1
FORM 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended SEPTEMBER 30, 1997

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-15135

TEKELEC
(Exact name of registrant as specified in its charter)

CALIFORNIA 95-2746131
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

26580 W. AGOURA ROAD, CALABASAS, CALIFORNIA 91302
(Address and zip code of principal executive offices)

(818) 880-5656
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes [X] No [ ]

As of November 3, 1997 there were 25,784,447 shares of the registrant's
common stock, without par value, outstanding.

TEKELEC
FORM 10-Q
INDEX

PART I -- FINANCIAL INFORMATION PAGE

Item 1. Consolidated Financial Statements

Consolidated Balance Sheets at September 30, 1997
and December 31, 1996 3

Consolidated Statements of Operations for the three
and nine months ended September 30, 1997 and 1996 4

Consolidated Statements of Cash Flow for the
nine months ended September 30, 1997 and 1996 5

Notes to Consolidated Financial Statements 6

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11

PART II -- OTHER INFORMATION

Item 2. Changes in Securities and Use of Proceeds 19

Item 6. Exhibits and Reports on Form 8-K 19

SIGNATURES 21

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3

PART I -- FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

TEKELEC
CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, December 31,
1997 1996
------------- ------------
(thousands, except share data)
ASSETS (unaudited) (audited)

CURRENT ASSETS:
Cash and cash equivalents ..................... $ 37,082 $17,211
Short-term investments, at fair value ......... 9,051 17,913
Accounts and notes receivable, less
allowances of $411 and $368, respectively ... 30,393 17,026
Inventories ................................... 12,687 8,116
Amounts due from related parties .............. 1,625 2,381
Income taxes receivable ....................... 861 --
Deferred income taxes ......................... 3,361 242
Prepaid expenses and other current assets ..... 3,849 1,505
-------- -------
Total current assets ...................... 98,909 64,394
Long-term investments, at fair value .............. 11,997 9,120
Property and equipment, net ....................... 9,781 8,174
Deferred income taxes ............................. 6,524 207
Other assets ...................................... 568 623
-------- -------
Total assets .............................. $127,779 $82,518
======== =======

LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
Trade accounts payable ........................ $ 7,306 $ 5,631
Accrued expenses .............................. 5,570 5,989
Accrued payroll and related expenses .......... 4,747 4,027
Deferred revenues ............................. 17,522 3,778
Income taxes payable .......................... -- 1,342
-------- -------
Total current liabilities ................. 35,145 20,767
-------- -------
Total liabilities ......................... 35,145 20,767
-------- -------
SHAREHOLDERS' EQUITY (NOTE H):
Common stock, without par value,
100,000,000 shares authorized; 25,691,867 and
24,020,198 shares issued and outstanding,
respectively ................................ 68,429 57,049
Retained earnings ............................. 23,938 3,879
Cumulative translation adjustment ............. 267 823
-------- -------
Total shareholders' equity ................ 92,634 61,751
-------- -------
Total liabilities and shareholders' equity $127,779 $82,518
======== =======

See notes to consolidated financial statements.

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TEKELEC
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
1997 1996 1997 1996
-------- -------- -------- --------
(thousands, except per share data)

REVENUES:
Sales to third parties ................ $ 35,086 $ 18,288 $ 78,705 $ 45,321
Sales to related parties .............. 1,026 1,108 3,061 2,799
-------- -------- -------- --------
Total revenues .................... 36,112 19,396 81,766 48,120

COSTS AND EXPENSES:
Cost of goods sold .................... 12,349 7,410 28,039 18,746
Research and development .............. 5,686 4,420 14,942 13,107
Selling, general and administrative ... 9,027 6,834 24,507 21,004
Restructuring ......................... -- 327 -- 327
-------- -------- -------- --------
Total costs and expenses .......... 27,062 18,991 67,488 53,184
-------- -------- -------- --------

Income (Loss) from operations ............ 9,050 405 14,278 (5,064)
Other income (expense):
Interest, net ......................... 562 422 1,593 1,262
Other, net ............................ (80) (8) (96) (70)
-------- -------- -------- --------
Total other income ................ 482 414 1,497 1,192
-------- -------- -------- --------

Income (Loss) before provision for
income taxes ............................ 9,532 819 15,775 (3,872)
Provision for (Benefit from)
income taxes ........................ (5,529) 544 (4,284) 1,233
-------- -------- -------- --------
NET INCOME (LOSS) ..................... $ 15,061 $ 275 $ 20,059 $ (5,105)
======== ======== ======== ========

EARNINGS (LOSS) PER SHARE (NOTE H):
Primary ............................... $ 0.52 $ 0.01 $ 0.71 $ (0.22)
Fully diluted ......................... 0.52 0.01 0.69 (0.22)

WEIGHTED AVERAGE NUMBER OF SHARES (NOTE H):
Primary ............................... 28,995 25,272 28,128 23,466
Fully diluted ......................... 29,153 25,692 28,880 23,466

See notes to consolidated financial statements.

