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(TEKELEC LOGO)

UNITED STATES SECURITIES AND EXCHANGE
COMMISSION


Washington, D.C. 20549


Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934


For the fiscal year ended December 31,
2003

Commission file number 0-15135

Tekelec

(Exact name of registrant as specified in its
charter)


|                                                                                              |  |                                                   
|--------------------------------------------------------------------------------------------- |  | --------------------------------------------------
|California(State or other jurisdiction of
    incorporation or organization)                  |  | 95-2746131(I.R.S. Employer
    Identification No.)
|                                                                                             
|26580 West Agoura Road,
    Calabasas, California(Address of principal executive
    offices) |  | 91302(Zip Code)                                   

Registrants telephone number, including
area code:

(818) 880-5656


Securities registered pursuant to
Section 12(b) of the Act:

None


Securities registered pursuant to
Section 12(g) of the Act:

Common Stock, without par value


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

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any
amendment to this
Form 10-K.     þ

Indicate by check mark whether the registrant is
an accelerated
filer.     Yes þ          No o

The aggregate market value of the voting stock
held by non-affiliates of the registrant, based upon the last
reported sale price of the Common Stock on June 30, 2003 as
reported on The Nasdaq Stock Market, was approximately
$529,069,837.

The number of shares outstanding of the
registrants Common Stock on March 1, 2004 was
62,158,654.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrants definitive
Proxy Statement to be delivered to shareholders in connection
with their Annual Meeting of Shareholders to be held on
May 14, 2004 are incorporated by reference into
Part III of this Annual Report.



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TEKELEC

INDEX TO ANNUAL REPORT ON FORM 10-K

For the Fiscal Year Ended December 31,
2003


|             |  |                                                                                                        |  |      |    | 
|------------ |  | ------------------------------------------------------------------------------------------------------ |  | ---- | -- | 
|             |  |                                                                                                        |  | Page
|             |  |                                                                                                        |  |     
|PART I      
|Item 1.      |  | Business                                                                                               |  |      | 2  | 
|Item 2.      |  | Properties                                                                                             |  |      | 24 | 
|Item 3.      |  | Legal Proceedings                                                                                      |  |      | 25 | 
|Item 4.      |  | Submission of Matters to a
    Vote of Security Holders                                                |  |      | 26 | 
|PART II     
|Item 5.      |  | Market for Registrants
    Common Equity and Related Stockholder Matters                              |  |      | 27 | 
|Item 6.      |  | Selected Financial Data                                                                                |  |      | 27 | 
|Item 7.      |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations              |  |      | 29 | 
|Item 7A.     |  | Quantitative and Qualitative
    Disclosures about Market Risk                                         |  |      | 40 | 
|Item 8.      |  | Financial Statements and
    Supplementary Data                                                        |  |      | 41 | 
|Item 9.      |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure               |  |      | 41 | 
|Item 9A.     |  | Controls and Procedures                                                                                |  |      | 41 | 
|PART III    
|Item 10.     |  | Directors and Executive
    Officers of the Registrant                                                 |  |      | 41 | 
|Item 11.     |  | Executive Compensation                                                                                 |  |      | 41 | 
|Item 12.     |  | Security Ownership of
    Certain Beneficial Owners and Management and Related Stockholder
    Matters |  |      | 41 | 
|Item 13.     |  | Certain Relationships and
    Related Transactions                                                     |  |      | 42 | 
|Item 14.     |  | Principal Accounting Fees
    and Services                                                             |  |      | 42 | 
|PART IV     
|Item 15.     |  | Exhibits, Financial
    Statement Schedules, and Reports on Form 8-K                                   |  |      | 42 | 
|EXHIBIT 3.2 
|EXHIBIT 14.1
|EXHIBIT 21.1
|EXHIBIT 23.1
|EX-31.1     
|EX-31.2     
|EX-32.1     



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PART I






|        |          
|------- | ---------
|Item 1. | Business.

Overview

Tekelec designs, manufactures, markets and
supports network signaling products, switching solutions and
selected service applications for telecommunications networks
and contact centers. Our customers include telecommunications
carriers, network service providers, and contact center
operators.

Our network signaling products help direct and
control voice and data communications. They enable carriers to
control, establish and terminate calls. They also enable
carriers to offer intelligent services, which include any
services other than the call or data transmission itself.
Examples include familiar products such as call waiting, caller
ID, voice messaging, toll free calls (e.g.,800 calls), prepaid calling cards, text
messaging and local number portability. Some of our network
signaling products also allow the monitoring and surveillance of
network elements while the network is in operation and deliver
revenue assurance features such as fraud protection.

Our contact center products provide workforce
management and intelligent call routing systems for single and
multiple site contact centers. We sell our contact center
products primarily to customers in industries with significant
contact center operations such as financial services,
telecommunications and retail.

Our next-generation switching products are
focused primarily on creating and enhancing next-generation
switching solutions for both traditional (TDM-based) and new
(Packet-based) Class 4, Class 5, and wireless
applications. The switching portion of a network carries and
routes the actual voice or data comprising a call.
We believe that voice and data networks will increasingly
interoperate, or converge. Network convergence should provide
opportunities to expand the sales of our switching solutions
which are designed specifically for converged networks.

In August 2002, we sold our network diagnostics
business and related operations. Accordingly, our network
diagnostics business is reflected as a discontinued operation in
our consolidated financial statements.

Our internet address is www.tekelec.com. We are
not including the information contained on our website as a part
of, or incorporating it by reference into, this Annual Report on
Form 10-K. We make available free of charge through our
website our Annual Reports on Form 10-K, Quarterly Reports
on Form 10-Q and Current Reports on Form 8-K, and
amendments to these reports, as soon as reasonably practicable
after we electronically file such material with, or furnish such
material to, the Securities and Exchange Commission.

Industry Background

Usage of communications networks has expanded
rapidly in recent years. Driving this trend has been the growth
in demand for voice and data communications and wireless
connectivity, deregulation and the emergence of new competitors,
services and technologies.

Growth in data traffic has been driven by the
increase in the number of businesses and consumers that use the
Internet and by the adoption of broadband access technologies.
According to International Data Corp., an independent market
research firm, the volume of Internet traffic generated by end
users worldwide will increase from 180 petabits
(1 petabit = 1 million gigabits) per day in 2002
to 5,175 petabits per day by the end of 2007. The number of
wireless subscribers has also grown rapidly in recent years and
is expected to exceed 1.75 billion subscribers by 2007,
according to a study released in September 2003 by the Yankee
Group, a research consulting firm.

The increase in data traffic, combined with the
inherent efficiency of packet switched networks, have led many
carriers to build new packet networks and to seek ways to enable
existing circuit switched networks to interface reliably and
efficiently with these new packet switched networks.

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Deregulation has played a key role in the
emergence of new competitive service providers in recent years.
In addition, technological developments such as DSL, cable
modems and broadband wireless have enabled alternative access
technologies and fostered new types of service providers.

As competition has grown in recent years,
per-minute revenue from basic telephony service has declined
significantly. As a result, intelligent services have become
core competitive features of a network, providing incremental
revenues to service providers and offering more service choices
to subscribers. As these services have become less expensive and
more widely accessible, customer demand for them has grown.

Deregulation has also spurred the offering of
intelligent services. The Telecommunications Act of 1996
mandates that subscribers of U.S. telephone service be
given the option of changing their local service provider while
retaining their local phone number. Several European and Asian
countries have also recently adopted or are considering adopting
similar number portability requirements to allow subscribers to
retain their telephone numbers while changing service providers.
In November 2003, the Federal Communications Commission
(FCC) regulation mandating that wireless customers
in the U.S. be offered this same option was finally
implemented, after several years of delay.



| |                                                               
| | --------------------------------------------------------------
| | Recent Changes in Telecommunications
    Operating Environment

Throughout the late 1990s, capital
investment in telecommunications equipment grew rapidly before
experiencing moderate growth in the second half of 2000. In
2001, telecom capital investment declined for the first time in
several years as telecommunications industry fundamentals
deteriorated. In 2002, telecom capital investment continued to
decline, as telecom service provider revenues remained under
pressure, resulting in significantly lower overall capital
expenditures. The industrys growth prior to the second
half of 2000 was driven principally by significant capital
investment by new types of service providers, such as
competitive local exchange carriers (CLECs) formed after
industry deregulation, and by substantial growth in capital
spending from wireless operators to support the expansion of
mobile networks. In addition, capital investment from incumbent
carriers, such as Regional Bell Operating Companies (RBOCs),
increased in response to the new threat of competition from
CLECs and other new entrants. Adding to the favorable
environment for telecom capital investment prior to mid-2000,
capital markets were extremely active and institutional
investors were willing to fund many new and established
telecommunications service providers alike. The healthy capital
markets and favorable valuations for telecommunications service
providers led carriers to re-invest higher than normal
percentages of their revenue into capital equipment purchases
because new capital was perceived to be readily available.

Beginning in 2000 and increasingly in 2001 and
2002, capital available from equity markets declined
significantly and the emerging competitive carriers began to
experience difficulty attracting new funding. In many cases, the
emerging carriers had accumulated considerable debt loads that
required new capital to service their interest payments. In
addition, economic weakness, particularly in the U.S., also
impacted the market for telecommunications services, and
particularly impacted the competitive carriers, many of which
had been targeting businesses. As a result of these trends,
competitive carriers sharply reduced their capital spending, and
several filed for bankruptcy protection as a means to
restructure their debt obligations. In addition, while the
capital spending by wireless service providers continued to
increase in 2001 given the continuing rapid growth of their
businesses, capital investment by incumbent wireline carriers
declined in 2001 in part due to the reduced threat from
competitive carriers.

In 2002, continued economic weakness and investor
concerns over the reliability and credibility of published
financial statements made financing through the capital markets
even more difficult. High profile bankruptcies and questionable
accounting practices by some telecom operators made investors
reluctant to provide financing to telecom operators in general.
Across all carrier types, the limited availability in the
capital markets and reduced valuations in the equity markets,
has heightened the focus on operating measures such as cash
flows, which has led service providers to conserve cash and
reduce capital investment whenever possible.

In 2003, a generally improving economy and
improved capital market conditions contributed to a broad
turnaround in the financial condition of many telecom equipment
providers. While wireline service providers generally continued
to experience access line losses and flat to declining revenues,
wireless service providers

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experienced strong subscriber growth and
increased end-user adoption of wireless data services and
applications. In order to improve their competitive position
relative to their wireless competitors, and in order to lower
operating costs, a number of Tier 1 carriers announced
their intentions or definitive plans to implement packet
switching technology, generally referred to as Voice over
Internet Protocol (VoIP). These factors combined to allow
equipment suppliers focused on wireless infrastructure and VoIP
infrastructure to perform particularly well.


While future capital spending trends are
difficult to predict, industry analysts expect capital spending
on telecommunications equipment to increase modestly in 2004
from 2003 levels across all service provider segments.



| |                                      
| | -------------------------------------
| | Challenges Service Providers
    Face

To compete in todays environment, service
providers are seeking to expand and differentiate their products
and services while lowering their costs. This has increased
demand for technologies that enable the rapid creation and
delivery of innovative services on existing and converged
networks. Some of the key challenges that service providers face
include:



| |   |                                                                                                                                                                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | expanding and/or upgrading their signaling
    network to support new and enhanced services, and growing
    volumes of signaling traffic, particularly on
    signaling-intensive wireless networks which generate several
    times the amount of signaling traffic as wireline networks;
|
| |  | building and managing networks that can
    cost-effectively support circuit and packet network
    convergence; and                                                                                                                                                                       
|
| |  | monitoring increasingly complex networks.                                                                                                                                                                                                                                                  



| |                                       
| | --------------------------------------
| | Signaling and Intelligent
    Services

Traditional voice telephone networks consist of
two basic elements  switching and signaling. The
switching portion of a network carries and routes the actual
voice or data comprising a call. The signaling
portion of a network instructs the switching portion how to do
its job. Signaling messages are carried on a different logical
transmission path than the actual call itself. Signaling is
responsible for establishing and terminating a call. The
signaling portion of the network also enables service providers
to offer intelligent services such as call waiting, caller ID
and voice messaging.

The signaling portions of existing voice
telephone networks in most of the world are based upon a set of
complex standards known as Signaling System #7, or SS7. The
primary network elements within a traditional circuit network
architecture based on SS7 are as follows:

Signal Transfer Point
(STP) A signal transfer
point is a packet switch for the signaling portion of the
network. It controls and directs the signaling messages used to
establish and terminate telephone calls and to coordinate the
provision of intelligent services.

Service Switching Point
(SSP) A service switching
point (often called a Class 4 or Class 5 switch,
depending on its location in the network) is a carriers
switch that connects to the SS7 network and serves as the
origination and termination points for the SS7 messages in a
network. In this capacity, the service switching point, via
signaling transfer points, sends and processes the signaling
messages used to establish and terminate telephone calls. When a
service switching point identifies a call requiring instructions
for intelligent services, it sends a signaling message to a
signal transfer point and awaits further routing or call
processing instructions.

Service Control Point
(SCP) A service control
point is a specialized database containing network and customer
information. It is queried by service switching points via
signaling transfer points for information required for the
delivery of intelligent services. Different service control
points contain the information used by the SS7 network to
perform different types of functions.

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Signaling
Links A signaling link is
a physical or logical connection or channel between any two
different parts of the signaling portion of the network, or a
connection or channel between the signaling portion of the
network and the switching portion of the network. To create
additional network capacity to accommodate increases in
signaling traffic, additional links must be added to signal
transfer points, or new signal transfer points must be added.
Traditionally, signaling links have operated on dedicated
circuit facilities. Newer network architectures support
signaling over packet transmission technologies such as IP
or ATM.

The market for SS7 equipment is driven by growth
in network traffic and by demand for intelligent services.
Carriers and service providers must increase the performance and
capacity of their signaling networks in order to increase call
processing capacity or to offer intelligent services. Because of
its role in providing reliability and features to a voice
network, STPs must deliver high performance and reliability.
Typically, STPs need to deliver 99.999% reliability, or less
than three minutes of unscheduled downtime per year. Service
providers also require an SS7 solution that is
scalable  that is, a solution that can initially be
matched to support a carriers current capacity but with
the capability to have its capacity increased to support the
carriers growth without requiring the replacement of
certain network elements.



| |                                                       
| | ------------------------------------------------------
| | Unique Signaling Requirements of Wireless
    Networks

Wireless networks generate substantially more
signaling traffic than fixed line networks due to additional SS7
features inherent in wireless telephony such as mobile
registrations, roaming, and handoffs between cellular equipment.
As a result, wireless operators generally invest in SS7-related
equipment, such as signal transfer points, more frequently than
fixed line carriers to accommodate the unique signaling demands
of mobile telephony. In addition, rapid growth in wireless
minutes of use and increased popularity of wireless services
enabled by signaling networks such as voice mail and text
messaging have led to a significant increase in SS7 traffic on
mobile networks in recent years, which has created a need for
high capacity signaling infrastructure. Driving the higher usage
in wireless networks, particularly in the United States, are
flat rate pricing plans that feature no additional charges for
long distance calls. Innovative service offerings like camera
phones, the increasing popularity of family calling plans, and
continued wireline to wireless substitution are also
contributing to renewed subscriber growth. Wireless usage is
expected to continue to increase in the coming years, which will
create further demand for signaling infrastructure.



| |                                          
| | -----------------------------------------
| | Supporting Voice and Data
    Convergence

Currently, virtually all networks which carry
both voice and data communications rely on a technology called
circuit switching. Another technology, packet switching, has
been used almost exclusively for data-only networks. Circuit
switching and packet switching are fundamentally different
technologies. While circuit switching has offered reliable and
high quality voice communications, packet switching is
inherently more efficient and cost effective. Industry sources
estimate that the cost of a transmission minute is as much as
25% to 50% less for a packet network than for a circuit network.

The cost and performance superiority of packet
switching has led many incumbent and new carriers to build
packet networks to handle data traffic. It has also led carriers
to explore the transmission of voice communications over packet
networks. This requires circuit networks and packet networks to
seamlessly interconnect.

To support voice and data communications, packet
networks need signaling to provide the same reliability and
quality of transmissions as circuit networks and to provide the
intelligent services consumers have come to expect and demand.
Because SS7 is the global industry standard for voice networks,
we believe that signaling for the converged circuit and packet
networks will be based upon SS7 or its derivatives as well. This
allows new carriers with packet networks to more easily
interconnect with existing circuit networks and would allow
incumbent carriers to leverage their investment in their
existing networks even as they build out their data networks.

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We believe that the primary network elements of
converged circuit and packet networks, including signaling, call
control and switching technologies, are as follows:

Signal Transfer
Point As in the present
circuit networks, a signal transfer point relays messages needed
to establish and terminate telephone calls and to coordinate the
provision of intelligent services. It can relay messages within
the circuit network, between circuit and packet networks, and
possibly within some forms of packet networks.

Service Control
Point As in the present
circuit networks, a service control point is a specialized
database containing information used to deliver intelligent
services. Service control points in converged networks may
support packet-based signaling interfaces.

Signaling
Gateway A signaling
gateway receives signaling messages from signal transfer points,
reformats these messages and presents them to one or more media
gateway controllers.

Media Gateway
Controller A media gateway
controller, frequently called a softswitch or call agent, is a
specialized computer that provides the intelligence, or call
control, to direct switching. It controls one or more voice/data
switches called media gateways.

Media
Gateway A media gateway is
a voice/data switch that receives the message part of a call and
redirects it as specified by the media gateway controller to a
single destination or to multiple destinations. If necessary, a
media gateway can translate the actual call from a packet
switching format to a circuit switching format and vice versa.

Application
Server Similar to a
service control point, an application server is a specialized
database that contains information to deliver certain
intelligent services in packet networks, interacting with the
Media Gateway Controller via IP-based protocols such as Session
Initiation Protocol (SIP).

SIP
Server A SIP server is a
session control platform for voice-over-packet networks.
Interoperating with media gateway controllers, the SIP server
provides the foundation for initiating and terminating sessions
as well as service delivery within a pure-packet, signaling
network.

The primary difference between the converged
architecture and the circuit architecture described above is the
use of the signaling gateway, media gateway controller and media
gateway to perform the same switch functions that are currently
performed by certain service switching points in circuit
networks. However, industry experts believe it will take decades
to replace all of the existing service switching points with
packet switching technologies.

We believe carriers are seeking fully featured
packet telephony solutions that can facilitate the convergence
of circuit and packet networks, without compromising
functionality, reliability, scalability, support and flexibility.

The Tekelec Solution

We are a leading designer and developer of
telecommunications signaling infrastructure, packet telephony
solutions, and service applications. Our network signaling
products are widely deployed in traditional and next-generation,
or converged wireline and wireless networks and
contact centers worldwide. Our systems assist our customers in
meeting their primary challenges in the competitive
telecommunications environment; differentiating their offerings
and lowering network costs. We offer signaling and packet
telephony systems and services to enable the delivery of
intelligent services and facilitate convergence of voice and
data networks. We believe that our open, standards-based
solutions are highly reliable and enable operators to more
cost-effectively manage their networks and offer intelligent
services.

Our Eagle 5 Signaling Application System
(SAS); the latest release of our STP product, and
previous versions of the Eagle STP, have been widely deployed
and, according to market research firms, have achieved leading
market share in North America. We are expanding our global
operations to increase our market share in international markets
within Europe, Latin America, Asia Pacific and other parts of
the world. The Eagle 5 SAS offers high capacity and throughput,
reliability and efficiency that support the growth of traffic and

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demand for intelligent services in service
provider networks. The reliability of our products enable us to
offer service providers solutions that reduce their total cost
of ownership of network signaling products. Our Eagle products
meet industry standards for 99.999% reliability and less than
three minutes of unscheduled downtime per year. We also offer a
feature of Eagle that enables our Eagle 5 to support SS7
signaling into Internet Protocol (IP) networks and to realize
substantial efficiencies inherent in IP networks.


Use of our SS7-over-IP solutions results in a
substantial increase in signaling efficiency by enabling SS7
signaling over IP at faster rates than traditional SS7
signaling. Customers may choose to deploy the Eagle 5 with
SS7-over-IP capability to gain signaling efficiencies, among
other benefits, as a precursor to deploying a complete packet
telephony switch as a circuit switch replacement. In addition,
customers of our SS7 products may upgrade their existing
solutions to enable SS7 signaling over IP. The upgrade enables
them to preserve the value of their existing SS7 infrastructure
and makes them fully capable of facilitating interoperability
between circuit and next-generation packet networks.

In June 2003, we acquired a controlling ownership
interest in Santera Systems (Santera), a privately
held company, founded in 1998, with a core competency in packet
switching. Santeras principal product, the SanteraOne, is
an integrated voice and data switching solution, capable of
simultaneously delivering full-featured IXC Tandem, Class 4
and Class 5 functionality, as well as additional
revenue-generating data services. With both TDM and packet
fabrics, SanteraOne is a cost-effective alternative for either
TDM only or TDM/ data centric applications. The switch enables a
smooth migration from traditional circuit-based networks to
next-generation packet-based technology.

The flexibility of SanteraOne allows it to
simultaneously perform different roles, from a full-featured IXC
Tandem, Class 4/5 TDM switch to a full-featured data
switching platform, while still maintaining a carrier grade
level of reliability.

Business Strategy

Our objective is to be a premier supplier of
network infrastructure products for existing and next-generation
converged voice and data communications networks. We intend to
focus on the market opportunities arising from the convergence
of voice and data communications and to apply our technology to
develop next-generation networking products and services for
such communications networks. In order to achieve this goal we
intend to leverage our established expertise in SS7 technology
and our resultant Signaling Transfer Point (STP) market position
and customer relationships. Our strategy is to establish and
maintain technology leadership with respect to next-generation
networking, take advantage of the market discontinuities
provided for through the adoption of next-generation networking
technology, expand globally, seek continued operating
improvements, and pursue new market segments and additional
strategic relationships. Key elements of our strategy to achieve
this objective include:

Maintaining Technology
Leadership.We believe that one of our
core competitive strengths is the breadth of our knowledge and
expertise in communications technologies, particularly in SS7
and related signaling technologies. We have developed this
expertise over more than a decade. We intend to enhance our
existing products and to develop new products by continuing to
make significant investments in research and development. As
part of our commitment to technology leadership, we have
developed the Transport Adapter Layer Interface (TALI), an
Internet Protocol signaling interface that enables the transport
of signaling messages using the Internet Protocol. We have made
available the TALI source code free of charge to the industry,
and have entered into TALI licensing agreements with more than
200 companies, several of which are using the interface in live
networks. We also support other IP signaling protocols,
including the Internet Engineering Task Force SIGTRAN suite of
signaling protocols for next-generation network connectivity. We
have also assumed a leadership role within the Softswitch
Consortium, an industry organization created for global
cooperation and coordination in the development of open
standards and interoperability for packet networks.

Targeting the Convergence of Voice and Data
Networks.We are continuing to invest
significantly to develop signaling and call control products and
features that enable the convergence of voice and data
communications networks. The acquisition in June of a majority
interest in Santera Systems allows Tekelec to

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offer customers a complete next-generation
switching solution, including a signaling gateway, media gateway
controller, and media gateway. We believe our pursuit of this
new market opportunity leverages our expertise in signaling and
call control and will enhance the market potential for our
traditional solutions by ensuring that customers who invest in
Tekelec equipment can be upgraded to perform in converged voice
and data networks.


Expanding Globally.We are increasingly pursuing international opportunities,
primarily through our European sales and support office in the
United Kingdom and by opening additional international sales
offices. We recently established customer service offices in
Brazil, France, India, and Mexico in addition to sales offices
in Russia and Spain. We continue to operate sales and customer
service offices in Singapore and China. Our European sales
efforts have resulted in significant expansion in our customer
base, including Orange Personal Communications Systems, Bouygues
Telecom, the Cegetel Group mobile subsidiary SFR,
Cable & Wireless, British Telecom, and Vodafone. In
India, we have added three leading Indian operators as
customers, Reliance Infocomm, Tata, and Bharti Enterprises.
India is one of the fastest growing telecommunications markets
in the world, more than doubling its total number of wireless
subscribers in 2003, compared to 2002. Analysts expect the
Indian mobile market to surpass 50 million subscribers in
2004. The increasing implementation of number portability in
Europe and other regions is expected to result in increasing
demand for SS7 network elements such as Signal Transfer
Points (STPs) to accommodate the increase in signaling traffic,
and number portability solutions, such as those offered by
Tekelec, to facilitate the deployment of number portability.

Focus on Continued Operating
Improvements.We will continue to
identify and implement new ways to improve our operating
efficiency and business processes to enhance our profitability.
The use of contract manufacturing and improved supplier
relationships have helped to lower our material costs and
allowed us to improve our gross margins. We will pursue
additional such savings in the future. We will continue to
review all job openings to determine whether job functions or
business processes can be assumed by other Tekelec personnel or
reengineered, resulting in lower personnel costs. We will
continue to regularly review and evaluate all employee
performance to ensure that under performing employees are
provided the opportunity to improve their performance or are
separated from us.

Pursuing Additional Strategic Relationships,
Original Equipment Manufacturers (OEM) Partners and
Acquisitions.We intend to seek
additional strategic relationships, including original equipment
manufacturer partners, referral arrangements, teaming
agreements, distribution agreements and acquisition candidates.
Our existing strategic relationships include technology
development and OEM relationships with Alcatel and BroadSoft;
technology development and marketing relationships with Harris,
Telcordia and Nortel; a collaboration agreement with Alcatel;
and distribution relationships with Mercury (formerly Daewoo)
and numerous other product distributors.

Pursuing New Market
Segments.We intend to continue our
strategy of internally developing and acquiring products in
order to enter new market segments. A number of products
currently under development will enable us to serve new and
emerging next-generation networking markets. On
February 25, 2004, we announced that we entered into a
definitive agreement to purchase Taqua, Inc., a leading
privately-held provider of next-generation Class 5 packet
switching systems, located in Richardson, Texas. Taqua brings to
Tekelec a market-leading Class 5 switching solution
optimized for the small switch service provider market. This
complements our existing SanteraOne platform which is optimized
for the mid to large size Class 4, Class 5 and
wireless markets.

Seeking Additional Opportunities to Provide
Upgrades, Extensions and Service
Agreements.We intend to leverage our
strong customer relationships to seek opportunities to better
serve our customers needs in the future. In particular, we
will continue to develop and market software upgrades, link
extensions, extended service agreements and other enhancements
as a means to pursue repeat business opportunities. Such
products and services accounted for over 60% of revenues in our
network signaling division in 2003.

Products

We currently offer products in three broad
categories: network signaling products, contact center products
and next-generation switching products.

8



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| |                                                     
| | ----------------------------------------------------
| | Network Signaling Products(formerly Network Systems)

Our principal network signaling products are
described below:

|                                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|---------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Product                                  |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Eagle 5 Signaling Application
    System |  | Our EAGLE 5 Signaling Application System
    (EAGLE 5 SAS) is a multi-disciplined, high-capacity, highly
    flexible, and highly reliable signaling platform designed to be
    the heart of the mobile, fixed line and IP networks of today and
    tomorrow. EAGLE 5 SAS provides solutions in five functional
    areas: Signal Transfer, Signaling Gateway, Number Portability,
    Data Acquisition, and Integrated Applications. The Signal
    Transfer Function is tailored to the global CCS7 switching needs
    of wireline carriers, network service providers and wireless
    operators, among others. It offers high capacity and throughput,
    features a fully distributed, standards-based, open architecture
    and is scalable from 2 to 2,000 links with growth up to
    7,000 links. The Signaling Gateway Function can provide
    signaling information to media gateway controllers and
    IP-signaling enabled SCPs in multiple locations. It can deliver
    these services in multi-protocol, multi-vendor converged
    networks or in circuit switched networks that deploy signaling
    over IP primarily to realize economic benefits. It provides the
    capability for next generational IP signaling, and bridges the
    gap between legacy networks and next-generation Packet Telephony
    capabilities.
|                                         |  | The EAGLE 5 SAS platform also provides a
    complete line of fully integrated EAGLE 5
    database and advanced routing applications, deployment of
    advanced value-added applications and data mining capabilities
    as described below.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                         |  | The Number Portability function introduces
    solutions for wireline and wireless networks worldwide with a
    combination of capacity and performance. The Data Acquisition
    function provides a base for Revenue Gateway, Fraud Protection
    and other capabilities within a signaling network. The
    Integrated Applications Function delivers mediation, mobility,
    and Intelligent Network applications.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|Tekware Applications                     |  | Our TekWare family of communication services
    applications is designed to assist service providers in
    migrating services as they roll out converged network
    technologies. TekWare applications not only satisfy the service
    implementation needs in the current network technologies, they
    also enable service implementation in the converged network
    environment. Service providers can deploy TekWare applications
    immediately for IN-based TDM SS7 networks and can evolve
    the platform, as needed, to support converged network services.
    TekWare application products cover both wireline and wireless
    communication markets. The products offer traditional
    Intelligent Network-based service implementation as well as
    mediation based (triggerless) service implementation. The
    TekWare family consists of the following service applications:                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                         |  |  Business Applications: Business
    applications use signaling data that is rich in content to
    provide reports, statistics, real-time alerting, and event
    management to aid in controlling costs, stopping fraud loss,
    ensuring accurate revenue reporting, and creating new streams of
    revenue.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

9



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|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|-------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Product  |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         |  |  ISS/ Security Applications: With
    signaling firewalls and unique security related software
    applications, we provide solutions to ensure that our
    customers networks will be secure from attack and, if an
    attack does occur, the tools to prevent collateral network
    damage.                                                                                                                                                                                                                                                                                        
|         |  |  Network Services Applications:
    Network based applications enhance the operations of
    telecommunication networks. These applications improve network
    efficiencies; reduce network operating costs, as well as satisfy
    government network service mandates.                                                                                                                                                                                                                                                                                                                
|         |  |  End-user Services Applications:
    End-User-Services provide value added revenue generating
    services to basic voice in order to achieve higher Average
    Revenue per User (ARPU) and to assist our customers in
    maintaining and increasing their subscriber base.                                                                                                                                                                                                                                                                                                            
|         |  |  Messaging Applications: As an
    alternative form of communication, message based (text or
    graphic) communications has become very popular. Messaging
    applications assist the operators in managing message based
    traffic as well as providing value added services for increasing
    message-based revenue.                                                                                                                                                                                                                                                              
|Sentinel |  | Sentinel is a data acquisition product capturing
    data from signaling networks. Associated value added
    applications provide network maintenance, surveillance and
    revenue assurance solutions that enables service providers to
    ensure the reliability of telecommunication products and
    services implemented across their SS7/IP networks. Sentinel also
    enables revenue assurance features such as fraud prevention,
    billing and billing verification. Sentinel can be deployed on a
    standalone basis or as an integrated feature of the Eagle 5
    SAS.



| |                        
| | -----------------------
| | Contact Center Products

Our contact center products provide planning,
management and analysis tools for both single site and multiple
site contact center environments. These tools help contact
center managers deliver better, more consistent service to their
customers while improving employee productivity and lowering
operating costs.

|          |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Product   |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|          |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|TotalView |  | Our TotalView Workforce Management solution
    generates staffing schedules based on forecasted workloads and
    the availability and skills of contact center staff. It performs
    real-time monitoring and detailed analysis of contact center
    performance in both traditional and multi-channel contact center
    environments. The TotalView solution also offers the capability
    to easily integrate with the various systems and applications
    commonly found in the contact center to facilitate information
    exchange.
|TotalNet  |  | Our TotalNet Call Routing Solution for multiple
    site contact centers routes calls to multiple locations as if
    they were a single contact center and balances workload across
    contact center sites based on staffing levels, call volume and
    caller requirements. TotalNet also maintains contact center
    statistics and analyzes contact center operations.                                                                                                                                                                  

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| |                                       
| | --------------------------------------
| | Next-Generation Switching
    Products

Our principal next-generation switching products
are described below:

|                  |  |                                                                                                                                                                                                                                                                                                                                                                 
|----------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|SanteraOne Family |  | The SanteraOne family of products includes a
    highly scalable Media Gateway Controller (OFX) with integrated
    Signaling Gateway and Media Server as well as a high density
    Media Gateway (BoX). The Media Gateway is capable of terminating
    and switching both TDM and packet voice traffic in Class 5,
    Class 4, and PRI offload applications.

Product Development

The communications market is characterized by
rapidly changing technology, evolving industry standards and
frequent new product introductions. Standards for new
technologies and services such as 3G wireless, softswitching,
signaling for packet networks, internet protocol and
asynchronous transfer mode are still evolving. As these
standards evolve and the demand for services and applications
increases, we intend to adapt and enhance our products and
develop and support new products. We solicit product development
input through discussions with our customers and participation
in various industry organizations and standards committees, such
as the Telecommunications Industry Association, the Internet
Engineering Task Force, the Softswitch Consortium and the
Asynchronous Transfer Mode Forum, and by closely monitoring the
activities of the International Telecommunications Union, the
European Telecommunications Standards Institute, the
International Organization for Standardization and Telcordia.

Our network signaling product development group
is principally focused on addressing the requirements of the
converged voice and data networks and on releasing new software
versions to incorporate enhancements or new features or
functionality desired by customers. This group also focuses on
compliance with standards to enable the Eagle solutions to
address additional domestic and international markets. In
addition, we plan continued improvement of hardware components
to improve their performance and capabilities.

Our contact center product development activities
are principally focused on expanding the capabilities of the
contact center products, including the skills and multimedia
scheduling capabilities of the TotalView Workforce Management
product and the functionality of the TotalNet Call Routing
product.

Our next-generation switching product development
group is focused primarily on creating and enhancing
next-generation switching solutions for both traditional
(TDM-based) and new (Packet-based) Class 5 and Class 4
global applications. The range of developments covers
softswitching, multimedia media gateways, and application
servers with a focus on compliance with national and
international standards. Because our customers networks
often have a mix of traditional and new technologies or because
they have to interwork with a mix of traditional and new
technologies, our solutions focus on providing a common platform
for traditional TDM-voice, Voice over ATM (VoATM), and Voice
over IP (VoIP).

Sales and Marketing

Our sales and marketing strategies include
selling through our direct sales forces, selling indirectly
through distributors and other resellers, entering into
strategic alliances and targeting certain markets and customers.
To promote awareness of Tekelec and our products, we also
advertise in trade journals, exhibit at trade shows, participate
in industry forums and panels, maintain a presence on the
Internet, use direct mail and from time to time, our employees
author articles for trade journals.

Distribution.We
sell our products in the U.S. principally through our
direct sales forces and indirectly through strategic
relationships with various third parties. Our North America
direct sales forces operate out of our regional offices located
in California, Colorado, Georgia, Illinois, New Jersey, North
Carolina, Virginia and Texas. Internationally, we sell our
network signaling products through our direct sales force, sales
agents and distribution relationships. We also sell direct from
our wholly owned subsidiaries in the United Kingdom, Canada,
Germany, France, Italy, Singapore, India, Mexico,
Brazil and our sales offices in China and the Russian Federation.

