##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549


Form 10-K

|           |  |                                                                                                 
|---------- |  | ------------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                                 
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended September 30,
    2004                                                
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the transition period
    from          to          .                                       

Commission File Number: 0-24701

Catapult Communications Corporation

(Exact name of Registrant as specified in its
charter)


|                         |  |                                         
|------------------------ |  | ----------------------------------------
|Nevada                   |  | 77-0086010                              
|(State of Incorporation) |  | (IRS Employer
    Identification Number)

160 South Whisman Road, Mountain View,
California 94041

(Address of principal executive offices,
including zip code)


Registrants telephone number, including
area code:

(650) 960-1025


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

None


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

Common Stock, $0.001 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 a 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.     o

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Rule 12b-2 of the
Exchange
Act).     Yes þ          No o

The aggregate market value of the voting stock
held by non-affiliates of the Registrant (based upon the closing
price of the Registrants common stock on March 31,
2004 of $17.86 per share) was approximately $127,274,468.
Shares of common stock held by each executive officer and
director of the outstanding common stock have been excluded in
that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a
conclusive determination for other purposes.

As of November 30, 2004,
14,616,050 shares of the Registrants common stock,
$0.001 par value, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates information by
reference from the definitive proxy statement for the Annual
Meeting of Stockholders scheduled to be held on January 25,
2005.









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TABLE OF CONTENTS

|             |  |                                                                                           |  |  |    |  |  | 
|------------ |  | ----------------------------------------------------------------------------------------- |  |  | -- |  |  | 
|PART I      
|ITEM 1.      |  | BUSINESS                                                                                  |  |  | 2  | 
|ITEM 2.      |  | PROPERTIES                                                                                |  |  | 12 | 
|ITEM 3.      |  | LEGAL PROCEEDINGS                                                                         |  |  | 13 | 
|ITEM 4.      |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY
    HOLDERS                                   |  |  | 13 | 
|PART II     
|ITEM 5.      |  | MARKET FOR THE REGISTRANTS COMMON EQUITY
    AND RELATED STOCKHOLDER MATTERS             |  |  | 13 | 
|ITEM 6.      |  | SELECTED FINANCIAL DATA                                                                   |  |  | 13 | 
|ITEM 7.      |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF
    FINANCIAL CONDITION AND RESULTS OF OPERATIONS |  |  | 16 | 
|ITEM 7A.     |  | QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
    MARKET RISKS                            |  |  | 33 | 
|ITEM 8.      |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                               |  |  | 34 | 
|ITEM 9.      |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
    ACCOUNTING AND FINANCIAL DISCLOSURE  |  |  | 59 | 
|ITEM 9A.     |  | CONTROLS AND PROCEDURES                                                                   |  |  | 59 | 
|ITEM 9B.     |  | OTHER INFORMATION                                                                         |  |  | 60 | 
|PART III    
|ITEM 10.     |  | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                        |  |  | 60 | 
|ITEM 11.     |  | EXECUTIVE COMPENSATION                                                                    |  |  | 60 | 
|ITEM 12.     |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
    AND MANAGEMENT                        |  |  | 60 | 
|ITEM 13.     |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                            |  |  | 60 | 
|ITEM 14.     |  | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                    |  |  | 60 | 
|PART IV     
|ITEM 15.     |  | EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
    REPORTS ON FORM 8-K                      |  |  | 61 | 
|EXHIBIT 21.1
|EXHIBIT 23.1
|EXHIBIT 31.1
|EXHIBIT 31.2
|EXHIBIT 32  



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FORWARD-LOOKING STATEMENTS

THIS REPORT ON FORM 10-K CONTAINS STATEMENTS THAT
ARE NOT HISTORICAL FACTS BUT ARE FORWARD-LOOKING STATEMENTS
RELATING TO SUCH MATTERS AS ANTICIPATED FINANCIAL PERFORMANCE,
BUSINESS PROSPECTS, TECHNOLOGICAL DEVELOPMENTS, NEW PRODUCTS,
THE INTEGRATION OF THE BUSINESS ACQUIRED DURING THE PREVIOUS
FISCAL YEAR AND SIMILAR MATTERS. SUCH STATEMENTS ARE GENERALLY
IDENTIFIED BY THE USE OF FORWARD-LOOKING WORDS AND PHRASES, SUCH
AS INTENDED, EXPECTS,
ANTICIPATES AND IS (OR ARE) EXPECTED (OR
ANTICIPATED). THESE FORWARD-LOOKING STATEMENTS INCLUDE BUT
ARE NOT LIMITED TO THOSE IDENTIFIED IN THIS REPORT WITH AN
ASTERISK (*) SYMBOL. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM
THOSE DISCUSSED IN SUCH FORWARD-LOOKING STATEMENTS, AND OUR
STOCKHOLDERS SHOULD CAREFULLY REVIEW THE CAUTIONARY STATEMENTS
SET FORTH IN THIS REPORT ON FORM 10-K, INCLUDING THOSE SET FORTH
UNDER THE CAPTION FACTORS THAT MAY AFFECT FUTURE
RESULTS.

WE MAY FROM TIME TO TIME MAKE ADDITIONAL WRITTEN
AND ORAL FORWARD-LOOKING STATEMENTS, INCLUDING STATEMENTS
CONTAINED IN OUR FILINGS WITH THE SECURITIES AND EXCHANGE
COMMISSION AND IN OUR REPORTS TO STOCKHOLDERS. WE DO NOT
UNDERTAKE TO UPDATE ANY FORWARD-LOOKING STATEMENTS THAT MAY BE
MADE FROM TIME TO TIME BY US OR ON OUR BEHALF.




PART I






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

The Company

Catapult Communications Corporation
(we, Catapult, the Company
or the Registrant) designs, develops, manufactures,
markets and supports advanced software-based test systems for
the global telecommunications industry. Our DCT, MGTS and
Chameleon products are digital communications test systems
designed to enable equipment manufacturers and network operators
to deliver complex digital telecommunications equipment and
services more quickly and cost-effectively, while helping to
ensure interoperability and reliability. Our advanced software
and hardware assist customers in the design, integration,
installation and acceptance testing of a broad range of digital
telecommunications equipment and services by performing a
variety of test functions, including:



| |   |                                 
| | - | --------------------------------
| |  | design and feature verification;
|
| |  | conformance testing;            
|
| |  | interoperability testing;       
|
| |  | load and stress testing; and    
|
| |  | monitoring and analysis.        

We market our products through our direct sales
force with offices in the United States, the United Kingdom,
Germany, France, Finland, Canada, Japan and China. In other
markets, we use distributors. Our end customers include industry
leaders such as Alcatel, Cingular Wireless, Evolium SAS, Fujitsu
Limited, LM Ericsson, Lucent Technologies, Inc., Motorola, Inc.,
NEC Corporation, Nippon Telephone and Telegraph, Nokia
Corporation, Nortel Networks Limited, NTT DoCoMo, Inc., Siemens
AG and Vodafone Group Plc.

Catapult was incorporated in California in
October 1985, reincorporated in Nevada in 1998, and has
operations in the United States, Canada, the United Kingdom,
Germany, France, Finland, Japan, China and

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Australia. We completed our initial public
offering in 1999 and acquired the Network Diagnostics Business
(NDB) from Tekelec in 2002.


We are subject to the informational requirements
of the Securities Exchange Act of 1934 (the Exchange Act) and
hence file periodic reports, proxy statements and other
information with the Securities and Exchange Commission (the
SEC). Such reports, proxy statements and other information may
be obtained by visiting the Public Reference Room of the SEC at
450 Fifth Street, NW, Washington, DC 20549 or by calling
the SEC at 1-800-SEC-0330. In addition, the SEC maintains an
Internet site (http://www.sec.gov) that contains reports, proxy
and information statements and other information regarding
issuers that file electronically.

Financial and other information can also be
obtained at our web site, www.catapult.com, where we make
available, free of charge, copies of our annual report on
Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and amendments to those reports filed
or furnished pursuant to Section 13(a) or 15(d) of the
Exchange Act as soon as reasonably practicable after filing such
material electronically or otherwise furnishing it to the SEC.

Recent Stock Offering

In September 2004, we completed an underwritten
stock offering that included 200,000 shares of Common Stock
newly issued by us, 1,081,250 shares which Tekelec received
upon conversion of $17.3 million in notes issued by our
Irish subsidiary in connection with the acquisition of NDB, and
an aggregate of 300,000 shares sold by Dr. Richard
Karp, our Chairman and Chief Executive Officer, and by Nancy
Karp, one of our directors. In October 2004, Dr. Karp and
Ms. Karp sold an aggregate of 137,187 additional shares of
our Common Stock pursuant to an over-allotment option they had
granted to the underwriters. In November 2004, Dr. Karp and
Ms. Karp sold a further 950,000 shares of Common Stock
in an underwritten offering.

Our DCT, MGTS and Chameleon Products

Our telecommunications test product line consists
of three products: the DCT system, originally introduced in 1985
and since extensively enhanced; the MGTS system, acquired in
connection with the acquisition of NDB; and the Chameleon
protocol analyzer, announced in February 2004 and released for
beta test in the fourth calendar quarter of 2004.

The DCT and MGTS products perform a variety of
test functions, including design and feature verification,
conformance testing, interoperability testing, load and stress
testing, and monitoring and analysis. We maintain an extensive
library of software modules that provide test support for a
large number of industry standard protocols and variants
thereon. Our emphasis is on testing complex, high-level and
emerging protocols, including:



| |   |                                                                                   
| | - | ----------------------------------------------------------------------------------
| |  | Third and Fourth Generation Cellular (3G and 4G),
    including UMTS and cdma2000;
|
| |  | General Packet Radio Service (GPRS);                                              
|
| |  | Global Systems for Mobile Communications (GSM);                                   
|
| |  | Code Division Multiple Access (CDMA);                                             
|
| |  | IP Telephony (Voice over IP or VoIP);                                             
|
| |  | Asynchronous Transfer Mode (ATM); and                                             
|
| |  | Signaling System #7 (SS7).                                                        

Our extensive technical know-how and proprietary
software development tools enable us to implement test support
for new protocols and protocol variants rapidly in response to
customer needs. With their extensive libraries of software
protocol test modules, large selection of proprietary hardware
physical interfaces and versatile range of hardware platforms,
the DCT and MGTS products are easily configured to support a
wide variety of digital testing functions, thereby reducing a
customers need for multiple test systems. In addition, the
DCT and MGTS systems multi-protocol, multi-user
capabilities allow multiple complex testing

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operations to be performed simultaneously,
helping our customers to accelerate their product development
cycles.


DCT and MGTS systems consist of advanced
proprietary software running on third-party Sun Microsystems
SolarisTM UNIX-based workstations or Linux-based
computers together with our proprietary hardware interfaces.
When acquiring a system, customers typically license one or more
software modules and purchase hardware and ongoing software
support. Customers may upgrade their systems by purchasing
additional software protocol test modules and additional
hardware interfaces to meet future testing needs. Prices for DCT
and MGTS systems vary widely depending upon the overall system
configuration, including the number and type of software
protocol modules and the number of physical interfaces required
by the customer. A DCT or MGTS system sale typically ranges in
price from approximately $50,000 to over $250,000.

The Chameleon protocol analyzer consists of
advanced proprietary software running on a third-party
Linux-based rack-mount or portable personal computer together
with our proprietary hardware interfaces. A Chameleon protocol
analyzer typically will range in price from approximately
$30,000 to $45,000.



| |             
| | ------------
| | Applications

The principal applications of the DCT and MGTS
systems are feature verification, conformance testing,
interoperability testing, load and stress testing, and
monitoring and analysis. The principal application of Chameleon
is monitoring and analysis.

Feature
Verification.DCT and MGTS systems
perform feature verification by simulating one or more network
devices and testing a wide variety of possible scenarios to
establish that the device under test handles all features
specified by the protocol. The user is able to initiate multiple
simultaneous calls across one or many links, create correct call
scenarios, send messages out of sequence to verify error
response mechanisms and verify a voice or data path.

Conformance Testing.DCT and MGTS systems verify that network devices conform to
industry standards. Because industry standards for protocols are
constantly changing, we regularly develop new protocol test
modules and update existing protocol test modules so that
customers can validate the implementation of new features and
the functionality of existing features against those standards.

Interoperability
Testing.DCT and MGTS systems simulate
one or more network devices, emulating their actions and
responses. By simulating various network devices, such as
digital switches, wireless base stations, network access nodes
and network databases, our products assist engineers
cost-effectively to develop equipment that will be compatible
with the networks within which they will be deployed. This helps
ensure that equipment will interoperate reliably, thereby
reducing costly failures after installation.

Load and Stress
Testing.DCT and MGTS systems verify
that a device under test can successfully handle its designed
traffic capacity and that its performance will degrade
gradually, rather than fail completely, when stressed beyond its
specifications. The scalable architectures of the DCT and MGTS
systems combined with the recently introduced m5000 hardware
platform described below significantly improve our ability to
address our customers growing need to generate and
maintain high traffic volumes for load testing.

Monitoring and
Analysis.DCT and MGTS systems are
used in development laboratories to monitor network links and
store network activity information for future analysis,
typically without affecting network traffic. By collecting and
analyzing traffic, our systems help ensure that the links have
been brought into service and that the devices connected by the
links are functioning properly. DCT and MGTS systems can also
provide notice of network device failure, set traps
and triggers, count error messages and filter
packets by address or selected field criteria. Our systems can
simultaneously monitor multiple links, each of which may be
using different protocols. Chameleon is intended to be used to
perform these functions on a more cost-effective basis in
operating and field test environments as well as in development
labs.

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| |                                         
| | ----------------------------------------
| | DCT and, MGTS and Chameleon
    Software

Our test systems run under the Sun Microsystems
SolarisTM UNIXTM or LinuxTM
operating system and consist of proprietary test software,
specialized programming languages and tools, graphical user
interfaces and extensive libraries of proprietary test modules
for a large number of protocols and variants. This enables the
systems to be configured for many different applications. Test
modules are developed in accordance with telecom industry
standard specifications and may include protocol encoders and
decoders, state machines, validation tests and conformance test
suites.

DCT and MGTS systems include a number of
productivity tools. Using the DCT, customers may choose to
program their tests by using our graphical user interface,
CATTgen, or by writing their own code using our Digital
Communication Programming Language, DCPL. DCPL is a fully
featured, optimized communications language. DCT customers can
also choose to integrate their own libraries of test subroutines
written in industry standard programming languages such as C or
C++. Using the MGTS system, customers may implement their tests
using our Protocol Adaptable State Machine, PASM. PASM allows
the user to construct custom tests in a graphical environment.
The DCT and MGTS products also provide Quick Start
applications to aid in training new users and provide a starting
point for developing new test applications.

Chameleon is an advanced protocol analyzer
designed to assist in 3G wireless network development and
deployment. Chameleon provides a rich set of monitoring and
analysis tools that enable users to understand and resolve
network protocol issues and to diagnose and troubleshoot complex
interfaces. Chameleon provides both real-time and
post-processing capabilities, including a trace feature that
allows tracking individual calls at the protocol layer level.
Chameleon provides decode analysis down to the bit level with a
single mouse click, making it possible to understand
protocol-related problems quickly and easily.



| |                                     
| | ------------------------------------
| | DCT, MGTS and Chameleon
    Hardware

Our products employ modular hardware
architectures that support a wide variety of proprietary
physical interfaces connecting the systems to devices under test.

Until September, 2004 both the DCT and MGTS
products utilized Sun Microsystems workstations for control
purposes but each product used different proprietary hardware
physical interfaces. The DCT2000 extends the processing power of
the workstation by means of a family of interface cards, each of
which includes a PowerPC processor. The MGTS i3000 system is
based on a distributed-processor architecture with one central
controller and up to 256 distributed link processors. The MGTS
i3000 uses a high-speed bus architecture based on the PCI2 and
CompactPCI3 (cPCI) standards and supports a family
of Line Interface Cards for industry standard physical
interfaces.

When we acquired the MGTS product line from
Tekelec in August 2002, we began to design a new generation of
hardware which would support both the DCT and MGTS products. In
October 2003, we introduced the first of these common hardware
platforms, the high-performance m5000, which addressed the
telecom industrys need for higher 3G/ ATM load test
performance. The m5000s serial-mesh backplane architecture
supports up to 18 interface cards and provides the advantages of
scalability, data traffic management and computing resource
flexibility. The m5000 platform already supports our new
m5000-OC3/12 computing interface card that employs two IBM
PowerPC RISC processors to provide high capacity computing
power. Using the m5000 platform, the DCT system can support up
to 26 PowerPCI co-processor cards, up to 72 m5000-OC3/12
Computing Interface cards or a combination of PowerPCI and
m5000-OC3/12 cards, which are installed in the workstation and
up to four expansion chassis. The m5000 also requires a Sun
workstation.

In September 2004, we announced a full range of
five hardware common platforms that will allow the DCT and MGTS
systems to target an even broader range of telecom test
environments and applications. These new platforms meet an
increasing demand for transportable, desktop and rack-mount form
factors that provide greater price and performance scalability.
The new range of platforms support both Catapult PowerPCI®
and cPCI type network interface cards: the transportable and
desktop platforms support up to four PowerPCI network interface
cards; while small and medium rack-mount platforms support up to
two and up

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to nine PowerPCI cards, respectively; and the
high capacity rack-mount platform supports up to 18 more
powerful Catapult cPCI type cards. All of the new platforms are
Linux-based and do not require a Sun workstation. Our Chameleon
protocol analyzer is available on either a rack-mount or
transportable platform.


Customers

Catapults worldwide customer base includes
both telecommunications equipment manufacturers and network
operators.

Revenues from our top five customers represented
approximately 64%, 50% and 55% of total revenues in fiscal 2002,
2003 and 2004, respectively. In fiscal 2004, sales to Nortel,
NTT DoCoMo, Ericsson and NEC accounted for approximately 13%,
12%, 12% and 11% of total revenues, respectively. In fiscal
2003, sales to NTT DoCoMo, Nortel and NEC accounted for
approximately 13%, 12%, and 10% of total revenues, respectively.
In fiscal 2002, sales to Nortel, NEC and NTT DoCoMo accounted
for approximately 24%, 14%, and 12% of total revenues,
respectively. Separate engineering groups of the same customer
at different locations generally make independent decisions to
purchase our products. For example, several divisions of one
major customer have independently installed DCT systems at
multiple locations in the United States as well as in Ireland,
the United Kingdom, Israel, India and China.

We expect that we will continue to depend upon a
relatively limited number of customers for substantially all of
our revenues in future periods, although no customer is
presently obligated either to purchase a specific amount of
products or to provide us with binding forecasts of purchases
for any period. The loss of a major customer or the reduction,
delay or cancellation of orders from one or more of our
significant customers could materially adversely affect our
business, financial condition and results of operations.

Sales and Marketing

We market our products and services through our
direct sales force, most of whom have technical degrees. As of
September 30, 2004, our direct sales force consisted of 26
employees. This direct sales force is supported by applications
engineering, administrative and marketing personnel. Our sales
and marketing staff is located in North America, Europe, Japan
and China. In addition, we sell our products through
distributors in Europe, the Middle East, Africa, Australia and
South America.

Our sales strategy is to focus on the functional
groups related to the customers product development cycle,
including research and development, network integration and
final test. Sales to a new customer have often led to additional
sales at other facilities of that customer, because often a
customer performs development at multiple sites. We intend to
continue to leverage our existing customer base not only for
follow-on and upgrade sales but also to gain access to new
customers. For example, because users of similar test systems
can benefit from sharing test scripts and results, an initial
sale can facilitate a subsequent sale to other equipment
manufacturers and network operators.

We have implemented a number of marketing
initiatives to support the sales of our products and services.
These efforts are intended to inform customers of the
capabilities and benefits of our advanced software-based test
systems. Marketing programs include direct mail, on-site
customer seminars, limited participation in industry trade
shows, technology conferences and forums, and dissemination of
information concerning products through our website.

Customers generally purchase on an as-needed
basis, and none of our customers has entered into agreements
that require minimum purchases. Our products generally are
shipped within 15 to 30 days after orders are received. As
a result, we generally do not have a significant backlog of
orders, and revenues in any quarter are substantially dependent
on orders booked and shipped in that quarter.

A customers decision to purchase our
products typically involves a significant technical evaluation
and may also involve internal procedural delays associated with
large capital expenditure approvals. For these and other
reasons, the sales cycle associated with our products is
typically lengthy and subject to a number of significant risks
over which we have little or no control. Historically, the
period between initial customer contact and purchase of our
products has typically ranged from two to nine months, with
sales to new

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customers (including new divisions within
existing customers) at the upper end of this range. Because of
the lengthy sales cycle and the relatively small number and
large size of customers orders, if revenues forecasted
from a specific customer for a particular quarter are not
realized in that quarter, our operating results for that quarter
could be materially adversely affected.


International Sales

International sales outside the United States
constituted approximately 85%, 65% and 76% of our total revenues
in fiscal 2002, 2003 and 2004, respectively. We expect that
international sales will continue to account for a significant
portion of our revenues in future periods. We sell our products
worldwide through our direct sales force and distribution
channels. We have sales staff outside the United States located
in offices in Japan, the United Kingdom, Germany, France,
Finland, Canada and China, and we plan to open new offices
internationally from time to time.

Information with respect to our revenues and
identifiable long-lived assets by principal geographic area of
operations is set forth in Note 15 of the Notes to
Consolidated Financial Statements in Item 8 of this report.

Product Support

Due to the complexity of our customers
testing needs, we offer our customers support and training using
our highly skilled technical personnel. As of September 30,
2004, we had 60 applications engineers worldwide who provide
full-time technical assistance and development support to our
customers. We provide ongoing training, generally at the
customers site, and technical assistance from all of our
offices. Support is generally offered during normal business
hours applicable to each office. We also offer product
warranties for various lengths of time, depending on the product
and the country of purchase or operation.

We provide periodic software releases that
contain new features, new protocol variants and other
improvements. Each new software release is carefully designed
not only to enhance performance and flexibility, but also to
maximize compatibility with our earlier software releases,
enabling our products to continue to be used as customer needs
and applications evolve. As part of our ongoing software
support, we may occasionally develop protocol variants at the
request of our customers.

Product Development

Our development efforts are directed at improving
the capability, performance and ease of use of the DCT, MGTS and
Chameleon products. We intend to continue to devote a large
portion of our engineering resources to the enhancement of our
suite of software protocol test and analysis modules in order to
meet current and projected customer requirements. We also intend
to continue to develop and enhance our proprietary internal
tools and techniques for supporting new protocols in the DCT,
MGTS and Chameleon systems.

We are continually seeking to make the DCT, MGTS
and Chameleon products easier to use in order to expand our
market to include a broader range of users. In order to run test
scenarios, particularly on advanced telecommunications systems,
users may need to create customized test scripts, a process that
may require significant technical expertise. To assist this
process, we plan to continue the expansion and refinement of our
GUI and other script development tools. In addition, we will
continue to support test suites specified by telecommunications
standards bodies, such as ITU-T (International), ETSI (European)
and EIA-TIA (North American), where appropriate.

Most of our hardware development program is
directed towards designing protocol co-processors and associated
physical interfaces. We have initiated these projects to
increase the performance and capabilities of the DCT, MGTS and
Chameleon products and expand the range of devices to which
these products can be directly connected for testing purposes.

Our research and product development expenses
were approximately $7.5 million, $13.5 million and
$11.7 million in fiscal 2002, 2003 and 2004, respectively.
In addition, in fiscal 2002 we recorded a $1.4 million
in-process research and development expense in connection with
the purchase of NDB. Our policy is to

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evaluate software development projects for
technological feasibility to determine if they meet
capitalization requirements. To date, all software development
costs have been expensed as research and development expenses as
incurred. As of September 30, 2004, 73 of our engineers
were engaged in or provided support to research and development.


Manufacturing

Our manufacturing operations consist of the
procurement and inspection of components, final assembly,
quality control tests and packaging. Workstations and PCs that
host our products are either purchased by customers directly or
purchased by us on behalf of our customers. Printed circuit
boards, chassis and most of the other major components used in
our products are sub-assembled to our specifications by
independent contractors. The sub-assembled components are then
delivered to our facilities for final assembly, quality control
and testing against product specifications and product
configuration, including installation of our software and
proprietary hardware. We believe that our use of independent
contractors for sub-assembly combined with in-house final
assembly improves production planning, increases efficiency,
reduces costs and improves quality.

We have a computerized manufacturing inventory
control system that is integrated with our financial accounting
system. This manufacturing control system monitors purchasing,
inventory control and production.

Competition

The market for telecommunications test and
analysis products is characterized by intense competition. We
believe that the principal competitive factors affecting our
market include availability of a broad range of protocols and
protocol variants, system performance, length of operating
history and industry experience, product reliability, ease of
use, quality of service and support, status as an independent
vendor and price/performance. In addition, we believe that
potential customers consider other factors, such as the number
of protocols required and whether the test system vendor sells
competing telecommunications products. We believe that we
compete favorably with respect to these factors.

We believe our principal competitors are Artiza
Networks, Acterna Corporation, Agilent Technologies, Inc.,
ipNetfusion, Spirent plc, NetHawk Oyj, Radcom Ltd. and
Tektronix, Inc. Many of our existing and potential competitors
are large domestic and international companies that have
substantially greater financial, manufacturing, technological,
marketing, sales, distribution and other resources, larger
installed customer bases, greater name recognition and
longer-standing customer relationships than we have.
Accordingly, such competitors or potential competitors may be
able to respond more quickly to new or emerging technologies and
changes in customer requirements or to devote greater resources
to the development, promotion and sales of their products than
we may be able to. We believe that the market for high-end
testing systems is fragmented geographically. For example,
Tektronix is our primary competitor in North America, while our
primary competitors in Europe are Tektronix, Acterna, Spirent
and NetHawk. Our primary competitor in Japan is Artiza. We also
face competition from several relatively small private companies.

We also compete with the internal test system
groups of our customers and potential customers. Many of our
existing and potential customers have the technical capability
and financial resources to produce their own test systems and
perform test services internally. These systems and services
would be competitive with the test systems offered by us.

We expect competition to increase in the future
from existing competitors and from other companies that may
enter this market with solutions that may be less costly or
provide higher performance or offer more features than our
solutions. Current and potential competitors have established or
may establish cooperative relationships among themselves or with
third parties to develop new test solutions for internal use or
for sale to third parties in our markets. Accordingly, it is
possible that new competitors may emerge and acquire significant
market share. Increased competition may result in price
reductions, reduced gross margins and loss of market share, any
of which would have a material adverse effect on our business,
financial condition, results of operations and cash flows.

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Intellectual Property

We rely on a combination of trademark, copyright
and trade secret laws, as well as nondisclosure agreements and
other contractual restrictions, to establish and protect our
proprietary rights. We generally enter into nondisclosure and
invention assignment agreements with our employees and
consultants, and into nondisclosure agreements with our
customers and suppliers. To date, we have generally not sought
patent protection for our proprietary technology. We believe
that, historically, because of the rapid pace of technological
change in the telecommunications test system market, patent
protection has been a less significant factor than the
knowledge, ability and experience of our employees, the nature
and frequency of product enhancement and the quality of our
support services. However, there can be no assurance that patent
protection will not become a more significant factor in our
industry in the future. Likewise, there can be no assurance that
the measures we undertake will be adequate to protect our
proprietary technology. To date, we have federally registered
certain of our trademarks or copyrights. Our practice is to
affix copyright notices on software, hardware and product
literature in order to assert copyright protection for these
works. There can be no assurance that the lack of federal
registration of all of our trademarks and copyrights would not
have a material adverse effect on our intellectual property
rights in the future. Additionally, we may be subject to further
risks as we enter into transactions in countries where
intellectual property laws are unavailable, do not provide
adequate protection or are difficult to enforce.

In connection with our acquisition of
Tekelecs Network Diagnostics Business, Catapult and
Tekelec entered into license agreements with respect to certain
technology and intellectual property that were used by Tekelec
in NDBs business but were not transferred outright to us.
Under these agreements, Tekelec granted to us and our Irish
subsidiary perpetual, royalty-free, worldwide (except as to the
United States for the subsidiary) licenses to exploit the
subject technology and intellectual property. These licenses are
exclusive to us and our subsidiary for eight years from the date
of the acquisition for products used in protocol analysis or
simulating, diagnosing, analyzing or testing communications
networks, or which are otherwise similar to the MGTS products,
excluding products similar to Tekelecs Sentinel product
(the Catapult Field). However, during the first five
years, we and our subsidiary may not use the licensed technology
and intellectual property for products for signaling or network
infrastructure, packet telephony networks, network maintenance,
surveillance and revenue assurance, and planning, management and
call routing and control tools for contact center environments,
including products similar to Tekelecs Sentinel product
(the Tekelec Field). We also granted back to Tekelec
a perpetual royalty-free, worldwide license to the technology
and intellectual property that was transferred outright by
Tekelec to us. This license is exclusive to Tekelec for five
years within the Tekelec Field, and Tekelec may not use the
licensed technology and intellectual property within the
Catapult Field for eight years.

Despite our efforts to protect our proprietary
rights, unauthorized parties may attempt to duplicate aspects of
our products or to obtain and use information that we regard as
proprietary. There can be no assurance that the steps taken by
us to protect our proprietary technology will be adequate to
prevent misappropriation of such technology or that they will
preclude competitors from independently developing products with
functionality or features similar to our products. The failure
by us to protect our proprietary technology would have a
material adverse effect on our business, financial condition and
results of operations.

