the severe decline that the telecommunications industry had experienced in the
previous two years had ended and that at least the beginnings of a recovery were in evidence. This
improvement in market conditions resulted in increased purchasing of our products and services by
our customers overseas, where third generation wireless deployment has begun. In North America,
where third generation wireless deployment had yet to begin except in a few markets, our revenues
were unchanged from the previous year. In the six months ended March 31, 2005, we saw continuing evidence of improving market
conditions in our Europe and Rest of World regions, as well as evidence of improvement in the North
American market. In Japan, revenues decreased by 21% in comparison with the same period in the
previous year due to the loss in the latter period of fiscal year end budget surplus orders placed
by our Japanese customers to a large Japanese OEM supplier to those customers. The resulting weak
order input in Japan also resulted in a significant reduction in order backlog as at March 31, 2005
in comparison with a year earlier. Summary of Our Financial Performance in the Second Quarter of Fiscal 2005 Our financial performance in the three months ended March 31, 2005 improved over our
performance in the same period in the previous year. Our revenues increased by 10% to $19.1 million
and our net income increased by 20% to $5.4 million. Two major factors contributed to this improved financial performance:  
    In North America, Europe and Rest of World, our revenues increased by 46%, 69%
and 222%, respectively, all due primarily to the improvement in market conditions
discussed above.
    Our overall gross profit margin improved by two percentage points due
principally to a more favorable product mix. During the second quarter of fiscal 2005, our cash, cash equivalents and short-term
investments increased by $7.7 million, of which $7.6 million was provided by operating activities.
Capital expenditures in the second quarter of fiscal 2005 amounted to $0.3 million. Critical Accounting Policies and Estimates There have been no material changes to our critical accounting policies and estimates as
disclosed in our Annual Report on Form 10-K for the year ended September 30, 2004. Results of Operations The following table sets forth, for the periods indicated, the percentage relationship of
certain items from our condensed consolidated statements of income to total revenues. 15




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##### Table of Contents



For the three months ended
    
    
    For the six months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Revenues:Products
    
    
    79.2
    %
    
    
    80.8
    %
    
    
    78.7
    %
    
    
    79.0
    %Services
    
    
    20.8
    
    
    
    19.2
    
    
    
    21.3
    
    
    
    21.0Total revenues
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0Cost of revenues:Products
    
    
    7.5
    
    
    
    9.1
    
    
    
    7.6
    
    
    
    9.0Services
    
    
    4.5
    
    
    
    5.3
    
    
    
    4.8
    
    
    
    5.8Amortization of purchased technology
    
    
    0.9
    
    
    
    1.0
    
    
    
    1.0
    
    
    
    1.2Total cost of revenues
    
    
    12.9
    
    
    
    15.4
    
    
    
    13.4
    
    
    
    16.0Gross profit
    
    
    87.1
    
    
    
    84.6
    
    
    
    86.6
    
    
    
    84.0Operating expenses:Research and development
    
    
    16.9
    
    
    
    17.8
    
    
    
    17.7
    
    
    
    20.2Sales and marketing
    
    
    25.2
    
    
    
    27.0
    
    
    
    27.2
    
    
    
    30.5General and administrative
    
    
    10.6
    
    
    
    10.3
    
    
    
    11.3
    
    
    
    12.2Total operating expenses
    
    
    52.7
    
    
    
    55.1
    
    
    
    56.2
    
    
    
    62.9Income from operations
    
    
    34.4
    
    
    
    29.5
    
    
    
    30.4
    
    
    
    21.1Interest income
    
    
    1.5
    
    
    
    1.1
    
    
    
    1.5
    
    
    
    1.3Interest expense
    
    
    
    
    
    
    (0.5
    )
    
    
    
    
    
    
    (0.6
    )Other income
    
    
    (0.7
    )
    
    
    0.3
    
    
    
    (0.4
    )
    
    
    0.6Income before income taxes
    
    
    35.2
    
    
    
    30.4
    
    
    
    31.5
    
    
    
    22.4Provision for income taxes
    
    
    6.7
    
    
    
    4.1
    
    
    
    5.0
    
    
    
    3.2Net income
    
    
    28.5
    %
    
    
    26.3
    %
    
    
    26.5
    %
    
    
    19.2
    %Gross margin on product sales
    
    
    90.5
    %
    
    
    88.8
    %
    
    
    90.3
    %
    
    
    88.5
    %Gross margin on services
    
    
    78.5
    %
    
    
    72.5
    %
    
    
    77.6
    %
    
    
    72.5
    %
 Comparison of the Three-Month Periods Ended March 31, 2005 and 2004 Revenues Our revenues increased by approximately 10% from $17.2 million for the three months ended
March 31, 2004 to $19.1 million for the three months ended March 31, 2005. Over the same period,
product revenues increased by approximately 8% from $13.9 million to $15.1 million. The increase in
product revenues was attributable to increased sales of our DCT and MGTS test systems due to the
improvement in market conditions discussed above. Services revenues increased approximately 19%
from $3.3 million to $4.0 million due primarily to an increase in the number and value of DCT and
MGTS system maintenance contracts. For the reasons discussed above under the heading Conditions and Trends in Our Industry, our
revenues by geographic region varied as follows in the three months ended March 31, 2005 in
comparison with the three months ended March 31, 2004:  
    North American revenues increased by 46% from $2.7 million to $3.9 million;
    European revenues increased by 69% from $2.7 million to $4.6 million;
    Japanese revenues decreased by 25% from $11.2 million to $8.4 million; and
    Rest of World revenues increased by 222% from $0.7 million to $2.1 million. 16




