Tekelec (TKLC) - Description of business

Tekelec is a leading global provider of telecommunications network systems and software applications. Our customers include traditional landline or "wireline" telecommunications carriers, mobile or "wireless" communications operators, emerging competitive service providers and cable television service providers who are offering communication services (collectively, "service providers"). Our customers, including many of the largest service providers in the world, have deployed more than 1,000 Tekelec systems and software applications in over 300 networks located in over 30 countries worldwide.

As further described below, we offer systems and software applications that include (a) high performance, network-centric, mission critical applications for signaling and session control; (b) complementary applications that enable service providers to better measure, manage and monetize the communication services they provide; and (c) subscriber-centric applications that enable service providers to deliver basic and enhanced voice and data communications services. These network applications are derived from our portfolio of systems, software and related professional services that we design, develop, manufacture, market, sell and support. Our network applications enable our service provider customers to optimize their network efficiency and performance and to provide basic and enhanced voice and data services to their subscribers. Our network applications are designed to assist our customers as they transition their traditional networks to Internet Protocol (or IP) based networks.

We deliver these network systems and software applications through the following three reportable business segments:

• Network Signaling Group (NSG): Our network signaling product portfolio enables service providers to establish, control, and terminate voice and data communications "calls" or "sessions." Over the years, we have gained considerable signaling expertise and intellectual property. We believe that we are one of the leading vendors of network signaling applications worldwide. Historically, our NSG business segment has accounted for the most significant portion of our revenue, representing approximately 67% of our revenues for 2006.
• Communications Software Solutions Group (CSSG): Our CSSG business unit leverages our NSG installed customer base, and its product portfolio complements the functionality of our NSG product portfolio. Our CSSG solutions assist our customers in measuring network and service performance, managing network and service efficiency, and monetizing their networks and service offerings through the reduction of revenue loss. Our CSSG business segment represented approximately 13% of our revenues for 2006.
• Switching Solutions Group (SSG): Our SSG solutions control and route the actual voice or data comprising a "call" or a "session." Our SSG network applications enable our customers to offer basic and enhanced voice and data services utilizing traditional and IP-based networking technologies. Our SSG business segment represented approximately 20% of our revenues for 2006.

We derive our revenues from the sale or licensing of these telecommunications network systems and software applications and the related professional services, such as installation, training services and customer support, including customer post-warranty service contracts and our recently announced TekelecCare offering. Payment terms for contracts with our customers are negotiated with each customer and are based on a variety of factors, including the customer's credit standing and our history with the customer. For financial information by operating segment, product category, and geographical area, please see Note 16 "Operating Segment Information" to our Consolidated Financial Statements and "Results of Operations - Revenues" in the section of this Annual Report entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations."

We were incorporated in California in December 1971, and our headquarters are in Morrisville, North Carolina. Our Internet address is www.tekelec.com . We are not including the information contained on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. We make available free of charge through our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission. Copies of this Annual Report and other reports are available without charge upon written request to us.


Industry Background


Historically, landline, also known as "wireline" or "fixed," telecommunications service providers have been either government owned or heavily regulated , and their primary objective has been to provide voice services. Their networks, often referred to as Public Switched Telephone Networks, or PSTNs, were built and have evolved and been maintained over long periods of time, in many instances for decades, and were primarily designed to provide seamless, reliable and secure global voice communications. The technology upon which today's PSTN is based is commonly known as "circuit switched" and utilizes time division multiplexing (TDM) standards for transmission of the electronic signals carrying the voice conversation. The electronic signals carrying the voice conversations are referred to as "media," and in a circuit switched network they follow a dedicated path, or circuit.

Further evolution of the circuit switched network included the introduction of additional services, which we refer to as "intelligent network" services, by adding both a signaling network layer and an enhanced intelligent network services layer on top of the TDM voice switching network. The signaling network layer improved network performance by reducing call setup times, improving the efficiency of the network, providing for interoperability between two independently owned networks, and providing access to an enhanced intelligent network services layer. The critical technology underpinning the intelligent network is the globally accepted signaling protocol known as Signaling System #7, or SS7. The flexibility of the three-layered intelligent network design permitted the introduction of a number of new and enhanced services, including toll free numbers and number portability, whereby subscribers are able to retain their local phone number, yet move their phone service to a new service provider. While SS7 was initially created to support signaling in the PSTN, it has also become an essential element for connecting calls and delivering enhanced services in wireless networks.

Wireless networks are often referred to as Public Land Mobile Networks, or PLMNs. Wireless networks generate substantially more SS7 signaling traffic than fixed line networks due to additional capabilities inherent in wireless telephony such as mobile registrations, roaming, and mobile call handoffs between cellular towers and equipment. As a result, wireless operators generally invest more in SS7-related equipment, such as signal transfer points, or STPs, than landline telecommunications service providers in order to accommodate the unique signaling demands of mobile telephony. In addition, rapid growth in wireless subscribers, minutes of use and increased popularity of wireless services such as voice mail, short text messaging, pre-paid billing and wireless number portability have led to a significant increase in SS7 traffic on mobile networks in recent years, and has created a need for high capacity signaling infrastructure. Driving the higher usage in wireless networks, particularly in the United States, are flat rate pricing plans that feature no incremental charges for any calls up to a specified monthly limit. Innovative service offerings like camera phones, the increasing popularity of family calling plans, and continued wireline to wireless substitution are also contributing to continuing wireless subscriber growth. We believe that wireless usage may continue to increase in the coming years and create additional SS7 signaling traffic and increased demand for our network applications.

In the past, networks designed primarily for data services have emerged and are commonly referred to as the Internet. The Internet is a collection of Internet Protocol, or IP, -based networks that provide global reach for a broad range of information services such as web browsing, e-mail, electronic commerce and research. IP networks are "packet switched" networks because the IP protocol breaks the media into packets before transporting them, each packet often taking separate path, to the intended destination where the packets are then reassembled prior to delivery to the intended recipient.

Increased competition among service providers has resulted in a reduction in the price per minute that service providers charge for traditional voice services. This, in turn, has driven increased subscriber demand for voice services as well as

demand for innovative new services, including basic data services. With the resulting revenue and margin pressure, service providers are attempting to reduce the expense of delivering traditional service while expanding their networks to handle the greater volume of traffic. We believe these dynamics are a primary driver of the recent wide spread consolidation among service providers, as they attempt to take advantage of increased economies of scale and/or position themselves to offer both wireline and wireless services. In further response to consumer demand and declines in prices brought about by expanding competition, service providers have also begun to offer services beyond those traditionally offered, including bundling voice, video and data services.

The Emergence of a Converged Network

Today, most service providers operate both circuit switched networks and packet networks. Currently, the majority of networks which carry voice communications rely on TDM circuit switching technology, and, until recently, packet switching has been used almost exclusively for data communications. Managing multiple distinct networks is not expected to be a viable economic alternative. While circuit switching has offered reliable and high quality voice communications, packet switching is inherently more efficient and cost effective. As a result, service providers are beginning to migrate toward a single IP network architecture, or converged network, to serve as the foundation for their enhanced voice, video and data service offerings.

Convergence has a wide variety of meanings within the communications industry. The term convergence encompasses: (a) the convergence of circuit and packet-based technologies to support voice services (voice transported over IP and SS7 signaling transported over IP); (b) the convergence of mobile networks and fixed networks and the associated flexibility of accessing networks utilizing a variety of subscriber devices; (c) the convergence of widely utilized information technologies with proprietary legacy telecommunication technologies; and (d) the convergence of basic voice and data services and enhanced multimedia services.

In the last several years, the IP Multimedia Subsystem architecture, or IMS, has emerged as an architecture well suited for converged IP networking. Variations of the IMS architecture have been and are being adopted by various standard-setting bodies within the wireless, wireline and cable industries. Very much like the SS7-based intelligent networking architecture employed by circuit switched networks, IMS includes a three-layer architecture: a media transport layer, a signaling and session control layer and an applications layer. However, instead of employing the SS7 protocol for signaling, IMS uses a newer signaling protocol, Session Initiation Protocol, or SIP. SIP's advantages include its ability to manage multimedia services (voice, video and data) in an IP network, making them accessible from a wide variety of devices, such as mobile phones, personal computers, ordinary phones and personal digital assistants, or so called "smart phones."

Transitioning to a Converged Network

The transition to a converged network poses a challenge for service providers: when and how can they cost effectively transition from existing networking technology to the converged network, without disrupting existing services and without abandoning current and recent investments in existing networks? We believe this transition process will evolve through three phases: the current state, the transition state and the future state.

• We believe the current state includes basic voice and data services signaled with SS7 and transported over TDM-based networks.
• We believe the transition state will offer basic and enhanced voice and data services signaled with SS7, but transported over IP-based networks. Examples of network applications many service providers are evaluating and deploying include voice services transported over IP, or VoIP, and SS7 signaling transported over IP, or SIGTRAN.
• We believe the future state will be based upon the emerging industry consensus for IMS architectures providing enhanced multimedia service (voice, video and data) signaled with SIP and transported over an IP-based, converged network.

While this trend is global in nature, there remain considerable differences by geography in the PSTN, PLMN and Internet maturity, as well as in the economic opportunities that service providers are attempting to capitalize upon. These differences generally affect the decision as to when and how service providers adopt newer technologies and commence their transition to a converged network. As a result, we expect adoption of, and, thus, demand for the networking technologies to vary from market to market, and current state, transitional state and future state networks to overlap for a considerable period of time. We believe that there will likely be instances of all three network states, or hybrid networks, concurrently owned and operated by a single service provider, especially the larger providers who own networks in several markets. For example, service providers operating current state networks in emerging markets will need to interoperate with service providers operating transitional networks and converged networks in maturing markets. Finally, service providers must be able to measure performance, manage the quality and availability of service and monetize the newer services in and across current, transition and future state networks.