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Strategic
    Relationships.We believe that our
    current and future strategic relationships with leading
    communications system integrators will improve market
    penetration and acceptance for our network signaling and
    switching products. Many of these system integrators have
    long-standing relationships with public telecommunications
    carriers and provide a broad range of services to these carriers
    through their existing sales and support networks. We seek
    strategic relationships that:



| |   |                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | enhance our presence and strengthen the our
    competitive position in our target markets;                                                                                                      
|
| |  | offer products that complement our network
    signaling and switching solutions to provide value-added
    networking solutions; and                                                            
|
| |  | leverage our core technologies to enable
    communications equipment suppliers to develop enhanced products
    with market differentiation that can be integrated with
    Tekelecs solutions.

Our strategic relationships include:



| |   |                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an agreement with Harris whereby we will market
    and resell its operations, administration and maintenance
    network management system;                                                                    
|
| |  | an exclusive distribution and OEM agreement with
    Mercury under which Mercury distributes our Eagle STP in South
    Korea;                                                                                  
|
| |  | agreements with the Call Center Professional
    Services groups of Verizon and SBC whereby those organizations
    market and resell the TotalView Workforce Management solution.                              
|
| |  | an agreement with Spatial Communications
    Technologies (Spatial) whereby Spatial acts as a
    reseller of Santeras media gateways in the wireless market
    on an original equipment manufacturer basis.

We believe that our strategic third party
relationships provide us with additional opportunities to
penetrate the network signaling and switching markets and
demonstrate our strategic partners recognition of the
technical advantages of our network products. Through our
relationships with, among others, Alcatel, BroadSoft, Spatial,
Harris and Mercury, we are enhancing our market presence and the
ability to access leading network service providers. In general,
these agreements can be terminated by either party on limited
notice and, except for our agreement with Mercury, do not
require minimum purchases. Although our current sales through
these relationships are not significant, a termination of our
relationship with, or the sale of competing products by, any of
these strategic partners could adversely affect our future
potential business and operating results.

We believe that our ability to compete
successfully in the network signaling and switching markets also
depends in part on our distribution and marketing relationships
with leading communications equipment suppliers and resellers.
If we cannot successfully enter into these relationships on
terms that are favorable to us or if we cannot maintain these
relationships, our business may suffer.

Service, Support and Warranty

We believe that customer service, support and
training are important to building and maintaining strong
customer relationships. We service, repair and provide technical
support for our products. Support services include 24-hour
technical support, remote access diagnostics and servicing
capabilities, extended maintenance and support programs,
comprehensive technical customer training, extensive customer
documentation, field installation and emergency replacement. We
also offer to our customers and certain resellers of our
products technical training with respect to the proper use,
support and maintenance of our products.

We maintain an in-house repair facility and
provide ongoing training and technical assistance to customers
and international distributors and other resellers from our
headquarters in Calabasas, California and certain
U.S. regional offices. Our technical assistance centers in
Morrisville, North Carolina, Plano, Texas and Egham, United
Kingdom, support our network signaling and switching products on
a 24 hour-a-day, seven day-a-week basis. Our technical
assistance center in Richardson, Texas supports our contact
center products.

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In addition, Tekelec has invested in providing
in-country service and support in Brazil, France, India,
and Mexico.


We also offer network implementation services in
connection with our effort to supply a complete solution for
signaling and switching telephony deployments, including
products from our vendor partners. In such instances, we will
offer specific service contracts to support the needs of our
carrier customers that choose to migrate their network, for
example, to packet technologies.

We typically warrant our products against defects
in materials and workmanship for one year after the sale and
thereafter offer extended service warranties.

Customers

Our customers include end users and marketing
intermediaries. End users for our Network Signaling products
consist primarily of network service providers, wireless network
operators, interexchange carriers, competitive access providers,
local exchange carriers and Regional Bell Operating Companies.
Wireless service providers accounted for almost 60% of our
network signaling revenue in 2003. End users for our
next-generation switching products currently consist primarily
of rural service providers, independent operating companies and
competitive access providers. Our contact center solutions have
been sold primarily to Fortune 500 companies, financial
services companies and telecommunications carriers. We
anticipate that our operating results in any given period will
continue to depend to a significant extent upon revenues from a
small percentage of our customers.

Backlog

Backlog for our network signaling and
next-generation switching products typically consists of
contracts or purchase orders for both product delivery scheduled
within the next 12 months and extended service warranty to
be provided generally over periods of up to three years. Backlog
for our contact center products typically consists of products
and services ordered for delivery within the next
12 months. Primarily because of variations in the size and
duration of orders we receive and customer delivery
requirements, which may be subject to cancellation or
rescheduling by the customer, our backlog at any particular date
may not be a meaningful indicator of future financial results.
Due to the decreasing relevance of this metric as an indicator
of our overall financial health, we discontinued disclosing the
backlog information effective with the first quarter
of 2003.

At December 31, 2002, our backlog amounted
to approximately $182.7 million, of which
$108.2 million related to network signaling service
warranties. This compared to a backlog of approximately
$176.0 million at December 31, 2001, of which
$86.3 million related to network signaling service
warranties.

We regularly review our backlog to ensure that
our customers continue to honor their purchase commitments and
have the financial means to purchase and deploy our products and
services in accordance with the terms of their purchase
contracts.

Competition

Network Signaling
Products.The market for our network
signaling products is competitive and has been highly
concentrated among a limited number of dominant suppliers. We
presently compete in the network signaling market with, among
others, Alcatel, Nortel, Cisco Systems, Ericsson, Siemens and
Huawei. We expect that competition may increase in the future
from existing and new competitors.

We believe that the principal competitive factors
in the network signaling products market are product
performance, scalability and functionality, product quality and
reliability, customer service and support, price and the
suppliers financial resources and marketing and
distribution capability. We anticipate that responsiveness in
adding new features and functionality will become an
increasingly important competitive factor. While some of our
competitors have greater financial resources, we believe that we
compete favorably in other respects. New entrants or established
competitors may, however, offer products that are superior to
our products in performance, quality, service and support and/or
are priced lower than our products.

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We believe that our ability to compete
successfully in the network signaling market also depends in
part on our distribution and marketing relationships with
leading communications equipment suppliers and resellers. If we
cannot successfully enter into these relationships on terms that
are favorable to us, or if we cannot maintain these
relationships, our business could suffer.

Contact Center
Products.The market for contact
center products is extremely competitive. We compete principally
with Aspect Communications and Blue Pumpkin Software in the
market for workforce management solutions and with Cisco and
Alcatel in the market for call routing solutions. We also
compete to a lesser extent in these markets with a number of
other manufacturers, some of which have greater financial,
marketing, manufacturing and other resources than Tekelec. We
believe that the success of our TotalView product will depend in
part on our ability to offer competitive prices and to further
develop our workforce management scheduling and other
technologies and our international distribution channels. We
believe that the success of the TotalNet product will depend, to
a significant degree, on our ability to capture market share and
to improve product functionality through strategic partnering
with third parties.

Next-Generation Switching
Products.The market for our
next-generation switching products is extremely competitive and
is highly fragmented. We presently compete in the
next-generation switching market with numerous public and
private companies. The public companies include, among others,
Alcatel, Nortel, Cisco, Lucent Technologies, Sonus Networks and
Siemens. The private companies include, among others, Telica. We
expect competition to remain intense, particularly until the
market matures and until the number of competitors is reduced.

We believe that the principal competitive factors
in the next-generation switching market are product performance,
scalability and functionality, product quality and reliability,
customer service and support, price and the suppliers
financial resources and marketing and distribution capabilities.
We believe that our ability to compete successfully in the
next-generation switching market will, in part, depend in our
ability to gain a Tier 1 wireline or wireless operator as a
reference account for our next-generation switching products. A
number of our competitors have existing relationships with
Tier 1 operators as their legacy switching providers. As
such, it may be difficult for Tekelec to displace these
incumbent suppliers with our next-generation gear.

Intellectual Property

Our success depends, to a significant degree, on
our proprietary technology and other intellectual property. We
rely on a combination of patents, copyrights, trademarks, trade
secrets, confidentiality agreements and contractual restrictions
to establish and protect our proprietary rights both in the
United States and abroad. We have been issued a number of
patents and have a number of patent applications pending. These
measures, however, afford only limited protection and may not
prevent third parties from misappropriating our technology or
other intellectual property. In addition, the laws of certain
foreign countries do not protect our proprietary rights to the
same extent as do the laws of the United States and thus make
the possibility of misappropriation of our technology and other
intellectual property more likely. If we fail to successfully
enforce or defend our intellectual property rights, or if we
fail to detect misappropriation of our proprietary rights, our
ability to effectively compete could be seriously impaired.

Our pending patent and trademark registration
applications may not be allowed and our competitors may
challenge the validity or scope of our patent or trademark
registration applications. In addition, we may face challenges
to the validity or enforceability of our proprietary rights and
litigation may be necessary to enforce and protect our rights,
to determine the validity and scope of our proprietary rights
and the rights of others, or to defend against claims of
infringement or invalidity. Any such litigation would be
expensive and time consuming, would divert the attention of our
management and key personnel from business operations and would
likely harm our business and operating results.

The communications industry is characterized by
the existence of a large number of patents and frequent
litigation based on allegations of patent infringement. From
time to time, third parties may assert patent, copyright,
trademark and other intellectual property rights to technologies
that are important to us. From time to time, we receive notices
from, or are sued by, third parties regarding patent claims. Any
claims made against us regarding patents or other intellectual
property rights could be expensive and time consuming to

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resolve or defend, would divert the attention of
our management and key personnel from our business operations
and may require us to modify or cease marketing our products,
develop new technologies or products, acquire licenses to
proprietary rights that are the subject of the infringement
claim or refund to our customers all or a portion of the amounts
paid for infringing products. If such claims are asserted, there
can be no assurances that the dispute could be resolved without
litigation or that we would prevail or be able to acquire any
necessary licenses on acceptable terms, if at all. In addition,
we may be requested to defend and indemnify certain of our
customers and resellers against claims that our products
infringe the proprietary rights of others. We may also be
subject to potentially significant damages or injunctions
against the sale of certain products or use of certain
technologies. See Legal Proceedings in
Part I, Item 3, of our Annual Report on
Form 10-K.


Employees

At February 20, 2004, we had
1,065 employees, comprising 396 in sales, marketing and
support, 90 in manufacturing, 463 in research, development and
engineering and 116 in management, administration and finance.
Virtually all of our employees hold stock options in our stock
option plans. None of our employees are represented by a labor
union, and we have not experienced any work stoppages. We
believe that our employee relations are excellent.

Risk Factors

The statements that are not historical facts
contained in this Annual Report on Form 10-K are
forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. These statements
reflect the current belief, expectations, estimates, forecast or
intent of our management and are subject to and involve certain
risks and uncertainties. Many of these risks and uncertainties
are outside of our control and are difficult for us to forecast
or mitigate. In addition to the risks described elsewhere in
this Annual Report on Form 10-K and in certain of our other
Securities and Exchange Act Commission filings, the following
risks and uncertainties, among others, could cause our actual
results to differ materially from those contemplated by any
forward-looking statement contained herein.



| |                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------
| | Because our quarterly operating results are
    difficult to predict and may fluctuate, the market price for our
    stock may be volatile.

Our quarterly operating results are difficult to
predict and may fluctuate significantly. We have failed to
achieve our revenue and net income expectations for certain
prior periods, and it is possible that we will fail to achieve
such expectations in the future. Fluctuations in our quarterly
operating results may contribute to the volatility in our stock
price. A number of factors, many of which are outside our
control, can cause fluctuations in our quarterly operating
results, including among others:



| |   |                                                                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | changes in overall telecommunications spending;                                                                                                                                                                                                                          
|
| |  | changes in general economic conditions and
    specific market conditions in the telecommunications industry;                                                                                                                                                            
|
| |  | fluctuations in demand for our products and the
    size, timing, terms and conditions of orders and shipments;                                                                                                                                                          
|
| |  | the lengthy sales cycle of our Network Signaling
    and Next-Generation Switching products, especially with respect
    to our international customers, and the reduced visibility into
    our customers spending plans for those products and
    associated revenue;
|
| |  | the progress and timing of the convergence of
    voice and data networks and other convergence-related risks
    described below;                                                                                                                                       
|
| |  | the ability of carriers to utilize excess
    capacity of signaling infrastructure and related products in
    their networks;                                                                                                                                           

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| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | the capital spending patterns of our customers,
    including deferrals or cancellations of purchases by customers;             
|
| |  | the trend toward industry consolidation among our
    customers;                                                                
|
| |  | our ability to achieve targeted cost reductions;                                                                                
|
| |  | our dependence on wireless carriers for a
    significant percentage of our revenues;                                           
|
| |  | the success or failure of our strategic alliances
    and acquisitions, including the Santera transaction;                      
|
| |  | unanticipated delays or problems in releasing new
    products or services;                                                     
|
| |  | the mix of products and services that we sell;                                                                                  
|
| |  | the geographic mix of our revenues and the
    associated impact on gross margins;                                              
|
| |  | foreign currency exchange rate fluctuations;                                                                                    
|
| |  | the introduction and market acceptance of our and
    our competitors new products, services and technologies;                 
|
| |  | the timing of the deployment by our customers of
    new technologies and services;                                             
|
| |  | the ability of our customers to obtain financing
    or to otherwise fund capital expenditures;                                 
|
| |  | the timing and level of our research and
    development expenditures and other expenses;                                       
|
| |  | the expansion of our marketing and support
    operations, both domestically and internationally;                               
|
| |  | changes in accounting rules, such as a change
    requiring the recording of employee stock option grants as
    expense;       
|
| |  | changes in our pricing policies and those of our
    competitors;                                                               
|
| |  | worldwide economic or political
    instability; and                                                                            
|
| |  | failure of certain customers to successfully and
    timely reorganize their operations, including emerging from
    bankruptcy.

Our product sales in any quarter depend largely
on orders booked and shipped in that quarter. A significant
portion of our product shipments in each quarter occurs at or
near the end of the quarter. Since individual orders can
represent a meaningful percentage of our revenues and net income
in any quarter, the deferral or cancellation of or failure to
close a single order in a quarter can result in a revenue and
net income shortfall that causes us to fail to meet securities
analysts expectations for that period. We base our current
and future expense levels on our internal operating plans and
sales forecasts, and our operating costs are to a large extent
fixed. As a result, we may not be able to sufficiently reduce
our costs in any quarter to adequately compensate for an
unexpected near-term shortfall in revenues, and even a small
shortfall could disproportionately and adversely affect our
operating results for that quarter.

The factors described above are difficult to
forecast and could have a material adverse effect on our
business, operating results and financial condition. We may
experience a shortfall in revenues in the future, which would
adversely affect our operating results. The results in any one
quarter should not be relied upon as an indication of our future
performance.

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| |                                                                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have limited product offerings, and our
    revenues may suffer if demand for any of our products declines
    or fails to develop as we expect and if we are not able to
    develop and market additional and enhanced product
    offerings.

We derive a substantial portion of our revenues
from sales of our Network Signaling products. During each of
2001, 2002 and 2003, our Eagle products and related services
generated over 50% of our revenues, and we expect that these
products and services and our other Network Signaling products
will continue to account for a substantial majority of our
revenues for the foreseeable future. As a result, factors
adversely affecting the pricing of or demand for these products,
such as competition, technological change or a slower than
anticipated rate of deployment of new products and technologies,
could cause a significant decrease in our revenues and
profitability. Continued and widespread market acceptance of
these products is therefore critical to our future success.
Moreover, our future financial performance will depend in
significant part on the successful and timely development,
introduction and customer acceptance of new and enhanced
versions of our Eagle as well as other Network Signaling
products and Next-Generation Switching. Introducing new and
enhanced products such as these requires a significant
commitment to research and development that may not result in
success. There are no assurances that we will continue to be
successful in developing and marketing our Network Signaling and
Next-Generation Switching products and related services.

In addition, as a result of our August 2002 sale
of the assets of our Network Diagnostics Division, our product
offerings are more limited than they were prior to that time. In
2001 we derived approximately 20% of our revenues from sales of
our Network Diagnostics products, which are included in
discontinued operations.



| |                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If wireless carriers do not continue to
    grow and to buy our Network Signaling products and services, our
    Network Signaling business would be harmed.

The success of our Network Signaling business
will depend in large part on the continued growth of wireless
network operators and their purchases of our products and
services. We derive a substantial portion of our revenues from
the sale of our Network Signaling products and services to
wireless network operators. In each of 2002 and 2003, sales to
the wireless market accounted for more than 50% of our Network
Signaling revenues. We expect that our sales of Network
Signaling products and services to wireless companies will
continue to account for a substantial majority of our revenues
for the foreseeable future. The continued growth of the domestic
and international wireless markets is subject to a number of
risks that could adversely affect our revenues and
profitability, including:



| |   |                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | continuing or worsening weakness in the domestic
    or global economy;                                                                                      
|
| |  | a further slowdown in capital spending by
    wireless network operators;                                                                                    
|
| |  | continuing and further adverse changes in the
    debt and equity markets and in the ability of wireless carriers
    to obtain financing on favorable terms;
|
| |  | delays or scaling back of plans for the
    deployment by wireless network operators of new wireless
    broadband technologies; and                         
|
| |  | slowing growth of wireless network subscribers or
    minutes of use.                                                                                        

Consequently, there can be no assurances that the
wireless network carriers will continue to purchase our Network
Signaling products or services for the build-out or expansion of
their networks.

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| |                                                                          
| | -------------------------------------------------------------------------
| | Risks related to the potential convergence
    of voice and data networks

The market for our products is evolving.
Currently, voice conversations are carried primarily over
circuit switched networks. Another type of network, packet
switched networks, carries primarily data. Circuit and packet
networks use fundamentally different technologies. Although we
expect a substantial portion of any increases in our future
sales of Next-Generation Switching products to result from the
interconnection, or convergence, of circuit and packet networks,
we cannot accurately predict when such convergence will occur or
whether it will fully occur. Therefore, this convergence
presents several significant and related risks to our business.

If the convergence of circuit and packet networks
does not fully occur or takes longer than anticipated, sales of
our network infrastructure products, and our profitability,
could be adversely affected. Any factor which might prevent or
slow the convergence of circuit and packet networks could
materially and adversely affect growth opportunities for our
business. Such factors include:



| |   |                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the failure to solve or difficulty in solving
    certain technical obstacles to the transmission of voice
    conversations over a packet network;
|
| |  | delays in the formulation of standards for the
    transmission of voice conversations over a packet
    network; and                              
|
| |  | the imposition on packet network operators of
    access fees, which they currently do not pay.                                                    

It may be difficult or impossible to solve
certain technical obstacles to the transmission of voice
conversations over a packet network with the same quality and
reliability of a circuit network. For example, delays or gaps in
the timing of a message are typically not as critical to data
transmissions as they are to voice conversations. The nature of
packet switching makes it difficult to prevent such delays or
gaps as well as to repair such defects in a way that does not
degrade the quality of a voice conversation. If this problem is
not solved, the convergence of circuit and packet networks may
never fully occur or may occur at a much slower rate than we
anticipate. It may also be difficult or time-consuming for the
industry to agree to standards incorporating any one solution to
such technical issues if such a solution does exist. Without
uniform standards, substantial convergence of circuit and packet
networks may not occur.

We cannot accurately predict when these technical
problems will be solved, when uniform standards will be agreed
upon or when market acceptance of such solutions will occur.
Convergence may, however, take much longer than we expect or, as
noted above, not fully occur at all. Moreover, uncertainty
regarding the technology or standards to be employed in
converged networks may cause carriers to delay their purchasing
plans.

Finally, the imposition of access fees on packet
networks might slow the convergence of circuit and packet
networks. Today, federal regulation requires an operator of a
long distance circuit network to pay an access fee to the local
phone company serving the recipient of a long distance call.
Packet network operators do not currently pay such access fees.
In the future, access fees may be imposed on carriers using
packet networks to transmit voice calls. These access fees might
also be imposed on the termination of pure data
messages by operators of packet networks. The imposition of
these access fees would reduce the economic advantages of using
packet networks for voice and other transmissions, which may
slow the convergence of circuit and packet networks.



| |                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------
| | The integration of the business operations
    of our Packet Telephony Business Unit and Santera may not be
    successful.

The Santera transaction requires that we
integrate Santeras operations with those of our Packet
Telephony Business Unit. We may not be successful in integrating
these operations and we may not realize the expected benefits of
the transaction. The integration requires the dedication of
management resources, which diverts attention from our
day-to-day business. The difficulties of integration may be
increased by coordinating geographically separated organizations
and integrating personnel. The integration process may cause an
interruption of, or a loss of momentum in, the activities of
either or both of the companies and may adversely

18



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affect our operations. Furthermore, the process
of integrating the operations of Santera with our operations
could have a material and adverse effect on our ability to
retain the key managerial personnel who are critical to our
operations.




| |                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------
| | We may have difficulty in identifying and
    executing any acquisitions, strategic alliances and joint
    ventures.

Our growth is dependent on market growth, our
ability to enhance existing products, our ability to introduce
new products on a timely basis and market acceptance of our
existing and new products. Our growth strategy includes
acquiring new products and technologies through acquisitions,
strategic alliances and joint ventures. Transactions such as
these are inherently risky because of the difficulties that may
arise in integrating people, operations, technologies and
products. We may incur significant acquisition, administrative
and other costs in connection with these transactions, including
costs related to integration of acquired businesses. There can
be no assurance that any of the businesses we may acquire can be
successfully integrated, that they will perform well once
integrated or that they will not materially and adversely affect
our business, operating results or financial condition.
Acquisitions may also lead to potential write-down,
restructuring, or other one-time charges due to unforeseen
business developments, which charges may adversely affect our
earnings.



| |                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------
| | If our products do not satisfy customer
    demand for performance or price, our customers could purchase
    products from our competitors.

The telecommunications equipment industry in
which we operate is highly competitive, and we expect that the
level of competition on pricing and product offerings to
continue to be intense. If we are not able to compete
successfully against our current and future competitors, our
current and potential customers may choose to purchase similar
products offered by our competitors, which would negatively
affect our revenues. We face formidable competition from a
number of companies offering a variety of network signaling,
next-generation switching, monitoring or contact center
products. The markets for our products are subject to rapid
technological changes, evolving industry standards and
regulatory developments. Our competitors include many large
domestic and international companies as well as many smaller
established and emerging technology companies. We compete
principally on the basis of:



| |   |                                       
| | - | --------------------------------------
| |  | product performance and functionality;
|
| |  | product quality and reliability;      
|
| |  | customer service and support; and     
|
| |  | price.                                

Many of our competitors have substantially
greater financial and technological resources, product
development, marketing, distribution and support capabilities,
name recognition, established relationships with
telecommunications service providers and other resources than we
have. In addition, new competitors may enter our markets as a
result of shifts in technology, and these competitors may
include entrants from the telecommunications, computer software,
computer services, data networking and semiconductor industries.

We anticipate that competition will continue to
intensify with the anticipated convergence of voice and data
networks. We may not be able to compete effectively against
existing or future competitors or to maintain or capture
meaningful market share, and our business could be harmed if our
competitors solutions provide higher performance, offer
additional features and functionality or are more reliable or
less expensive than our products. Increased competition could
force us to lower our prices or take other actions to
differentiate our products, which could adversely affect our
operating results.

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| |                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We depend on a limited number of customers
    for a substantial portion of our revenues, and the loss of one
    or more of these customers could adversely affect our operating
    results.

Historically, a limited number of customers has
accounted for a significant percentage of our Network Signaling
revenues in each fiscal quarter. Less than 10% of our customers
accounted for approximately 50% of our revenues in each of 2001,
2002 and 2003. We anticipate that our operating results in any
given period will continue to depend to a significant extent
upon revenues from a small number of customers. Reductions,
delays or cancellations of orders from one or more of our
significant customers or the loss of one or more of our
significant customers in any period could have a material
adverse effect on our operating results. In addition, the
telecommunications industry has recently experienced a
consolidation of both U.S. and non-U.S. companies. We also
anticipate that the mix of our customers in each fiscal period
will continue to vary. In order to increase our revenues, we
will need to attract additional significant customers on an
ongoing basis. Our failure to attract a sufficient number of
such customers during a particular period could adversely affect
our revenues, profitability and cash flow.



| |                                                                                                       
| | ------------------------------------------------------------------------------------------------------
| | If we fail to develop or introduce new
    products in a timely fashion, our business will
    suffer.

If we fail to develop or introduce on a timely
basis new products or product enhancements or features that
achieve market acceptance, our business will suffer. Rapidly
changing technology, frequent new product introductions and
enhancements, short product life cycles, changes in customer
requirements and evolving industry standards characterize the
markets for our Network Signaling and Next-Generation Switching
products. Our success will depend to a significant extent upon
our ability to accurately anticipate the evolution of new
products, technologies and market trends and to enhance our
existing products. It will also depend on our ability to timely
develop and introduce innovative new products and enhancements
that gain market acceptance. Finally, sales of our Network
Signaling and Next-Generation Switching products depend in part
on the continuing development and deployment of emerging
standards and our ability to offer new products and services
that comply with these standards. We may not be successful in
forecasting future customer requirements or in selecting,
developing, manufacturing and marketing new products or
enhancing our existing products on a timely or cost-effective
basis. Moreover, we may encounter technical problems in
connection with our product development that could result in the
delayed introduction of new products or product enhancements. We
may also focus on technologies that do not function as expected
or are not widely adopted. In addition, products or technologies
developed by others may render our products noncompetitive or
obsolete and result in a significant reduction in orders from
our customers.



| |                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our products are complex and may have
    errors that are not detected until deployment, and litigation
    related to warranty and product liability claims could be
    expensive and could negatively affect our reputation and
    profitability.

We may be exposed to warranty and product
liability claims if our products fail to perform as expected or
the use of our products results in property damage or bodily
injury. Products as highly complex as ours may contain
undetected defects or errors when first introduced or as new
versions are released, and those defects or errors may not be
detected until deployment. Such defects or errors, particularly
those that result in a failure of telecommunications networks or
our signaling or switching products, could harm our customer
relationships, business and reputation, and result in material
warranty or product liability losses and there can be no
assurances that our products will not have defects or errors. A
warranty or product liability claim brought against us could
result in costly, protracted, highly disruptive and time
consuming litigation, which would harm our business. In
addition, we may be subject to claims arising from our failure
to properly service or maintain our products or to adequately
remedy defects in our products once such defects have been
detected. Although our agreements with our customers typically
contain provisions designed to limit our exposure to potential
warranty and product liability claims, it is possible that these
limitations may not be effective under the laws of some
jurisdictions, particularly since we have significant
international sales. Although we maintain product liability
insurance and maintain a warranty reserve, it may not be
sufficient to cover all claims to which we may be subject. The
successful assertion against us of one or a series of large
uninsured claims would harm our business. Although we have not
experienced any significant warranty or product liability claims
to date, our sale and support of products may entail the risk of
these types of claims and subject us to such claims in the
future.

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| |                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------
| | Our relationships with strategic partners
    and distributors and other resellers are important to our future
    growth.

We believe that our ability to compete
successfully against other network signaling and next-generation
switching product manufacturers depends in part on distribution
and marketing relationships with leading communications
equipment suppliers. If we cannot successfully enter these types
of relationships on favorable terms to us or maintain these
relationships, our business may suffer.

In addition, we expect to increasingly rely on
the deployment of our products with those of other
manufacturers, systems integrators and resellers, both
domestically and internationally. To the extent our products are
so incorporated, we depend on the timely and successful
development of those other products.



| |                                                                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our compliance with telecommunications
    regulations and standards may be time consuming, difficult and
    costly, and if we fail to comply, our product sales would
    decrease.

In order to maintain market acceptance, our
products must continue to meet a significant number of
regulations and standards. In the United States, our products
must comply with various regulations defined by the Federal
Communications Commission and Underwriters Laboratories as well
as standards established by Telcordia (formerly Bell
Telecommunications Research). Internationally, our products must
comply with standards established by telecommunications
authorities in various countries as well as with recommendations
of the International Telecommunications Union. As these
standards evolve and if new standards are implemented, we will
be required to modify our products or develop and support new
versions of our products, and this will increase our costs. The
failure of our products to comply, or delays in compliance, with
the various existing and evolving industry standards could
prevent or delay introduction of our products, which could harm
our business.

In order to penetrate our target markets, it is
important that we ensure the interoperability of our products
with the operations, administration, maintenance and
provisioning systems used by our customers. To ensure this
interoperability, we periodically submit our products to
technical audits. Our failure or delay in obtaining favorable
technical audit results could adversely affect our ability to
sell products to some segments of the communications market.

Government regulatory policies are likely to
continue to have a major impact on the pricing of existing as
well as new public network services and, therefore, are expected
to affect demand for such services and the communications
products, including our products, which support such services.
Tariff rates, whether determined autonomously by carriers or in
response to regulatory directives, may affect cost effectiveness
of deploying public network services. Tariff policies are under
continuous review and are subject to change. User uncertainty
regarding future policies may also affect demand for
communications products, including our products. In addition,
the convergence of circuit and packet networks could be subject
to governmental regulation. Regulatory initiatives in this area
could adversely affect our business.



| |                                                                                            
| | -------------------------------------------------------------------------------------------
| | We have significant international sales,
    and international markets have inherent risks.

International sales are subject to inherent
risks, including unexpected changes in regulatory requirements,
tariffs and duties, changes in a countrys political or
economic conditions including military conflicts or political or
social unrest, difficulties in staffing and managing foreign
operations and distributors, longer accounts receivable cycles,
differing technology standards and customer requirements,
greater difficulty in accounts receivable collection, trade
regulations, nationalization of business, economic instability
and potentially adverse tax consequences. Doing business
overseas is generally more costly than doing business in the
United States. We sell our products worldwide through our direct
sales forces, distributors and other resellers, wholly owned
subsidiaries in the United Kingdom, Canada, France, Italy,
Germany, Brazil, Singapore, India, Spain, and Mexico, and
representative offices in China and the Russian Federation.
International sales of our products accounted for 17% in 2001,
18% in 2002 and 17% in 2003. Our international sales are to a
limited extent denominated in local currencies while most of our
international sales are U.S. dollar-denominated. We expect
that international sales will continue to account for a
significant portion of our revenues in future periods.

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Our international sales and other activities also
subject us to the risks relating to price controls, export
regulations, restrictions on foreign currencies and trade
barriers imposed by foreign countries, exchange rate
fluctuations and exchange controls, changes in local economics,
changes in laws and regulations, unsettled potential conditions
and possible terrorist attacks against American interests. For
example, exchange rate fluctuations on foreign currency
transactions and translations arising from international
operations may contribute to fluctuations in our business and
operating results. Fluctuations in exchange rates could also
affect demand for our products. If, for any reason, exchange or
price controls or other restrictions in foreign countries are
imposed, our business and operating results could suffer. In
addition, any inability to obtain local regulatory approvals in
foreign markets on a timely basis could harm our business.

In particular, if we are not able to manage our
continuing expansion into Europe, Asia Pacific and Latin
America, our business may suffer. In addition, we are relatively
unknown in Asia Pacific and Latin America, and we may have
difficulty establishing relationships, building name recognition
or penetrating these markets, which could adversely affect our
performance in these markets. Moreover, telecommunications
networks outside of the United States generally have a different
structure, and our products may not be completely compatible
with this different structure. As a result, our products may not
be competitive with those of our competitors.

Access to foreign markets is often difficult due
to the established relationships between a government-owned or
controlled communications operating company and its traditional
suppliers of communications equipment. These foreign
communications networks are in many cases owned or strictly
regulated by government. There can be no assurances that we will
be able to successfully penetrate these markets, particularly
for our switching products.



| |                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our loss of services of key personnel or
    failure to attract and retain additional key personnel could
    adversely affect our ability to operate our company
    effectively.

We depend to a significant extent upon the
continuing services and contributions of our senior management
team and other key employees, particularly Fred Lax, our Chief
Executive Officer and President, Lori Craven, our Executive Vice
President, Global Sales and Marketing Group, and Debra May, our
Vice President and General Manager, Contact Center Division. We
do not have long-term employment agreements or other
arrangements with our employees that would prevent them from
leaving Tekelec. Our future success also depends upon our
ongoing ability to attract and retain highly skilled technical,
sales and marketing personnel. Even with the continuing economic
downturn, competition for these employees remains intense. Our
business could suffer and it would be more difficult for us to
meet our business plans and key objectives, such as timely
product introductions, if we were to lose any key personnel and
not be able to find qualified replacements in a timely manner or
if we were unable to recruit and retain additional highly
skilled personnel.



| |                                                                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | There can be no assurances that our
    measures to protect our proprietary technology and other
    intellectual property rights are adequate and if we fail to
    protect those rights, our business would be
    harmed.

Our success depends to a significant degree on
our proprietary technology and other intellectual property.
Although we regard our technology as proprietary, we have sought
only limited patent protection. We rely on a combination of
patents, copyrights, trademarks, trade secrets, confidentiality
agreements and contractual restrictions to establish and protect
our proprietary rights. These measures, however, afford only
limited protection and may not provide us with any competitive
advantage or prevent third parties from misappropriating our
technology or other intellectual property. In addition, the laws
of certain foreign countries do not protect our proprietary
rights to the same extent as do the laws of the United States,
which makes misappropriation of our technology and other
intellectual property more likely. It is possible that others
will independently develop similar products or design around our
patents and other proprietary rights. If we fail to successfully
enforce or defend our intellectual property rights or if we fail
to detect misappropriation of our proprietary rights, our
ability to effectively compete could be seriously impaired which
would limit our future revenues and harm our prospects.

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Our pending patent and trademark registration
applications may not be allowed, and our competitors and others
may challenge the validity or scope of our patent or trademark
registration applications. If we do not receive the patents or
trademark registrations we seek, or if other problems arise with
our intellectual property, our competitiveness could be
significantly impaired and our business, operations and
prospects may suffer. In addition, we from time to time face
challenges to the validity or enforceability of our proprietary
rights and litigation may be necessary to enforce and protect
our rights, to determine the validity and scope of our
proprietary rights and the rights of others, or to defend
against claims of infringement or invalidity. Any such
litigation would be expensive and time consuming, would divert
the attention of our management and key personnel from business
operations and would likely harm our business and operating
results.



| |                                                                                                                                                                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Because we are subject to third
    parties claims that we are infringing their intellectual
    property and may become subject to additional such claims in the
    future, we may be prevented from selling certain products and we
    may incur significant expenses in resolving these
    claims.