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TEKELEC
CONSOLIDATED STATEMENTS OF CASH FLOW
(unaudited)

Nine Months Ended
September 30,
-----------------------
1997 1996
-------- --------
(thousands)

CASH FLOW FROM OPERATING ACTIVITIES:
Net income (loss) ................................ $ 20,059 $ (5,105)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization .................... 3,488 2,835
Deferred income taxes ............................ (4,615) --
Changes in current assets and liabilities:
Accounts and notes receivable ................ (13,513) (366)
Inventories .................................. (4,639) (817)
Amounts due from related parties ............. 755 1,193
Income taxes receivable ...................... (861) --
Prepaid expenses and other current assets .... (2,347) (629)
Trade accounts payable ....................... 1,724 (224)
Accrued expenses ............................. (332) (559)
Accrued payroll and related expenses ......... 667 (309)
Deferred revenues ............................ 13,749 1,623
Income taxes payable ......................... (1,293) (630)
-------- --------
Total adjustments ......................... (7,217) 2,117
-------- --------
Net cash provided by (used in) operating
activities .............................. 12,842 (2,988)
-------- --------
CASH FLOW FROM INVESTING ACTIVITIES:
Proceeds from maturity of available-for-sale
securities ..................................... 18,000 12,000
Purchase of available-for-sale securities ........ (12,015) (35,968)
Purchase of property and equipment ............... (5,135) (4,179)
Decrease in other assets ......................... 33 173
-------- --------
Net cash provided by (used in) investing
activities ................................. 883 (27,974)
-------- --------
CASH FLOW FROM FINANCING ACTIVITIES:
Payments of short-term borrowings ................ -- (570)
Repayment of long-term debt ...................... -- (380)
Repayment of other obligations ................... -- (28)
Proceeds from issuance of common stock ........... 6,537 1,245
-------- --------
Net cash provided by financing activities .... 6,537 267
-------- --------
Effect of exchange rate changes on cash .............. (391) (596)
-------- --------
Net increase (decrease) in cash and cash
equivalents .................................... 19,871 (31,291)
Cash and cash equivalents at beginning of period ..... 17,211 43,609
-------- --------
Cash and cash equivalents at end of period ........... $ 37,082 $ 12,318
======== ========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
CASH PAID DURING THE PERIOD FOR:
Interest ......................................... $ -- $ 95
Income taxes ..................................... 2,442 1,878
SUPPLEMENTAL DISCLOSURE OF NON-CASH FLOW ACTIVITY:
Tax benefit related to stock options ............. 4,843 --

See notes to consolidated financial statements.

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TEKELEC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

A. BASIS OF PRESENTATION

The consolidated financial statements are unaudited, other than the
consolidated balance sheet at December 31, 1996, and reflect all adjustments
(consisting only of normal recurring adjustments) which are, in the opinion of
Management, necessary for a fair presentation of the Company's financial
condition and operating results for the interim periods.

The results of operations for the current interim periods are not
necessarily indicative of results to be expected for the current year. Certain
items shown in the prior financial statements have been reclassified to conform
with the presentation of the current period.

The Company operates under a thirteen-week calendar quarter; however,
for financial statement presentation purposes, the reporting periods are
referred to as ended on the last calendar day of the quarter. The accompanying
financial statements for the three and nine months ended September 30, 1997 and
1996 are for the thirteen and thirty-nine weeks ended September 26, 1997 and
September 27, 1996, respectively.

Earnings per share are computed using the weighted average number of
shares outstanding and dilutive common stock equivalents (options and warrants).

These consolidated financial statements should be read in conjunction
with the consolidated financial statements for the year ended December 31, 1996
and the notes thereto in the Company's Annual Report on Form 10-K for the year
ended December 31, 1996.