Tekelec's Network Applications


Our network applications assist our customers in meeting their primary challenges in the competitive communications environment, which are differentiating their revenue generating offerings and lowering network costs. They enable the delivery of intelligent services and facilitate transition to the converged network. We believe that our open, standards-based products and services are highly reliable and enable us to reach a larger addressable market, while enabling service providers to more cost effectively manage their networks and offer intelligent services that differentiate them from their competition.

Signaling Network Applications offered by our NSG business unit

With over 1,000 signaling systems in operation worldwide, we have one of the most widely deployed standalone signaling application platforms in the telecommunications industry. Our signaling systems and software are installed in all Tier 1 North American wireless and wireline service providers. As we expand internationally, we continue to grow our customer base among the leading wireless and wireline service providers in Europe, Asia, Africa, Central and South America. We believe that our EAGLE 5 Integrated Signaling System, or "EAGLE 5 ISS," is successful because of our focus on the development of a competitive, highly scalable system that is able to meet the rigorous technological demands of rapidly growing global service providers.

Over time, we have extended the features and capabilities of our signaling systems and software to include other integrated value-added network applications. The types of other network applications that we have targeted are those that are highly synergistic with our signaling network applications, such as our Number Portability application for number portability in mobile and fixed networks; our GFLEX application for improved mobility management through optimization of a service provider's Home Location Register, or HLR, resources; our TekMedia application for more efficient, network-based Short Message Service, or SMS, and control of unwanted text messages (commonly referred to as "SPAM" messages); as well as applications for integrated data collection used in concert with our real time performance management network application delivered by our CSSG business unit. By integrating or bundling other synergistic network applications with our signaling applications within our EAGLE 5 ISS platforms, we have enabled service providers to reduce the number of signaling connections between network elements and the congestion and bottlenecks in their signaling networks - thus enabling service providers to realize greater throughput capacity and efficiency in their communications networks.

As network traffic has grown, service providers have been looking for even more cost effective ways to handle the related increase in SS7 traffic. One of the main features of the EAGLE 5 ISS platform is its ability to support SIGTRAN, which is essentially SS7 transported over IP, and to help our customers realize substantial efficiencies inherent in IP networking. Use of our SIGTRAN systems, software and related applications results in a substantial increase in signaling efficiency by enabling SS7 signaling transported over IP at faster rates than traditional SS7 signaling transported over TDM or other packet networking technologies. Customers may choose to deploy the EAGLE 5 ISS with SIGTRAN capability to gain signaling efficiencies, among other benefits, as they transition their voice service to VoIP networks. In addition, customers of our signaling products may upgrade their existing infrastructure to enable SS7 signaling over IP. The upgrade enables them to preserve the value of their existing SS7 infrastructure and makes them capable of facilitating interoperability between circuit switched and next generation packet networks.

As a result of service provider challenges encountered in transitioning to the converged network, we believe that SS7 will continue as a requirement for the foreseeable future. In order to meet the various needs of our customers as they transition to IMS, we are developing SIP signaling systems and transitional product offerings that allow the current and future networks to interoperate. The device within the IMS architecture that manages SIP-based communications sessions is the Call Session Control Function, or CSCF. Our implementation of CSCF, the TekCore™ Session Manager, is designed to enable service providers to integrate CSCF functionality into their networks and seamlessly offer SS7, SIGTRAN and/or SIP based communications services.

As service providers adopt IMS, we believe that they will likely operate hybrid networks with both intelligent network and IMS services for years. IMS is designed to permit service providers to orchestrate service interaction of multiple SIP-based services. NSG's Service Mediation solution is designed to enable service interaction among legacy, mobile, VoIP and IMS networks. NSG's Service Mediation solution simplifies the interworking of network components that utilize different protocols without having to upgrade each network switch or re-architect the network. This allows service providers to simplify their network architecture for faster service rollout, to deliver value-added, bundled services and to cap investments in legacy technology based equipment. It bridges technologies, allowing SS7-based, intelligent network service platforms to coexist and interact with SIP-based, IMS network service platforms.

Network Applications offered by our CSSG business unit

We believe the synergy between our industry leading signaling platforms and performance management, revenue

management and service creation applications provides significant value to our customers. Our CSSG network and business applications help service providers measure, manage and monetize the communications traffic that traverses their networks. Specifically, these applications enhance the reliability and security of our customers' networks, reduce the time to troubleshoot problems, enable real-time management of service quality, and help detect and correct revenue leaks due to fraud, incorrect billings, and errors in recordkeeping. These products also help service providers deploy new services more cost effectively and improve their return on investment in existing and new services across both legacy and next generation telecommunications networks.

We provide comprehensive real-time network and business applications measurement capability for traditional and IP networks, as well as hybrid networks. Our CSSG solutions allow a service provider to verify overall network performance and quickly isolate problems in the network, while reducing capital and operating expenditures.

Our real time performance management system and software applications are offered as a solution with the EAGLE 5 ISS, complementing and leveraging the functionality of our signaling network applications. Our performance management solutions address a variety of activities related to the service provider's end user's experience, including traffic management, quality of service and troubleshooting. Our products allow the service providers to collect data about the operation of their networks and to graphically analyze and pinpoint network and quality of service problems.

Our revenue service applications are designed to permit service providers to monetize their services by gathering business-critical intelligence to make informed decisions, identifying sources of revenue loss, recovering revenue while increasing margins, and enabling new revenue generating services. We believe our CSSG applications provide valuable data on subscriber behavior, which may be used by marketing professionals to create highly targeted service bundles that increase profitability and customer value.

Basic and Enhanced Voice and Data Network Applications offered by our SSG business unit

Our switching solutions are focused primarily on creating and enhancing next-generation voice and data switching products and subscriber-centric services for both traditional circuit switched networks and newer packet switched networks. We offer wireline (Class 4 and Class 5) and wireless telephony solutions, as well as enhanced VoIP network applications. We believe that voice and data networks will increasingly interoperate, or converge. We have designed and are designing our switching solutions products and subscriber-centric services to enable our service provider customers to implement converged voice and data networks.

Recently, both VoIP and voice, video and data convergence activity has increased, as leading service providers and cable operators have begun to compete for subscribers by offering a "bundled" package of voice, data and video services, also known as "triple-play" service offerings (e.g., phone, internet and cable services). While VoIP has been a significant factor in business communication systems and services for many years, its growth has been limited in the broader consumer market. During 2006, new service providers, incumbent wireline service providers (e.g., Verizon), and cable operators realized significant growth in VoIP subscribers, which we believe is due in part to the maturing of these new technologies and the entrance of more established providers into the market. We believe our VoIP solutions are well positioned to meet this growing VoIP market demand.

As service providers seek additional ways to improve their service offerings, we believe that they are beginning to explore ways of achieving "continuous mobility." Continuous mobility is the ability of a mobile customer to seamlessly move from a traditional mobile wireless network to a home or business fixed wireless network, also known as a "WiFi" network, without disrupting service. WiFi fixed wireless networks enable access to VoIP services typically provided by a wireline service provider. This network capability is known as "Fixed Mobile Convergence," or FMC. Demand for FMC is supported by mobile phone manufacturers who have begun delivering "dual mode" mobile handsets that can communicate over both traditional wireless networks and over WiFi networks. Historically, consumers have been required to maintain multiple phone devices and service plans, such as a wireline phone service for the home along with a separate wireless service plan. The availability of "dual mode" mobile handsets combined with FMC network capabilities enables service providers to attract and retain customers by reducing the requirement for multiple phone devices and by providing customers with access to more economical wireline-based VoIP services while using a mobile phone handset.

Our switching solutions products are also designed to support the transition of a service provider's network to IMS through simultaneous support of both SS7 and SIP signaling interfaces. In addition, our products are distributed and provide the media transport and application layers in the three layer IMS architecture. This capability allows service providers to initially deploy our solutions in a pre-IMS network to provide for cost effective VoIP and/or TDM services. When these service providers are ready, they can evolve to a full IMS network by deploying the additional CSCF equipment to provide the session control layer in a more cost effective manner.



Our Business Strategy


Our objective is to be a premier supplier of communications systems, software and related professional services, delivering high performance, mission critical network applications for existing, transitional and converged voice and data communications networks. Key elements of our strategy to achieve this objective include:

Leveraging Our Installed Base and Established Customer Relationships. With over 1,000 signaling systems in operation worldwide, we have one of the most widely deployed, standalone signaling application platforms in the telecommunications industry. Our strategy is to leverage our worldwide installed base and our well established relationships with our customers in order to deepen our market penetration globally and to pursue selected emerging new market segments. We believe that we can leverage our installed base and established customer relationships by offering network applications that function not only in today's networks, but that also enable our customers to transition to converged IMS networks in the future.

Maintaining Technology Expertise and Knowledge. We believe that one of our core competitive strengths is the breadth of our knowledge and expertise in communications technologies, particularly in signaling and session control; in high performance, mission critical applications which utilize real time or near-real time data (especially data derived from signaling networks); and in voice call control. We have developed this expertise over more than two decades and, during 2006, we filed a significant number of new patent applications. We intend to enhance our existing products, develop new products and expand our portfolio of patented intellectual property by continuing to make significant investments in research and development. As part of our commitment to technology leadership, we were an early leader in developing solutions for SS7 signaling over IP; using real time database applications (including number portability and integrated network monitoring); as well as our offering of packet-based voice switching solutions.

Focusing on Continued Operating Improvements. We intend to continue to identify and implement new ways to improve our operating efficiency and business processes to enhance our profitability. We lowered our unit material costs and improved our margins through the use of contract manufacturing and improved supplier relationships. In 2005 and 2006, we continued to expand our sourcing of raw materials and services globally to lower our unit costs and increase our labor rate productivity. This included the sourcing of printed circuit boards from China, the assembly of our printed circuit boards in Thailand and Guadalajara, Mexico and the off-shoring of certain product development efforts to India, China and the Czech Republic. In 2006, in connection with the creation of our EAAA regional sales and marketing organization, comprised of Europe, the Middle East, Asia Pacific (including India and China), Africa and Australia, we combined seven regional sales and marketing teams into three. From time to time, we review our organizational and operating structure to determine whether new or expanded job functions or business processes can be assumed by existing personnel or reengineered, resulting in higher productivity.