We receive from time to time claims of
infringement from third parties or we otherwise become aware of
relevant patents or other intellectual property rights of third
parties that may lead to disputes and litigation. Any claims
made against us regarding patents or other intellectual property
rights could be expensive and time consuming to resolve or
defend and could have a material adverse effect on our business.
In addition, any such claims would divert the attention of our
management and key personnel from our business operations. A
claim by a third party may require us to modify or cease
marketing our products, develop new technologies or products,
enter into costly royalty or license agreements with respect to
the proprietary rights that are the subject of the infringement
claim or refund to our customers all or a portion of the amounts
they have paid for infringing products. If such claims are
asserted, there can be no assurances that we would prevail,
successfully modify our products or be able to acquire any
necessary licenses on acceptable terms, if at all. In addition,
we may be requested to defend and indemnify certain of our
customers and resellers against claims that our products
infringe the proprietary rights of others. We may also be
subject to potentially significant damages or injunctions
against the sale of certain products or use of certain
technologies, and there can be no assurances that any such
litigation can be avoided or successfully concluded. There can
be no assurances that our technologies or products do not
infringe on the proprietary rights of third parties or that such
parties will not initiate infringement actions against us.



| |                                                                                                                                                                                                                                                                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we fail to accurately forecast our
    manufacturing requirements or customer demand or fail to
    effectively manage our contract manufacturer relationships, we
    could incur additional costs or be unable to timely fulfill our
    customer commitments which would adversely affect our business
    and results of operations and harm our customer
    relationships.

During 2004, we expect to outsource a substantial
portion of our manufacturing and repair service operations to
independent contract manufacturers and other third parties. Our
contract manufacturers will manufacture our products based on
rolling forecasts of our product needs that we provide to them
on a regular basis. The contract manufacturers will be
responsible for procuring components necessary to build our
products based on our rolling forecasts, will build and assemble
the products, will test the products in accordance with our
specifications and then ship the products to us. We will
configure the products to our customer requirements, conduct
final testing and then ship the products to our customers.
Although we plan to partner with multiple major contract
manufacturers, there can be no assurance that we will not
encounter problems as we become increasingly dependent on
contract manufacturers to provide these manufacturing services.

If we fail to accurately predict our
manufacturing requirements or forecast customer demand, we may
incur additional costs and our gross margins and financial
results could be adversely affected. If we overestimate our
requirements, our contract manufacturers may experience an
oversupply of components and assess us charges for excess or
obsolete components that could adversely affect our gross
margins. If we underestimate our requirements, our contract
manufacturers may have inadequate inventory or components, which
could interrupt manufacturing and result in higher manufacturing
costs, shipment delays, damage customer relationships and/or
result in our payment of penalties to our customers.

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In addition, if we fail to effectively manage our
relationships with our contract manufacturers or other service
providers, or if one or more of them should not fully comply
with their contractual obligations or should experience delays,
disruptions, component procurement problems or quality control
problems, then our ability to ship products to our customers or
otherwise fulfill our contractual obligations to our customers
could be delayed or impaired which would adversely affect our
business, financial results and customer relationships.



| |                                                                                                                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We rely on third parties to provide many of
    our subsystems and components. If we are unable to obtain our
    subsystems and components from these parties at reasonable
    prices or on a timely basis, we may not be able to obtain
    substitute subsystems or components on terms that are as
    favorable.

Certain of our products contain subsystems or
components acquired from third parties. These products are often
available only from a limited number of manufacturers. In the
event that a product becomes unavailable from a current third
party vendor, second sourcing would be required. This sourcing
may not be available on reasonable terms, if at all, and could
delay customer deliveries, which could adversely affect our
business.



| |                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------
| | We are exposed to the credit risk of some
    of our customers and to credit exposures in weakened
    markets.

We are vulnerable to downturns in the economy and
the telecommunications industry and to adverse changes in our
customers businesses and financial condition. The current
slowdown in the economy in general and in the telecommunications
market in particular has weakened the financial condition of
many of our customers, which has adversely affected their
creditworthiness. Although we have programs in place to monitor
and mitigate the associated risks, there can be no assurance
that such programs will be effective in reducing our credit
risks. We also continue to monitor credit exposure from weakened
financial conditions in certain geographic regions, and the
impact that such conditions may have on the worldwide economy.
We have experienced losses due to customers failing to
meet their obligations. Although these losses have not been
significant, future losses, if incurred, could harm our business
and have a material adverse effect on our operating results and
financial condition.



| |                                                                                    
| | -----------------------------------------------------------------------------------
| | Business disruptions could adversely affect
    our business and financial results.

Our operations could be subject to natural
disasters and other business disruptions, which could adversely
affect our business and financial results. Our corporate
headquarters, manufacturing operations and some of our suppliers
are located in California, near major earthquake faults. The
ultimate impact on us and our significant suppliers of being
located near major earthquake faults is unknown, but our
business and financial results could suffer in the event of a
major earthquake. In addition, some areas, including California
and parts of the United States, have experienced, and may
continue to experience, major power shortages and blackouts.
These blackouts could cause disruptions to our operations or the
operations of our suppliers, distributors and resellers, or our
customers. We are predominately self-insured for losses and
interruptions caused by earthquakes and other natural or manmade
disasters.






|        |            
|------- | -----------
|Item 2. | Properties.

Our executive offices and principal manufacturing
operations are located in Calabasas, California in facilities
consisting of approximately 77,000 square feet. We lease
the facilities under a lease expiring in November 2004, subject
to a five-year renewal option.

We occupy a 155,000 square-foot facility in
Morrisville, North Carolina under a lease expiring in November
2009. This facility is used primarily for engineering, product
development, customer support and regional sales activities for
our network signaling products. An additional
161,000 square foot facility in Morrisville, North Carolina
is maintained under a lease expiring in 2011. As a result of the
NDD divestiture, the building is not fully occupied. During the
course of 2004, we will relocate our manufacturing operations
from Calabasas, California to this facility. We continue to
evaluate additional alternatives with respect to the utilization
of these facilities.

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Our IEX subsidiary leases a facility consisting
of approximately 56,000 square feet in Richardson, Texas
under a lease expiring in February 2013. The IEX facility is
used for engineering, product development, customer support, and
general administrative and sales activities for our contact
center products.

Our subsidiary in the United Kingdom occupies
approximately 6,100 square feet in Egham under a lease
expiring in March 2016.

Our majority owned subsidiary, Santera, leases a
facility of approximately 100,000 square feet in Plano,
Texas under a lease expiring in August 2005.

Our international subsidiaries, sales and
customer service locations occupy an aggregate of approximately
8,000 square feet under short term leases in
Sao Paulo, Brazil; Beijing, China; Singapore; Moscow, the
Russian Federation; Mexico City, Mexico; New Delhi, India;
Amsterdam, the Netherlands; Madrid, Spain; and Grisheim, Germany.

Domestically, we have seven regional sales
offices occupying an aggregate of approximately
7,700 square feet under short term leases in
San Diego, California; Englewood, Colorado; Lombard,
Illinois; Irving, Texas; Sunset Hills, Virginia; Mount Laurel,
New Jersey; and Miami, Florida,

We believe that our existing facilities will be
adequate to meet our needs at least through 2004, and that we
will be able to obtain additional space when, where and as
needed on acceptable terms.






|        |                   
|------- | ------------------
|Item 3. | Legal Proceedings.

From time to time, various claims and litigation
are asserted or commenced against us arising from or related to
contractual matters, intellectual property matters, product
warranties and personnel and employment disputes. As to such
claims and litigation, including those matters discussed below,
we can give no assurance that we will prevail. While we
currently do not believe that the ultimate outcome of these
matters, individually or in the aggregate, will have a material
adverse effect on our business or consolidated financial
position, litigation is subject to inherent uncertainties. An
unfavorable outcome in any of these matters could have a
material adverse effect on our business or our consolidated
financial position, results of operations or cash flows in the
quarter or annual period in which one or more of these matters
are resolved.

IEX Corporation vs. Blue Pumpkin
Software, Inc.

In January 2001, IEX Corporation, a wholly
owned subsidiary of Tekelec (IEX), filed suit
against Blue Pumpkin Software, Inc., in the United States
District Court for the Eastern District of Texas, Sherman
Division. In its complaint, IEX asserts that certain of
Blue Pumpkins products and services infringe United States
Patent No. 6,044,355 held by IEX. In the suit, IEX
seeks damages and an injunction prohibiting Blue Pumpkins
further infringement of the patent. In February 2001, Blue
Pumpkin responded to IEXs suit denying that Blue Pumpkin
infringes IEXs patent and asserting that such patent is
invalid. Discovery in the case closed in December 2002. Blue
Pumpkin filed a motion for summary judgment of non-infringement,
and the Court granted that motion finding that Blue Pumpkin did
not infringe the 355 patent as a matter of law. IEX timely
filed a notice of appeal and submitted its appellate brief to
the Federal Circuit Court of Appeals in January 2004. Blue
Pumpkins response is due in April 2004. Tekelec currently
believes that the ultimate outcome of the lawsuit will not have
a material adverse effect on its financial position, results of
operations or cash flows.

Lemelson Medical, Education and Research
Foundation, Limited Partnership vs. Tekelec

In March 2002, the Lemelson Medical,
Education & Research Foundation, Limited Partnership
(Lemelson) filed a complaint against thirty
defendants, including Tekelec, in the United States District
Court for the District of Arizona. The complaint alleges that
all defendants make, offer for sale, sell, import, or have
imported products that infringe eighteen patents assigned to
Lemelson, and the complaint also alleges that the defendants use
processes that infringe the same patents. The patents at issue
relate to computer image analysis technology and automatic
identification technology. Lemelson has not identified the
specific Tekelec products or processes that allegedly infringe
the patents at issue. Several Arizona lawsuits, including the

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lawsuit in which Tekelec is a named defendant,
involve the same patents and have been stayed pending a
non-appealable resolution of a lawsuit involving the same
patents in the United States District Court for the District of
Nevada. On January 23, 2004, the Court in the District of
Nevada case issued an Order finding that certain Lemelson
patents covering bar code technology and machine vision
technology were: (1) unenforceable under the doctrine of
prosecution laches; (2) not infringed by any of the accused
products sold by any of the eight plaintiffs; and
(3) invalid for lack of written description and enablement.
Tekelec currently believes that the ultimate outcome of the
lawsuit will not have a material adverse effect on our financial
position, results of operations or cash flows.


Syndia Corporation

In January 2002, Syndia Corporation
(Syndia) sent a letter to Tekelec accusing Tekelec
of infringing two patents and offering to license these and
other patents to Tekelec. The patents at issue relate to
integrated circuit technology. Syndia has not identified the
specific Tekelec products or processes that allegedly infringe
the patents at issue, and Tekelec is currently investigating
which products and/or processes might be subject to
Syndias claims. Tekelec currently believes that the
ultimate outcome of the lawsuit will not have a material adverse
effect on our financial position, results of operations or cash
flows.

Tekelec v. Telica, Inc.

On August 14, 2003, Tekelec filed a
complaint against Telica, Inc. (Telica) in the
United States District Court for the Central District of
California. The complaint alleges that Telica refused to provide
certain financial statements and information required to be
provided to Tekelec, as an investor in Telica, pursuant to a
stockholders agreement among Telica and certain of its
stockholders, including Tekelec. Tekelec contends, among other
things, that such refusal by Telica has injured Tekelec,
including by interfering with Tekelecs ability to monitor
its investment in Telica. In the complaint, Tekelec alleges
claims for breach of contract and specific performance and seeks
damages and an injunction compelling Telica to deliver all
required financial statements and information. On
September 15, 2003, Tekelec filed its First Amended
Complaint, adding certain individuals as defendants and adding
claims for breach of the implied covenant of good faith and fair
dealing and breach of fiduciary duty.

On November 7, 2003, Telica filed a
counterclaim against Tekelec, seeking an unspecified amount of
damages and costs and alleging claims for breach of contract,
breach of the covenant of good faith and fair dealing, fraud and
intentional interference with prospective economic advantage. On
December 5, 2003, Tekelec filed its reply to the
counterclaim, denying Telicas claims and asserting various
affirmative defenses. The parties have commenced the discovery
phase of the case, and a trial date of June 8, 2004 has
been set by the Court. Tekelec currently believes that the
ultimate outcome of the lawsuit will not have a material adverse
effect on its financial position, results of operations or cash
flows.






|        |                                                         
|------- | --------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders.

Inapplicable.

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##### Table of Contents






PART II






|        |                                                                           
|------- | --------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity and
    Related Stockholder Matters.

Our Common Stock is traded on The Nasdaq Stock
Market under the symbol TKLC. The following table sets forth the
range of high and low closing sales prices for the Common Stock
for the periods indicated. As of March 1, 2004, there were
483 record shareholders of Tekelec Common Stock. This number
does not include shareholders for whom shares are held in
nominee or street name.

|     |                |      |   |       |  |  |   |       | 
|---- | -------------- | ---- | - | ----- |  |  | - | ----- | 
|     |                | High |   | Low  
|     |                |      |   |      
|2002 |                |      |   |       |  |  |   |      
|     | First Quarter  |      | $ | 20.20 |  |  | $ | 11.18 | 
|     | Second Quarter |      |   | 12.10 |  |  |   | 8.03  | 
|     | Third Quarter  |      |   | 12.00 |  |  |   | 6.27  | 
|     | Fourth Quarter |      |   | 10.58 |  |  |   | 7.92  | 
|2003 |                |      |   |       |  |  |   |      
|     | First Quarter  |      | $ | 12.06 |  |  | $ | 8.04  | 
|     | Second Quarter |      |   | 14.29 |  |  |   | 8.72  | 
|     | Third Quarter  |      |   | 18.08 |  |  |   | 11.34 | 
|     | Fourth Quarter |      |   | 18.00 |  |  |   | 14.68 | 

We have never paid a cash dividend on our Common
Stock. It is our present policy to retain earnings to finance
the growth and development of our business and, therefore, we do
not anticipate paying cash dividends on our Common Stock in the
foreseeable future.

In June 2003, we issued and sold $125,000,000
principal amount of our 2.25% Senior Subordinated
Convertible Notes due 2008 (the Notes). The Notes
were issued in a private offering in reliance on
Section 4(2) of the Securities Act of 1933, as amended (the
Securities Act). The initial purchaser of the Notes
was Morgan Stanley & Co. Incorporated, which resold the
Notes to qualified institutional buyers pursuant to
Rule 144A promulgated under the Securities Act. The
aggregate offering price of the Notes was $125,000,000, and the
aggregate proceeds to Tekelec were approximately $121,184,000
after expenses. The Notes mature on June 15, 2008, and are
convertible prior to the close of business on their final
maturity date into shares of our common stock at a conversion
rate of 50.8906 shares per $1,000 principal amount of the
Notes, subject to adjustment in certain circumstances.






|        |                         
|------- | ------------------------
|Item 6. | Selected Financial Data.

The statement of operations data included in the
selected consolidated financial data set forth below for the
years ended December 31, 2003, 2002 and 2001 and the
balance sheet data set forth below at December 31, 2003 and
2002 are derived from, and are qualified in their entirety by
reference to, our audited consolidated financial statements and
notes thereto included in this Annual Report on Form 10-K.
The statement of operations data set forth below for the years
ended December 31, 2000 and 1999 and the balance sheet data
set forth below at December 31, 2001, 2000 and 1999 are
derived from our audited consolidated financial statements,
which are not included herein. The statements of operations data
set forth below are adjusted to reflect the sale of our Network
Diagnostics Division (NDD) in August 2002, which was
accounted for as a discontinued operation. Accordingly, the
historical statements of operations data for periods prior to
the sale have been revised to reflect NDD as a discontinued
operation. For the year ended December 31, 2003, the
statement of operations data set forth below reflects the
financial results of Santera as of the date of acquisition,
June 10, 2003, less minority interest. The
December 31, 2003 balance sheet data includes the results
of Santera.

27



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##### Table of Contents



Five-Year Selected Financial Data

|                                                                               |         |                                    |         |        |  |      |         |        |   |      |         |        |   |   |         |        |  |   |         |        |  
|------------------------------------------------------------------------------ | ------- | ---------------------------------- | ------- | ------ |  | ---- | ------- | ------ | - | ---- | ------- | ------ | - | - | ------- | ------ |  | - | ------- | ------ | -
|                                                                               |         |                                   
|                                                                               |         | For the Years Ended December 31,  
|                                                                               |         |                                   
|                                                                               |         | 2003                               |         | 2002   |  | 2001 |         | 2000   |   | 1999
|                                                                               |         |                                    |         |        |  |      |         |        |   |     
|                                                                               |         |                                   
|                                                                               |         | (Thousands, except per share data)
|Statement of Operations Data:                                                  |         |                                    |         |        |  |      |         |        |   |      |         |        |   |   |         |        |  |   |         |       
|Revenues                                                                       |         | $                                  | 263,700 |        |  | $    | 260,341 |        |   | $    | 249,369 |        |   | $ | 252,327 |        |  | $ | 169,875 |       
|Income (Loss) from continuing operations before
    provision for income taxes |         |                                    | 8,967   |        |  |      | 24,054  |        |   |      | (488    | )      |   |   | 21,754  |        |  |   | 2,702   |       
|Income (Loss) from continuing operations                                       |         |                                    | 15,159  |        |  |      | 15,914  |        |   |      | (6,610  | )      |   |   | 6,228   |        |  |   | (4,482  | )     
|Income (Loss) from discontinued operation, net of
    income taxes             |         |                                    |        |        |  |      | (3,308  | )      |   |      | (289    | )      |   |   | 6,668   |        |  |   | 4,926   |       
|Gain on sale of discontinued operation, net of
    income taxes                |         |                                    | 3,293   |        |  |      | 28,312  |        |   |      |        |        |   |   |        |        |  |   |        |       
|Net income (loss)                                                              |         |                                    | 18,452  |        |  |      | 40,918  |        |   |      | (6,899  | )      |   |   | 12,896  |        |  |   | 444     |       
|Earnings (Loss) per share from continuing
    operations:                      |         |                                    |         |        |  |      |         |        |   |      |         |        |   |   |         |        |  |   |         |       
|                                                                               | Basic   |                                    | $       | 0.25   |  |      | $       | 0.26   |   |      | $       | (0.11  | ) |   | $       | 0.11   |  |   | $       | (0.08  | )
|                                                                               | Diluted |                                    |         | 0.24   |  |      |         | 0.26   |   |      |         | (0.11  | ) |   |         | 0.10   |  |   |         | (0.08  | )
|Earnings (Loss) per share from discontinued
    operation:                     |         |                                    |         |        |  |      |         |        |   |      |         |        |   |   |         |        |  |   |         |       
|                                                                               | Basic   |                                    | $       |       |  |      | $       | (0.05  | ) |      | $       | (0.01  | ) |   | $       | 0.11   |  |   | $       | 0.09   |  
|                                                                               | Diluted |                                    |         |       |  |      |         | (0.05  | ) |      |         | (0.01  | ) |   |         | 0.10   |  |   |         | 0.09   |  
|Earnings per share from gain on sale of
    discontinued operation:            |         |                                    |         |        |  |      |         |        |   |      |         |        |   |   |         |        |  |   |         |       
|                                                                               | Basic   |                                    | $       | 0.05   |  |      | $       | 0.47   |   |      | $       |       |   |   | $       |       |  |   | $       |       |  
|                                                                               | Diluted |                                    |         | 0.05   |  |      |         | 0.46   |   |      |         |       |   |   |         |       |  |   |         |       |  
|Earnings (Loss) per share:                                                     |         |                                    |         |        |  |      |         |        |   |      |         |        |   |   |         |        |  |   |         |       
|                                                                               | Basic   |                                    | $       | 0.30   |  |      | $       | 0.68   |   |      | $       | (0.12  | ) |   | $       | 0.22   |  |   | $       | 0.01   |  
|                                                                               | Diluted |                                    |         | 0.29   |  |      |         | 0.67   |   |      |         | (0.12  | ) |   |         | 0.20   |  |   |         | 0.01   |  
|Weighted average number of shares outstanding:                                 |         |                                    |         |        |  |      |         |        |   |      |         |        |   |   |         |        |  |   |         |       
|                                                                               | Basic   |                                    |         | 61,163 |  |      |         | 60,358 |   |      |         | 59,574 |   |   |         | 57,823 |  |   |         | 54,931 |  
|                                                                               | Diluted |                                    |         | 62,911 |  |      |         | 61,386 |   |      |         | 59,574 |   |   |         | 64,123 |  |   |         | 58,690 |  
|Balance Sheet Data (at
    December 31):                                       |         |                                    |         |        |  |      |         |        |   |      |         |        |   |   |         |        |  |   |         |       
|Cash and liquid investments                                                    |         | $                                  | 339,359 |        |  | $    | 309,830 |        |   | $    | 225,956 |        |   | $ | 151,308 |        |  | $ | 92,977  |       
|Working capital                                                                |         |                                    | 135,039 |        |  |      | 187,912 |        |   |      | 185,168 |        |   |   | 218,935 |        |  |   | 127,702 |       
|Total assets                                                                   |         |                                    | 614,933 |        |  |      | 525,683 |        |   |      | 484,404 |        |   |   | 458,524 |        |  |   | 394,434 |       
|Long-term liabilities                                                          |         |                                    | 132,051 |        |  |      | 145,098 |        |   |      | 137,929 |        |   |   | 136,050 |        |  |   | 137,552 |       
|Shareholders equity                                                           |         |                                    | 328,811 |        |  |      | 302,007 |        |   |      | 248,822 |        |   |   | 237,597 |        |  |   | 176,595 |       

28



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|        |                                                                                           
|------- | ------------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of
    Financial Condition and Results of Operations.

The following discussion should be read in
conjunction with, and is qualified in its entirety by, the
consolidated financial statements and the notes thereto included
in this Annual Report on Form 10-K. Historical results and
percentage relationships among any amounts in the financial
statements are not necessarily indicative of trends in operating
results for any future periods.

Our logo, IEX, TALI, and Eagle are
registered trademarks of Tekelec. Tekelec, IP7, IP7
Secure Gateway, ASi 4000, VXi, TekWare, TekServer, TotalView,
and TotalNet are trademarks of Tekelec. Santera and SanteraOne
are registered trademarks of Santera, our majority owned
subsidiary. BOX and OFX are trademarks of Santera.

Overview

In August 2002, we completed the sale of our
Network Diagnostics Division (NDD) to Catapult
Communications Corporation (Catapult) for
$59.8 million, consisting of $42.5 million in cash and
convertible subordinated promissory notes issued by
Catapults wholly owned Irish subsidiary and guaranteed by
Catapult in the total amount of $17.3 million, subject to
certain adjustments. The sale of NDD resulted in a pre-tax gain
of approximately $41.7 million ($28.3 million after
income taxes) and was accounted for as a discontinued operation
in accordance with SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets.
Accordingly our historical financial results have been revised
to reflect NDD as a discontinued operation.

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

On February 25, 2004, we announced that we
entered into a definitive agreement to purchase
Taqua, Inc., a privately-held provider of next-generation
Class 5 packet switching systems, located in Richardson,
Texas. Upon the closing of the transaction, we will purchase all
of Taquas outstanding stock for approximately
$85 million cash, plus assume outstanding options. The
purchase is expected to close no later than April 2004, pending
United States anti-trust approval and the completion of certain
contractual requirements. Taquas business will become part
of our next-generation switching business.

Our product offerings are currently organized
into three distinct product lines: network signaling, contact
center, and next-generation switching.

Network Signaling (formerly Network
Systems).Our network signaling
product line consists principally of the Eagle 5 SAS and
products, features and applications based on the Eagle platform,
including TekWare and TekServer, our local number portability
solution, Sentinel, and other convergence products.

Contact Center.Our
IEX contact center products provide planning, management and
call routing and control tools for single contact centers and
for complex, multiple site contact center environments. This
product line includes the TotalView Workforce Management and
TotalNet Call Routing solutions.

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Next-Generation
Switching.Santeras portfolio of
switching solutions allows network service providers to migrate
their network infrastructure from circuit-based technology to
packet-based technology. Santeras product portfolio
includes SanteraOne, a carrier-grade, integrated voice and data
switching solution which delivers applications like IXC tandem,
Class 4/5, PRI offload, packet/cell switching and Voice
over Broadband services.



| |                                               
| | ----------------------------------------------
| | Critical Accounting Policies and
    Estimates

Managements Discussion and Analysis of
Financial Condition and Results of Operations are based upon our
consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements
requires making estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. On an
on-going basis, estimates are evaluated, including those related
to revenue recognition, allowance for doubtful accounts,
inventories, investments, notes receivable, deferred taxes and
impairment of goodwill and longlived assets, product
warranty, and contingencies and litigation. These estimates are
based on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the
carrying values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from
these estimates.

We apply the following critical accounting
policies in the preparation of our consolidated financial
statements:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Revenue Recognition
    Policy.Revenues are derived from
    sales of network signaling products, contact center products and
    next-generation switching products. Revenues are recognized upon
    the transfer of title, generally at the time of shipment to the
    customers final site and satisfaction of related Company
    obligations, if any, provided that persuasive evidence of an
    arrangement exists, the fee is fixed and determinable and
    collectability is deemed probable. For certain products, our
    sales arrangements include acceptance provisions which are based
    on our published specifications. Revenue is recognized upon
    shipment of these products assuming all other revenue
    recognition criteria are met, provided that we have previously
    demonstrated that the product meets the specified criteria and
    has established a history with substantially similar
    transactions. Revenue is deferred for sales arrangements that
    include customer-specific acceptance provisions where we are
    unable to reliably demonstrate that the delivered product meets
    all of the specified criteria until customer acceptance is
    obtained. Revenues associated with multiple-element arrangements
    are allocated to each element based on vendor specific objective
    evidence of fair value. Revenues associated with installation
    services, if provided, are deferred based on the fair value of
    such services and are recognized upon completion. Revenue is
    recognized for maintenance agreements ratably over the contract
    term. Significant management judgments and estimates must be
    made and used in connection with the revenue recognized in any
    accounting period. Material differences may result in the amount
    and timing of our revenue for any period if management made
    different judgments or utilized different estimates.
|
| |  | Allowance for Doubtful
    Accounts.An allowance for doubtful
    accounts is maintained for estimated losses resulting from the
    inability of our customers to make required payments. If the
    financial condition of our customers were to deteriorate,
    resulting in an impairment of their ability to make payments,
    additional allowances may be required.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | Inventories.Inventory levels are based on projections of future demand and
    market conditions. Any sudden decline in demand and/or rapid
    product improvements and technological changes can result in
    excess and/or obsolete inventories. On an ongoing basis
    inventories are reviewed and written down for estimated
    obsolescence or unmarketable inventories equal to the difference
    between the costs of inventories and the estimated net
    realizable value based upon forecasts for future demand and
    market conditions. If actual market conditions are less
    favorable than our forecasts, additional inventory write downs
    may be required. Estimates could be influenced by sudden decline
    in demand due to economic downturn, rapid product improvements
    and technological changes.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Investments.Our
    marketable securities are classified as available-for-sale
    securities and are accounted for at their fair value, and
    unrealized gains and losses on these securities are reported as
    a separate component of shareholders equity. When the fair
    value of an investment declines below its original cost, we
    consider all available evidence to evaluate whether the decline
    is other-than-temporary. Among other things, we consider the
    duration and extent of the decline and economic factors
    influencing the markets. To date, we have had no such
    other-than-temporary declines below cost basis. At
    December 31, 2003 and 2002, net unrealized gains or losses
    on available-for-sale securities were not significant. We
    utilize specific identification in computing realized gains and
    losses on the sale of investments. Realized gains and losses are
    reported in other income and expense, and were not significant
    for 2003, 2002 and 2001.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We also invest in equity instruments of
    privately-held companies for business and strategic purposes.
    These investments are classified as long-term assets and are
    accounted for under the cost method since we do not have the
    ability to exercise significant influence over their operations.
    We periodically review these investments for
    other-than-temporary declines in fair value and write down
    investments to their fair value when an other-than-temporary
    decline has occurred. Fair values for investments in
    privately-held companies are estimated based on several factors
    including; the values for recent rounds of financing;
    quoted market prices for comparable public companies or market
    values for recent acquisitions of similar private companies; and
    pricing models using historical and forecasted financial
    information. To date, there have been no impairments of
    investments in privately-held companies.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Notes Receivable.Notes receivable from Catapult Communications, Inc. related to
    our sale of the NDD business are reflected in the balance sheet
    at their estimated fair value determined with the assistance of
    a third party appraisal. The fair value was computed by
    discounting the face value amount to present value using a fair
    value rate of interest and then determining the fair value of
    the conversion option using the Black-Scholes valuation model.
    The fair value of the notes is being adjusted for the
    amortization to the redemption amount at maturity. See
    Note C  Disposition of Network Diagnostics
    Business.                                                                                                                                                                                  
|
| |  | Deferred Taxes.A
    valuation allowance is recorded to reduce deferred tax assets to
    the amount that is more likely than not to be realized. We have
    provided a $71.7 million valuation allowance against the
    deferred tax assets of Santera, due to uncertainties surrounding
    the timing and realization of the benefits from Santeras
    tax attributes in future tax returns. Realization of the
    remaining deferred tax assets of $12.8 million is dependent
    on the extent of our income in carryback years and on our
    generating sufficient taxable income in the future. Should it be
    determined that we would not be able to realize all or part of
    the net deferred tax asset in the future, an adjustment to the
    deferred tax asset would reduce income in the period such
    determination was made.        
|
| |  | Goodwill and Purchased Intangible
    Assets.The purchase method of
    accounting for acquisitions requires extensive use of accounting
    estimates and judgments to allocate the purchase price paid to
    the fair value of the net tangible assets and intangible assets
    acquired, including in-process research and development, or
    IPR&D. The amounts and useful lives assigned to identifiable
    intangible assets impact future amortization and the amounts
    assigned to IPR&D are expensed immediately. If the
    assumptions and estimates used to allocate the purchase price
    are not correct, purchase price adjustments or future asset
    impairment charges could be required.                                                                                                                                             
|
| |  | Impairment of Goodwill and Other Long-Lived
    Assets.Effective January 1,
    2002, we adopted the provisions of Statement of Financial
    Accounting Standards (SFAS) No. 142,
    Goodwill and Other Intangible Assets.
    SFAS No. 142 eliminated the amortization of goodwill.
    Instead, goodwill is reviewed for impairment at least annually
    thereafter. In connection with our performance of the impairment
    tests, we obtained valuations of our individual reporting units
    from an independent third-party valuation firm. The valuation
    methodologies included, but were not limited to, estimated net
    present value of the projected cash flows of these reporting
    units. As a result of these impairment tests, we determined that
    there was no goodwill impairment in 2002 or 2003. If actual
    results are

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| |  |                                                                                                                                                                                                                   
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | substantially lower than our projections
    underlying these valuations, or if market discount rates
    increase, this could adversely affect our future valuations and
    result in future impairment charges.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We assess potential impairment of our finite
    lived, intangible assets and other long-lived assets when there
    is evidence that recent events or changes in circumstances
    indicate that their carrying value may not be recoverable.
    Reviews are performed to determine whether the carrying value of
    assets is impaired based on a comparison to the undiscounted
    estimated future cash flows. If the comparison indicates that
    there is an impairment, the impaired asset is written down to
    fair value, which is typically calculated using discounted
    estimated future cash flows. The amount of an impairment would
    be recognized as the excess of the assets carrying value
    over its fair value. Events or changes in circumstances which
    may cause an impairment include: significant changes in the
    manner of use of the acquired asset, negative industry or
    economic trends, and significant underperformance relative to
    historical or projected future operating results.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Product Warranty.We
    generally warrant our products against defects in materials and
    workmanship for one year after sale and provide for estimated
    future warranty costs at the time revenue is recognized. Our
    warranty obligation is affected by product failure rates,
    material usage and service delivery costs incurred in correcting
    product failures. Should actual product failure rates, material
    usage or service delivery costs differ from our estimates,
    revisions to the estimated warranty liability would be required.
|
| |  | Contingencies and
    Litigation.We evaluate contingent
    liabilities including threatened or pending litigation in
    accordance with SFAS No. 5, Accounting for
    Contingencies and record accruals when the outcome of
    these matters is deemed probable and the liability is reasonably
    estimable. We make these assessments based on the facts and
    circumstances and in some instances based in part on the advice
    of outside legal counsel.                                                                                              

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Results of Operations

The following table sets forth, for the periods
indicated, the percentages that statement of operations items
bear to total revenues:

|                                                                               |                                                |                        |                            |      |     |      |       |      |      |     |       |      |      |     | 
|------------------------------------------------------------------------------ | ---------------------------------------------- | ---------------------- | -------------------------- | ---- | --- | ---- | ----- | ---- | ---- | --- | ----- | ---- | ---- | --- | 
|                                                                               |                                                |                       
|                                                                               |                                                | Percentage of Revenues
|                                                                               |                                                | For the Years Ended   
|                                                                               |                                                | December 31,          
|                                                                               |                                                |                       
|                                                                               |                                                | 2003                   |                            | 2002 |     | 2001
|                                                                               |                                                |                        |                            |      |     |     
|Revenues                                                                       |                                                |                        | 100.0                      | %    |     |      | 100.0 | %    |      |     | 100.0 | %   
|                                                                               | Cost of goods sold                             |                        |                            | 22.3 |     |      |       | 25.6 |      |     |       | 30.7 |     
|                                                                               | Amortization of purchased technology           |                        |                            | 4.2  |     |      |       | 3.9  |      |     |       | 4.1  |     
|                                                                               |                                                |                        |                            |      |     |      |       |      |      |     |       |     
|Gross Profit                                                                   |                                                |                        | 73.5                       |      |     |      | 70.5  |      |      |     | 65.2  |     
|                                                                               | Research and development                       |                        |                            | 27.8 |     |      |       | 22.9 |      |     |       | 21.9 |     
|                                                                               | Selling, general and administrative            |                        |                            | 39.6 |     |      |       | 36.9 |      |     |       | 34.7 |     
|                                                                               | Acquired in-process research and development   |                        |                            | 1.1  |     |      |       |     |      |     |       |     |     
|                                                                               | Amortization of goodwill and other intangibles |                        |                            | 0.7  |     |      |       | 0.6  |      |     |       | 8.7  |     
|                                                                               |                                                |                        |                            |      |     |      |       |      |      |     |       |     
|Income (Loss) from operations                                                  |                                                |                        | 4.3                        |      |     |      | 10.1  |      |      |     | (0.1  | )   
|                                                                               | Interest and other expense, net                |                        |                            | (1.0 | )   |      |       | (0.9 | )    |     |       | (0.1 | )   
|                                                                               |                                                |                        |                            |      |     |      |       |      |      |     |       |     
|Income (Loss) from continuing operations before
    provision for income taxes |                                                |                        | 3.3                        |      |     |      | 9.2   |      |      |     | (0.2  | )   
|                                                                               |                                                |                        | Provision for income taxes |      |     | 5.1  |       |      |      | 3.1 |       |      |      | 2.5 | 
|                                                                               |                                                |                        |                            |      |     |      |       |      |      |     |       |     
|Income (Loss) before minority interest                                         |                                                |                        | (1.8                       | )    |     |      | 6.1   |      |      |     | (2.7  | )   
|Minority interest                                                              |                                                |                        | 7.5                        |      |     |      |      |      |      |     |      |     
|                                                                               |                                                |                        |                            |      |     |      |       |      |      |     |       |     
|Income (Loss) from continuing operations                                       |                                                |                        | 5.7                        |      |     |      | 6.1   |      |      |     | (2.7  | )   
|Income (Loss) from discontinued operation, net of
    income taxes             |                                                |                        |                           |      |     |      | (1.3  | )    |      |     | (0.1  | )   
|Gain on sale from discontinued operation, net of
    income taxes              |                                                |                        | 1.3                        |      |     |      | 10.9  |      |      |     |      |     
|                                                                               |                                                |                        |                            |      |     |      |       |      |      |     |       |     
|                                                                               |                                                | Net income (loss)      |                            |      | 7.0 | %    |       |      | 15.7 | %   |       |      | (2.8 | )% 
|                                                                               |                                                |                        |                            |      |     |      |       |      |      |     |       |     

The following table sets forth, for the periods
indicated, the revenues by principal product line as a
percentage of total revenues:

|                          |       |                     |    |      |   |      |    |     |   |  |    |     |  
|------------------------- | ----- | ------------------- | -- | ---- | - | ---- | -- | --- | - |  | -- | --- | -
|                          |       |                    
|                          |       | Percentage of      
|                          |       | Revenues           
|                          |       | For the Years Ended
|                          |       | December 31,       
|                          |       |                    
|                          |       | 2003                |    | 2002 |   | 2001
|                          |       |                     |    |      |   |     
|Network Signaling         |       |                     | 82 | %    |   |      | 85 | %   |   |  | 85 | %  
|Contact Center            |       |                     | 14 |      |   |      | 15 |     |   |  | 15 |    
|Next-Generation Switching |       |                     | 4  |      |   |      |   |     |   |  |   |    
|                          |       |                     |    |      |   |      |    |     |   |  |    |    
|                          | Total |                     |    | 100  | % |      |    | 100 | % |  |    | 100 | %
|                          |       |                     |    |      |   |      |    |     |   |  |    |    

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The following table sets forth, for the periods
indicated, the revenues by geographic territory as a percentage
of total revenues:

|              |       |                     |    |      |   |      |    |     |   |  |    |     |  
|------------- | ----- | ------------------- | -- | ---- | - | ---- | -- | --- | - |  | -- | --- | -
|              |       |                    
|              |       | Percentage of      
|              |       | Revenues           
|              |       | For the Years Ended
|              |       | December 31,       
|              |       |                    
|              |       | 2003                |    | 2002 |   | 2001
|              |       |                     |    |      |   |     
|North America |       |                     | 83 | %    |   |      | 82 | %   |   |  | 83 | %  
|Europe        |       |                     | 6  |      |   |      | 10 |     |   |  | 4  |    
|Rest of World |       |                     | 11 |      |   |      | 8  |     |   |  | 13 |    
|              |       |                     |    |      |   |      |    |     |   |  |    |    
|              | Total |                     |    | 100  | % |      |    | 100 | % |  |    | 100 | %
|              |       |                     |    |      |   |      |    |     |   |  |    |    



| |                        
| | -----------------------
| | 2003 Compared with 2002

Revenues.Our
revenues increased by $3.4 million, or 1%, during 2003 due
to the addition of sales from our next-generation switching
products partially offset with lower sales in both our network
signaling and contact center operation segments.