While, to date, we have not been subject to
claims of infringement or misappropriation of intellectual
property of third parties, there can be no assurance that third
parties will not assert infringement claims against us, that any
such assertion of infringement will not result in litigation or
that we would prevail in such litigation. Furthermore, any such
claims, with or without merit, could result in substantial cost
to us and diversion of our personnel, require us to develop new
technology or require us to enter into royalty or licensing
arrangements. Such royalty or licensing arrangements, if
required, may not be available on terms acceptable to us or at
all. Because we do not rely on patents to protect our
technology, we will not be able to offer a license for patented
technology in connection with any settlement of patent
infringement lawsuits. In the event of a successful claim of
infringement or misappropriation against us and our failure or
inability to develop non-infringing technology or to license the
infringed, misappropriated or similar technology at a reasonable
cost, our business, financial condition and results of
operations would be materially adversely affected. In addition,
we indemnify our customers against claimed infringement of
patents, trademarks, copyrights and other

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proprietary rights of third parties. Any
requirement for us to indemnify a customer could have a material
adverse effect on our business, financial condition and results
of operations.


Employees

As of September 30, 2004, we employed
219 full-time employees, including 73 in research and
development, 23 in application engineering customer support, 79
in sales, 12 in marketing, 19 in administration and 13 in
manufacturing. Of these employees, 151 were employed in North
America, where our head office and NDB office are both located,
33 in the United Kingdom and Europe, 18 in Japan, 14 in
Australia and 3 in China. We are not subject to any collective
bargaining agreement and have not experienced any work
stoppages. We believe that our relations with our employees are
good.

Our Executive Officers

The following table sets forth certain
information, as of September 30, 2004, with respect to our
executive officers:

|                      |  |     |    |           |  |                                                               
|--------------------- |  | --- | -- | --------- |  | --------------------------------------------------------------
|Name                  |  | Age |    | Positions
|                      |  |     |    |          
|Richard A. Karp       |  |     | 60 |           |  | Chief Executive Officer and Chairman of the Board             
|David Mayfield        |  |     | 55 |           |  | President and Chief Operating Officer                         
|Glenn Stewart         |  |     | 54 |           |  | Vice President of Engineering and Chief
    Technology Officer
|Chris Stephenson      |  |     | 53 |           |  | Vice President, Chief Financial Officer and
    Secretary     
|Sean Kelly            |  |     | 53 |           |  | Vice President of Sales                                       
|Adam Fowler           |  |     | 42 |           |  | Vice President of Advanced Development                        
|Guy R. Simpson        |  |     | 46 |           |  | Vice President of Customer Support                            
|Barbara J. Fairhurst  |  |     | 56 |           |  | Vice President of Operations                                  
|Terry Eastham         |  |     | 57 |           |  | Vice President of Marketing                                   
|Kathy T. Omaye-Sosnow |  |     | 48 |           |  | Vice President of Human Resources                             

Dr. Richard A. Karp founded Catapult in 1985
and has served as our Chief Executive Officer and Chairman of
the Board since inception. In May 2000, Dr. Karp
relinquished his title as President to David Mayfield, our Chief
Operating Officer. Dr. Karp holds a Ph.D. in computer
science from Stanford University, an M.S. in mathematics from
the University of Wisconsin and a B.S. in science from the
California Institute of Technology.

Mr. David Mayfield joined Catapult in May
2000 as our President and Chief Operating Officer. Prior to
joining Catapult, Mr. Mayfield served as interim General
Manager at Scitex Digital Video, a manufacturer of non-linear
digital video editing systems. Prior to 1998, Mr. Mayfield
was Executive Vice President and General Manager of the Philips
DVS organization in Salt Lake City, UT, a manufacturer of
digital video systems. Mr. Mayfield holds a B.S. in
Electrical Engineering from California Polytechnic State
University and has completed selected courses towards MSEE at
the University of Santa Clara.

Mr. Glenn Stewart joined Catapult in 1992 as
Vice President of Engineering and was promoted to the position
of Chief Technology Officer in January 2003. Prior to joining
Catapult, he was Director of Engineering at Tektronix/ LP Com, a
manufacturer of telecommunications test products. Previously, he
spent nine years at Bell Northern Research as a manager of
development of telecommunications products and services.
Mr. Stewart holds an M.Sc. and a B.Sc. in Computer Science
from the University of Toronto.

Mr. Chris Stephenson joined Catapult in July
2000 in a full-time consulting capacity and assumed the role of
Chief Financial Officer in February 2001 upon approval of the
required work visa. From 1985 to April 2000, he was Chief
Financial Officer of Telco Research Corporation Limited and its
predecessor, TSB

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International Inc., both telecommunications
management companies. He holds a B.A. and an M.A. from the
University of Toronto.


Mr. Sean Kelly joined Catapult in July 2003
as Vice President of Sales. From 1980 to 2002, Mr. Kelly
held progressively more senior product management, marketing and
sales management positions with Hewlett-Packard Company, most
recently that of General Manager  Worldwide Business
Customer Sales  Industry Standard Servers, PCs,
Printers. Mr. Kelly holds a B.S. in Mathematics from the
U.S. Naval Academy.

Mr. Adam Fowler joined Catapult in August
2002 in connection with our acquisition of the Network
Diagnostics Business from Tekelec and was promoted to the
position of Vice President of Advanced Development in January
2003. From 1998 to 2002, Mr. Fowler held progressively more
senior development management positions with Tekelec, most
recently that of Assistant Vice President of Engineering with
responsibility for the MGTS product line. Prior to 1998, he was
employed by Nortel, Inc. for 14 years, where his last
position was Senior Manager, Product Development and
Verification. Mr. Fowler holds a B.S.E in Electrical
Engineering from Duke University.

Mr. Guy R. Simpson joined Catapult in 1989
and has held a number of technical and management positions with
us since that time. Mr. Simpson has served as Deputy
Chairman of Catapult Communications Ltd. (CCL), our
UK subsidiary, since October 1996 and was appointed Vice
President of Applications Development of Catapult in May 1998.
Prior to joining Catapult, Mr. Simpson was employed for
eight years by AT&T Bell Laboratories, where he held a
variety of engineering and management positions in the area of
advanced digital switching systems. Mr. Simpson holds a
B.Sc. degree in Computer Science from Hatfield Polytechnic at
the University of Hertfordshire, United Kingdom.

Ms. Barbara J. Fairhurst joined Catapult in
June 1995 as Director of Operations. From 1994 to 1995,
Ms. Fairhurst was Principal at BJF Consulting, a consulting
firm, where she developed business plans and implemented
operating systems. From 1990 to 1993, Ms. Fairhurst was
Corporate Vice President at Intersource Technologies, Inc., a
developer of lighting technology, where she was responsible for
operations and manufacturing. Prior to that time,
Ms. Fairhurst spent 10 years as President and Chief
Operating Officer of Sequential Circuits, a manufacturer of
electronic music equipment. Ms. Fairhurst holds a M.B.A.
from the Santa Clara University and a B.A. from
San Jose State University.

Mr. Terry Eastham joined Catapult in 1999 as
our first Vice President of Marketing. Prior to joining
Catapult, he served as Chief Operating Officer for Sherwood
Networks, a manufacturer of network computers and display
terminals. Previously, he spent six years at Wyse Technology, a
manufacturer of display terminals, as Vice President of Product
Marketing and 17 years at Hewlett-Packard Company where he
held a variety of marketing and sales development positions.
Mr. Eastham holds both a M.B.A. degree and a M.S. in
Physics degree from Washington University and a B.S. degree in
Physics from Oklahoma State University.

Ms. Kathy T. Omaye-Sosnow joined Catapult in
1997 as our Manager of Human Resources. She was promoted to the
position of Director of Human Resources in June 1999 and to Vice
President of Human Resources in November 2000. Prior to joining
Catapult, she held a variety of human resources positions, most
recently as Manager of Corporate Employment at McKesson HBOC
Corporation, a pharmaceutical distributor and health management
corporation. Ms. Omaye-Sosnow holds a B.S. degree in Human
Resources from California State University, Sacramento.

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GLOSSARY



|                                                  |  |                                                                                                                                                                                           
|------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3G                                                |  | Third generation digital cellular
    telecommunication.                                                                                                                                  
|                                                 
|Asynchronous Transfer Mode 
     (ATM)            |  | A cell-based network technology protocol that
    supports simultaneous transmission of data, voice and video
    typically at T-1 or higher speeds.                                      
|                                                 
|cdma2000                                          |  | A third generation digital high speed wireless
    technology for packet-based transmission of text, digitized
    voice, video, and multimedia that is the successor to CDMA.            
|                                                 
|Code Division Multiple Access (CDMA)              |  | A digital wireless technology that uses a
    modulation technique in which many channels are independently
    coded for transmission over a single wideband channel.                    
|                                                 
|General Packet Radio Service (GPRS)               |  | A packet-based digital intermediate speed
    wireless technology based on GSM.                                                                                                           
|                                                 
|Global System for Mobile Communications (GSM)     |  | A digital wireless technology that is widely
    deployed in Europe and, increasingly, in other parts of the
    world.                                                                   
|                                                 
|Graphical User Interface (GUI)                    |  | A graphics-based computer interface that usually
    incorporates icons, pull-down menus and a mouse.                                                                                     
|                                                 
|Protocol                                          |  | A specific set of rules, procedures or
    conventions governing the format, means and timing of
    transmissions between two devices.                                                   
|                                                 
|Signaling System 7 (SS7)                          |  | A message-based protocol for exchanging signaling
    and control information between telephony network entities.                                                                         
|                                                 
|Variant                                           |  | A specific implementation of a protocol,
    typically unique to a country or region.                                                                                                     
|                                                 
|Universal Mobile Telecommunications System (UMTS) |  | A third generation digital high speed wireless
    technology for packet-based transmission of text, digitized
    voice, video, and multimedia that is the successor to GSM and
    GPRS.
|                                                 
|Voice over IP (VoIP)                              |  | The transmission of voice signals over IP
    networks, primarily the Internet.                                                                                                           






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

Our executive offices, product development and
primary support and production operations are located in
Mountain View, California, where we occupy approximately
39,100 square feet pursuant to leases that expire in 2010.
The annual rent for the property is approximately $420,000. In
addition we lease approximately 31,000 square feet in
Morrisville, North Carolina for product development and support
operations, expiring in 2008. The annual rent for the property
is approximately $270,000. We believe that these facilities will
be adequate for our planned purposes.*

In addition, we lease a total of approximately
30,000 square feet of professional services office space in
the following 11 locations: Schaumburg, Illinois; Dallas, Texas;
Ottawa, Canada; Chippenham, England; Gilching, Germany; Antony
Cedex, France; Helsinki, Finland; Tokyo, Japan; Yokosuka
Research Park, Japan; Melbourne, Australia and Shanghai, China.

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

A lawsuit was instituted in October 2002 against
us and one of our subsidiaries, Catapult Communications
International Limited, an Irish corporation, in the Antwerp
Commercial Court, Antwerp, Belgium, by Tucana Telecom NV, a
Belgian company. Tucana had been a distributor of products for
Tekelec, the company from which we acquired NDB in August 2002.
The writ alleges that the defendants improperly terminated an
exclusive distribution agreement with Tucana following the
acquisition of NDB and seeks damages of
12,461,000, plus
costs. A trial date on the matter was scheduled for
January 16, 2004 but Tucana did not appear. We strongly
believe that we properly terminated any contract we had with
Tucana and that Tucana is not entitled to any damages in this
matter. We intend to defend ourselves vigorously. We may be able
to seek indemnification from Tekelec for any damages assessed
against us in this matter under the terms of the Asset Purchase
Agreement we entered into with Tekelec, although there is no
assurance that such indemnification would be available.






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

No matters were submitted to a vote of security
holders during the fourth quarter of fiscal 2004.




PART II






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

Our common stock is quoted on the Nasdaq National
Market System (Nasdaq) under the symbol
CATT. The following table sets forth the range of
high and low closing sales prices for each fiscal period
indicated:

|                      |  |      |       |      |  |      |       |     |  |   |       |  |  |   |       | 
|--------------------- |  | ---- | ----- | ---- |  | ---- | ----- | --- |  | - | ----- |  |  | - | ----- | 
|                      |  |      |       |     
|                      |  | 2003 |       | 2004
|                      |  |      |       |     
|                      |  | High |       | Low  |  | High |       | Low
|                      |  |      |       |      |  |      |       |    
|First fiscal quarter  |  | $    | 13.07 |      |  | $    | 8.01  |     |  | $ | 16.79 |  |  | $ | 10.70 | 
|Second fiscal quarter |  | $    | 12.85 |      |  | $    | 6.08  |     |  | $ | 25.26 |  |  | $ | 14.47 | 
|Third fiscal quarter  |  | $    | 13.51 |      |  | $    | 5.74  |     |  | $ | 23.36 |  |  | $ | 16.00 | 
|Fourth fiscal quarter |  | $    | 14.96 |      |  | $    | 10.12 |     |  | $ | 24.99 |  |  | $ | 17.00 | 

We had seven stockholders of record as of
November 30, 2004. We have not declared or paid any cash
dividends on our common stock and presently intend to retain our
future earnings, if any, to fund the development and growth of
our business. Therefore, we do not anticipate paying cash
dividends in the foreseeable future.






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

The following selected financial data is
qualified by reference to and should be read in conjunction with
the Management Discussion and Analysis of Financial
Condition and Results of Operations section and the
Consolidated Financial Statements and Notes thereto included
elsewhere in this Report on Form 10-K.

Consolidated Statements of Income
Data:

|          |                |                                       |   |        |  |      |   |        |  |      |   |        |  |  |   |        |  |  |   |        | 
|--------- | -------------- | ------------------------------------- | - | ------ |  | ---- | - | ------ |  | ---- | - | ------ |  |  | - | ------ |  |  | - | ------ | 
|          |                |                                      
|          |                | Fiscal Year Ended September 30,      
|          |                |                                      
|          |                | 2000                                  |   | 2001   |  | 2002 |   | 2003   |  | 2004
|          |                |                                       |   |        |  |      |   |        |  |     
|          |                |                                      
|          |                | (In thousands, except per share data)
|Revenues: |                |                                       |   |        |  |      |   |        |  |      |   |        |  |  |   |        |  |  |   |       
|          | Products       |                                       | $ | 22,045 |  |      | $ | 34,689 |  |      | $ | 33,988 |  |  | $ | 35,344 |  |  | $ | 45,703 | 
|          | Services       |                                       |   | 5,001  |  |      |   | 5,197  |  |      |   | 6,051  |  |  |   | 9,880  |  |  |   | 12,315 | 
|          |                |                                       |   |        |  |      |   |        |  |      |   |        |  |  |   |        |  |  |   |       
|          | Total revenues |                                       |   | 27,046 |  |      |   | 39,886 |  |      |   | 40,039 |  |  |   | 45,224 |  |  |   | 58,018 | 
|          |                |                                       |   |        |  |      |   |        |  |      |   |        |  |  |   |        |  |  |   |       

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|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |        | 
|---------------------------------------------------------------------------------------------- | --------------------------------------------- | ------------------------------------- | ------ | ------ |  | ---- | ------ | ------ |  | ---- | ------ | ------ | - | - | ------ | ------ |  | - | ------ | ------ | 
|                                                                                               |                                               |                                      
|                                                                                               |                                               | Fiscal Year Ended September 30,      
|                                                                                               |                                               |                                      
|                                                                                               |                                               | 2000                                  |        | 2001   |  | 2002 |        | 2003   |  | 2004
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |     
|                                                                                               |                                               |                                      
|                                                                                               |                                               | (In thousands, except per share data)
|Cost of revenues:                                                                              |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|                                                                                               | Products                                      |                                       |        | 2,209  |  |      |        | 3,794  |  |      |        | 2,700  |   |   |        | 5,652  |  |   |        | 5,192  | 
|                                                                                               | Services                                      |                                       |        | 971    |  |      |        | 591    |  |      |        | 1,172  |   |   |        | 2,825  |  |   |        | 3,570  | 
|                                                                                               | Amortization of purchased technology          |                                       |        |       |  |      |        |       |  |      |        | 57     |   |   |        | 686    |  |   |        | 686    | 
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|                                                                                               | Total cost of revenues                        |                                       |        | 3,180  |  |      |        | 4,385  |  |      |        | 3,929  |   |   |        | 9,163  |  |   |        | 9,448  | 
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|Gross profit                                                                                   |                                               |                                       | 23,866 |        |  |      | 35,501 |        |  |      | 36,110 |        |   |   | 36,061 |        |  |   | 48,570 |       
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|Operating expenses:                                                                            |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|                                                                                               | Research and development                      |                                       |        | 3,037  |  |      |        | 4,938  |  |      |        | 7,520  |   |   |        | 13,519 |  |   |        | 11,740 | 
|                                                                                               | Sales and marketing                           |                                       |        | 9,427  |  |      |        | 10,673 |  |      |        | 10,714 |   |   |        | 14,506 |  |   |        | 17,075 | 
|                                                                                               | General and administrative                    |                                       |        | 3,703  |  |      |        | 5,369  |  |      |        | 4,899  |   |   |        | 6,679  |  |   |        | 6,885  | 
|                                                                                               | Restructuring costs                           |                                       |        |       |  |      |        |       |  |      |        |       |   |   |        | 730    |  |   |        |       | 
|                                                                                               | Purchased in-process research and development |                                       |        |       |  |      |        |       |  |      |        | 1,400  |   |   |        |       |  |   |        |       | 
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|                                                                                               | Total operating expenses                      |                                       |        | 16,167 |  |      |        | 20,980 |  |      |        | 24,533 |   |   |        | 35,434 |  |   |        | 35,700 | 
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|Operating income                                                                               |                                               |                                       | 7,699  |        |  |      | 14,521 |        |  |      | 11,577 |        |   |   | 627    |        |  |   | 12,870 |       
|Interest income                                                                                |                                               |                                       | 2,674  |        |  |      | 2,919  |        |  |      | 1,456  |        |   |   | 786    |        |  |   | 801    |       
|Interest expense                                                                               |                                               |                                       |       |        |  |      |       |        |  |      | (29    | )      |   |   | (350   | )      |  |   | (321   | )     
|Other income (expense), net                                                                    |                                               |                                       | 169    |        |  |      | (585   | )      |  |      | (219   | )      |   |   | 1,216  |        |  |   | 148    |       
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|Income from continuing operations before income
    taxes                                      |                                               |                                       | 10,542 |        |  |      | 16,855 |        |  |      | 12,785 |        |   |   | 2,279  |        |  |   | 13,498 |       
|Provision for (benefit from) income taxes                                                      |                                               |                                       | 3,976  |        |  |      | 5,810  |        |  |      | 3,580  |        |   |   | (2,086 | )      |  |   | (413   | )     
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|Income from continuing operations                                                              |                                               |                                       | 6,566  |        |  |      | 11,045 |        |  |      | 9,205  |        |   |   | 4,365  |        |  |   | 13,911 |       
|Loss from discontinued operations, adjusted for
    applicable benefit for income taxes of $46 |                                               |                                       |       |        |  |      |       |        |  |      | (56    | )1     |   |   |       |        |  |   |       |       
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|Net income                                                                                     |                                               | $                                     | 6,566  |        |  | $    | 11,045 |        |  | $    | 9,149  |        |   | $ | 4,365  |        |  | $ | 13,911 |       
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|Net income per share  basic                                                                   |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|                                                                                               | Income from continuing operations             |                                       | $      | 0.51   |  |      | $      | 0.85   |  |      | $      | 0.71   |   |   | $      | 0.34   |  |   | $      | 1.06   | 
|                                                                                               | Loss from discontinued operations             |                                       |        |       |  |      |        |       |  |      |        | (0.00  | ) |   |        |       |  |   |        |       | 
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|Net income per share  basic                                                                   |                                               | $                                     | 0.51   |        |  | $    | 0.85   |        |  | $    | 0.70   |        |   | $ | 0.34   |        |  | $ | 1.06   |       
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|Net income per share  diluted                                                                 |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|                                                                                               | Income from continuing operations             |                                       | $      | 0.50   |  |      | $      | 0.83   |  |      | $      | 0.69   |   |   | $      | 0.33   |  |   | $      | 0.95   | 
|                                                                                               | Loss from discontinued operations             |                                       |        |       |  |      |        |       |  |      |        | (0.00  | ) |   |        |       |  |   |        |       | 
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|Net income per share  diluted                                                                 |                                               | $                                     | 0.50   |        |  | $    | 0.83   |        |  | $    | 0.69   |        |   | $ | 0.33   |        |  | $ | 0.95   |       
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|Shares used in per share calculation:                                                          |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|                                                                                               | Basic                                         |                                       |        | 12,801 |  |      |        | 12,933 |  |      |        | 13,039 |   |   |        | 12,948 |  |   |        | 13,100 | 
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       
|                                                                                               | Diluted                                       |                                       |        | 13,123 |  |      |        | 13,276 |  |      |        | 13,313 |   |   |        | 13,113 |  |   |        | 14,556 | 
|                                                                                               |                                               |                                       |        |        |  |      |        |        |  |      |        |        |   |   |        |        |  |   |        |       



---

Note:



|    |                                                                                   
|--- | ----------------------------------------------------------------------------------
|(1) | See Note 5 in the accompanying notes to the
    consolidated financial statements.

14



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##### Table of Contents



Consolidated Balance Sheets Data:

|                                                  |  |                |        |      |  |      |        |      |  |      |         |  |  |   |         |  |  |   |         | 
|------------------------------------------------- |  | -------------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------- |  |  | - | ------- |  |  | - | ------- | 
|                                                  |  |               
|                                                  |  | September 30, 
|                                                  |  |               
|                                                  |  | 2000           |        | 2001 |  | 2002 |        | 2003 |  | 2004
|                                                  |  |                |        |      |  |      |        |      |  |     
|                                                  |  |               
|                                                  |  | (In thousands)
|Cash, cash equivalents and short-term investments |  | $              | 48,637 |      |  | $    | 61,476 |      |  | $    | 35,365  |  |  | $ | 30,671  |  |  | $ | 52,670  | 
|Working capital                                   |  |                | 49,164 |      |  |      | 61,517 |      |  |      | 28,852  |  |  |   | 16,629  |  |  |   | 55,347  | 
|Total assets                                      |  |                | 59,343 |      |  |      | 72,833 |      |  |      | 117,850 |  |  |   | 107,089 |  |  |   | 128,271 | 
|Convertible notes payable                         |  |                |       |      |  |      |       |      |  |      | 18,081  |  |  |   | 17,674  |  |  |   |        | 
|Total stockholders equity                        |  |                | 50,887 |      |  |      | 63,490 |      |  |      | 72,965  |  |  |   | 76,621  |  |  |   | 115,765 | 

Results of Operations

The following table sets forth, for the periods
indicated, the percentage relationship of certain items from our
consolidated statements of income to total revenues.

|                                                          |                                               |                              |      |       |   |      |      |       |   |  |      |       |  
|--------------------------------------------------------- | --------------------------------------------- | ---------------------------- | ---- | ----- | - | ---- | ---- | ----- | - |  | ---- | ----- | -
|                                                          |                                               |                             
|                                                          |                                               | Percentage of Total Revenues
|                                                          |                                               | Year Ended September 30,    
|                                                          |                                               |                             
|                                                          |                                               | 2002                         |      | 2003  |   | 2004
|                                                          |                                               |                              |      |       |   |     
|Revenues:                                                 |                                               |                              |      |       |   |      |      |       |   |  |      |      
|                                                          | Products                                      |                              |      | 84.9  | % |      |      | 78.2  | % |  |      | 78.8  | %
|                                                          | Services                                      |                              |      | 15.1  |   |      |      | 21.8  |   |  |      | 21.2  |  
|                                                          |                                               |                              |      |       |   |      |      |       |   |  |      |      
|                                                          | Total revenues                                |                              |      | 100.0 |   |      |      | 100.0 |   |  |      | 100.0 |  
|                                                          |                                               |                              |      |       |   |      |      |       |   |  |      |      
|Cost of revenues:                                         |                                               |                              |      |       |   |      |      |       |   |  |      |      
|                                                          | Products                                      |                              |      | 6.8   |   |      |      | 12.5  |   |  |      | 8.9   |  
|                                                          | Services                                      |                              |      | 2.9   |   |      |      | 6.2   |   |  |      | 6.2   |  
|                                                          | Amortization of purchased technology          |                              |      | 0.1   |   |      |      | 1.5   |   |  |      | 1.2   |  
|                                                          |                                               |                              |      |       |   |      |      |       |   |  |      |      
|                                                          | Total cost of revenues                        |                              |      | 9.8   |   |      |      | 20.2  |   |  |      | 16.3  |  
|                                                          |                                               |                              |      |       |   |      |      |       |   |  |      |      
|Gross profit                                              |                                               |                              | 90.2 |       |   |      | 79.8 |       |   |  | 83.7 |      
|                                                          |                                               |                              |      |       |   |      |      |       |   |  |      |      
|Operating expenses:                                       |                                               |                              |      |       |   |      |      |       |   |  |      |      
|                                                          | Research and development                      |                              |      | 18.8  |   |      |      | 29.9  |   |  |      | 20.2  |  
|                                                          | Sales and marketing                           |                              |      | 26.8  |   |      |      | 32.1  |   |  |      | 29.4  |  
|                                                          | General and administrative                    |                              |      | 12.2  |   |      |      | 14.8  |   |  |      | 11.9  |  
|                                                          | Restructuring costs                           |                              |      |      |   |      |      | 1.6   |   |  |      |      |  
|                                                          | Purchased in process research and development |                              |      | 3.5   |   |      |      |      |   |  |      |      |  
|                                                          |                                               |                              |      |       |   |      |      |       |   |  |      |      
|                                                          | Total operating expenses                      |                              |      | 61.3  |   |      |      | 78.4  |   |  |      | 61.5  |  
|                                                          |                                               |                              |      |       |   |      |      |       |   |  |      |      
|Operating income                                          |                                               |                              | 28.9 |       |   |      | 1.4  |       |   |  | 22.2 |      
|Interest income                                           |                                               |                              | 3.6  |       |   |      | 1.7  |       |   |  | 1.4  |      
|Interest expense                                          |                                               |                              | (0.1 | )     |   |      | (0.7 | )     |   |  | (0.6 | )    
|Other income (expense)                                    |                                               |                              | (0.5 | )     |   |      | 2.6  |       |   |  | 0.3  |      
|                                                          |                                               |                              |      |       |   |      |      |       |   |  |      |      
|Income from continuing operations before income
    taxes |                                               |                              | 31.9 |       |   |      | 5.0  |       |   |  | 23.3 |      
|Provision for (benefit from) income taxes                 |                                               |                              | 8.9  |       |   |      | (4.7 | )     |   |  | (0.7 | )    
|                                                          |                                               |                              |      |       |   |      |      |       |   |  |      |      
|Income from continuing operations                         |                                               |                              | 23.0 |       |   |      | 9.7  |       |   |  | 24.0 |      
|Loss from discontinued operations                         |                                               |                              | (0.1 | )     |   |      |     |       |   |  |     |      
|                                                          |                                               |                              |      |       |   |      |      |       |   |  |      |      
|Net income                                                |                                               |                              | 22.9 | %     |   |      | 9.7  | %     |   |  | 24.0 | %    
|                                                          |                                               |                              |      |       |   |      |      |       |   |  |      |      
|Gross profit margin on products                           |                                               |                              | 92.1 | %     |   |      | 84.0 | %     |   |  | 88.6 | %    
|                                                          |                                               |                              |      |       |   |      |      |       |   |  |      |      
|Gross profit margin on services                           |                                               |                              | 80.6 | %     |   |      | 71.4 | %     |   |  | 71.0 | %    
|                                                          |                                               |                              |      |       |   |      |      |       |   |  |      |      

15



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

Overview

Our revenues are derived from product sales,
which include both licenses of the DCT and MGTS system software
and sales of DCT and MGTS hardware, and from services, which
include customer support under hardware and software support
contracts as well as installation and training. Prices for the
DCT and MGTS systems vary widely depending upon overall system
configuration, including the number and type of software
protocol modules and the number of physical interfaces required
by the customer. A DCT or MGTS system sale typically ranges in
price from approximately $50,000 to over $250,000. In addition
to the initial system purchase, customers also may upgrade their
systems by purchasing additional software protocol modules and
hardware. Customers have the option to purchase a third-party
workstation or PC from us or provide a workstation or PC to us
for configuration. Product sales are recognized upon shipment
or, if installation services are purchased, when installation is
complete, provided collection is probable.

We offer product warranties for various lengths
of time, depending on the product and the country of purchase or
operation. Customers may elect to purchase a software support
contract which includes both ongoing technical support and any
new software releases on a when-and-if available basis during
the term of the contract. These software releases may include
updates for protocols already licensed by the customer. Revenues
from software support contracts are recognized ratably over the
contract period, which is generally one year. New customers
often purchase onsite training, which is charged on a
fixed-price basis and recognized when complete.

Conditions and Trends in Our
Industry

After several years of relatively rapid growth,
the global telecommunications industry experienced a severe and
well-publicized contraction beginning in 2001. By 2002, our
customers began cutting their research and development budgets
that fund the majority of our revenues. As a result, beginning
in the second quarter of calendar 2002, we faced challenging
conditions in our telecommunications test business.

Over the course of our last fiscal year ended
September 30, 2004, there has been increasing evidence,
also well-publicized, that the overall decline in the
telecommunications industry has ended, and that at least the
beginnings of a recovery are in evidence. This improvement in
market conditions has resulted in increased purchasing of our
products and services by our customers overseas, where third
generation wireless deployment has begun. In North America,
where third generation wireless deployment has yet to begin
except in a few markets, our revenues were unchanged from the
previous year.

Summary of Our Financial Performance in Fiscal
2004

Our financial performance in the year ended
September 30, 2004 improved significantly over our
performance in the previous year: our revenues increased by 28%
to $58.0 million and our net income increased by 219% to
$13.9 million.

