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 JUNE 30, 1998

[ ] 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 August 3, 1998, there were 53,798,655 shares of the registrant's
common stock, without par value, outstanding.

2
TEKELEC
FORM 10-Q
INDEX

PART I -- FINANCIAL INFORMATION PAGE
----

Item 1. Consolidated Financial Statements

Consolidated Balance Sheets at June 30, 1998
and December 31, 1997 3

Consolidated Income Statements for the three and six
months ended June 30, 1998 and 1997 4

Consolidated Statements of Comprehensive Income for the three
and six months ended June 30, 1998 and 1997 5

Consolidated Statements of Cash Flow for the six
months ended June 30, 1998 and 1997 6

Notes to Consolidated Financial Statements 7

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12

PART II -- OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders 19

Item 5. Other Information 19

Item 6. Exhibits and Reports on Form 8-K 20

SIGNATURES

3
PART I -- FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

TEKELEC
CONSOLIDATED BALANCE SHEETS

JUNE 30, December 31,
1998 1997
------------- -------------
(thousands, except share data)
ASSETS (unaudited) (audited)

CURRENT ASSETS:
Cash and cash equivalents .......................... $ 53,200 $ 38,748
Short-term investments, at fair value .............. 26,435 19,773
Accounts and notes receivable, less
allowances of $634 and $469, respectively ........ 37,569 29,141
Inventories ........................................ 10,822 11,281
Amounts due from related parties ................... 1,844 2,286
Income taxes receivable ............................ 58 805
Deferred income taxes, net ......................... 8,352 8,309
Prepaid expenses and other current assets .......... 2,175 1,760
------------- -------------
Total current assets ........................... 140,455 112,103
Long-term investments, at fair value ................... 13,744 11,997
Property and equipment, net ............................ 9,770 9,841
Deferred income taxes, net ............................. 2,164 1,999
Other assets ........................................... 555 525
------------- -------------
Total assets ................................... $ 166,688 $ 136,465
============= =============

LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
Trade accounts payable ............................. $ 6,976 $ 4,919
Accrued expenses ................................... 8,258 5,862
Accrued payroll and related expenses ............... 3,802 6,846
Current portion of deferred revenues ............... 9,572 7,693
Income taxes payable ............................... 1,778 429
------------- -------------
Total current liabilities ...................... 30,386 25,749
Long-term portion of deferred revenues ............. 2,325 2,839
------------- -------------
Total liabilities .............................. $ 32,711 $ 28,588
------------- -------------

SHAREHOLDERS' EQUITY:
Common stock, without par value,
200,000,000 shares authorized; 53,717,339 and
52,252,086 shares issued and outstanding,
respectively ................................... 87,616 75,627
Retained earnings .................................. 47,896 32,875
Cumulative translation adjustment .................. (1,535) (625)
------------- -------------
Total shareholders' equity ..................... 133,977 107,877
------------- -------------
Total liabilities and shareholders' equity ..... $ 166,688 $ 136,465
============= =============

See notes to consolidated financial statements.

4
TEKELEC
CONSOLIDATED INCOME STATEMENTS
(unaudited)

Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------- --------------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
(thousands, except per share data)

REVENUES:
Sales to third parties ....................... $ 41,669 $ 24,279 $ 75,367 $ 43,619
Sales to related parties ..................... 1,280 798 2,490 2,035
------------- ------------- ------------- -------------
Total revenues ........................... 42,949 25,077 77,857 45,654

COSTS AND EXPENSES:
Cost of goods sold ........................... 14,131 9,012 25,536 15,690
Research and development ..................... 5,783 4,789 11,351 9,257
Selling, general and administrative .......... 10,659 7,914 20,292 15,481
Insurance recovery ........................... -- -- (1,663) --
------------- ------------- ------------- -------------
Total costs and expenses ................. 30,573 21,715 55,516 40,428
------------- ------------- ------------- -------------

Income from operations ........................... 12,376 3,362 22,341 5,226
Other income (expense):
Interest, net ................................ 1,150 513 2,129 1,029
Other, net ................................... (38) (29) (247) (12)
------------- ------------- ------------- -------------
Total other income ....................... 1,112 484 1,882 1,017
------------- ------------- ------------- -------------