Revenues from network signaling products
decreased by $5.1 million, or 2%, due primarily to lower
sales of Eagle STP products, partially offset by higher
revenues from upgrades, extension sales and revenues from
service agreements. Eagle STP product sales decreased in
2003 as a result of customers increasing the capacity of their
existing STP nodes by purchasing extensions rather than initial
systems.

Revenues from contact center products decreased
by $3.0 million, or 8%, primarily as a result of decreased
sales of the TotalView product. The decrease in the revenues was
attributable primarily to a reduction in information technology
capital spending and increasing competition in the industry.

Revenues from next-generation switching products
for 2003 were $11.5 million, reflecting the addition of
sales of next-generation products following the June 2003
acquisition of a majority interest in Santera. (See
Note B  Acquisition of Majority Interest in
Santera)

Revenues in North America increased by
$4.1 million, or 2%, due primarily to increased revenues
from upgrades, extension sales and revenues from service
agreements. Revenues in Europe decreased by $9.7 million,
or 37%, due primarily to weaker sales of Eagle STP products.
Rest of world revenues increased by $9.0 million or 46% due
primarily to higher sales of Eagle STP products.

We believe that our future revenue growth depends
in large part upon a number of factors, including the continued
market acceptance, both domestically and internationally, of our
products, particularly the Eagle products and related
applications as well as our suite of products for converged
circuit and packet networks.

Gross Profit.Gross
profit as a percentage of revenues increased to 73.5% in 2003
compared with 70.5% in 2002. The increase in gross margins was
due primarily to a higher proportion of sales of Eagle STP
upgrades and extensions and service agreements, which typically
carry higher margins. Changes in the following factors, among
others, may affect gross profit: product and distribution
channel mix; competition; customer discounts; supply and demand
conditions in the electronic components industry; internal
manufacturing capabilities and efficiencies; foreign currency
fluctuations; pricing pressure as we expand internationally; and
general economic conditions.

Research and
Development.Research and development
expenses increased overall by $13.6 million, or 22.7%, and
increased as a percentage of revenues to 27.8% in 2003 from
22.9% in 2002. These increases were due primarily to an increase
in salary and related expenses attributable to the hiring of
additional personnel and our acquisition of a majority interest
in Santera (See Note B  Acquisition of a
Majority Interest in Santera).

We intend to continue to make substantial
investments in product and technology development, and we
believe that our future success depends in a large part upon our
ability to continue to enhance existing products and to develop
or acquire new products that maintain our technological
competitiveness.

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Selling, General and Administrative
Expenses.Selling, general and
administrative expenses increased by $8.3 million, or 8.6%,
and increased as a percentage of revenues to 39.6% in 2003 from
36.9% in 2002. The increases were due primarily to our
acquisition of a majority interest in Santera (See
Note B  Acquisition of a Majority Interest in
Santera) and secondarily to an increase in facility costs and
consulting services related to Santera integration activities.

Acquired In-Process Research and
Development.Acquired in-process
research and development expense (IPRD) of
$2.9 million in 2003 represents the write-off in the second
quarter of acquired in-process research and development related
to the Santera acquisition. IPRD was valued using a discounted
cash flow approach commonly known as the excess
earnings approach. (See Note B 
Acquisition of Majority Interest in Santera).

Amortization of Intangible
Assets.Amortization of intangible
assets in 2003 increased by $300,000 to $1.9 million. This
increase was due to the increase in intangible assets related to
our acquisition of a majority interest in Santera (See
Note B  Acquisition of a Majority Interest in
Santera).

Interest and Other Income (Expense),
net.Interest expense decreased by
$373,000, or 4%, due primarily to the June 2003 issuance of our
new convertible debt which carries an interest rate of 2.25%
compared to the former convertible debt interest rate of 6.75%.
The former convertible debt was redeemed in July 2003. Interest
income decreased to $426,000, or 6%, due to lower interest rates
in 2003 compared to 2002.

Provision for Income
Taxes.Provisions for income taxes for
2003 and 2002 were $13.6 million and $8.1 million,
respectively, and reflected the effect of non-deductible
acquisition-related costs and amortization, partially offset by
a benefit of $3.1 million and $4.2 million,
respectively, from the utilization of deferred tax liabilities
related to certain of these acquisition-related costs. Our
provision for income taxes does not include any benefit from the
losses generated by Santera due to the following: Santeras
losses cannot be included on our consolidated federal tax return
because our ownership interest in Santera does not meet the
threshold to consolidate under income tax rules and regulations;
and a full valuation allowance has been established against
Santeras deferred tax assets due to uncertainties
surrounding the timing and realization of the benefits from
Santeras tax attributes in future tax returns. Our
effective tax rate was 151.7% for 2003 and 33.8% for 2002 and
includes 117.7% in 2003 and (1.2)% in 2002 relating to
acquisition related items and the results of Santera in 2003.
Excluding the effect of these acquisition-related items and the
operating results of Santera, our effective tax rate was 34% and
35% in 2003 and 2002, respectively and represented federal,
state and foreign taxes on our income, reduced primarily by
research and development credits, foreign tax credits and other
benefits from foreign sourced income. We expect that our
effective tax rate, excluding the effect of acquisition-related
items and the operating results of Santera, will remain
relatively consistent with and within the range of the effective
tax rates in prior years. Changes in the tax rate can be
affected by changes in the mix of international sales and
changes in the amount of the research and development and other
credits.

Minority Interest.Minority interest represents the losses of Santera allocable to
Santeras minority shareholders. The net income and losses
of Santera are allocated between Tekelec and the minority
interest based on their relative interests in the equity of
Santera and the related liquidation preferences. This approach
requires net losses to be allocated first to the Series A
Preferred Stock until fully absorbed and then to the
Series B Preferred Stock. Subsequent net income will be
allocated first to the Series B Preferred Stock to the
extent of previously recognized net losses allocated to
Series B Preferred Stock. Additional net income will then
be allocated to the Series A Preferred Stock to the extent
of previously recognized losses allocated to Series A
Preferred Stock and then to Common Stock in proportion to their
relative ownership interests in the equity of Santera. The loss
allocated to minority interest of Santera for the period of
June 10, 2003 through December 31, 2003 was computed
as follows (dollars in thousands):

|                                                                                                                      |  |   |        | 
|--------------------------------------------------------------------------------------------------------------------- |  | - | ------ | 
|Santera net loss (includes amortization of
    intangibles and IPRD charges of $4,069 and $2,900, respectively)       |  | $ | 31,922 | 
|Percentage of losses attributable to the minority
    interest based on capital structure and liquidation preferences |  |   | 62%    | 
|                                                                                                                      |  |   |        | 
|Net loss allocated to minority interest                                                                               |  | $ | 19,792 | 
|                                                                                                                      |  |   |        | 

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Loss from Discontinued
Operation.There was no income or loss
recorded in 2003 relating to our discontinued operation compared
to a loss from discontinued operation of $3.3 million for
2002.

Gain on Disposal of Discontinued
Operation.Gain on disposal of our
discontinued operation represents the gain recognized, net of
income taxes, on the sale of the Network Diagnostics Division
sold in August 2002 as discussed above in the
Overview section. In 2003, we recognized a gain of
$3.3 million as a result of the final resolution of
contingencies under the sale agreement.



| |                        
| | -----------------------
| | 2002 Compared with 2001

Revenues.Our
revenues increased by $11 million, or 4%, during 2002 due
primarily to higher sales of network signaling products and
services.

Revenues from network signaling products
increased by $10.4 million, or 5%, due primarily to higher
sales of Eagle STP products and secondarily to higher sales of
Sentinel products.

Revenues from contact center products increased
by $618,000, or 2%, primarily as a result of increased sales of
the TotalView product.

Revenues in North America increased by
$6.9 million, or 3%, due primarily to increased sales of
Sentinel and Eagle services. Revenues in Europe increased by
$16.3 million, or 164%, due primarily to stronger sales of
Eagle STP products. Rest of world revenues decreased by
$12.2 million or 39% due primarily to lower sales of Eagle
STP products.

Gross Profit.Gross
profit as a percentage of revenues increased to 70.5% in 2002
compared with 65.2% in 2001. The increase in gross margins was
due primarily to a higher proportion of sales of Eagle STP
upgrades and extensions and service agreements, which typically
carry higher margins.

Research and
Development.Research and development
expenses increased overall by $5.3 million, or 9.7%, and
increased slightly as a percentage of revenues to 22.9% in 2002
from 21.9% in 2001. The dollar increase was due primarily to an
increase in variable compensation expense.

Selling, General and Administrative
Expenses.Selling, general and
administrative expenses increased by $9.4 million, or 11%,
and increased as a percentage of revenues to 36.9% in 2002 from
34.7% in 2001. The dollar increase was due primarily to an
increase in compensation costs, including a $5.9 million
charge for the accrual of retirement benefits for our former
Chief Executive Officer who retired in February 2003, comprised
of a $5.3 million non-cash stock-based compensation charge
for the modification of certain stock option awards to allow for
the extension of the exercise period upon qualified retirement
from 90 days to the remaining contracted term of the
options, a $300,000 one-time cash severance payment and $304,000
for post-retirement health benefits.

Amortization of Goodwill and Other Intangible
Assets.Amortization of goodwill and
intangible assets in 2002 decreased by $20.0 million to
$1.6 million. This decrease was due to the adoption of
SFAS No. 142 on January 1, 2002, which no longer
permits the amortization of acquisition-related goodwill.

Interest and Other Income (Expense),
net.Interest expense increased by
$246,000, or 2.7%, in 2002 compared to 2001. Interest income
decreased $2.2 million, or 24.7%, due to lower interest
rates in 2002 compared to 2001.

Provision for Income
Taxes.Provisions for income taxes for
2002 and 2001 were $8.1 million and $6.1 million,
respectively, and reflected the effect of non-deductible
acquisition-related costs and amortization, partially offset by
a benefit of $4.2 million and $4.6 million,
respectively, from the utilization of deferred tax liabilities
related to certain of these acquisition-related costs. Our
effective tax rates in 2002 and 2001 was 33.8% and (1,254.5)%,
respectively, which includes (1.2)% and (1,289.5)% in 2002 and
2001, respectively, relating to these acquisition related items.
Excluding the effect of these acquisition-related items, our
effective tax rate was 35% in 2002 and 2001 and represented
federal, state and foreign taxes on our income, reduced
primarily by research and development credits, foreign tax
credits and other benefits from foreign sourced income.

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Loss from Discontinued
Operation.Loss from our discontinued
operation increased to $3.3 million for 2002 compared to a
loss from discontinued operation of $289,000 for 2001. The
increased loss was a result of reduced sales and operating
results for our Network Diagnostics Division sold in August 2002.

Gain on Disposal of Discontinued
Operation.Gain on disposal of our
discontinued operation represents the gain recognized, net of
income taxes, on the sale of the Network Diagnostics Division
sold in August 2002 as discussed above in the
Overview section.



| |                                    
| | -----------------------------------
| | Liquidity and Capital
    Resources

During 2003, cash and cash equivalents decreased
by $76.4 million to $45.3 million. Operating
activities, net of the effects of exchange rate changes on cash,
provided $27.7 million, compared to $46.5 million in
2002 and $89.2 million in 2001 primarily as a result of
changes in working capital. Cash flows from operating activities
were comprised mainly of net income adjusted for minority
interest, the gain on the sale of our Network Diagnostics
Division, depreciation and amortization, and an increase in
deferred revenue. Deferred revenue increased by 43% during 2003
due primarily to an increase in revenue not recognizable for
transactions that had not completed acceptance or delivery
requirements. Financing activities, which represented both
retirement and issuance of convertible debt and proceeds from
the issuance of common stock upon the exercise of options, used
$3.4 million in 2003 compared to $3.9 million provided
in 2002 and $12.8 million provided in 2001 related to
proceeds from the issuance of common stock. Investing activities
used $100.7 million and was comprised primarily of
$105.3 million for net purchases of short-term and
long-term investments and $6.5 million for capital
expenditures in 2003. Cash used in investing activities in 2002
was $17.9 million and included $37.8 million of
proceeds from the sale of NDD offset by net purchases of
investments of $49.4 million. Cash used in investing
activities in 2001 was $81.0 million and included net
purchases of investments of $45.1 million and
$16.5 million paid for the investments in private companies
and $18.9 million paid for property and equipment
representing the planned addition of equipment principally for
research and development and manufacturing operations.

We have a $20.0 million line of credit with
a U.S. bank. Our $20.0 million credit facility bears
interest at or, in some cases, below the lenders prime
rate (4.0% at December 31, 2003) and expires on
August 31, 2004, if not renewed. Under the terms of this
credit facility, we are required to maintain certain financial
ratios and meet certain net worth and indebtedness covenants. We
believe we are in compliance with these requirements. There have
been no borrowings under this credit facility.

As a result of the Santera transaction (see note
B  Acquisition of Majority Interest in Santera), we
have two notes payable to U.S. financial institutions. One
of the notes has an outstanding balance of $3.2 million and
is secured by the assets purchased under the note, bears
interest at 10% and matures in February 2005. The second note
for $3.3 million is secured by the assets purchased under
the note and substantially all of Santeras assets,
excluding the assets secured under the $3.2 million note,
bears interest at 6.36% and matures in November 2005. Under the
terms of this facility, we are required to maintain certain
financial reporting covenants. We believe we are in compliance
with these requirements.

On February 25, 2004, we announced that we
entered into a definitive agreement to purchase Taqua, Inc., a
privately-held provider of next-generation Class 5 packet
switching systems. Upon the closing of this transaction, we will
purchase all of Taquas outstanding stock, for
approximately $85 million cash, plus assume outstanding
options. The purchase is expected to close no later than April
2004.

In November 1999, we completed the private
placement of $135.0 million principal amount at maturity of
3.25% convertible subordinated discounted notes due in
2004, issued at 85.35% of their face amount (equivalent to gross
proceeds of approximately $115.2 million at issuance before
discounts and expenses). The discounted notes were called and
subsequently redeemed in July 2003.

In June 2003, we completed the private placement
of $125.0 million principal amount of 2.25% Senior
Subordinated Convertible Notes (Notes) due in 2008.
The Notes are convertible into 50.8906 shares of

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common stock per $1,000 principal amount, subject
to certain adjustments, on their final maturity. There are no
financial covenants related to the notes and there are no
restrictions on us paying dividends, incurring debt or issuing
or repurchasing securities.


We believe that existing working capital, funds
generated through operations, and our current bank credit
facility will be sufficient to satisfy operating requirements
for at least the next twelve months. Nonetheless, we may seek
additional sources of capital as necessary or appropriate to
fund acquisitions or to otherwise finance our growth or
operations; however, there can be no assurance that such funds,
if needed, will be available on favorable terms, if at all.



| |                        
| | -----------------------
| | Contractual Obligations

The following table summarizes our contractual
obligations at December 31, 2003, and the effect such
obligations are expected to have on our liquidity and cash flows
in future periods.

|                            |  |                |         |             |  |           |        |           |  |             |        |  |  |   |         |  |  |   |        | 
|--------------------------- |  | -------------- | ------- | ----------- |  | --------- | ------ | --------- |  | ----------- | ------ |  |  | - | ------- |  |  | - | ------ | 
|                            |  |                |         | Less than 1 |  |           |        |           |  | More than 5
|                            |  | Total          |         | Year        |  | 1-3 Years |        | 3-5 Years |  | Years      
|                            |  |                |         |             |  |           |        |           |  |            
|                            |  |               
|                            |  | (In thousands)
|Notes Payable               |  | $              | 6,508   |             |  | $         | 3,934  |           |  | $           | 2,574  |  |  | $ |        |  |  | $ |       | 
|Long-term convertible debt  |  |                | 125,000 |             |  |           |       |           |  |             |       |  |  |   | 125,000 |  |  |   |       | 
|Operating lease obligations |  |                | 47,014  |             |  |           | 8,365  |           |  |             | 12,263 |  |  |   | 11,779  |  |  |   | 14,607 | 
|Purchase obligations(1)     |  |                |        |             |  |           |       |           |  |             |       |  |  |   |        |  |  |   |       | 
|                            |  |                |         |             |  |           |        |           |  |             |        |  |  |   |         |  |  |   |        | 
|Total                       |  | $              | 178,522 |             |  | $         | 12,299 |           |  | $           | 14,837 |  |  | $ | 136,779 |  |  | $ | 14,607 | 
|                            |  |                |         |             |  |           |        |           |  |             |        |  |  |   |         |  |  |   |        | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | From time to time in the normal course of
    business we may enter into purchasing agreements with our
    suppliers that require us to accept delivery of, and remit full
    payment for, finished products that we have ordered, finished
    products that we requested be held as safety stock, and work in
    process started on our behalf in the event we cancel or
    terminate the purchasing agreement. It is not our intent, nor is
    it reasonable likely, that we would cancel a purchase order
    which we have executed. Because these agreements do not specify
    fixed or minimum quantities, do not specify minimum or variable
    price provisions, and do not specify the approximate timing of
    the transaction, we have no basis to estimate any future
    liability.



| |               
| | --------------
| | Financial Risk

We conduct business in a number of foreign
countries, with certain transactions denominated in local
currencies. In certain instances where we have entered into
contracts that are denominated in foreign currencies, we have
obtained foreign currency forward contracts, principally
denominated in Euros or British Pounds, to offset the impact of
currency rate fluctuations on accounts receivable. These
contracts are used to reduce our risk associated with exchange
rate movements, as gains and losses on these contracts are
intended to offset exchange losses and gains on underlying
exposures. Changes in the fair value of these forward contracts
are recorded immediately in earnings.

As of December 31, 2003, we had one foreign
currency forward contract outstanding to sell approximately
1,700,000 Euros in order to hedge certain receivables
denominated in that currency. This contract had an expiration
date of January 7, 2004 and did not meet specific hedge
accounting requirements. We had no forward or option contracts
outstanding as of December 31, 2002.

We do not enter into derivative instrument
transactions for trading or speculative purposes. The purpose of
our foreign currency management policy is to minimize the effect
of exchange rate fluctuations on certain foreign denominated
anticipated cash flows. The terms of currency instruments used
for hedging purposes are consistent with the timing of the
transactions being hedged. We may continue to use foreign
currency forward contracts to manage foreign currency exchange
risks in the future.

38



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Fixed income securities are subject to interest
rate risk. The fair value of our investment portfolio would not
be significantly impacted by either a 100 basis point
increase or decrease in interest rates due mainly to the
short-term nature of the major portion of our investment
portfolio. The portfolio is diversified and consists primarily
of investment grade securities to minimize credit risk.

There have been no borrowings under our variable
rate credit facilities. All of our outstanding long-term debt is
fixed rate and not subject to interest rate fluctuations.

With respect to trade receivables, we design,
manufacture, market and support network signaling products and
selected service applications for telecommunications networks
and contact centers. Our customers include telecommunications
carriers, network providers, and contact center operators.
Credit is extended based on an evaluation of each
customers financial condition, and generally collateral is
not required. Generally, payment terms stipulate payment within
90 days of shipment and currently, we do not engage in
leasing or other customer financing arrangements. Many of our
international sales are secured with import insurance or letters
of credit to mitigate credit risk. Although we have processes in
place to monitor and mitigate credit risk, there can be no
assurance that such programs will be effective in eliminating
such risk. Historically, credit losses have been within
managements expectations. Our exposure to credit risk has
increased as a result of weakened financial conditions in
certain market segments such as the competitive local exchange
carrier segment. Credit losses for such customers have been
provided for in the financial statements. Future losses, if
incurred, could harm our business and have a material adverse
effect on our financial position, results of operations or cash
flows.



| |                                     
| | ------------------------------------
| | Recent Accounting
    Pronouncements

In January 2003, FASB issued Interpretation
(FIN) No. 46, Consolidation of Variable
Interest Entities  an Interpretation of ARB
No. 51. The Interpretation clarified the application
of Accounting Research Bulletin No. 51, Consolidated
Financial Statements, to certain entities in which equity
investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional
subordinated financial support from other parties. The
provisions of this Interpretation are effective for all
enterprises with variable interest entities created after
January 31, 2003. On October 8, 2003, the FASB
deferred the implementation date of Interpretation No. 46
from the third quarter of 2003 to the fourth quarter of 2003.
The adoption of Interpretation No. 46 did not have a
material impact on our financial position, results of
operations, or cash flows.

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

In April 2003, the FASB issued Statement of
Financial Accounting Standard (SFAS) No. 149,
Amendment of Statement 133 on Derivative Instruments and
Hedging Activities. SFAS No. 149 amends and
clarifies the accounting guidance on derivative instruments
(including certain derivative instruments embedded in other
contracts) and hedging activities that fall within the scope of
SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities. SFAS No. 149 is effective for
all contracts entered into or modified after June 30, 2003,
with certain exceptions, and for hedging relationships
designated after June 30, 2003. The guidance is to be
applied prospectively. The adoption of SFAS No. 149
did not have a material impact on our financial position,
results of operations or cash flows.

In May 2003, the FASB issued
SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and
Equity. SFAS No. 150 changes the accounting for
certain financial instruments that under previous guidance could
be classified as equity, or mezzanine equity, by now

39



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##### Table of Contents



requiring those instruments to be classified as
liabilities in the statement of financial position. Further,
SFAS No. 150 requires disclosure regarding the terms
of those instruments and settlement alternatives. SFAS No.
150 is generally effective for all financial instruments entered
into or modified after May 31, 2003, and was otherwise
effective at the beginning of the first interim period beginning
after June 15, 2003. The adoption of SFAS No. 150
did not have a material impact on our financial position,
results of operations, or cash flows.


In December 2003, the Securities and Exchange
Commission (SEC) issued Staff Accounting Bulletin
(SAB) No. 104. This staff accounting bulletin
revises or rescinds certain sections of SAB 101, which
gives interpretation guidance about revenue recognition.
SAB 104 makes this interpretive guidance of SAB 101
consistent with current authoritative accounting and auditing
guidance and SEC rules and regulations. The adoption of
SAB 104 in December 2003 did not have a material impact on
our financial position, results of operations or cash flows.

Effective the first quarter of 2003, we adopted
EITF No. 02-16, Accounting by a Customer (including a
Reseller) for Certain Consideration Received from a
Vendor. EITF No. 02-16 addresses how a retailer
should account for vendor credits and cash consideration
received from a vendor. Adoption of the provisions of EITF
No. 02-16 did not have a material impact on our financial
position, results of operations or cash flows.

In November 2003, the EITF reached a consensus on
Issue No. 03-10, Application of EITF 02-16 by
Resellers to Sales Incentives Offered to Consumers by
Manufacturers. EITF No. 03-10 addresses the accounting for
manufacturer sales incentives offered directly to consumers,
including manufacturer coupons. EITF No. 03-10 is effective
for the first interim period beginning after November 25,
2003. Adoption of the provisions of EITF No. 03-10 will not
have a material impact on our financial position, results of
operations or cash flows.






| |                                                                             
| | ----------------------------------------------------------------------------
| | Item 7A.     Quantitative
    and Qualitative Disclosures About Market Risk.

We conduct business in a number of foreign
countries, with certain transactions denominated in local
currencies. In certain instances where we have entered into
contracts that are denominated in foreign currencies, we have
obtained foreign currency forward contracts, principally
denominated in Euros or British Pounds, to offset the impact of
currency rates on accounts receivable. These contracts are used
to reduce our risk associated with exchange rate movements, as
gains and losses on these contracts are intended to offset
exchange losses and gains on underlying exposures. Changes in
the fair value of these forward contracts are recorded
immediately in earnings.

As of December 31, 2003, we had one foreign
currency forward contract outstanding to sell approximately
1,700,000 Euros in order to hedge certain receivables
denominated in that currency. This contract had an expiration
date of January 7, 2004 and did not meet specific hedge
accounting requirements. We had no forward or option contracts
outstanding as of December 31, 2002.

We do not enter into derivative instrument
transactions for trading or speculative purposes. The purpose of
our foreign currency management policy is to minimize the effect
of exchange rate fluctuations on certain foreign denominated
anticipated cash flows. The terms of currency instruments used
for hedging purposes are consistent with the timing of the
transactions being hedged. We may continue to use foreign
currency forward contracts to manage foreign currency exchange
risks in the future.

Fixed income securities are subject to interest
rate risk. The fair value of our investment portfolio would not
be significantly impacted by either a 100 basis point
increase or decrease in interest rates due mainly to the
short-term nature of the major portion of our investment
portfolio. The portfolio is diversified and consists primarily
of investment grade securities to minimize credit risk.

There have been no borrowings under our variable
rate credit facilities. All of our outstanding long-term debt is
fixed rate and not subject to interest rate fluctuation. The
fair value of the long-term debt will increase or decrease as
interest rates decrease or increase, respectively.

40



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##### Table of Contents








|        |                                                 
|------- | ------------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data.

See the consolidated financial statements of
Tekelec and our subsidiaries included herein and listed in
Item 15(a) of this Annual Report on Form 10-K.






|        |                                                                                              
|------- | ---------------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with
    Accountants on Accounting and Financial
    Disclosure.

None.






|         |                             
|-------- | ----------------------------
|Item 9A. | Controls and
    Procedures.



|    |                                                     
|--- | ----------------------------------------------------
|(a) | Evaluation of Disclosure Controls and
    Procedures

As required by Rule 13a-15(b) under the
Exchange Act, we carried out an evaluation, under the
supervision and with the participation of our management,
including our President and Chief Executive Officer and our
Chief Financial Officer, of the effectiveness, as of the end of
the period covered by this report, of the design and operation
of our disclosure controls and procedures as defined
in Exchange Act Rule 13a-14 promulgated by the SEC under
the Exchange Act. Based upon that evaluation, our President and
Chief Executive Officer and our Chief Financial Officer
concluded that our disclosure controls and procedures, as of the
end of such period, were adequate and effective to ensure that
information required to be disclosed by us in the reports that
we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in SEC
rules and forms.



|    |                             
|--- | ----------------------------
|(b) | Changes in Internal Controls

There have not been any significant changes in
our internal controls over financial reporting or in other
factors that could significantly affect our internal controls
over financial reporting subsequent to the date of the
evaluation referred to above.




PART III






|         |                                                        
|-------- | -------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant.

Certain information required by this Item is
incorporated by reference to the sections of our definitive
Proxy Statement for the 2004 Annual Meeting of Shareholders to
be held on May 14, 2004, entitled Election of
Directors, Executive Officers and
Section 16(a) Beneficial Ownership Reporting
Compliance to be filed with the Commission. The Proxy
Statement will be filed within 120 days after the date of
our fiscal year-end of December 31, 2003. We have adopted a
Code of Ethics that applies to our Chief Executive Officer,
Chief Financial Officer, and Controller and the Chief Financial
Officer of Santera. A copy of the Code of Ethics is attached as
Exhibit 14.1 to this Annual Report on Form 10-K.






|         |                        
|-------- | -----------------------
|Item 11. | Executive Compensation.

The information required by this Item is
incorporated by reference to the sections of our definitive
Proxy Statement for the 2004 Annual Meeting of Shareholders to
be held on May 14, 2004, entitled Election of
Directors  Compensation of Directors,
Executive Compensation and Other Information,
Board of Directors and Compensation Committee Reports on
Executive Compensation and Performance Graph,
to be filed with the Commission. The Proxy Statement will be
filed within 120 days after the date of our fiscal year-end
of December 31, 2003.






|         |                                                                                                        
|-------- | -------------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder
    Matters.

The information required by this Item is
incorporated by reference to the section of our definitive Proxy
Statement for the 2004 Annual Meeting of Shareholders to be held
on May 14, 2004, entitled Common Stock Ownership of
Principal Shareholders and Management, to be filed with
the Commission. The Proxy Statement will be filed within
120 days after the date of our fiscal year-end of
December 31, 2003.

41



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##### Table of Contents



The equity compensation plan information required
to be provided in this Annual Report on Form 10-K is
incorporated by reference to the section of our definitive Proxy
Statement for the Annual Meeting of Shareholders to be held on
May 14, 2004, entitled Executive Compensation and
Other Information  Equity Compensation Plan
Information, to be filed with the Commission.






|         |                                                    
|-------- | ---------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions.

The information required by this Item is
incorporated by reference to the section of our definitive Proxy
Statement for the 2004 Annual Meeting of Shareholders to be held
on May 14, 2004, entitled Certain Relationships and
Related Transactions, to be filed with the Commission. The
Proxy Statement will be filed within 120 days after the
date of our fiscal year-end of December 31, 2003.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accounting Fees and
    Services

The information required by this Item is
incorporated by reference to the section of our definitive Proxy
Statement for the 2004 Annual Meeting of Shareholders to be held
on May 14, 2004, entitled Principal Accounting Fees
and Services. The Proxy Statement will be filed within
120 days after the date of our fiscal year-end of
December 31, 2003.




PART IV






|         |                                                                      
|-------- | ---------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules,
    and Reports on Form 8-K.

(a) The following documents are filed as
part of this Report:

1.Consolidated
Financial Statements

|                                                                                                                                 |                                            |      |     |     | 
|-------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ---- | --- | --- | 
|                                                                                                                                 |                                            | Page
|                                                                                                                                 |                                            |     
|Report of Independent Auditors                                                                                                   |                                            |      | F-1 |    
|Consolidated Statements of Operations for each of
    the three years in the period ended December 31, 2003                      |                                            |      | F-2 |    
|Consolidated Balance Sheets as of
    December 31, 2003 and 2002                                                                 |                                            |      | F-3 |    
|Consolidated Statements of Cash Flows for each of
    the three years in the period ended December 31, 2003                      |                                            |      | F-4 |    
|Consolidated Statements of Shareholders
    Equity for each of the three years in the period ended
    December 31, 2003        |                                            |      | F-5 |    
|Consolidated Statements of Comprehensive Income
    (Loss) for each of the three years in the period ended
    December 31, 2003 |                                            |      | F-6 |    
|                                                                                                                                 | Notes to Consolidated Financial Statements |      |     | F-7 | 

2.Consolidated
Financial Statement Schedule

|                                                                                                                                     |  |  |     | 
|------------------------------------------------------------------------------------------------------------------------------------ |  |  | --- | 
|Report of Independent Auditors on Financial
    Statement Schedule                                                                   |  |  | S-1 | 
|Schedule II Valuation and Qualifying
    Accounts and Reserves for each of the three years in the period
    ended December 31, 2003 |  |  | S-2 | 

Schedules that are not listed above have been
omitted because they are not applicable or the information
required to be set forth therein is included in the consolidated
financial statements or notes thereto.