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B. STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS NOT YET ADOPTED

In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings
per Share." This statement requires dual presentation of newly defined basic and
diluted earnings per share ("EPS") on the face of the income statement for all
entities with complex capital structures. The accounting standard is effective
for fiscal years ending after December 15, 1997 and requires restatement of all
prior period EPS data presented. Earlier application is not permitted. However,
disclosure of pro forma EPS data computed using SFAS No. 128 in the notes to the
financial statements is permitted in the periods prior to required adoption. The
pro forma EPS data for the three and nine months ended September 30, 1997 and
1996 computed using SFAS No. 128 is as follows (shares in thousands):

Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
1997 1996 1997 1996
---- ---- ---- ----

EARNINGS (LOSS) PER SHARE:
Basic.............................. $ 0.59 $ 0.01 $ 0.80 $(0.22)
Diluted............................ 0.52 0.01 0.71 (0.22)

WEIGHTED AVERAGE NUMBER OF SHARES:
Basic.............................. 25,463 23,688 24,943 23,466
Diluted............................ 28,995 25,272 28,128 23,466

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." This statement establishes standards for the reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements. Comprehensive income generally represents all changes in
shareholders' equity during the period except those resulting from investments
by, or distributions to, shareholders. SFAS No. 130 is effective for fiscal
years beginning after December 15, 1997 and requires restatement of earlier
periods presented. Management is currently evaluating the requirements of SFAS
No. 130.

In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 131 establishes standards
for the way that a public enterprise reports information about operating
segments in annual financial statements, and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to shareholders. SFAS No. 131 is effective for fiscal years
beginning after December 15, 1997 and requires restatement of earlier periods
presented. Management is currently evaluating the requirements of SFAS No. 131.

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8

TEKELEC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

C. CERTAIN BALANCE SHEET ITEMS

The components of inventories are:

SEPTEMBER 30, December 31,
1997 1996
------- --------
(thousands)

Raw materials ......................... $ 3,314 $ 2,825
Work in process ....................... 2,673 1,869
Finished goods ........................ 6,700 3,422
------- --------
$12,687 $ 8,116
======= ========

Property and equipment consist of the following:

Manufacturing and development equipment $ 16,617 $ 13,520
Furniture and office equipment ........ 7,790 7,300
Demonstration equipment ............... 3,823 4,055
Leasehold improvements ................ 1,348 1,118
-------- --------
29,578 25,993
Less, accumulated depreciation and
amortization .......................... (19,797) (17,819)
-------- --------
Property and Equipment, net ......... $ 9,781 $ 8,174
======== ========

D. RELATED PARTY TRANSACTIONS

Sales to related parties consist of, and amounts due from related
parties are, the result of transactions between the Company and foreign
affiliates controlled by the Company's Chairman of the Board.

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9

TEKELEC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

E. INCOME TAXES

During the three-month period ended September 30, 1997, the Company
recorded a tax benefit of $9.0 million resulting from a reduction of its
valuation allowance for deferred taxes. The reduction in the valuation allowance
was based on the Company's improved operating results and management's
assessment of various uncertainties related to the future realization of its
deferred tax benefits. For the three months ended September 30, 1997, excluding
the one-time tax benefit, the Company had a tax provision of $3.4 million,
resulting in an effective tax rate of 36%, compared to $544,000, or an effective
tax rate of 66%, for the same period in 1996. For the nine months ended
September 30, 1997, excluding the one-time tax benefit, the Company had a tax
provision of $4.7 million, resulting in an effective tax rate of 30%. Although
the Company's pre-tax results showed a loss for the corresponding nine-month
period in 1996, the Company had a tax provision of $1.2 million. The tax
provision for both periods in 1996 was principally foreign taxes on the income
of the Company's Japanese subsidiary and reflected the Company's then inability
to recognize a benefit for its U.S. loss and credits carryforwards.

F. BORROWINGS

The Company has a $10.0 million line of credit with a U.S. bank and
lines of credit aggregating $2.9 million available to the Company's Japanese
subsidiary from certain Japan-based banks.

The Company's $10.0 million line of credit is collateralized by
substantially all of the Company's assets, bears interest at, or in some cases
below, the U.S. prime rate (8.5% at September 30, 1997), and expires June 30,
1998, if not renewed. Under the terms of this facility, the Company is required
to maintain certain financial ratios and meet certain net worth and indebtedness
tests with which the Company is in compliance. There have been no borrowings
under this credit facility.