Expanding Globally. We sell our products internationally through our direct sales force, sales agents, partnerships and distributor relationships. We also sell directly from our wholly owned subsidiaries in Argentina, Brazil, Canada, Colombia, the Czech Republic, France, Germany, India, Italy, Malaysia, Mexico, Singapore, Spain, Taiwan and the United Kingdom and from our sales offices in China, Dubai, the Russian Federation and South Africa. Total international revenues for 2006, 2005, and 2004 were $241.5 million, $134.0 million, and $87.1 million, respectively, representing 44%, 28%, and 27% of our total revenues, respectively.

Pursuing Opportunities with Strategic Partners. We intend to complement our product offerings and extend our market reach through selected strategic partnering relationships, including original equipment manufacturer, or "OEM," partners, referral arrangements, teaming agreements and distribution agreements. Our existing strategic relationships include technology development, outbound OEM and collaboration relationships with companies such as Alcatel-Lucent, NEC and ZTE. In addition to these strategic partnerships, from time-to-time we have also made acquisitions of technologies, competencies and businesses, where we sought to leverage synergies with our existing technologies, competencies and commercial opportunities. In 2005, we acquired privately-held iptelorg GmbH ("iptelorg") to augment our signaling portfolio with SIP routing software and additional SIP expertise. In 2006, we entered into a worldwide license to certain technologies and intellectual property rights that we believe will form the core software platform for our service mediation product family.  We believe this technology provides key capabilities, which will provide our customers with a smooth evolution from SS7 to SIP-based signaling and next-generation high performance network applications once we complete development of the product offerings based on this technology.  We anticipate that, from time to time, we may make additional acquisitions where we believe synergies with our existing business can be leveraged.


Recent Acquisitions and Dispositions


In July 2006, we completed the sale of IEX Corporation ("IEX"), a wholly owned subsidiary, to NICE-Systems Ltd. for approximately $201.5 million in cash, which included a $1.5 million working capital adjustment. IEX provided workforce

management and intelligent call routing systems for single- and multiple-site contact centers. IEX sold its products primarily to customers in industries with significant contact center operations such as airlines, financial services, telecommunications and retail. Prior to our decision to sell IEX, the results of IEX's operations were reported as the IEX Contact Center Group reporting segment.

During 2005, we completed the acquisition of iptelorg, a developer of SIP routing software, which is now included within our NSG reporting segment. In October 2004, we acquired Steleus Group Inc. ("Steleus"), a real time performance management supplier that provides business related intelligence products and services to telecommunications service providers. During the fourth quarter of 2004, Steleus' telecommunications product line was combined with certain of our existing business intelligence applications, such as billing verification and other network element independent applications to form our CSSG reporting segment.

In October 2005, we acquired the remaining minority ownership interest in Santera Systems Inc. ("Santera"), a developer of integrated voice and data switching solutions, which had become a majority owned subsidiary in June 2003. In April 2004, we acquired Taqua, Inc. ("Taqua"), a privately held provider of next generation packet switching systems. In September 2004, we acquired privately held VocalData, Inc. ("VocalData"), a provider of hosted IP telephony applications that enable the delivery of advanced telecom services and applications to business and residential customers. The former Santera, Taqua and the VocalData businesses form our SSG reporting segment.


Our Sales and Marketing Strategy


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

Distribution. We sell our products in the United States principally through our direct sales force and indirectly through strategic relationships with various third parties. Our North American direct sales force operates out of our regional offices located throughout the United States. Internationally, we sell our products through our direct sales force, sales agents, partnerships and distributor relationships. As market conditions warrant, we may increase our direct sales and marketing activities worldwide.

Strategic Relationships. We believe that our current and future strategic relationships with other leading communication solution providers will improve market penetration and acceptance for our network applications. Many of these system integrators have long-standing relationships with public telecommunications service providers and offer a broad range of services to these service providers through their existing sales and support networks. We seek strategic relationships that:

• enhance our presence and strengthen our competitive position in our target markets;
• offer products that complement our network applications to provide value-added networking products and services; and
• leverage our core technologies to enable communications equipment suppliers to develop enhanced products with market differentiation that can be integrated with Tekelec's products and services.

We believe that our strategic third-party relationships present us with additional opportunities to penetrate the communications network application market and demonstrate our strategic partners' recognition of the technical advantages of our network products. Through our relationships with, among others, Alcatel-Lucent, FiberHome, NEC Neva and NEC do Brazil we are enhancing our market presence and the ability to access leading network service providers. Although our current sales through these relationships are not significant (other than Alcatel-Lucent), a termination of one or more of our relationships, or the sale of competing products by any of these strategic partners could have a material adverse effect on our future operating results.



Our Systems and Software


We currently offer systems and software through our three business units. Our principal Network Signaling Group solutions are described below:

 

Solution

 

Description

Signaling and Session Control

Our EAGLE®5 Integrated Signaling System (ISS) provides global signaling and real time, transaction-based applications from a single platform. Substantial database size, signaling capacity and transaction speed are coupled with next generation IP connectivity, providing a transition path to the converged network.

The same platform delivers full signal transfer point, or STP, capabilities and a portfolio of integrated applications. Applications integrated with the platform provide the delivery of an array of intelligent routing and other value-added services. Service providers are able to optimize the use of network resources, deploy number portability, manage subscribers and services, migrate to new technologies, control fraud and interoperate networks with disparate technologies.

Transitional and IMS Solutions

We offer a portfolio of products to support IMS and the transition to IMS networks. By leveraging our expertise in SS7 signaling and SIP session control, we provide a signaling bridge that enables interoperability between circuit and packet switched technologies. Our systems and software thus permit our customers to approach the transition to converged networking through the signaling layer. We also offer core session control for SIP-based, IMS networks.

Our IMS solution enables service providers to gradually migrate to IMS at the signaling layer. We believe this transitional approach allows service providers to control the pace of evolution and provides a cost effective approach for migrating to IMS and for managing a hybrid SS7-SIP signaling network.

Specific IMS-transitional systems and software include:

Service Mediation

Our Service Mediation solutions are designed to enable service interaction among legacy, mobile, VoIP and IMS networks. These solutions bridge technologies and enable unified service delivery across SS7 and SIP-based networks. Transitional benefits include:

• Reduced investment in legacy technologies
• Service continuity across hybrid networks
• Leveraging of existing intelligent network applications, like number portability, to support IMS subscribers
• Offering of new SIP-based services to customers with SS7-based handsets, improving our service provider customer return on investment

TekCore Session Manager

Our open, standards-based CSCF is designed to support high performance SIP-signaling and session control in core IMS networks, enabling multimedia services. TekCore also supports SIP aggregation in VoIP networks, allowing service providers to cost effectively scale their VoIP networks, while laying the groundwork for the eventual migration to IMS.

Service Dispatch and Control

High performance "Pre-IMS" server enables certain new services such as prepaid or enhanced voice services to be deployed to all subscribers, whether served by the IMS or the legacy network.

 

Number Portability

We simplify number portability by integrating advanced database management and signaling functions on a single network platform, providing advantages over solutions that rely on external service control points. We provide a full suite of number portability solutions for fixed and mobile networks in the U.S. and international markets.

The convergence of the PSTN with IP networks requires a new type of number portability/translation with the ability to map telephone numbers to IP addresses. This new number portability/translation is known as Electronic Number Mapping, or ENUM. Next generation services such as VoIP, multimedia service, push-to-talk and instant messaging will possibly require high ENUM transaction rates. We have leveraged our experience in high capacity, low latency database applications to develop our ENUM solution.

Mobility Management

Wireless voice and data communications generate substantially more signaling traffic than fixed-line calls. Our mobile service provider customers benefit from our intelligent routing applications ability to handle network expansion in a reliable, cost effective manner. Applications such as HLR (Home Location Register) optimization, Equipment Identity Register (EIR) and voice mail redirection help service providers to manage network growth, improve network efficiency, reduce costs and meet regulatory requirements.

Messaging

Our short text messaging solutions are designed to span both traditional SS7 based TDM, or "2G" networks and SIP-based IP, or 3G networks. The access-independent solution enables the delivery of text messaging — from simple store-and-forward short message service (SMS) to more advanced networked messaging services.

TekMedia SMS is an innovative, modular solution, which enables service providers to deliver advanced networked messaging. Service providers can grow capacity and capabilities incrementally or create a complete, end-to-end SMS solution.

Our principal Communications Software Solutions Group solutions are described below:

 

Solution

 

Description

Performance Management Solutions

Our portfolio of Performance Management solutions provides real time or historical information based on network traffic. Service providers can gain insight into the performance of the network, roaming activity, service usage, and customer behavior.

Our solutions deliver network visibility to service providers, assisting them in managing and routing traffic in an efficient and cost effective manner. By monitoring network transactions, service providers can improve service delivery and more accurately bill their subscribers for content downloads. They can verify the successful delivery of content from third-party providers and pay only for successful downloads.

Applications include:

•   troubleshooting

•   network management

•   roaming management

•   services management

•   revenue leakage discovery

•   revenue recovery and generation

•   market intelligence and analytics

Our Performance Management solution collects, correlates, processes, and stores data from the network. Various applications use this data to enable network operators to ensure the performance, reliability and security of the network; to detect and track revenue leaks and potential recovery; and to provide timely market and business intelligence needed to drive business improvement. The solution supports wireline and wireless service providers across both the traditional TDM-based networks and IP-based networks. This solution can be deployed on a stand-alone basis or as an integrated feature of the EAGLE 5 ISS. Our Performance Management solution is installed in a number of service providers' networks.