Three major factors contributed to this improved
financial performance:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In Europe and Japan, we saw strong revenue
    increases of 90% and 26%, respectively due to the improvement in
    overseas market conditions discussed above and to a 10% increase
    in the value of the Japanese yen, in which all our revenues in
    Japan are denominated.                                                                                                                                                          
|
| |  | We saw an improvement of four percentage points
    in overall gross profit margin due principally to two factors:
    our product mix was weighted more heavily to higher margin
    product; and, despite a 29% increase in our product revenues,
    our manufacturing overhead costs decreased by 28% or
    $0.7 million in the absence of the transitional
    acquisition-related manufacturing costs we incurred in fiscal
    2003.
|
| |  | We limited the increase in our operating expenses
    to 1%, well below the 28% increase in total revenues. Increased
    variable compensation related to above-target performance
    together with the increased cost of overseas employees resulting
    from higher exchange rates were largely offset by the effects of
    a 15%                                                                                                     

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##### Table of Contents



| |  |                                                                                                                     
| |  | --------------------------------------------------------------------------------------------------------------------
| |  | staff reduction undertaken in the fourth quarter
    of fiscal 2003 and a further 1% staff reduction in fiscal 2004.

During fiscal 2004, our cash, cash equivalents
and short-term investments increased by $22.0 million, of
which $15.2 million was provided by operating activities,
$4.8 million was provided from the sale of stock under our
stock option and employee share purchase plans and
$3.0 million was provided from the sale of
200,000 shares in an underwritten public offering. The
offering also included 1,081,250 shares which Tekelec
received upon conversion of $17.3 million in notes, and
1,387,187 shares sold by two of our directors (of which
137,187 shares represented an over-allotment exercised by
the underwriters shortly after year end, and 950,000 shares
were sold in a subsequent closing). As a result of the note
conversion, we ended the fiscal year debt-free. Capital
expenditures in fiscal 2004 amounted to $1.1 million, well
below our $1.8 million in depreciation.

Critical Accounting Policies and
Estimates

We have identified the accounting policies below
and the methods, estimates and judgments that we use in applying
these policies as critical to our business operations and the
understanding of our results of operations. The impact and any
associated risks related to these policies on our business
operations are discussed below and throughout Managements
Discussion and Analysis of Financial Condition and Results of
Operations where such policies affect our reported and expected
future financial results. We also have other key accounting
policies. We believe that these other policies either do not
generally require us to make estimates and judgments that are as
difficult or as subjective, or it is less likely that they would
have a material impact on our reported results of operations for
a given period. For a discussion on the application of these
other accounting policies, see Note 1 of the Notes to the
Consolidated Financial Statements.



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

Sales of our product arrangements normally
include hardware and software. Certain of our sales may also
include installation. We also offer training and maintenance
services separately from our product arrangements. We recognize
revenue on system sales upon shipment or, if installation
services are purchased, when installation is complete, provided
persuasive evidence of an arrangement exists, the fee is fixed
or determinable and collection of the resulting receivable is
probable. In connection with each transaction involving these
arrangements, we examine the customer agreement and/or purchase
order to determine that persuasive evidence of an arrangement
exists, we judge that the fee is fixed or determinable by
verifying that it corresponds to the fee charged for comparable
arrangements and that the payment terms do not extend
significantly beyond our customary range, and we judge that
collection is probable based on customer credit information and
payment history. Training and maintenance revenues are based on
our established history of charging separate fees for training
and maintenance. Revenues allocated to training are recognized
at the time the training is complete. Revenues allocated to
maintenance are recognized ratably over the term of the
maintenance contract during which the services are provided.

The amount and timing of revenue recognized in
any period may differ materially if we make different judgments
in any of these areas involving revenue recognition.



| |                                                               
| | --------------------------------------------------------------
| | Foreign Exchange Risk and Derivative
    Financial Instruments

Our foreign subsidiaries operate and sell our
products in various global markets. As a result, we are exposed
to changes in exchange rates on foreign currency denominated
transactions with foreign subsidiaries. We use foreign currency
forward exchange contracts, and we infrequently use options, to
mitigate the risk of future movements in foreign exchange rates
that affect certain foreign currency denominated inter-company
receivables or expected revenues. The forward contracts and
options are not designated as accounting hedges. We attempt to
match the forward contracts with the underlying receivables in
terms of currency, amount and maturity, and to match the options
with expected foreign currency revenue in terms of currency,
amount and recognition period. We do not use derivative
financial instruments for speculative or trading purposes. Gains
or losses on forward contracts and options as well as the cost
of the options are included in other income

17



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##### Table of Contents



(expense), net. To the extent that our judgment
in mitigating the risk of movements in foreign exchange rates is
imperfect, we may incur foreign exchange losses that could
affect our results of operations.




| |                                                      
| | -----------------------------------------------------
| | Use of Estimates; Allowance for Doubtful
    Accounts

The preparation of financial statements requires
us to make estimates and assumptions that affect the reported
amount of assets and disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reported
period. Our use of estimates and assumptions includes, but is
not limited to, our allowance for doubtful accounts. We
specifically analyze accounts receivable, historical bad debt
experience, customer concentration, customer credit-worthiness,
current economic trends and changes in customer payment terms
when judging the adequacy of our allowance for doubtful
accounts. The amount and timing of revenue recognized in any
period may differ materially if we make different judgments. Our
accounts receivable balance as of September 30, 2004 was
$10.1 million, net of an allowance for doubtful accounts of
$0.3 million.



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

As part of the process of preparing consolidated
financial statements, we are required to estimate income taxes
in each of the jurisdictions in which we operate. This process
involves estimating our actual current tax exposure together
with assessing temporary differences resulting from differing
treatment of items, such as deferred revenue, for tax and
accounting purposes.

These temporary differences result in deferred
tax assets and liabilities, which are included within our
consolidated balance sheet. We then assess the likelihood that
our deferred tax assets will be recovered from future taxable
income and, to the extent we believe that recovery is not
likely, we establish a valuation allowance. To the extent that
we establish or increase a valuation allowance in a period, the
change is included as an expense within the tax provision in the
consolidated statement of income. Significant management
judgment is required in determining our provision for income
taxes, our deferred tax assets and liabilities, and any
valuation allowance recorded against our net deferred tax
assets. Based on our estimates concerning future results of
operation, we have not recorded a valuation allowance for net
operating losses or for foreign tax credits. In the event that
actual results differ from these estimates or we adjust these
estimates in future periods, we may need to establish an
additional valuation allowance, which could materially impact
our financial position and results of operations. Net operating
losses totaled $1.5 million and $13,000 at
September 30, 2004 and 2003, respectively. Foreign tax
credits amounted to $0.7 million and $0.6 million at
September 30, 2004 and 2003, respectively.

In addition, the estimation of our tax
liabilities involves dealing with uncertainties in the
application of complex tax regulations in all the jurisdictions
in which we do business. We recognize liabilities for
anticipated tax audit issues based on our estimate of the
possibility that additional taxes will be due. If we ultimately
determine that payment of additional amounts is unnecessary, we
reverse the associated liabilities and recognize a tax benefit
in the period in which this determination is made. If we
determine that our recorded tax liability is less than we expect
the ultimate assessment to be, we record an additional charge in
our provision for taxes in the period in which this
determination is made.



| |                                   
| | ----------------------------------
| | Goodwill and Long Lived
    Assets

Effective October 1, 2002, we adopted the
provisions of Statement of Financial Accounting Standard
(SFAS) No. 142, Goodwill and Other
Intangible Assets, which requires, among other things, the
discontinuance of goodwill amortization and an annual impairment
test. We performed our most recent annual impairment test on
September 30, 2004 and determined that we have a single
reporting unit. We did not record a loss on impairment of
goodwill during the fiscal years ended September 30, 2004,
2003 and 2002. We will continue to perform this test annually
using the methodology described in Note 1 of the Notes to
Consolidated Financial Statements in Item 8 of this report.
If our estimates or the related assumptions change in the
future, we may be required to record an impairment charge on
goodwill to reduce its carrying amount to its estimated fair
value. Goodwill was $49.4 million at September 30,
2004 and 2003.

18



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##### Table of Contents



SFAS No. 142 also requires that
intangible assets with estimable useful lives be amortized over
their respective estimated useful lives and reviewed for
impairment in accordance with SFAS No. 144,
Accounting for Impairment or Disposal of Long-Lived
Assets. For assets to be held and used, including acquired
intangibles, we initiate a review whenever events or changes in
circumstances indicate that the carrying value of a long-lived
asset may not be recoverable. Recoverability of an asset is
measured by comparing its carrying value to the future
undiscounted cash flows that the asset is expected to generate.
Any impairment is measured by the amount by which the carrying
value exceeds the projected discounted future operating cash
flows. Assets to be disposed of and that we have committed to a
plan to dispose of, whether through sale or abandonment, are
reported at the lower of carrying value or fair value less costs
to sell. During the years ended September 30, 2004 and
2003, we did not record any impairment charges on long-lived
assets or certain intangible assets. If our estimates or the
related assumptions change in the future, we may be required to
record an impairment charge on long-lived assets and certain
intangible assets to reduce the carrying amount of these assets.
Net intangible assets and long-lived assets were
$5.1 million and $6.1 million at September 30,
2004 and 2003, respectively.

Fiscal Years Ended September 30, 2003 and
2004



| |         
| | --------
| | Revenues

Total revenues increased by 28% from
$45.2 million in fiscal 2003 to $58.0 million in
fiscal 2004. Product revenues increased by approximately 29%
from $35.3 million in fiscal 2003 to $45.7 million in
fiscal 2004, due to overseas market recovery that resulted in
increased shipments of our test products and to a 10% increase
in the value of the Japanese yen, in which all our revenues in
Japan are denominated. Services revenues increased by
approximately 25% from $9.9 million in fiscal 2003 to
$12.3 million in fiscal 2004 due to the increase in the
number of systems under maintenance.

By geographic region, North American revenues in
fiscal 2004 remained unchanged from fiscal 2003 at
$17.4 million, European revenues increased by approximately
90% from $9.7 million in fiscal 2003 to $18.4 million
in fiscal 2004, Japanese revenues increased by approximately 26%
from $15.6 million in fiscal 2003 to $19.6 million in
fiscal 2004 and Rest of World revenues increased by
approximately 6% from $2.5 million in fiscal 2003 to
$2.7 million in fiscal 2004.



| |                 
| | ----------------
| | Cost of Revenues

Cost of product revenues decreased by
approximately 8% from $5.7 million in fiscal 2003 to
$5.2 million in fiscal 2004. Gross margin on product
revenues increased from 84.0% in fiscal 2003 to 88.6% in fiscal
2004. Both the decrease in cost of product revenues and the
increase in gross margin on product revenues reflected primarily
two factors: first, our product mix was weighted more heavily to
higher margin product; and secondly, our manufacturing overhead
costs decreased by 28% or $0.7 million in the absence of
the transitional acquisition-related manufacturing costs we
incurred in fiscal 2003.

Cost of services revenues increased by
approximately 26% from $2.8 million in fiscal 2003 to
$3.6 million in fiscal 2004 due primarily to a
$0.3 million increase in variable compensation related to
above-target performance and to a provision of $0.3 million
for the replacement of certain product under maintenance
contract. Gross margin on services revenues decreased from 71.4%
in fiscal 2003 to 71.0% in fiscal 2004 as the cost of providing
services revenues, consisting primarily of compensation costs,
grew slightly more than the associated revenues. Gross margin on
services revenues may also vary depending on the timing of
system sales and support contract renewals.

Amortization of purchased technology in fiscal
2004 remained unchanged from the $0.7 million expensed in
fiscal 2003.

Cost of revenues expressed as a percentage of
revenues did not vary significantly by geographic region.

19



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##### Table of Contents





| |                         
| | ------------------------
| | Research and Development

Research and development expenses decreased by
approximately 13% from $13.5 million in fiscal 2003 to
$11.7 million in fiscal 2004. This decrease reflected
primarily four factors: a decrease of approximately
$2.9 million due to a reduction of 23%, or 22 employees, in
the number of research and development personnel largely as a
result of the staff reduction undertaken in the fourth quarter
of fiscal 2003; increases totaling $0.4 million in variable
compensation related to above-target performance; increases of
$0.3 million in new product development and testing costs;
and an exchange rate driven increase of $0.3 million due to
average increases of 19% in the Australian dollar and 12% in the
British pound against the US dollar. As a percentage of total
revenues, research and development expenses decreased from 29.9%
in fiscal 2003 to 20.2% in fiscal 2004. We expect the absolute
annual level of research and development expenses to increase by
approximately 10% in fiscal 2005 primarily as a result of an
anticipated increase in the number of employees in this area.*



| |                    
| | -------------------
| | Sales and Marketing

Sales and marketing expenses increased by
approximately 18% from $14.5 million in fiscal 2003 to
$17.1 million in fiscal 2004 primarily as a result of three
factors: a $2.2 million increase in variable compensation
related to above-target performance; a decrease of approximately
$1.4 million due to a reduction of 11%, or 11 employees, in
the number of sales and marketing personnel largely as a result
of the staff reduction undertaken in the fourth quarter of
fiscal 2003; and an exchange rate driven increase of
$0.9 million due to average increases of 10% in the
Japanese yen, 12% in the British pound and 13% in the Euro
against the US dollar. As a percentage of total revenues, sales
and marketing expenses decreased from 32.1% of revenues in
fiscal 2003 to 29.4% in fiscal 2004. We expect the absolute
annual level of sales and marketing expenses to increase by
approximately 4% in fiscal 2005 primarily as a result of an
anticipated increase in the number of employees in this area.*



| |                           
| | --------------------------
| | General and Administrative

General and administrative expenses increased by
approximately 3% from $6.7 million in fiscal 2003 to
$6.9 million in fiscal 2004. This increase was due
primarily to a $0.6 million increase in variable
compensation related to above-target performance, a
$0.2 million decrease in facilities costs in the absence of
transitional costs related to the NDB acquisition and a
$0.2 million increase in legal and accounting costs due to
increased regulatory compliance costs. As a percentage of total
revenues, general and administrative expenses decreased from
14.8% to 11.9% over the same period. We expect the absolute
annual level of general and administrative expenses to increase
by up to 10% in fiscal 2005 due to increased regulatory
compliance costs.*



| |                    
| | -------------------
| | Restructuring Costs

No restructuring charge was recorded in fiscal
2004. A restructuring charge of $0.7 million was recorded
in the fourth quarter of fiscal 2003 related to costs associated
with the involuntary termination of 39 employees, including 25
in research and development, 10 in sales and marketing, 3 in the
customer service component of services cost of goods and 1 in
the manufacturing component of product cost of goods. The
terminations represented 15% of our pre-termination workforce.



| |                
| | ---------------
| | Interest Income

Interest income remained unchanged at
$0.8 million in fiscal 2004 in comparison with fiscal 2003
as the effect of higher cash, cash equivalents and short-term
investment balances was offset by lower prevailing rates of
return. Realized gains and losses on sale of securities are
included in interest income.



| |                 
| | ----------------
| | Interest Expense

Interest expense on the convertible notes payable
decreased from $0.35 million in fiscal 2003 to
$0.32 million in fiscal 2004 due to a decrease in interest
accrued on the convertible notes payable resulting from these
notes being outstanding for a shorter period of time in fiscal
2004 than in fiscal 2003.

20



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| |             
| | ------------
| | Other Income

Other income decreased from $1.2 million in
fiscal 2003 to $0.1 million in fiscal 2004 due principally
to a reduction of $0.4 million in foreign exchange gains
and the absence in fiscal 2004 of a Japanese consumption tax
refund in the amount of approximately $0.7 million received
in fiscal 2003.



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

We recorded a benefit from income taxes of
$0.4 million in fiscal 2004 primarily due to a reduction of
approximately $2.3 million in the estimated tax payable at
the end of the fiscal year. This reduction was made as a result
of a determination that additional taxes for which we had
previously recognized liabilities would not be due. In fiscal
2003, we recorded a benefit from income taxes of
$2.1 million as a result of three factors: the
identification of approximately $0.8 million in additional
taxes recoverable from a previous period; a reduction of
approximately $1.0 million in the estimated tax payable at
the end of the fiscal year as a result of the likely favorable
outcome of a tax audit of our Japanese subsidiary; and the
recognition of approximately $0.8 million in future tax
benefits of foreign tax credits created in the liquidation of
the Japanese subsidiary acquired from Tekelec. As a result, our
effective tax rate changed from a benefit of 92% in fiscal 2003
to a benefit of 3% in fiscal 2004. We do not expect to record a
tax benefit in fiscal 2005.*



| |                                                              
| | -------------------------------------------------------------
| | Potential additional expense for
    stock-based compensation

On October 13, 2004, the Financial
Accounting Standards Board (FASB) concluded that proposed
Statement 123R, Share-Based Payment, which would
require all companies to measure compensation expense for all
share based payments (including employee stock options) at fair
value, will be effective, if it is adopted by the FASB, for
public companies for interim or annual periods beginning after
June 15, 2005. Adoption of FASB Statement 123R would
require us to record an expense for stock-based compensation
plans and would result in ongoing accounting charges that would
significantly reduce our net income. See the section entitled
Stock-based Compensation in Note 1 of the Notes to
our Consolidated Financial Statements for further information.

Fiscal Years Ended September 30, 2002 and
2003

Revenues, cost of revenues and operating expenses
for the year ended September 30, 2003 include a full
12 months of the results of the continuing operations of
NDB. The corresponding figures for the year ended
September 30, 2002 include one month of the results of the
continuing operations of NDB from August 30, 2002, the date
it was acquired by us, and exclude the results of the
discontinued distribution and consulting businesses engaged in
by Tekelec Limited in Japan as described in Note 5 of the
Notes to the Consolidated Financial Statements.



| |         
| | --------
| | Revenues

Total revenues increased by 13% from
$40.0 million in fiscal 2002 to $45.2 million in
fiscal 2003. Despite the additional MGTS revenues resulting from
the NDB acquisition, product revenues increased by only
approximately 4% from $34.0 million in fiscal 2002 to
$35.3 million in fiscal 2003, due to prevailing market
weakness that negatively affected shipments of both DCT and MGTS
products. Services revenues increased by approximately 63% from
$6.1 million in fiscal 2002 to $9.9 million in fiscal
2003 due to the increase in the number of systems under
maintenance, primarily as a result of the NDB acquisition.

By geographic region, North American revenues
increased by approximately 122% from $7.8 million in fiscal
2002 to $17.4 million fiscal 2003 primarily due to
additional revenues from the NDB acquisition. European revenues
decreased by approximately 42% from $16.7 million in fiscal
2002 to $9.7 million in fiscal 2003. Japanese revenues
increased by approximately 1% from $15.5 million in fiscal
2002 to $15.6 million in fiscal 2003. Rest of World
revenues of $2.5 million were reported for the first time
in fiscal 2003.

21



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| |                 
| | ----------------
| | Cost of Revenues

Cost of product revenues increased by
approximately 109% from $2.7 million in fiscal 2002 to
$5.7 million in fiscal 2003. Gross margin on product
revenues decreased from 92.1% in fiscal 2002 to 84.0% in fiscal
2003. Both the increase in cost of product revenues and the
decrease in gross margin on product revenues reflected two
factors: first, the higher cost of goods on the more hardware
intensive MGTS product in comparison with the DCT product; and
second, the additional manufacturing costs incurred on MGTS
product during the six month period ended February 28, 2003
when this product was manufactured for us by Tekelec under a
Transitional Services Agreement.

Cost of services revenues increased by
approximately 141% from $1.2 million in fiscal 2002 to
$2.8 million in fiscal 2003 as a result of a corresponding
increase in the costs of customer support personnel due to the
NDB acquisition. Gross margin on services revenues decreased
from 80.6% in fiscal 2002 to 71.4% in fiscal 2003 as the cost of
providing services revenues, consisting primarily of
compensation costs, grew more than the associated revenues.
Gross margin on services revenues may also vary depending on the
timing of system sales and support contract renewals.

Amortization of purchased technology increased
from $57,000 in fiscal 2002 to $686,000 in fiscal 2003
reflecting a full 12 months of amortization in the latter
year in comparison with a single month in the former.



| |                         
| | ------------------------
| | Research and Development

Research and development expenses increased by
approximately 80% from $7.5 million in fiscal 2002 to
$13.5 million in fiscal 2003 due to a corresponding
increase in compensation and other costs associated with NDB
research and development activities. As a percentage of total
revenues, research and development expenses increased from 18.8%
in fiscal 2002 to 29.9% in fiscal 2003.



| |                    
| | -------------------
| | Sales and Marketing

Sales and marketing expenses increased by
approximately 35% from $10.7 million in fiscal 2002 to
$14.5 million in fiscal 2003 as a result of two factors: an
increase of approximately $3.2 million in compensation and
other associated costs due to an increase in the number of
personnel engaged in sales and marketing activities as a result
of the NDB acquisition, and an increase of approximately
$550,000 in the cost of sales and marketing activities outside
the United States due to an increase in the values of the
foreign currencies in which this cost is incurred. As a
percentage of total revenues, sales and marketing expenses
increased from 26.8% of revenues in fiscal 2002 to 32.1% in
fiscal 2003.



| |                           
| | --------------------------
| | General and Administrative

General and administrative expenses increased by
approximately 36% from $4.9 million in fiscal 2002 to
$6.7 million in fiscal 2003. This increase was due to four
factors: an increase of $850,000 in facilities costs due
primarily to the NDB acquisition; an increase of $155,000 in
compensation costs due to an increase in the number of personnel
engaged in the performance of general and administrative
activities; an increase of $470,000 in premiums for general
liability, directors and officers and workers compensation
insurance; and an increase of $336,000 in non-cash amortization
of acquisition related intangibles. As a percentage of total
revenues, general and administrative expenses increased from
12.2% to 14.8% over the same period.



| |                    
| | -------------------
| | Restructuring Costs

A restructuring charge of $730,000 was recorded
in the fourth quarter of fiscal 2003 related to costs associated
with the involuntary termination of 39 employees, including 25
in research and development, 10 in sales and marketing, 3 in the
customer service component of services cost of goods and 1 in
the manufacturing component of product cost of goods. The
terminations represented 15% of our pre-termination workforce.
No restructuring charge was recorded in fiscal 2002.

22



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| |                                                  
| | -------------------------------------------------
| | Purchased In-Process Research and
    Development

In fiscal 2002, $1.4 million in purchased
in-process research and development was charged to operating
expenses. This amount represented two NDB research and
development projects in process as of August 30, 2002, the
date of the acquisition of NDB. The value of these projects was
determined by an independent appraiser using established
valuation techniques and was expensed because technological
feasibility had not been established and no future alternative
uses existed as of the date of acquisition. There was no expense
recorded in fiscal 2003 for purchased in-process research and
development.



| |                
| | ---------------
| | Interest Income

Interest income decreased from $1.5 million
in fiscal 2002 to $786,000 in fiscal 2003 due to lower cash and
short term investment balances resulting from the
$42.5 million paid on closing of the NDB acquisition and to
lower prevailing rates of return, partially offset by
amortization of $407,000 of the convertible notes valuation
premium in fiscal 2003 in comparison with $34,000 in fiscal
2002. Realized gains and losses on sale of securities are
included in interest income.



| |                 
| | ----------------
| | Interest Expense

Interest expense increased from $29,000 in fiscal
2002 to $350,000 in fiscal 2003 due to an increase in interest
accrued on the convertible notes payable resulting from these
notes being outstanding for a longer period of time in fiscal
2003 than in fiscal 2002.



| |                            
| | ---------------------------
| | Other Income (Expense), Net

Other income improved from an expense of $219,000
in fiscal 2002 to income of $1.2 million in fiscal 2003 due
to two factors: foreign exchange gains recorded in fiscal 2003
in contrast with the foreign exchange losses in fiscal 2002 and
the receipt in fiscal 2003 of a Japanese consumption tax refund
in the amount of approximately $695,000.



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

We recorded a benefit from income taxes of
$2.1 million in fiscal 2003 as a result of three factors:
the identification of approximately $830,000 in additional taxes
recoverable from a previous period; a reduction of approximately
$970,000 in the estimated tax payable at the end of the fiscal
year as a result of the likely favorable outcome of a tax audit
of our Japanese subsidiary; and the recognition of approximately
$775,000 in future tax benefits of foreign tax credits created
in the liquidation of the Japanese subsidiary acquired from
Tekelec. As a result, our effective tax rate changed from a
provision of 28% in fiscal 2002 to a benefit of 92% in fiscal
2003.

Liquidity and Capital Resources

We have financed our operations primarily through
cash generated from operations, from the proceeds of our initial
public offering completed in early 1999 and from the proceeds of
a second public offering completed in September 2004. The
proceeds to us from the 1999 and 2004 offerings, net of
underwriter fees and other expenses, were approximately
$19.2 million and $3.0 million, respectively.

Our purchase of NDB was additionally financed
through the issuance of two convertible notes in the aggregate
principal amount of $17.3 million. The convertible notes
were issued by our Irish subsidiary and were guaranteed by us.
These notes were converted by Tekelec into 1,081,250 shares
of our common stock in September 2004.

Our operating activities provided cash of
$12.4 million, $3.6 million and $15.2 million in
fiscal 2002, 2003 and 2004, respectively. In each of these
years, net income was the primary component of cash flows from
operating activities, providing $9.1 million,
$4.4 million and $13.9 million in fiscal 2002, 2003
and 2004, respectively. Cash generated by net income was
increased by adjustments for non-cash charges totaling
$1.9 million, $1.6 million and $1.6 million in
fiscal 2002, 2003 and 2004, respectively. The level of these

23



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non-cash charges increased in comparison with
historical rates beginning in fiscal 2002 due to charges for
additional depreciation, amortization and purchased in process
research and development related to our acquisition of NDB. The
purchased in process research and development charge was
incurred in fiscal 2002, the additional non-cash depreciation
charges will end in fiscal 2005 and the majority of the non-cash
amortization charges will end in fiscal 2009. Finally, our cash
flows from operations are affected by changes in current assets
and liabilities, net of the effects of the acquisition. These
changes in non-cash working capital components increased cash
flow from operations by $1.3 million in fiscal 2002,
decreased cash flow from operations by $2.4 million in
fiscal 2003 and decreased cash flow from operations by
$0.4 million in fiscal 2004.


Our primary source of operating cash flow is the
collection of accounts receivable from our customers. We measure
the effectiveness of our collection efforts by an analysis of
average accounts receivable days outstanding (days
outstanding). We calculate our days outstanding by
dividing our accounts receivable balance net of allowances at
the end of a period by the revenues for that period and
multiplying the result by the number of days in the period. Our
days outstanding improved from 100 days for the year ended
September 30, 2002 to 85 days for the year ended
September 30, 2003 because the accounts receivable
component of the days outstanding calculation as of
September 30, 2002 included accounts receivable acquired
with NDB but the revenue component of the calculation did not
include the associated pre-acquisition revenues. Our days
outstanding further improved to 64 days for the year ended
September 30, 2004 due primarily to the increased
intra-quarter invoicing linearity that resulted from an
improvement in business conditions over the year then ended.
Collections of accounts receivable and related days outstanding
will fluctuate in future periods due to the timing and amount of
our future revenues, payment terms extended to our customers and
the effectiveness of our collection efforts.

Investing activities have consisted of three
components: the acquisition of NDB, purchases of property and
equipment and purchases and sales of short-term investments. Our
acquisition of NDB used cash of $38.2 million in fiscal
2002 and $6.0 million in fiscal 2003. Purchases of property
and equipment increased from a pre-acquisition $0.6 million
in fiscal 2002 to $1.3 million in fiscal 2003 and
$1.1 million in fiscal 2004. We expect that capital
expenditures will total approximately $1.2 million in
fiscal 2005.* We invest cash that is surplus to our operating
requirements in our short-term investment portfolio. Purchases
and sales of short-term investments used cash of
$5.6 million in fiscal 2002 as surplus cash was invested,
provided cash of $3.9 million in fiscal 2003 as cash was
withdrawn to assist with the final acquisition payment and used
cash of $15.5 million in fiscal 2004 as surplus cash that
we generated was invested.

Financing activities provided cash of
$0.7 million in fiscal 2002 from the exercise of stock
options and the sale of shares under our employee stock purchase
plan. Financing activities used cash of $1.2 million in
fiscal 2003 as we repurchased a higher value of common stock
than the value that we issued. Financing activities provided
cash of $7.8 million in fiscal 2004 from the sale of shares
in a public offering, the exercise of stock options and the sale
of shares under our employee stock purchase plan.

As of September 30, 2004, we had working
capital of $55.3 million, cash and cash equivalents of
$18.3 million and short-term investments of
$34.4 million. As of September 30, 2004, we had the
following contractual obligations, in millions:

|                                   |  |                        |     |           |  |           |     |           |  |         |     |  |  |   |     |  |  |   |     | 
|---------------------------------- |  | ---------------------- | --- | --------- |  | --------- | --- | --------- |  | ------- | --- |  |  | - | --- |  |  | - | --- | 
|                                   |  |                       
|                                   |  | Payments Due by Period
|                                   |  |                       
|                                   |  |                        |     | Less Than |  |           |     | After    
|Contractual Obligations            |  | Total                  |     | 1 Year    |  | 1-3 Years |     | 4-5 Years |  | 5 Years
|                                   |  |                        |     |           |  |           |     |           |  |        
|Operating leases                   |  | $                      | 4.9 |           |  | $         | 1.2 |           |  | $       | 2.1 |  |  | $ | 1.4 |  |  | $ | 0.2 | 
|                                   |  |                        |     |           |  |           |     |           |  |         |     |  |  |   |     |  |  |   |     | 
|Total contractual cash obligations |  | $                      | 4.9 |           |  | $         | 1.2 |           |  | $       | 2.1 |  |  | $ | 1.4 |  |  | $ | 0.2 | 
|                                   |  |                        |     |           |  |           |     |           |  |         |     |  |  |   |     |  |  |   |     | 

We believe that inflation has not had a material
impact on our business.