Income before provision for income taxes ......... 13,488 3,846 24,223 6,243
Provision for income taxes ................... 5,123 476 9,202 1,245
------------- ------------- ------------- -------------
NET INCOME ............................... $ 8,365 $ 3,370 $ 15,021 $ 4,998
============= ============= ============= =============

EARNINGS PER SHARE:
Basic ........................................ $ 0.16 $ 0.07 $ 0.28 $ 0.10
Diluted ...................................... 0.14 0.06 0.26 0.09

WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic ........................................ 53,434 49,856 53,043 49,353
Diluted ...................................... 59,049 55,176 58,760 54,257

See notes to consolidated financial statements.

5
TEKELEC
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)

NET INCOME ....................................... $ 8,365 $ 3,370 $ 15,021 $ 4,998

Other comprehensive income:
Foreign currency translation adjustments ..... (607) 1,128 (910) 331
------------- ------------- ------------- -------------
COMPREHENSIVE INCOME ............................. $ 7,758 $ 4,498 $ 14,111 $ 5,329
============= ============= ============= =============

See notes to consolidated financial statements.

6
TEKELEC
CONSOLIDATED STATEMENTS OF CASH FLOW
(unaudited)

Six Months Ended
June 30,
--------------------------------
1998 1997
------------- -------------
(thousands)

CASH FLOW FROM OPERATING ACTIVITIES:
Net income .................................................. $ 15,021 $ 4,998
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ............................... 2,722 2,228
Deferred income taxes ....................................... (245) --
Changes in current assets and liabilities:
Accounts and notes receivable ........................... (8,705) (6,509)
Inventories ............................................. 384 (4,784)
Amounts due from related parties ........................ 441 7
Income taxes receivable ................................. 733 --
Prepaid expenses and other current assets ............... (422) (1,836)
Trade accounts payable .................................. 2,254 186
Accrued expenses ........................................ 2,449 1
Accrued payroll and related expenses .................... (3,026) (26)
Deferred revenues ....................................... 1,401 6,694
Income taxes payable .................................... 8,170 (192)
------------- -------------
Total adjustments ....................................... 6,156 (4,231)
------------- -------------
Net cash provided by operating activities .............. 21,177 767
------------- -------------
CASH FLOW FROM INVESTING ACTIVITIES:
Proceeds from maturity of available-for-sale securities ..... 17,000 15,000
Purchase of available-for-sale securities ................... (25,409) (8,051)
Purchase of property and equipment .......................... (2,704) (3,304)
(Increase) Decrease in other assets ......................... (64) 11
------------- -------------
Net cash provided by (used in) investing activities ..... (11,177) 3,656
------------- -------------
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock ...................... 5,219 3,337
------------- -------------
Net cash provided by financing activities ............... 5,219 3,337
------------- -------------
Effect of exchange rate changes on cash ......................... (767) 293
------------- -------------
Net change in cash and cash equivalents ..................... 14,452 8,053
Cash and cash equivalents at beginning of period ................ 38,748 17,211
------------- -------------
Cash and cash equivalents at end of period ...................... $ 53,200 $ 25,264
============= =============

SUPPLEMENTAL DISCLOSURE OF NON-CASH FLOW ACTIVITY:
Tax benefit related to stock options ........................ $ 6,770 $ --

See notes to consolidated financial statements.

7
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, 1997, 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, operating results and cash flows 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. For
financial statement presentation purposes, however, the reporting periods are
referred to as ended on the last calendar day of the quarter. The accompanying
financial statements for the three and six months ended June 30, 1998 and 1997
are for the thirteen and twenty-six weeks ended July 3, 1998 and June 27, 1997,
respectively.

In 1998, the Company adopted Statement of Position (SOP) 97-2, "Software
Revenue Recognition," which addresses software revenue recognition under
generally accepted accounting principles. The adoption of SOP 97-2 did not
result in a significant change in the Company's revenue recognition practices.