Service Creation Solutions

Our Service Creation Solutions, or SCS, offer service providers an alternative to traditional, legacy service platforms. Our SCS are supplied with pre-packaged solutions permitting service providers to launch their own services thus reducing lengthy development cycles. At the same time, a creation environment is provided which allows our customers to customize their existing services as well as to create new services themselves.


Applications include:
    •   number screening
   •   routing
   •   number translation
   •   charging
   •   content and marketing

Revenue Management

Tekelec's Revenue Management portfolio is designed to help service providers gather business-critical intelligence to make informed decisions, identify sources of revenue loss and increase margins.

These solutions give service providers visibility into network traffic data that is specific to inter-carrier compensation and subscriber activities. Service providers can identify possible sources of revenue leakage and recover lost revenues caused by fraudulent abuse, poor network planning or network attacks. Valuable data provided on subscriber behavior and service preferences enables marketing professionals to create highly targeted service bundles that increase profitability and customer value.

Our principal Switching Solutions Group solutions are described below:

 

Solution

 

Description

Enhanced VoIP Solution

Our Enhanced VoIP Solution (EVS) offers service providers a fully integrated way to offer a wide set of advanced IP-based features and services to both their VoIP and traditional voice service customers. EVS can be deployed by both small and large service providers. New service providers, also known as competitive service providers, and cable television network service providers can use EVS to upgrade their networks for broadband services. EVS consists of the Tekelec 7000 and 6000 products packaged as a solution.

Hosted VoIP Solution

Our Hosted VoIP Solution (HVS) provides a wide set of feature-rich business and residential VoIP services. HVS consists of the Tekelec 6000 combined with an optional set of Tekelec media gateways - T9000, T8000, T7000, or a combination thereof. Our HVS enables VoIP service providers to start small and grow while offering voice and video services that can both replace PBXs and economically serve home users. HVS offers high quality VoIP services with reduced service provider integration efforts, thereby lowering operating expense for service providers.

Transit Network Solution

Our Transit Network Solution (TNS) brings new capabilities and cost savings to service providers which operate large and geographically distributed networks. TNS allows service providers to achieve improved network survivability through geographic diversity and distributed processing. Our Transit Network Solution consists of the Tekelec 9000 Distributed Switching System deployed with one or more T3000 Media Gateway Controllers, and multiple T8000 Media Gateways.

Fixed Mobile Convergence Solution

Our Fixed Mobile Convergence (FMC) solutions are designed to help mobile and fixed service providers gain new revenues from their current networks. Service providers can offer features that help them lower customer turnover and gain subscribers without complex network replacement. Our FMC solutions allow end users to have a single number identity with the ability to originate and answer calls from their wireless or wireline phones. Our FMC consists of a Tekelec 6000 combined with a Tekelec 9000 and a convergence gateway. This solution allows mobile and fixed service providers to gain new revenues from their current networks.

Converged Media Gateway (CMG)

Our Converged Media Gateway solution (CMG) is typically offered to large equipment vendors, such as Alcatel-Lucent, and system integrators who combine our CMG with other equipment they provide. Our CMG consists of the Tekelec 8000 family of media gateways and offers a flexible, scalable, cost effective media gateway platform that can be deployed in wireless or wireline networks.



Systems and Software Development


The communications market is characterized by rapidly changing technology, evolving industry standards and frequent new product introductions. Standards for new technologies and services such as Third Generation, or "3G" wireless services, softswitching, signaling for packet networks, internet protocol and IMS architectures are still evolving. As these standards evolve and the demand for services and applications increases, we intend to adapt and enhance our products and develop and support new products. We solicit product development input through discussions with our customers and participation in various industry organizations and standards committees, such as the Telecommunications Industry Association, the Internet Engineering Task Force, the Softswitch Consortium, the 3rd Generation Partnership Project ("3GPP"), and the IMS Forum, and by closely monitoring the activities of the International Telecommunications Union, the European Telecommunications Standards Institute, and the International Organization for Standardization and Alliance for Telecommunications Industry Solutions ("ATIS").

We continue to invest in research and development in order to expand the technological capability, functionality and breadth of our applications. From 2004 to 2006 we invested over $350 million-approximately $148.4 million, $119.2 million, and $93.7 million during 2006, 2005, and 2004, respectively, in product development.

We currently expect that a substantial portion of our development of new products and enhancements to existing and future products will be developed internally or through outsourced development contractors, with the possibility of selective acquisitions to complement and supplement our product development pipeline when deemed prudent. Our product development efforts to date have resulted in leading telecommunication network applications, and we believe that our current and future product development efforts will continue to yield leading telecommunication network applications. There are risks associated with the development of our products, which are discussed further in the section entitled "Risk Factors" in this Annual Report.


Service, Support and Warranty


We believe that customer service, support and training are important to building and maintaining strong customer relationships. We service, repair and provide technical support for our products. Our support services include:

• 24-hour technical support,
• remote access diagnostics and servicing capabilities,
• extended maintenance and support programs,
• comprehensive technical customer training,
• extensive customer documentation,
• field installation, emergency replacement and regular software maintenance releases, and
• limited upgrades and enhancements.

To our customers and certain resellers of our products, we also offer technical training with respect to the proper use, support and maintenance of our products.

We maintain in-house repair facilities and provide ongoing training and technical assistance to customers and international distributors and other resellers at our technical assistance centers in Morrisville, North Carolina; Plano, Texas; Egham, United Kingdom and Singapore. These centers also support our network signaling and switching products on a 24 hour-a-day, seven day-a-week basis. In addition, we have invested in providing in-country service and support in Brazil, France, India, and Mexico.

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

We typically warrant our products against defects in materials and workmanship for one year after delivery and installation, which period may not exceed 15 months following shipment, and thereafter offer extended service warranties.


Customers


Customers for our NSG products consist primarily of network service providers. Wireless service providers accounted for over 50% of NSG's revenues in 2006. Customers for CSSG products are generally the same as those for our NSG products, but typically are a different department (e.g., finance, marketing and sales). Customers for SSG products currently consist

primarily of rural service providers, independent operating companies, competitive access providers and large international public telephone and telegraph companies. Alcatel-Lucent is also a customer of SSG. Alcatel-Lucent resells certain SSG products on an OEM basis together with its own systems directly to service providers.

Historically, a limited number of customers have accounted for greater than 10% of our annual revenues. In 2006 and 2005, Cingular, including AT&T prior to the merger of Cingular and AT&T Wireless, represented approximately 10% and 18%, respectively, of our annual revenues. In 2005, Alcatel represented approximately 19% of our revenues. We anticipate that our operating results in any given period will continue to depend, to a significant extent, upon revenues from a small percentage of our customers.


Backlog


Backlog for our products typically consists of contracts or purchase orders for both product deliveries scheduled within the next 12 months and extended service warranty to be provided generally over periods of up to three years. Our backlog at any particular date may not be a meaningful or accurate indicator of future financial results primarily because (i) we account for our customer contracts under the residual method prescribed by Statement of Position 97-2, "Software Revenue Recognition" ("SOP 97-2") and (ii) the size and duration of orders and customer delivery and installation requirements vary and may be cancelled or rescheduled by the customer.

At December 31, 2006, our total backlog amounted to approximately $455.3 million, compared to total backlog of approximately $520.2 million at December 31, 2005. We regularly review our backlog to ensure that our customers continue to honor their purchase commitments and have the financial means to purchase and deploy our products and services in accordance with the terms of their purchase contracts.


Competition

Network Signaling Group. The market for our network signaling products is competitive and has been highly concentrated among a limited number of suppliers. We presently compete in the network signaling market primarily with Siemens, Cisco Systems and Huawei. We expect that competition will increase in the future from both existing and new competitors.

We believe that the principal competitive factors in the high performance, mission critical network signaling systems and software market are system performance, scalability and functionality, system quality and reliability, customer service and support, price and the supplier's financial resources and marketing and distribution capability. We anticipate that responsiveness in adding new features and functionality will become an increasingly important competitive factor. New entrants or established competitors may offer systems that are superior to our systems in performance, quality, service and support and/or are priced lower than our systems.

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


Communications Software Solutions Group. The market for monitoring and revenue management software solutions is very competitive. Our major competitors include Tektronix, Agilent and Anritsu, as well as a number of smaller competitors existing in different geographic markets. We believe the market will remain very competitive with a number of smaller competitors continuing to enter this market.

We believe the integration of CSSG's products with NSG's products, including the EAGLE 5 ISS, provides a key competitive advantage. The added simplicity and reliability of our integrated approach provides a direct benefit to our customers. We also offer a non-integrated, probe-based solution where needed to allow our customers to derive additional value from our applications. Our applications offer an array of configuration tools and a Web-based user interface for ease of use. Our applications have the added benefit of supporting both existing protocols and newer protocols such as SIP, GPRS, and UMTS from a common architecture. We provide critical network capabilities, such as the ability to continuously trace a call end-to-end as it traverses both traditional circuit and newer packet network domains. Our real time capabilities allow an operator to discover and correct network and related business issues quickly.


Switching Solutions Group. The market for our switching solutions is extremely competitive and is highly fragmented. We presently compete in the next-generation switching market with numerous public and private companies. The public companies include, among others, Nortel, Cisco, Alcatel-Lucent, Sonus Networks and

Siemens. The private companies include, among others, Veraz Networks, MetaSwitch, BroadSoft and CopperCom. We expect competition to remain intense, particularly as this market matures and until the number of competitors is reduced or rationalized.

We believe that the principal competitive factors in the next-generation switching market are product performance, scalability, functionality, quality and reliability, customer service and support, price and the supplier's financial resources and marketing and distribution capabilities. We believe that our ability to compete successfully in the next-generation switching market will, in part, depend on our ability to secure large and leading wireline or wireless service providers as reference accounts for our next-generation switching products. Because a number of our competitors have existing relationships with these large and leading service providers as their legacy switching providers, it may be difficult for us to displace these incumbent suppliers with our next-generation products.