We may require additional funds to support our
working capital requirements or for other purposes. There can be
no assurance that additional financing will be available or
that, if available, such financing will be obtainable on terms
favorable to us or our stockholders. We believe that cash and
cash equivalents, short-term investments and funds generated
from operations will provide us with sufficient funds to finance
our requirements for at least the next 12 months.*

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##### Table of Contents



Factors That May Affect Future
Results

The risks described below are not the only ones
we face. Additional risks not presently known to us or that we
currently believe are immaterial may also impair our business
operations.

Risks Related to Our Business



| |                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------
| | Our quarterly operating results may
    fluctuate significantly, and this may result in volatility in
    the market price of our common stock.

We have experienced, and anticipate that we will
continue to experience, significant fluctuations in quarterly
revenues and operating results. Our revenues and operating
results are relatively difficult to forecast for a number of
reasons, including:



| |   |                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the variable size and timing of individual
    purchases by our customers;                                                                                                                                   
|
| |  | seasonal factors that may affect capital spending
    by customers, such as the varying fiscal year ends of customers
    and the reduction in business during the summer months,
    particularly in Europe;
|
| |  | the relatively long sales cycles for our products;                                                                                                                                                           
|
| |  | competitive conditions in our markets;                                                                                                                                                                       
|
| |  | exchange rate fluctuations;                                                                                                                                                                                  
|
| |  | the timing of the introduction and market
    acceptance of new products or product enhancements by us and by
    our customers, competitors and suppliers;                                                  
|
| |  | costs associated with developing and introducing
    new products;                                                                                                                                           
|
| |  | product life cycles;                                                                                                                                                                                         
|
| |  | changes in the level of operating expenses
    relative to revenues;                                                                                                                                         
|
| |  | product defects and other quality problems;                                                                                                                                                                  
|
| |  | customer order deferrals in anticipation of new
    products;                                                                                                                                                
|
| |  | supply interruptions;                                                                                                                                                                                        
|
| |  | changes in global or regional economic conditions
    or in the telecommunications industry;                                                                                                                 
|
| |  | delays in purchasing decisions or customer orders
    due to customer consolidation;                                                                                                                         
|
| |  | the ability to hire sales and technical personnel;                                                                                                                                                           
|
| |  | changes in the mix of products sold; and                                                                                                                                                                     
|
| |  | changes in the regulatory environment.                                                                                                                                                                       

Our revenues in any period generally have been,
and may continue to be, derived from relatively small numbers of
sales and service transactions with relatively high average
revenues per order. Therefore, the loss of any orders or delays
in closing such transactions could have a more significant
impact on our quarterly revenues and results of operations than
on those of companies with relatively high volumes of sales or
low revenues per order. Our products generally are shipped
within 15 to 45 days after orders are received. As a
result, we generally do not have a significant backlog of
orders, and revenues in any quarter are substantially dependent
on orders booked, shipped and installed in that quarter.

Most of our costs, including personnel and
facilities costs, are relatively fixed, and our operating
expenses are based on anticipated revenue. As a result, a
decline in revenue from even a limited number of transactions,
failure to achieve expected revenue in any quarter or
unanticipated variations in the timing of recognition of
specific revenues can cause significant variations in our
quarterly operating results and could result in losses. We
believe, therefore, that period-to-period comparisons of our
operating results should not be relied upon as an indication of
future performance.

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Due to the factors described above, as well as
other unanticipated factors, it is possible that in some future
quarter our results of operations could fail to meet the
expectations of public market analysts or investors. If this
occurs, the price of our common stock may fall.



| |                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Historically, our revenues have been
    dependent upon a few significant customers, the loss of one or
    more of which could significantly reduce our
    revenues.

Our customer base is highly concentrated, and a
relatively small number of companies have accounted for
substantially all of our revenues to date. In our fiscal year
ended September 30, 2004, our top five customers
represented approximately 55% of total revenues. We expect that
we will continue to depend upon a relatively limited number of
customers for substantially all of our revenues in future
periods, although no customer is presently obligated either to
purchase a specific amount of products or to provide us with
binding forecasts of purchases for any period. If we were to
lose a significant customer or if a significant customer were to
reduce, delay or cancel its orders, our operating results could
be seriously harmed.



| |                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our business is dependent on our customers
    outsourcing their telecommunications testing needs, and our
    business could be harmed if the market for outsourced testing
    solutions declines or fails to grow.

Our success will depend on continued growth in
the market for telecommunications test systems and services and
the continued commercial acceptance of our products as a
solution to address the testing requirements of
telecommunications equipment manufacturers and network
operators. While most of our present and potential customers
have the technical capability and financial resources to produce
their own test systems and perform test services internally, to
date, many have chosen to outsource a substantial proportion of
their test system and service requirements. Our customers may
not continue, and potential new customers may not choose, to
outsource any of their test systems and service requirements. If
the market for telecommunications test systems and services, or
the demand for outsourcing, declines or fails to grow, or if our
products and services are not widely adopted as a
telecommunications test solution, our business, financial
condition and operating results could be seriously harmed.



| |                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------
| | If we do not effectively manage our growth,
    our business and operating results could be adversely
    affected.

Our growth has placed, and is expected to
continue to place, significant demands on our management,
administrative and operational resources. To manage expansion
effectively, we need to continue to develop and improve our
operational and financial systems, sales and marketing
capabilities and expand, train, retain, manage and motivate our
employee base. Our systems, procedures or controls may not be
adequate to support our operations and our management may not be
able to successfully exploit future market opportunities or
successfully manage our relationships with customers and other
third parties. We may not continue to grow and, if we do, we may
not effectively manage such growth. Any failure to manage growth
could have an adverse effect on our business, financial
condition and results of operations.



| |                                                                                                                                                     
| | ----------------------------------------------------------------------------------------------------------------------------------------------------
| | We face foreign business, political and
    economic risks because a significant portion of our sales is to
    customers outside the United States.

We derive a significant percentage of our
revenues from customers outside of North America, and we
maintain operations in seven other countries. International
sales and operations are subject to inherent risks, including:



| |   |                                                                                          
| | - | -----------------------------------------------------------------------------------------
| |  | longer customer payment cycles;                                                          
|
| |  | greater difficulty in accounts receivable
    collection;                                
|
| |  | difficulties in staffing and managing foreign
    operations;                            
|
| |  | changes in regulatory requirements or in economic
    or trade policy;                   
|
| |  | costs related to localizing products for foreign
    countries;                          
|
| |  | potentially weaker protection for intellectual
    property in certain foreign countries;

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| |   |                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------
| |  | the burden of complying with a wide variety of
    foreign laws and practices, tariffs and other trade
    barriers; and
|
| |  | potentially adverse tax consequences, including
    restrictions on repatriation of earnings.                           

During the last three fiscal years, a significant
portion of our international sales has been to customers in
Japan. If economic conditions in Japan deteriorate, our
business, financial condition and results of operations could be
materially adversely affected. An inability to obtain necessary
regulatory approvals in foreign markets on a timely basis could
also have an adverse effect on our business, financial condition
and results of operations.

A significant portion of our sales, including all
our sales in Japan, is denominated in local currencies. Although
we currently engage in hedging transactions with respect to
receivables resulting from some inter-company sales, we may not
continue to do so and our hedging activities may not be
successful. Fluctuations in foreign currency exchange rates may
contribute to fluctuations in our operating results. For
example, changes in foreign currency exchange rates could
adversely affect the revenues, net income, earnings per share
and cash flow of our operations in affected markets. Similarly,
such fluctuations may cause us to raise prices, which could
affect demand for our products and services. In addition, if
exchange or price controls or other restrictions are imposed in
countries in which we do business, our business, financial
condition and operating results could be seriously harmed.



| |                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------
| | We may not be able to achieve the
    anticipated benefits of any acquisitions we may make of other
    companies, products or technologies.

As part of our business strategy, we acquired
Tekelecs Network Diagnostics Business in 2002, and we may
make further acquisitions of, or significant investments in,
companies, products or technologies that we believe are
complementary. Any such transactions would be accompanied by the
risks commonly encountered in making acquisitions of companies,
products and technologies. Such risks include, among others:



| |   |                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------
| |  | difficulties associated with assimilating the
    personnel and operations of acquired companies;                         
|
| |  | potential disruption of our ongoing business;                                                                             
|
| |  | distraction of management and other resources;                                                                            
|
| |  | integration of personnel and technology of an
    acquired company;                                                       
|
| |  | difficulties in evaluating the technology of a
    potential target;                                                      
|
| |  | inability to motivate and retain new personnel;                                                                           
|
| |  | maintenance of uniform standards, controls,
    procedures and policies; and                                              
|
| |  | impairment of relationships with employees and
    clients as a result of the integration of new management
    personnel.

We have limited experience in assimilating
acquired companies or product lines into our operations. We may
not be successful in overcoming these risks or any other
problems encountered in connection with any such future
acquisitions. Furthermore, any future acquisitions could result
in the issuance of dilutive equity securities, the incurrence of
debt or contingent liabilities or amortization expenses related
to goodwill and other intangible assets, any of which could
seriously harm our business, financial condition and operating
results or decrease the value of our common stock.



| |                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We face intense competition in our markets
    from more established test solutions providers, and if we are
    unable to compete successfully we may not be able to maintain or
    grow our business.

The market for our products is highly
competitive. A number of our competitors are better known and
have substantially greater financial, technological, production
and marketing resources than we do. While we believe that the
price/performance characteristics of our products are
competitive, competition in the markets for our products could
force us to reduce prices. Any material reduction in the price
of our products without

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corresponding decreases in manufacturing costs
and increases in unit volume would negatively affect our gross
margins. Increased competition for our products that results in
lower product sales could also adversely impact our upgrade
sales. Our ability to maintain our competitive position will
depend upon, among other factors, our success in anticipating
industry trends, investing in product research and development,
developing new products with improved price/performance
characteristics and effectively managing the introduction of new
products into targeted markets.




| |                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have experienced delays in completing
    our new Chameleon product, which could result in lost sales
    opportunities and lower financial results.

We originally introduced our new Chameleon
product in February 2004 and announced our intention to begin
shipping this product to customers in May 2004 for beta testing.
However, due to delays associated with development and testing,
we only began beta testing in the fourth calendar quarter of
2004. This delay may have caused us to miss a portion of the
market window for Chameleon as we believe that mobile
telecommunications operators may have made or may make many of
their key 3G maintenance procurement decisions before Chameleon
is shipped commercially.



| |                                                                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our success depends on the continued growth
    of the telecommunications industry and increased use of our test
    solutions, and lack of growth in this industry could harm our
    business.

Our future success is dependent upon the
continued growth of the telecommunications industry. The global
telecommunications industry is evolving rapidly, and it is
difficult to predict its potential growth rate or future trends
in technology development. The deregulation, privatization and
economic globalization of the worldwide telecommunications
market that have resulted in increased competition and
escalating demand for new technologies and services may not
continue in a manner favorable to us or our business strategies.
In addition, the growth in demand for Internet services and the
resulting need for high speed or enhanced telecommunications
equipment may not continue at its current rate or at all.

Our future success depends upon the increased
utilization of our test solutions by network operators and
telecommunications equipment manufacturers. Industry-wide
network equipment and infrastructure development driving the
demand for our products and services may be delayed or prevented
by a variety of factors, including cost, regulatory obstacles or
the lack of or reduction in consumer demand for advanced
telecommunications products and services. Telecommunications
equipment manufacturers and network operators may not develop
new technology or enhance current technology. Further, any such
new technology or enhancements may not lead to greater demand
for our products or services.



| |                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our business could be harmed if we were to
    lose the services of one or more members of our senior
    management team, or if we are unable to attract and retain
    qualified personnel.

Our future growth and success depends to a
significant extent upon the continuing services of our executive
officers and other key employees. We do not have long-term
employment agreements or non-competition agreements with any of
our employees. Competition for qualified management and other
high-level telecommunications industry personnel is intense, and
we may not be successful in attracting and retaining qualified
personnel. If we lose the services of any key employees, we may
not be able to manage our business successfully or achieve our
business objectives.

Our success also depends on our ability to
identify, attract and retain qualified technical, sales, finance
and management personnel. We have experienced, and may continue
to experience, difficulty in hiring and retaining candidates
with appropriate qualifications. If we do not succeed in hiring
and retaining candidates with appropriate qualifications, our
revenues and product development efforts could be harmed.

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| |                                                                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our ability to deliver products that meet
    customer demand is dependent on our ability to meet new and
    changing requirements for telecommunications test systems and
    services.

The market for telecommunications test systems
and services is subject to rapid technological change, evolving
industry standards, rapid changes in customer requirements and
frequent product and service introductions and enhancements.

Our future success will depend in part on our
ability to anticipate and respond to these changes by enhancing
our existing products and services and by developing and
introducing, on a timely and cost-effective basis, new products,
features and services that address the needs of our customer
base. We may not be successful in identifying, developing and
marketing new products, product enhancements and related
services that respond to technological change or evolving
industry standards or that adequately meet new market demands.
In addition, because of the rapid technological change
characteristic of the telecommunications industry, we may be
required to support legacy systems used by our customers. As a
result, this may place additional demands on our personnel and
other resources and may require us to maintain an inventory of
otherwise obsolete components.

Our test systems currently operate only on Sun
Microsystemss SolarisTM and the
LinuxTM operating systems. Our current and
prospective customers may require other operating systems, such
as Windows 2000 or Windows XP, to be used in their
telecommunications test systems or may require the integration
of other industry standards. We may not be able to successfully
adapt our products to such operating systems on a timely or
cost-effective basis, if at all. Our failure to respond to
rapidly changing technologies and to develop and introduce new
products and services in a timely manner could adversely affect
our operations and overall profitability.

Our success will depend in part on whether a
large number of telecommunications equipment manufacturers and
network operators purchase our products and services. Because
the telecommunications market is rapidly evolving, it is
difficult to predict the future success of products and services
in this market. The customers in this market use products from a
number of competing suppliers for various testing purposes, and
there has not been broad adoption of the products of one
company. Our current or future products or services may not
achieve widespread acceptance among telecommunications equipment
manufacturers, network operators or other potential customers.
In addition, our competitors may develop solutions that could
render our products obsolete or uncompetitive. In the event the
telecommunications industry does not broadly adopt our products
or services or does so less rapidly than we expect, or in the
event our products are rendered obsolete or uncompetitive by
more advanced solutions, our business, financial condition and
operating results could be seriously harmed.



| |                                                                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Many of our suppliers are sole source or
    single source suppliers, and our inability to obtain adequate
    amounts of components from these suppliers could harm our
    business.

We purchase many key components, including
certain microprocessors, workstations, bus interface and other
chips, connectors and other hardware, from the sole supplier of
a particular component. For other components, even though
multiple vendors may exist, we may purchase components from only
a single source. We do not have any long-term supply agreements
with these vendors to ensure uninterrupted supply of these
components. If our supply of a key component is reduced or
interrupted, we might require a significant amount of time to
qualify alternative suppliers and receive an adequate flow of
replacement components. We may also need to reconfigure our
products to adapt to new components, which could entail
substantial time and expense. In addition, the process of
manufacturing certain of these components is extremely complex,
and our reliance on the suppliers of these components exposes us
to potential production difficulties and quality variations.
These could negatively affect cost and timely delivery of our
products. We have in the past experienced supply problems as a
result of the financial or operational difficulties of our
suppliers, shortages and discontinuations resulting from
component obsolescence. Although to date we have not experienced
material delays in product deliveries to our customers resulting
from supply problems, such problems may recur or, if such
problems do recur, we may not find satisfactory solutions. If we
are unable to obtain adequate amounts of fully functional

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components or are otherwise required to seek
alternative sources of supply, our relationship with our
customers and our results of operations could be harmed.




| |                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------
| | We depend on a limited number of
    independent manufacturers, which reduces our ability to control
    our manufacturing process.

We rely on a limited number of independent
manufacturers, some of which are small, privately held
companies, to provide certain assembly services to our
specifications. We do not have any long-term supply agreements
with any third-party manufacturer. If our assembly services are
reduced or interrupted, our business, financial condition and
results of operations could be adversely affected until we are
able to establish sufficient assembly services supply from
alternative sources. Alternative manufacturing sources may not
be able to meet our future requirements, and existing or
alternative sources may not continue to be available to us at
favorable prices.



| |                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The high level of complexity and
    integration of our products increases the risk of latent
    defects, which could damage customer relationships and increase
    our costs.

Our complex products may contain undetected
errors or bugs, particularly when first introduced
or when new versions are released. Errors may be found in future
releases of our software. In addition, any such errors may
generate adverse publicity, impair the market acceptance of
these products, create customer concerns or adversely affect
operating results due to product returns, the costs of
generating corrective releases or otherwise.



| |                                                                                                   
| | --------------------------------------------------------------------------------------------------
| | We face exposure to product liability
    claims, which if successful could harm our
    business.

Our license agreements with our customers
typically contain provisions designed to limit our exposure to
potential product liability claims. However, it is possible that
the limitation of liability provisions contained in our license
agreements may not be effective under the laws of certain
jurisdictions, particularly since we sell a majority of our
products internationally. Although we have not experienced any
product liability claims to date, our sale and support of
products may entail the risk of such claims. We may be subject
to such claims in the future. A successful product liability
claim brought against us could have a material adverse effect
upon our business, financial condition and results of
operations. If we fail to maintain adequate product liability
insurance and if we were to lose a large uninsured claim, then
such a loss could significantly harm our business, financial
condition and operating results.



| |                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our success is dependent on our ability to
    protect our intellectual property, and our failure to protect
    our intellectual property could have a significant adverse
    impact on our business.

Our success and ability to compete effectively
are dependent in part upon our proprietary technology. We rely
on a combination of trademark, copyright and trade secret laws,
as well as nondisclosure agreements and other contractual
restrictions, to establish and protect our proprietary rights.
To date, we have generally not sought patent protection for our
proprietary technology. Patent protection may become more
significant in our industry in the future. Likewise, the
measures we undertake may not be adequate to protect our
proprietary technology. To date, we have federally registered
certain of our trademarks or copyrights. Our practice is to
affix copyright notices on software, hardware and product
literature in order to assert copyright protection for these
works. The lack of federal registration of all of our trademarks
and copyrights may have an adverse effect on our intellectual
property rights in the future. Additionally, we may be subject
to further risks as we enter into transactions in countries
where intellectual property laws are unavailable, do not provide
adequate protection or are difficult to enforce. Despite our
efforts to protect our proprietary rights, unauthorized parties
may attempt to duplicate aspects of our products or to obtain
and use information that we regard as proprietary. Our steps to
protect our proprietary technology may not be adequate to
prevent misappropriation of such technology, and may not
preclude competitors from independently developing products with
functionality or features similar to our products. If we fail to
protect our proprietary technology, our business, financial
condition and results of operations could be harmed
significantly.

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| |                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We could become subject to litigation
    regarding intellectual property, which could divert management
    attention, be costly to defend and prevent us from using or
    selling the challenged technology.

The telecommunications industry is characterized
by a relatively high level of litigation based on allegations of
infringement of proprietary rights. While to date we have not
been subject to claims of infringement or misappropriation of
intellectual property by third parties, third parties may assert
infringement claims against us. In addition, an assertion of
infringement may result in litigation in which we may not
prevail. Furthermore, any such claims, with or without merit,
could result in substantial cost to us and diversion of our
personnel. In addition, infringement claims may require us to
develop new technology or require us to enter into royalty or
licensing arrangements. These royalty or licensing agreements,
if required, may not be available on terms acceptable to us.
Because we do not rely on patents to protect our technology, we
will not be able to offer a license for patented technology in
connection with any settlement of patent infringement lawsuits.
If a claim of infringement or misappropriation against us were
successful and we fail or are unable to develop non-infringing
technology or license any infringed, misappropriated or similar
technology at a reasonable cost, our business, financial
condition and results of operations would be adversely affected.
In addition, we indemnify our customers against claimed
infringement of patents, trademarks, copyrights and other
proprietary rights of third parties. Any requirement for us to
indemnify a customer may significantly harm our business,
financial condition and operating results.



| |                                                                                    
| | -----------------------------------------------------------------------------------
| | Our success depends on the timely
    development and introduction of new products.

Our future success will depend in part on our
ability to anticipate and respond to changing industry standards
and customer requirements by enhancing our existing products and
services. We may need to develop and introduce, on a timely and
cost-effective basis, new products, features and services that
address the needs of our customer base. We may not be successful
in identifying, developing and marketing new products, product
enhancements and related services that respond to technological
change or evolving industry standards or that adequately meet
new market demands.



| |                                                                                                                                                                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we are unable to determine and
    demonstrate that we maintain effective controls over internal
    financial reporting, this may cause investors to lose confidence
    in our reported financial information and the price of our stock
    could drop significantly.

Pursuant to Section 404 of the
Sarbanes-Oxley Act of 2002, beginning with our fiscal year
ending September 30, 2005, we will be required to include
in our Annual Report on Form 10-K an assessment of the
effectiveness of our internal controls over financial reporting
together with a report from our independent registered public
accountants on our assessment. In the course of preparing our
assessment, we may identify deficiencies which we may not be
able to remediate in time to meet the deadline for compliance
with the requirements of Section 404. In addition, if we
fail to achieve and maintain the adequacy of our internal
controls, as such standards are modified, supplemented or
amended from time to time, we may not be able to ensure that we
can conclude on an ongoing basis that we have effective internal
controls over financial reporting. Moreover, effective internal
controls are necessary for us to produce reliable financial
reports and are important in helping prevent financial fraud. If
we cannot provide reliable financial reports or prevent fraud,
our business and operating results could be harmed, investors
could lose confidence in our reported financial information, and
the trading price of our stock could drop significantly.

Risks Related to Our Stock



| |                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| | Sales of substantial amounts of our common
    stock by our major stockholders and others could adversely
    affect the market price of our common stock

Sales of substantial numbers of shares of common
stock by our major stockholders in the public market could harm
the market price for our common stock. As of November 30,
2004, Richard A. Karp, our Chief Executive Office and Chairman
of our Board, beneficially owned 2,953,061 shares, and
Nancy H. Karp, one of our directors, beneficially owned
1,354,937 shares of our common stock. These shares are
eligible for resale into the public market within the
restrictions imposed by Rule 144 under the Securities Act
of 1933. Sales of a

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significant amount of these shares could
adversely affect the market price for our common stock. In
connection with our public offering in September 2004, all of
our directors and officers entered into lock-ups terminating
December 15, 2004. These lockups were waived with respect
to Dr. Karp and Ms. Karp in connection with their
sales of stock in October and November 2004, and may be waived
as to any other holder at the discretion of the underwriters of
our public offering. Dr. Karp and Ms. Karp entered
into new lock-ups terminating February 8, 2005. In
addition, we have requested on behalf of certain officers and
directors that the underwriters waive the lock-ups with respect
to 40,000 shares of our common stock.




| |                                                                                                                                                                                         
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our stock has been and will likely continue
    to be subject to substantial price and volume fluctuations due
    to a number of factors, many of which will be beyond our
    control.

In recent years, the stock market in general and
the market for technology stocks in particular, including our
common stock, have experienced extreme price fluctuations. The
market price of our common stock may be significantly affected
by various factors such as:



| |   |                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------
| |  | quarterly variations in our operating results;                                                                    
|
| |  | changes in our revenue growth rates as a whole or
    for specific geographic areas or products;                  
|
| |  | changes in earning estimates by market analysts;                                                                  
|
| |  | changes in the extent to which a significant
    percentage of our shares are held by a small number of investors;
|
| |  | the announcements of new products or product
    enhancements by us or our competitors;                           
|
| |  | speculation in the press or analyst
    community; and                                                            
|
| |  | general market conditions or market conditions
    specific to particular industries.                             

The market price of our common stock may
experience significant fluctuations in the future.



| |                                                                          
| | -------------------------------------------------------------------------
| | Our principal stockholder could prevent or
    delay a change in control.

As of November 30, 2004, Dr. Karp
beneficially owned 2,953,061 shares or approximately 20% of
our common stock outstanding. Such a concentration of ownership
and voting power may have the effect of delaying or preventing a
change in the control of our company.



| |                                                                                                                                                                                  
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Provisions in our charter documents and
    Nevada law could prevent or delay a change in the control of our
    company and may reduce the market price of our common
    stock.

Nevada law, our articles of incorporation and our
bylaws contain provisions that could discourage a proxy contest
or make more difficult the acquisition of a substantial block of
our common stock. In addition, our board of directors is
authorized to issue, without stockholder approval, up to
5,000,000 shares of preferred stock with voting, conversion
and other rights and preferences that may be superior to those
of the common stock and that could adversely affect the voting
power or other rights of the holders of common stock. The
issuance of preferred stock or rights to purchase preferred
stock could be used to discourage an unsolicited acquisition
proposal.



| |                                                                                                                                                                                                                                                                                         
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we are required in the future to record
    an expense for our stock-based compensation plans, the resultant
    ongoing accounting charges would significantly reduce our
    reported net income and net income per share, and the price of
    our stock could drop significantly.

On October 13, 2004, the Financial
Accounting Standards Board (FASB) concluded that proposed
Statement 123R, Share-Based Payment, which
would require all companies to measure compensation expense for
all share based payments (including employee stock options) at
fair value, will be effective, if it is adopted by the FASB, for
public companies for interim or annual periods beginning after
June 15, 2005. Adoption of FASB Statement 123R would
require us to record an expense for stock-based compensation
plans and would result in ongoing accounting charges that would
significantly reduce our net income. See the section

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entitled Stock-based Compensation in
Note 1 of the Notes to our Consolidated Financial
Statements for further information.







|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosure
    About Market Risks

Foreign Exchange Risk and Derivative Financial
Instruments

Our foreign subsidiaries operate and sell our
products in various global markets. As a result, we are exposed
to changes in exchange rates on foreign currency denominated
transactions with foreign subsidiaries. We use foreign currency
forward exchange contracts, and we infrequently use options, to
mitigate the risk of future movements in foreign exchange rates
that affect certain foreign currency denominated inter-company
receivables or expected revenues. The forward contracts and
options are not designated as accounting hedges. We attempt to
match the forward contracts with the underlying receivables in
terms of currency, amount and maturity, and to match the options
with expected foreign currency revenue in terms of currency,
amount and recognition period. We do not use derivative
financial instruments for speculative or trading purposes.
Because the impact of movements in currency exchange rates on
forward contracts and options generally offsets the related
impact on the exposures economically hedged, these derivative
financial instruments do not subject us to speculative risk that
would otherwise result from changes in currency exchange rates.
Gains and losses on forward exchange contracts generally offset
the foreign exchange transaction gains or losses from
revaluation of foreign currency denominated amounts receivable.
Gains on options generally offset the opportunity cost of
foreign currency revenue recognized at an exchange rate less
favorable than the option rate. To date, we have not fully
mitigated all risk associated with our revenues and resulting
accounts receivable denominated in foreign currencies, and there
can be no assurance that our mitigation activities, if any, will
be successful.

At September 30, 2004, we had forward
exchange contracts maturing in fiscal 2005 to sell approximately
$0.9 million in Japanese Yen designed to mitigate the risk
of future movements in foreign exchange rates relating to
intercompany accounts receivable. There were no options
outstanding at that date. The fair market value of these
contracts at September 30, 2004 was not material.

We have evaluated the potential near-term losses
in future earnings, fair values and cash flows from reasonably
possible near-term currency fluctuations, and we believe that
any such losses would not be material.*

Interest Rate Risk

Our exposure to market risk for changes in
interest rates relates primarily to our short-term investment
portfolio. As of September 30, 2004, cash equivalents and
short-term investments consisted of available-for-sale
securities of $34.4 million (see Note 8. Balance
Sheet Components in the Notes to Consolidated Financial
Statements). These fixed income marketable securities included
corporate and municipal bonds and government securities, all of
which are of high investment grade. They are subject to interest
rate risk and will decline in value if the market interest rates
increase. If the market interest rates were to increase
immediately and uniformly by 10% from levels as of
September 30, 2004, the decline in the fair value of the
portfolio would not be material to our financial position.