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A 2% increase in the value of the Japanese yen, in which all our revenues in Japan are
denominated, had the effect of increasing our revenues by $0.2 million. In Europe, because almost
all customer orders are
denominated in dollars, the 5% increase in the value of the Euro and the 3% increase in the value
of the pound had no material quantifiable impact on our revenues. Nevertheless, because our
European customers earn their revenues in Euros and pounds, the relative decrease in the value of
the dollar against those currencies has made our dollar-denominated product prices more favorable
to our European customers when expressed in their local currencies, and this may have resulted in
increased purchases by these customers. Information on revenues from major customers is provided in Note 14 to the Unaudited Condensed
Consolidated Financial Statements. Cost of Revenues Cost of product revenues consists of the costs of board assembly by independent contractors,
purchased components, payroll and benefits for personnel in product testing, purchasing, shipping
and inventory management, as well as supplies, media and freight. Cost of product revenues
decreased approximately 9% from $1.6 million for the three months ended March 31, 2004 to $1.4
million for the three months ended March 31, 2005 and gross profit margin on product revenues
increased from 89% to 91% due to a more favorable product mix and to economies of scale in our
manufacturing operation. We expect our gross profit margin on product revenues to continue to
fluctuate based on product mix and revenue levels. Cost of services revenues consists primarily of the costs of payroll and benefits for customer
support, installation and training personnel. Cost of services revenues for the three months ended
March 31, 2005 remained substantially unchanged at $0.9 million from the three months ended March
31, 2004 as an increase of 9%, or 2 employees, in the number of employees engaged in customer
support was offset by a reduction of $0.2 million in variable compensation due to below target
performance in the three months ended March 31, 2005 in contrast to above target performance in the
three months ended March 31, 2004. Gross profit margin on services revenues increased from 73% to
79% as services revenues increased more than the cost of those revenues. We expect our gross profit
margin on services revenues to continue to fluctuate based primarily on revenue levels. Amortization of purchased technology related to the NDB acquisition remained unchanged at $0.2
million in the three months ended March 31, 2005 compared with the same period the previous year. Gross profit margins did not vary significantly by geographic region. Research and Development Research and development expenses consist primarily of the costs of payroll and benefits for
engineers, materials, equipment and consulting services. To date, because we release our products
as soon as technological feasibility is established, all software development costs have been
charged to research and development expenses as incurred. Research and development expenses
increased by approximately 5% from $3.1 million for the three months ended March 31, 2004 to $3.2
million for the three months ended March 31, 2005 reflecting an increase of 5%, or 4 employees, in
the number of employees engaged in research and development. As a percentage of total revenues,
research and development expenses decreased from 18% to 17% over the same period. We expect
research and development expenses in each of the remaining quarters of the current fiscal year to
increase, primarily as a result of an anticipated increase in the number of engineering employees.* Sales and Marketing Sales and marketing expenses consist primarily of the costs of payroll, benefits, commissions
and bonuses, occupancy costs, travel and promotional expenses, such as product brochure and trade
show costs. Sales and marketing expenses increased by approximately 3% from $4.7 million for the
three months ended March 31, 2004 to $4.8 million for the three months ended March 31, 2005,
reflecting an increase of 8%, or 7 employees, in the number of sales and marketing personnel
together with an increase of $0.2 million in 17




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recruiting costs, partially offset by a decrease of
$0.5 million in variable compensation due to below-target performance in the three months ended
March 31, 2005 in contrast to above target performance in the three
months ended March 31, 2004. As a percentage of total revenues, sales and marketing expenses
decreased from 27% to 25% over the same period. We expect quarterly sales and marketing expenses to
remain relatively constant over the remainder of the current fiscal year.* General and Administrative General and administrative expenses include costs associated with our general corporate and
risk management, public reporting, employee recruitment and retention, regulatory compliance,
investor relations and finance functions, as well as amortization of certain intangible assets
acquired with NDB. General and administrative expenses increased approximately 14% from $1.8
million for the three months ended March 31, 2004 to $2.0 million for the three months ended March
31, 2005, reflecting primarily an increase of $0.3 million in legal and accounting expenses,
largely due to increased regulatory compliance costs, partially offset by a reduction of $0.1
million in variable compensation. As a percentage of total revenues, general and administrative
expenses increased from 10% to 11% over the same period. We expect general and administrative
expenses in each of the remaining quarters of the current fiscal year to increase, primarily as a
result of continuing costs of meeting the requirements of Section 404 of the Sarbanes-Oxley Act.* Provision for income taxes Our provision for income taxes consists of federal, state and foreign income taxes. We
recorded a tax provision of $1.3 million, or 19% of pre-tax income, in the three months ended March
31, 2005, compared with a provision of $0.7 million, or 14% of pre-tax income, in the three months
ended March 31, 2004. The increase in our tax rate was due to
an increase in the projected relative share of our annual
taxable income from our domestic operations versus our
international operations. Our future tax
rate will vary depending in part on the relative pre-tax
contribution from our domestic and foreign operations. Comparison of the Six-Month Periods Ended March 31, 2005 and 2004 Revenues Our revenues increased by approximately 23% from $28.3 million for the six months ended March
31, 2004 to $34.9 million for the six months ended March 31, 2005. Over the same period, product
revenues increased by approximately 23% from $22.4 million to $27.5 million. The increase in
product revenues was attributable to increased sales of our DCT and MGTS test systems due to the
improvement in market conditions discussed above. Services revenues increased approximately 25%
from $5.9 million to $7.5 million. The increase in services revenues was due primarily to an
increase in the number and value of DCT and MGTS system maintenance contracts. For the reasons discussed above under the heading Conditions and Trends in Our Industry, our
revenues by geographic region varied as follows in the six months ended March 31, 2005 in
comparison with the six months ended March 31, 2004:  
    North American revenues increased by 51% from $6.9 million to $10.5 million;
    European revenues increased by 60% from $5.9 million to $9.5 million;
    Japanese revenues decreased by 21% from $14.7 million to $11.6 million; and
    Rest of World revenues increased by 357% from $0.7 million to $3.3 million. A 3% increase in the value of the Japanese yen, in which all our revenues in Japan are
denominated, had the effect of increasing our revenues by $0.3 million. In Europe, because almost
all customer orders are denominated in dollars, the 6% increase in the value of both the Euro and
the pound had no material quantifiable impact on our revenues. Nevertheless, because our European
customers earn their revenues in Euros and pounds, the relative decrease in the value of the dollar
against those currencies has made our dollar-denominated product prices more favorable to our
European customers when expressed in their local currencies, and this may have resulted in
increased purchases by these customers. 18