Intellectual Property


Our success depends, to a significant degree, on our proprietary technology and other intellectual property. We rely on a combination of patents, copyrights, trademarks, trade secrets, non-disclosure policies, confidentiality agreements and contractual restrictions to establish and protect our proprietary rights both in the United States and abroad. In 2006, we filed a significant number of new patent applications. Inventions by members of our research and engineering staff have been, and continue to be, important to our growth and success. Patents have been granted to us on many of these inventions in the United States and other countries. Our patent portfolio has been developed over time and, accordingly, the remaining terms of our patents vary. Some of the earlier issued patents have now expired or are approaching expiration. Between 2007 and 2010, less than 1% of our patents will expire. However, we intend to continue to seek and obtain patents protecting our newer innovations. Each business segment possesses its own patent portfolio that provides certain competitive advantages in protecting our innovations. Although we believe that our patents will become increasingly important in maintaining and improving our competitive position, no single patent is essential to our business as a whole, and no one patent is considered material to any of our business segments.

The measures discussed above afford only limited protection and may not prevent third parties from misappropriating our technology or other intellectual property. In addition, the laws of certain foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States and the possibility of misappropriation of our technology and other intellectual property is more likely in these countries. If we fail to successfully enforce or defend our intellectual property rights, or if we fail to detect misappropriation of our proprietary rights, our ability to effectively compete could be seriously impaired.

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

We also license software and other intellectual property from third parties. Based on experience, we believe that such licenses can generally be obtained or renewed on commercially acceptable terms. Nonetheless, there can be no assurances that such licenses can be obtained or renewed on acceptable terms, or at all. Our inability to obtain or renew certain licenses or to obtain or renew such licenses on favorable terms could have a material adverse effect on our business, operating results and financial condition. The communications industry is characterized by the existence of rapidly changing technology, an increasingly large number of patents and frequent claims and litigation based on allegations of patent infringement. From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights to technologies that are important to us. There can be no assurance that our patent rights will not be challenged, invalidated or circumvented. From time to time, we receive notices from, or are sued by, third parties regarding patent claims. Any claims made against us regarding patents or other intellectual property rights could be expensive and time consuming to resolve or defend, would divert the attention of our management and key personnel from our business operations and may require us to modify or cease marketing our products, develop new technologies or products, acquire licenses to proprietary rights that are the subject of the infringement claim or refund to our customers all or a portion of the amounts paid for infringing products. If such claims are asserted, there can be no assurances that the dispute could be resolved without litigation or that we would prevail or be able to acquire any necessary licenses on acceptable terms, or at all. In addition, we may be requested to defend and indemnify certain of our customers, resellers and partners against claims that our products infringe the proprietary rights of others. We may also be subject to potentially significant damages or injunctions against the sale of certain products or use of certain technologies. See "Legal Proceedings" in Part I, Item 3, of this Annual Report.



Environmental Matters


Our operations are subject to a wide range of environmental laws in various jurisdictions around the world. We seek to operate our business in compliance with such laws. Tekelec is and will continue to be subject to various product content laws and product takeback and recycling requirements that will require full compliance in the coming years. We expect that these laws will require us to incur additional compliance costs. Although costs relating to environmental matters have not resulted in a material adverse effect on our business, results of operations, financial condition and liquidity in the past, there can be no assurance that we will not incur increased environmental costs in the future, which may have a material adverse effect on our business, results of operations, financial condition and liquidity.


Working Capital


For a discussion of our working capital practices, see section entitled "Application of Critical Accounting Policies and Use of Estimates" in Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Annual Report.


Employees


At December 31, 2006, we employed 1,409 regular full time employees. The classification of our employees by business segment and corporate function as of that date is as follows:


Network Signaling Group

Communications Software Solutions Group

Switching Solutions Group

Sales, Marketing and Customer Support

Operations

Management, Administration and Finance

Total

1,409

We also employ individuals on a regular part-time basis and on a temporary full-time basis, as well as utilize the services of contractors as required. Many of our employees hold stock options, restricted stock units and/or stock appreciation rights under our equity compensation plans. None of our employees are represented by a labor union, except for certain employees in France, and we have not experienced any work stoppages.

We believe that our relations with our employees are good. Employee morale, job satisfaction and career development continue to be important areas of our focus. We believe that it is increasingly important to our future success to recruit and retain skilled employees. For more information on this subject, see the "Risk Factors" section of this Annual Report under the heading "Failure to recruit and retain key personnel could harm our ability to meet key objectives and adversely affect our business and the price of our common stock."


Available Information


We intend to make this Annual Report, as well as our quarterly reports on Form 10-Q, our current reports on Form 8-K and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act, publicly available on our website (www.tekelec.com) without charge as soon as reasonably practicable following our filing of such reports with the Securities and Exchange Commission ("SEC"). Our SEC reports can be accessed through the investor relations section of our website. The information found on our website is not part of this or any other report we file with or furnish to the SEC. We assume no obligation to update or revise any forward looking statements in this Annual Report or in other reports filed with the SEC, whether as a result of new information, future events or otherwise, unless we are required to do so by law. A copy of this Annual Report and our other reports is available without charge upon written request to James Chiafery, Director, Investor Relations, Tekelec, 5200 Paramount Parkway, Morrisville, North Carolina 27560.

Further, a copy of this Annual Report is obtainable from the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and our other filings at www.sec.gov.


Item 1A. Risk Factors .


As indicated above in this Annual Report under "Forward-Looking Statements," the statements that are not historical facts contained in this Annual Report are forward-looking statements within the meaning of the Private Securities Litigation Reform

Act of 1995. These statements reflect the current belief, expectations, estimates, forecast or intent of our management and are subject to and involve certain risks and uncertainties. Many of these risks and uncertainties are outside of our control and are difficult for us to forecast or mitigate. In addition to the risks described elsewhere in this Annual Report and in certain of our other filings with the SEC, the following risks and uncertainties, among others, could cause our actual results to differ materially from those contemplated by us or by any forward-looking statement contained herein. Prospective and existing investors are strongly urged to carefully consider the various cautionary statements and risks set forth in this Annual Report and our other public filings.


Our operating results have historically fluctuated and are expected to fluctuate in future periods, which may adversely affect the market price of our common stock.


Our quarterly and annual operating results are difficult to predict and may fluctuate significantly. We have failed to achieve our revenue and net income expectations for certain prior periods, and it is possible that we will fail to meet these expectations in the future.

Our product revenues in any quarter depend in part on orders booked and shipped in that quarter. A significant portion of our product shipments in each quarter occurs at or near the end of the quarter. Since individual orders can represent a meaningful percentage of our revenues and net income in any quarter, the deferral, cancellation of or failure to ship an entire order in a quarter can result in a revenue and net income shortfall that causes us to fail to meet securities analysts' expectations or our business plan for that period. We base our current and future expense levels on our internal operating plans and revenue forecasts, and our operating costs in the short term are fixed to a large extent. As a result, we may not be able to sufficiently reduce our costs in any quarter to adequately compensate for an unexpected near-term shortfall in revenues, and even a small shortfall could disproportionately and adversely affect our operating results for that quarter. In addition, a number of other factors, many of which are outside our control, can cause fluctuations in our quarterly and annual operating results, including among others:

• fluctuations in demand for our products and services, especially by service providers, in part due to a changing global economic environment;
• price and product competition in the telecommunications industry which can change rapidly due to technological innovation;
• the success or failure of our strategic alliances, acquisitions, or disposals of or exits from certain businesses;
• the ability to enforce our intellectual property rights and to defend claims that our offerings may infringe another company's intellectual property;
• the introduction and market acceptance of our and our competitors' new products, services and technologies;
• the timing of the purchase and deployment by our customers of new technologies and services, including VoIP, SIGTRAN and SIP;
• changes in general economic conditions and specific market conditions in the telecommunications industry;
• the ability of telecommunications service providers to utilize excess capacity of signaling infrastructure and related products in their networks;
• the progress and timing of the convergence of voice and data networks and other convergence-related risks described below;
• the trend toward industry consolidation among our customers and our competitors which may result in reduced demand and pricing pressure on our products;
• the size, timing, terms and conditions of customer orders and shipments;
• sudden or unanticipated shortages of components provided by our vendors;
• the lengthy sales cycle of our products, especially with respect to our international customers, and the reduced visibility into our customers' spending plans for those products and associated revenue;
• the capital and operating spending patterns of our customers, including deferrals or cancellations of purchases by customers;
• the ability of our customers to obtain financing or to otherwise fund capital expenditures;
• our ability to achieve targeted cost and expense reductions;
• our dependence on wireless telecommunications service providers for a significant percentage of our revenues;
• unanticipated delays or problems in developing or releasing new products or services;
• variations in sales channels, product costs, or mix of products sold;

• the geographic mix of our revenues and the associated impact on our gross margins;
• the mix of our product sales across product lines (i.e., between our higher margin signaling products and lower margin switching products), which can have significant impact on our gross margins;
• the expense and other potential negative impact of current and future litigation;
• actual events, circumstances, outcomes, and amounts differing from judgments, assumptions, and estimates used in determining the values of certain assets, including the amounts of related valuation allowances, liabilities, and other items reflected in our Consolidated Financial Statements;
• changes in accounting rules, such as recently adopted rules regarding stock-based compensation, which require the expensing of employee equity-based awards, as well as recent income tax accounting pronouncements;
• our judgments regarding the recognition and deferral of revenues in accordance with GAAP, including as to whether an arrangement includes multiple elements and if so, whether vendor specific objective evidence of fair value exists for those elements, which judgments impact the amount and timing of product and service revenue recognized;
• our ability to fund and sustain our research and development activities and their impact on the development of new products;
• the expansion of our sales, marketing and support operations, both domestically and internationally;
• changes in our pricing policies and those of our competitors;
• our ability to successfully comply with increased and complex regulations affecting our business;
• further restructuring costs;
• failure of certain customers to successfully and timely reorganize their operations, including emerging from bankruptcy;
• worldwide economic or political instability; and
• foreign currency exchange rate fluctuations.