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

CATAPULT COMMUNICATIONS CORPORATION

INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

AND SUPPLEMENTARY DATA


|                                          |                                                                                                                                                                   |      |  |    | 
|----------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---- |  | -- | 
|                                          |                                                                                                                                                                   | Page
|                                          |                                                                                                                                                                   |     
|Consolidated Financial Statements:        |                                                                                                                                                                   |      |  |   
|                                          | Report of Independent Registered Public
    Accounting Firm                                                                                                       |      |  | 35 | 
|                                          | Consolidated Balance Sheets at September 30,
    2003 and 2004                                                                                                    |      |  | 36 | 
|                                          | Consolidated Statements of Income for each of the
    three years in the period ended September 30, 2004                                                          |      |  | 37 | 
|                                          | Consolidated Statements of Stockholders
    Equity for each of the three years in the period ended
    September 30, 2004                                        |      |  | 38 | 
|                                          | Consolidated Statements of Cash Flows for each of
    the three years in the period ended September 30, 2004                                                      |      |  | 39 | 
|                                          | Notes to Consolidated Financial Statements                                                                                                                        |      |  | 40 | 
|Financial Statement Schedules:            |                                                                                                                                                                   |      |  |   
|                                          | All schedules are omitted because they are not
    applicable or the required information is shown in the
    consolidated financial statements or notes thereto. |      |  |    | 
|Supplementary Financial Data (unaudited): |                                                                                                                                                                   |      |  |   
|                                          | Quarterly Financial Data for each of the years
    ended September 30, 2003 and 2004                                                                              |      |  | 59 | 

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REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

To the Board of Directors and Stockholders of
Catapult Communications Corporation:

In our opinion, the accompanying consolidated
balance sheets and the related consolidated statements of income
and of stockholders equity and of cash flows present
fairly, in all material respects, the financial position of
Catapult Communications Corporation and its subsidiaries at
September 30, 2004 and 2003, and the results of their
operations and their cash flows for each of the three years in
the period ended September 30, 2004, 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 of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements,
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.



| |                               
| | ------------------------------
| | /S/ PRICEWATERHOUSECOOPERS LLP

San Jose, California

December 2, 2004


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CATAPULT COMMUNICATIONS CORPORATION

CONSOLIDATED BALANCE SHEETS

|                                         |                                                                                                                                                                            |                                            |        |        |         |  |        |        |         | 
|---------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ------ | ------- |  | ------ | ------ | ------- | 
|                                         |                                                                                                                                                                            |                                           
|                                         |                                                                                                                                                                            | September 30,                             
|                                         |                                                                                                                                                                            |                                           
|                                         |                                                                                                                                                                            | 2003                                       |        | 2004  
|                                         |                                                                                                                                                                            |                                            |        |       
|                                         |                                                                                                                                                                            |                                           
|                                         |                                                                                                                                                                            | (In thousands, except                     
|                                         |                                                                                                                                                                            | share and per share data)                 
|ASSETS                                  
|Current Assets:                          |                                                                                                                                                                            |                                            |        |        |         |  |        |       
|                                         | Cash and cash equivalents                                                                                                                                                  |                                            | $      | 11,770 |         |  | $      | 18,320 |        
|                                         | Short-term investments                                                                                                                                                     |                                            |        | 18,901 |         |  |        | 34,350 |        
|                                         | Accounts receivable, net of allowances of $320
    and $294 as of September 30, 2003 and 2004, respectively                                                                |                                            |        | 10,598 |         |  |        | 10,110 |        
|                                         | Inventories                                                                                                                                                                |                                            |        | 2,325  |         |  |        | 2,380  |        
|                                         | Deferred income taxes                                                                                                                                                      |                                            |        | 2,407  |         |  |        | 985    |        
|                                         | Prepaid expenses                                                                                                                                                           |                                            |        | 1,096  |         |  |        | 1,638  |        
|                                         |                                                                                                                                                                            |                                            |        |        |         |  |        |       
|                                         |                                                                                                                                                                            | Total current assets                       |        |        | 47,097  |  |        |        | 67,783  | 
|Property and equipment, net              |                                                                                                                                                                            |                                            | 3,384  |        |         |  | 2,640  |       
|Goodwill                                 |                                                                                                                                                                            |                                            | 49,394 |        |         |  | 49,394 |       
|Other intangibles, net                   |                                                                                                                                                                            |                                            | 6,093  |        |         |  | 5,072  |       
|Other assets                             |                                                                                                                                                                            |                                            | 1,121  |        |         |  | 3,382  |       
|                                         |                                                                                                                                                                            |                                            |        |        |         |  |        |       
|                                         |                                                                                                                                                                            | Total assets                               |        | $      | 107,089 |  |        | $      | 128,271 | 
|                                         |                                                                                                                                                                            |                                            |        |        |         |  |        |       
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|Current Liabilities:                     |                                                                                                                                                                            |                                            |        |        |         |  |        |       
|                                         | Accounts payable                                                                                                                                                           |                                            | $      | 1,216  |         |  | $      | 1,502  |        
|                                         | Accrued liabilities                                                                                                                                                        |                                            |        | 6,002  |         |  |        | 5,546  |        
|                                         | Deferred revenue                                                                                                                                                           |                                            |        | 5,391  |         |  |        | 5,388  |        
|                                         | Convertible notes payable                                                                                                                                                  |                                            |        | 17,674 |         |  |        |       |        
|                                         |                                                                                                                                                                            |                                            |        |        |         |  |        |       
|                                         |                                                                                                                                                                            | Total current liabilities                  |        |        | 30,283  |  |        |        | 12,436  | 
|Deferred revenue long term portion       |                                                                                                                                                                            |                                            | 185    |        |         |  | 70     |       
|                                         |                                                                                                                                                                            |                                            |        |        |         |  |        |       
|                                         |                                                                                                                                                                            | Total liabilities                          |        |        | 30,468  |  |        |        | 12,506  | 
|                                         |                                                                                                                                                                            |                                            |        |        |         |  |        |       
|Commitments and contingencies (Note 13)  |                                                                                                                                                                            |                                            |        |        |         |  |        |       
|Stockholders Equity:                    |                                                                                                                                                                            |                                            |        |        |         |  |        |       
|                                         | Preferred stock, $0.001 par value,
    5,000,000 shares authorized; none issued and outstanding                                                                            |                                            |        |       |         |  |        |       |        
|                                         | Common stock, $0.001 par value,
    40,000,000 shares authorized; 12,886,545 and 14,545,546
    issued and outstanding as of September 30, 2003 and 2004,
    respectively |                                            |        | 13     |         |  |        | 15     |        
|                                         | Additional paid-in capital                                                                                                                                                 |                                            |        | 21,187 |         |  |        | 46,297 |        
|                                         | Deferred stock-based compensation                                                                                                                                          |                                            |        | (75    | )       |  |        | (39    | )      
|                                         | Accumulated other comprehensive income                                                                                                                                     |                                            |        | 575    |         |  |        | 660    |        
|                                         | Retained earnings                                                                                                                                                          |                                            |        | 54,921 |         |  |        | 68,832 |        
|                                         |                                                                                                                                                                            |                                            |        |        |         |  |        |       
|                                         |                                                                                                                                                                            | Total stockholders equity                 |        |        | 76,621  |  |        |        | 115,765 | 
|                                         |                                                                                                                                                                            |                                            |        |        |         |  |        |       
|                                         |                                                                                                                                                                            | Total liabilities and stockholders equity |        | $      | 107,089 |  |        | $      | 128,271 | 
|                                         |                                                                                                                                                                            |                                            |        |        |         |  |        |       

The accompanying notes are an integral part of
these consolidated financial statements.

36



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |        | 
|---------------------------------------------------------------------------------------------- | --------------------------------------------- | ------------------------ | ------ | ------ | - | ---- | ------ | ------ |  | - | ------ | ------ | 
|                                                                                               |                                               |                         
|                                                                                               |                                               | Year Ended September 30,
|                                                                                               |                                               |                         
|                                                                                               |                                               | 2002                     |        | 2003   |   | 2004
|                                                                                               |                                               |                          |        |        |   |     
|                                                                                               |                                               |                         
|                                                                                               |                                               | (In thousands, except   
|                                                                                               |                                               | per share data)         
|Revenues:                                                                                      |                                               |                          |        |        |   |      |        |        |  |   |        |       
|                                                                                               | Products                                      |                          | $      | 33,988 |   |      | $      | 35,344 |  |   | $      | 45,703 | 
|                                                                                               | Services                                      |                          |        | 6,051  |   |      |        | 9,880  |  |   |        | 12,315 | 
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|                                                                                               | Total revenues                                |                          |        | 40,039 |   |      |        | 45,224 |  |   |        | 58,018 | 
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|Cost of revenues:                                                                              |                                               |                          |        |        |   |      |        |        |  |   |        |       
|                                                                                               | Products                                      |                          |        | 2,700  |   |      |        | 5,652  |  |   |        | 5,192  | 
|                                                                                               | Services                                      |                          |        | 1,172  |   |      |        | 2,825  |  |   |        | 3,570  | 
|                                                                                               | Amortization of purchased technology          |                          |        | 57     |   |      |        | 686    |  |   |        | 686    | 
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|                                                                                               | Total cost of revenues                        |                          |        | 3,929  |   |      |        | 9,163  |  |   |        | 9,448  | 
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|Gross profit                                                                                   |                                               |                          | 36,110 |        |   |      | 36,061 |        |  |   | 48,570 |       
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|Operating expenses:                                                                            |                                               |                          |        |        |   |      |        |        |  |   |        |       
|                                                                                               | Research and development                      |                          |        | 7,520  |   |      |        | 13,519 |  |   |        | 11,740 | 
|                                                                                               | Sales and marketing                           |                          |        | 10,714 |   |      |        | 14,506 |  |   |        | 17,075 | 
|                                                                                               | General and administrative                    |                          |        | 4,899  |   |      |        | 6,679  |  |   |        | 6,885  | 
|                                                                                               | Restructuring costs                           |                          |        |       |   |      |        | 730    |  |   |        |       | 
|                                                                                               | Purchased in-process research and development |                          |        | 1,400  |   |      |        |       |  |   |        |       | 
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|                                                                                               | Total operating expenses                      |                          |        | 24,533 |   |      |        | 35,434 |  |   |        | 35,700 | 
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|Operating income                                                                               |                                               |                          | 11,577 |        |   |      | 627    |        |  |   | 12,870 |       
|Interest income                                                                                |                                               |                          | 1,456  |        |   |      | 786    |        |  |   | 801    |       
|Interest expense                                                                               |                                               |                          | (29    | )      |   |      | (350   | )      |  |   | (321   | )     
|Other income (expense), net                                                                    |                                               |                          | (219   | )      |   |      | 1,216  |        |  |   | 148    |       
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|Income from continuing operations before income
    taxes                                      |                                               |                          | 12,785 |        |   |      | 2,279  |        |  |   | 13,498 |       
|Provision for (benefit from) income taxes                                                      |                                               |                          | 3,580  |        |   |      | (2,086 | )      |  |   | (413   | )     
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|Net income from continuing operations                                                          |                                               |                          | 9,205  |        |   |      | 4,365  |        |  |   | 13,911 |       
|Loss from discontinued operations, adjusted for
    applicable benefit for income taxes of $46 |                                               |                          | (56    | )      |   |      |       |        |  |   |       |       
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|Net income                                                                                     |                                               | $                        | 9,149  |        |   | $    | 4,365  |        |  | $ | 13,911 |       
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|Net income per share  basic                                                                   |                                               |                          |        |        |   |      |        |        |  |   |        |       
|                                                                                               | Income from continuing operations             |                          | $      | 0.71   |   |      | $      | 0.34   |  |   | $      | 1.06   | 
|                                                                                               | Loss from discontinued operations             |                          |        | (0.00  | ) |      |        |       |  |   |        |       | 
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|Net income per share  basic                                                                   |                                               | $                        | 0.70   |        |   | $    | 0.34   |        |  | $ | 1.06   |       
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|Net income per share  diluted                                                                 |                                               |                          |        |        |   |      |        |        |  |   |        |       
|                                                                                               | Income from continuing operations             |                          | $      | 0.69   |   |      | $      | 0.33   |  |   | $      | 0.95   | 
|                                                                                               | Loss from discontinued operations             |                          |        | (0.00  | ) |      |        |       |  |   |        |       | 
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|Net income per share  diluted                                                                 |                                               | $                        | 0.69   |        |   | $    | 0.33   |        |  | $ | 0.95   |       
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|Shares used in per share calculation:                                                          |                                               |                          |        |        |   |      |        |        |  |   |        |       
|                                                                                               | Basic                                         |                          |        | 13,039 |   |      |        | 12,948 |  |   |        | 13,100 | 
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       
|                                                                                               | Diluted                                       |                          |        | 13,313 |   |      |        | 13,113 |  |   |        | 14,556 | 
|                                                                                               |                                               |                          |        |        |   |      |        |        |  |   |        |       

The accompanying notes are an integral part of
these consolidated financial statements.

37



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

|                                                                        |  |                                   |            |            |  |             |    |               |  |               |        |          |  |               |      |               |  |        |      |   |  |   |      |   |  |   |        |  |  |   |         |   |  |   |        |  
|----------------------------------------------------------------------- |  | --------------------------------- | ---------- | ---------- |  | ----------- | -- | ------------- |  | ------------- | ------ | -------- |  | ------------- | ---- | ------------- |  | ------ | ---- | - |  | - | ---- | - |  | - | ------ |  |  | - | ------- | - |  | - | ------ | -
|                                                                        |  |                                   |            |            |  |             |    | Accumulated   |  |               |        |          |  |               |      |              
|                                                                        |  | Common Stock                      |            | Additional |  | Deferred    |    | Other         |  |               |        |          |  | Total         |      |              
|                                                                        |  |                                   |            | Paid-In    |  | Stock-Based |    | Comprehensive |  | Treasury      |        | Retained |  | Stockholders |      | Comprehensive
|                                                                        |  | Shares                            |            | Amount     |  | Capital     |    | Compensation  |  | Income (loss) |        | Stock    |  | Earnings      |      | Equity        |  | Income
|                                                                        |  |                                   |            |            |  |             |    |               |  |               |        |          |  |               |      |               |  |       
|                                                                        |  |                                  
|                                                                        |  | (In thousands, except share data)
|Balances at September 30, 2001                                          |  |                                   | 12,990,960 |            |  | $           | 13 |               |  | $             | 21,758 |          |  | $             |     |               |  | $      | 612  |   |  | $ | (300 | ) |  | $ | 41,407 |  |  | $ | 63,490  |   |  | $ | 11,055 |  
|                                                                        |  |                                   |            |            |  |             |    |               |  |               |        |          |  |               |      |               |  |        |      |   |  |   |      |   |  |   |        |  |  |   |         |   |  |   |        |  
|Issuance of common stock                                                |  |                                   | 64,313     |            |  |             |   |               |  |               | 723    |          |  |               |     |               |  |        |     |   |  |   |      |   |  |   |       |  |  |   | 723     |   |  |   |        |  
|Deferred stock-based compensation                                       |  |                                   |           |            |  |             |   |               |  |               | 144    |          |  |               | (144 | )             |  |        |     |   |  |   |     |   |  |   |       |  |  |   |        |   |  |   |        |  
|Amortization of deferred stock-based compensation                       |  |                                   |           |            |  |             |   |               |  |               |       |          |  |               | 33   |               |  |        |     |   |  |   |      |   |  |   |       |  |  |   | 33      |   |  |   |        |  
|Currency translation adjustment                                         |  |                                   |           |            |  |             |   |               |  |               |       |          |  |               |     |               |  |        | (353 | ) |  |   |     |   |  |   |       |  |  |   | (353    | ) |  | $ | (353   | )
|Unrealized gains and (losses) on investments, net                       |  |                                   |           |            |  |             |   |               |  |               |       |          |  |               |     |               |  |        | (77  | ) |  |   |     |   |  |   |       |  |  |   | (77     | ) |  |   | (77    | )
|Net income                                                              |  |                                   |           |            |  |             |   |               |  |               |       |          |  |               |     |               |  |        |     |   |  |   |     |   |  |   | 9,149  |  |  |   | 9,149   |   |  |   | 9,149  |  
|                                                                        |  |                                   |            |            |  |             |    |               |  |               |        |          |  |               |      |               |  |        |      |   |  |   |      |   |  |   |        |  |  |   |         |   |  |   |        |  
|Balances at September 30, 2002                                          |  |                                   | 13,055,273 |            |  |             | 13 |               |  |               | 22,625 |          |  |               | (111 | )             |  |        | 182  |   |  |   | (300 | ) |  |   | 50,556 |  |  |   | 72,965  |   |  | $ | 8,719  |  
|                                                                        |  |                                   |            |            |  |             |    |               |  |               |        |          |  |               |      |               |  |        |      |   |  |   |      |   |  |   |        |  |  |   |         |   |  |   |        |  
|Issuance of common stock                                                |  |                                   | 88,672     |            |  |             |   |               |  |               | 530    |          |  |               |     |               |  |        |     |   |  |   |     |   |  |   |       |  |  |   | 530     |   |  |   |        |  
|Tax benefit from employee stock transactions                            |  |                                   |           |            |  |             |   |               |  |               | 92     |          |  |               |     |               |  |        |     |   |  |   |     |   |  |   |       |  |  |   | 92      |   |  |   |        |  
|Cancellation of treasury stock                                          |  |                                   |           |            |  |             |   |               |  |               | (300   | )        |  |               |     |               |  |        |     |   |  |   | 300  |   |  |   |       |  |  |   |        |   |  |   |        |  
|Repurchase of common stock                                              |  |                                   | (257,400   | )          |  |             |    |               |  |               | (1,760 | )        |  |               |     |               |  |        |     |   |  |   |     |   |  |   |       |  |  |   | (1,760  | ) |  |   |        |  
|Amortization of deferred stock-based compensation                       |  |                                   |           |            |  |             |   |               |  |               |       |          |  |               | 36   |               |  |        |     |   |  |   |     |   |  |   |       |  |  |   | 36      |   |  |   |        |  
|Currency translation adjustment                                         |  |                                   |           |            |  |             |   |               |  |               |       |          |  |               |     |               |  |        | 399  |   |  |   |     |   |  |   |       |  |  |   | 399     |   |  | $ | 399    |  
|Unrealized gains and (losses) on investments, net                       |  |                                   |           |            |  |             |   |               |  |               |       |          |  |               |     |               |  |        | (6   | ) |  |   |     |   |  |   |       |  |  |   | (6      | ) |  |   | (6     | )
|Net income                                                              |  |                                   |           |            |  |             |   |               |  |               |       |          |  |               |     |               |  |        |     |   |  |   |     |   |  |   | 4,365  |  |  |   | 4,365   |   |  |   | 4,365  |  
|                                                                        |  |                                   |            |            |  |             |    |               |  |               |        |          |  |               |      |               |  |        |      |   |  |   |      |   |  |   |        |  |  |   |         |   |  |   |        |  
|Balances at September 30, 2003                                          |  |                                   | 12,886,545 |            |  |             | 13 |               |  |               | 21,187 |          |  |               | (75  | )             |  |        | 575  |   |  |   |     |   |  |   | 54,921 |  |  |   | 76,621  |   |  | $ | 4,758  |  
|                                                                        |  |                                   |            |            |  |             |    |               |  |               |        |          |  |               |      |               |  |        |      |   |  |   |      |   |  |   |        |  |  |   |         |   |  |   |        |  
|Issuance of common stock from exercise of stock
    options             |  |                                   | 377,751    |            |  |             |   |               |  |               | 3,390  |          |  |               |     |               |  |        |     |   |  |   |     |   |  |   |       |  |  |   | 3,390   |   |  |   |        |  
|Tax benefit from employee stock transactions                            |  |                                   |           |            |  |             |   |               |  |               | 1,409  |          |  |               |     |               |  |        |     |   |  |   |     |   |  |   |       |  |  |   | 1,409   |   |  |   |        |  
|Conversion of notes payable                                             |  |                                   | 1,081,250  |            |  |             | 2  |               |  |               | 17,299 |          |  |               |     |               |  |        |     |   |  |   |     |   |  |   |       |  |  |   | 17,301  |   |  |   |        |  
|Issuance of common stock from stock offering, net
    of offering costs |  |                                   | 200,000    |            |  |             |   |               |  |               | 3,012  |          |  |               |     |               |  |        |     |   |  |   |     |   |  |   |       |  |  |   | 3,012   |   |  |   |        |  
|Amortization of deferred stock-based compensation                       |  |                                   |           |            |  |             |   |               |  |               |       |          |  |               | 36   |               |  |        |     |   |  |   |     |   |  |   |       |  |  |   | 36      |   |  |   |        |  
|Currency translation adjustment                                         |  |                                   |           |            |  |             |   |               |  |               |       |          |  |               |     |               |  |        | 93   |   |  |   |     |   |  |   |       |  |  |   | 93      |   |  | $ | 93     |  
|Unrealized gains and (losses) on investments, net                       |  |                                   |           |            |  |             |   |               |  |               |       |          |  |               |     |               |  |        | (8   | ) |  |   |     |   |  |   |       |  |  |   | (8      | ) |  |   | (8     | )
|Net income                                                              |  |                                   |           |            |  |             |   |               |  |               |       |          |  |               |     |               |  |        |     |   |  |   |     |   |  |   | 13,911 |  |  |   | 13,911  |   |  |   | 13,911 |  
|                                                                        |  |                                   |            |            |  |             |    |               |  |               |        |          |  |               |      |               |  |        |      |   |  |   |      |   |  |   |        |  |  |   |         |   |  |   |        |  
|Balances at September 30, 2004                                          |  |                                   | 14,545,546 |            |  | $           | 15 |               |  | $             | 46,297 |          |  | $             | (39  | )             |  | $      | 660  |   |  |   |     |   |  | $ | 68,832 |  |  | $ | 115,765 |   |  | $ | 13,996 |  
|                                                                        |  |                                   |            |            |  |             |    |               |  |               |        |          |  |               |      |               |  |        |      |   |  |   |      |   |  |   |        |  |  |   |         |   |  |   |        |  

The accompanying notes are an integral part of
these consolidated financial statements.

38



---



##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                            |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |         |        |      |         |  
|--------------------------------------------------------------------------- | ------------------------------------------------------------------------------------- | -------------------------------------------------------------------- | -------------------------------------- | ------------------------------------------------------- | ------ | ------ | ------- | ------- | ------ | ------ | ------ | ------- | ------ | ---- | ------- | -
|                                                                            |                                                                                       |                                                                     
|                                                                            |                                                                                       | Year Ended September 30,                                            
|                                                                            |                                                                                       |                                                                     
|                                                                            |                                                                                       | 2002                                                                 |                                        | 2003                                                    |        | 2004  
|                                                                            |                                                                                       |                                                                      |                                        |                                                         |        |       
|                                                                            |                                                                                       |                                                                     
|                                                                            |                                                                                       | (In thousands)                                                      
|Cash flows from operating activities:                                       |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|                                                                            | Net income                                                                            |                                                                      | $                                      | 9,149                                                   |        |        | $       | 4,365   |        |        | $      | 13,911  |       
|                                                                            | Adjustments to reconcile net income to net cash
    provided by operating activities: |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |         |       
|                                                                            |                                                                                       | Depreciation and amortization of property and
    equipment          |                                        |                                                         | 807    |        |         |         | 1,659  |        |        |         | 1,842  |     
|                                                                            |                                                                                       | Amortization of deferred stock-based compensation                    |                                        |                                                         | 33     |        |         |         | 36     |        |        |         | 36     |     
|                                                                            |                                                                                       | Purchased in-process research and development                        |                                        |                                                         | 1,400  |        |         |         |       |        |        |         |       |     
|                                                                            |                                                                                       | Amortization of purchased technology                                 |                                        |                                                         | 57     |        |         |         | 686    |        |        |         | 686    |     
|                                                                            |                                                                                       | Amortization of other acquisition related
    intangibles            |                                        |                                                         | 228    |        |         |         | 536    |        |        |         | 335    |     
|                                                                            |                                                                                       | Provision for (recovery of) doubtful accounts                        |                                        |                                                         | (35    | )      |         |         | 282    |        |        |         | 16     |     
|                                                                            |                                                                                       | Deferred income taxes                                                |                                        |                                                         | (586   | )      |         |         | (1,193 | )      |        |         | (895   | )   
|                                                                            |                                                                                       | Tax benefits from employee stock option plans                        |                                        |                                                         |       |        |         |         | 92     |        |        |         | 1,409  |     
|                                                                            |                                                                                       | Loss on sale of property and equipment                               |                                        |                                                         | 68     |        |         |         |       |        |        |         |       |     
|                                                                            |                                                                                       | Amortization of convertible notes premium                            |                                        |                                                         | (34    | )      |         |         | (407   | )      |        |         | (374   | )   
|                                                                            |                                                                                       | Change in assets and liabilities (net of effect
    of acquisition): |                                        |                                                         |        |        |         |         |        |        |        |         |        |     
|                                                                            |                                                                                       |                                                                      | Accounts receivable                    |                                                         |        | 724    |         |         |        | (588   | )      |         |        | 461  |        
|                                                                            |                                                                                       |                                                                      | Inventories                            |                                                         |        | 344    |         |         |        | 1,047  |        |         |        | (47  | )      
|                                                                            |                                                                                       |                                                                      | Prepaid expenses                       |                                                         |        | 116    |         |         |        | 314    |        |         |        | (516 | )      
|                                                                            |                                                                                       |                                                                      | Assets of discontinued operations      |                                                         |        | (2,636 | )       |         |        | 2,636  |        |         |        |     |        
|                                                                            |                                                                                       |                                                                      | Other assets                           |                                                         |        | (202   | )       |         |        | 51     |        |         |        | 57   |        
|                                                                            |                                                                                       |                                                                      | Accounts payable                       |                                                         |        | 684    |         |         |        | (1,113 | )      |         |        | 244  |        
|                                                                            |                                                                                       |                                                                      | Accrued liabilities                    |                                                         |        | 1,225  |         |         |        | (5,030 | )      |         |        | (487 | )      
|                                                                            |                                                                                       |                                                                      | Deferred revenue                       |                                                         |        | 162    |         |         |        | 1,084  |        |         |        | (119 | )      
|                                                                            |                                                                                       |                                                                      | Liabilities of discontinued operations |                                                         |        | 889    |         |         |        | (889   | )      |         |        |     |        
|                                                                            |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|                                                                            |                                                                                       |                                                                      |                                        | Net cash provided by operating activities               |        |        | 12,393  |         |        |        | 3,568  |         |        |      | 16,559  |  
|                                                                            |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|Cash flows from investing activities:                                       |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|                                                                            | Sale and maturities of short-term investments                                         |                                                                      |                                        | 90,200                                                  |        |        |         | 45,145  |        |        |        | 17,119  |       
|                                                                            | Purchase of short-term investments                                                    |                                                                      |                                        | (95,792                                                 | )      |        |         | (41,262 | )      |        |        | (32,576 | )     
|                                                                            | Acquisition, net of cash acquired                                                     |                                                                      |                                        | (38,209                                                 | )      |        |         | (5,976  | )      |        |        |        |       
|                                                                            | Purchase of property and equipment                                                    |                                                                      |                                        | (589                                                    | )      |        |         | (1,302  | )      |        |        | (1,077  | )     
|                                                                            |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|                                                                            |                                                                                       |                                                                      |                                        | Net cash used in investing activities                   |        |        | (44,390 | )       |        |        | (3,395 | )       |        |      | (16,534 | )
|                                                                            |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|Cash flows from financing activities:                                       |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|                                                                            | Repurchase of common stock                                                            |                                                                      |                                        |                                                        |        |        |         | (1,760  | )      |        |        |        |       
|                                                                            | Proceeds from exercise of stock options                                               |                                                                      |                                        | 723                                                     |        |        |         | 530     |        |        |        | 3,390   |       
|                                                                            | Proceeds from stock offering, net of offering
    costs                               |                                                                      |                                        |                                                        |        |        |         |        |        |        |        | 3,012   |       
|                                                                            |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|                                                                            |                                                                                       |                                                                      |                                        | Net cash provided by (used in) financing
    activities |        |        | 723     |         |        |        | (1,230 | )       |        |      | 6,402   |  
|                                                                            |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|Effect of exchange rate changes on cash and cash
    equivalents            |                                                                                       |                                                                      | (353                                   | )                                                       |        |        | 252     |         |        |        | 123    |        
|                                                                            |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|Net increase (decrease) in cash and cash
    equivalents                    |                                                                                       |                                                                      | (31,627                                | )                                                       |        |        | (805    | )       |        |        | 6,550  |        
|Cash and cash equivalents, beginning of year                                |                                                                                       |                                                                      | 44,202                                 |                                                         |        |        | 12,575  |         |        |        | 11,770 |        
|                                                                            |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|Cash and cash equivalents, end of year                                      |                                                                                       | $                                                                    | 12,575                                 |                                                         |        | $      | 11,770  |         |        | $      | 18,320 |        
|                                                                            |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|Supplemental disclosures of cash flow information:                          |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|                                                                            |                                                                                       | Income taxes paid                                                    |                                        | $                                                       | 3,510  |        |         | $       | 1,586  |        |        | $       | 1,807  |     
|                                                                            |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|Supplemental disclosure of non cash investing and
    financing activities: |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        
|                                                                            |                                                                                       | Convertible notes issued for acquisition                             |                                        | $                                                       | 18,115 |        |         | $       |       |        |        | $       |       |     
|                                                                            |                                                                                       | Conversion of notes payable to common stock                          |                                        | $                                                       |       |        |         | $       |       |        |        | $       | 17,300 |     
|                                                                            |                                                                                       |                                                                      |                                        |                                                         |        |        |         |         |        |        |        |        

The accompanying notes are an integral part of
these consolidated financial statements.

39



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



|         |                                                               
|-------- | --------------------------------------------------------------
|Note 1  | The Company and Summary of Significant
    Accounting Policies



| |            
| | -----------
| | The Company

Catapult Communications Corporation and its
subsidiaries (we or the Company) design,
develop, manufacture, market and support advanced software-based
test systems offering integrated suites of testing applications
for the global telecommunications industry. Our advanced test
systems assist our customers in the design, integration,
installation and acceptance testing of a broad range of digital
telecommunications equipment and services. The Company was
incorporated in California in October 1985, was reincorporated
in Nevada in 1998, and has operations in the United States,
Canada, the United Kingdom, Europe, Japan, China and Australia.
Management has determined that we conduct our business within
one industry segment: the design, development, manufacture,
marketing and support of advanced software-based test systems
globally.



| |                       
| | ----------------------
| | Basis of Consolidation

The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries,
Catapult Communications Limited, Catapult Communications K.K.,
Catapult Communications International Limited, Catapult
Communications (China) Co. Limited and Tekelec Limited (from the
August 30, 2002 date it was acquired by us to the
September 30, 2003 date it was liquidated). All significant
inter-company accounts and transactions have been eliminated in
consolidation.



| |                  
| | -----------------
| | Reclassifications

Certain reclassifications have been made to the
prior year financial statements in order to conform to the
current year presentation. These reclassifications did not
change the previously recorded stockholders equity, net
income or net income per share.



| |                 
| | ----------------
| | Use of Estimates

The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States of America 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 date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual
results could differ from those estimates.