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Information on revenues from major customers is provided in Note 14 to the Unaudited Condensed
Consolidated Financial Statements. Cost of Revenues Cost of product revenues consists of the costs of board assembly by independent contractors,
purchased components, payroll and benefits for personnel in product testing, purchasing, shipping
and inventory management, as well as supplies, media and freight. Cost of product revenues
increased approximately 4% from $2.6 million for the six months ended March 31, 2004 to $2.7
million for the six months ended March 31, 2005 and gross profit margin on product revenues
increased from 89% to 90% due to a more favorable product mix and to economies of scale in our
manufacturing operation. Cost of services revenues consists primarily of the costs of payroll and benefits for customer
support, installation and training personnel. Cost of services revenues increased by approximately
3% from $1.6 million for the six months ended March 31, 2004 to $1.7 million for the six months
ended March 31, 2005 due to an increase of 14%, or 3 employees, in the number of employees engaged
in customer support, partially offset by a reduction of $0.1 million in variable compensation due
to below target results in the six months ended March 31, 2005 in contrast to above target
performance in the six months ended March 31, 2004. Gross profit margin on services revenues
increased from 73% to 78% as services revenues increased more than the cost of those revenues. Amortization of purchased technology related to the NDB acquisition remained unchanged at $0.3
million in the six months ended March 31, 2005 compared with the same period the previous year. Gross profit margins did not vary significantly by geographic region. Research and Development Research and development expenses consist primarily of the costs of payroll and benefits for
engineers, materials, equipment and consulting services. To date, because we release our products
as soon as technological feasibility is established, all software development costs have been
charged to research and development expenses as incurred. Research and development expenses
increased by approximately 8% from $5.7 million for the six months ended March 31, 2004 to $6.2
million for the six months ended March 31, 2005 reflecting an increase of 1%, or 1 employee, in the
number of employees engaged in research and development as well as an increase of $0.1 million in
new product development and testing costs. As a percentage of total revenues, research and
development expenses decreased from 20% to 18% over the same period. Sales and Marketing Sales and marketing expenses consist primarily of the costs of payroll, benefits, commissions
and bonuses, occupancy costs, travel and promotional expenses, such as product brochure and trade
show costs. Sales and marketing expenses increased by approximately 10% from $8.6 million for the
six months ended March 31, 2004 to $9.5 million for the six months ended March 31, 2005, reflecting
an increase of 6%, or 6 employees, in the number of sales and marketing personnel, an increase of
$0.2 million in recruiting costs and an exchange rate driven increase of $0.2 million due to
average increases of 3% in the Japanese yen and 6% in both the British pound and the Euro against
the dollar. These increases were partially offset by a decrease of $0.2 million in variable
compensation due to below-target performance in the six months ended March 31, 2005 in contrast to
above target performance in the six months ended March 31, 2004. As a percentage of total revenues,
sales and marketing expenses decreased from 30% to 27% over the same period. General and Administrative General and administrative expenses include costs associated with our general corporate and
risk management, public reporting, employee recruitment and retention, regulatory compliance,
investor relations and finance functions, as well as amortization of certain intangible assets
acquired with NDB. General and 19




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administrative expenses increased approximately 14% from $3.5
million for the six months ended March 31, 2004 to $3.9 million for the six months ended March 31,
2005, reflecting primarily an increase of $0.4 million in legal and accounting expenses, largely
due to increased regulatory compliance costs, partially offset by a
reduction of $0.1 million in variable compensation. As a percentage of total revenues, general and
administrative expenses decreased from 12% to 11% over the same period. Provision for income taxes Our provision for income taxes consists of federal, state and foreign income taxes. We
recorded a tax provision of $1.7 million, or 16% of pre-tax income, in the six months ended March
31, 2005, compared with a provision of $0.9 million, or 14% of pre-tax income, in the six months
ended March 31, 2004. The increase in our tax rate was due to
an increase in the projected relative share of our annual
taxable income
from our domestic operations versus our international operations. Our future tax
rate will vary depending in part on the relative pre-tax
contribution from our domestic and foreign operations. Liquidity and Capital Resources We have financed our operations primarily through cash generated from operations, from the
proceeds of our initial public offering completed in early 1999 and from the proceeds of a second
public offering completed in September 2004. The proceeds to us from the 1999 and 2004 offerings,
net of underwriter fees and offering costs, were approximately $19.2 million and $3.0 million,
respectively. Our purchase of NDB was additionally financed through the issuance of two convertible notes in
the aggregate principal amount of $17.3 million. The convertible notes were issued by our Irish
subsidiary and were guaranteed by us. These notes were converted by Tekelec into 1,081,250 shares
of our common stock in September 2004. Our operating activities provided cash of $10.5 million and $6.2 million in the six months
ended March 31, 2005 and 2004, respectively. In each of these periods, net income was the primary
component of cash flows from operating activities, providing $9.2 million and $5.4 million in the
six months ended March 31, 2005 and 2004, respectively. Cash generated by net income was increased
by adjustments for non-cash depreciation and amortization charges totaling $1.4 million and $1.2
million in the six months ended March 31, 2005 and 2004, respectively. Finally, our cash flows from
operations are affected by changes in current assets and liabilities. These changes in non-cash
working capital components decreased cash flow from operations by $0.3 million and $0.5 million in
the six months ended March 31, 2005 and 2004, respectively. Our primary source of operating cash flow is the collection of accounts receivable from our
customers. We measure the effectiveness of our collection efforts by an analysis of average
accounts receivable days outstanding (days outstanding). We calculate our days outstanding by
dividing our accounts receivable balance net of allowances at the end of a period by the revenues
for that period and multiplying the result by the number of days in the period. Our days
outstanding decreased from 68 days at March 31, 2004 to 60 days at March 31, 2005 primarily due to
stronger invoicing early in the quarter in the latter period, due in turn to an
uncharacteristically high level of backlog as of December 31, 2004. Collections of accounts
receivable and related days outstanding will fluctuate in future periods due to the timing and
amount of our future revenues, payment terms extended to our customers and the effectiveness of our
collection efforts. Investing activities have consisted of two components: purchases of property and equipment,
and purchases and sales of short-term investments. Purchases of property and equipment increased
from $0.3 million in the six months ended March 31, 2004 to $0.5 million in the six months ended
March 31, 2005. We expect that purchases of property and equipment for the full fiscal year ending
September 30, 2005 will total approximately $1.2 million.* We invest cash that is surplus to our
operating requirements in professionally managed investment portfolios. Those portfolios consist of
both cash equivalents and short-term investments, and the mix between these elements may vary from
period to period due to changes in the investment approaches of the portfolio managers. Purchases
and sales of short-term investments used cash of $6.4 million and $5.9 million in the three months
ended March 31, 2005 and 2004, respectively. 20