The factors described above are difficult to forecast and mitigate and could have a material adverse effect on our business, operating results and financial condition. We may experience a shortfall in revenues or an increase in operating expenses in the future, which would adversely affect our operating results. As a consequence, operating results for a particular period are difficult to predict, and, therefore, prior results are not necessarily indicative of results to be expected in future periods. Any of the foregoing factors, or any other factors discussed elsewhere herein, could have a material adverse effect on our business, results of operations, and financial condition that could adversely affect our stock price.


Our operating results may be adversely affected by unfavorable economic and market conditions and the uncertain geopolitical environment.


Economic conditions worldwide have contributed to slowdowns in the telecommunications industry and may impact our business resulting in:

• reduced demand for our products and services as a result of continued constraints on capital expenditures by our customers;
• increased price competition for our products;
• risk of excess and obsolete inventories; and
• higher overhead costs as a percentage of our revenues.

Recent turmoil in the geopolitical environment in many parts of the world, including terrorist activities and military actions, particularly the continuing tension in and around Iraq and the plans to nationalize privately owned telecommunications, oil and utility companies in Venezuela, as well as changes in energy, natural resources and precious metal costs, may continue to adversely affect global economic conditions. If the economic and market conditions in the United States or internationally deteriorate, we may experience material adverse impacts on our business, operating results, and financial condition.


We expect our gross margins to vary over time and our recent level of gross margins may not be sustainable, which may have a material adverse effect on our future profitability.


Our recent level of gross margins may not be sustainable and may continue to be adversely affected by numerous factors, including:

• increased price competition, including competitors from Asia, especially China;
• increased industry consolidation among our customers, which may lead to decreased demand for and downward pricing pressure on our products;

• changes in customer, geographic, or product mix, including mix of configurations within each product group;
• an increase in sales of our SSG products (which typically carry lower margins than sales of our NSG products) as a percentage of total revenues;
• our ability to reduce and control production costs;
• increases in material or labor costs;
• excess inventory and inventory holding costs;
• obsolescence charges;
• changes in shipment volume;
• reductions in cost savings due to changes in component pricing or charges incurred due to inventory holding periods if parts ordering does not correctly anticipate product demand;
• changes in distribution channels;
• losses on customer contracts; and
• increased warranty costs.

Our Switching Solutions Group business unit has a history of operating losses and we may continue to incur losses and not achieve profitability in this business unit in the future, which may negatively affect our operating results, financial condition and the price of our common stock.


In 2006, we continued to experience significant operating losses in SSG. A comprehensive evaluation in 2006 of SSG's operations showed that both revenues and orders for fiscal year 2007 were expected to fall short of our previous projections, and resulted in material impairment charges in 2006 related to write-downs of acquired technology and of goodwill. As a result of this assessment, we expanded the scope of the restructuring of SSG's operations initiated earlier in 2006 to reduce the cost structure of the SSG business and to better align the cost structure with the business opportunities. There can be no assurance, however, that we will realize all of the anticipated benefits of our restructuring activities. Please refer to the "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Notes to Consolidated Financial Statements" sections of this Annual Report for a more detailed discussion of this matter.

We may continue to incur losses in SSG, which may have a material adverse effect on our operating results, our financial condition and the market value of our common stock.


The markets in which we compete are intensely competitive, which could adversely affect our revenue and net income growth.


For information regarding our competition and the risks arising out of the competitive environment in which we operate, see the section entitled "Competition" contained in Item 1 of Part 1 of this Annual Report. Please also see the risk factor below entitled "If our products do not satisfy customer demand for performance or price, our customers could purchase products from our competitors."


Telecommunications industry consolidation may lead to increased competition and fewer customers and may harm our operating results.


There has been a trend toward industry consolidation in our markets for several years. We expect this trend to continue as companies attempt to strengthen or hold their market positions in an evolving industry, and as companies are acquired or are unable to continue or expand operations. We believe that industry consolidation may result in stronger competitors and fewer customers. Consolidation among our customers may cause delays or reductions in capital expenditure plans and/or increased competitive pricing pressures as the number of available customers declines and their relative purchasing power increases. Also, consolidation among our customers may increase their leverage in contract negotiations which may require us to agree to terms that are less favorable to our company than the terms of our prior agreements. This could have a material adverse effect on our gross margins, operating results, and financial condition.


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


We derive a substantial portion of our revenues from sales of NSG products. In each of 2006, 2005, and 2004, our NSG products and services generated over 50% of our revenues, and we expect that these products and services will continue to account for a majority of our revenues for the foreseeable future. As a result, factors adversely affecting the pricing of or demand for these products, such as competition, technological change or a slower than anticipated rate of development or deployment of new products, features and technologies, could cause a significant decrease in our revenues and profitability. Continued and widespread market acceptance of these products is therefore critical to our future success. Moreover, our future financial performance will depend in significant part on the successful and timely development, introduction and customer

acceptance of new and enhanced versions of our EAGLE 5 ISS product line as well as our other products. Introducing new and enhanced products such as these requires a significant commitment to research and development that may entail substantial risk and may not result in success. There are no assurances that we will be successful in developing and marketing additional products and related services.


If wireless service providers do not continue to grow and to buy our NSG products and services, our network signaling related business would be harmed.


The success of our NSG business unit will depend in large part on the continued growth of wireless network operators and their purchases of our products and services. We derive a substantial portion of our revenues from the sale of our NSG products and services to wireless network operators. In each of 2006, 2005, and 2004, our sales to the wireless market accounted for more than 50% of NSG revenues. We expect that our sales of NSG products and services to wireless service providers will continue to account for a majority of NSG revenues for the foreseeable future. The continued growth of the domestic and international wireless markets is subject to a number of risks that could adversely affect our revenues and profitability, including:

• a downturn in the domestic or global economy;
• a slowdown in capital spending by wireless network operators;
• adverse changes in the debt and equity markets and in the ability of wireless service providers to obtain financing on favorable terms;
• delays in or scaling back of plans for the deployment by wireless network operators of new wireless broadband technologies and applications; 
• slowing growth of wireless network subscribers, minutes of use or adoption of new services; and
• increased competition.

Consequently, there can be no assurances that wireless service providers will continue to purchase our Network Signaling products or services for the build-out or expansion of their networks. A decrease in such purchases could have a material adverse impact on our revenues and net income.


If the convergence of voice and data networks does not fully occur, or takes longer than anticipated, sales of our products and our profitability may decrease.


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

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

• the failure to solve or difficulty in solving certain technical obstacles to the transmission of voice communications over a packet network;
• delays in the formulation of standards for the transmission of voice communications over a packet network; and
• the imposition of access fees on packet network operators, which are not currently charged.

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

We cannot accurately predict when these technical problems will be solved, when uniform standards will be agreed upon or when market acceptance of such products and services will occur. Convergence may, however, take much longer than we expect or, as noted above, not fully occur at all. Moreover, uncertainty regarding the technology or standards (e.g. the IP Multimedia Subsystem architecture, or IMS) to be employed in converged networks may cause service providers to abandon or

delay their purchasing plans.

Finally, the imposition of access fees on packet networks might slow the convergence of circuit and packet networks. In the future, access fees may be imposed on service providers using packet networks to transmit voice calls. These access fees might also be imposed on the termination of "pure" data messages by operators of packet networks. The imposition of these access fees would reduce the economic advantages of using packet networks for voice and other transmissions, which may slow the convergence of circuit and packet networks.


We may not realize the anticipated benefits of past or future acquisitions, which could materially and adversely affect our operations, financial position and market value of our common stock, and the integration of acquisitions may disrupt our business and management.


Our growth is dependent on a number of factors, including market growth, our ability to enhance existing products, our ability to introduce new products on a timely basis and market acceptance of our existing and new products. Our strategy includes acquiring new products and technologies through acquisitions, strategic alliances and joint ventures, and may also include divesting all or a portion of our interests in some business units.

We have in the past and may in the future grow through the acquisition of companies, products or technologies. During the last four years, we have engaged in a number of acquisitions, including our acquisitions of Santera, Taqua, Steleus, VocalData and iptelorg. Acquisitions are inherently risky, and no assurance can be given that our previous or future acquisitions will be successful or will not materially and adversely affect our business, operating results or financial condition. We may not realize the expected benefits of an acquisition. In addition, acquisitions may also lead to potential write-downs, restructuring, or other one-time charges due to unforeseen business developments and other factors, and these charges may adversely affect our operating results, financial condition and the market value of our common stock.

For example, at the time of our acquisition of Taqua, we, along with several of our competitors, expected the market for small switch service providers to grow rapidly in the coming years. We acquired Taqua in 2004 in order to expand our next-generation switching product line to address this market. This market to date has failed to meet the growth projections estimated by us and, as a result, this product line has consistently underperformed against our expectations. As a result of a significant shortfall in orders for these products compared with our expectations, in the fourth quarter of 2005, we reassessed our forecast of Taqua's future revenues and cash flows and concluded that an impairment existed. Therefore, we wrote off approximately $49.9 million of impaired purchased technology and goodwill that was originally recorded in connection with our acquisition of Taqua in 2004.

In addition, during the third quarter of 2006, it became apparent that future revenues, cash flows and expected orders related to the other SSG reporting unit, consisting of our Santera and VocalData product lines, would underperform our previous expectations. As a result, we lowered our forecasts of this reporting unit's revenues and cash flows and concluded that an impairment existed. Therefore, we wrote off a total of approximately $100.6 million of impaired purchased technology and goodwill that was originally recorded in connection with our initial investment in Santera in 2003, our acquisition of the remaining minority interest in Santera in 2005, and our acquisition of VocalData in 2004.