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

We maintain our cash in bank deposit accounts at
financial institutions in the United States, Japan, the United
Kingdom, Ireland and Canada. Cash equivalents are investments
with an original maturity of 90 days or less. This type of
investment consists principally of U.S. treasury
securities, commercial paper and money market instruments, the
fair value of which approximates cost. Interest is accrued as
earned.



| |                       
| | ----------------------
| | Short-Term Investments

Short-term investments are investments with an
original maturity between 91 days and one year. Our
short-term investments are placed in portfolios managed by three
professional money management firms. At September 30, 2003
and 2004, the portfolios consisted primarily of commercial
paper, investment quality corporate bonds, collateralized
mortgage obligations, and U.S. government agency securities.

At September 30, 2003 and 2004, our
short-term investments are classified as available for sale and
are carried at their estimated fair value in the accompanying
consolidated balance sheets. Unrealized gains and losses are
included in stockholders equity as a component of
accumulated other comprehensive income.

40



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Realized gains and losses are reported in
interest income in the accompanying consolidated statements of
income.



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

Sales of our product arrangements normally
include hardware and software. Certain of our sales may also
include installation. We also offer training and maintenance
services separately from our product arrangements. We recognize
revenue on system sales upon shipment or when installation is
complete, if installation services are purchased, provided
persuasive evidence of an arrangement exists, the fee is fixed
or determinable and collection of the resulting receivable is
probable. Training and maintenance services revenues are based
on our established history of charging separate fees for
training and maintenance. Revenues allocated to training are
recognized at the time the training is complete. Revenues
allocated to maintenance are recognized ratably over the term of
the maintenance contract.



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

Certain of our foreign subsidiaries use their
respective local currencies as their functional currencies. In
consolidation, assets and liabilities are translated at year-end
currency exchange rates and revenue and expense items are
translated at average currency exchange rates prevailing during
the period. Gains and losses from foreign currency translation
are recorded in accumulated other comprehensive income. Gains
and losses resulting from foreign currency transactions are
included in other income (expense), net in the accompanying
consolidated statements of income and amounted to losses of
$248,000, gains of $411,000 and gains of $44,000 in fiscal 2002,
2003 and 2004, respectively.



| |                                     
| | ------------------------------------
| | Derivative Financial
    Instruments

Our foreign subsidiaries operate and sell our
products in various global markets. As a result, we are exposed
to changes in exchange rates on foreign currency denominated
transactions with foreign subsidiaries. We use foreign currency
forward exchange contracts, and we infrequently use options, to
mitigate the risk of future movements in foreign exchange rates
that affect certain foreign currency denominated inter-company
receivables or expected revenues. The forward contracts and
options are not designated as accounting hedges. We attempt to
match the forward contracts with the underlying receivables in
terms of currency, amount and maturity, and to match the options
with expected foreign currency revenue in terms of currency,
amount and recognition period. We do not use derivative
financial instruments for speculative or trading purposes.
Because the impact of movements in currency exchange rates on
forward contracts and options generally offsets the related
impact on the exposures economically hedged, these derivative
financial instruments do not subject us to speculative risk that
would otherwise result from changes in currency exchange rates.
Gains and losses on forward exchange contracts generally offset
the foreign exchange transaction gains or losses from
revaluation of foreign currency denominated amounts receivable.
Gains on options generally offset the opportunity cost of
foreign currency revenue recognized at an exchange rate less
favorable than the option rate.

At September 30, 2004, we had forward
exchange contracts maturing in fiscal 2005 to sell approximately
$0.9 million in Japanese Yen designed to mitigate the risk
of future movements in foreign exchange rates on our foreign
currency denominated intercompany receivables. The fair value of
these contracts at September 30, 2004 was not material.



| |                                        
| | ---------------------------------------
| | Fair Value of Financial
    Instruments

The carrying value of our financial instruments
including cash and cash equivalents, accounts receivable,
accounts payable and accrued liabilities approximate their fair
values due to their relatively short maturity. The fair value of
the convertible notes payable at the date they were issued,
August 30, 2002, was determined by an independent valuation
and included a premium over the principal amounts payable.

41



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                                  
| | -------------------------------------------------
| | Concentration of Credit Risk/ Major
    Customers

Financial instruments that potentially subject us
to a concentration of credit risk consist of cash and cash
equivalents, short-term investments and accounts receivable.
Substantially all of our cash, cash equivalents and short-term
investments are managed or held by five financial institutions.
Our accounts receivable are derived from revenue earned from
customers located in Japan, North America, the United Kingdom
and Europe, China and Korea. We perform ongoing credit
evaluations of our customers financial condition and,
generally, require no collateral from our customers. We maintain
an allowance for doubtful accounts based upon the expected
collection of the outstanding receivable balance.

We currently sell our products to a small number
of customers. As of September 30, 2003 and 2004 and for the
fiscal years ended September 30, 2002, 2003 and 2004,
customers representing 10% or more of the accounts receivable
balance or revenues were as follows:

|           |  |                     |      |                           |  |      |      |      |  |      |      |  |  |  |      |  |  |  |     | 
|---------- |  | ------------------- | ---- | ------------------------- |  | ---- | ---- | ---- |  | ---- | ---- |  |  |  | ---- |  |  |  | --- | 
|           |  |                     |      |                           |  |      |      |     
|           |  | Percentage of       |      |                          
|           |  | Accounts            |      | Percentage of Revenues   
|           |  | Receivable          |      | for the Fiscal Year Ended
|           |  | as of September 30, |      | September 30,            
|           |  |                     |      |                          
|           |  | 2003                |      | 2004                      |  | 2002 |      | 2003 |  | 2004
|           |  |                     |      |                           |  |      |      |      |  |     
|Customer A |  |                     | 26%  |                           |  |      | <10% |      |  |      | 24%  |  |  |  | 12%  |  |  |  | 13% | 
|Customer B |  |                     | 10%  |                           |  |      | <10% |      |  |      | 12%  |  |  |  | 13%  |  |  |  | 12% | 
|Customer C |  |                     | <10% |                           |  |      | 14%  |      |  |      | <10% |  |  |  | <10% |  |  |  | 12% | 
|Customer D |  |                     | 10%  |                           |  |      | 12%  |      |  |      | 14%  |  |  |  | 10%  |  |  |  | 11% | 

Certain of the components and subassemblies
included in our systems are obtained from a single source or
limited group of suppliers. Although we seek to reduce
dependence on those sole and limited source suppliers, the
partial or complete loss of certain of these sources could have
at least a temporary adverse effect on our results of operations
and damage customer relationships. Further, a significant
increase in the price of one or more of these components could
adversely affect our results of operation.



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

Inventories are stated at the lower of cost or
market, using the first-in first-out (FIFO) method.



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

Software development costs not qualifying for
capitalization are included in research and development and are
expensed as incurred. After technological feasibility is
established, material software development costs are
capitalized. The capitalized cost is then amortized on a
straight-line basis over the greater of the estimated product
life or on the ratio of current revenues to total projected
product revenues. We define technological feasibility as the
establishment of a working model, which typically occurs upon
completion of the first beta version. To date, the period
between achieving technological feasibility and the general
availability of such software has been short and software
development costs qualifying for capitalization have been
insignificant. Accordingly, to date we have not capitalized any
software development costs.



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

Property and equipment, including leasehold
improvements, are stated at cost less accumulated depreciation
and amortization. Depreciation and amortization are computed
using the straight-line method over the shorter of the estimated
useful lives, generally four years, or, as appropriate, the
lease term of the respective assets. When property and equipment
are retired or otherwise disposed of, the cost and related
accumulated depreciation are removed from the accounts and the
resulting gain or loss is included in income.

42



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                        
| | -----------------------
| | Repairs and Maintenance

Repair and maintenance costs are expensed as
incurred.



| |         
| | --------
| | Warranty

We provide a limited warranty for our products
for a period of from three to twelve months. We defer a portion
of the revenue related to each product transaction and recognize
the amount deferred ratably over the term of the warranty period
during which warranty service is provided. A provision for the
estimated warranty cost is recorded at the time revenue is
recognized based on our historical experience.



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

We account for income taxes under the liability
method, which requires recognition of deferred tax assets and
liabilities for the future tax consequences of temporary
differences between the tax bases of assets and liabilities and
their reported amounts. A valuation allowance is provided
against deferred tax assets unless it is more likely than not
that they will be realized, either through the generation of
future taxable income or through carry-back potential. We
recognize liabilities for anticipated tax audit issues based on
our estimate of the possibility that additional taxes will be
due. If we ultimately determine that payment of additional
amounts is unnecessary, we reverse the associated liabilities
and recognize a tax benefit in the period in which this
determination is made. If we determine that our recorded tax
liability is less than we expect the ultimate assessment to be,
we record an additional charge in our provision for taxes in the
period in which this determination is made.



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

We account for goodwill using the provisions of
SFAS No. 142 and perform an impairment review of our
goodwill balance annually, or as other indications of a
potential impairment may be present. The impairment test
performed by us involves a two-step process as follows:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Step 1: We compare the market value of our
    reporting unit to the carrying value, including goodwill of the
    unit. If the carrying value of the reporting unit, including
    goodwill, exceeds the units market value, we move on to
    step 2. If the market value of the reporting unit exceeds the
    carrying value, no further work is performed and no impairment
    charge is necessary.                                                                                                                                                             
|
| |  | Step 2: We perform an allocation of the market
    value of the reporting unit to its identifiable tangible and
    non-goodwill intangible assets and liabilities. This derives an
    implied fair value for the reporting units goodwill. We
    then compare the implied fair value of the reporting units
    goodwill with the carrying amount of the reporting units
    goodwill. If the carrying amount of the reporting units
    goodwill is greater than the implied fair value of its goodwill,
    an impairment charge is recognized for the excess.

Between October 1, 2002 and
September 30, 2003, our goodwill balance decreased by
$0.4 million to $49.4 million as a result of the
finalization of the working capital adjustment related to the
NDB acquisition as described in Note 2. We performed our
most recent annual impairment test on September 30, 2004,
showing no impairment of goodwill. As such, there was no
write-down of the goodwill balance.



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

Other intangible assets are presented at cost,
net of accumulated amortization. Amortization is calculated
using the straight-line method over estimated useful lives of
the assets, which are 7 years for purchased technology,
trade names and customer relationships and 8 years for
non-compete agreements.

43



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                    
| | -----------------------------------
| | Impairment of Long Lived
    Assets

Long-lived assets and certain identifiable
intangible assets are reviewed for impairment. For assets to be
held and used, including acquired intangibles, the we initiate a
review whenever events or changes in circumstances indicate that
the carrying value of a long-lived asset may not be recoverable.
Recoverability of an asset is measured by comparing its carrying
value to the future undiscounted cash flows that the asset is
expected to generate. Any impairment is measured by the amount
by which the carrying value exceeds the projected discounted
future operating cash flows. Assets to be disposed of and that
we have committed to a plan to dispose of, whether through sale
or abandonment, are reported at the lower of carrying value or
fair value less costs to sell. To date, our reviews have not
identified any impairment.



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

We account for stock-based employee compensation
arrangements in accordance with provisions of Accounting
Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, as
interpreted by FASB Interpretation No. 44 Accounting
for Certain Transactions Involving Stock Compensation, an
Interpretation of Opinion No. 25. We also comply with
the disclosure provisions of SFAS No. 123,
Accounting for Stock-Based Compensation and
SFAS No. 148, Accounting for Stock-Based
Compensation, Transition and Disclosure. Under APB Opinion
No. 25, compensation cost is recognized over the vesting
period based on the difference, if any, on the date of grant
between the fair value of our stock and the amount an employee
must pay to acquire the stock.

The fair value of each option is estimated on the
date of grant using the Black-Scholes option-pricing model with
the assumptions set out in the tables below:

|                        |  |                             |            |                              |  |      |            |      |  |      |            |      |  |  |            |  |  |  |            |  |  |  |            | 
|----------------------- |  | --------------------------- | ---------- | ---------------------------- |  | ---- | ---------- | ---- |  | ---- | ---------- | ---- |  |  | ---------- |  |  |  | ---------- |  |  |  | ---------- | 
|                        |  |                             |            |                             
|                        |  | Employee Stock Option Plans |            | Employee Stock Purchase Plan
|                        |  |                             |            |                             
|                        |  |                             |            |                             
|                        |  | Year Ended September 30,    |            | Year Ended September 30,    
|                        |  |                             |            |                             
|                        |  | 2002                        |            | 2003                         |  | 2004 |            | 2002 |  | 2003 |            | 2004
|                        |  |                             |            |                              |  |      |            |      |  |      |            |     
|Dividend yield          |  |                             | 0.0%       |                              |  |      | 0.0%       |      |  |      | 0.0%       |      |  |  | 0.0%       |  |  |  | 0.0%       |  |  |  | 0.0%       | 
|Expected life of option |  |                             | 3.0  years |                              |  |      | 3.0  years |      |  |      | 2.7  years |      |  |  | 0.5  years |  |  |  | 0.5  years |  |  |  | 0.5  years | 
|Risk-free interest rate |  |                             | 3.62%      |                              |  |      | 2.38%      |      |  |      | 2.85%      |      |  |  | 1.92%      |  |  |  | 1.21%      |  |  |  | 1.15%      | 
|Expected volatility     |  |                             | 112.8%     |                              |  |      | 104.9%     |      |  |      | 90.1%      |      |  |  | 110.0%     |  |  |  | 78.9%      |  |  |  | 71.3%      | 

44



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Had compensation expense been determined based on
the fair value at the grant dates for the awards under these
plans using the Black-Scholes model prescribed by
SFAS No. 123, our pro forma net income and pro forma
basic and diluted earnings per share for fiscal years 2002, 2003
and 2004 would have been as set forth in the table below. Such
pro forma disclosures may not be representative of future
compensation expense because options vest over several years and
additional grants are made each year.

|                                                                                                                                                    |                                          |                          |        |      |  |      |        |      |  |   |        |      | 
|--------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------- | ------------------------ | ------ | ---- |  | ---- | ------ | ---- |  | - | ------ | ---- | 
|                                                                                                                                                    |                                          |                         
|                                                                                                                                                    |                                          | Year Ended September 30,
|                                                                                                                                                    |                                          |                         
|                                                                                                                                                    |                                          | 2002                     |        | 2003 |  | 2004
|                                                                                                                                                    |                                          |                          |        |      |  |     
|                                                                                                                                                    |                                          |                         
|                                                                                                                                                    |                                          | (In thousands, except   
|                                                                                                                                                    |                                          | per share amounts)      
|Net income  as reported, for basic
    earnings per share                                                                                          |                                          | $                        | 9,149  |      |  | $    | 4,365  |      |  | $ | 13,911 |     
|Interest on convertible notes, net of related tax
    effects                                                                                       |                                          |                          |       |      |  |      |       |      |  |   | (24    | )   
|                                                                                                                                                    |                                          |                          |        |      |  |      |        |      |  |   |        |     
|Net income, for diluted earnings per share                                                                                                          |                                          |                          | 9,149  |      |  |      | 4,365  |      |  |   | 13,887 |     
|Add: Stock-based employee compensation expense
    included in reported income, net of related tax effects                                          |                                          |                          | 26     |      |  |      | 26     |      |  |   | 31     |     
|Deduct: Total stock-based employee compensation
    expense determined under fair-value based method for all awards,
    net of related tax effects |                                          |                          | (2,187 | )    |  |      | (2,506 | )    |  |   | (2,404 | )   
|                                                                                                                                                    |                                          |                          |        |      |  |      |        |      |  |   |        |     
|Pro forma net income, for basic earnings per share                                                                                                  |                                          | $                        | 6,988  |      |  | $    | 1,885  |      |  | $ | 11,538 |     
|                                                                                                                                                    |                                          |                          |        |      |  |      |        |      |  |   |        |     
|Pro forma net income, for diluted earnings per
    share                                                                                            |                                          | $                        | 6,988  |      |  | $    | 1,885  |      |  | $ | 11,514 |     
|                                                                                                                                                    |                                          |                          |        |      |  |      |        |      |  |   |        |     
|Net income per share:                                                                                                                               |                                          |                          |        |      |  |      |        |      |  |   |        |     
|                                                                                                                                                    | Basic net income per share  as reported |                          | $      | 0.70 |  |      | $      | 0.34 |  |   | $      | 1.06 | 
|                                                                                                                                                    |                                          |                          |        |      |  |      |        |      |  |   |        |     
|                                                                                                                                                    | Basic net income per share  pro forma   |                          | $      | 0.54 |  |      | $      | 0.15 |  |   | $      | 0.88 | 
|                                                                                                                                                    |                                          |                          |        |      |  |      |        |      |  |   |        |     
|                                                                                                                                                    | Diluted net income per share as reported |                          | $      | 0.69 |  |      | $      | 0.33 |  |   | $      | 0.95 | 
|                                                                                                                                                    |                                          |                          |        |      |  |      |        |      |  |   |        |     
|                                                                                                                                                    | Diluted net income per share pro forma   |                          | $      | 0.52 |  |      | $      | 0.14 |  |   | $      | 0.79 | 
|                                                                                                                                                    |                                          |                          |        |      |  |      |        |      |  |   |        |     

45



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                   
| | ------------------
| | Earnings Per Share

We have presented earnings per share for all
periods in accordance with SFAS No. 128,
Earnings per Share. SFAS No. 128 requires
the presentation of basic and diluted earnings per share. Basic
earnings per share are computed using the weighted average
number of common shares outstanding during the period. Diluted
earnings per share include the effect of dilutive potential
common shares using the treasury stock method. The following is
a reconciliation of the denominator used in calculating basic
and diluted earnings per share:

|                                                                          |  |                          |        |      |  |      |        |  |  |   |        |  
|------------------------------------------------------------------------- |  | ------------------------ | ------ | ---- |  | ---- | ------ |  |  | - | ------ | -
|                                                                          |  |                         
|                                                                          |  | Year Ended September 30,
|                                                                          |  |                         
|                                                                          |  | 2002                     |        | 2003 |  | 2004
|                                                                          |  |                          |        |      |  |     
|                                                                          |  |                         
|                                                                          |  | (In thousands, except   
|                                                                          |  | per share data)         
|Net income from continuing operations                                     |  | $                        | 9,205  |      |  | $    | 4,365  |  |  | $ | 13,911 |  
|Interest on convertible notes, net of related tax
    effects             |  |                          |       |      |  |      |       |  |  |   | (24    | )
|Net income from continuing operations, for
    diluted earnings per share |  | $                        | 9,205  |      |  | $    | 4,365  |  |  | $ | 13,887 |  
|                                                                          |  |                          |        |      |  |      |        |  |  |   |        |  
|Net loss from discontinued operations                                     |  |                          | (56    | )    |  |      |       |  |  |   |       |  
|                                                                          |  |                          |        |      |  |      |        |  |  |   |        |  
|Net income                                                                |  | $                        | 9,149  |      |  | $    | 4,365  |  |  | $ | 13,887 |  
|                                                                          |  |                          |        |      |  |      |        |  |  |   |        |  
|Weighted average shares outstanding                                       |  |                          | 13,039 |      |  |      | 12,948 |  |  |   | 13,100 |  
|Dilutive common stock options                                             |  |                          | 274    |      |  |      | 165    |  |  |   | 404    |  
|Convertible notes payable                                                 |  |                          |       |      |  |      |       |  |  |   | 1,052  |  
|                                                                          |  |                          |        |      |  |      |        |  |  |   |        |  
|Weighted average shares assuming dilution                                 |  |                          | 13,313 |      |  |      | 13,113 |  |  |   | 14,556 |  
|                                                                          |  |                          |        |      |  |      |        |  |  |   |        |  
|Net income per share from continuing operations:                          |  |                          |        |      |  |      |        |  |  |   |        |  
|Basic                                                                     |  | $                        | 0.71   |      |  | $    | 0.34   |  |  | $ | 1.06   |  
|                                                                          |  |                          |        |      |  |      |        |  |  |   |        |  
|Diluted                                                                   |  | $                        | 0.69   |      |  | $    | 0.33   |  |  | $ | 0.95   |  
|                                                                          |  |                          |        |      |  |      |        |  |  |   |        |  
|Net loss per share from discontinued operations:                          |  |                          |        |      |  |      |        |  |  |   |        |  
|Basic                                                                     |  | $                        | (0.00  | )    |  |      |       |  |  |   |       |  
|                                                                          |  |                          |        |      |  |      |        |  |  |   |        |  
|Diluted                                                                   |  | $                        | (0.00  | )    |  |      |       |  |  |   |       |  
|                                                                          |  |                          |        |      |  |      |        |  |  |   |        |  
|Net income per share:                                                     |  |                          |        |      |  |      |        |  |  |   |        |  
|Basic                                                                     |  | $                        | 0.70   |      |  | $    | 0.34   |  |  | $ | 1.06   |  
|                                                                          |  |                          |        |      |  |      |        |  |  |   |        |  
|Diluted                                                                   |  | $                        | 0.69   |      |  | $    | 0.33   |  |  | $ | 0.95   |  
|                                                                          |  |                          |        |      |  |      |        |  |  |   |        |  

Diluted earnings per share do not include the
effect of the following anti-dilutive potential shares:

|                          |  |                          |           |      |  |      |           |  |  |  |         | 
|------------------------- |  | ------------------------ | --------- | ---- |  | ---- | --------- |  |  |  | ------- | 
|                          |  |                         
|                          |  | Year Ended September 30,
|                          |  |                         
|                          |  | 2002                     |           | 2003 |  | 2004
|                          |  |                          |           |      |  |     
|Common stock options      |  |                          | 242,000   |      |  |      | 1,453,000 |  |  |  | 493,000 | 
|Convertible notes payable |  |                          | 1,081,250 |      |  |      | 1,081,250 |  |  |  |        | 
|                          |  |                          |           |      |  |      |           |  |  |  |         | 



| |                                         
| | ----------------------------------------
| | Recently Issued Accounting
    Standards

In April 2004, the Emerging Issues Task Force
issued Statement No. 03-06 Participating Securities
and the Two  Class Method Under FASB Statement
No. 128, Earnings Per Share
(EITF 03-06). EITF 03-06 addresses a
number of questions regarding the computation of earnings per
share by companies

46



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

that have issued securities other than common
stock that contractually entitle the holder to participate in
dividends and earnings of the company when, and if, it declares
dividends on its common stock. EITF 03-06 also provides
further guidance in applying the two-class method of calculating
earnings per share, clarifying what constitutes a participating
security and how to apply the two-class method of computing
earnings per share once it is determined that a security is
participating, including how to allocate undistributed earnings
to such a security. EITF 03-06 is effective for fiscal
periods beginning after March 31, 2004. We adopted
EITF 03-06 and have concluded that it does not have any
effect on our results of operations or net income per share.

At its November 2003 meeting, the EITF reached a
consensus on disclosure guidance previously discussed under
EITF 03-01, The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments. The
consensus provided for certain disclosure requirements that were
effective for fiscal years ending after December 15, 2003.
We adopted the disclosure guidance with respect to
EITF 03-01 in our accounting for our short-term investments
and we believe that the adoption of this standard will not have
any effect on our results of operations or net income per share.

In March 2004, the EITF reached a consensus on
recognition and measurement guidance previously discussed under
EITF 03-01. The consensus clarifies the meaning of
other-than-temporary impairment and its application to
investments classified as either available-for-sale or
held-to-maturity under FASB Statement No. 115,
Accounting for Certain Investments in Debt and Equity
Securities, and other investments accounted for under the
cost method. The recognition and measurement guidance for which
the consensus was reached in March 2004 is to be applied to
other-than-temporary impairment evaluations in reporting periods
beginning after June 15, 2004. In September 2004, the FASB
issued a final FASB Staff Position that delays the effective
date for the measurement and recognition guidance for all
investments within the scope of EITF Issue No. 03-01. The
consensus reached in March 2004 also provided for certain
disclosure requirements associated with cost method instruments
that were effective for fiscal years ending after June 15,
2004. We will evaluate the effect of adopting the recognition
and measurement guidance when the final consensus is reached.



|         |                                          
|-------- | -----------------------------------------
|Note 2  | Business Combination: NDB
    Acquisition

On August 30, 2002, we purchased certain
assets and assumed certain liabilities of the Network
Diagnostics Business (NDB) of Tekelec. The assets
acquired included the shares of Tekelecs Japanese
subsidiary, Tekelec Limited. The total purchase price of
$68.3 million consisted of a cash payment of
$42.5 million on closing, a cash payment of
$3.3 million in settlement of a net working capital
adjustment in September 2003, two 2% convertible
subordinated notes in the aggregate principal amount of
$17.3 million maturing on August 30, 2004, a premium
of $0.8 million ascribed to the convertible notes payable,
and transaction costs of $4.4 million.

In the finalization of the NDB purchase
accounting that occurred after the amount of the working capital
adjustment was agreed, the following adjustments were made to
amounts originally estimated: the total purchase price was
reduced by $1.2 million (reflecting a $1.3 million
reduction in the cash paid to Tekelec under the working capital
adjustment partially offset by an additional $32,000 in
transaction costs); and the value of net assets acquired was
reduced by $791,000 (reflecting a reduction of $423,000 in the
warranty liability assumed, the recognition of an additional
$551,000 in other liabilities assumed, a reduction of $497,000
in the net realizable value of inventory, a reversal of $560,000
in unused restructuring cost accruals and a reduction of
$726,000 in accounts receivable and other assets). As a result
of these adjustments, the goodwill resulting from the
transaction was reduced by $439,000.

NDBs principal product was the MGTS digital
telecommunications test system, which is similar to our DCT test
systems. NDB operated in the same market segment as us, the
development and manufacture of

47



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

advanced digital telecommunications test
products. We acquired NDB in order to enhance our position in
the digital telecommunications test market.

The consolidated financial statements include the
operating results of NDB from the date of acquisition.

Management allocated the purchase price as
follows:

|                                              |  |               |      | 
|--------------------------------------------- |  | ------------- | ---- | 
|Asset Category                                |  | Value        
|                                              |  |              
|                                              |  | (In millions)
|Net tangible assets                           |  | $             | 9.9  | 
|Purchased in-process research and development |  |               | 1.4  | 
|Intangible assets                             |  |               | 7.6  | 
|Goodwill                                      |  |               | 49.4 | 
|                                              |  |               |      | 
|Net assets acquired                           |  | $             | 68.3 | 
|                                              |  |               |      | 

The amount of $1.4 million allocated to
purchased in-process research and development was charged to
operating expenses upon acquisition. This amount represented two
NDB research and development projects in process as of
August 30, 2002, the date of the acquisition of NDB. The
value of these projects was determined using established
valuation techniques and was expensed because technological
feasibility had not been established and no future alternative
uses existed as of the date of acquisition.

The unaudited pro forma information set forth
below assumes the acquisition of NDB had occurred at the
beginning of fiscal 2002. The unaudited pro forma information is
presented for informational purposes only and is not necessarily
indicative of our future results of operations or the results of
operations that would have been achieved had the acquisitions
been consummated at that time.

|                                                                     |  |                |        |  
|-------------------------------------------------------------------- |  | -------------- | ------ | -
|                                                                     |  | Year Ended    
|                                                                     |  | September 30, 
|Pro Forma Information                                                |  | 2002          
|                                                                     |  |               
|                                                                     |  | (In thousands,
|                                                                     |  | except        
|                                                                     |  | net income    
|                                                                     |  | per share)    
|                                                                     |  | (Unaudited)   
|Revenue                                                              |  | $              | 69,660 |  
|Net income (loss)                                                    |  | $              | (1,796 | )
|Net income (loss) per share from continuing
    operations  basic   |  | $              | (0.14  | )
|Net income (loss) per share from continuing
    operations  diluted |  | $              | (0.14  | )



|         |                               
|-------- | ------------------------------
|Note 3  | Goodwill and Intangible Assets

Between October 1, 2002 and
September 30, 2003, our goodwill balance decreased by
$439,000 to $49.4 million as a result of the finalization
of the working capital adjustment related to the NDB acquisition
described in Note 2. We performed our most recent annual
impairment test on September 30, 2004 and determined that
goodwill was not impaired. As such, there was no write-down of
the goodwill balance.