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Financing activities provided cash of $1.9 million and $1.4 million in the six months ended
March 31, 2005 and 2004, respectively, from the exercise of stock options and the sale of shares
under our employee stock purchase plan. As of March 31, 2005, we had working capital of $67.9 million and cash, cash equivalents and
short-term investments of $64.7 million. As of March 31, 2005, we had the following contractual
obligations, in millions: Payments Due by PeriodLess Than
    
    
    2-3
    
    
    4-5
    
    
    AfterContractual Obligations
    
    Total
    
    
    1 Year
    
    
    Years
    
    
    Years
    
    
    5 YearsOperating leases
    
    $
    4.3
    
    
    $
    1.2
    
    
    $
    1.9
    
    
    $
    1.1
    
    
    $
    0.1Total contractual cash obligations
    
    $
    4.3
    
    
    $
    1.2
    
    
    $
    1.9
    
    
    $
    1.1
    
    
    $
    0.1
 We believe that inflation has not had a material impact on our liquidity or cash requirements. We may require additional funds to support our working capital requirements or for other
purposes. There can be no assurance that additional financing will be available or that, if
available, such financing will be obtainable on terms favorable to us or our stockholders. We
believe that cash, cash equivalents and short-term investments together with funds generated from
operations will provide us with sufficient funds to finance our requirements for at least the next
12 months.* Recent Accounting Pronouncements See
Note 2 of the Notes to our Unaudited Condensed Consolidated Financial Statements for
information on recent accounting pronouncements. Risk Factors The risks described below are not the only ones we face. Additional risks not presently known
to us or that we currently believe are immaterial may also impair our business operations. Risks Related to Our Business Our quarterly operating results may fluctuate significantly, and this may result in volatility in
the market price of our common stock. We have experienced, and anticipate that we will continue to experience, significant
fluctuations in quarterly revenues and operating results. Our revenues and operating results are
relatively difficult to forecast for a number of reasons, including:  
    the variable size and timing of individual purchases by our customers;
    seasonal factors that may affect capital spending by customers, such as the
varying fiscal year ends of customers and the reduction in business during the summer
months, particularly in Europe;
    the relatively long sales cycles for our products;
    competitive conditions in our markets;
    exchange rate fluctuations;
    the timing of the introduction and market acceptance of new products or product
enhancements by us and by our customers, competitors and suppliers;
    costs associated with developing and introducing new products;
    product life cycles;
    changes in the level of operating expenses relative to revenues;
    product defects and other quality problems;
    customer order deferrals in anticipation of new products;
    supply interruptions;
    changes in global or regional economic conditions or in the telecommunications industry;
    delays in purchasing decisions or customer orders due to customer consolidation; 21




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
    the ability to hire sales and technical personnel;
    changes in the mix of products sold; and
    changes in the regulatory environment. Our revenues in any period generally have been, and may continue to be, derived from
relatively small numbers of sales and service transactions with relatively high average revenues
per order. Therefore, the loss of any orders or delays in closing such transactions could have a
more significant impact on our quarterly revenues and results of operations than on those of
companies with relatively high volumes of sales or low revenues per order. Our products generally
are shipped within 15 to 45 days after orders are received. As a result, we generally do not have a
significant backlog of orders, and revenues in any quarter are substantially dependent on orders
booked, shipped and installed in that quarter. Most of our costs, including personnel and facilities costs, are relatively fixed, and our
operating expenses are based on anticipated revenue. As a result, a decline in revenue from even a
limited number of transactions, failure to achieve expected revenue in any quarter or unanticipated
variations in the timing of recognition of specific revenues can cause significant variations in
our quarterly operating results and could result in losses. We believe, therefore, that
period-to-period comparisons of our operating results should not be relied upon as an indication of
future performance. Due to the factors described above, as well as other unanticipated factors, it is possible
that in some future quarter our results of operations could fail to meet the expectations of public
market analysts or investors. If this occurs, the price of our common stock may fall. Historically, our revenues have been dependent upon a few significant customers, the loss of one
or more of which could significantly reduce our revenues. Our customer base is highly concentrated, and a relatively small number of companies have
accounted for substantially all of our revenues to date. In our fiscal year ended September 30,
2004, the top five customers represented approximately 55% of total revenues. In the three months
ended March 31, 2005, the top five customers represented approximately 63% of revenues. We
typically see a higher level of customer concentration in a three month period than in a full
fiscal year. We expect that we will continue to depend upon a relatively limited number of
customers for substantially all of our revenues in future periods, although no customer is
presently obligated either to purchase a specific amount of products or to provide us with binding
forecasts of purchases for any period. If we were to lose a significant customer or if a
significant customer were to reduce, delay or cancel its orders, our operating results could be
seriously harmed. Our business is dependent on our customers outsourcing their telecommunications testing needs, and
our business could be harmed if the market for outsourced testing solutions declines or fails to
grow. Our success will depend on continued growth in the market for telecommunications test systems
and services and the continued commercial acceptance of our products as a solution to address the
testing requirements of telecommunications equipment manufacturers and network operators. While
most of our present and potential customers have the technical capability and financial resources
to produce their own test systems and perform test services internally, to date, many have chosen
to outsource a substantial proportion of their test system and service requirements. Our customers
may not continue, and potential new customers may not choose, to outsource any of their test
systems and service requirements. If the market for telecommunications test systems and services,
or the demand for outsourcing, declines or fails to grow, or if our products and services are not
widely adopted as a telecommunications test solution, our business, financial condition and
operating results could be seriously harmed. If we do not effectively manage our growth, our business and operating results could be adversely
affected. Our growth has placed, and is expected to continue to place, significant demands on our
management, administrative and operational resources. To manage expansion effectively, we need to
continue to develop and improve our operational and financial systems, sales and marketing
capabilities and expand, train, retain, manage and motivate our employee base. Our systems,
procedures or controls may not be adequate to support our operations and our management may not be
able to successfully exploit future market opportunities or successfully manage our relationships
with customers and other third parties. We may not continue to grow 22