The Company's Japanese subsidiary has collateralized yen-denominated
lines of credit with Japan-based banks, primarily available for use in Japan,
amounting to the equivalent of $2.9 million with interest at the Japanese prime
rate (1.625% at September 30, 1997) plus 0.125% per annum which expire between
March 31, 1998, and August 5, 1998, if not renewed. There have been no
borrowings under these lines of credit.

G. MAJOR CUSTOMERS

Sales to Bell Atlantic Corporation amounted to 34% of revenues for the
third quarter of 1997. There were no customers accounting for 10% or more of
third quarter 1996 revenues.

Sales to Bell Atlantic Corporation amounted to 23% of revenues for the
first nine months of 1997. Sales to Nippon Telegraph and Telephone amounted to
10% of revenues for the first nine months of 1996.

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10
TELELEC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

H. COMMON STOCK

On August 22, 1997, the Company effected a two-for-one stock split. All
references to numbers of shares and per share amounts have been restated to
reflect the stock split.

On August 25, 1997, the Company adopted a shareholder rights plan to
protect shareholders against unsolicited attempts to acquire control of the
Company which do not offer what the Company believes to be an adequate price to
all shareholders. Under the plan, a dividend distribution of one right for each
outstanding share of Tekelec Common Stock was made to shareholders of record on
September 5, 1997, and such rights expire on September 5, 2007. Each right
entitles the registered holder to purchase from the Company one share of Common
Stock at a price of $180 per share, subject to adjustment (the "Purchase
Price").

The rights will be exercisable only if a person or group (except for
certain exempted persons or groups, including those shareholders of the Company
who at the time of adoption of the Plan beneficially owned more than 15% of
Tekelec Common Stock) acquires 15% or more of Tekelec's Common Stock or
announces a tender offer which would result in ownership of 15% or more of the
Common Stock.

Under the plan, if any person or group (other than the Company, any
subsidiary of the Company or any employee benefit plan of the Company or any
exempted person or group) acquires 15% or more of the Company's outstanding
voting stock without the prior written consent of the Company's Board of
Directors, each right, except those held by such acquiring persons or group,
would entitle each holder of a right to acquire such number of shares of the
Company's Common Stock as equals the result obtained by multiplying the then
current Purchase Price by the number of shares of Common Stock for which a right
is then exercisable and dividing the product by 50% of the then current
per-share market price of the Company's Common Stock.

The Company may redeem the rights at $0.01 per right at any time until
ten business days after a person or group acquires 15% or more of the Company's
outstanding shares. The Company also may, at any time after a person or group
acquires 15% or more, but less than 50%, of the Company's shares, exchange each
right for one share of Common Stock.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion should be read in conjunction with, and is
qualified in its entirety by, the consolidated financial statements and the
notes thereto included in Item 1 of this Quarterly Report and the consolidated
financial statements and notes thereto and Management's Discussion and Analysis
of Financial Condition and Results of Operations contained in the Company's
Annual Report on Form 10-K for the year ended December 31, 1996. Historical
results and percentage relationships among any amounts in the financial
statements are not necessarily indicative of trends in operating results for any
future periods.

RESULTS OF OPERATIONS

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

PERCENTAGE OF REVENUES
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
1997 1996 1997 1996
----- ----- ----- -----

Revenues................................ 100.0% 100.0% 100.0% 100.0%
Cost of goods sold...................... 34.2 38.2 34.3 39.0
----- ----- ----- -----
Gross profit............................ 65.8 61.8 65.7 61.0

Research and development................ 15.7 22.8 18.2 27.2
Selling, general and administrative..... 25.0 35.2 30.0 43.6
Restructuring........................... -- 1.7 -- 0.7
----- ----- ----- -----
Total operating expenses................ 40.7 59.7 48.2 71.5
----- ----- ----- -----

Income (Loss) from operations........... 25.1 2.1 17.5 (10.5)

Interest and other income, net.......... 1.3 2.1 1.8 2.5
----- ----- ----- -----
Income (Loss) before provision for
income taxes.......................... 26.4 4.2 19.3 (8.0)
Provision for (Benefit from)
income taxes.......................... (15.3) 2.8 (5.2) 2.6
----- ----- ----- -----
Net income (loss)....................... 41.7% 1.4% 24.5% (10.6)%
===== ===== ===== =====