48



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Intangible assets subject to amortization consist
of purchased technology, trade names and customer relationships
that are being amortized over a period of seven years,
non-compete agreements that are being amortized over a period of
eight years, and a backlog that was amortized over a period of
six months, as follows (in thousands):

|                       |  |                          |       |                          |  |          |        |          |  |              |       |          |  |   |       |  |  |   |        |   |  |   |       | 
|---------------------- |  | ------------------------ | ----- | ------------------------ |  | -------- | ------ | -------- |  | ------------ | ----- | -------- |  | - | ----- |  |  | - | ------ | - |  | - | ----- | 
|                       |  |                          |       |                         
|                       |  | As of September 30, 2003 |       | As of September 30, 2004
|                       |  |                          |       |                         
|                       |  | Gross                    |       |                          |  | Net      |        | Gross    |  |              |       | Net     
|                       |  | Carrying                 |       | Accumulated              |  | Carrying |        | Carrying |  | Accumulated  |       | Carrying
|                       |  | Amount                   |       | Amortization             |  | Amount   |        | Amount   |  | Amortization |       | Amount  
|                       |  |                          |       |                          |  |          |        |          |  |              |       |         
|Purchased technology   |  | $                        | 4,800 |                          |  | $        | (743   | )        |  | $            | 4,057 |          |  | $ | 4,800 |  |  | $ | (1,428 | ) |  | $ | 3,372 | 
|Trade names            |  |                          | 1,000 |                          |  |          | (155   | )        |  |              | 845   |          |  |   | 1,000 |  |  |   | (298   | ) |  |   | 702   | 
|Customer relationships |  |                          | 1,000 |                          |  |          | (155   | )        |  |              | 845   |          |  |   | 1,000 |  |  |   | (298   | ) |  |   | 702   | 
|Non-compete agreement  |  |                          | 400   |                          |  |          | (54    | )        |  |              | 346   |          |  |   | 400   |  |  |   | (104   | ) |  |   | 296   | 
|System backlog         |  |                          | 400   |                          |  |          | (400   | )        |  |              |      |          |  |   | 400   |  |  |   | (400   | ) |  |   |      | 
|                       |  |                          |       |                          |  |          |        |          |  |              |       |          |  |   |       |  |  |   |        |   |  |   |       | 
|Total                  |  | $                        | 7,600 |                          |  | $        | (1,507 | )        |  | $            | 6,093 |          |  | $ | 7,600 |  |  | $ | (2,528 | ) |  | $ | 5,072 | 
|                       |  |                          |       |                          |  |          |        |          |  |              |       |          |  |   |       |  |  |   |        |   |  |   |       | 

The estimated future amortization expense of
purchased intangible assets as of September 30, 2004 was as
follows:

|            |  |               |     | 
|----------- |  | ------------- | --- | 
|Fiscal Year |  | Amount       
|            |  |              
|            |  | (In millions)
|2005        |  | $             | 1.0 | 
|2006        |  |               | 1.0 | 
|2007        |  |               | 1.0 | 
|2008        |  |               | 1.0 | 
|2009        |  |               | 1.0 | 
|Thereafter  |  |               | 0.1 | 
|            |  |               |     | 
|Total       |  | $             | 5.1 | 
|            |  |               |     | 



|         |                                   
|-------- | ----------------------------------
|Note 4  | Restructuring of Acquired Business

Prior to the effective date of the acquisition of
NDB, we developed a formal plan to restructure NDB by reducing
the staff complement of the acquired business by 66 employees,
or approximately 39%, and by closing the Tokyo office of Tekelec
Limited due to redundancy with our previously established Tokyo
office. On completion of the acquisition, the plan was
communicated to the employee group as a whole and the estimated
costs were included in the liabilities assumed in the
acquisition. In fiscal 2003, $560,000 of the originally
estimated redundancy costs was determined to be surplus to
actual requirements and was accordingly reversed. The remaining
costs were all paid by September 30, 2003 as follows:

|                              |  |                    |     |             |  |                  |     |                    |  |   |     |  |  |   |   | 
|----------------------------- |  | ------------------ | --- | ----------- |  | ---------------- | --- | ------------------ |  | - | --- |  |  | - | - | 
|                              |  | Accrual as at      |     | Paid in     |  | Adjustments Made |     | Balance at        
|Restructuring Costs           |  | September 30, 2002 |     | Fiscal 2003 |  | in Fiscal 2003   |     | September 30, 2003
|                              |  |                    |     |             |  |                  |     |                   
|                              |  |                   
|                              |  | (In millions)     
|Redundancy compensation costs |  | $                  | 1.2 |             |  | $                | 0.6 |                    |  | $ | 0.6 |  |  | $ |  | 
|Occupancy costs               |  |                    | 0.3 |             |  |                  | 0.3 |                    |  |   |    |  |  |   |  | 
|Associated costs              |  |                    | 0.2 |             |  |                  | 0.2 |                    |  |   |    |  |  |   |  | 
|                              |  |                    |     |             |  |                  |     |                    |  |   |     |  |  |   |   | 
|Totals                        |  | $                  | 1.7 |             |  | $                | 1.1 |                    |  | $ | 0.6 |  |  | $ |  | 
|                              |  |                    |     |             |  |                  |     |                    |  |   |     |  |  |   |   | 

49



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|         |                        
|-------- | -----------------------
|Note 5  | Discontinued Operations

Effective September 30, 2002, we
discontinued the distribution and consulting businesses engaged
in by Tekelec Limited in Japan. The results of operations and
the assets and liabilities of the discontinued operations were
segregated in the consolidated financial statements. The revenue
attributable to discontinued operations in the amount of
$2.2 million has been excluded from the consolidated
statement of income for the year ended September 30, 2002.



|         |                     
|-------- | --------------------
|Note 6  | Restructuring Charge

A restructuring charge of $730,000 was recorded
and paid in the fourth quarter of fiscal 2003 related to costs
associated with the involuntary termination of 39 employees
including 25 in research and development, 10 in sales and
marketing, 3 in the customer service component of services cost
of goods and 1 in the manufacturing component of product cost of
goods. The terminations represented 15% of our pre-termination
workforce. No restructuring charge was recorded in fiscal 2002
or fiscal 2004.



|         |                            
|-------- | ---------------------------
|Note 7  | Other Income (Expense), Net

Other income in fiscal 2004 represented primarily
foreign exchange gains and losses, net. Other income in fiscal
2003 represented primarily a Japanese consumption tax refund in
the amount of approximately $695,000 as well as foreign exchange
gains in the amount of approximately $411,000. Other expense in
fiscal 2002 represented primarily foreign exchange losses and
gains, net.



|         |                         
|-------- | ------------------------
|Note 8  | Balance Sheet Components

At September 30, 2003 and 2004, short term
investments and cash equivalents were classified as
available-for-sale securities and are reported at fair value as
follows (in thousands):

|                       |                                |                    |        |            |  |            |   |            |  |   |   |   |  |   |        |        | 
|---------------------- | ------------------------------ | ------------------ | ------ | ---------- |  | ---------- | - | ---------- |  | - | - | - |  | - | ------ | ------ | 
|                       |                                |                   
|                       |                                | September 30, 2003
|                       |                                |                   
|                       |                                | Gross              |        | Gross      |  | Gross      |   |           
|                       |                                | Amortized          |        | Unrealized |  | Unrealized |   | Estimated 
|                       |                                | Cost               |        | Gains      |  | Losses     |   | Fair Value
|                       |                                |                    |        |            |  |            |   |           
|Cash equivalents       |                                |                    |        |            |  |            |   |            |  |   |   |   |  |   |        |       
|                       | Commercial paper               |                    | $      | 1,650      |  |            | $ |           |  |   | $ |  |  |   | $      | 1,650  | 
|                       | State and municipal securities |                    |        | 3,218      |  |            |   |           |  |   |   |  |  |   |        | 3,218  | 
|                       |                                |                    |        |            |  |            |   |            |  |   |   |   |  |   |        |       
|                       |                                | $                  | 4,868  |            |  | $          |  |            |  | $ |  |   |  | $ | 4,868  |       
|                       |                                |                    |        |            |  |            |   |            |  |   |   |   |  |   |        |       
|Short term investments |                                |                    |        |            |  |            |   |            |  |   |   |   |  |   |        |       
|                       | Commercial paper               |                    | $      |           |  |            | $ |           |  |   | $ |  |  |   | $      |       | 
|                       | State and municipal securities |                    |        | 18,896     |  |            |   | 5          |  |   |   |  |  |   |        | 18,901 | 
|                       |                                |                    |        |            |  |            |   |            |  |   |   |   |  |   |        |       
|                       |                                | $                  | 18,896 |            |  | $          | 5 |            |  | $ |  |   |  | $ | 18,901 |       
|                       |                                |                    |        |            |  |            |   |            |  |   |   |   |  |   |        |       

50



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                       |                                            |                    |        |            |  |            |   |            |  |   |    |    |   |   |        |        | 
|---------------------- | ------------------------------------------ | ------------------ | ------ | ---------- |  | ---------- | - | ---------- |  | - | -- | -- | - | - | ------ | ------ | 
|                       |                                            |                   
|                       |                                            | September 30, 2004
|                       |                                            |                   
|                       |                                            | Gross              |        | Gross      |  | Gross      |   |           
|                       |                                            | Amortized          |        | Unrealized |  | Unrealized |   | Estimated 
|                       |                                            | Cost               |        | Gains      |  | Losses     |   | Fair Value
|                       |                                            |                    |        |            |  |            |   |           
|Cash equivalents       |                                            |                    |        |            |  |            |   |            |  |   |    |    |   |   |        |       
|                       | Commercial paper                           |                    | $      | 12,739     |  |            | $ |           |  |   | $  |   |   |   | $      | 12,739 | 
|                       |                                            |                    |        |            |  |            |   |            |  |   |    |    |   |   |        |       
|                       |                                            | $                  | 12,739 |            |  | $          |  |            |  | $ |   |    |   | $ | 12,739 |       
|                       |                                            |                    |        |            |  |            |   |            |  |   |    |    |   |   |        |       
|Short term investments |                                            |                    |        |            |  |            |   |            |  |   |    |    |   |   |        |       
|                       | U.S. government, corporations and agencies |                    | $      | 3,547      |  |            | $ |           |  |   | $  |   |   |   | $      | 3,547  | 
|                       | State and municipal securities             |                    |        | 30,806     |  |            |   |           |  |   |    | (3 | ) |   |        | 30,803 | 
|                       |                                            |                    |        |            |  |            |   |            |  |   |    |    |   |   |        |       
|                       |                                            | $                  | 34,353 |            |  | $          |  |            |  | $ | (3 | )  |   | $ | 34,350 |       
|                       |                                            |                    |        |            |  |            |   |            |  |   |    |    |   |   |        |       

Included in our state and municipal securities
investments at September 30, 2004 was $3,000 in unrealized
losses. We have determined that the unrealized losses on our
investments are temporary in nature. Realized gains and losses
are included in interest income.

|                        |                                                |                |       |        |   |   |       |        |  
|----------------------- | ---------------------------------------------- | -------------- | ----- | ------ | - | - | ----- | ------ | -
|                        |                                                |               
|                        |                                                | September 30, 
|                        |                                                |               
|                        |                                                | 2003           |       | 2004  
|                        |                                                |                |       |       
|                        |                                                |               
|                        |                                                | (In thousands)
|Inventories:            |                                                |                |       |        |   |   |       |       
|                        | Raw materials                                  |                | $     | 2,092  |   |   | $     | 1,908  |  
|                        | Work-in-process                                |                |       | 140    |   |   |       | 298    |  
|                        | Finished goods                                 |                |       | 93     |   |   |       | 174    |  
|                        |                                                |                |       |        |   |   |       |       
|                        |                                                | $              | 2,325 |        |   | $ | 2,380 |       
|                        |                                                |                |       |        |   |   |       |       
|Property and equipment: |                                                |                |       |        |   |   |       |       
|                        | Equipment                                      |                | $     | 6,062  |   |   | $     | 7,073  |  
|                        | Leasehold improvements                         |                |       | 1,859  |   |   |       | 1,915  |  
|                        |                                                |                |       |        |   |   |       |       
|                        |                                                |                | 7,921 |        |   |   | 8,988 |       
|                        | Less accumulated depreciation and amortization |                |       | (4,537 | ) |   |       | (6,348 | )
|                        |                                                |                |       |        |   |   |       |       
|                        |                                                | $              | 3,384 |        |   | $ | 2,640 |       
|                        |                                                |                |       |        |   |   |       |       

|                                 |                               |                         |                                               |      |    |      |   |    |     |     |   |     |     |     |  
|-------------------------------- | ----------------------------- | ----------------------- | --------------------------------------------- | ---- | -- | ---- | - | -- | --- | --- | - | --- | --- | --- | -
|                                 |                               |                        
|                                 |                               | September 30,          
|                                 |                               |                        
|                                 |                               | 2002                    |                                               | 2003 |    | 2004
|                                 |                               |                         |                                               |      |    |     
|Allowance for doubtful accounts: |                               |                         |                                               |      |    |      |   |    |     |     |   |    
|                                 | Balances at beginning of year |                         | $                                             | 73   |    |      | $ | 38 |     |     | $ | 320 |    
|                                 |                               |                         | Provision for (recovery of) doubtful accounts |      |    | (35  | ) |    |     | 282 |   |     |     | 16  |  
|                                 |                               |                         | Write-off of doubtful accounts                |      |    |     |   |    |     |    |   |     |     | (42 | )
|                                 |                               |                         |                                               |      |    |      |   |    |     |     |   |    
|                                 |                               | Balances at end of year |                                               | $    | 38 |      |   | $  | 320 |     |   | $   | 294 |    
|                                 |                               |                         |                                               |      |    |      |   |    |     |     |   |    

51



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                     |                              |                |       |       |  |   |       |       | 
|-------------------- | ---------------------------- | -------------- | ----- | ----- |  | - | ----- | ----- | 
|                     |                              |               
|                     |                              | September 30, 
|                     |                              |               
|                     |                              | 2003           |       | 2004 
|                     |                              |                |       |      
|                     |                              |               
|                     |                              | (In thousands)
|Accrued liabilities: |                              |                |       |       |  |   |       |      
|                     | Payroll and related expenses |                | $     | 1,688 |  |   | $     | 2,716 | 
|                     | Income taxes payable         |                |       | 2,258 |  |   |       | 881   | 
|                     | Other taxes payable          |                |       | 838   |  |   |       | 228   | 
|                     | Stock offering costs         |                |       |      |  |   |       | 409   | 
|                     | Other                        |                |       | 1,218 |  |   |       | 1,312 | 
|                     |                              |                |       |       |  |   |       |      
|                     |                              | $              | 6,002 |       |  | $ | 5,546 |      
|                     |                              |                |       |       |  |   |       |      

The following table represents the activity in
Warranty Accrual for the years ended September 30, 2003 and
2004 (in thousands):

|                              |                         |                                                           |     |      |      |   |    |    |     |  
|----------------------------- | ----------------------- | --------------------------------------------------------- | --- | ---- | ---- | - | -- | -- | --- | -
|                              |                         | 2003                                                      |     | 2004
|                              |                         |                                                           |     |     
|Balances at beginning of year |                         | $                                                         | 600 |      |      | $ | 60 |   
|                              |                         | Warranty accrual used during the period                   |     |      | (126 | ) |    |    | (69 | )
|                              |                         | Adjustments to goodwill for acquired warranty
    accrual |     |      | (423 | ) |    |    |    |  
|                              |                         | Accruals for warranties issued during the period          |     |      | 9    |   |    |    | 78  |  
|                              |                         |                                                           |     |      |      |   |    |   
|                              | Balances at end of year |                                                           | $   | 60   |      |   | $  | 69 |    
|                              |                         |                                                           |     |      |      |   |    |   



|         |                          
|-------- | -------------------------
|Note 9  | Convertible Notes Payable

In connection with the acquisition of NDB
described in Note 2, our Irish subsidiary issued two
convertible notes to Tekelec in the principal amounts of
$10.0 million and $7.3 million, respectively. These
notes were guaranteed by us, bore interest at 2% and were due
and payable on or before August 30, 2004. The notes were
convertible at the option of the holder into
1,081,250 shares of our common stock (subject to adjustment
for certain events) between August 30, 2003 and the
maturity date.

The fair value of the notes was
$18.1 million, which had been recorded in the balance
sheet. The premium of $0.8 million was amortized to
interest income over the term of the notes on an effective
interest method. The resultant amounts credited to interest
income were $34,000, $407,000 and $374,000 in 2002, 2003 and
2004, respectively.

The two notes were converted by Tekelec in
September 2004 into 1,081,250 registered shares of our common
stock.



|          |                          
|--------- | -------------------------
|Note 10  | Related Party Transaction

David Mayfield, our President and Chief Operating
Officer, received an interest-free employee relocation loan of
$250,000 in connection with his initial employment with
Catapult. The loan is secured by a second deed of trust on
Mr. Mayfields principal residence. The loan is
repayable in quarterly payments of $2,100, with a balloon
payment due in November 2015. The principal amount outstanding
on the loan as of October 1, 2003 was $226,900 and the debt
had been reduced to $218,500 at September 30, 2004.



|          |             
|--------- | ------------
|Note 11  | Income Taxes

Consolidated income before income taxes includes
non-U.S. income of approximately $10.8 million,
$4.3 million and $12.6 million in fiscal 2002, 2003
and 2004, respectively.

52



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CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The provision for income taxes consists of the
following:

|          |              |                          |        |        |   |      |        |        |   |   |      |        |  
|--------- | ------------ | ------------------------ | ------ | ------ | - | ---- | ------ | ------ | - | - | ---- | ------ | -
|          |              |                         
|          |              | Year Ended September 30,
|          |              |                         
|          |              | 2002                     |        | 2003   |   | 2004
|          |              |                          |        |        |   |     
|          |              |                         
|          |              | (In thousands)          
|Current:  |              |                          |        |        |   |      |        |        |   |   |      |       
|          | U.S. federal |                          | $      | 2,419  |   |      | $      | (1,212 | ) |   | $    | (2,677 | )
|          | State        |                          |        | 190    |   |      |        | 30     |   |   |      | 30     |  
|          | Foreign      |                          |        | 2,047  |   |      |        | 978    |   |   |      | 2,012  |  
|          |              |                          |        |        |   |      |        |        |   |   |      |       
|          |              |                          | 4,656  |        |   |      | (204   | )      |   |   | (635 | )     
|          |              |                          |        |        |   |      |        |        |   |   |      |       
|Deferred: |              |                          |        |        |   |      |        |        |   |   |      |       
|          | U.S. federal |                          |        | (1,001 | ) |      |        | (1,677 | ) |   |      | 100    |  
|          | State        |                          |        | (75    | ) |      |        | (205   | ) |   |      | 122    |  
|          |              |                          |        |        |   |      |        |        |   |   |      |       
|          |              |                          | (1,076 | )      |   |      | (1,882 | )      |   |   | 222  |       
|          |              |                          |        |        |   |      |        |        |   |   |      |       
|          |              | $                        | 3,580  |        |   | $    | (2,086 | )      |   | $ | (413 | )     
|          |              |                          |        |        |   |      |        |        |   |   |      |       

A reconciliation of the U.S. federal income
tax rate to our effective tax rate is as follows:

|                                    |  |               |    |      |  |      |     |    |  |  |     |   
|----------------------------------- |  | ------------- | -- | ---- |  | ---- | --- | -- |  |  | --- | --
|                                    |  |              
|                                    |  | Year Ended   
|                                    |  | September 30,
|                                    |  |              
|                                    |  | 2002          |    | 2003 |  | 2004
|                                    |  |               |    |      |  |     
|Tax at federal rate                 |  |               | 34 | %    |  |      | 34  | %  |  |  | 34  | % 
|State taxes, net of federal benefit |  |               |   |      |  |      | (8  | )  |  |  | 1   |   
|Excess foreign tax rate             |  |               | (3 | )    |  |      | (42 | )  |  |  | (36 | ) 
|Foreign tax credit                  |  |               | (2 | )    |  |      | (45 | )  |  |  |    |   
|Research credit                     |  |               | (2 | )    |  |      | (25 | )  |  |  | (1  | ) 
|Tax exempt interest                 |  |               |   |      |  |      |    |    |  |  | (1  | ) 
|Other                               |  |               | 1  |      |  |      | (6  | )  |  |  |    |   
|                                    |  |               |    |      |  |      |     |    |  |  |     |   
|                                    |  |               | 28 | %    |  |      | (92 | )% |  |  | (3  | )%
|                                    |  |               |    |      |  |      |     |    |  |  |     |   

We recorded a benefit from income taxes of
$0.4 million in fiscal 2004 primarily due to a reduction of
approximately $2.3 million in the estimated tax payable at
the end of the fiscal year. This reduction was made as a result
of a determination that additional taxes for which we had
previously recognized liabilities would not be due. We recorded
a benefit from income taxes of $2.1 million in fiscal 2003
as a result of three factors: the identification of
approximately $830,000 in additional taxes recoverable from a
previous period; a reduction of approximately $970,000 in the
estimated tax payable at the end of the fiscal year as a result
of the likely favorable outcome of a tax audit of our Japanese
subsidiary; and the recognition of approximately $775,000 in
future tax benefits of foreign tax credits created in the
liquidation of the Japanese subsidiary acquired from Tekelec. As
a result, our effective tax rate changed from a benefit of 92%
in fiscal 2003 to a benefit of 3% in fiscal 2004.

53



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Net deferred tax assets consist of the following:

|                                 |                          |                |       |       |   |   |       |       |  
|-------------------------------- | ------------------------ | -------------- | ----- | ----- | - | - | ----- | ----- | -
|                                 |                          |               
|                                 |                          | September 30, 
|                                 |                          |               
|                                 |                          | 2003           |       | 2004 
|                                 |                          |                |       |      
|                                 |                          |               
|                                 |                          | (In thousands)
|Accruals and reserves            |                          | $              | 1,837 |       |   | $ | 915   |      
|Net operating losses             |                          |                | 13    |       |   |   | 1,491 |      
|Current and deferred state taxes |                          |                | 10    |       |   |   | 9     |      
|Research credit                  |                          |                | 687   |       |   |   | 1,108 |      
|Foreign tax credit               |                          |                | 587   |       |   |   | 688   |      
|                                 |                          |                |       |       |   |   |       |      
|                                 | Deferred tax assets      |                |       | 3,134 |   |   |       | 4,211 |  
|                                 |                          |                |       |       |   |   |       |      
|Depreciation                     |                          |                | (18   | )     |   |   | (199  | )    
|                                 |                          |                |       |       |   |   |       |      
|                                 | Deferred tax liabilities |                |       | (18   | ) |   |       | (199  | )
|                                 |                          |                |       |       |   |   |       |      
|                                 | Net deferred tax assets  |                |       | 3,116 |   |   |       | 4,012 |  
|                                 |                          |                |       |       |   |   |       |      
|Less: Non-current portion        |                          |                | 709   |       |   |   | 3,027 |      
|                                 |                          |                |       |       |   |   |       |      
|                                 |                          | $              | 2,407 |       |   | $ | 985   |      
|                                 |                          |                |       |       |   |   |       |      

As of September 30, 2004, U.S. income
taxes and foreign withholding taxes were not provided for on a
cumulative total of $18.3 million of undistributed earnings
for certain non-U.S. subsidiaries. We intend to reinvest
these earnings indefinitely in operations outside the United
States.

As of September 30, 2004, we had federal and
state tax credit carry-forwards for income tax purposes of
$1.4 million and $580,000, respectively. If not utilized,
the federal credits will expire in fiscal years 2021 through
2024. The state tax credits can be carried forward indefinitely.



|          |                     
|--------- | --------------------
|Note 12  | Stockholders Equity



| |                   
| | ------------------
| | Stock Option Plans

At September 30, 1997, 1,800,000 shares
and 154,500 shares of common stock had been reserved for
issuance to employees under the 1989 Incentive Stock Option Plan
(the 1989 Plan) and the UK Executive Share Option
Scheme (the UK Scheme), respectively. In June 1998,
the Board of Directors adopted the 1998 Stock Plan (the
1998 Plan) which provided for the issuance of
options to purchase an additional 1,800,000 shares. At the
January 2003 Annual Meeting, stockholders approved an increase
of 1,000,000 shares to the 1998 Plan. The Board of
Directors has the authority to determine optionees, the number
of shares, the term of each option and the exercise price.
Options under the 1989 and 1998 Plans generally become
exercisable at a rate of  1/8th of the total options
granted six months after the option grant date and then at a
rate of  1/48th per month thereafter. Options under the UK
Scheme become exercisable at the rate of  1/36th of the
total options granted per month commencing twelve months after
the option grant date. Options will expire, if not exercised,
upon the earlier of 10 years from the date of grant or
30 days after termination as an employee of the Company.
The 1989 Plan and the UK Scheme were terminated as to future
grants in 1998 effective with the adoption of the 1998 Plan.

54



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Information with respect to stock option activity
from September 30, 2001 through September 30, 2004 is
set forth below:

|                              |                   |             |           |                  |   |   |       |       | 
|----------------------------- | ----------------- | ----------- | --------- | ---------------- | - | - | ----- | ----- | 
|                              |                   | Number of   |           |                 
|                              |                   | Options     |           | Weighted Average
|                              |                   | Outstanding |           | Exercise Price  
|                              |                   |             |           |                 
|Balance at September 30, 2001 |                   |             | 1,033,546 |                  |   | $ | 12.39 |      
|                              | Options granted   |             |           | 263,640          |   |   | $     | 18.53 | 
|                              | Options exercised |             |           | (50,340          | ) |   | $     | 9.03  | 
|                              | Options canceled  |             |           | (18,204          | ) |   | $     | 18.84 | 
|                              |                   |             |           |                  |   |   |       |      
|Balance at September 30, 2002 |                   |             | 1,228,642 |                  |   | $ | 13.75 |      
|                              | Options granted   |             |           | 777,466          |   |   | $     | 10.08 | 
|                              | Options exercised |             |           | (55,577          | ) |   | $     | 4.27  | 
|                              | Options canceled  |             |           | (164,738         | ) |   | $     | 12.81 | 
|                              |                   |             |           |                  |   |   |       |      
|Balance at September 30, 2003 |                   |             | 1,785,793 |                  |   | $ | 12.54 |      
|                              | Options granted   |             |           | 253,034          |   |   | $     | 18.79 | 
|                              | Options exercised |             |           | (344,943         | ) |   | $     | 8.91  | 
|                              | Options canceled  |             |           | (62,374          | ) |   | $     | 16.92 | 
|                              |                   |             |           |                  |   |   |       |      
|Balance at September 30, 2004 |                   |             | 1,631,510 |                  |   | $ | 14.15 |      
|                              |                   |             |           |                  |   |   |       |      

As of September 30, 2004, 872,092 options
remained available for grant. As of September 30, 2004, the
options outstanding and exercisable are presented below:

|                        |       |             |  |             |  |          |       |                     |  |                     |  |          |           |  |  |          |     |  |  |   |       |  |  |  |         |  |  |   |       | 
|----------------------- | ----- | ----------- |  | ----------- |  | -------- | ----- | ------------------- |  | ------------------- |  | -------- | --------- |  |  | -------- | --- |  |  | - | ----- |  |  |  | ------- |  |  | - | ----- | 
|                        |       |             |  |             |  |          |       |                     |  |                    
|                        |       |             |  |             |  |          |       | Options Outstanding |  | Options Exercisable
|                        |       |             |  |             |  |          |       |                     |  |                    
|                        |       |             |  |             |  |          |       |                     |  | Weighted            |  |          |           | 
|                        |       |             |  |             |  |          |       |                     |  | Average             |  | Weighted |           |  |  | Weighted
|                        |       |             |  |             |  |          |       |                     |  | Remaining           |  | Average  |           |  |  | Average 
|                        |       | Number      |  | Contractual |  | Exercise |       | Number              |  | Exercise           
|Range of Exercise Price |       | Outstanding |  | Life        |  | Price    |       | Outstanding         |  | Price              
|                        |       |             |  |             |  |          |       |                     |  |                    
|$                       | 0.23  |             |  | -           |  | $        | 9.91  |                     |  |                     |  |          | 359,204   |  |  |          | 6.8 |  |  | $ | 5.40  |  |  |  | 193,748 |  |  | $ | 5.06  | 
|$                       | 11.01 |             |  | -           |  | $        | 12.70 |                     |  |                     |  |          | 379,722   |  |  |          | 8.3 |  |  | $ | 12.22 |  |  |  | 129,233 |  |  | $ | 12.13 | 
|$                       | 12.75 |             |  | -           |  | $        | 17.50 |                     |  |                     |  |          | 367,315   |  |  |          | 5.6 |  |  | $ | 16.21 |  |  |  | 357,089 |  |  | $ | 16.22 | 
|$                       | 18.16 |             |  | -           |  | $        | 19.21 |                     |  |                     |  |          | 335,775   |  |  |          | 8.2 |  |  | $ | 19.03 |  |  |  | 135,438 |  |  | $ | 18.86 | 
|$                       | 19.25 |             |  | -           |  | $        | 25.10 |                     |  |                     |  |          | 189,494   |  |  |          | 7.2 |  |  | $ | 22.01 |  |  |  | 115,812 |  |  | $ | 21.59 | 
|                        |       |             |  |             |  |          |       |                     |  |                     |  |          |           |  |  |          |     |  |  |   |       |  |  |  |         |  |  |   |       | 
|$                       | 0.23  |             |  | -           |  | $        | 25.10 |                     |  |                     |  |          | 1,631,510 |  |  |          | 7.2 |  |  | $ | 14.15 |  |  |  | 931,320 |  |  | $ | 14.38 | 
|                        |       |             |  |             |  |          |       |                     |  |                     |  |          |           |  |  |          |     |  |  |   |       |  |  |  |         |  |  |   |       | 

The weighted average exercise prices and fair
values of options granted during 2002, 2003 and 2004 were as
follows:

|                                      |  |                  |       |                  |  |   |       | 
|------------------------------------- |  | ---------------- | ----- | ---------------- |  | - | ----- | 
|                                      |  | Weighted Average |       | Weighted Average
|                                      |  | Exercise Price   |       | Fair Value      
|                                      |  |                  |       |                 
|Year Ended September 30, 2002         |  |                  |       |                  |  |   |       | 
|Exercise price equal to market value  |  | $                | 17.51 |                  |  | $ | 11.41 | 
|Exercise price less than market value |  | $                | 19.32 |                  |  | $ | 14.27 | 
|All options granted                   |  | $                | 18.53 |                  |  | $ | 13.08 | 
|Year Ended September 30, 2003         |  |                  |       |                  |  |   |       | 
|Exercise price equal to market value  |  | $                | 10.08 |                  |  | $ | 6.40  | 
|Year Ended September 30, 2004         |  |                  |       |                  |  |   |       | 
|Exercise price equal to market value  |  | $                | 18.79 |                  |  | $ | 10.07 | 

55



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                             
| | ----------------------------
| | Employee Stock Purchase Plan

In June 1998, the we adopted the 1998 Employee
Stock Purchase Plan (the Purchase Plan). A total of
750,000 shares of common stock have been reserved for
issuance under the Purchase Plan. The Purchase Plan permits
eligible employees to purchase common stock through payroll
deductions of up to 7% of an employees total compensation.
The price of the common stock will generally be 85% of the lower
of the fair market value at the beginning of the offering period
or the end of the relevant purchase period. The maximum number
of shares a participant may purchase during a single offering
period is 300 shares. A total of 13,973 shares,
33,095 shares and 32,808 shares were issued under the
Purchase Plan in the years ended September 30, 2002, 2003
and 2004, respectively. As of September 30, 2004,
636,110 shares remained available for issuance.



| |                         
| | ------------------------
| | Issuance of Common Stock

In September 2004, as part of our public offering
under our previously filed shelf Registration Statement on
Form S-3 (File No. 333-112610) which was declared
effective by the Securities and Exchange Commission on
March 31, 2004, we issued 200,000 shares of our common
stock at a price to us before expenses of $18.02 per share.
As part of the public offering we also registered, upon
conversion of notes issued to Tekelec, 1,081,250 shares of
common stock. Also included in the public offering were 300,000
currently outstanding shares of certain selling stockholders.
The external incremental costs of the offering were
approximately $592,000.



| |                           
| | --------------------------
| | Repurchase of Common Stock

In December 1999, our Board of Directors
authorized a stock repurchase program of up to
2,000,000 shares of its common stock. Depending on market
conditions and other factors, repurchases can be made from time
to time in the open market and in negotiated transactions,
including block transactions, and this program may be
discontinued at any time. In the year ended September 30,
2003, we repurchased 257,400 shares at a cost of
approximately $1.8 million. The shares repurchased were
restored to the status of authorized but unissued. In addition,
$300,000 in treasury stock previously repurchased were restored
to the status of authorized but unissued. In the years ended
September 30, 2002 and 2004, we repurchased no shares. As
at September 30, 2004, we are authorized to repurchase an
additional 1,742,600 shares of our common stock under the
stock repurchase program.



|          |           
|--------- | ----------
|Note 13  | 401-K Plan

We operate a 401-K plan for our employees and
since fiscal 1999 have matched employee contributions to a
certain level. Our total contributions to the 401-K plan in the
years ended September 30, 2002, 2003 and 2004 were
$106,000, $217,000 and $209,176, respectively.



|          |                              
|--------- | -----------------------------
|Note 14  | Commitments and Contingencies



| |                 
| | ----------------
| | Operating Leases

We lease our facility in Mountain View,
California under non-cancelable operating lease agreements for
approximately 39,000 square feet that expire in 2010. The
lease agreements provide for minimum annual rent of
approximately $420,000. Under these agreements, we pay certain
shared operating expenses of the facility. The agreements
provide for rent increases at scheduled intervals. In addition,
we have entered into a lease in Morrisville, North Carolina for
approximately 31,000 square feet for product development
and support space commencing February 2003 and expiring in 2008.
We lease other facilities in Illinois, Texas, Canada, Japan,
China, Australia, the United Kingdom, France, Sweden, Finland
and Germany under leases with the longest term expiring in 2010.