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and, if we do, we may not
effectively manage such growth. Any failure to manage growth could have an adverse effect on our
business, financial condition and results of operations. We face foreign business, political and economic risks because a significant portion of our sales
is to customers outside the United States. We derive a significant percentage of our revenues from customers outside of North America,
and we maintain operations in seven other countries. International sales and operations are subject
to inherent risks, including:  
    longer customer payment cycles;
    greater difficulty in accounts receivable collection;
    difficulties in staffing and managing foreign operations;
    changes in regulatory requirements or in economic or trade policy;
    costs related to localizing products for foreign countries;
    potentially weaker protection for intellectual property in certain foreign countries;
    the burden of complying with a wide variety of foreign laws and practices,
tariffs and other trade barriers; and
    potentially adverse tax consequences, including restrictions on repatriation of
earnings. During the last three fiscal years, a significant portion of our international sales has been
to customers in Japan. If economic conditions in Japan deteriorate, our business, financial
condition and results of operations could be materially adversely affected. An inability to obtain
necessary regulatory approvals in foreign markets on a timely basis could also have an adverse
effect on our business, financial condition and results of operations. A significant portion of our sales, including all our sales in Japan, is denominated in local
currencies. Although we currently engage in hedging transactions with respect to receivables
resulting from some inter-company sales, we may not continue to do so and our hedging activities
may not be successful. Fluctuations in foreign currency exchange rates may contribute to
fluctuations in our operating results. For example, changes in foreign currency exchange rates
could adversely affect the revenues, net income, earnings per share and cash flow of our operations
in affected markets. Similarly, such fluctuations may cause us to raise prices, which could affect
demand for our products and services. In addition, if exchange or price controls or other
restrictions are imposed in countries in which we do business, our business, financial condition
and operating results could be seriously harmed. We may not be able to achieve the anticipated benefits of any acquisitions we may make of other
companies, products or technologies. As part of our business strategy, we acquired Tekelecs Network Diagnostics Business in 2002,
and we may make further acquisitions of, or significant investments in, companies, products or
technologies that we believe are complementary. Any such transactions would be accompanied by the
risks commonly encountered in making acquisitions of companies, products and technologies. Such
risks include, among others:  
    difficulties associated with assimilating the personnel and operations of acquired companies;
    potential disruption of our ongoing business;
    distraction of management and other resources;
    integration of personnel and technology of an acquired company;
    difficulties in evaluating the technology of a potential target;
    inability to motivate and retain new personnel;
    maintenance of uniform standards, controls, procedures and policies; and
    impairment of relationships with employees and clients as a result of the
integration of new management personnel. We have limited experience in assimilating acquired companies or product lines into our
operations. We may not be successful in overcoming these risks or any other problems encountered in
connection with any such future acquisitions. Furthermore, any future acquisitions could result in
the issuance of dilutive equity securities, the incurrence of debt or contingent liabilities or
amortization expenses related to goodwill and other intangible assets, any of which could seriously
harm our business, financial condition and operating results or decrease the value of our common
stock. 23




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We face intense competition in our markets from more established test solutions providers, and if
we are unable to compete successfully we may not be able to maintain or grow our business. The market for our products is highly competitive. A number of our competitors are better
known and have substantially greater financial, technological, production and marketing resources
than we do. While we believe that the price/performance characteristics of our products are
competitive, competition in the markets for our products could force us to reduce prices. Any
material reduction in the price of our products without corresponding decreases in manufacturing
costs and increases in unit volume would negatively affect our gross margins. Increased competition
for our products that results in lower product sales could also adversely impact our upgrade sales.
Our ability to maintain our competitive position will depend upon, among other factors, our success
in anticipating industry trends, investing in product research and development, developing new
products with improved price/performance characteristics and effectively managing the introduction
of new products into targeted markets. We have experienced delays in completing our new Chameleon product, which could result in lost
sales opportunities and lower financial results. Due
to a six month delay associated with development and testing, Chameleon was not commercially released
and made available for beta testing until technological feasibility was established in the fourth
calendar quarter of 2004. This delay may have caused us to miss a portion of the market window for
Chameleon as we believe that mobile telecommunications operators may have made or may make many of
their key 3G maintenance procurement decisions before Chameleon is evaluated. Our success depends on the continued growth of the telecommunications industry and increased use
of our test solutions, and lack of growth in this industry could harm our business. Our future success is dependent upon the continued growth of the telecommunications industry.
The global telecommunications industry is evolving rapidly, and it is difficult to predict its
potential growth rate or future trends in technology development. The deregulation, privatization
and economic globalization of the worldwide telecommunications market that have resulted in
increased competition and escalating demand for new technologies and services may not continue in a
manner favorable to us or our business strategies. In addition, the growth in demand for Internet
services and the resulting need for high speed or enhanced telecommunications equipment may not
continue at its current rate or at all. Our future success depends upon the increased utilization of our test solutions by network
operators and telecommunications equipment manufacturers. Industry-wide network equipment and
infrastructure development driving the demand for our products and services may be delayed or
prevented by a variety of factors, including cost, regulatory obstacles or the lack of or reduction
in consumer demand for advanced telecommunications products and services. Telecommunications
equipment manufacturers and network operators may not develop new technology or enhance current
technology. Further, any such new technology or enhancements may not lead to greater demand for our
products or services. Our business could be harmed if we were to lose the services of one or more members of our senior
management team, or if we are unable to attract and retain qualified personnel. Our future growth and success depends to a significant extent upon the continuing services of
our executive officers and other key employees. We do not have long-term employment agreements or
non-competition agreements with any of our employees. Competition for qualified management and
other high-level telecommunications industry personnel is intense, and we may not be successful in
attracting and retaining qualified personnel. If we lose the services of any key employees, we may
not be able to manage our business successfully or achieve our business objectives. Our success also depends on our ability to identify, attract and retain qualified technical,
sales, finance and management personnel. We have experienced, and may continue to experience,
difficulty in hiring and retaining candidates with appropriate qualifications. If we do not succeed
in hiring and retaining candidates with appropriate qualifications, our revenues and product
development efforts could be harmed. 24