If we make any further acquisitions, we may issue stock that would dilute our existing shareholders' percentage ownership or our earnings per share, incur substantial debt or assume contingent or unknown liabilities. We have only limited experience in acquiring and integrating other businesses and technologies. Acquisitions involve numerous risks, including the following:

• the industry may develop in a different direction than we anticipated, and the technologies we acquire may not prove to be those we need or the business model of acquired companies may become obsolete;
• the future valuations of acquired businesses may decrease from the market price we paid for these acquisitions;
• problems or delays in integrating or assimilating the acquired operations, technologies or products;
• difficulty in maintaining controls, procedures and policies during the transition and integration;
• unanticipated costs associated with the acquisition;
• disruption of our ongoing business and distraction of our management and employees due to integration issues;
• inability to retain key customers, distributors, vendors and other business partners of the acquired business;
• inability to achieve the financial and strategic goals for the acquired and combined businesses;
• acquisition-related costs or amortization costs for acquired intangible assets that could impact our operating results;
• our relationships with existing customers, partners or third-party providers of technology or products could be impaired;
• the due diligence processes may fail to identify significant issues with product quality, architecture and development, or legal and financial contingencies, among other things;
• we may incur significant exit or restructuring charges if the products acquired in business combinations do not meet our sales expectations or are unsuccessful;

• risks associated with entering new markets in which we have no or limited prior experience; and
• potential loss of the acquired organization's or our own key employees.

Ultimately, if we do not successfully complete the integration of acquired businesses in a timely manner, or at all, we may not realize the anticipated benefits of the acquisitions to the extent anticipated, which could adversely affect our business, financial condition or results of operations. We cannot assure that we will be successful in overcoming problems in connection with our past or future acquisitions, and our inability to do so could significantly harm our assets acquired in such acquisitions, revenues and results of operations. In addition, if we attempt to divest some of our business units, we may not successfully complete this activity or we may not realize the benefits of any divesting activities which could adversely affect our business, financial condition and results of operations.


We may undertake further restructurings which may adversely impact our operations, and we may not realize all of the anticipated benefits of our prior or any future restructurings.


We continue to restructure and transform our business to realign resources and achieve desired cost savings in an increasingly competitive market. During 2004, 2005, and 2006, we undertook a series of restructurings of our operations involving, among other things, the reduction of our workforce, the relocation of our corporate headquarters, and the consolidation of certain of our manufacturing facilities (the "Restructurings"), as described more fully in Note 4 to the accompanying Consolidated Financial Statements. As part of the Restructurings, we ceased to use certain of our leased facilities. If we consolidate additional facilities in the future, we may incur additional restructuring and related expenses, which could have a material adverse effect on our business, financial condition or results of operations.

We have based our restructuring efforts on certain assumptions regarding the cost structure of our businesses and our assumptions may or may not be correct and we may also determine that further restructuring will be needed in the future. We therefore cannot assure you that we will realize all of the anticipated benefits of the Restructurings or that we will not further reduce or otherwise adjust our workforce or exit, or dispose of, certain businesses. Any decision by management to further limit investment or to exit, or dispose of, businesses may result in the recording of additional restructuring charges. As a result, the costs actually incurred in connection with the restructuring efforts may be higher than originally planned and may not lead to the anticipated cost savings and/or improved results.

In addition, employees, whether or not directly affected by restructurings, may seek future employment with our business partners, customers or competitors. We cannot assure you that the confidential nature of our proprietary information will not be compromised by any such employees who terminate their employment with us. Further, we believe that our future success will depend in large part upon our ability to attract, incent and retain highly skilled personnel. We may have difficulty attracting and retaining such personnel as a result of a perceived risk of future workforce reductions.


If we do not successfully manage the size of our operations, our profitability may be negatively impacted, and we may incur future restructuring charges which may adversely impact our operations.


If we fail to manage the size of our operations effectively, our business, financial condition and operating results could be materially and adversely affected. From 2003 to 2005, our business grew rapidly as a result of strategic acquisitions and other factors. This growth in our business placed a significant strain on our management systems and resources. In connection with integrating these acquisitions into our operations, we identified certain cost synergies, primarily facility consolidations and headcount reductions, in order to positively affect future operating income. As a result of these decisions, management completed a series of Restructurings, as described more fully in Note 4 "Restructuring and Other Costs" to the accompanying Consolidated Financial Statements. Restructurings have particular risks, many of which are discussed above under the risk factor entitled "We may incur future restructuring charges, which may adversely impact our operations." In addition, as our operations continue to grow, we may need to implement new systems or upgrade current systems. The failure to successfully implement such new or improved systems could materially and adversely affect our business, financial condition and operating results.

The majority of our operating expenses are personnel-related costs such as employee compensation and benefits, along with the cost of the infrastructure (facility space and equipment) to support our operations and employee base. The failure to adjust our employee base to the appropriate level to support our revenues could materially and adversely affect our business, operating results and financial condition. In addition, expanding the distribution of our products may place new and increased demands on our direct sales force, professional services staff, and technical and sales support staff. Although we currently believe that we invest sufficient resources in our direct sales force, professional services staff, and our technical and sales support staff, there are only a limited number of qualified personnel in these areas. Our ability to achieve expanded distribution and revenue growth in the future will depend, in part, on our success in recruiting and training sufficient direct sales, professional services, and technical and sales support personnel. If we are not able to expand our direct sales force,

professional services staff, and technical and sales support staff as may be necessary to support our operations, our business and operations could be harmed.


Commencing in 2006, we recognized expense for stock-based compensation, and there is no assurance that the expense measures accurately the value of the stock-based compensation awards, and, as a result, the recognition of this expense could adversely affect our earnings and the price of our common stock.


Effective January 1, 2006, we adopted the provisions of, and account for stock-based compensation in accordance with, Statement of Financial Accounting Standards No. 123 - revised 2004 "Share-Based Payment" ("SFAS 123R"). As a result, our operating results for periods subsequent to December 31, 2005 contain charges for stock-based compensation expense related to employee equity-based incentives and employee stock purchases under our equity incentive plans.

The application of SFAS 123R requires the use of an option-pricing model to determine the fair value of stock-based compensation awards. The fair value calculation is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables, including, but not limited to, expected stock price volatility over the term of the awards and projected employee stock option exercise behaviors. Stock option valuation models were developed to assist with estimating the fair value of traded options that have no vesting or transfer restrictions. Because our employee stock options have certain characteristics that are different from traded options, and because changes in the assumptions used can materially affect the estimated value of the awards, the existing valuation models may not provide an accurate measure of the fair value of our stock-based compensation. Although the fair value of our stock-based compensation expense was determined in accordance with SFAS 123R, it may not represent an accurate measure of the fair value of the awards granted for the purposes of determining our net income and results of operations.

Prior to the adoption of SFAS 123R, we accounted for our stock-based compensation using the intrinsic value method prescribed by APB No. 25 " Accounting for Stock Issued to Employees" and related Interpretations and provided the pro forma disclosures required by SFAS 123. Applying the intrinsic value method generally resulted in no compensation expense being recognized related to our employee stock option grants in periods prior to our adoption of SFAS 123R. The adoption of SFAS 123R has had a material impact on our consolidated financial position and results of operations and will continue to have a material impact in future periods as a result of our continuing recognition of expense for stock-based compensation. We cannot predict the effect that this impact on our earnings will have on the price of our common stock, but such impact could be adverse.


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


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

• product performance and functionality;
• product quality and reliability;
• customer service and support; and
• price.

Many of our competitors have substantially broader product portfolios and greater financial and technological resources, product development, marketing, distribution and support capabilities, name recognition, established relationships with telecommunications service providers, and other resources than we have. In addition, new competitors may enter our markets as a result of shifts in technology, and these competitors may include entrants from the telecommunications, computer software, computer services, data networking and semiconductor industries. The industries in which we operate are also undergoing consolidation which may result in stronger competitors and a change in our relative market position.

We anticipate that competition will continue to intensify with the ongoing convergence of voice and data networks. We may not be able to compete effectively against existing or future competitors or to maintain or capture meaningful market share, and our business could be harmed if our competitors' products and services provide higher performance, offer additional features and functionality or are more reliable or less expensive than our products. Increased competition could force us to

lower our prices or take other actions to differentiate our products, which could adversely affect our operating results.


Less than 10% of our customers account for a majority of our revenues, and the loss of one or more of these customers and our failure to attract additional customers could adversely affect our operating results.


In 2006, 12 of our customers accounted for over 50% of our revenues. We anticipate that our operating results in any given period will continue to depend to a significant extent upon revenues from a small number of customers. In 2006 and 2005, Cingular, including AT&T prior to the merger of Cingular and AT&T Wireless, represented approximately 10% and 18%, respectively, of our annual revenues. In 2005, Alcatel represented approximately 19% of our revenues. Reductions, delays or cancellations of orders from one or more of our significant customers or the loss of one or more of our significant customers in any period could have a material adverse effect on our operating results. In addition, the telecommunications industry has recently experienced a consolidation of both U.S. and non-U.S. companies. This consolidation leads to fewer customers which means that the loss of a major customer could have a material impact on results not anticipated in a customer marketplace composed of more numerous participants. In order to increase our revenues, we will need to attract additional significant customers on an ongoing basis. Our failure to attract a sufficient number of such customers during a particular period, or our inability to replace a significant customer lost in a consolidation or merger, could adversely affect our revenues, profitability and cash flow.


Our large customers have substantial negotiating leverage, which may require that we agree to terms and conditions that may have an adverse effect on our business.


Large telecommunications providers have substantial purchasing power and leverage in negotiating contractual arrangements with us. These customers may require us to develop additional features and may impose penalties on us for failure to deliver such features on a timely basis, or failure to meet performance standards. As we seek to sell more products to large service providers, we may be required to agree to such terms and conditions, which may affect the timing of revenue recognition and amount of deferred revenues and may adversely affect our profitability and financial condition in the applicable periods affected.