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

PERCENTAGE OF REVENUES
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
1997 1996 1997 1996
---- ---- ---- ----

Data network diagnostics........... 14% 31% 16% 34%
Intelligent network diagnostics.... 24 26 28 28
Network switching.................. 62 43 56 38
--- --- --- ---
Total...................... 100% 100% 100% 100%
=== === === ===

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

PERCENTAGE OF REVENUES
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
1997 1996 1997 1996
---- ---- ---- ----

North America...................... 73% 59% 71% 58%
Japan.............................. 11 21 15 22
Europe............................. 6 10 6 9
Rest of the World.................. 10 10 8 11
--- --- --- ---
Total...................... 100% 100% 100% 100%
=== === === ===

THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED WITH THE
THREE MONTHS ENDED SEPTEMBER 30, 1996

Revenues. The Company's revenues increased by $16.7 million, or 86%,
during the third quarter of 1997 due to higher sales of network switching
products and intelligent network diagnostics products.

Revenues from switching products increased by $14.1 million, or 169%, in
the third quarter of 1997 primarily due to increased EAGLE STP market acceptance
principally in the U.S., and the addition of sales of the Company's Local Number
Portability (LNP) and related Local Service Management System (LSMS) features.
Additionally, EAGLE STP average selling price increased principally as a result
of the Company's sales of larger systems in the Regional Bell Operating Company
(RBOC) market. The Company expects that its switching product revenues will
continue

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to be higher both in dollars and as a percentage of revenues for the remainder
of 1997 when compared to 1996.

Revenues from intelligent network diagnostics products increased by $3.6
million, or 73%, due primarily to increased MGTS product sales in the U.S.,
Japan and Europe.

Revenues from data network diagnostics products, which consisted
principally of sales to the research and development market, decreased by $1.0
million, or 17%, primarily due to increased competition in that market. The
Company is taking steps to expand its Chameleon products' reach into the network
operator market including the planned introduction, in the fourth quarter of
1997, of software applications addressing specific needs of this market which
could provide additional sales opportunities.

Revenues in North America increased by $15.0 million, or 132%, primarily
as a result of higher EAGLE STP (including LNP and LSMS) and MGTS product sales.
Notwithstanding higher sales of MGTS products, overall sales in Japan were flat
primarily as a result of lower Chameleon product sales and unfavorable exchange
rate fluctuations on foreign currency translations. Other international revenues
increased by $1.7 million, or 43%, primarily due to the first EAGLE STP sales
under the Company's distribution agreement with Daewoo Telecom and higher MGTS
product sales in Europe.

The impact of exchange rate fluctuations on foreign currency
translations decreased revenues by approximately $360,000, or 1%, and decreased
net income by $41,000, or less than 1%, in the third quarter of 1997.

The Company believes that its future revenue growth depends in large
part upon a number of factors, including the continued market acceptance of the
Company's products, particularly the EAGLE STP product and new applications such
as the Company's LNP and related LSMS features for its EAGLE STP. In the second
and third quarters of 1997, the Company experienced significant quarter to
quarter sequential revenue growth, in part because of the initial success of its
STP product in the Regional Bell Operating Companies (RBOC) market and the
market acceptance of its LNP and LSMS solution. In the fourth quarter of 1997,
the Company expects lower quarter to quarter sequential growth when compared
with the quarter to quarter sequential growth rates of the second and third
quarters of 1997.

Gross Profit. Gross profit as a percentage of revenues increased from
62% in the third quarter of 1996 to 66% in the third quarter of 1997, primarily
due to higher switching product margins resulting from the addition of sales of
higher margin LNP and LSMS features and improved manufacturing efficiencies due
to higher sales volumes.

Research and Development. Although research and development expenses
increased by $1.3 million, or 29%, in the third quarter of 1997, such expenses
decreased as a percentage of revenues from 23% in the third quarter of 1996 to
16% in the third quarter of 1997. The dollar increase was due primarily to
increased switching product expenses and the accrual of certain costs for
performance-related award programs. The switching product expense increase was
primarily attributable to ongoing development expenses for the Company's LNP and
LSMS features on the EAGLE STP product and consisted principally of expenses
incurred in connection with the hiring of additional personnel and contractors
and higher depreciation expenses as a result of equipment

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acquisitions. Based on expected revenues and expense levels, the Company
believes that research and development expenses will be higher in dollars and
lower as a percentage of revenues for the remainder of 1997 when compared with
1996.