3.List of
Exhibits

|        |   |         |  |                                                                                                                                
|------- | - | ------- |  | -------------------------------------------------------------------------------------------------------------------------------
|Exhibit |   |        
|Number  |   | Exhibit
|        |   |        
|        | 2 | .1      |  | Registration Rights Agreement dated July 15,
    2002 between the Registrant and Catapult Communications
    Corporation(1)    
|        | 2 | .2      |  | Subordinated Guaranty dated July 15, 2002
    executed by Catapult Communications Corporation in favor of the
    Registrant(1)

42



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##### Table of Contents



|        |    |         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|------- | -- | ------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |        
|Number  |    | Exhibit
|        |    |        
|        | 2  | .3      |  | Convertible Subordinated Promissory Note due
    2004, dated August 30, 2002, in the principal amount of
    $10,000,000, issued by Catapult Communications International
    Limited to the Registrant(2)                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        | 2  | .4      |  | Convertible Subordinated Promissory Note due
    2004, dated August 30, 2002, in the principal amount of
    $7,300,000 issued by Catapult Communications International
    Limited to the Registrant(2)                                                                                                                                                                                                                                                                                                                                                                                                                                             
|        | 2  | .5      |  | Agreement and Plan of Merger dated April 30,
    2003 by and among Tekelec, Luke Acquisition Corp., Certain
    Stockholders of Santera Systems Inc., Santera Systems Inc. and
    Austin Ventures VI, L.P., as the Representative, including form
    of Certificate of Merger and of Amended and Restated Certificate
    of Incorporation of Santera Systems Inc. (schedules and certain
    exhibits are omitted from this agreement and from the other
    agreements filed herewith as Exhibits 2.6, 2.7 and 2.8, and
    Tekelec agrees to furnish supplementally a copy of any such
    schedule or exhibit to the Commission upon request(3)
|        | 2  | .6      |  | Escrow Agreement dated as of April 30, 2003
    by and among Tekelec, Santera Systems, Inc., Certain
    Stockholders of Santera Systems Inc., Austin Ventures VI,
    L.P., as the Representative, and J.P. Morgan Trust Company,
    National Association, as Escrow Agent(3)                                                                                                                                                                                                                                                                                                                                                                      
|        | 2  | .7      |  | Stockholders Agreement dated as of April 30,
    2003 between Tekelec and Santera Systems Inc.(3)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|        | 2  | .8      |  | Registration Rights Agreement dated as of
    April 30, 2003 by and among Tekelec, Santera Systems Inc.,
    Certain Stockholders of Santera Systems Inc. and Austin Ventures
    VI, L.P., as the Representative(3)                                                                                                                                                                                                                                                                                                                                                                                                                                 
|        | 2  | .9      |  | Agreement and Plan of Merger dated as of
    February 25, 2004 by and among Tekelec,
    Buckaroo, Inc., Taqua, Inc. and, as representatives of
    the stockholders of Taqua, Inc., Bessemer Venture
    Partners V L.P. and Columbia Capital, L.L.C. (schedules are
    omitted from this agreement, and Tekelec agrees to furnish
    supplementally a copy of any such schedule to the Commission
    upon request)(4)                                                                                                                                                                                                                           
|        | 2  | .10     |  | Indemnification Agreement dated as of
    February 25, 2004 and among Tekelec, Buckaroo, Inc.,
    Taqua, Inc. and certain stockholders of Taqua, Inc.(4)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|        | 3  | .1      |  | Amended and Restated Articles of Incorporation(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|        | 3  | .2      |  | Bylaws, as amended(6), as further amended by
    Amendment No. 1 thereto dated June 27, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|        | 4  | .1      |  | Rights Agreement dated as of August 25, 1997
    between the Registrant and U.S. Stock Transfer Corporation
    as Rights Agent(7)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|        | 4  | .2      |  | Indenture dated as of June 17, 2003 between
    Registrant and Deutsche Bank Trust Company Americas, including
    form of Registrants 2.25% Senior Subordinated Convertible
    Notes due 2008(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        | 4  | .3      |  | Registration Rights Agreement dated as of
    June 17, 2003 between Registrant and Morgan
    Stanley & Co. Incorporated(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|        | 10 | .1      |  | Amended and Restated Non-Employee Director Equity
    Incentive Plan, including form of nonstatutory stock option
    agreement(7), as amended February 21, 1996(9)(10)                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|        | 10 | .2      |  | Form of Indemnification Agreement between the
    Registrant and all directors of the Registrant(9)(11)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|        | 10 | .3      |  | Amended and Restated 1994 Stock Option Plan,
    including form of stock option agreement(12), as amended by
    Amendment 1 thereto dated May 8, 2003(8)(9)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|        | 10 | .4      |  | Lease Agreement dated as of February 8, 1988
    between the Registrant and State Street Bank and Trust Company
    of California, N.A., not individually, but solely as an
    Ancillary Trustee for State Street Bank and Trust Company, a
    Massachusetts banking corporation, not individually, but solely
    as Trustee for the AT&T Master Pension Trust, covering our
    principal facilities in Calabasas, California(13)                                                                                                                                                                                                                
|        | 10 | .5      |  | Officer Severance Plan, including form of
    Employment Separation Agreement(14), as amended March 8,
    1999 (15) and February 4, 2000(9)(16)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

43



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|        |    |         |  |                                                                                                                                                                                                                                                                                                                                                                                                                           
|------- | -- | ------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |        
|Number  |    | Exhibit
|        |    |        
|        | 10 | .6      |  | Amended and Restated Employee Stock Purchase
    Plan, including form of subscription agreement (9)(17), amended
    and restated                                                                                                                                                                                                                                                                                         
|        | 10 | .7      |  | Warrants to purchase shares of the
    Registrants Common Stock and Schedule of
    Warrantholders(9)(18)                                                                                                                                                                                                                                                                                                                
|        | 10 | .8      |  | Lease Agreement dated as of November 6, 1998
    between the Registrant and Weeks Realty, L.P., covering certain
    of the Registrants facilities in Morrisville, North
    Carolina(15) as amended by First Amendment thereto dated
    May 27, 1999, Second Amendment thereto dated
    October 1, 1999, Third Amendment thereto dated
    November 30, 1999, and Fourth Amendment thereto dated
    July 19, 2000(19)
|        | 10 | .9      |  | Loan Agreement dated October 31, 2001
    between the Registrant and Union Bank of California (20), as
    amended by First Amendment thereto dated December 18, 2002
    and by Second Amendment thereto and consent dated as of
    June 9, 2003(8)                                                                                                                                                                     
|        | 10 | .10     |  | Lease Agreement as of July 19, 2000 between
    the Registrant and Duke Construction Limited Partnership
    covering certain of our facilities in Morrisville, North
    Carolina(19)                                                                                                                                                                                                                                    
|        | 10 | .11     |  | Nonstatutory Stock Option Agreement dated
    February 1, 2001 between the Registrant and Frederick
    M. Lax(9)(21)                                                                                                                                                                                                                                                                                                     
|        | 10 | .12     |  | Stock Award Agreement dated February 1, 2001
    between the Registrant and Frederick M. Lax(9)(21)                                                                                                                                                                                                                                                                                                                       
|        | 10 | .13     |  | Non-Employee Director Stock Option Plan,
    including form of stock option agreements(9)(22)                                                                                                                                                                                                                                                                                                                             
|        | 10 | .14     |  | Nonstatutory Stock Option Agreement dated
    January 18, 2002 between the Registrant and Lori
    A. Craven(9)(23)                                                                                                                                                                                                                                                                                                       
|        | 10 | .15     |  | 2003 Stock Option Plan(9)(17)                                                                                                                                                                                                                                                                                                                                                                                             
|        | 10 | .16     |  | Nonstatutory Stock Option Agreement dated
    June 11, 2003 between the Registrant and David Heard(8)(9)                                                                                                                                                                                                                                                                                                                  
|        | 10 | .17     |  | Consulting Agreement dated June 25, 2003
    between Santera Systems Inc. and Martin A. Kaplan(8)(9)                                                                                                                                                                                                                                                                                                                      
|        | 10 | .18     |  | Form of Stock Award Agreement dated as of
    May 23, 2003 between Registrant and each of Jean-Claude
    Asscher, Robert V. Adams, Daniel L. Brenner, Howard Oringer and
    Jon F. Rager (8)(9)                                                                                                                                                                                                                         
|        | 10 | .19     |  | Indemnification Agreement dated as of
    June 27, 2003 between Registrant and Martin A. Kaplan(8)                                                                                                                                                                                                                                                                                                                        
|        | 14 | .1      |  | Code of Ethics for Chief Executive and Senior
    Financial Officers                                                                                                                                                                                                                                                                                                                                                      
|        | 21 | .1      |  | Subsidiaries of the Registrant                                                                                                                                                                                                                                                                                                                                                                                            
|        | 23 | .1      |  | Consent of PricewaterhouseCoopers LLP                                                                                                                                                                                                                                                                                                                                                                                     
|        | 31 | .1      |  | Certification of President and Chief Executive
    Officer of Registrant pursuant to Rule 13a-14(a) under the
    Exchange Act, as adopted pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                  
|        | 31 | .2      |  | Certification of Vice President and Chief
    Financial Officer of Registrant pursuant to Rule 13a-14(a)
    under the Exchange Act, as adopted pursuant to Section 302
    of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                             
|        | 32 | .1      |  | Certification of Chief Executive Officer and
    Chief Financial Officer of Tekelec pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                      



---



| |     |                                                                                                                                                         
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Incorporated by reference to the
    Registrants Quarterly Report on Form 10-Q (File
    No. 0-15135) for the quarter ended June 30, 2002.             
|
| | (2) | Incorporated by reference to the
    Registrants Current Report on Form 8-K (File
    No. 0-15135) filed with the Commission on
    September 16, 2002.
|
| | (3) | Incorporated by reference to the
    Registrants Current Report on Form 8-K (File
    No. 0-15135) filed with the Commission on May 7, 2003.           
|
| | (4) | Incorporated by Registrants Current Report
    on Form 8-K (File No. 0-15135) filed with the
    Commission on March 4, 2004.                          

44



---



##### Table of Contents





| |     |                                                                                                                                                              
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (5) | Incorporated by reference to the
    Registrants Quarterly Report on Form 10-Q (File
    No. 0-15135)for the quarter ended June 30, 1998.                   
|
| | (6) | Incorporated by reference to the
    Registrants Annual Report on Form 10-K (File
    No. 0-15135) for the year ended December 31, 1996.                    
|
| | (7) | Incorporated by reference to the
    Registrants Quarterly Report on Form 10-Q (File
    No. 0-15135) for the quarter ended September 30, 1997.             
|
| | (8) | Incorporated by reference to the
    Registrants Quarterly Report on Form 10-Q (File
    No. 0-15135) for the quarter ended June 30, 2003.                  
|
| | (9) | Constitutes a management contract or compensatory
    plan contract or arrangement required to be filed as an exhibit
    to this Annual Report on Form 10-K.



|     |                                                                                                                                                                                
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Incorporated by reference to the
    Registrants Registration Statement on Form S-8
    (Registration No. 333-05933) filed with the Commission on
    June 13, 1996.          
|    
|(11) | Incorporated by reference to the
    Registrants Annual Report on Form 10-K (File
    No. 0-15135) for the year ended December 31, 1987.                                      
|    
|(12) | Incorporated by reference to the
    Registrants Annual Report on Form 10-K (File
    No. 0-15135) for the year ended December 31, 2002.                                      
|    
|(13) | Incorporated by reference to the
    Registrants Quarterly Report on Form 10-Q (File
    No. 0-15135) for the quarter ended June 30, 1988.                                    
|    
|(14) | Incorporated by reference to the
    Registrants Annual Report on Form 10-K (File
    No. 0-15135) for the year ended December 31, 1993.                                      
|    
|(15) | Incorporated by reference to the
    Registrants Annual Report on Form 10-K (File
    No. 0-15135) for the year ended December 31, 1998.                                      
|    
|(16) | Incorporated by reference to the
    Registrants Annual Report on Form 10-K (File
    No. 0-15135) for the year ended December 31, 1999.                                      
|    
|(17) | Incorporated by reference to the
    Registrants Registration Statement on Form S-8
    (Registration Statement No. 333-105879) filed with the
    Commission on June 5, 2003.
|    
|(18) | Incorporated by reference to the
    Registrants Registration Statement on Form S-8
    (Registration No. 333-37843) filed with the Commission on
    October 14, 1997.       
|    
|(19) | Incorporated by reference to the
    Registrants Annual Report on Form 10-K (File
    No. 0-15135) for the year ended December 31, 2000.                                      
|    
|(20) | Incorporated by reference to the
    Registrants Annual Report on Form 10-K (File
    No. 0-15135) for the year ended December 31, 2001.                                      
|    
|(21) | Incorporated by reference to the
    Registrants Quarterly Report on 10-Q (File
    No. 0-15135) for the quarter ended March 31, 2001.                                        
|    
|(22) | Incorporated by reference to the
    Registrants Registration Statement on Form S-8
    (Registrants No. 333-97793) filed with the Commission
    on August 7, 2002.         
|    
|(23) | Incorporated by reference to the
    Registrants Quarterly Report on 10-Q (File
    No. 0-15135) for the quarter ended March 31, 2002.                                        

(b) Reports on Form 8-K



| |     |                                                                                                                                                                                                                                                                                                                                                                                                             
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | i.  | On October 22, 2003, the Registrant filed a
    Current Report on Form 8-K with the Commission with respect
    to its issuance of a press release announcing the
    Registrants financial results for the quarter ended
    September 30, 2003.                                                                                                                                                          
|
| | ii. | On December 10, 2003, the Registrant filed a
    Current Report on Form 8-K/ A with the Commission that
    amended the Current Report on Form 8-K, filed with the
    Commission on June 11, 2003, as amended by the
    Registrants Form 8-K/ A (Amendment No. 1) filed
    with the Commission on June 25, 2003, and by the
    Registrants Form 8-K/ A (Amendment No. 2) filed
    with the Commission

45



---



##### Table of Contents



| |  |                                                                                                                                                          
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | on September 16, 2003. The Form 8-K/ A
    was filed to provide updated pro forma financial information for
    the nine months ended September 30, 2003.



|    |         
|--- | --------
|(c) | Exhibits

See the list of Exhibits under Item 15(a) 3
of this Annual Report on Form 10-K.



|    |                              
|--- | -----------------------------
|(d) | Financial Statement Schedules

See the Schedule under Item 15(a) 2 of this
Annual Report on Form 10-K.

46



---



##### Table of Contents



SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the Registrant
has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.



| |        
| | -------
| | TEKELEC



| |     |                     
| | --- | --------------------
| | By: | /s/ FREDERICK M. LAX

| |                                          
| | -----------------------------------------
| |                                          
| | Frederick M. Lax                         
| | President and Chief Executive
    Officer

Dated: March 15, 2004

Pursuant to the requirements of the Securities
Act of 1934, this report has been signed below by the following
persons on behalf of the Registrant and in the capacities and on
the dates indicated.

|                                           |  |                                                                                                   |  |                |  | 
|------------------------------------------ |  | ------------------------------------------------------------------------------------------------- |  | -------------- |  | 
|                                           |  |                                                                                                   |  |               
|Signature                                  |  | Title                                                                                             |  | Date          
|                                           |  |                                                                                                   |  |               
|                                          
|/s/ JEAN-CLAUDE ASSCHERJean-Claude Asscher |  | Chairman of the Board                                                                             |  | March 15, 2004
|                                          
|/s/ FREDERICK M. LAXFrederick M. Lax       |  | President, Chief Executive Officer and Director                                                   |  | March 15, 2004
|                                          
|/s/ ROBERT V. ADAMSRobert V. Adams         |  | Director                                                                                          |  | March 15, 2004
|                                          
|/s/ DANIEL L. BRENNERDaniel L. Brenner     |  | Director                                                                                          |  | March 15, 2004
|                                          
|/s/ MARTIN A. KAPLANMartin A. Kaplan       |  | Director                                                                                          |  | March 15, 2004
|                                          
|/s/ HOWARD ORINGERHoward Oringer           |  | Director                                                                                          |  | March 15, 2004
|                                          
|/s/ JON F. RAGERJon F. Rager               |  | Director                                                                                          |  | March 15, 2004
|                                          
|/s/ PAUL J. PUCINOPaul J. Pucino           |  | Vice President and Chief Financial Officer
    (Principal Financial and Chief Accounting Officer) |  | March 15, 2004

47



---



##### Table of Contents



REPORT OF INDEPENDENT AUDITORS

To The Shareholders and Board of Directors of
Tekelec

In our opinion, the accompanying consolidated
balance sheets and the related consolidated statements of
operations, cash flows, shareholders equity, and
comprehensive income (loss) present fairly, in all material
respects, the financial position of Tekelec and its subsidiaries
(the Company) at December 31, 2003 and 2002,
and the results of their operations and their cash flows for
each of the three years in the period ended December 31,
2003, in conformity with accounting principles generally
accepted in the United States of America. These financial
statements are the responsibility of the Companys
management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards
generally accepted in the United States of America which require
that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used
and significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

As discussed in Note A to the consolidated
financial statements, effective January 1, 2002, the
Company adopted Statement of Financial Accounting Standards
No. 142, Goodwill and other Intangible Assets.

/s/ PricewaterhouseCoopers LLP

Los Angeles, California

January 30, 2004


F-1



---



##### Table of Contents



TEKELEC

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                                               |                                                |                                    |         |         |         |      |         |        |         |   |         |        |         |  
|------------------------------------------------------------------------------ | ---------------------------------------------- | ---------------------------------- | ------- | ------- | ------- | ---- | ------- | ------ | ------- | - | ------- | ------ | ------- | -
|                                                                               |                                                |                                   
|                                                                               |                                                | For the Years Ended December 31,  
|                                                                               |                                                |                                   
|                                                                               |                                                | 2003                               |         | 2002    |         | 2001
|                                                                               |                                                |                                    |         |         |         |     
|                                                                               |                                                |                                   
|                                                                               |                                                | (Thousands, except per share data)
|Revenues                                                                       |                                                | $                                  | 263,700 |         |         | $    | 260,341 |        |         | $ | 249,369 |       
|Cost of Sales:                                                                 |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|                                                                               | Cost of goods sold                             |                                    |         | 58,697  |         |      |         | 66,536 |         |   |         | 76,466 |        
|                                                                               | Amortization of purchased technology           |                                    |         | 11,178  |         |      |         | 10,169 |         |   |         | 10,324 |        
|                                                                               |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|                                                                               |                                                | Total cost of sales                |         |         | 69,875  |      |         |        | 76,705  |   |         |        | 86,790  |  
|                                                                               |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|                                                                               |                                                | Gross profit                       |         |         | 193,825 |      |         |        | 183,636 |   |         |        | 162,579 |  
|                                                                               |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|Operating expenses:                                                            |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|                                                                               | Research and development                       |                                    |         | 73,328  |         |      |         | 59,746 |         |   |         | 54,479 |        
|                                                                               | Selling, general and administrative            |                                    |         | 104,247 |         |      |         | 95,973 |         |   |         | 86,592 |        
|                                                                               | Acquired in-process research and development   |                                    |         | 2,900   |         |      |         |       |         |   |         |       |        
|                                                                               | Amortization of goodwill and other intangibles |                                    |         | 1,900   |         |      |         | 1,600  |         |   |         | 21,664 |        
|                                                                               |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|                                                                               |                                                | Total operating expenses           |         |         | 182,375 |      |         |        | 157,319 |   |         |        | 162,735 |  
|                                                                               |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|                                                                               |                                                | Income (Loss) from operations      |         |         | 11,450  |      |         |        | 26,317  |   |         |        | (156    | )
|Interest and other income (expense):                                           |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|                                                                               | Interest income                                |                                    |         | 6,259   |         |      |         | 6,685  |         |   |         | 8,883  |        
|                                                                               | Interest expense                               |                                    |         | (8,828  | )       |      |         | (9,201 | )       |   |         | (8,955 | )      
|                                                                               | Other, net                                     |                                    |         | 86      |         |      |         | 253    |         |   |         | (260   | )      
|                                                                               |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|                                                                               |                                                | Total other expense                |         |         | (2,483  | )    |         |        | (2,263  | ) |         |        | (332    | )
|                                                                               |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|Income (Loss) from continuing operations before
    provision for income taxes |                                                |                                    | 8,967   |         |         |      | 24,054  |        |         |   | (488    | )     
|                                                                               | Provision for income taxes                     |                                    |         | 13,600  |         |      |         | 8,140  |         |   |         | 6,122  |        
|                                                                               |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|Income (Loss) before minority interest                                         |                                                |                                    | (4,633  | )       |         |      | 15,914  |        |         |   | (6,610  | )     
|Minority interest                                                              |                                                |                                    | 19,792  |         |         |      |        |        |         |   |        |       
|                                                                               |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|Income (Loss) from continuing operations                                       |                                                |                                    | 15,159  |         |         |      | 15,914  |        |         |   | (6,610  | )     
|Loss from discontinued operation, net of income
    taxes                      |                                                |                                    |        |         |         |      | (3,308  | )      |         |   | (289    | )     
|Gain on sale of discontinued operation, net of
    income taxes                |                                                |                                    | 3,293   |         |         |      | 28,312  |        |         |   |        |       
|                                                                               |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|                                                                               |                                                | Net income (Loss)                  |         | $       | 18,452  |      |         | $      | 40,918  |   |         | $      | (6,899  | )
|                                                                               |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|Earnings (Loss) per share from continuing
    operations:                      |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|                                                                               | Basic                                          |                                    | $       | 0.25    |         |      | $       | 0.26   |         |   | $       | (0.11  | )      
|                                                                               | Diluted                                        |                                    |         | 0.24    |         |      |         | 0.26   |         |   |         | (0.11  | )      
|Loss per share from discontinued
    operation:                                |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|                                                                               | Basic                                          |                                    | $       |        |         |      | $       | (0.05  | )       |   | $       | (0.01  | )      
|                                                                               | Diluted                                        |                                    |         |        |         |      |         | (0.05  | )       |   |         | (0.01  | )      
|Earnings per share from gain on sale of
    discontinued operation:            |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|                                                                               | Basic                                          |                                    | $       | 0.05    |         |      | $       | 0.47   |         |   | $       |       |        
|                                                                               | Diluted                                        |                                    |         | 0.05    |         |      |         | 0.46   |         |   |         |       |        
|Earnings (Loss) per share:                                                     |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|                                                                               | Basic                                          |                                    | $       | 0.30    |         |      | $       | 0.68   |         |   | $       | (0.12  | )      
|                                                                               | Diluted                                        |                                    |         | 0.29    |         |      |         | 0.67   |         |   |         | (0.12  | )      
|Weighted average number of shares
    outstanding:                             |                                                |                                    |         |         |         |      |         |        |         |   |         |       
|                                                                               | Basic                                          |                                    |         | 61,163  |         |      |         | 60,358 |         |   |         | 59,574 |        
|                                                                               | Diluted                                        |                                    |         | 62,911  |         |      |         | 61,386 |         |   |         | 59,574 |        

See notes to consolidated financial statements

F-2



---



##### Table of Contents



TEKELEC

CONSOLIDATED BALANCE SHEETS

|                                                                      |                                                                                                                                               |                                            |         |         |         |  |         |         |         | 
|--------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------- | ------- | ------- |  | ------- | ------- | ------- | 
|                                                                      |                                                                                                                                               |                                           
|                                                                      |                                                                                                                                               | December 31,                              
|                                                                      |                                                                                                                                               |                                           
|                                                                      |                                                                                                                                               | 2003                                       |         | 2002   
|                                                                      |                                                                                                                                               |                                            |         |        
|                                                                      |                                                                                                                                               |                                           
|                                                                      |                                                                                                                                               | (Thousands, except                        
|                                                                      |                                                                                                                                               | share data)                               
|ASSETS                                                               
|Current assets:                                                       |                                                                                                                                               |                                            |         |         |         |  |         |        
|                                                                      | Cash and cash equivalents                                                                                                                     |                                            | $       | 45,261  |         |  | $       | 121,636 |        
|                                                                      | Short-term investments, at fair value                                                                                                         |                                            |         | 83,800  |         |  |         | 59,936  |        
|                                                                      | Accounts receivable, less allowances of $2,619and $4,860, respectively                                                                        |                                            |         | 52,781  |         |  |         | 44,061  |        
|                                                                      | Convertible notes receivable ($17,300 principal
    amount)                                                                                   |                                            |         | 17,580  |         |  |         |        |        
|                                                                      | Inventories                                                                                                                                   |                                            |         | 21,434  |         |  |         | 10,560  |        
|                                                                      | Deferred income taxes, net                                                                                                                    |                                            |         | 4,958   |         |  |         | 13,806  |        
|                                                                      | Prepaid expenses and other current assets                                                                                                     |                                            |         | 22,088  |         |  |         | 16,491  |        
|                                                                      |                                                                                                                                               |                                            |         |         |         |  |         |        
|                                                                      |                                                                                                                                               | Total current assets                       |         |         | 247,902 |  |         |         | 266,490 | 
|Long-term investments, at fair value                                  |                                                                                                                                               |                                            | 210,298 |         |         |  | 128,258 |        
|Property and equipment, net                                           |                                                                                                                                               |                                            | 22,172  |         |         |  | 21,387  |        
|Investments in privately-held companies                               |                                                                                                                                               |                                            | 17,322  |         |         |  | 16,525  |        
|Deferred income taxes                                                 |                                                                                                                                               |                                            | 7,876   |         |         |  | 11,502  |        
|Other assets                                                          |                                                                                                                                               |                                            | 6,342   |         |         |  | 2,263   |        
|Long-term convertible notes receivable ($17,300
    principal amount) |                                                                                                                                               |                                            |        |         |         |  | 17,987  |        
|Goodwill                                                              |                                                                                                                                               |                                            | 68,903  |         |         |  | 44,942  |        
|Intangible assets, net                                                |                                                                                                                                               |                                            | 34,118  |         |         |  | 16,329  |        
|                                                                      |                                                                                                                                               |                                            |         |         |         |  |         |        
|                                                                      |                                                                                                                                               | Total assets                               |         | $       | 614,933 |  |         | $       | 525,683 | 
|                                                                      |                                                                                                                                               |                                            |         |         |         |  |         |        
|                                                                      |                                                                                                                                               | LIABILITIES AND SHAREHOLDERS
    EQUITY   |         |         |         |  |         |         |         | 
|Current liabilities:                                                  |                                                                                                                                               |                                            |         |         |         |  |         |        
|                                                                      | Trade accounts payable                                                                                                                        |                                            | $       | 8,974   |         |  | $       | 6,674   |        
|                                                                      | Accrued expenses                                                                                                                              |                                            |         | 30,812  |         |  |         | 31,011  |        
|                                                                      | Accrued payroll and related expenses                                                                                                          |                                            |         | 17,967  |         |  |         | 11,360  |        
|                                                                      | Current portion of long-term debt                                                                                                             |                                            |         | 3,934   |         |  |         |        |        
|                                                                      | Current portion of deferred revenues                                                                                                          |                                            |         | 50,105  |         |  |         | 28,355  |        
|                                                                      | Income taxes payable                                                                                                                          |                                            |         | 1,071   |         |  |         | 1,178   |        
|                                                                      |                                                                                                                                               |                                            |         |         |         |  |         |        
|                                                                      |                                                                                                                                               | Total current liabilities                  |         |         | 112,863 |  |         |         | 78,578  | 
|Notes payable                                                         |                                                                                                                                               |                                            | 2,574   |         |         |  |        |        
|Long-term convertible debt                                            |                                                                                                                                               |                                            | 125,000 |         |         |  | 126,973 |        
|Deferred income taxes                                                 |                                                                                                                                               |                                            | 790     |         |         |  | 14,493  |        
|Long-term portion of deferred revenues                                |                                                                                                                                               |                                            | 3,687   |         |         |  | 3,632   |        
|                                                                      |                                                                                                                                               |                                            |         |         |         |  |         |        
|                                                                      |                                                                                                                                               | Total liabilities                          |         |         | 244,914 |  |         |         | 223,676 | 
|                                                                      |                                                                                                                                               |                                            |         |         |         |  |         |        
|Minority interest                                                     |                                                                                                                                               |                                            | 41,208  |         |         |  |        |        
|                                                                      |                                                                                                                                               |                                            |         |         |         |  |         |        
|Commitments and Contingencies
    (Note O)                            |                                                                                                                                               |                                            |         |         |         |  |         |        
|Shareholders equity:                                                 |                                                                                                                                               |                                            |         |         |         |  |         |        
|                                                                      | Common stock, without par value,
    200,000,000 shares authorized; 61,625,518 and
    60,892,730 shares issued and outstanding, respectively |                                            |         | 189,908 |         |  |         | 182,277 |        
|                                                                      | Retained earnings                                                                                                                             |                                            |         | 137,895 |         |  |         | 119,443 |        
|                                                                      | Accumulated other comprehensive income                                                                                                        |                                            |         | 1,008   |         |  |         | 287     |        
|                                                                      |                                                                                                                                               |                                            |         |         |         |  |         |        
|                                                                      |                                                                                                                                               | Total shareholders equity                 |         |         | 328,811 |  |         |         | 302,007 | 
|                                                                      |                                                                                                                                               |                                            |         |         |         |  |         |        
|                                                                      |                                                                                                                                               | Total liabilities and shareholders equity |         | $       | 614,933 |  |         | $       | 525,683 | 
|                                                                      |                                                                                                                                               |                                            |         |         |         |  |         |        

See notes to consolidated financial statements.

F-3



---



##### Table of Contents



TEKELEC

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                       |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |          |        |         |  
|------------------------------------------------------ | -------------------------------------------------------------------------------------------- | ----------------------------------------- | -------------------------------------------------------- | -------- | ------ | -------- | ------- | -------- | ------- | ------- | ------ | -------- | ------ | ------- | -
|                                                       |                                                                                              |                                          
|                                                       |                                                                                              | For the Years Ended December 31,         
|                                                       |                                                                                              |                                          
|                                                       |                                                                                              | 2003                                      |                                                          | 2002     |        | 2001    
|                                                       |                                                                                              |                                           |                                                          |          |        |         
|                                                       |                                                                                              |                                          
|                                                       |                                                                                              | (Thousands)                              
|Cash flows from operating
    activities:              |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|                                                       | Net income (loss)                                                                            |                                           | $                                                        | 18,452   |        |          | $       | 40,918   |         |         | $      | (6,899   | )     
|                                                       | Adjustments to reconcile net income (loss) to net
    cash provided by operation activities: |                                           |                                                          |          |        |          |         |          |         |         |        |          |       
|                                                       | Minority interest                                                                            |                                           |                                                          | (19,792  | )      |          |         |         |         |         |        |         |       
|                                                       | Net gain on disposal discontinued operation                                                  |                                           |                                                          | (3,293   | )      |          |         | (28,312  | )       |         |        |         |       
|                                                       | Net loss from discontinued operation                                                         |                                           |                                                          |         |        |          |         | 3,308    |         |         |        | 289      |       
|                                                       | Allowance for doubtful accounts                                                              |                                           |                                                          | 415      |        |          |         | 950      |         |         |        | 4,412    |       
|                                                       | Inventory provision                                                                          |                                           |                                                          | 1,558    |        |          |         | 6,177    |         |         |        | 3,448    |       
|                                                       | Depreciation                                                                                 |                                           |                                                          | 14,493   |        |          |         | 15,618   |         |         |        | 15,959   |       
|                                                       | Amortization                                                                                 |                                           |                                                          | 17,047   |        |          |         | 11,661   |         |         |        | 31,528   |       
|                                                       | Amortization of deferred financing costs                                                     |                                           |                                                          | 2,121    |        |          |         | 819      |         |         |        | 819      |       
|                                                       | Convertible debt accretion                                                                   |                                           |                                                          | 2,335    |        |          |         | 3,981    |         |         |        | 3,723    |       
|                                                       | Deferred income taxes                                                                        |                                           |                                                          | 501      |        |          |         | (3,908   | )       |         |        | (6,916   | )     
|                                                       | Stock-based compensation                                                                     |                                           |                                                          | 459      |        |          |         | 5,612    |         |         |        | 310      |       
|                                                       | Tax benefit related to stock options exercised                                               |                                           |                                                          | 1,213    |        |          |         | 929      |         |         |        | 6,943    |       
|                                                       | Changes in assets and liabilities (net of
    business disposal and acquisition):            |                                           |                                                          |          |        |          |         |          |         |         |        |          |       
|                                                       |                                                                                              | Accounts and notes receivable             |                                                          |          | (7,342 | )        |         |          | 10,188  |         |        |          | 30,393 |        
|                                                       |                                                                                              | Inventories                               |                                                          |          | (7,027 | )        |         |          | (1,955  | )       |        |          | (4,594 | )      
|                                                       |                                                                                              | Prepaid expenses and other current assets |                                                          |          | (9,644 | )        |         |          | 3,315   |         |        |          | (5,687 | )      
|                                                       |                                                                                              | Trade accounts payable                    |                                                          |          | (957   | )        |         |          | (7,890  | )       |        |          | 1,941  |        
|                                                       |                                                                                              | Accrued expenses                          |                                                          |          | (5,908 | )        |         |          | 8,311   |         |        |          | 622    |        
|                                                       |                                                                                              | Accrued payroll and related expenses      |                                                          |          | 6,600  |          |         |          | 3,311   |         |        |          | (2,143 | )      
|                                                       |                                                                                              | Deferred revenues                         |                                                          |          | 16,192 |          |         |          | (13,861 | )       |        |          | 15,919 |        
|                                                       |                                                                                              | Income taxes payable                      |                                                          |          | (115   | )        |         |          | (12,791 | )       |        |          | (814   | )      
|                                                       |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|                                                       |                                                                                              |                                           | Total adjustments                                        |          |        | 8,856    |         |          |         | 5,463   |        |          |        | 96,152  |  
|                                                       |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|                                                       |                                                                                              |                                           | Net cash provided by operating activities                |          |        | 27,308   |         |          |         | 46,381  |        |          |        | 89,253  |  
|                                                       |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|Cash flows from investing
    activities:              |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|                                                       | Purchase of available-for-sale securities                                                    |                                           |                                                          | (407,297 | )      |          |         | (486,453 | )       |         |        | (257,472 | )     
|                                                       | Proceeds from maturity of available-for-sale
    securities                                  |                                           |                                                          | 302,036  |        |          |         | 437,067  |         |         |        | 212,387  |       
|                                                       | Net cash acquired in the acquisition of majority
    interest in Santera                     |                                           |                                                          | 12,335   |        |          |         |         |         |         |        |         |       
|                                                       | Investments in privately-held companies                                                      |                                           |                                                          | (797     | )      |          |         |         |         |         |        | (16,500  | )     
|                                                       | Purchase of property and equipment                                                           |                                           |                                                          | (6,509   | )      |          |         | (5,500   | )       |         |        | (18,906  | )     
|                                                       | Purchase of technology                                                                       |                                           |                                                          | (3,166   | )      |          |         | (1,089   | )       |         |        |         |       
|                                                       | Proceeds from disposal of discontinued operation                                             |                                           |                                                          | 3,293    |        |          |         | 37,883   |         |         |        |         |       
|                                                       | Decrease (Increase) in other assets                                                          |                                           |                                                          | (602     | )      |          |         | 177      |         |         |        | (507     | )     
|                                                       |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|                                                       |                                                                                              |                                           | Net cash used in investing activities                    |          |        | (100,707 | )       |          |         | (17,915 | )      |          |        | (80,998 | )
|                                                       |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|Cash flows from financing
    activities:              |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|                                                       | Retirement of convertible debt                                                               |                                           |                                                          | (129,307 | )      |          |         |         |         |         |        |         |       
|                                                       | Proceeds from issuance of convertible debt                                                   |                                           |                                                          | 125,000  |        |          |         |         |         |         |        |         |       
|                                                       | Debt issuance costs                                                                          |                                           |                                                          | (3,816   | )      |          |         |         |         |         |        |         |       
|                                                       | Payments on notes payable                                                                    |                                           |                                                          | (1,224   | )      |          |         |         |         |         |        |         |       
|                                                       | Proceeds from issuance of common stock                                                       |                                           |                                                          | 5,959    |        |          |         | 3,890    |         |         |        | 12,763   |       
|                                                       |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|                                                       |                                                                                              |                                           | Net cash provided by (used in) financing
    activities  |          |        | (3,388   | )       |          |         | 3,890   |        |          |        | 12,763  |  
|                                                       |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|Effect of exchange rate changes on cash                |                                                                                              |                                           | 412                                                      |          |        |          | 125     |          |         |         | (91    | )       
|                                                       |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|Net cash flows from discontinued operation             |                                                                                              |                                           |                                                         |          |        |          | 2,007   |          |         |         | 8,636  |         
|                                                       |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|                                                       |                                                                                              |                                           | Net increase (decrease) in cash and cash
    equivalents |          |        | (76,375  | )       |          |         | 34,488  |        |          |        | 29,563  |  
|                                                       |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|Cash and cash equivalents at beginning of the
    year |                                                                                              |                                           | 121,636                                                  |          |        |          | 87,148  |          |         |         | 57,585 |         
|                                                       |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|Cash and cash equivalents at end of the
    year       |                                                                                              | $                                         | 45,261                                                   |          |        | $        | 121,636 |          |         | $       | 87,148 |         
|                                                       |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|Supplemental disclosure of cash flow
    information:  |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|Cash paid during the year for:                         |                                                                                              |                                           |                                                          |          |        |          |         |          |         |         |        |         
|                                                       | Interest                                                                                     |                                           | $                                                        | 17,417   |        |          | $       | 4,396    |         |         | $      | 4,398    |       
|                                                       | Income taxes                                                                                 |                                           |                                                          | 11,034   |        |          |         | 15,093   |         |         |        | 6,210    |       