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Our ability to deliver products that meet customer demand is dependent on our ability to meet new
and changing requirements for telecommunications test systems and services. The market for telecommunications test systems and services is subject to rapid technological
change, evolving industry standards, rapid changes in customer requirements and frequent product
and service introductions and enhancements. Our future success will depend in part on our ability to anticipate and respond to these
changes by enhancing our existing products and services and by developing and introducing, on a
timely and cost-effective basis, new products, features and services that address the needs of our
customer base. We may not be successful in identifying, developing and marketing new products,
product enhancements and related services that respond to technological change or evolving industry
standards or that adequately meet new market demands. In addition, because of the rapid
technological change characteristic of the telecommunications industry, we may be required to
support legacy systems used by our customers. As a result, this may place additional demands on our
personnel and other resources and may require us to maintain an inventory of otherwise obsolete
components. Our test systems currently operate only on Sun Microsystemss Solaris and the Linux
operating systems. Our current and prospective customers may require other operating systems, such
as Windows 2000 or Windows XP, to be used in their telecommunications test systems or may require
the integration of other industry standards. We may not be able to successfully adapt our products
to such operating systems on a timely or cost-effective basis, if at all. Our failure to respond to
rapidly changing technologies and to develop and introduce new products and services in a timely
manner could adversely affect our operations and overall profitability. Our success will depend in part on whether a large number of telecommunications equipment
manufacturers and network operators purchase our products and services. Because the
telecommunications market is rapidly evolving, it is difficult to predict the future success of
products and services in this market. The customers in this market use products from a number of
competing suppliers for various testing purposes, and there has not been broad adoption of the
products of one company. Our current or future products or services may not achieve widespread
acceptance among telecommunications equipment manufacturers, network operators or other potential
customers. In addition, our competitors may develop solutions that could render our products
obsolete or uncompetitive. In the event the telecommunications industry does not broadly adopt our
products or services or does so less rapidly than we expect, or in the event our products are
rendered obsolete or uncompetitive by more advanced solutions, our business, financial condition
and operating results could be seriously harmed. Many of our suppliers are sole source or single source suppliers, and our inability to obtain
adequate amounts of components from these suppliers could harm our business. We purchase many key components, including certain microprocessors, workstations, bus
interface and other chips, connectors and other hardware, from the sole supplier of a particular
component. For other components, even though multiple vendors may exist, we may purchase components
from only a single source. We do not have any long-term supply agreements with these vendors to
ensure uninterrupted supply of these components. If our supply of a key component is reduced or
interrupted, we might require a significant amount of time to qualify alternative suppliers and
receive an adequate flow of replacement components. We may also need to reconfigure our products to
adapt to new components, which could entail substantial time and expense. In addition, the process
of manufacturing certain of these components is extremely complex, and our reliance on the
suppliers of these components exposes us to potential production difficulties and quality
variations. These could negatively affect cost and timely delivery of our products. We have in the
past experienced supply problems as a result of the financial or operational difficulties of our
suppliers, shortages and discontinuations resulting from component obsolescence. Although to date
we have not experienced material delays in product deliveries to our customers resulting from
supply problems, such problems may recur or, if such problems do recur, we may not find
satisfactory solutions. If we are unable to obtain adequate amounts of fully functional components
or are otherwise required to seek alternative sources of supply, our relationship with our
customers and our results of operations could be harmed. 25




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We depend on a limited number of independent manufacturers, which reduces our ability to control
our manufacturing process. We rely on a limited number of independent manufacturers, some of which are small, privately
held companies, to provide certain assembly services to our specifications. We do not have any
long-term supply agreements with any third-party manufacturer. If our assembly services are reduced
or interrupted, our business, financial condition and results of operations could be adversely
affected until we are able to establish sufficient assembly services supply from alternative
sources. Alternative manufacturing sources may not be able to meet our future requirements, and
existing or alternative sources may not continue to be available to us at favorable prices. The high level of complexity and integration of our products increases the risk of latent defects,
which could damage customer relationships and increase our costs. Our complex products may contain undetected errors or bugs, particularly when first
introduced or when new versions are released. Errors may be found in future releases of our
software. In addition, any such errors may generate adverse publicity, impair the market acceptance
of these products, create customer concerns or adversely affect operating results due to product
returns, the costs of generating corrective releases or otherwise. We face exposure to product liability claims, which if successful could harm our business. Our license agreements with our customers typically contain provisions designed to limit our
exposure to potential product liability claims. However, it is possible that the limitation of
liability provisions contained in our license agreements may not be effective under the laws of
certain jurisdictions, particularly since we sell a majority of our products internationally.
Although we have not experienced any product liability claims to date, our sale and support of
products may entail the risk of such claims. We may be subject to such claims in the future. A
successful product liability claim brought against us could have a material adverse effect upon our
business, financial condition and results of operations. If we fail to maintain adequate product
liability insurance and if we were to lose a large uninsured claim, then such a loss could
significantly harm our business, financial condition and operating results. Our success is dependent on our ability to protect our intellectual property, and our failure to
protect our intellectual property could have a significant adverse impact on our business. Our success and ability to compete effectively are dependent in part upon our proprietary
technology. We rely on a combination of trademark, copyright and trade secret laws, as well as
nondisclosure agreements and other contractual restrictions, to establish and protect our
proprietary rights. To date, we have generally not sought patent protection for our proprietary
technology. Patent protection may become more significant in our industry in the future. Likewise,
the measures we undertake may not be adequate to protect our proprietary technology. To date, we
have federally registered certain of our trademarks or copyrights. Our practice is to affix
copyright notices on software, hardware and product literature in order to assert copyright
protection for these works. The lack of federal registration of all of our trademarks and
copyrights may have an adverse effect on our intellectual property rights in the future.
Additionally, we may be subject to further risks as we enter into transactions in countries where
intellectual property laws are unavailable, do not provide adequate protection or are difficult to
enforce. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to
duplicate aspects of our products or to obtain and use information that we regard as proprietary.
Our steps to protect our proprietary technology may not be adequate to prevent misappropriation of
such technology, and may not preclude competitors from independently developing products with
functionality or features similar to our products. If we fail to protect our proprietary
technology, our business, financial condition and results of operations could be harmed
significantly. We could become subject to litigation regarding intellectual property, which could divert
management attention, be costly to defend and prevent us from using or selling the challenged
technology. The telecommunications industry is characterized by a relatively high level of litigation
based on allegations of infringement of proprietary rights. While to date we have not been subject
to claims of infringement or misappropriation of intellectual property by third parties, third
parties may assert infringement claims against us. In addition, an assertion of infringement may
result in litigation in which we may not prevail. Furthermore, any such claims, with or without
merit, could result in substantial cost to us and diversion of our personnel. In addition,
infringement claims may require us to develop new technology or 26