Selling, General and Administrative Expenses. Although selling, general
and administrative expenses increased by $2.2 million, or 32%, in the third
quarter of 1997, such expenses decreased as a percentage of revenues from 35% in
the third quarter of 1996 to 25% in the third quarter of 1997. The dollar
increase was due primarily to increased infrastructure costs to meet the needs
of the growing EAGLE installed base and to support higher sales levels, and the
accrual of certain costs for performance-related award programs. Based on
expected revenues and expense levels, the Company believes that selling, general
and administrative expenses will continue to be lower as a percentage of
revenues for the remainder of 1997 when compared with 1996.

Income Taxes. During the three-month period ended September 30, 1997,
the Company recorded a tax benefit of $9.0 million resulting from a reduction of
its valuation allowance for deferred taxes. The reduction in the valuation
allowance was based on the Company's improved operating history and management's
assessment of various uncertainties related to the future realization of its
deferred tax benefits. For the three months ended September 30, 1997, excluding
the one-time tax benefit, the Company had a tax provision of $3.4 million,
resulting in an effective tax rate of 36%, compared to $544,000, or an effective
tax rate of 66% for the same period in 1996. The tax provision for 1996 was
principally foreign taxes on the income of the Company's Japanese subsidiary,
and reflected the Company's then inability to recognize a benefit for its U.S.
loss and credits carryforwards.

NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED WITH THE
NINE MONTHS ENDED SEPTEMBER 30, 1996

Revenues. The Company's revenues increased by $33.6 million, or 70%,
during the first nine months of 1997 due primarily to higher sales of network
switching products and intelligent network diagnostics products. Sales of data
network diagnostics products decreased both in dollars and as a percentage of
total sales.

Revenues from switching products increased by $27.2 million, or 149%,
primarily due to increased EAGLE STP market acceptance primarily in the U.S.,
and the addition of sales of the Company's Local Number Portability (LNP) and
related Local Service Management System (LSMS) features. Additionally, EAGLE STP
average selling price increased as a result of the Company's sales of larger
systems in the Regional Bell Operating Company (RBOC) market.

Revenues from intelligent network diagnostics products increased by $9.6
million, or 71%, primarily due to strong demand for the Company's MGTS products
particularly in the domestic and Japanese markets.

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Revenues from data network diagnostics products, which consisted
primarily of sales to the research and development market, decreased by $3.2
million, or 20%, primarily as a result of lower worldwide sales of the Company's
Chameleon products due to increased competition.

Revenues in North America increased by $29.9 million, or 106%, primarily
as a result of higher EAGLE STP (including LNP and LSMS) and MGTS product sales.
Sales in Japan increased by $1.7 million, or 17%, due primarily to higher MGTS
product sales, partially offset by lower Chameleon product sales and unfavorable
exchange rate fluctuations on foreign currency translations. Other international
revenues increased by $2.0 million, or 21%, primarily due to increased EAGLE STP
product sales, including shipments under the Company's distribution agreement
with Daewoo Telecom.

The impact of exchange rate fluctuations on foreign currency
translations decreased revenues by $1.4 million, or 2%, and decreased the
Company's net income by $143,000, or 1%, in the first nine months of 1997.

Gross Profit. Gross profit as a percentage of revenues increased from
61% in the first nine months of 1996 to 66% in the first nine months of 1997,
primarily due to improved EAGLE STP product margins, the addition of sales of
higher margin LNP and LSMS features and improved manufacturing efficiencies as a
result of higher sales volumes.

Research and Development. Although research and development expenses
increased overall by $1.8 million, or 14%, in the first nine months of 1997,
such expenses decreased as a percentage of revenues from 27% in the first nine
months of 1996 to 18% in the first nine months of 1997. The dollar increase in
such expenses was primarily attributable to ongoing development expenses for the
Company's LNP and LSMS features on the EAGLE STP product and consisted
principally of expenses incurred in connection with the hiring of additional
personnel and contractors and higher depreciation expenses as a result of
equipment acquisitions. Additionally, research and development expenses
increased as a result of the accrual of certain costs for performance-related
award programs.