See notes to consolidated financial statements

F-4



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##### Table of Contents



TEKELEC

CONSOLIDATED STATEMENTS OF SHAREHOLDERS
EQUITY

|                           |                                                                                                      |              |        |        |  |             |         |               |  |               |         |        |   |   |        |        |   |   |         |        |  
|-------------------------- | ---------------------------------------------------------------------------------------------------- | ------------ | ------ | ------ |  | ----------- | ------- | ------------- |  | ------------- | ------- | ------ | - | - | ------ | ------ | - | - | ------- | ------ | -
|                           |                                                                                                      |              |        |        |  |             |         |              
|                           |                                                                                                      | Common Stock |        |        |  | Accumulated |         |              
|                           |                                                                                                      |              |        |        |  | Other       |         | Total        
|                           |                                                                                                      | Number       |        |        |  | Retained    |         | Comprehensive |  | Shareholders
|                           |                                                                                                      | of Shares    |        | Amount |  | Earnings    |         | Income (Loss) |  | Equity       
|                           |                                                                                                      |              |        |        |  |             |         |               |  |              
|                           |                                                                                                      |             
|                           |                                                                                                      | (Thousands) 
|Balance, December 31, 2000 |                                                                                                      |              | 58,897 |        |  | $           | 151,830 |               |  | $             | 85,424  |        |   | $ | 343    |        |   | $ | 237,597 |       
|                           | Exercise of stock options and warrants and
    issuance of shares under employee stock purchase plan |              |        | 1,180  |  |             |         | 12,763        |  |               |         |       |   |   |        |       |   |   |         | 12,763 |  
|                           | Compensation related to vesting of restricted
    stock                                              |              |        | 30     |  |             |         | 310           |  |               |         |       |   |   |        |       |   |   |         | 310    |  
|                           | Stock option tax benefits                                                                            |              |        |       |  |             |         | 6,943         |  |               |         |       |   |   |        |       |   |   |         | 6,943  |  
|                           | Translation adjustment                                                                               |              |        |       |  |             |         |              |  |               |         |       |   |   |        | (1,892 | ) |   |         | (1,892 | )
|                           | Net loss                                                                                             |              |        |       |  |             |         |              |  |               |         | (6,899 | ) |   |        |       |   |   |         | (6,899 | )
|                           |                                                                                                      |              |        |        |  |             |         |               |  |               |         |        |   |   |        |        |   |   |         |       
|Balance, December 31, 2001 |                                                                                                      |              | 60,107 |        |  | $           | 171,846 |               |  | $             | 78,525  |        |   | $ | (1,549 | )      |   | $ | 248,822 |       
|                           | Exercise of stock options and warrants and
    issuance of shares under employee stock purchase plan |              |        | 786    |  |             |         | 3,890         |  |               |         |       |   |   |        |       |   |   |         | 3,890  |  
|                           | Compensation related to vesting of restricted
    stock                                              |              |        |       |  |             |         | 328           |  |               |         |       |   |   |        |       |   |   |         | 328    |  
|                           | Stock-based compensation charge for stock option
    modification                                    |              |        |       |  |             |         | 5,284         |  |               |         |       |   |   |        |       |   |   |         | 5,284  |  
|                           | Stock option tax benefits                                                                            |              |        |       |  |             |         | 929           |  |               |         |       |   |   |        |       |   |   |         | 929    |  
|                           | Translation adjustment                                                                               |              |        |       |  |             |         |              |  |               |         |       |   |   |        | 1,836  |   |   |         | 1,836  |  
|                           | Net income                                                                                           |              |        |       |  |             |         |              |  |               |         | 40,918 |   |   |        |       |   |   |         | 40,918 |  
|                           |                                                                                                      |              |        |        |  |             |         |               |  |               |         |        |   |   |        |        |   |   |         |       
|Balance, December 31, 2002 |                                                                                                      |              | 60,893 |        |  | $           | 182,277 |               |  | $             | 119,443 |        |   | $ | 287    |        |   | $ | 302,007 |       
|                           | Exercise of stock options and warrants and
    issuance of shares under employee stock purchase plan |              |        | 733    |  |             |         | 5,959         |  |               |         |       |   |   |        |       |   |   |         | 5,959  |  
|                           | Compensation related to vesting of restricted
    stock                                              |              |        |       |  |             |         | 459           |  |               |         |       |   |   |        |       |   |   |         | 459    |  
|                           | Stock option tax benefits                                                                            |              |        |       |  |             |         | 1,213         |  |               |         |       |   |   |        |       |   |   |         | 1,213  |  
|                           | Net unrealized gain on available-for-sale
    securities, net of tax benefit                         |              |        |       |  |             |         |              |  |               |         |       |   |   |        | 643    |   |   |         | 643    |  
|                           | Translation adjustment                                                                               |              |        |       |  |             |         |              |  |               |         |       |   |   |        | 78     |   |   |         | 78     |  
|                           | Net income                                                                                           |              |        |       |  |             |         |              |  |               |         | 18,452 |   |   |        |       |   |   |         | 18,452 |  
|                           |                                                                                                      |              |        |        |  |             |         |               |  |               |         |        |   |   |        |        |   |   |         |       
|Balance, December 31, 2003 |                                                                                                      |              | 61,626 |        |  | $           | 189,908 |               |  | $             | 137,895 |        |   | $ | 1,008  |        |   | $ | 328,811 |       
|                           |                                                                                                      |              |        |        |  |             |         |               |  |               |         |        |   |   |        |        |   |   |         |       

See notes to consolidated financial statements

F-5



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##### Table of Contents



TEKELEC

CONSOLIDATED STATEMENTS OF COMPREHENSIVE
INCOME (LOSS)

|                                   |                                                          |                                  |        |      |  |      |        |       |  |   |        |        |  
|---------------------------------- | -------------------------------------------------------- | -------------------------------- | ------ | ---- |  | ---- | ------ | ----- |  | - | ------ | ------ | -
|                                   |                                                          |                                 
|                                   |                                                          | For the Years Ended December 31,
|                                   |                                                          |                                 
|                                   |                                                          | 2003                             |        | 2002 |  | 2001
|                                   |                                                          |                                  |        |      |  |     
|                                   |                                                          |                                 
|                                   |                                                          | (Thousands)                     
|Net income (loss)                  |                                                          | $                                | 18,452 |      |  | $    | 40,918 |       |  | $ | (6,899 | )     
|Other comprehensive income (loss): |                                                          |                                  |        |      |  |      |        |       |  |   |        |       
|                                   | Foreign currency translation adjustments                 |                                  |        | 78   |  |      |        | 1,836 |  |   |        | (1,892 | )
|                                   | Net unrealized gain on available-for-sale
    securities |                                  |        | 643  |  |      |        |      |  |   |        |       |  
|                                   |                                                          |                                  |        |      |  |      |        |       |  |   |        |       
|Comprehensive income (loss)        |                                                          | $                                | 19,173 |      |  | $    | 42,754 |       |  | $ | (8,791 | )     
|                                   |                                                          |                                  |        |      |  |      |        |       |  |   |        |       

See notes to consolidated financial statements

F-6



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##### Table of Contents



TEKELEC

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

Note A  Summary of Significant
Accounting Policies



| |         
| | --------
| | Business

We design, manufacture, market and support
network signaling products, switching solutions, and selected
service applications for telecommunications networks and contact
centers. Our customers include telecommunications carriers,
network service providers and contact center operators.



| |                                                 
| | ------------------------------------------------
| | Principles of Consolidation and
    Presentation

The consolidated financial statements include the
accounts and operating results of Tekelec, our wholly owned
subsidiaries, and our majority owned subsidiary, Santera, less
minority interest from the acquisition date of June 10,
2003. See Note B  Acquisition of Majority
Interest in Santera. All significant intercompany accounts and
transactions have been eliminated. Certain items shown in the
December 31, 2002 and 2001 financial statements have been
reclassified to conform to the current period presentation. As
more fully discussed in Note C, we sold our Network
Diagnostics Division (NDD) effective August 30,
2002. Accordingly, comparative historical financial results and
notes have been revised to reflect the Network Diagnostics
Division as a discontinued operation.



| |                                                      
| | -----------------------------------------------------
| | Use of Estimates and Critical Accounting
    Policies

The preparation of financial statements requires
management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the dates of the financial
statements and revenues and expenses during the reporting
periods. Actual results could differ from those estimates.

The most significant areas that require
management judgement are revenue recognition, allowance for
doubtful accounts, inventories, impairment of investments and
notes receivable, deferred taxes, impairment of goodwill and
long-lived assets, product warranty and contingencies and
litigation. The accounting policies for these areas are
discussed in this or other footnotes to these consolidated
financial statements.



| |                          
| | -------------------------
| | Cash and Cash Equivalents

We consider all highly liquid investments
purchased with an original maturity of three months or less to
be cash equivalents.



| |            
| | -----------
| | Investments

Marketable securities are classified as
available-for-sale securities and are accounted for at their
fair value, and unrealized gains and losses on these securities
are reported as a separate component of shareholders
equity. When the fair value of an investment declines below its
original cost, we consider all available evidence to evaluate
whether the decline is other-than-temporary. Among other things,
we consider the duration and extent of the decline and economic
factors influencing the markets. To date, we have had no such
other-than-temporary declines below cost basis. At
December 31, 2003 and 2002, net unrealized gains or losses
on available-for-sale securities were not significant. We
utilize specific identification in computing realized gains and
losses on the sale of investments. Realized gains and losses are
reported in other income and expense, and were not significant
for 2003, 2002 and 2001.

We also invest in equity instruments of
privately-held companies for business and strategic purposes.
These investments are classified as long-term assets and are
accounted for under the cost method since we do not have the
ability to exercise significant influence over their operations.
We periodically review these investments for
other-than-temporary declines in their value and write down
investments to their fair value when an other-than-temporary
decline has occurred. Fair values for investments in
privately-held companies

F-7



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##### Table of Contents



TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

are estimated based on several factors including;
the values for recent rounds of financing; quoted market prices
for comparable public companies or market values for recent
acquisitions of similar private companies; and pricing models
using historical and forecasted financial information. To date,
there have been no impairments of investments in privately-held
companies.



| |            
| | -----------
| | Inventories

Inventories are stated at the lower of cost
(first in, first out) or market.



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment are stated at cost, less
accumulated depreciation and amortization. Depreciation and
amortization are provided using the straight-line method. The
estimated useful lives are:

|                                        |  |                                         
|--------------------------------------- |  | ----------------------------------------
|Manufacturing and development equipment |  | 3-5 years                               
|Furniture and office equipment          |  | 5 years                                 
|Demonstration equipment                 |  | 3 years                                 
|Leasehold improvements                  |  | The shorter of useful life or lease term



| |                                        
| | ---------------------------------------
| | Software Developed for Internal
    Use

We capitalize costs of software, consulting
services, hardware and payroll-related costs incurred to
purchase or develop internal-use software. We expense costs
incurred during preliminary project assessment, research and
development, re-engineering, training and application
maintenance.



| |                           
| | --------------------------
| | Software Development Costs

We provide for capitalization of certain software
development costs once technological feasibility is established.
The costs capitalized are amortized on a straight-line basis
over the estimated product life (generally eighteen months to
three years), or on the ratio of current revenue to total
projected product revenues, whichever is greater. To date, the
establishment of technological feasibility of our products and
general release have substantially coincided. As a result, we
have not capitalized any internal software development costs as
costs qualifying for such capitalization have not been
significant.



| |         
| | --------
| | Goodwill

Goodwill represents the excess of the purchase
price over the fair value of the identifiable net assets
acquired in an acquisition accounted for using the purchase
method. Effective the first quarter of 2002, we adopted the
provisions of Statement of Financial Accounting Standards
(SFAS) No. 142, Goodwill and Other
Intangible Assets SFAS No. 142 eliminates the
amortization of goodwill. Instead, goodwill is reviewed for
impairment at least annually thereafter. In connection with our
performance of the impairment tests, we obtained valuations of
our individual reporting units from an independent third-party
valuation firm. The valuation methodologies included, but were
not limited to, estimated net present value of the projected
future cash flows of these reporting units. With the use of
these impairment tests, we determined that there was no goodwill
impairment.



| |                  
| | -----------------
| | Intangible Assets

Intangible assets consist of purchased technology
and other intangible assets, all of which are generally
amortized over periods ranging from three to five years.
Intangible assets are stated at cost, less accumulated
amortization.

F-8



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##### Table of Contents



TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |                  
| | -----------------
| | Long-Lived Assets

We identify and record impairment of long-lived
assets when events or circumstances indicate that the carrying
value of such assets may not be recoverable. Events and
circumstances that may indicate an impairment include:
significant decreases in the fair market value of an asset,
negative industry or economic trend, a change in the extent or
manner in which an asset is used, shifts in technology,
significant underperformance relative to historical or projected
future operating results, exiting an activity in connection with
a restructure and a significant decline in our market
capitalization relative to net book value.

If events and circumstances indicate that that
the carrying amount of an asset may not be recoverable and the
expected undiscounted future cash flows attributable to the
asset is less than the carrying amount of the asset, an
impairment loss equal to the excess of the assets carrying
value over its fair value is recorded. Fair value is determined
based on the present value of estimated expected future cash
flows using a discount rate commensurate with the risks
involved, quoted market prices or appraised values, depending on
the nature of the assets. To date, no such impairment has been
recorded.



| |                       
| | ----------------------
| | Product Warranty Costs

We generally warrant our products against defects
in materials and workmanship for one year after sale and provide
for estimated future warranty costs at the time revenue is
recognized. At December 31, 2003 and 2002, accrued product
warranty costs amounted to $5.1 million and
$5.3 million, respectively, and are included in accrued
expenses. All warranty claims are expected to be utilized within
one year.

An analysis of changes in the liability for
product warranty costs is as follows (In thousands):

|                                      |  |                     |        |      |  |      |        |   |  |   |        |  
|------------------------------------- |  | ------------------- | ------ | ---- |  | ---- | ------ | - |  | - | ------ | -
|                                      |  |                    
|                                      |  | For the Years Ended
|                                      |  | December 31,       
|                                      |  |                    
|                                      |  | 2003                |        | 2002 |  | 2001
|                                      |  |                     |        |      |  |     
|Balance at beginning of period        |  | $                   | 5,271  |      |  | $    | 5,462  |   |  | $ | 3,434  |  
|Current year provision                |  |                     | 1,396  |      |  |      | 3,617  |   |  |   | 3,965  |  
|Expenditures and other adjustments(1) |  |                     | (1,608 | )    |  |      | (3,808 | ) |  |   | (1,937 | )
|                                      |  |                     |        |      |  |      |        |   |  |   |        |  
|Balance at end of period              |  | $                   | 5,059  |      |  | $    | 5,271  |   |  | $ | 5,462  |  
|                                      |  |                     |        |      |  |      |        |   |  |   |        |  



---



|    |                                                                                                                                                                                                                        
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes increase in warranty reserve as a result
    of the acquisition of Santera in 2003 amounting to $438 and also
    includes decrease warranty accrual in 2002 for the disposition
    of NDD amounting to $442.



| |                    
| | -------------------
| | Revenue Recognition

Revenues from sales of network signaling,
next-generation switching and contact center products are
recognized upon the transfer of title, generally at the time of
shipment to the customers final site and satisfaction of
related obligations, if any, provided that persuasive evidence
of an arrangement exists, the fee is fixed and determinable and
collectability is deemed probable. For certain products, our
sales arrangements include acceptance provisions which are based
on our published specifications. Revenue is recognized when
these products are shipped assuming all other revenue
recognition criteria are met, provided that we have previously
demonstrated that the product meets the specified criteria and
has established a history with substantially similar
transactions. Revenue is deferred for sales arrangements that
include customer-specific acceptance provisions where we are
unable to reliably demonstrate that the delivered product meets
all of the specified criteria until customer acceptance is
obtained. Revenues associated with multiple-element arrangements
are allocated to each element based on vendor specific objective
evidence of fair value. Revenues associated with installation
services, if provided, are deferred based on the fair value of
such services and are recognized upon completion. Installation
services are accounted for as a separate element based on the

F-9



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TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

customers obligation to pay the contract
price upon shipment of the related equipment and the fact that
such services are not essential to the functionality of the
related equipment, are available from other vendors and can be
purchased unaccompanied by other elements. Extended warranty
service revenues are recognized ratably over the warranty
period. Engineering service revenues are recognized on delivery
or as the services are performed. Development contract revenues
are recognized using the percentage-of-completion method based
on the costs incurred relative to total estimated costs.
Provisions for anticipated losses, if any, on development
contracts are recognized in income currently.



| |             
| | ------------
| | Income Taxes

Income tax expense is the tax payable for the
period and the change during the period in non-capital-related
deferred tax assets and liabilities. Deferred income taxes are
determined based on the difference between the financial
reporting and tax bases of assets and liabilities using enacted
rates in effect during the year in which the differences are
expected to reverse. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected
to be realized.



| |            
| | -----------
| | Advertising

Advertising costs are expensed as incurred and
amounted to approximately $842,000, $421,000 and $980,000 for
2003, 2002 and 2001, respectively.



| |                         
| | ------------------------
| | Stock-Based Compensation

At December 31, 2003, we have five
stock-based employee compensation plans which are described more
fully in Note P. In addition, certain employees have received
stock based awards upon commencement of employment that are
outside these plans. We account for employee stock option plans
in accordance with the provisions of Accounting Principals Board
(APB) Opinion No. 25, Accounting for
Stock Issued to Employees and the related interpretations
of FASB Interpretation (FIN) No. 44,
Accounting for Certain Transactions Involving Stock
Compensation. Accordingly, compensation expense related to
employee stock options is recorded, if on the date of the grant,
the fair value of the underlying stock exceeds the exercise
price.

To date, options have been granted at exercise
prices that equal or exceed market value of the underlying
common stock on the grant date. However, we have modified
certain option grants that did require remeasurement on the
modification date and accordingly have resulted in stock-based
compensation as the exercise prices were below the fair market
value on the date of the modification. The following table
illustrates the effect on stock-based compensation, net income
and earnings (loss) per share if we had applied the fair

F-10



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TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

value recognition provisions of
SFAS No. 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation.

|                                          |                                                                                                                                  |                                  |   |        |  |      |   |        |  |  |   |         |  
|----------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------- | -------------------------------- | - | ------ |  | ---- | - | ------ |  |  | - | ------- | -
|                                          |                                                                                                                                  |                                 
|                                          |                                                                                                                                  | For the Years Ended December 31,
|                                          |                                                                                                                                  |                                 
|                                          |                                                                                                                                  | 2003                             |   | 2002   |  | 2001
|                                          |                                                                                                                                  |                                  |   |        |  |     
|Stock-based compensation, net of
    tax: |                                                                                                                                  |                                  |   |        |  |      |   |        |  |  |   |        
|                                          | As reported                                                                                                                      |                                  | $ | 303    |  |      | $ | 3,648  |  |  | $ | 202     |  
|                                          | Additional stock-based compensation expense
    determined under the fair value method                                           |                                  |   | 16,810 |  |      |   | 14,891 |  |  |   | 22,278  |  
|                                          |                                                                                                                                  |                                  |   |        |  |      |   |        |  |  |   |        
|                                          | Pro forma                                                                                                                        |                                  | $ | 17,113 |  |      | $ | 18,539 |  |  | $ | 22,480  |  
|                                          |                                                                                                                                  |                                  |   |        |  |      |   |        |  |  |   |        
|Net income (loss):                        |                                                                                                                                  |                                  |   |        |  |      |   |        |  |  |   |        
|                                          | As reported                                                                                                                      |                                  | $ | 18,452 |  |      | $ | 40,918 |  |  | $ | (6,899  | )
|                                          | Less: additional stock-based compensation expense
    determined under the fair value method, net of tax                         |                                  |   | 16,810 |  |      |   | 14,891 |  |  |   | 22,278  |  
|                                          |                                                                                                                                  |                                  |   |        |  |      |   |        |  |  |   |        
|                                          | Pro forma                                                                                                                        |                                  | $ | 1,642  |  |      | $ | 26,027 |  |  | $ | (29,177 | )
|                                          |                                                                                                                                  |                                  |   |        |  |      |   |        |  |  |   |        
|Earnings (loss) per share-basic:          |                                                                                                                                  |                                  |   |        |  |      |   |        |  |  |   |        
|                                          | As reported                                                                                                                      |                                  | $ | 0.30   |  |      | $ | 0.68   |  |  | $ | (0.12   | )
|                                          | Less: per share effect of additional stock-based
    compensation expense determined under the fair value method, net
    of tax |                                  |   | 0.28   |  |      |   | 0.25   |  |  |   | 0.37    |  
|                                          |                                                                                                                                  |                                  |   |        |  |      |   |        |  |  |   |        
|                                          | Pro forma                                                                                                                        |                                  | $ | 0.02   |  |      | $ | 0.43   |  |  | $ | (0.49   | )
|                                          |                                                                                                                                  |                                  |   |        |  |      |   |        |  |  |   |        
|Earnings (loss) per share-diluted:        |                                                                                                                                  |                                  |   |        |  |      |   |        |  |  |   |        
|                                          | As reported                                                                                                                      |                                  | $ | 0.29   |  |      | $ | 0.67   |  |  | $ | (0.12   | )
|                                          | Less: per share effect of additional stock-based
    compensation expense determined under the fair value method, net
    of tax |                                  |   | 0.27   |  |      |   | 0.25   |  |  |   | 0.37    |  
|                                          |                                                                                                                                  |                                  |   |        |  |      |   |        |  |  |   |        
|                                          | Pro forma                                                                                                                        |                                  | $ | 0.02   |  |      | $ | 0.42   |  |  | $ | (0.49   | )
|                                          |                                                                                                                                  |                                  |   |        |  |      |   |        |  |  |   |        

The key assumptions used for the determination of
the fair value are further described in Note P.

We account for stock issued to non-employees in
accordance with the provisions of SFAS No. 123 and
Emerging Issues Task Force (EITF) No. 96-18,
Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling,
Goods and Services.



| |                 
| | ----------------
| | Foreign Currency

Translation of foreign currencies is accounted
for using the local currency as the functional currency of our
foreign subsidiaries. All assets and liabilities are translated
at exchange rates in effect on the balance sheet dates while
revenues and expenses are translated at average rates in effect
for the period. The resulting gains and losses are included in a
separate component of shareholders equity. Realized gains
(losses) on foreign currency transactions are reflected in net
income (loss) and amounted to ($105,000), $282,000, and
($462,000) for 2003, 2002 and 2001, respectively.



| |                          
| | -------------------------
| | Earnings (loss) Per Share

Earnings (loss) per share are computed using the
weighted average number of shares outstanding and potentially
dilutive shares (options and warrants), in accordance with
SFAS No. 128, Earnings per Share.

F-11



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TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |                     
| | --------------------
| | Comprehensive Income

Comprehensive income generally represents all
changes in shareholders equity during the period except
those resulting from investments by, or distributions to,
shareholders.



| |                    
| | -------------------
| | Segment Information

We use the management approach in
determining reportable business segments. The management
approach designates the internal organization that is used by
management for making operating decisions and assessing
performance as the source of our reportable segments. We
currently have three reportable segments: Network Signaling;
Contact Center; and Next-Generation Switching.

Recent Accounting Pronouncements

In January 2003, FASB issued FIN No. 46,
Consolidation of Variable Interest Entities-an
Interpretation of ARB No. 51. The Interpretation
clarified the application of Accounting Research Bulletin
No. 51, Consolidated Financial Statements, to
certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not
have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support
from other parties. The provisions of this Interpretation are
effective for all enterprises with variable interest entities
created after January 31, 2003. On October 8, 2003,
the FASB deferred the implementation date of Interpretations
No. 46 from the third quarter of 2003 to the fourth quarter
of 2003. The adoption of Interpretation No. 46 did not have
a material impact on our financial position, results of
operations, or cash flows.

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

In April 2003, the FASB issued
SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities.
SFAS No. 149 amends and clarifies the accounting
guidance on derivative instruments (including certain derivative
instruments embedded in other contracts) and hedging activities
that fall within the scope of SFAS No. 133,
Accounting for Derivative Instruments and Hedging
Activities. SFAS No. 149 is effective for all
contracts entered into or modified after June 30, 2003,
with certain exceptions, and for hedging relationships
designated after June 30, 2003. The guidance is to be
applied prospectively. The adoption of SFAS No. 149
did not have a material impact on our financial position,
results of operations or cash flows.

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

F-12



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TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

In December 2003, the Securities and Exchange
Commission (SEC) issued Staff Accounting Bulletin
(SAB) No. 104. This staff accounting bulletin
revises or rescinds certain sections of SAB 101, which
gives interpretation guidance about revenue recognition.
SAB 104 makes this interpretive guidance of SAB 101
consistent with current authoritative accounting and auditing
guidance and SEC rules and regulations. The adoption of
SAB 104 in December 2003 did not have a material impact on
our financial position, results of operations or cash flows.

Effective the first quarter of 2003, we adopted
EITF No. 02-16, Accounting by a Customer (including a
Reseller) for Certain Consideration Received from a
Vendor. EITF No. 02-16 addresses how a retailer
should account for vendor credits and cash consideration
received from a vendor. Adoption of the provisions of EITF
No. 02-16 did not have a material impact on our financial
position, results of operations or cash flows.

In November 2003, the EITF reached a consensus on
Issue No. 03-10, Application of EITF 02-16 by
Resellers to Sales Incentives Offered to Consumers by
Manufacturers. EITF No. 03-10 addresses the
accounting for manufacturer sales incentives offered directly to
consumers, including manufacturer coupons. EITF No. 03-10
is effective for the first interim period beginning after
November 25, 2003. Adoption of the provisions of EITF No.
03-10 will not have a material impact on our financial position,
results of operations or cash flows.

Note B. Acquisition of Majority Interest
in Santera

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

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

|                                           |  |             |        |  
|------------------------------------------ |  | ----------- | ------ | -
|                                           |  | (Thousands)
|Fair value of Santera                      |  | $           | 61,000 |  
|Direct acquisition costs                   |  |             | 3,700  |  
|Less: Santera tangible net assets acquired |  |             | (7,767 | )
|                                           |  |             |        |  
|Fair value step-up                         |  | $           | 56,933 |  
|                                           |  |             |        |  

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TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The total purchase price step-up were allocated
among the Santera assets acquired and liabilities assumed based
on their estimated fair values determined by a third party
appraisal as follows:

|                                    |  |             |        | 
|----------------------------------- |  | ----------- | ------ | 
|                                    |  | (Thousands)
|In-process research and development |  | $           | 2,900  | 
|Goodwill                            |  |             | 25,835 | 
|Identifiable intangible assets      |  |             | 27,200 | 
|Acquired backlog                    |  |             | 500    | 
|Inventory fair value step-up        |  |             | 498    | 
|                                    |  |             |        | 
|                                    |  | $           | 56,933 | 
|                                    |  |             |        | 

The PTBU assets and liabilities contributed
remain at historical cost.

Based on the purchase price allocation,
$2.9 million of the purchase price represented acquired
in-process research and development (IPRD) that had
not yet reached technological feasibility and had no alternative
future use. IPRD was valued using a discounted cash flow
approach commonly known as the excess earnings
approach. The IPRD amount was recorded as an expense in the
second quarter of 2003. The identifiable intangible assets
created as a result of the acquisition will be amortized over
their estimated useful lives of 15 years, with the
exception of acquired backlog which has an estimated life of one
year. Amortization expense of purchased technology and other
intangible assets of Santera, including the intangible assets
contributed by PTBU, amounted to $4.1 million for the year
ended December 31, 2003.

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

|                      |         |                        |         |      |  |   |         |      | 
|--------------------- | ------- | ---------------------- | ------- | ---- |  | - | ------- | ---- | 
|                      |         |                       
|                      |         | For the Years Ended   
|                      |         | December 31,          
|                      |         |                       
|                      |         | 2003                   |         | 2002
|                      |         |                        |         |     
|                      |         |                       
|                      |         | (Thousands, except per
|                      |         | share amounts)        
|Revenues              |         | $                      | 269,510 |      |  | $ | 264,356 |     
|Net income            |         |                        | 14,204  |      |  |   | 24,151  |     
|Net income per share: |         |                        |         |      |  |   |         |     
|                      | Basic   |                        |         | 0.23 |  |   |         | 0.40 | 
|                      | Diluted |                        |         | 0.23 |  |   |         | 0.39 | 

The net income and losses of Santera are
allocated between Tekelec and the minority interest based on
their relative interests in the equity of Santera and the
related liquidation preferences. This approach requires net
losses to be allocated first to the Series A Preferred
Stock until fully absorbed and then to the Series B
Preferred Stock. Subsequent net income will be allocated first
to the Series B Preferred Stock to the extent of previously
recognized net losses allocated to Series B Preferred
Stock. Additional net income will then be allocated to the
Series A Preferred Stock to the extent of previously
recognized losses allocated to Series A Preferred Stock and
then to Common Stock in proportion to their relative ownership
interests in the equity of Santera. The loss allocated to
minority interest of Santera for the period of June 10,
2003 through December 31, 2003 was computed as follows
(dollars in thousands):

|                                                                                                                      |  |   |        |  
|--------------------------------------------------------------------------------------------------------------------- |  | - | ------ | -
|Santera net loss (includes amortization of
    intangibles and IPRD charges of $4,069 and $2,900, respectively)       |  | $ | 31,922 |  
|Percentage of losses attributable to the minority
    interest based on capital structure and liquidation preferences |  |   | 62     | %
|                                                                                                                      |  |   |        |  
|Net loss allocated to minority interest                                                                               |  | $ | 19,792 |  
|                                                                                                                      |  |   |        |  

F-14



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TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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

Note C  Disposition of Network
Diagnostics Business

On August 30, 2002, we completed the sale of
NDD to Catapult Communications Corporation
(Catapult) for $59.8 million, consisting of
cash in the amount of $42.5 million and convertible
subordinated promissory notes (the Notes) issued by
Catapults wholly owned Irish subsidiary and guaranteed by
Catapult in the total principal amount of $17.3 million.
The sale resulted in a pre-tax gain of approximately
$41.7 million ($28.3 million after taxes) in 2002.
During the third quarter of 2003, an additional
$3.3 million gain on the sale was recognized based on post
closing adjustments, including working capital, resulting from
the final settlement with Catapult in accordance with the asset
purchase agreement. In accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived
Assets, the sale of the NDD business segment has been
presented as a discontinued business and our historical
financial results for periods prior to disposition have been
revised to reflect NDD as a discontinued operation. Accordingly,
the revenues, costs and expenses, assets and liabilities, and
cash flows of NDD have been condensed in the accompanying
consolidated statements of operations, balance sheets and cash
flows.

Revenues and loss from our discontinued operation
were as follows:

|                                         |  |              |   |      |  |      |         |   |  |   |         |  
|---------------------------------------- |  | ------------ | - | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                         |  |             
|                                         |  | December 31,
|                                         |  |             
|                                         |  | 2003         |   | 2002 |  | 2001
|                                         |  |              |   |      |  |     
|                                         |  |             
|                                         |  | (Thousands) 
|Revenues                                 |  | $            |  |      |  | $    | (26,556 | ) |  | $ | (63,082 | )
|Pre-tax loss from discontinued operation |  |              |  |      |  |      | (6,015  | ) |  |   | (328    | )
|Benefit from income taxes                |  |              |  |      |  |      | (2,707  | ) |  |   | (39     | )
|Loss from discontinued operation         |  | $            |  |      |  | $    | (3,308  | ) |  | $ | (289    | )

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

The Notes were initially reflected in the
consolidated balance sheet at their estimated fair value with
the assistance of a third party appraisal. The fair value was
computed by discounting the face value amount to present value
using a fair value rate of interest and then determining the
fair value of the conversion option using the Black-Scholes
valuation model. The carrying value of the Notes is being
adjusted to the redemption

F-15



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TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

amount at maturity based on an effective interest
amortization method, with periodic charges to interest. The
carrying values of the Notes and the conversion option are as
follows:

|                                        |                                        |              |        |              |  |   |        |        | 
|--------------------------------------- | -------------------------------------- | ------------ | ------ | ------------ |  | - | ------ | ------ | 
|                                        |                                        | December 31, |        | December 31,
|                                        |                                        | 2003         |        | 2002        
|                                        |                                        |              |        |             
|                                        |                                        |             
|                                        |                                        | (Thousands) 
|Notes: face value at $17,300            |                                        | $            | 14,869 |              |  | $ | 14,869 |       
|Fair value of conversion option feature |                                        |              | 3,246  |              |  |   | 3,246  |       
|                                        |                                        |              |        |              |  |   |        |       
|                                        | Fair value of Notes at August 30, 2002 |              |        | 18,115       |  |   |        | 18,115 | 
|Less, accumulated amortization          |                                        |              | (535   | )            |  |   | (128   | )     
|                                        |                                        |              |        |              |  |   |        |       
|                                        | Carrying value of Notes                |              | $      | 17,580       |  |   | $      | 17,987 | 
|                                        |                                        |              |        |              |  |   |        |       

Note D  Fair Value of
Investments

We had short-term investments in commercial
paper, municipals and money market funds with original
maturities of less than 90 days whose carrying amounts
approximate their fair values because of their short maturities.
These investments are included in cash and cash equivalents and
amounted to $10.8 million and $75.5 million at
December 31, 2003 and 2002, respectively.