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require us to enter into royalty or licensing arrangements. These royalty or licensing agreements,
if required, may not be available on terms acceptable to us. Because we do not rely on patents to
protect our technology, we will not be able to offer a license for patented technology in
connection with any settlement of patent infringement lawsuits. If a claim of infringement or
misappropriation against us were successful and we fail or are unable to develop non-infringing
technology or license any infringed, misappropriated or similar technology at a reasonable cost,
our business, financial condition and results of operations would be adversely affected. In
addition, we indemnify our customers against claimed infringement of patents, trademarks,
copyrights and other proprietary rights of third parties. Any requirement for us to indemnify a
customer may significantly harm our business, financial condition and operating results. Our success depends on the timely development and introduction of new products. Our future success will depend in part on our ability to anticipate and respond to changing
industry standards and customer requirements by enhancing our existing products and services. We
may need to develop and introduce, on a timely and cost-effective basis, new products, features and
services that address the needs of our customer base. We may not be successful in identifying,
developing and marketing new products, product enhancements and related services that respond to
technological change or evolving industry standards or that adequately meet new market demands. Risks Related to Our Stock Our stock has been and will likely continue to be subject to substantial price and volume
fluctuations due to a number of factors, many of which will be beyond our control. In recent years, the stock market in general and the market for technology stocks in
particular, including our common stock, have experienced extreme price fluctuations. The market
price of our common stock may be significantly affected by various factors such as:  
    quarterly variations in our operating results;
    changes in our revenue growth rates as a whole or for specific geographic areas or products;
    changes in earning estimates by market analysts;
    changes in the extent to which a significant percentage of our shares are held
by a small number of investors;
    the announcements of new products or product enhancements by us or our competitors;
    speculation in the press or analyst community; and
    general market conditions or market conditions specific to particular industries. The market price of our common stock may experience significant fluctuations in the future. The requirement to record an expense for our stock-based compensation plans, and the resultant
ongoing accounting charges, will significantly reduce our reported net income and net income per
share, and the price of our stock could drop significantly. In December 2004, the Financial Accounting Standards Board (FASB) issued Statement Number
123 (revised 2004), SFAS 123(R), Share-Based Payment, which requires all companies to measure
compensation expense for all share-based payments (including employee stock options) at fair value,
and will be effective for public companies for annual reporting periods that begin after June 15,
2005. Our future adoption of SFAS 123(R) will require us to record an expense for stock-based
compensation plans commencing in the first quarter of our 2006 fiscal year and will result in
ongoing accounting charges that will significantly reduce our net income. See Notes 2 and 3 of the
Notes to our Unaudited Condensed Consolidated Financial Statements for further information. If we are unable to determine and demonstrate that we maintain effective controls over internal
financial reporting, this may cause investors to lose confidence in our reported financial
information and the price of our stock could drop significantly. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with our Annual Report on
Form 10-K for our fiscal year ending September 30, 2005, we will be required to include in our
Annual Report on Form 10-K an assessment of the effectiveness of our internal controls over
financial reporting together with a report from our independent registered public accounting firm
on our assessment and the effectiveness of our controls over financial reporting. In the course of
preparing our assessment, we may identify deficiencies, which we may not be able to remediate in
time to meet the deadline for compliance with the requirements of Section 404. In addition, if we
fail to achieve and maintain the adequacy of our internal controls, as such 27