56



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##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Rent expense for all facilities for the years
ended September 30, 2002, 2003 and 2004 was approximately
$1.0 million, $1.6 million and $1.3 million,
respectively.

Future minimum annual rental payments under
non-cancelable operating leases as of September 30, 2004
are as follows (in thousands):

|                          |  |   |       | 
|------------------------- |  | - | ----- | 
|Year ending September 30, |  |   |       | 
|2005                      |  | $ | 1,224 | 
|2006                      |  |   | 1,127 | 
|2007                      |  |   | 936   | 
|2008                      |  |   | 842   | 
|2009                      |  |   | 568   | 
|Thereafter                |  |   | 164   | 
|                          |  |   |       | 
|                          |  | $ | 4,861 | 
|                          |  |   |       | 



| |              
| | -------------
| | Contingencies

A lawsuit was instituted in October 2002 against
us and one of our subsidiaries, Catapult Communications
International Limited, an Irish corporation, in the Antwerp
Commercial Court, Antwerp, Belgium, by Tucana Telecom NV, a
Belgian company. Tucana had been a distributor of products for
Tekelec, the company from which NDB was acquired in August 2002.
The writ alleges that the defendants improperly terminated an
exclusive distribution agreement with Tucana following the
acquisition of NDB and seeks damages of 12,461,000 euros plus
costs. A trial date on the matter had been scheduled for
January 16, 2004 but Tucana did not appear. We strongly
believe that we properly terminated any contract we had with
Tucana and that Tucana is not entitled to any damages in this
matter. We intend to defend ourselves vigorously. We may be able
to seek indemnification from Tekelec for any damages assessed
against us in this matter under the terms of the Asset Purchase
Agreement it entered into with Tekelec, although there is no
assurance that such indemnification would be available.

From time to time, we may be involved in other
lawsuits, claims, investigations and proceedings, consisting of
intellectual property, commercial, employment and other matters,
which arise in the ordinary course of business. In accordance
with SFAS No. 5, Accounting for
Contingencies, we make a provision for a liability when it
is both probable that a liability has been incurred and the
amount of the loss can be reasonably estimated. These provisions
are reviewed at least quarterly and adjusted to reflect the
impacts of negotiations, settlements, rulings, advice of legal
counsel and other information and events pertaining to a
particular case. Litigation is inherently unpredictable.
However, we believe that we have valid defenses with respect to
the legal matters pending against us, as well as adequate
provisions for any probable and estimable losses. If an
unfavorable ruling were to occur in any specific period, there
exists the possibility of a material adverse impact on the
results of operations of that period. We believe that, given our
current liquidity and cash and investment balances, even were we
to receive an adverse judgment with respect to litigation that
we are currently a party to, such a judgment would not have a
material impact on liquidity.



| |                 
| | ----------------
| | Indemnifications

We provide general indemnification provisions in
its license agreements. In these agreements, we generally state
that we will defend or settle, at our own expense, any claim
against the customer by a third party asserting a patent,
copyright, trademark, trade secret or proprietary right
violation related to any products that we have licensed to the
customer. We agree to indemnify our customers against any loss,
expense or liability, including reasonable attorneys fees,
from any damages alleged against the customer by a third party
in its course of using products sold by us.

57



---



##### Table of Contents



CATAPULT COMMUNICATIONS CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Our Articles of Incorporation provide that we
shall indemnify to the fullest extent permitted by Nevada law
any person made a party to an action or proceeding by reason of
the fact such person was a director, officer, employee or our
agent . Our Bylaws also obligate us to indemnify directors and
officers to the fullest extent permitted by law, as do the terms
of indemnification agreements that we have entered into with our
directors and officers. The indemnification covers any expenses
and liabilities reasonably incurred in connection with the
investigation, defense, settlement or appeal of legal
proceedings.

We have not received any claims under these
indemnifications and do not know of any instances in which such
a claim may be brought against us in the future and as a result
we have not accrued any indemnification expenses.



|          |                       
|--------- | ----------------------
|Note 15  | Geographic Information

In June 1997, the FASB issued
SFAS No. 131, Disclosures About Segments of an
Enterprise and Related Information. The statement requires
us to report certain financial information about operating
segments. It also requires that we report certain information
about our services, the geographic areas in which we operate and
our major customers. The method specified in
SFAS No. 131 for determining what information to
report is referred to as the management approach.
The management approach is based on the way that management
organizes the segments within the enterprise for making
operating decisions and assessing performance.

We are organized to operate and service a single
industry segment: the design, development, manufacture,
marketing and support of advanced software-based test systems
globally.

Although we operate in one geographic segment,
our chief decision makers evaluate net revenues by customer
location based on four geographic regions, as follows (in
thousands):

|                                     |  |         |        |         |  |       |        |         |  |              |        |  |  |   |       |  |  |   |        | 
|------------------------------------ |  | ------- | ------ | ------- |  | ----- | ------ | ------- |  | ------------ | ------ |  |  | - | ----- |  |  | - | ------ | 
|                                     |  |         |        | UK,     |  |       |        |         |  |             
|                                     |  | North   |        | Europe  |  |       |        | Rest of |  | Consolidated
|                                     |  | America |        | & Other |  | Japan |        | World   |  | Total       
|                                     |  |         |        |         |  |       |        |         |  |             
|Year ended September 30, 2002        |  |         |        |         |  |       |        |         |  |              |        |  |  |   |       |  |  |   |        | 
|Revenues from unaffiliated customers |  | $       | 7,849  |         |  | $     | 16,733 |         |  | $            | 15,457 |  |  | $ |      |  |  | $ | 40,039 | 
|Year ended September 30, 2003        |  |         |        |         |  |       |        |         |  |              |        |  |  |   |       |  |  |   |        | 
|Revenues from unaffiliated customers |  | $       | 17,399 |         |  | $     | 9,676  |         |  | $            | 15,622 |  |  | $ | 2,527 |  |  | $ | 45,224 | 
|As at September 30, 2003             |  |         |        |         |  |       |        |         |  |              |        |  |  |   |       |  |  |   |        | 
|Goodwill                             |  | $       | 22,896 |         |  | $     | 26,498 |         |  | $            |       |  |  | $ |      |  |  | $ | 49,394 | 
|Long-lived assets                    |  | $       | 5,849  |         |  | $     | 3,753  |         |  | $            | 286    |  |  | $ |      |  |  | $ | 9,888  | 
|Year ended September 30, 2004        |  |         |        |         |  |       |        |         |  |              |        |  |  |   |       |  |  |   |        | 
|Revenues from unaffiliated customers |  | $       | 17,355 |         |  | $     | 18,355 |         |  | $            | 19,628 |  |  | $ | 2,680 |  |  | $ | 58,018 | 
|As at September 30, 2004             |  |         |        |         |  |       |        |         |  |              |        |  |  |   |       |  |  |   |        | 
|Goodwill                             |  | $       | 22,896 |         |  | $     | 26,498 |         |  | $            |       |  |  | $ |      |  |  | $ | 49,394 | 
|Long-lived assets                    |  | $       | 4,480  |         |  | $     | 3,276  |         |  | $            | 311    |  |  | $ |      |  |  | $ | 8,067  | 

Revenues are segmented based on the location of
the end customer and exclude all inter-company sales.

International sales represented 76%, 65%, and 85%
of our total revenues in 2004, 2003, and 2002, respectively.
Customers located in France accounted for 19% of our
consolidated net revenues to unaffiliated customers for the year
ended September 30, 2002. Customers located in Germany
accounted for 11% of our consolidated net revenues to
unaffiliated customers for the year ended September 30,
2004. Operations in Ireland accounted for 33% and 36% of the
consolidated identifiable assets at September 30, 2004 and
2003, respectively.

58



---



##### Table of Contents



Supplementary Financial Data

Quarterly Financial Data (unaudited)

Consolidated Statements of Income
Data:


|                        |         |                                       |        |          |  |          |        |           |  |   |        |      |  |   |        |      | 
|----------------------- | ------- | ------------------------------------- | ------ | -------- |  | -------- | ------ | --------- |  | - | ------ | ---- |  | - | ------ | ---- | 
|                        |         |                                      
|                        |         | Quarter Ended                        
|                        |         |                                      
|                        |         | Dec. 31,                              |        | Mar. 31, |  | June 30, |        | Sept. 30,
|                        |         | 2002(1)                               |        | 2003     |  | 2003(2)  |        | 2003(3)  
|                        |         |                                       |        |          |  |          |        |          
|                        |         |                                      
|                        |         | (In thousands, except per share data)
|Revenues                |         | $                                     | 10,385 |          |  | $        | 14,036 |           |  | $ | 10,597 |      |  | $ | 10,206 |     
|Gross profit            |         |                                       | 8,140  |          |  |          | 11,311 |           |  |   | 8,644  |      |  |   | 7,966  |     
|Operating income (loss) |         |                                       | (763   | )        |  |          | 2,258  |           |  |   | 239    |      |  |   | (1,107 | )   
|Net income              |         | $                                     | 111    |          |  | $        | 1,668  |           |  | $ | 1,361  |      |  | $ | 1,225  |     
|Net income per share:   |         |                                       |        |          |  |          |        |           |  |   |        |      |  |   |        |     
|                        | Basic   |                                       | $      | 0.01     |  |          | $      | 0.13      |  |   | $      | 0.11 |  |   | $      | 0.10 | 
|                        | Diluted |                                       | $      | 0.01     |  |          | $      | 0.13      |  |   | $      | 0.10 |  |   | $      | 0.09 | 

|                        |         |          |        |          |  |          |        |           |  |   |        |      |  |   |        |      | 
|----------------------- | ------- | -------- | ------ | -------- |  | -------- | ------ | --------- |  | - | ------ | ---- |  | - | ------ | ---- | 
|                        |         | Dec. 31, |        | Mar. 31, |  | June 30, |        | Sept. 30,
|                        |         | 2003     |        | 2004     |  | 2004     |        | 2004(4)  
|                        |         |          |        |          |  |          |        |          
|Revenues                |         | $        | 11,049 |          |  | $        | 17,242 |           |  | $ | 14,320 |      |  | $ | 15,407 |     
|Gross profit            |         |          | 9,157  |          |  |          | 14,594 |           |  |   | 12,166 |      |  |   | 12,653 |     
|Operating income (loss) |         |          | 879    |          |  |          | 5,086  |           |  |   | 3,283  |      |  |   | 3,622  |     
|Net income              |         | $        | 915    |          |  | $        | 4,530  |           |  | $ | 2,923  |      |  | $ | 5,543  |     
|Net income per share:   |         |          |        |          |  |          |        |           |  |   |        |      |  |   |        |     
|                        | Basic   |          | $      | 0.07     |  |          | $      | 0.35      |  |   | $      | 0.22 |  |   | $      | 0.42 | 
|                        | Diluted |          | $      | 0.07     |  |          | $      | 0.32      |  |   | $      | 0.20 |  |   | $      | 0.38 | 



---

Notes:



|    |                                                                                                      
|--- | -----------------------------------------------------------------------------------------------------
|(1) | Net income includes a Japanese consumption tax
    recovery of $0.7 million.                         
|   
|(2) | Net income includes a tax benefit of
    $1.1 million.                                               
|   
|(3) | Net income includes a tax benefit of
    $1.7 million and a restructuring charge of
    $0.7 million.
|   
|(4) | Net income includes a tax benefit of
    $1.8 million.                                               






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

Not applicable.






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

(a) Evaluation of disclosure controls and
procedures.

Our management evaluated, with the participation
of our Chief Executive Officer and our Chief Financial Officer,
the effectiveness of our disclosure controls and procedures as
of the end of the period covered by this Annual Report on
Form 10-K. Based on this evaluation, our Chief Executive
Officer and our Chief Financial Officer have concluded that our
disclosure controls and procedures are effective to ensure that
information we are required to disclose in reports that it files
or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commission rules
and forms.

(b) Changes in internal controls over
financial reporting.

There was no change in our internal control over
financial reporting that occurred during the fourth quarter of
fiscal 2004 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.

59



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##### Table of Contents








|         |                  
|-------- | -----------------
|Item 9B. | Other Information

Not applicable.




PART III

Certain information required by Part III is
omitted from this Annual Report on Form 10-K because we
will file a definitive proxy statement within one hundred twenty
(120) days after the end of our fiscal year pursuant to
Regulation 14A (the Proxy Statement) for our
Annual Meeting of Stockholders currently scheduled for
January 25, 2005, and the information included in the Proxy
Statement is incorporated herein by reference.






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

Information regarding our directors is
incorporated by reference to the information under the heading
Proposal One  Election of Directors in
our Proxy Statement.

Information regarding our executive officers is
incorporated by reference to the section of Part I of this
Annual Report on Form 10-K entitled
Item 1  Business  Executive
Officers of the Company.

Information regarding compliance with
Section 16 of the Securities Exchange Act of 1934, as
amended, is incorporated by reference to the information under
the heading Section 16(a) Beneficial Ownership
Reporting Compliance in our Proxy Statement.

Audit Committee Financial Expert

Our Board of Directors has determined that there
is currently no Audit Committee Financial Expert (as that term
is defined in applicable rules of the Securities and Exchange
Commission) serving on our audit committee. Our Board of
Directors is currently evaluating potential candidates for this
position.

Code of Ethics

We have adopted a Code of Ethics for Principal
Executive and Senior Financial Officers, a copy of which has
been filed and is incorporated as Exhibit 14 to this Report
on Form 10-K.






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

Information regarding the compensation of our
executive officers and directors is incorporated by reference
from the information under the headings Executive
Compensation and Certain Transactions in our
Proxy Statement.






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

Incorporated by reference to the information
under the headings Security Ownership of Principal
Stockholders and Management and Executive
Compensation  Equity Compensation Plan Information
in our Proxy Statement.






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

Incorporated by reference to the information
under the caption Certain Transactions in our Proxy
Statement.






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

Incorporated by reference to the information
under the caption Proposal Two  Ratification of
Appointment of Independent Registered Public Accounting
Firm in our Proxy Statement.

60



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##### Table of Contents






PART IV






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

(a) The following documents are filed as
part of this Annual Report on Form 10-K:



|   |                     
|-- | --------------------
|1. | Financial Statements

Consolidated Financial
Statements:See Index to Consolidated
Financial Statements at Item 8 on page 36 of this
report.



|   |                              
|-- | -----------------------------
|2. | Financial Statement Schedules

Financial Statement
Schedule:See Index to Consolidated
Financial Statements at Item 8 on page 36 of this
report.



|   |         
|-- | --------
|3. | Exhibits

The following exhibits are incorporated herein by
reference or are filed with this reports as indicated below
(numbered in accordance with Item 601 of
Regulation S-K):

|        |    |             |  |                                                                                                                                                                                                                 
|------- | -- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 2  | .1          |  | Asset Purchase Agreement dated July 15, 2002
    between the Company and Tekelec  incorporated by reference
    to Exhibit 2.2.1 to Registrants Quarterly Report on
    Form 10-Q dated August 14, 2002.      
|        | 3  | .1          |  | Articles of Incorporation of Registrant 
    incorporated by reference to Exhibit 3.1 to Registration
    Statement No. 333-56627.                                                                             
|        | 3  | .2          |  | Bylaws of the Registrant, as amended through
    November 20, 2003  incorporated by reference to
    Exhibit 3.2 to the Registrants Annual Report
    Form 10-K dated December 5, 2003.                       
|        | 10 | .1          |  | Forms of Indemnification Agreement entered into
    by Registrant with each of its directors and executive officers
     incorporated by reference to Exhibit 10.1 to
    Registration Statement No. 333-56627.
|        | 10 | .2*         |  | 1989 Stock Option Plan and related agreements
     incorporated by reference to Exhibit 10.3 to our
    Form 10-K dated December 17, 2001.                                                                     
|        | 10 | .3*         |  | UK Executive Share Option Scheme and related
    agreements  incorporated by reference to Exhibit 10.4
    to Registration Statement No. 333-56627.                                                            
|        | 10 | .4*         |  | 1998 Stock Plan, as amended October 28, 2003
    (related agreements are incorporated by reference to
    Exhibit 10.5 to our Form 10-Q dated May 15,
    2003.).                                               
|        | 10 | .5*         |  | 1998 Employee Stock Purchase Plan and related
    agreements  incorporated by reference to Exhibit 10.6
    to Registration Statement No. 333-56627.                                                           
|        | 10 | .6          |  | Lease for office space located at 160 and 190
    South Whisman Road, Mountain View, CA  incorporated by
    reference to Exhibit 10.9 to our Form 10-K dated
    December 17, 2001.                           
|        | 10 | .7          |  | Lease for office space located at 800 Perimeter
    Park Drive, Morrisville, NC 27560  incorporated by
    reference to Exhibit 10.9 to our Form 10-K dated
    December 20, 2002.                             
|        | 10 | .8          |  | Form of Software Support Agreement 
    incorporated by reference to Exhibit 10.9 to Registration
    Statement No. 333-56627.                                                                                 
|        | 10 | .9          |  | Lease for office space located at 160 and 190
    South Whisman Road, Mountain View, CA  incorporated by
    reference to Exhibit 10.0 to our Form 10-Q dated
    May 3, 2004.                                 
|        | 10 | .10         |  | License Agreement dated July 15, 2002
    between the Company and Tekelec  incorporated by reference
    to Exhibit 2.2.3 to Registrants Form 10-Q dated
    August 14, 2002.                                 
|        | 10 | .11         |  | International Rights License Agreement dated
    July 15, 2002 between the Company and Tekelec 
    incorporated by reference to Exhibit 2.2.4 to Registrants
    Form 10-Q dated August 14, 2002.            
|        | 10 | .12         |  | Lease for office space located at 190 South
    Whisman Road, building G, Mountain View, CA  incorporated
    by reference to Exhibit 10.8 to Registrants
    Form 10-K dated December 17, 2001.              

61



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##### Table of Contents



|        |    |             |  |                                                                                                                                                                                              
|------- | -- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 10 | .13*        |  | Executive Officer Fiscal Year 2005 Variable
    Compensation Plan  incorporated by reference to
    Exhibit 10.1 to Registrants Form 8-K dated
    November 3, 2004.                       
|        | 11 | .1          |  | Calculation of Earnings per Common Share
    (contained in Note 1 of the Notes to Financial Statements).                                                                                     
|        | 14 |             |  | Code of Ethics for Principal Executive and Senior
    Financial Officers  incorporated by reference to
    Exhibit 14 to Registrants Annual Report on
    Form 10-K dated December 5, 2003.
|        | 21 | .1          |  | Subsidiaries of the Registrant.                                                                                                                                                              
|        | 23 | .1          |  | Consent of PricewaterhouseCoopers LLP,
    Independent Registered Public Accounting Firm.                                                                                                    
|        | 24 | .1          |  | Power of Attorney. Contained in the signature
    page of this Annual Report on Form 10-K.                                                                                                   
|        | 31 | .1          |  | Certification of Chief Executive Officer Pursuant
    to 18 U.S.C. Section 1350, as Adopted Pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                   
|        | 31 | .2          |  | Certification of Chief Financial Officer Pursuant
    to 18 U.S.C. Section 1350, as Adopted Pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                   
|        | 32 |             |  | Certification of Chief Executive Officer and
    Chief Financial Officer Pursuant to 18 U.S.C. Section 1350,
    as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
    Act of 2002.   



---



|  |                                                                                                                                                          
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|* | Represents a management contract or compensatory
    plan, contract or arrangement in which any director or any of
    the named executives participates.

We will mail a copy of any exhibit listed above
for a nominal fee to any stockholder upon written request.

(b) Reports on Form 8-K

The following reports on Form 8-K were filed
by us during the quarter ended September 30, 2004:



| |    |                                                                                                                                                                          
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. | On July 22, 2004, we filed a Current Report
    on Form 8-K to furnish information concerning our results
    of operations.                                             
|
| | 2. | On August 31, 2004, we filed a Current
    Report on Form 8-K regarding Tekelecs election to
    extend the maturity date of certain notes payable by us.               
|
| | 3. | On September 7, 2004, we filed a Current
    Report on Form 8-K regarding our filing of a preliminary
    prospectus in connection with our shelf Registration Statement.
|
| | 4. | On September 7, 2004, we filed a Current
    Report on Form 8-K regarding a public offering of our
    securities.                                                       
|
| | 5. | On September 15, 2004, we filed a Current
    Report on Form 8-K including an opinion of counsel and a
    form of underwriting agreement.                               
|
| | 6. | On September 16, 2004, we filed a Current
    Report on Form 8-K regarding the pricing of our
    underwritten public offering.                                          
|
| | 7. | On September 21, 2004, we filed a Current
    Report on Form 8-K including a definitive underwriting
    agreement.                                                      

62



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, we have as duly
caused the report to be signed on our behalf by the undersigned,
thereunto duly authorized.



| |                                    
| | -----------------------------------
| | CATAPULT COMMUNICATIONS CORPORATION



| |     |                    
| | --- | -------------------
| | By: | /s/ RICHARD A. KARP

| |                                                    
| | ---------------------------------------------------
| |                                                    
| | Richard A. Karp                                    
| | Chief Executive Officer & Chairman of
    the Board

Date: December 10, 2004

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each
person whose signature appears below constitutes and appoints
Richard A. Karp, his attorney-in-fact, with the power of
Substitution, for him in any and all capacities, to sign any
amendments to this Report on Form 10-K, and to file the
same, with Exhibits thereto and other documents in connection
therewith with the Securities and Exchange Commission, hereby
ratifying and confirming all that said attorney-in-fact, or
substitute or substitutes may do, or cause to be done, by virtue
hereof.

Pursuant to the requirements of the Securities
Exchange 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/ RICHARD A. KARP(Richard A. Karp)                     |  | Chief Executive Officer,
    Chairman of the Board (Principal Executive Officer)       |  | December 10, 2004
|                                                        
|/s/ CHRISTOPHER A. STEPHENSON(Christopher A. Stephenson) |  | Chief Financial Officer
    (Principal Financial and Principal
    Accounting Officer) |  | December 10, 2004
|                                                        
|/s/ CHARLES L. WAGGONER(Charles L. Waggoner)             |  | Director                                                                               |  | December 10, 2004
|                                                        
|/s/ JOHN M. SCANDALIOS(John M. Scandalios)               |  | Director                                                                               |  | December 10, 2004
|                                                        
|/s/ NANCY H. KARP(Nancy H. Karp)                         |  | Director                                                                               |  | December 10, 2004
|                                                        
|/s/ HENRY P. MASSEY, JR.(Henry P. Massey, Jr.)           |  | Director                                                                               |  | December 10, 2004
|                                                        
|/s/ PETER CROSS(Peter Cross)                             |  | Director                                                                               |  | December 10, 2004

63



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##### Table of Contents






EXHIBIT INDEX

|        |    |             |  |                                                                                                                                                                                                                 
|------- | -- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 2  | .1          |  | Asset Purchase Agreement dated July 15, 2002
    between the Company and Tekelec  incorporated by reference
    to Exhibit 2.2.1 to Registrants Quarterly Report on
    Form 10-Q dated August 14, 2002.      
|        | 3  | .1          |  | Articles of Incorporation of Registrant 
    incorporated by reference to Exhibit 3.1 to Registration
    Statement No. 333-56627.                                                                             
|        | 3  | .2          |  | Bylaws of the Registrant, as amended through
    November 20, 2003  incorporated by reference to
    Exhibit 3.2 to the Registrants Annual Report
    Form 10-K dated December 5, 2003.                       
|        | 10 | .1          |  | Forms of Indemnification Agreement entered into
    by Registrant with each of its directors and executive officers
     incorporated by reference to Exhibit 10.1 to
    Registration Statement No. 333-56627.
|        | 10 | .2*         |  | 1989 Stock Option Plan and related agreements
     incorporated by reference to Exhibit 10.3 to our
    Form 10-K dated December 17, 2001.                                                                     
|        | 10 | .3*         |  | UK Executive Share Option Scheme and related
    agreements  incorporated by reference to Exhibit 10.4
    to Registration Statement No. 333-56627.                                                            
|        | 10 | .4*         |  | 1998 Stock Plan, as amended October 28, 2003
    (related agreements are incorporated by reference to
    Exhibit 10.5 to our Form 10-Q dated May 15,
    2003.).                                               
|        | 10 | .5*         |  | 1998 Employee Stock Purchase Plan and related
    agreements  incorporated by reference to Exhibit 10.6
    to Registration Statement No. 333-56627.                                                           
|        | 10 | .6          |  | Lease for office space located at 160 and 190
    South Whisman Road, Mountain View, CA  incorporated by
    reference to Exhibit 10.9 to our Form 10-K dated
    December 17, 2001.                           
|        | 10 | .7          |  | Lease for office space located at 800 Perimeter
    Park Drive, Morrisville, NC 27560  incorporated by
    reference to Exhibit 10.9 to our Form 10-K dated
    December 20, 2002.                             
|        | 10 | .8          |  | Form of Software Support Agreement 
    incorporated by reference to Exhibit 10.9 to Registration
    Statement No. 333-56627.                                                                                 
|        | 10 | .9          |  | Lease for office space located at 160 and 190
    South Whisman Road, Mountain View, CA  incorporated by
    reference to Exhibit 10.0 to our Form 10-Q dated
    May 3, 2004.                                 
|        | 10 | .10         |  | License Agreement dated July 15, 2002
    between the Company and Tekelec  incorporated by reference
    to Exhibit 2.2.3 to Registrants Form 10-Q dated
    August 14, 2002.                                 
|        | 10 | .11         |  | International Rights License Agreement dated
    July 15, 2002 between the Company and Tekelec 
    incorporated by reference to Exhibit 2.2.4 to Registrants
    Form 10-Q dated August 14, 2002.            
|        | 10 | .12         |  | Lease for office space located at 190 South
    Whisman Road, building G, Mountain View, CA  incorporated
    by reference to Exhibit 10.8 to Registrants
    Form 10-K dated December 17, 2001.              
|        | 10 | .13*        |  | Executive Officer Fiscal Year 2005 Variable
    Compensation Plan  incorporated by reference to
    Exhibit 10.1 to Registrants Form 8-K dated
    November 3, 2004.                                          
|        | 11 | .1          |  | Calculation of Earnings per Common Share
    (contained in Note 1 of the Notes to Financial Statements).                                                                                                        
|        | 14 |             |  | Code of Ethics for Principal Executive and Senior
    Financial Officers  incorporated by reference to
    Exhibit 14 to Registrants Annual Report on
    Form 10-K dated December 5, 2003.                   
|        | 21 | .1          |  | Subsidiaries of the Registrant.                                                                                                                                                                                 
|        | 23 | .1          |  | Consent of PricewaterhouseCoopers LLP,
    Independent Registered Public Accounting Firm.                                                                                                                       
|        | 24 | .1          |  | Power of Attorney. Contained in the signature
    page of this Annual Report on Form 10-K.                                                                                                                      
|        | 31 | .1          |  | Certification of Chief Executive Officer Pursuant
    to 18 U.S.C. Section 1350, as Adopted Pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                      
|        | 31 | .2          |  | Certification of Chief Financial Officer Pursuant
    to 18 U.S.C. Section 1350, as Adopted Pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                      
|        | 32 |             |  | Certification of Chief Executive Officer and
    Chief Financial Officer Pursuant to 18 U.S.C. Section 1350,
    as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
    Act of 2002.                      



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|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|* | Represents a management contract or compensatory
    plan, contract or arrangement in which any director or any of
    the named executives participates.