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


If we fail to develop or introduce on a timely basis new products or product enhancements or features that achieve market acceptance, our business will suffer. Rapidly changing technology, frequent new product introductions and enhancements, short product life cycles, changes in customer requirements and evolving industry standards characterize the markets for our products. Our success will depend to a significant extent upon our ability to accurately anticipate the evolution of new products, technologies and market trends and to enhance our existing products. It will also depend on our ability to timely develop and introduce innovative new products and enhancements that gain market acceptance. Finally, sales of our products depend in part on the continuing development and deployment of emerging technology and network architecture standards (including IMS) and our ability to offer new products and services that comply with these standards. We may not be successful in forecasting future customer requirements or in selecting, developing, manufacturing and marketing new products or enhancing our existing products on a timely or cost-effective basis. Moreover, we may encounter technical problems in connection with our product development that could result in the delayed introduction of or inability to introduce new products or product enhancements and the cancellation of customer orders or delays in fulfilling customer orders. Such cancellations or delays could result in the imposition of penalties or other liabilities on us, a decrease in sales and/or a loss of customers. Our products may also experience technical difficulties when deployed by our customers in their networks which may subject us to penalties and damages. We may also focus on technologies that do not function as expected or are not widely adopted. In addition, products or technologies developed by others may render our products noncompetitive or obsolete and result in a significant reduction in orders from our customers and the loss of existing and prospective customers.


We outsource substantial portions of our research and development activities to a third party vendor, and a loss of or deterioration in this relationship could adversely affect our revenues and profitability.


Significant portions of our research and development work are carried out by one third party vendor operating in India. The loss of or deterioration in the relationship with this vendor for any reason could result in a delay or failure to complete research and development projects, which could adversely affect our ability to introduce new products or product enhancements and negatively affect our revenues and profitability.


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


We may be exposed to warranty, breach of contract, product liability, fraud and other claims if our products fail to perform as expected or if the use of our products results in property damage or bodily injury. Our highly complex products may contain

undetected defects or errors when first introduced or as new versions are released, and those defects or errors may not be detected until deployment or long after a product has been deployed. Such defects or errors, particularly those that result in service interruptions or a failure of telecommunications networks, could harm our customer relationships, business and reputation, and/or result in material warranty or product liability losses. There can be no assurances that our products will not have defects or errors. A warranty or product liability claim brought against us could result in costly, protracted, highly disruptive and time consuming litigation, which would harm our business. In addition, we may be subject to claims arising from our failure to properly service or maintain our products or to adequately remedy defects in our products once such defects have been detected. Although our agreements with our customers typically contain provisions designed to limit our exposure to potential warranty and product liability claims, it is possible that these limitations may not be effective under the laws of some jurisdictions, particularly since we have significant international sales. Although we maintain product liability insurance and a warranty reserve, they may not be sufficient to cover all claims to which we may be subject. The successful assertion against us of one or more large uninsured claims would harm our business reputation, our profitability and our financial condition.


Our relationships with strategic partners and distributors and other resellers are important to our future growth, and any inability to sustain these relationships or business failures by such third parties could harm our business.


We believe that our ability to compete successfully depends in part on distribution and marketing relationships with leading telecommunications equipment suppliers. If we cannot successfully enter into these types of relationships on terms favorable to us or maintain these relationships, our business may suffer.

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


Our business is subject to changing regulation of corporate governance and public disclosure that has resulted in increased costs and may continue to result in additional costs in the future.


We are subject to rules and regulations of federal and state regulatory authorities, The Nasdaq Stock Market and financial market entities charged with the protection of investors and the oversight of companies whose securities are publicly traded. During the past few years, these entities, including the Public Company Accounting Oversight Board, the SEC and Nasdaq, have issued new requirements and regulations and continue to develop additional regulations and requirements partly in response to laws enacted by Congress, most notably the Sarbanes-Oxley Act of 2002 ("SOX"). Our efforts to comply with these requirements and regulations have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of substantial management time and attention from revenue-generating activities to compliance activities.

In particular, our efforts to comply with Section 404 of SOX and the related regulations regarding our required assessment of our internal control over financial reporting and our external auditors' audit of our assessment and the internal control over financial reporting, has required, and continues to require, the commitment of significant financial and managerial resources. Moreover, because these laws, regulations and standards are subject to varying interpretations, their application in practice may evolve over time as new guidance becomes available. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to our disclosure and governance practices.


Uncertainties associated with and implications of the changing regulatory landscape in the telecommunications industry may adversely affect our business, operating results and financial condition. Our compliance with telecommunications regulations and standards, as well as ensuring the interoperability of our products with our customers' networks, may be time consuming, difficult and costly, and if we fail to comply, our product sales would decrease.


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

Government regulatory policies are likely to continue to have a major impact on the pricing of existing as well as new public network services and, therefore, are expected to affect demand for such services and the communications products,

including our products, which support such services. Tariff rates, the rates charged by service providers to their customers, whether determined autonomously by service providers or in response to regulatory directives, may affect cost effectiveness of deploying public network services. Tariff policies are under continuous review and are subject to change. Future changes in tariffs by regulatory agencies or application of tariff requirements to additional services could adversely affect the sales of our products for certain classes of customers.

There may be future changes in U.S. telecommunications regulations that could slow the expansion of the service providers' network infrastructures and materially adversely affect our business, operating results, and financial condition. User uncertainty regarding future policies may also affect demand for communications products, including our products. In addition, the convergence of circuit and packet networks could be subject to governmental regulation. Regulatory initiatives in this area could adversely affect our business.

In addition, in order to penetrate new target markets, it is important that we ensure the interoperability of our products with the operations, administration, maintenance and provisioning systems used by our customers. Our failure or delay in achieving such interoperability could adversely affect our ability to sell products to some segments of the communications market.


We have significant international sales, and international markets have inherent risks, which could adversely affect our business.


Doing business overseas is generally more costly than doing business in the United States. International opportunities may require significant investments for an extended period before returns on such investments, if any, are realized, and such investments may result in expenses growing at a faster rate than revenues. Telecommunications networks outside of the United States generally have a different structure than do networks inside the United States, and our products may not be completely compatible with this different structure. As a result, our products may not be competitive with those of our competitors in those markets. In addition, access to foreign markets is often difficult due to the established relationships between a government-owned or controlled communications operating company and its traditional suppliers of communications equipment. These foreign communications networks are in many cases owned or strictly regulated by government. There can be no assurances that we will be able to successfully penetrate these markets, particularly for our switching products.

Internationally, we sell our products through our direct sales force, sales agents and distribution relationships. We also sell direct through our wholly owned subsidiaries in Argentina, Brazil, Canada, Colombia, the Czech Republic, France, Germany, India, Italy, Malaysia, Mexico, Singapore, South Africa, Spain, Taiwan and the United Kingdom and our sales offices in China, Dubai and the Russian Federation. Total international revenues for 2006, 2005 and 2004 were $241.5 million, $134.0 million, and $87.1 million, respectively, representing 44%, 28% and 27% of our total revenues, respectively. We expect that international sales will continue to account for a significant portion of our revenues in future periods.

International sales are subject to inherent risks, including:

• unexpected changes in local regulatory requirements, tariffs and duties;
• changes in a country's political or economic conditions including military conflicts or political or social unrest;
• difficulties in staffing and managing foreign operations and distributors;
• longer accounts receivable cycles and difficulty in accounts receivable collection;
• differing technology standards and customer requirements;
• greater, trade regulations, nationalization of business, economic instability;
• potentially adverse tax consequences;
• import regulations and price controls imposed by local governments;
• restrictions on foreign currencies and trade barriers imposed by foreign countries;
• possible terrorist attacks against American interests; and
• exchange rate fluctuations and exchange controls.

Exchange rate fluctuations on foreign currency transactions and translations arising from international operations may contribute to fluctuations in our business and operating results. Fluctuations in exchange rates could also affect demand for our products. If, for any reason, exchange or price controls or other restrictions in foreign countries are imposed, our business and operating results could suffer. In addition, any inability to obtain local regulatory approvals in foreign markets on a timely basis could harm our business.

We intend to continue pursuing international and emerging market growth opportunities. An inability to maintain or to continue to expand our business in international and emerging markets, including Europe, Asia Pacific and Latin America, could have a material adverse effect on our business, results of operations and financial condition. In particular, we currently have limited operations in Asia Pacific and Latin America, and we may have difficulty establishing relationships, building

name recognition or penetrating these markets, which could adversely affect our performance in these markets.


Failure to recruit and retain key personnel could harm our ability to meet key objectives and adversely affect our business and the price of our common stock.


We depend to a significant extent upon the continuing services and contributions of our senior management team and other key employees. We generally do not have long-term employment agreements or other arrangements with our employees that would prevent them from leaving Tekelec. Our success also has depended in large part on our ability to attract and retain highly skilled technical, managerial, sales, and marketing personnel. Competition for these personnel is intense. The loss of services of any of our key personnel, or inability to attract, assimilate and retain qualified personnel in the future, or delays in hiring required personnel, particularly engineering and sales personnel, could make it difficult to meet our key objectives, such as timely and effective product introductions, and could have a negative impact on the price of our common stock. There can be no assurance that we will continue to be successful in attracting and retaining highly qualified employees in the future and any inability to do so could have a material adverse effect on our business.

In recent years, we have had all but one member of our senior management depart from our company. We have replaced or are seeking to replace these individuals with either internal candidates or individuals from outside our organization. While our internal candidates understand our business model, they must learn a new position and take on additional or new responsibilities, which could take time and disrupt our on-going operations. To integrate into our company, new senior personnel must spend a significant amount of time learning our business model and management systems, in addition to performing their regular duties. Accordingly, until new senior personnel become familiar with our business model and systems, their integration may result in some disruption to our on-going operations. We may need to hire additional personnel to fill newly created positions or to replace internal candidates who have been promoted and, as a result, we may experience increased compensation costs that are not offset by either improved productivity or higher revenues. We may also incur significant severance costs in the event that additional members of our senior management or other key e