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standards are modified, supplemented or amended from time to time, we may not be able to ensure
that we can conclude on an ongoing basis that we have effective internal controls over financial
reporting. Moreover, effective internal controls are necessary for us to produce reliable financial
reports and are important in helping prevent financial fraud. If we cannot provide reliable
financial reports or prevent fraud, our business and operating results could be harmed, investors
could lose confidence in our reported financial information, and the trading price of our stock
could drop significantly. Sales of substantial amounts of our common stock by our major stockholders and others could
adversely affect the market price of our common stock. Sales of substantial numbers of shares of common stock by our major stockholders in the public
market could harm the market price for our common stock. As of March 31, 2005, Richard A. Karp, our
Chief Executive Officer and Chairman of our Board, beneficially owned 2,958,894 shares, and Nancy
H. Karp, one of our directors, beneficially owned 1,356,395 shares of our common stock. These
shares are eligible for resale into the public market within the restrictions imposed by Rule 144
under the Securities Act of 1933. Sales of a significant amount of these shares could adversely
affect the market price for our common stock. Our principal stockholder could prevent or delay a change in control. As of March 31, 2005, Dr. Karp beneficially owned 2,958,894 shares or approximately 20% of our
common stock outstanding. Such a concentration of ownership and voting power may have the effect of
delaying or preventing a change in the control of our company. Provisions in our charter documents and Nevada law could prevent or delay a change in the control
of our company and may reduce the market price of our common stock. Nevada law, our articles of incorporation and our bylaws contain provisions that could
discourage a proxy contest or make more difficult the acquisition of a substantial block of our
common stock. In addition, our board of directors is authorized to issue, without stockholder
approval, up to 5,000,000 shares of preferred stock with voting, conversion and other rights and
preferences that may be superior to those of the common stock and that could adversely affect the
voting power or other rights of the holders of common stock. The issuance of preferred stock or
rights to purchase preferred stock could be used to discourage an unsolicited acquisition proposal. 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk Foreign Exchange Risk and Derivative Financial Instruments Our foreign subsidiaries operate and sell our products in various global markets. As a result,
we are exposed to changes in exchange rates on foreign currency denominated transactions with
foreign subsidiaries. We use foreign currency forward exchange contracts, and we infrequently use
options, to mitigate the risk of future movements in foreign exchange rates that affect certain
foreign currency denominated inter-company receivables or expected revenues. The forward contracts
and options are not designated as accounting hedges. We attempt to match the forward contracts with
the underlying receivables in terms of currency, amount and maturity, and to match the options with
expected foreign currency revenue in terms of currency, amount and recognition period. We do not
use derivative financial instruments for speculative or trading purposes. Because the impact of
movements in currency exchange rates on forward contracts and options generally offsets the related
impact on the exposures economically hedged, these derivative financial instruments do not subject
us to speculative risk that would otherwise result from changes in currency exchange rates. Gains
and losses on forward exchange contracts generally offset the foreign exchange transaction gains or
losses from revaluation of foreign currency denominated amounts receivable. Gains on options
generally offset the opportunity cost of foreign currency revenue recognized at an exchange rate
less favorable than the option rate. To date, we have not fully mitigated all risk associated with
our revenues and resulting accounts receivable denominated in foreign currencies, and there can be
no assurance that our mitigation activities, if any, will be successful. At March 31, 2005, we had no forward exchange contracts or options maturing in fiscal 2005. 28




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Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our short-term
investment portfolio. As of March 31, 2005, short-term investments consisted of available-for-sale
securities of $38.9 million. These fixed income marketable securities included corporate and
municipal bonds and government securities, all of which are of high investment grade. They are
subject to interest rate risk and will decline in value if the market interest rates increase. If
the market interest rates were to increase immediately and uniformly by 10% from levels as of March
31, 2005, the decline in the fair value of the portfolio would not be material to our financial
position. 
 Item 4. Controls and Procedures Evaluation of disclosure controls and procedures. Our management evaluated, with the participation of our Chief Executive Officer and our Chief
Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the
period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive
Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures
are effective to ensure that information we are required to disclose in reports that we file or
submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules and forms. Changes in internal control over financial reporting. There was no change in our internal control over financial reporting that occurred during the
period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting. 
 Part II. Other Information 
 Item 1. Legal Proceedings A lawsuit was instituted in October 2002 against us and one of our subsidiaries, Catapult
Communications International Limited, an Irish corporation, in the Antwerp Commercial Court,
Antwerp, Belgium, by Tucana Telecom NV, a Belgian company. Tucana had been a distributor of
products for Tekelec, the company from which NDB was acquired in August 2002. The writ alleges that
the defendants improperly terminated an exclusive distribution agreement with Tucana following the
acquisition of NDB and seeks damages of 12,461,000 euros ($16,161,917 as at March 31, 2005) plus
legal costs. A trial date on the matter had been scheduled for January 16, 2004 but Tucana did not
appear. On March 14, 2005, Tucana filed a further brief with the
Belgian court. We are currently in
process of submitting a response. We strongly believe that we properly terminated any contract we
had with Tucana and that Tucana is not entitled to any damages in this matter. We intend to defend
ourselves vigorously. We may be able to seek indemnification from Tekelec for any damages assessed
against us in this matter under the terms of the Asset Purchase Agreement it entered into with
Tekelec, although there is no assurance that such indemnification would be available. 
 Item 4. Submission of Matters to a Vote of Security Holders We held our Annual Meeting of Stockholders on January 25, 2005. Out of 14,616,050 shares of
Common Stock entitled to vote at such meeting, there were present in person or by proxy 13,357,049
shares. At the Annual Meeting, our stockholders approved the following matters: 29




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(a) The election of Peter S. Cross, Richard A. Karp, Nancy H. Karp, Henry P.
Massey, Jr., John M. Scandalios and Charles L. Waggoner, as directors of Catapult
Communications Corporation for the ensuing year and until their successors are
elected. The vote for the nominated directors was as follows: Peter S. Cross, 11,870,993 votes cast for and 1,486,056 votes withheld;Richard A. Karp, 7,706,783 votes cast for and 5,650,266 votes withheld;Nancy H. Karp, 7,009,545 votes cast for and 6,347,504 votes withheld;Henry P. Massey, Jr., 6,300,061 votes cast for and 7,056,988 votes withheld;John Scandalios, 10,963,414 votes cast for and 2,393,635 votes withheld;Charles Waggoner, 11,642,264 votes cast for and 1,714,785 votes withheld.
 (b) The ratification of the appointment of PricewaterhouseCoopers LLP as our
independent registered public accounting firm for the fiscal year ending September
30, 2005. 12,045,381 votes were cast for and 1,310,568 votes were cast against with
1,100 votes abstaining.
 
 Item 6. Exhibits. 31.1
    
    Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32
    
    Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
 
 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, we have duly caused this
report to be signed on our behalf by the undersigned thereunto duly authorized. CATAPULT COMMUNICATIONS CORPORATIONDate: May 3, 2005
    
    By: /s/ Christopher A. StephensonChristopher A. StephensonVice President and Chief Financial Officer(Principal Financial Officer)
 30




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EXHIBIT INDEX 31.1
    
    Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32
    
    Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.