We also had investments classified as
available-for-sale securities included in short-term and
long-term investments, categorized as follows:

|                                                                              |                              |              |         |         |  |   |         |         | 
|----------------------------------------------------------------------------- | ---------------------------- | ------------ | ------- | ------- |  | - | ------- | ------- | 
|                                                                              |                              |             
|                                                                              |                              | December 31,
|                                                                              |                              |             
|                                                                              |                              | 2003         |         | 2002   
|                                                                              |                              |              |         |        
|                                                                              |                              |             
|                                                                              |                              | (Thousands) 
|Type of Security:                                                             |                              |              |         |         |  |   |         |        
|Corporate debt securities with maturities of less
    than one year           |                              | $            | 15,050  |         |  | $ | 58,636  |        
|State securities with maturities of less than one
    year                    |                              |              | 68,750  |         |  |   | 1,300   |        
|                                                                              |                              |              |         |         |  |   |         |        
|                                                                              | Total short-term investments |              |         | 83,800  |  |   |         | 59,936  | 
|Corporate debt securities with maturities of
    between one and three years  |                              |              | 57,887  |         |  |   | 40,091  |        
|State securities with maturity between one and
    three years                |                              |              | 8,094   |         |  |   | 1,415   |        
|U.S. government securities with maturities
    of between one and three years |                              |              | 144,317 |         |  |   | 86,752  |        
|                                                                              |                              |              |         |         |  |   |         |        
|                                                                              | Total long-term investments  |              |         | 210,298 |  |   |         | 128,258 | 
|                                                                              |                              |              |         |         |  |   |         |        
|                                                                              |                              | $            | 294,098 |         |  | $ | 188,194 |        
|                                                                              |                              |              |         |         |  |   |         |        

These available-for-sale securities are accounted
for at their fair value, and unrealized gains and losses on
these securities are reported as a separate component of
shareholders equity. At December 31, 2003 the
unrealized gain on available-for-sale securities amounted to
approximately $1.0 million. At December 31, 2002, unrealized
gains or losses on available-for-sale securities were not
significant. We utilized specific identification in computing
realized gains and losses on the sale of investments. Realized
gains and losses are reported in other income and expense, and
were not significant for 2003 and 2002.

Note E  Business and Credit
Risk

Financial instruments, which potentially subject
us to concentration of credit risk, consist principally of cash,
investments and trade receivables. We invest our excess cash in
interest-bearing deposits with major banks, United States
government securities, high-quality commercial paper and money
market funds. At times our cash balances may be in excess of the
FDIC insurance limits.

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TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

With respect to trade receivables, we sell
network signaling, switching and contact center systems
worldwide primarily to telephone operating companies, equipment
manufacturers and corporations that use its systems to design,
install, maintain, test and operate communications equipment and
networks. Credit is extended based on an evaluation of each
customers financial condition, and generally collateral is
not required. Generally, payment terms stipulate payment within
90 days of shipment and currently, we do not engage in
leasing or other customer financing arrangements. Many of our
international sales are secured with import insurance or letters
of credit to mitigate credit risk. Although we have processes in
place to monitor and mitigate credit risk, there can be no
assurance that such programs will be effective in eliminating
such risk. Historically, credit losses have been within
managements expectations. Our exposure to credit risk has
increased as a result of weakened financial conditions in
certain market segments such as the Competitive Local Exchange
Carrier segment. Credit losses for such customers have been
provided for in the financial statements. Future losses, if
incurred, could harm our business and have a material adverse
effect on our financial position, results of operations or cash
flows.

Historically, a limited number of customers have
accounted for a significant percentage of our Network Signaling
revenues in each fiscal quarter. We anticipate that our
operating results in any given period will continue to depend
upon revenues from a small number of customers.

Sales to the wireless market have accounted for
over 50% of our Network Signaling revenues. We expect that our
sales of Network Signaling products and services will continue
to account for a substantial majority of our revenues.

We conduct business in a number of foreign
countries, with certain transactions denominated in local
currencies. In certain instances where we have entered into
contracts that are denominated in foreign currencies, we have
obtained foreign currency forward contracts, principally
denominated in Euros or British Pounds, to offset the impact of
currency rates on accounts receivable. These contracts are used
to reduce our risk associated with exchange rate movements, as
gains and losses on these contracts are intended to offset
exchange losses and gains on underlying exposures. Changes in
the fair value of these forward contracts are recorded
immediately in earnings. See note G  Financial
Instruments.

We do not enter into derivative instrument
transactions for trading or speculative purposes. The purpose of
our foreign currency management policy is to minimize the effect
of exchange rate fluctuations on certain foreign denominated
anticipated cash flows. The terms of currency instruments used
for hedging purposes are consistent with the timing of the
transactions being hedged. We may continue to use foreign
currency forward contracts to manage foreign currency exchange
risks in the future.

There have been no borrowings under our variable
rate credit facilities. All of our outstanding long-term debt is
fixed rate and not subject to interest rate fluctuation.

Note F  Related Party
Transactions

As of December 31, 2003, our principal
shareholder and our Chairman of the Board of Directors (the
Chairman) and his family owned an aggregate of
approximately 20% of our outstanding stock. We paid
directors fees and expenses to the Chairman of $59,000,
$55,000 and $51,000 in 2003, 2002 and 2001, respectively.

During 2003, we entered a consulting agreement
through our majority owned subsidiary, Santera, with Marty
Kaplan, formerly a Director and Chairman of the Board of
Santera. Under the terms of the agreement, Mr. Kaplan
receives cash compensation of $75,000 per annum and
non-statutory options (the Options) to purchase
50,000 shares of our Common Stock under our 2003 Stock
Option Plan. The Options shall vest cumulatively in quarterly
installments. During 2003, we paid directors fees and expenses
to Mr. Kaplan of $13,000.

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TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Our Japanese subsidiary purchased, for resale,
products under a distribution arrangement from an affiliate in
which three of our directors are directors and shareholders. In
August 2002, the Japanese subsidiary was sold as part of the
disposition of NDD (see Note C). The following is a summary
of transactions and balances with the formerly affiliated
company controlled by a director:

|                             |  |             |   |      |  |      |       |  |  |   |       | 
|---------------------------- |  | ----------- | - | ---- |  | ---- | ----- |  |  | - | ----- | 
|                             |  | 2003        |   | 2002 |  | 2001
|                             |  |             |   |      |  |     
|                             |  |            
|                             |  | (Thousands)
|Purchases from related party |  | $           |  |      |  | $    | 1,485 |  |  | $ | 2,165 | 
|Due to related party         |  |             |  |      |  |      |      |  |  |   | 168   | 

Note G  Financial
Instruments

As discussed in Note E, we use derivative
instruments, such as forward contracts, to manage our exposure
to market risks such as interest rate and foreign exchange
risks. In accordance with the provisions of
SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities (adopted in fiscal
2001) and Statement of Financial Accounting Standards
No. 138, Accounting for Certain Derivative
Instruments and Certain Hedging Activities  an
amendment of FASB Statement No. 133, we record
derivative instruments as assets or liabilities on the
Consolidated Balance Sheet, measured at fair value.

Corresponding gains and losses on these
contracts, as well as gains and losses on the items being
hedged, are included as a component of other income and expense
in our consolidated statement of operations. When we elect not
to designate a derivative instrument and hedged item as a fair
value hedge at inception of the hedge, or the relationship does
not qualify for fair value hedge accounting treatment under
SFAS Nos. 133/138, the full amount of changes in the
fair value of the derivative instrument will be recognized in
the consolidated financial statements.

As of December 31, 2003, we had one foreign
currency forward contract outstanding to sell approximately
1,700,000 Euros in order to hedge certain receivables
denominated in that currency. This contract had an expiration
date of January 7, 2004 and did not meet specific hedge
accounting requirements. We had no forward or option contracts
outstanding as of December 31, 2002. At December 31,
2003, our loss from foreign currency forward contracts was
$624,000. We did not enter into forward contracts for the year
ended December 31, 2002.

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

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TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Note H  Income Taxes

The provision for income taxes consists of the
following:

|                                    |                       |                                  |                                              |      |        |        |  |        |        |        |   |      |        |       |  
|----------------------------------- | --------------------- | -------------------------------- | -------------------------------------------- | ---- | ------ | ------ |  | ------ | ------ | ------ | - | ---- | ------ | ----- | -
|                                    |                       |                                 
|                                    |                       | For the Years Ended December 31,
|                                    |                       |                                 
|                                    |                       | 2003                             |                                              | 2002 |        | 2001  
|                                    |                       |                                  |                                              |      |        |       
|Continuing Operations:              |                       |                                  |                                              |      |        |        |  |        |        |        |   |     
|                                    | Current               |                                  |                                              |      |        |        |  |        |        |        |   |      |       
|                                    |                       | Federal                          |                                              | $    | 10,112 |        |  | $      | 8,124  |        |   | $    | 10,607 |      
|                                    |                       | State                            |                                              |      | 1,771  |        |  |        | 3,100  |        |   |      | 1,962  |      
|                                    |                       | Foreign                          |                                              |      | 1,216  |        |  |        | 824    |        |   |      | 469    |      
|Deferred:                           |                       |                                  |                                              |      |        |        |  |        |        |        |   |     
|                                    |                       | Federal                          |                                              |      | 278    |        |  |        | (4,410 | )      |   |      | (6,171 | )    
|                                    |                       | State                            |                                              |      | 223    |        |  |        | 502    |        |   |      | (726   | )    
|                                    |                       | Foreign                          |                                              |      |       |        |  |        |       |        |   |      | (19    | )    
|                                    |                       |                                  |                                              |      |        |        |  |        |        |        |   |     
|                                    |                       |                                  | Total Continuing Operations                  |      |        | 13,600 |  |        |        | 8,140  |   |      |        | 6,122 |  
|                                    |                       |                                  |                                              |      |        |        |  |        |        |        |   |     
|Discontinued Operation:             |                       |                                  |                                              |      |        |        |  |        |        |        |   |     
|                                    | Current income taxes  |                                  |                                              |     |        |        |  | (2,920 | )      |        |   | 417  |       
|                                    | Deferred income taxes |                                  |                                              |     |        |        |  | 213    |        |        |   | (456 | )     
|                                    |                       |                                  |                                              |      |        |        |  |        |        |        |   |     
|                                    |                       |                                  | Total Discontinued Operation                 |      |        |       |  |        |        | (2,707 | ) |      |        | (39   | )
|                                    |                       |                                  |                                              |      |        |        |  |        |        |        |   |     
|Disposal of Discontinued Operation: |                       |                                  |                                              |      |        |        |  |        |        |        |   |     
|                                    | Current income taxes  |                                  |                                              |     |        |        |  | 11,043 |        |        |   |     |       
|                                    | Deferred income taxes |                                  |                                              |     |        |        |  | 2,302  |        |        |   |     |       
|                                    |                       |                                  |                                              |      |        |        |  |        |        |        |   |     
|                                    |                       |                                  | Total Disposal of Discontinued
    Operation |      |        |       |  |        |        | 13,345 |   |      |        |      |  
|                                    |                       |                                  |                                              |      |        |        |  |        |        |        |   |     
|                                    |                       |                                  | Total                                        |      | $      | 13,600 |  |        | $      | 18,778 |   |      | $      | 6,083 |  
|                                    |                       |                                  |                                              |      |        |        |  |        |        |        |   |     

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TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The components of temporary differences that gave
rise to deferred taxes at December 31, 2003 and 2002 are as
follows:

|                                              |                                       |                                              |                              |                                                    |         |     |        |        |        |        |        | 
|--------------------------------------------- | ------------------------------------- | -------------------------------------------- | ---------------------------- | -------------------------------------------------- | ------- | --- | ------ | ------ | ------ | ------ | ------ | 
|                                              |                                       |                                             
|                                              |                                       | December 31,                                
|                                              |                                       |                                             
|                                              |                                       | 2003                                         |                              | 2002                                              
|                                              |                                       |                                              |                              |                                                   
|                                              |                                       |                                             
|                                              |                                       | (Thousands)                                 
|Deferred tax assets:                          |                                       |                                              |                              |                                                    |         |     |        |       
|                                              |                                       | Allowance for doubtful accounts              |                              | $                                                  | 994     |     |        | $      | 1,892  |       
|                                              |                                       | Inventory adjustments                        |                              |                                                    | 3,885   |     |        |        | 2,156  |       
|                                              |                                       | Capitalized organization charges             |                              |                                                    | 3,492   |     |        |        |       |       
|                                              |                                       | Depreciation and amortization                |                              |                                                    | (1,558  | )   |        |        | 739    |       
|                                              |                                       | Research and development credit carryforward |                              |                                                    | 1,231   |     |        |        | 1,231  |       
|                                              |                                       | Foreign tax credit carryforward              |                              |                                                    | 5,693   |     |        |        | 8,450  |       
|                                              |                                       | Accrued liabilities                          |                              |                                                    | 10,442  |     |        |        | 8,528  |       
|                                              |                                       | Warranty accrual                             |                              |                                                    | 1,948   |     |        |        | 2,053  |       
|                                              |                                       | Installment sale                             |                              |                                                    | (7,569  | )   |        |        |       |       
|                                              |                                       | Other                                        |                              |                                                    | 2,594   |     |        |        | 259    |       
|                                              |                                       | Operating loss carryforward                  |                              |                                                    | 63,413  |     |        |        |       |       
|                                              |                                       |                                              |                              |                                                    |         |     |        |       
|                                              |                                       |                                              |                              | Total deferred tax assets                          |         |     | 84,565 |        |        |        | 25,308 | 
|                                              |                                       |                                              |                              |                                                    |         |     |        |       
|                                              |                                       | Valuation allowance for deferred tax assets  |                              |                                                    | (71,731 | )   |        |        |       |       
|                                              |                                       |                                              |                              |                                                    |         |     |        |       
|                                              |                                       | Total net deferred tax asset                 |                              | $                                                  | 12,834  |     |        | $      | 25,308 |       
|                                              |                                       |                                              |                              |                                                    |         |     |        |       
|Deferred tax assets of continuing operations: |                                       |                                              |                              |                                                    |         |     |        |       
|                                              |                                       | Current portion                              |                              | $                                                  | 4,958   |     |        | $      | 13,806 |       
|                                              |                                       | Long-term portion                            |                              |                                                    | 7,876   |     |        |        | 11,502 |       
|                                              |                                       |                                              |                              |                                                    |         |     |        |       
|                                              |                                       |                                              |                              | Total deferred tax assets of continuing operations |         |     | 12,834 |        |        |        | 25,308 | 
|                                              |                                       |                                              |                              |                                                    |         |     |        |       
|                                              |                                       |                                              |                              | Total deferred tax assets                          |         | $   | 12,834 |        |        | $      | 25,308 | 
|                                              |                                       |                                              |                              |                                                    |         |     |        |       
|Deferred tax liabilities:                     |                                       |                                              |                              |                                                    |         |     |        |       
|                                              | Acquisition-related intangible assets |                                              | $                            | 790                                                |         |     | $      | 5,653  |       
|                                              | Installment sale                      |                                              |                              |                                                   |         |     |        | 8,840  |       
|                                              |                                       |                                              |                              |                                                    |         |     |        |       
|                                              |                                       |                                              | Total deferred tax liability |                                                    | $       | 790 |        |        | $      | 14,493 |       
|                                              |                                       |                                              |                              |                                                    |         |     |        |       
|                                              | Current portion                       |                                              |                              |                                                   |         |     | $      |       |       
|                                              | Long term portion                     |                                              |                              | 790                                                |         |     |        | 14,493 |       
|                                              |                                       |                                              |                              |                                                    |         |     |        |       
|                                              |                                       |                                              | Total deferred tax liability |                                                    | $       | 790 |        |        | $      | 14,493 |       
|                                              |                                       |                                              |                              |                                                    |         |     |        |       

The provision for income taxes does not include
any benefit from the losses generated by Santera due to the
following: Santeras losses cannot be included on
Tekelecs consolidated federal tax return because our
ownership interest in Santera does not meet the threshold to
consolidate under income tax rules and regulations; and a full
valuation allowance has been established against Santeras
deferred tax assets due to uncertainties surrounding the timing
and realization of the benefits from Santeras tax
attributes in future tax returns. Accordingly, we have provided
a $71.7 million valuation allowance against the deferred
tax assets of Santera. Realization of the remaining deferred tax
assets of $12.8 million is dependent on the extent of our
income in carryback years and on our generating sufficient
taxable income in the future. Although realization is not
assured, we believe it is more likely than not that the net
deferred tax assets will be realized. The amount

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TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

of the deferred tax assets considered realizable,
however, could be reduced in the future if estimates of future
taxable income are reduced. In connection with the acquisition
of IEX in 1999, we recorded deferred income tax liabilities of
$22.9 million associated with certain intangible assets.
These deferred income tax liabilities are amortized on a
straight-line basis and amounted to $790,000 at
December 31, 2003.

The provision for income taxes differs from the
amount obtained by applying the federal statutory income tax
rate to income before provision for income taxes as follows:

|                                                                                        |                                                          |                                  |       |        |        |      |  |       |       |   |        |       |        |  |  |      |      |   |        |       |       |  |  |         |        |   
|--------------------------------------------------------------------------------------- | -------------------------------------------------------- | -------------------------------- | ----- | ------ | ------ | ---- |  | ----- | ----- | - | ------ | ----- | ------ |  |  | ---- | ---- | - | ------ | ----- | ----- |  |  | ------- | ------ | --
|                                                                                        |                                                          |                                 
|                                                                                        |                                                          | For the Years Ended December 31,
|                                                                                        |                                                          |                                 
|                                                                                        |                                                          |                                  |       |        |        |     
|                                                                                        |                                                          | 2003                             |       | 2002   |        | 2001
|                                                                                        |                                                          |                                  |       |        |        |     
|                                                                                        |                                                          |                                  |       |        |        |      |  |       |       |   |        |      
|                                                                                        |                                                          |                                 
|                                                                                        |                                                          | (Thousands)                     
|Federal statutory provision                                                             |                                                          | $                                | 3,139 |        |        |      |  |       |       | $ | 8,418  |       |        |  |  |      |      | $ | (171   | )     |       |  |  |        
|State taxes, net of federal benefit                                                     |                                                          |                                  | 1,372 |        |        |      |  |       |       |   | 1,259  |       |        |  |  |      |      |   | 1,186  |       |       |  |  |        
|Research and development credits                                                        |                                                          |                                  | (406  | )      |        |      |  |       |       |   | (999   | )     |        |  |  |      |      |   | (1,200 | )     |       |  |  |        
|Nontaxable foreign source income                                                        |                                                          |                                  | (441  | )      |        |      |  |       |       |   | (231   | )     |        |  |  |      |      |   | (231   | )     |       |  |  |        
|Acquisition-related intangible assets, net of
    related deferred income tax liability |                                                          |                                  | 2,231 |        |        |      |  |       |       |   | (280   | )     |        |  |  |      |      |   | 6,367  |       |       |  |  |        
|Foreign taxes and other                                                                 |                                                          |                                  | (646  | )      |        |      |  |       |       |   | (27    | )     |        |  |  |      |      |   | 171    |       |       |  |  |        
|Increase in valuation allowance for Santera                                             |                                                          |                                  | 8,351 |        |        |      |  |       |       |   |       |       |        |  |  |      |      |   |       |       |       |  |  |        
|                                                                                        |                                                          |                                  |       |        |        |      |  |       |       |   |        |       |        |  |  |      |      |   |        |       |       |  |  |        
|                                                                                        | Total income tax provision for continuing
    operations |                                  |       | 13,600 |        |      |  | 151.7 | %     |   |        | 8,140 |        |  |  | 33.8 | %    |   |        | 6,122 |       |  |  | 1,254.5 | %     
|Income tax benefit (expense) for
    discontinued operation                             |                                                          |                                  |      |        |        |      |  |       |       |   | (2,707 | )     |        |  |  |      |      |   | (39    | )     |       |  |  |        
|Income tax provision for disposal of discontinued
    operation                         |                                                          |                                  |      |        |        |      |  |       |       |   | 13,345 |       |        |  |  |      |      |   |       |       |       |  |  |        
|                                                                                        |                                                          |                                  |       |        |        |      |  |       |       |   |        |       |        |  |  |      |      |   |        |       |       |  |  |        
|                                                                                        |                                                          | Total income tax provision       |       | $      | 13,600 |      |  |       | 151.7 | % |        | $     | 18,778 |  |  |      | 31.5 | % |        | $     | 6,083 |  |  |         | (748.2 | %)
|                                                                                        |                                                          |                                  |       |        |        |      |  |       |       |   |        |       |        |  |  |      |      |   |        |       |       |  |  |        

At December 31, 2003, we had available
$1.2 million and $5.7 million of state research and
development credit and foreign tax credit carryforwards which
will expire, if unused, beginning in 2004 and 2006,
respectively. We also had $63.4 million of Santera net
operating loss carryforwards which will begin to expire in 2019.

We have not provided for federal income taxes on
$1.1 million of undistributed earnings of our foreign
subsidiaries that have been reinvested in their operations.

Note I  Inventories

Inventories consist of the following:

|                |  |              |        |      |  |   |        | 
|--------------- |  | ------------ | ------ | ---- |  | - | ------ | 
|                |  |             
|                |  | December 31,
|                |  |             
|                |  | 2003         |        | 2002
|                |  |              |        |     
|                |  |             
|                |  | (Thousands) 
|Raw materials   |  | $            | 15,810 |      |  | $ | 4,777  | 
|Work in process |  |              | 128    |      |  |   | 179    | 
|Finished goods  |  |              | 5,496  |      |  |   | 5,604  | 
|                |  |              |        |      |  |   |        | 
|                |  | $            | 21,434 |      |  | $ | 10,560 | 
|                |  |              |        |      |  |   |        | 

F-21



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TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Note J  Property and
Equipment

Property and equipment consist of the following:

|                                        |                                                 |              |         |         |   |   |        |         |  
|--------------------------------------- | ----------------------------------------------- | ------------ | ------- | ------- | - | - | ------ | ------- | -
|                                        |                                                 |             
|                                        |                                                 | December 31,
|                                        |                                                 |             
|                                        |                                                 | 2003         |         | 2002   
|                                        |                                                 |              |         |        
|                                        |                                                 |             
|                                        |                                                 | (Thousands) 
|Manufacturing and development equipment |                                                 | $            | 61,400  |         |   | $ | 47,074 |        
|Furniture and office equipment          |                                                 |              | 29,464  |         |   |   | 26,819 |        
|Demonstration equipment                 |                                                 |              | 2,465   |         |   |   | 3,711  |        
|Leasehold improvements                  |                                                 |              | 8,989   |         |   |   | 8,382  |        
|                                        |                                                 |              |         |         |   |   |        |        
|                                        |                                                 |              | 102,318 |         |   |   | 85,986 |        
|                                        | Less, accumulated depreciation and amortization |              |         | (80,146 | ) |   |        | (64,599 | )
|                                        |                                                 |              |         |         |   |   |        |        
|                                        |                                                 | $            | 22,172  |         |   | $ | 21,387 |        
|                                        |                                                 |              |         |         |   |   |        |        

Note K  Goodwill

The changes in the carrying amount of goodwill
for the year ended December 31, 2003 are as follows (in
thousands):

|                                                                                 |  |           |         |         |  |                 |       |       |  |   |        |   |  |   |        |  
|-------------------------------------------------------------------------------- |  | --------- | ------- | ------- |  | --------------- | ----- | ----- |  | - | ------ | - |  | - | ------ | -
|                                                                                 |  | Network   |         | Contact |  | Next-Generation |       |      
|                                                                                 |  | Signaling |         | Center  |  | Switching       |       | Total
|                                                                                 |  |           |         |         |  |                 |       |      
|Balance at December 31, 2002                                                     |  | $         | 35,103  |         |  | $               | 9,839 |       |  | $ |       |   |  | $ | 44,942 |  
|Addition due to the acquisition of Santera                                       |  |           |        |         |  |                 |      |       |  |   | 25,834 |   |  |   | 25,834 |  
|Transferred to Santera from Network Signaling                                    |  |           | (35,103 | )       |  |                 |      |       |  |   | 35,103 |   |  |   |       |  
|Reclassification of deferred income taxes related
    to acquisition to goodwill |  |           |        |         |  |                 |      |       |  |   | (1,732 | ) |  |   | (1,732 | )
|Revaluation of goodwill based on actual
    transaction related costs            |  |           |        |         |  |                 | (141  | )     |  |   |       |   |  |   | (141   | )
|                                                                                 |  |           |         |         |  |                 |       |       |  |   |        |   |  |   |        |  
|Balance at December 31, 2003                                                     |  | $         |        |         |  | $               | 9,698 |       |  | $ | 59,205 |   |  | $ | 68,903 |  
|                                                                                 |  |           |         |         |  |                 |       |       |  |   |        |   |  |   |        |  

The net income for 2001 includes amortization of
goodwill and assembled workforce of approximately
$20.1 million. The adjusted net income and earnings per
share information for 2001 as if SFAS No. 142 was
adopted on January 1, 2000 would have been:

|                                  |  |          |        |          |  |   |        | 
|--------------------------------- |  | -------- | ------ | -------- |  | - | ------ | 
|                                  |  |         
|                                  |  | 2001    
|                                  |  |         
|                                  |  | As       |        | As      
|                                  |  | Reported |        | Adjusted
|                                  |  |          |        |         
|Net income (loss) (thousands)     |  | $        | (6,899 | )        |  | $ | 12,790 | 
|Basic earnings (loss) per share   |  |          | (0.12  | )        |  |   | 0.21   | 
|Diluted earnings (loss) per share |  |          | (0.12  | )        |  |   | 0.20   | 

F-22



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##### Table of Contents



TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Note L  Intangible Assets

Intangible assets consist of the following:

|                     |                                |              |        |         |   |   |        |         |  
|-------------------- | ------------------------------ | ------------ | ------ | ------- | - | - | ------ | ------- | -
|                     |                                |             
|                     |                                | December 31,
|                     |                                |             
|                     |                                | 2003         |        | 2002   
|                     |                                |              |        |        
|                     |                                |             
|                     |                                | (Thousands) 
|Purchased technology |                                | $            | 79,162 |         |   | $ | 49,995 |        
|Other                |                                |              | 14,600 |         |   |   | 10,000 |        
|                     |                                |              |        |         |   |   |        |        
|                     |                                |              | 93,762 |         |   |   | 59,995 |        
|                     | Less, accumulated amortization |              |        | (59,644 | ) |   |        | (43,666 | )
|                     |                                |              |        |         |   |   |        |        
|                     |                                | $            | 34,118 |         |   | $ | 16,329 |        
|                     |                                |              |        |         |   |   |        |        

The identifiable intangible assets will continue
to be amortized over their estimated useful lives. The estimated
aggregate amortization expense for intangibles for the
subsequent years is:

|                    |  |   |        | 
|------------------- |  | - | ------ | 
|For the Years       |  |  
|Ending December 31, |  |  
|                    |  |  
|2004                |  | $ | 6,859  | 
|2005                |  |   | 2,655  | 
|2006                |  |   | 2,321  | 
|2007                |  |   | 2,212  | 
|2008                |  |   | 2,212  | 
|Thereafter          |  |   | 17,859 | 
|                    |  |   |        | 
|Total               |  | $ | 34,118 | 
|                    |  |   |        | 

Note M  Lines of Credit and
Borrowings

We have a $20.0 million line of credit with
a U.S. bank. Our $20.0 million credit facility is
collateralized by a stock pledge of our holdings in Santera,
bears interest at or, in some cases, below the lenders
prime rate (4.0% at December 31, 2003), and expires on
August 31, 2004, if not renewed. Under the terms of this
credit facility, we are required to maintain certain financial
ratios and meet certain net worth and indebtedness covenants. We
believe we are in compliance with these requirements. There have
been no borrowings under this credit facility.

As a result of the Santera transaction (see note
B  Acquisition of Majority Interest in Santera) we
have two notes payable to U.S. financial institutions. One
of the notes has an outstanding balance of $3.2 million and
is collateralized by the assets purchased under the note, bears
interest at 10% and matures in February 2005. The second note
for $3.3 million is collateralized by the assets purchased
under the note and substantially all of Santeras assets,
excluding the assets collateralized under the $3.2 million
note, bears interest at 6.36% and matures in November 2005.
Under the terms of this facility, we are required to maintain
certain financial reporting covenants. We believe we are in
compliance with these requirements.

Note N  Long-Term Convertible
Debt

On November 2, 1999 we completed a private
placement of $135.0 million aggregate principal amount at
maturity of 3.25% convertible subordinated discounted notes
due in 2004. The notes were issued at 85.35% of their face
amount (equivalent to gross proceeds at issuance of
approximately $115.2 million before discounts and
expenses). The gross proceeds at issuance before discounts and
expenses also included approximately

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##### Table of Contents



TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

$15.2 million from the sale of notes issued
upon the initial purchasers exercise in full of their
over-allotment option.

The notes were issued with a 14.65% discount and
carried a cash interest (coupon) rate of 3.25%, payable on
May 2 and November 2 of each year, commencing on May 2,
2000. The payment of the principal amount of the notes at
maturity together with cash interest paid over the term of the
notes represents a yield to maturity of 6.75% per year,
computed on a semi-annual bond equivalent basis. Interest
expense was computed based on the accretion of the discount, the
accrual of the cash interest payment and the amortization of
expenses related to the offering of these notes on a
straight-line basis, and amounted to $6.2 million,
$9.2 million and $8.9 million for 2003, 2002 and 2001,
respectively.

The discounted notes were called and subsequently
redeemed on July 19, 2003.

In June 2003, we issued and sold $125,000,000
principal amount of our 2.25% Senior Subordinated
Convertible Notes due 2008 (the Notes). The Notes
were issued in a private offering in reliance on
Section 4(2) of the Securities Act of 1933, as amended (the
Securities Act). The initial purchaser of the Notes
was Morgan Stanley & Co. Incorporated, which resold the
Notes to qualified institutional buyers pursuant to
Rule 144A promulgated under the Securities Act. The
aggregate offering price of the Notes was $125,000,000, and the
aggregate proceeds to Tekelec were approximately $121,184,000,
after expenses. The Notes mature on June 15, 2008, and are
convertible prior to the close of business on their final
maturity date into shares of our common stock at a conversion
rate of 50.8906 shares per $1,000 principal amount of the
Notes, subject to adjustment in certain circumstances. There are
no financial covenants related to the Notes and there are no
restrictions on us paying dividends, incurring debt or issuing
or repurchasing securities.

Note O  Commitments and
Contingencies

We lease our office and manufacturing facilities
together with certain office equipment under operating lease
agreements. Lease terms generally range from one to ten years;
certain building leases contain options for renewal for
additional periods and are subject to increases up to 10% every
24 months.

Total rent expense was $8.6 million,
$7.1 million and $6.4 million for 2003, 2002 and 2001,
respectively.

Minimum annual non-cancelable lease commitments
at December 31, 2003 are:

|                    |  |             |        | 
|------------------- |  | ----------- | ------ | 
|For the Years       |  |            
|Ending December 31, |  |            
|                    |  |            
|                    |  | (Thousands)
|2004                |  | $           | 8,365  | 
|2005                |  |             | 6,542  | 
|2006                |  |             | 5,721  | 
|2007                |  |             | 5,820  | 
|2008                |  |             | 5,959  | 
|Thereafter          |  |             | 14,607 | 
|                    |  |             |        | 
|                    |  | $           | 47,014 | 
|                    |  |             |        | 



| |                                            
| | -------------------------------------------
| | Indemnities, Commitments and
    Guarantees

In the normal course of our business, we make
certain indemnities, commitments and guarantees under which we
may be required to make payments in relation to certain
transactions. These indemnities, commitments and guarantees
include, among others, intellectual property indemnities to our
customers in connection with the sale of our products and
licensing of our technology, indemnities for liabilities
associated

F-24



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##### Table of Contents



TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

with the infringement of other parties
technology based upon our products and technology, guarantees of
timely performance of our obligations, and indemnities to our
directors and officers to the maximum extent permitted by law.
The duration of these indemnities, commitments and guarantees
varies, and, in certain cases, is indefinite. The majority of
these indemnities, commitments and guarantees do not provide for
any limitation of the maximum potential future payments that we
could be obligated to make. We have not recorded a liability for
these indemnities, commitments or guarantees in the accompanying
balance sheets because future payment is not probable.



| |           
| | ----------
| | Litigation

From time to time, various claims and litigation
are asserted or commenced against us arising from or related to
contractual matters, intellectual property matters, product
warranties and personnel and employment disputes. As to such
claims and litigation, we can give no assurance that we will
prevail. However, we currently do not believe that the ultimate
outcome of any pending matters, individually or in the
aggregate, will have a material adverse effect on our
consolidated financial position, results of operations or cash
flows.

Note P  Stock Options and Employee
Benefit Plans

As of December 31, 2003, we have five
stock-based employee compensation plans. Under four of the stock
option plans with maximum terms of ten years there are
46.1 million shares of our Common Stock authorized and
reserved for issuance. The terms of options granted under these
option plans are determined at the time of grant, generally vest
ratably over a one- to five-year period, and in any case the
option price may not be less than the fair market value per
share on the date of grant. Both incentive stock options and
nonstatutory stock options can be issued under the option plans.

We also have an Employee Stock Purchase Plan
(ESPP), with a maximum term of ten years, the latest of which
expires in the year 2006, and under which 1.8 million
shares of the Companys Common Stock have been authorized
and reserved for issuance. Eligible employees may authorize
payroll deductions of up to 10% of their compensation to
purchase shares of Common Stock at 85% of the lower of the
market price per share at the beginning or end of each six-month
offering period.