Selling, General and Administrative Expenses. Although selling, general
and administrative expenses increased by $3.5 million, or 17%, in the first nine
months of 1997, such expenses decreased as a percentage of revenues from 44% in
the first nine months of 1996 to 30% in the first nine months of 1997. The
dollar increase in such expenses was primarily due to increased infrastructure
costs to meet the needs of the growing EAGLE installed base and to support
higher sales levels, and the accrual of certain costs for performance-related
award programs.

Income Taxes. During the three-month period ended September 30, 1997,
the Company recorded a tax benefit of $9.0 million resulting from a reduction of
its valuation allowance for deferred taxes. The reduction in the valuation
allowance was based on the Company's improved operating history and management's
assessment of various uncertainties related to the future realization of its
deferred tax benefits. For the nine months ended September 30, 1997, excluding
the one-time tax benefit, the Company had a tax provision of $4.7 million,
resulting in an effective tax rate of 30%. Although the Company's pre-tax
results showed a loss for the corresponding period in 1996, the Company had a
tax provision of $1.2 million. The tax provision for 1996 was

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principally foreign taxes on the income of the Company's Japanese subsidiary,
and reflected the Company's then inability to recognize a benefit for its U.S.
loss and credits carryforwards.

LIQUIDITY AND CAPITAL RESOURCES

During the nine months ended September 30, 1997, cash and cash
equivalents increased by $19.9 million to $37.1 million, including a net
transfer of approximately $6.0 million from short-term and long-term
investments. Operating activities, including the effects of exchange rate
changes on cash, provided $12.5 million and financing activities provided $6.5
million, while capital expenditures used $5.1 million.

Accounts receivable, including amounts due from related parties,
increased by $12.6 million, or 65%, during the first nine months of 1997 due
primarily to higher sales levels and the inclusion of $8.0 million in accounts
receivable billings for which revenue had not yet been recognized. These
billings represented shipments to customers for which revenue recognition is
dependent upon customer acceptance, which had not yet occurred at September 30,
1997. Inventories increased by $4.6 million, or 56%, during the first nine
months of 1997 primarily to meet customer shipments scheduled for the fourth
quarter of 1997 and product requirements for customer trials. Deferred revenues
increased by $13.7 million, or 364%, primarily due to shipments to customers
with extended acceptance periods.

Capital expenditures amounted to $5.1 million during the first nine
months of 1997 and represented the planned addition of equipment principally for
research and development, manufacturing operations and facility expansion.

Net cash in the amount of $6.5 million provided by financing activities
in the first nine months of 1997 represented net proceeds from the sale of
Common Stock issued upon the exercise of stock options and warrants.

The Company has a $10.0 million line of credit with a U.S. bank and
lines of credit aggregating $2.9 million available to the Company's Japanese
subsidiary from certain Japan-based banks.

The Company's $10.0 million line of credit is collateralized by
substantially all of the Company's assets, bears interest at, or in some cases
below, the U.S. prime rate (8.5% at September 30, 1997), and expires June 30,
1998, if not renewed. Under the terms of this facility, the Company is required
to maintain certain financial ratios and meet certain net worth and indebtedness
tests for which the Company is in compliance. There have been no borrowings
under this credit facility.

The Company's Japanese subsidiary has collateralized yen-denominated
lines of credit with Japan-based banks, primarily available for use in Japan,
amounting to the equivalent of $2.9 million with interest at the Japanese prime
rate (1.625% at September 30, 1997) plus 0.125% per annum which expire between
March 31, 1998 and August 5, 1998, if not renewed. There have been no borrowings
under these lines of credit.

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Upon the expiration of the above-described credit facilities, the
Company believes that, if necessary, it would be able to arrange for credit
facilities on terms generally no less favorable than those described above.

The Company believes that existing working capital, funds generated from
operations, and its current bank lines of credit should be sufficient to satisfy
anticipated operating requirements at least through 1998. Nonetheless, the
Company may seek additional sources of capital as necessary or appropriate to
fund acquisitions or to otherwise finance the Company's growth or operations;
however, there can be no assurance that such funds, if needed, will be available
on favorable terms, if at all.

STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NOT YET ADOPTED

In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings
per Share." This statement requires dual presentation of newly defined basic and
diluted earnings per share ("EPS") on the face of the income statement for all
entities with complex capital structures. The accounting standard is effective
for fiscal years ending after December 15, 1997 and requires restatement of all
prior period EPS data presented. Earlier application is not permitted. The
Company has determined that in some periods the presentation of basic EPS data
under SFAS No. 128 may differ significantly from previously reported EPS data as
a result of the exclusion of dilutive common stock equivalents (options and
warrants) in the basic EPS calculation. See Note B for further information and
the pro forma impact on EPS data for the periods ended September 30, 1997 and
1996.

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"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1996

The statements which are not actual reported financial results or
historical facts contained in this Management's Discussion and Analysis of
Financial Condition and Results of Operations are forward-looking statements
that involve certain risks and uncertainties including, but not limited to,
timing of significant orders and shipments, product mix, customer acceptance of
the Company's products, capital spending patterns of customers, competition and
pricing, new product introductions by the Company or its competitors, carrier
deployment of intelligent network services, the timing of research and
development expenditures, regulatory changes, general economic conditions and
other risks described in the Company's Annual Report on Form 10-K and in the
Company's other Securities and Exchange Commission filings.

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PART II --OTHER INFORMATION

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

On August 25, 1997, the Board of Directors of the Company declared a
dividend of one common stock purchase right (a "Right") for each
outstanding share of Common Stock, without par value (the "Common
Stock"), of the Company and entered into a Rights Agreement dated as of
August 25, 1997 between the Company and U.S. Stock Transfer Corporation,
as Rights Agent (the "Rights Agreement"). If and when the Rights become
exercisable, each Right entitles the registered holder to purchase from
the Company one share of Common Stock at a price of $180.00 per share,
subject to adjustment as set forth in the Rights Agreement.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

3.1 Amended and Restated Articles of Incorporation(1)

3.2 Bylaws, as amended(2)

4.1 Rights Agreement dated as of August 25, 1997 between the Company
and U.S. Stock Transfer Corporation as Rights Agent(3)

10.1 Agreement dated September 9, 1997 between the Company and Shigeru
Suzuki

10.2 Distribution and OEM Agreement dated as of June 1, 1997 between
the Company and Daewoo Telecom, Ltd.(4)

10.3 Warrants dated July 24, 1997 to purchase shares of the Company's
Common Stock and Schedule of Warrantholders(5)

11.1 Statement of Computation of Earnings Per Share for the Three and
Nine Months Ended September 30, 1997 and 1996

27.1 Financial Data Schedule

- -----------------------------

(1) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
(File No. 0-15135) for the quarter ended June 30, 1997.

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(2) Incorporated by reference to the Company's Annual Report on Form 10-K (File
No. 0-15135) for the year ended December 31, 1996.

(3) Incorporated by reference to the Company's Current Report on Form 8-K (File
No. 0-15135) filed with the Commission on August 25, 1997.

(4) Confidential treatment has been requested with respect to portions of this
exhibit and such confidential portions have been deleted and filed with the
Commission pursuant to Rule 24b-2 promulgated under the Securities Exchange
Act of 1934.

(5) Incorporated by reference to the Company's Registration Statement on Form
S-8 (Reg. No. 333-37843) filed with the Commission on October 14, 1997.

(b) Reports

On August 25, 1997, the Company filed with the Commission a Current
Report on Form 8-K reporting the Company's declaration on August 25,
1997 of a dividend distribution payable on September 5, 1997 of one
common stock purchase right for each outstanding share of Common Stock
of the Company.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

TEKELEC

November 11, 1997 /s/ Allan J. Toomer
----------------------------------------
Allan J. Toomer
President
(Duly authorized officer)

/s/ Gilles C. Godin
----------------------------------------
Gilles C. Godin
Chief Financial Officer and
Vice President, Finance
(Principal financial and chief
accounting officer)

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INDEX TO EXHIBITS

Sequentially
Exhibit Numbered
Number Description Page
- ------ ----------- ------------

10.1 Agreement dated September 9, 1997 between the
Company and Shigeru Suzuki

*10.2 Distribution and OEM Agreement dated as of June 1, 1997
between the Company and Daewoo Telecom, Ltd.

11.1 Statement of Computation of Earnings Per Share
for the Three and Nine Months Ended September 30,
1997 and 1996

27.1 Financial Data Schedule

- -----------------------------

* Confidential treatment has been requested with respect to portions of this
exhibit, and such confidential portions have been deleted and filed with
the Commission pursuant to Rule 24b-2 promulgated under the Securities
Exchange Act of 1934.