A summary of the status of our stock options, as
of December 31, 2003, 2002 and 2001, and the changes during
the year ended on those dates are presented below (shares in
thousands):

|                                                                    |                                                          |        |        |             |  |        |       |             |  |        |        |             |  |   |       |  |  |  |        |       |  |   |       |  | 
|------------------------------------------------------------------- | -------------------------------------------------------- | ------ | ------ | ----------- |  | ------ | ----- | ----------- |  | ------ | ------ | ----------- |  | - | ----- |  |  |  | ------ | ----- |  | - | ----- |  | 
|                                                                    |                                                          |        |        |             |  |       
|                                                                    |                                                          | 2003   |        | 2002        |  | 2001  
|                                                                    |                                                          |        |        |             |  |       
|                                                                    |                                                          |        |        | Wgtd. Avg.  |  |        |       | Wgtd. Avg.  |  |        |        | Wgtd. Avg. 
|                                                                    |                                                          | Shares |        | Exer. Price |  | Shares |       | Exer. Price |  | Shares |        | Exer. Price
|                                                                    |                                                          |        |        |             |  |        |       |             |  |        |        |            
|Outstanding at beginning of year                                    |                                                          |        | 14,551 |             |  | $      | 20.18 |             |  |        | 14,355 |             |  | $ | 21.17 |  |  |  | 11,600 |       |  | $ | 18.88 | 
|Granted  price equals fair value                                   |                                                          |        | 7,221  |             |  |        | 11.20 |             |  |        | 4,046  |             |  |   | 17.15 |  |  |  | 4,546  |       |  |   | 24.86 | 
|Granted  price greater than fair value                             |                                                          |        |       |             |  |        |      |             |  |        | 120    |             |  |   | 19.21 |  |  |  |       |       |  |   |       | 
|Exercised                                                           |                                                          |        | 644    |             |  |        | 7.92  |             |  |        | 635    |             |  |   | 4.51  |  |  |  | 1,013  |       |  |   | 9.33  | 
|Cancelled                                                           |                                                          |        | 3,074  |             |  |        | 26.76 |             |  |        | 3,335  |             |  |   | 23.61 |  |  |  | 778    |       |  |   | 24.21 | 
|                                                                    |                                                          |        |        |             |  |        |       |             |  |        |        |             |  |   |       |  |  |  |        |       |  |   |       | 
|Outstanding at year-end                                             |                                                          |        | 18,054 |             |  |        | 15.91 |             |  |        | 14,551 |             |  |   | 20.18 |  |  |  | 14,355 |       |  |   | 21.17 | 
|                                                                    |                                                          |        |        |             |  |        |       |             |  |        |        |             |  |   |       |  |  |  |        |       |  |   |       | 
|Options exercisable at year-end                                     |                                                          |        | 9,411  |             |  |        |       |             |  |        | 7,830  |             |  |   |       |  |  |  | 6,169  |       |  |   |       | 
|Options available for future grant                                  |                                                          |        | 5,406  |             |  |        |       |             |  |        | 6,539  |             |  |   |       |  |  |  | 3,869  |       |  |   |       | 
|Weighted average fair value of options granted
    during the year: |                                                          |        |        |             |  |        |       |             |  |        |        |             |  |   |       |  |  |  |        |       |  |   |       | 
|                                                                    | Exercise price equals fair value at grant date           |        | $      | 7.48        |  |        |       |             |  |        | $      | 12.16       |  |   |       |  |  |  | $      | 17.42 |  |   |       |  | 
|                                                                    | Exercise price greater than fair value at grant
    date |        |        |            |  |        |       |             |  |        |        | 10.07       |  |   |       |  |  |  |        |      |  |   |       |  | 

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##### Table of Contents



TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The following table summarizes information about
stock options outstanding at December 31, 2003 (shares in
thousands):

|                        |  |                     |        |                     |  |            |      |                   |  |            |       |  |  |  |       |  |  |   |       | 
|----------------------- |  | ------------------- | ------ | ------------------- |  | ---------- | ---- | ----------------- |  | ---------- | ----- |  |  |  | ----- |  |  | - | ----- | 
|                        |  |                     |        |                    
|                        |  | Options Outstanding |        | Options Exercisable
|                        |  |                     |        |                    
|                        |  |                     |        | Wgtd. Avg.          |  |            |      |                  
|                        |  | Number              |        | Remaining           |  | Wgtd. Avg. |      | Number            |  | Wgtd. Avg.
|                        |  | Outstanding at      |        | Contractual         |  | Exercise   |      | Outstanding at    |  | Exercise  
|Range of Exercise Price |  | December 31, 2003   |        | Life                |  | Price      |      | December 31, 2003 |  | Price     
|                        |  |                     |        |                     |  |            |      |                   |  |           
|$ 2.32 to $ 4.00        |  |                     | 419    |                     |  |            | 2.20 |                   |  | $          | 3.37  |  |  |  | 419   |  |  | $ | 3.37  | 
|4.16 to   9.56          |  |                     | 3,628  |                     |  |            | 5.50 |                   |  |            | 8.27  |  |  |  | 1,243 |  |  |   | 7.72  | 
|9.60 to  12.70          |  |                     | 5,027  |                     |  |            | 5.88 |                   |  |            | 12.08 |  |  |  | 1,488 |  |  |   | 11.33 | 
|12.94 to  21.56         |  |                     | 4,992  |                     |  |            | 6.29 |                   |  |            | 18.10 |  |  |  | 3,034 |  |  |   | 18.19 | 
|22.00 to  27.56         |  |                     | 3,454  |                     |  |            | 6.65 |                   |  |            | 24.96 |  |  |  | 2,780 |  |  |   | 24.82 | 
|30.81 to  48.00         |  |                     | 534    |                     |  |            | 6.57 |                   |  |            | 34.65 |  |  |  | 447   |  |  |   | 34.75 | 
|                        |  |                     |        |                     |  |            |      |                   |  |            |       |  |  |  |       |  |  |   |       | 
|2.32 to  48.00          |  |                     | 18,054 |                     |  |            | 6.00 |                   |  |            | 15.91 |  |  |  | 9,411 |  |  |   | 17.81 | 
|                        |  |                     |        |                     |  |            |      |                   |  |            |       |  |  |  |       |  |  |   |       | 

SFAS No. 123, Accounting for
Stock-Based Compensation (SFAS 123), encourages but
does not require companies to record compensation cost for
stock-based employee compensation plans at fair value for awards
granted subsequent to December 31, 1995. We have chosen to
continue to account for stock-based compensation using the
intrinsic value method prescribed in related interpretations.
However, in accordance with the disclosure only requirements of
SFAS 123, we have computed the fair value of our stock
option grants using the Black-Scholes option-pricing model with
the following assumptions: (i) dividend yield of 0%,
(ii) expected volatility of 82%, 92% and 89%, respectively,
for 2003, 2002 and 2001, (iii) weighted average risk-free
interest rates of 2.2%, 3.7% and 4.8% for 2003, 2002 and 2001,
respectively, (iv) weighted average expected option lives
of 4.13, 4.9 and 4.5 years for 2003, 2002 and 2001,
respectively, and (v) assumed forfeiture rate of 52%, 50%
and 34% for 2003, 2002 and 2001, respectively. See
Note A  Stock-Based Compensation for
the proforma impacts of applying SFAS 123.

In May 2001, we amended the original terms of the
stock option grants of the Chief Executive Officer to provide
that in the event of his Qualifying Retirement (as defined in
the 1994 Stock Option Plan) the exercise period of his stock
options following his termination of employment would be
extended from 90 days (as provided in the original stock
option grant), to the remaining contractual term of the stock
options. In November 2002, the Chief Executive Officer announced
his plans to retire in February 2003 which would meet the
requirement for a Qualifying Retirement. In accordance with
FIN 44, we recorded a $5.3 million non-cash
stock-based compensation charge to general and administrative
expense for the year ended December 31, 2002 to reflect the
difference between the stock option exercise price (average of
$21.43) and the fair market value of our common stock of $32.46
on the date of the May 2001 modification. In addition to the
stock option amendment, we have agreed to pay to the Chief
Executive Officer a one-time cash severance payment of $300,000
upon his retirement and post-retirement health benefits for life
with an estimated present value of $304,000. These amounts have
been fully accrued for and reflected in general and
administrative expense for the year ended December 31, 2003.

During 2003, 2002 and 2001, approximately 89,000,
150,000 and 165,000 shares, respectively, were purchased
under our ESPP at weighted average exercise prices of $9.64,
$6.83 and $18.95, respectively. At December 31, 2003, 2002
and 2001, there were approximately 712,000, 200 and
154,000 shares, respectively, available for future grants.
The weighted average fair values of ESPP shares granted in 2003,
2002 and 2001 were $4.37, $3.30 and $9.23 per share,
respectively.

We have a 401(k) tax-deferred savings plan under
which eligible employees may authorize from 2% to 50% of their
compensation to be invested in employee-elected investment funds
managed by an independent trustee and under which we may
contribute matching funds of up to 50% of the employees
first 12% of payroll

F-26



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##### Table of Contents



TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

deductions. During 2003, 2002 and 2001, our
contributions amounted to $2.9 million, $3.1 million
and $2.7 million respectively.

Note Q  Earnings Per
Share

The following table provides a reconciliation of
the numerators and denominators of the basic and diluted
per-share computations for the years ended December 31,
2003, 2002 and 2001:

|                                                               |  |                                      |        |               |  |           |        |  |  |   |       |  
|-------------------------------------------------------------- |  | ------------------------------------ | ------ | ------------- |  | --------- | ------ |  |  | - | ----- | -
|                                                               |  | Net Income (Loss)                    |        | Shares        |  | Per-Share
|                                                               |  | (Numerator)                          |        | (Denominator) |  | Amount   
|                                                               |  |                                      |        |               |  |          
|                                                               |  |                                     
|                                                               |  | (Thousands except per-share amounts)
|For the Year Ended December 31,
    2003:                      |  |                                      |        |               |  |           |        |  |  |   |       |  
|Basic earnings per share                                       |  | $                                    | 18,452 |               |  |           | 61,163 |  |  | $ | 0.30  |  
|Effect of Dilutive Securities  Stock
    Options and Warrants |  |                                      |       |               |  |           | 1,748  |  |  |   |       |  
|                                                               |  |                                      |        |               |  |           |        |  |  |   |       |  
|Diluted earnings per share                                     |  | $                                    | 18,452 |               |  |           | 62,911 |  |  | $ | 0.29  |  
|                                                               |  |                                      |        |               |  |           |        |  |  |   |       |  
|For the Year Ended December 31,
    2002:                      |  |                                      |        |               |  |           |        |  |  |   |       |  
|Basic loss per share                                           |  | $                                    | 40,918 |               |  |           | 60,358 |  |  | $ | 0.68  |  
|Effect of Dilutive Securities  Stock
    Options and Warrants |  |                                      |       |               |  |           | 1,028  |  |  |   |       |  
|                                                               |  |                                      |        |               |  |           |        |  |  |   |       |  
|Diluted loss per share                                         |  | $                                    | 40,918 |               |  |           | 61,386 |  |  | $ | 0.67  |  
|                                                               |  |                                      |        |               |  |           |        |  |  |   |       |  
|For the Year Ended December 31,
    2001:                      |  |                                      |        |               |  |           |        |  |  |   |       |  
|Basic earnings per share                                       |  | $                                    | (6,899 | )             |  |           | 59,574 |  |  | $ | (0.12 | )
|Effect of Dilutive Securities  Stock
    Options and Warrants |  |                                      |       |               |  |           |       |  |  |   |       |  
|                                                               |  |                                      |        |               |  |           |        |  |  |   |       |  
|Diluted earnings per share                                     |  | $                                    | (6,899 | )             |  |           | 59,574 |  |  | $ | (0.12 | )
|                                                               |  |                                      |        |               |  |           |        |  |  |   |       |  

The computation of diluted number of shares
excludes unexercised stock options and warrants and potential
shares issuable upon conversion of our convertible subordinated
discounted notes and senior subordinated convertible notes that
are anti-dilutive. The numbers of such shares excluded were
16.9 million, 22.3 million and 14.6 million for
the years ended December 31, 2003, 2002 and 2001,
respectively.

There were no transactions subsequent to
December 31, 2003, which, had they occurred prior to
January 1, 2004, would have changed materially the number
of shares in the basic or diluted earnings per share
computations.

Note R  Operating Segment
Information

The Network Signaling operating segment develops,
markets and sells our Eagle signaling products based on our high
capacity Eagle 5 Signaling Application System
(SAS) platform that has recently been expanded to include
TekWare and TekServer architecture, a high-density, high-speed
processing platform that is backward compatible with existing
technology; an SS7/ IP gateway for signaling in converged
networks, and other convergence products; Sentinel, a complete
network monitoring and revenue assurance system; and network
signaling products resulting our acquisition of IEX, including
ASi 4000 Service Control Point, an advanced database server used
for the provisioning of telephony applications.

The Contact Center operating segment develops,
markets and sells software-based solutions for call centers,
including TotalView Workforce Management and TotalNet Call
Routing.

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##### Table of Contents



TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The Next-Generation Switching segment develops,
markets and sells our Santera portfolio of switching solutions
that allows network service providers to migrate their network
infrastructure from circuit-based technology to packet-based
technology. Santeras product portfolio includes
SanteraOne, a carrier-grade, integrated voice and data switching
solution which delivers applications like IXC tandem,
Class 4/5, PRI offload, packet/cell switching and Voice
over Broadband services.

As discussed in Note C 
Disposition of Business, we sold NDD which was comprised of the
Network Diagnostics and the Japan Diagnostics operating
segments. NDD is reflected as a discontinued operation and
accordingly the historical operating segment data has been
restated to exclude the discontinued operation.

Transfers between operating segments are made at
prices reflecting market conditions. The allocation of revenues
from external customers by geographical area is determined by
the destination of the sale.

Our operating segments and geographical
information are as follows (in thousands):

Operating Segments

|                          |                    |          |         |         |  |      |         |         |  |   |         |         | 
|------------------------- | ------------------ | -------- | ------- | ------- |  | ---- | ------- | ------- |  | - | ------- | ------- | 
|                          |                    |         
|                          |                    | Revenues
|                          |                    |         
|                          |                    | 2003     |         | 2002    |  | 2001
|                          |                    |          |         |         |  |     
|Network Signaling         |                    | $        | 216,430 |         |  | $    | 221,492 |         |  | $ | 211,138 |        
|Contact Center            |                    |          | 35,820  |         |  |      | 38,849  |         |  |   | 38,231  |        
|Next-Generation Switching |                    |          | 11,450  |         |  |      |        |         |  |   |        |        
|                          |                    |          |         |         |  |      |         |         |  |   |         |        
|                          | Total net revenues |          | $       | 263,700 |  |      | $       | 260,341 |  |   | $       | 249,369 | 
|                          |                    |          |         |         |  |      |         |         |  |   |         |        

|                          |                                     |                               |         |        |  |      |         |        |  |   |         |      |  
|------------------------- | ----------------------------------- | ----------------------------- | ------- | ------ |  | ---- | ------- | ------ |  | - | ------- | ---- | -
|                          |                                     |                              
|                          |                                     | Income (Loss) From Operations
|                          |                                     |                              
|                          |                                     | 2003                          |         | 2002   |  | 2001
|                          |                                     |                               |         |        |  |     
|Network Signaling         |                                     | $                             | 70,654  |        |  | $    | 59,103  |        |  | $ | 46,956  |     
|Contact Center            |                                     |                               | 11,959  |        |  |      | 15,213  |        |  |   | 16,986  |     
|Next-Generation Switching |                                     |                               | (22,831 | )      |  |      |        |        |  |   |        |     
|General Corporate(1)      |                                     |                               | (48,332 | )      |  |      | (47,999 | )      |  |   | (64,098 | )   
|                          |                                     |                               |         |        |  |      |         |        |  |   |         |     
|                          | Total income (loss) from operations |                               | $       | 11,450 |  |      | $       | 26,317 |  |   | $       | (156 | )
|                          |                                     |                               |         |        |  |      |         |        |  |   |         |     



---



|    |                                                                                                                                                                                                                                                                                                                                            
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | General Corporate includes acquisition-related
    charges and amortization of $15,325, $11,200 and $31,264 for
    2003, 2002 and 2001 respectively, and other corporate expenses
    that are not specifically allocated to the operating segments or
    used by operating segment management to evaluate their segment
    performance.

Enterprise Wide Disclosures

The following table sets forth, for the periods
indicated, revenues from external customers by principal product
line (in thousands):

|                          |                                        |      |         |         |  |      |         |         |  |   |         |         | 
|------------------------- | -------------------------------------- | ---- | ------- | ------- |  | ---- | ------- | ------- |  | - | ------- | ------- | 
|                          |                                        | 2003 |         | 2002    |  | 2001
|                          |                                        |      |         |         |  |     
|Network Signaling         |                                        | $    | 216,430 |         |  | $    | 221,492 |         |  | $ | 211,138 |        
|Contact Center            |                                        |      | 35,820  |         |  |      | 38,849  |         |  |   | 38,231  |        
|Next-Generation Switching |                                        |      | 11,450  |         |  |      |        |         |  |   |        |        
|                          |                                        |      |         |         |  |      |         |         |  |   |         |        
|                          | Total revenues from external customers |      | $       | 263,700 |  |      | $       | 260,341 |  |   | $       | 249,369 | 
|                          |                                        |      |         |         |  |      |         |         |  |   |         |        

F-28



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##### Table of Contents



TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The following table sets forth, for the periods
indicated, revenues from external customers by geographic
territory (in thousands):

|              |                                        |      |         |         |  |      |         |         |  |   |         |         | 
|------------- | -------------------------------------- | ---- | ------- | ------- |  | ---- | ------- | ------- |  | - | ------- | ------- | 
|              |                                        | 2003 |         | 2002    |  | 2001
|              |                                        |      |         |         |  |     
|North America |                                        | $    | 218,540 |         |  | $    | 214,493 |         |  | $ | 207,616 |        
|Europe        |                                        |      | 16,573  |         |  |      | 26,309  |         |  |   | 9,967   |        
|Rest of World |                                        |      | 28,587  |         |  |      | 19,539  |         |  |   | 31,786  |        
|              |                                        |      |         |         |  |      |         |         |  |   |         |        
|              | Total revenues from external customers |      | $       | 263,700 |  |      | $       | 260,341 |  |   | $       | 249,369 | 
|              |                                        |      |         |         |  |      |         |         |  |   |         |        

The following table sets forth, for the periods
indicated, long-lived assets by geographic area in which we hold
assets (in thousands):

|              |                         |      |         |         |  |   |        |        | 
|------------- | ----------------------- | ---- | ------- | ------- |  | - | ------ | ------ | 
|              |                         | 2003 |         | 2002   
|              |                         |      |         |        
|United States |                         | $    | 147,696 |         |  | $ | 84,064 |       
|Other         |                         |      | 1,161   |         |  |   | 857    |       
|              |                         |      |         |         |  |   |        |       
|              | Total long-lived assets |      | $       | 148,857 |  |   | $      | 84,921 | 
|              |                         |      |         |         |  |   |        |       

For the year ended December 31, 2003, sales
to one customer accounted for 10% of our revenue and included
sales from all operating segments. There were no customers
accounting for 10% or more of the revenues in 2002. For the year
ended December 31, 2001, sales to two customers accounted
for 16% and 10% of the revenues and included sales from the
network signaling and contact center operating segments.

Note S  Common Stock

Warrants:At
December 31, 2003 and 2002, we had warrants outstanding to
purchase an aggregate of 195,000 shares of its Common
Stock, as more fully discussed below.

In July 1997, we issued warrants to purchase a
total of 360,000 shares of our Common Stock to five
directors and one corporate officer at $14.08 per share.
These warrants vested and became exercisable in 12 equal
quarterly installments beginning on September 30, 1997.
During 2003 and 2002, none of these warrants were exercised and
warrants to purchase 195,000 were outstanding at
December 31, 2003 and December 31, 2002.

Restricted Stock:In
February 2001, we granted a restricted stock award of
30,000 shares of our Common Stock to a corporate officer in
connection with the commencement of his employment. The
restricted shares vest in four equal annual installments
beginning in February 2002. This award was valued at $827,000,
which is being recognized as stock-based compensation expense
over the term of the award.

In May 2003, we granted a restricted stock
award of 25,000 shares of our Common Stock to five
directors in connection with additional compensation for
services rendered to us. The restricted shares vest in four
equal quarterly installments over one year beginning in
May 2003. This award was valued at $319,000, which is being
recognized as stock-based compensation expense over the term of
the award.

F-29



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##### Table of Contents



TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Note T  Quarterly Financial Summary
(Unaudited)

|                                                                               |         |                                    |        |        |   |       |        |        |   |   |        |        |   |   |        |        |  
|------------------------------------------------------------------------------ | ------- | ---------------------------------- | ------ | ------ | - | ----- | ------ | ------ | - | - | ------ | ------ | - | - | ------ | ------ | -
|                                                                               |         |                                   
|                                                                               |         | Quarters                          
|                                                                               |         |                                   
|For the Years Ended December 31,                                               |         | First                              |        | Second |   | Third |        | Fourth
|                                                                               |         |                                    |        |        |   |       |        |       
|                                                                               |         |                                   
|                                                                               |         | (Thousands, except per-share data)
|2003                                                                           |         |                                    |        |        |   |       |        |        |   |   |        |        |   |   |        |       
|Revenues                                                                       |         | $                                  | 55,006 |        |   | $     | 62,922 |        |   | $ | 70,747 |        |   | $ | 75,025 |       
|Gross profit                                                                   |         |                                    | 39,394 |        |   |       | 43,875 |        |   |   | 53,295 |        |   |   | 57,261 |       
|Income (Loss) from continuing operations before
    provision for income taxes |         |                                    | 2,146  |        |   |       | (1,280 | )      |   |   | 2,129  |        |   |   | 5,972  |       
|Minority interest                                                              |         |                                    |       |        |   |       | 4,505  |        |   |   | 8,015  |        |   |   | 7,272  |       
|Income (Loss) from continuing operations                                       |         |                                    | 1,514  |        |   |       | 1,210  |        |   |   | 5,157  |        |   |   | 7,278  |       
|Gain on sale of discontinued operation, net of
    income taxes                |         |                                    |       |        |   |       |       |        |   |   | 3,293  |        |   |   |       |       
|Net income                                                                     |         |                                    | 1,514  |        |   |       | 1,210  |        |   |   | 8,450  |        |   |   | 7,278  |       
|Earnings per share from continuing operations:                                 |         |                                    |        |        |   |       |        |        |   |   |        |        |   |   |        |       
|                                                                               | Basic   |                                    | $      | 0.02   |   |       | $      | 0.02   |   |   | $      | 0.09   |   |   | $      | 0.12   |  
|                                                                               | Diluted |                                    |        | 0.02   |   |       |        | 0.02   |   |   |        | 0.08   |   |   |        | 0.11   |  
|Earnings per share from gain on sale of
    discontinued operation:            |         |                                    |        |        |   |       |        |        |   |   |        |        |   |   |        |       
|                                                                               | Basic   |                                    | $      |       |   |       | $      |       |   |   | $      | 0.05   |   |   | $      |       |  
|                                                                               | Diluted |                                    |        |       |   |       |        |       |   |   |        | 0.05   |   |   |        |       |  
|Earnings per share:                                                            |         |                                    |        |        |   |       |        |        |   |   |        |        |   |   |        |       
|                                                                               | Basic   |                                    | $      | 0.02   |   |       | $      | 0.02   |   |   | $      | 0.14   |   |   | $      | 0.12   |  
|                                                                               | Diluted |                                    |        | 0.02   |   |       |        | 0.02   |   |   |        | 0.13   |   |   |        | 0.11   |  
|Weighted average number of shares outstanding:                                 |         |                                    |        |        |   |       |        |        |   |   |        |        |   |   |        |       
|                                                                               | Basic   |                                    |        | 60,934 |   |       |        | 61,032 |   |   |        | 61,206 |   |   |        | 61,481 |  
|                                                                               | Diluted |                                    |        | 61,632 |   |       |        | 62,276 |   |   |        | 69,915 |   |   |        | 70,544 |  
|2002                                                                           |         |                                    |        |        |   |       |        |        |   |   |        |        |   |   |        |       
|Revenues                                                                       |         | $                                  | 60,364 |        |   | $     | 68,010 |        |   | $ | 73,544 |        |   | $ | 58,423 |       
|Gross profit                                                                   |         |                                    | 39,035 |        |   |       | 48,333 |        |   |   | 54,589 |        |   |   | 41,679 |       
|Income (Loss) from continuing operations before
    provision for income taxes |         |                                    | 3,698  |        |   |       | 7,238  |        |   |   | 14,084 |        |   |   | (966   | )     
|Income (Loss) from continuing operations                                       |         |                                    | 2,513  |        |   |       | 4,735  |        |   |   | 9,324  |        |   |   | (658   | )     
|Income (Loss) from discontinued operation, net of
    income taxes             |         |                                    | (1,192 | )      |   |       | (218   | )      |   |   | (1,898 | )      |   |   |       |       
|Gain on sale of discontinued operation, net of
    income taxes                |         |                                    |       |        |   |       |       |        |   |   | 28,312 |        |   |   |       |       
|Net income (loss)                                                              |         |                                    | 1,321  |        |   |       | 4,517  |        |   |   | 35,738 |        |   |   | (658   | )     
|Earnings (Loss) per share from continuing
    operations:                      |         |                                    |        |        |   |       |        |        |   |   |        |        |   |   |        |       
|                                                                               | Basic   |                                    | $      | 0.04   |   |       | $      | 0.08   |   |   | $      | 0.15   |   |   | $      | (0.01  | )
|                                                                               | Diluted |                                    |        | 0.04   |   |       |        | 0.08   |   |   |        | 0.16   |   |   |        | (0.01  | )
|Earnings (Loss) per share from discontinued
    operation:                     |         |                                    |        |        |   |       |        |        |   |   |        |        |   |   |        |       
|                                                                               | Basic   |                                    | $      | (0.02  | ) |       | $      |       |   |   | $      | (0.03  | ) |   | $      |       |  
|                                                                               | Diluted |                                    |        | (0.02  | ) |       |        | (0.01  | ) |   |        | (0.03  | ) |   |        |       |  
|Earnings per share from gain on sale of
    discontinued operation:            |         |                                    |        |        |   |       |        |        |   |   |        |        |   |   |        |       
|                                                                               | Basic   |                                    | $      |       |   |       | $      |       |   |   | $      | 0.47   |   |   | $      |       |  
|                                                                               | Diluted |                                    |        |       |   |       |        |       |   |   |        | 0.41   |   |   |        |       |  
|Earnings (Loss) per share:                                                     |         |                                    |        |        |   |       |        |        |   |   |        |        |   |   |        |       
|                                                                               | Basic   |                                    | $      | 0.02   |   |       | $      | 0.08   |   |   | $      | 0.59   |   |   | $      | (0.01  | )
|                                                                               | Diluted |                                    |        | 0.02   |   |       |        | 0.07   |   |   |        | 0.54   |   |   |        | (0.01  | )
|Weighted average number of shares outstanding:                                 |         |                                    |        |        |   |       |        |        |   |   |        |        |   |   |        |       
|                                                                               | Basic   |                                    |        | 60,143 |   |       |        | 60,197 |   |   |        | 60,407 |   |   |        | 60,687 |  
|                                                                               | Diluted |                                    |        | 61,776 |   |       |        | 61,180 |   |   |        | 68,793 |   |   |        | 60,687 |  

For the three months ended September 30,
2003 and December 31, 2003, the calculation of earnings per
share includes, for the purposes of the calculation, the
add-back to net income of $591 and $590, respectively,

F-30



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##### Table of Contents



TEKELEC


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

for assumed after-tax interest cost related to
the convertible debt using the if-converted method
of accounting for diluted earnings per share. The weighted
average number of shares outstanding for each of the three
months ended September 30, 2003, and December 31, 2003
includes 6,361 shares related to the convertible debt using
the if-converted method.

For the three months ended September 30,
2002, the calculation of earnings per share includes, for the
purposes of the calculation, the add-back to net income of
$1,498 for assumed after-tax interest cost related to the
convertible subordinated discounted notes using the
if-converted method of accounting for diluted
earnings per share. The weighted average number of shares
outstanding for the three months ended September 30, 2002
includes 7,606 shares related to the convertible debt using
the if-converted method.

Typically a substantial portion of our revenues
in each quarter result from orders received in that quarter.
Further, we typically generate a significant portion of our
revenues for each quarter in the last month of the quarter. We
establish our expenditure levels based on our expectations as to
future revenues, and if revenue levels were to fall below
expectations this would cause expenses to be disproportionately
high. Therefore, a drop in near-term demand would significantly
affect revenues, causing a disproportionate reduction in profits
or even losses in a quarter. Our quarterly operating results may
fluctuate as a result of a number of factors, including general
economic and political conditions (such as recessions in the
U.S. or Europe), capital spending patterns of our
customers, increased competition, variations in the mix of
sales, fluctuation in proportion of foreign sales, and
announcements of new products by us or our competitors.

Note U  Subsequent Events
(Unaudited)

In January 2004 we began a transition plan to
relocate manufacturing facilities from Calabasas, California to
our facilities in Morrisville, North Carolina. The transition
will take place throughout 2004 with an anticipated completion
during the fourth quarter.

On February 25, 2004, we announced that we
entered into a definitive agreement to purchase
Taqua, Inc., a leading privately-held provider of
next-generation Class 5 packet switching systems, located
in Richardson, Texas. We are purchasing all of Taquas
outstanding stock, for approximately $85 million cash, plus
assuming outstanding options. The purchase is expected to close
no later than April 2004, pending United States anti-trust
approval and the completion of certain contractual requirements.
Taqua will become part of our next-generation switching
business. Taqua brings to Tekelec a Class 5 switching
solution optimized for the small switch service provider market.
This complements our existing SanteraOne platform which is
optimized for the mid to large size Class 4, Class 5
and wireless markets.

F-31



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##### Table of Contents



REPORT OF INDEPENDENT AUDITORS ON FINANCIAL
STATEMENT SCHEDULE

To the Shareholders and Board of Directors of
Tekelec

Our audits of the consolidated financial
statements referred to in our report dated January 30, 2004
appearing in the Annual Report to Shareholders of Tekelec (which
report and consolidated financial statements are included in
this Annual Report on Form 10-K) also included an audit of
the financial statement schedule appearing on page S-2 of
this Form 10-K. In our opinion, this financial statement
schedule presents fairly, in all material respects, the
information set forth therein when read in conjunction with the
related consolidated financial statements.

/s/ PricewaterhouseCoopers LLP

Los Angeles, California

January 30, 2004


S-1



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##### Table of Contents



TEKELEC

VALUATION AND QUALIFYING ACCOUNTS AND
RESERVES

|                                |  |             |       |            |  |             |       |            |  |   |       |     |  |   |       | 
|------------------------------- |  | ----------- | ----- | ---------- |  | ----------- | ----- | ---------- |  | - | ----- | --- |  | - | ----- | 
|Column A                        |  | Column B    |       | Column C   |  | Column D    |       | Column E  
|                                |  |             |       |            |  |             |       |           
|                                |  |             |       | Additions  |  |             |       |           
|                                |  | Balance at  |       | Charged to |  | Deductions  |       | Balance at
|                                |  | Beginning   |       | Costs and  |  | and other   |       | End of    
|Description                     |  | of Period   |       | Expenses   |  | Adjustments |       | Period    
|                                |  |             |       |            |  |             |       |           
|                                |  |            
|                                |  | (Thousands)
|Year ended December 31, 2001:   |  |             |       |            |  |             |       |            |  |   |       |     |  |   |       | 
|Allowance for doubtful accounts |  | $           | 4,287 |            |  | $           | 4,412 |            |  | $ | 3,350 |     |  | $ | 5,349 | 
|Product warranty                |  |             | 3,434 |            |  |             | 3,965 |            |  |   | 1,937 |     |  |   | 5,462 | 
|                               
|Year ended December 31, 2002:   |  |             |       |            |  |             |       |            |  |   |       |     |  |   |       | 
|Allowance for doubtful accounts |  | $           | 5,349 |            |  | $           | 950   |            |  | $ | 1,439 | (1) |  | $ | 4,860 | 
|Product warranty                |  |             | 5,462 |            |  |             | 3,617 |            |  |   | 3,808 | (2) |  |   | 5,271 | 
|                               
|Year ended December 31, 2003:   |  |             |       |            |  |             |       |            |  |   |       |     |  |   |       | 
|Allowance for doubtful accounts |  | $           | 4,860 |            |  | $           | 415   |            |  | $ | 2,656 | (3) |  | $ | 2,619 | 
|Product warranty                |  |             | 5,271 |            |  |             | 1,396 |            |  |   | 1,608 | (4) |  |   | 5,059 | 



---



|    |                                                            
|--- | -----------------------------------------------------------
|(1) | Includes $782 as a result of the disposition of
    NDD    
|   
|(2) | Includes $442 as a result of the disposition of
    NDD    
|   
|(3) | Includes $527 as a result of the acquisition of
    Santera
|   
|(4) | Includes $438 as a result of the acquisition of
    Santera

S-2



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##### Table of Contents



EXHIBIT INDEX

|        |    |             |  |                                                                                                                                                                                                                |  |  |  | 
|------- | -- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | 
|        |    |             |  | Sequentially                                                                                                                                                                                                  
|Exhibit |    |             |  | Numbered                                                                                                                                                                                                      
|Number  |    | Description |  | Page                                                                                                                                                                                                          
|        |    |             |  |                                                                                                                                                                                                               
|        | 3  | .2          |  | Amendment No. 1 to Bylaws, as amended.                                                                                                                                                                         |  |  |  | 
|        | 14 | .1          |  | Code of Ethics for Chief Executive and Senior
    Financial Officers.                                                                                                                                          |  |  |  | 
|        | 21 | .1          |  | Subsidiaries of the Registrant.                                                                                                                                                                                |  |  |  | 
|        | 23 | .1          |  | Consent of PricewaterhouseCoopers LLP.                                                                                                                                                                         |  |  |  | 
|        | 31 | .1          |  | Certification of President and Chief Executive
    Officer of Registrant pursuant to Rule 13a-14(a) under the
    Exchange Act, as adopted pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.      |  |  |  | 
|        | 31 | .2          |  | Certification of Vice President and Chief
    Financial Officer of Registrant pursuant to Rule 13a-14(a)
    under the Exchange Act, as adopted pursuant to Section 302
    of the Sarbanes-Oxley Act of 2002. |  |  |  | 
|        | 32 | .1          |  | Certification of Chief Executive Officer and
    Chief Financial Officer of Tekelec pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.          |  |  |  |