In 1998, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 130, "Reporting Comprehensive Income," and accordingly has included a
separate Statement of Comprehensive Income. Comprehensive income generally
represents all changes in shareholders' equity during the period except those
resulting from investments by, or distributions to, shareholders.

These consolidated financial statements should be read in conjunction
with the consolidated financial statements for the year ended December 31, 1997
and the notes thereto in the Company's Annual Report on Form 10-K for the year
ended December 31, 1997.

8
B. STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NOT YET ADOPTED

In June 1997, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 131, "Disclosures about Segments of an Enterprise and
Related Information." SFAS No. 131 establishes standards for public enterprises'
reporting of 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; however, the interim reporting
provisions of SFAS No. 131 are not required to be applied in the initial year of
adoption. Management is currently evaluating the requirements of SFAS No. 131.

C. CERTAIN BALANCE SHEET ITEMS

The components of inventories are:

JUNE 30, December 31,
1998 1997
------------- -------------
(thousands)

Raw materials ......................................... $ 3,915 $ 3,738
Work in process ....................................... 1,593 2,448
Finished goods ........................................ 5,314 5,095
------------- -------------
$ 10,822 $ 11,281
============= =============

Property and equipment consist of the following:

Manufacturing and development equipment ............... $ 19,157 $ 17,645
Furniture and office equipment ........................ 8,413 7,773
Demonstration equipment ............................... 3,755 3,964
Leasehold improvements ................................ 1,471 1,397
------------- -------------
32,796 30,779

Less, accumulated depreciation and amortization ....... (23,026) (20,938)
------------- -------------
Property and equipment, net ........................... $ 9,770 $ 9,841
============= =============

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.

E. INCOME TAXES

For the three- and six-month periods ended June 30, 1998, an estimated
effective tax rate of 38% was applied as compared with effective tax rates of
12% and 20% for the three- and six-month periods ended June 30, 1997,
respectively, and represented federal, state and foreign taxes on the Company's
income reduced primarily by research and development and foreign tax credits.
The provision for the three- and six-month periods ended June 30, 1997 were
principally foreign taxes on the income of the Company's Japanese subsidiary and
the provision for taxes on the Company's U.S.

9
taxable income at the federal alternative minimum tax rate and applicable state
taxes, and reflected the Company's ability to utilize a portion of its prior
years' U.S. loss carryforwards.

F. BORROWINGS

In July 1998, the Company renewed its line of credit with a U.S. bank
and increased the maximum credit available under this line to $15.0 million. The
company also has lines of credit aggregating $2.5 million available to its
Japanese subsidiary from various Japan-based banks.

The Company's $15.0 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 June 30, 1998), and expires June 30, 2000 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 $2.5 million with interest at the Japanese prime
rate (1.625% at June 30, 1998) plus 0.125% per annum which expire between
November 20, 1998, and March 31, 1999, if not renewed. There have been no
borrowings under these lines of credit.

G. MAJOR CUSTOMERS

Sales to Telkom SA Limited represented 14% and 16% of revenues for the
three- and six-month periods ended June 30, 1998, respectively, and sales to
Nextel represented 12% of revenues for the three-month period ended June 30,
1998. Sales to Bell Atlantic Corporation represented 15% and 13% of revenues for
the three- and six-month periods ended June 30, 1997, respectively, and sales to
Nippon Telegraph & Telephone represented 11% of revenues for the six-month
period ended June 30, 1997.

10
H. EARNINGS PER SHARE

The following table provides a reconciliation of the numerators and
denominators of the basic and diluted earnings per-share computations for the
three- and six-month periods ended June 30, 1998 and 1997:

NET INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
------------- ------------- ---------
FOR THE THREE MONTHS ENDED JUNE 30, 1998: (thousands except per share amount)

Basic EPS ................................... $ 8,365 53,434 $ 0.16
Effect of Dilutive Securities - Stock
Options and Warrants .................... -- 5,615
------------- -------------
Diluted EPS ................................. $ 8,365 59,049 $ 0.14
============= =============

FOR THE THREE MONTHS ENDED JUNE 30, 1997:

Basic EPS ................................... $ 3,370 49,856 $ 0.07
Effect of Dilutive Securities - Stock
Options and Warrants .................... -- 5,320
------------- -------------
Diluted EPS ................................. $ 3,370 55,176 $ 0.06
============= =============

FOR THE SIX MONTHS ENDED JUNE 30, 1998:

Basic EPS ................................... $ 15,021 53,043 $ 0.28
Effect of Dilutive Securities - Stock
Options and Warrants .................... -- 5,717
------------- -------------
Diluted EPS ................................. $ 15,021 58,760 $ 0.26
============= =============

FOR THE SIX MONTHS ENDED JUNE 30, 1997:

Basic EPS ................................... $ 4,998 49,353 $ 0.10
Effect of Dilutive Securities - Stock
Options and Warrants .................... -- 4,904
------------- -------------
Diluted EPS ................................. $ 4,998 54,257 $ 0.09
============= =============

I. COMMON STOCK

All references to numbers of shares and per share amounts have been
retroactively adjusted to reflect the two-for-one split of the Company's common
stock distributed July 6, 1998 to all shareholders of record on June 19, 1998.

11
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, 1997. 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 consolidated income statement items bear to total
revenues:

Percentage of Revenues
--------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- ------------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------

Revenues ............................ 100.0% 100.0% 100.0% 100.0%
Cost of goods sold .................. 32.9 35.9 32.8 34.4
------------- ------------- ------------- -------------
Gross profit ........................ 67.1 64.1 67.2 65.6

Research and development ............ 13.5 19.1 14.6 20.3
Selling, general & administrative ... 24.8 31.6 26.0 33.9
Insurance recovery .................. -- -- (2.1) --
------------- ------------- ------------- -------------
Total operating expenses ............ 38.3 50.7 38.5 54.2
------------- ------------- ------------- -------------

Income from operations .............. 28.8 13.4 28.7 11.4

Interest and other income, net ...... 2.6 1.9 2.4 2.2
------------- ------------- ------------- -------------
Income before provision for
income taxes ...................... 31.4 15.3 31.1 13.6
Provision for income taxes .......... 11.9 1.9 11.8 2.7
------------- ------------- ------------- -------------
Net income .......................... 19.5% 13.4% 19.3% 10.9%
============= ============= ============= =============

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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 Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------

Network switching ................. 65% 52% 63% 47%
Intelligent network diagnostics ... 28 31 28 35
Data network diagnostics .......... 7 17 9 18
------------- ------------- ------------- -------------
Total ......................... 100% 100% 100% 100%
============= ============= ============= =============

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

Percentage of Revenues
-----------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------

North America .......... 62% 73% 59% 69%
Japan .................. 12 13 14 18
Europe ................. 6 5 5 5
Rest of the World ...... 20 9 22 8
----------- ----------- ----------- -----------
Total ............. 100% 100% 100% 100%
=========== =========== =========== ===========

THREE MONTHS ENDED JUNE 30, 1998 COMPARED WITH THE THREE MONTHS ENDED
JUNE 30, 1997

Revenues. The Company's revenues increased by $17.9 million, or 71%,
during the second quarter of 1998 due primarily to higher sales of network
switching products and intelligent network diagnostics products, partially
offset by lower sales of data network diagnostics products.

Revenues from switching products increased by $15.1 million, or 116%, to
$28.1 million due primarily to increased EAGLE STP market acceptance worldwide
and secondarily to higher sales of software enhancements and upgrades to the
Company's larger EAGLE STP installed base.

Revenues from intelligent network diagnostics products increased by $4.0
million, or 51%, due primarily to higher sales of the Company's MGTS products
internationally and sales of MGTS-related development services in Japan.

13
Revenues from data network diagnostics products decreased by $1.2
million, or 30%, due to lower sales of the Company's Chameleon products,
particularly in Japan, partially offset by increased sales of third-party data
diagnostics products in Japan by the Company's Japanese subsidiary.

Revenues in North America increased by $8.4 million, or 46%, primarily
as a result of higher EAGLE STP sales. Sales in Japan increased by $1.9 million,
or 59%, due to higher sales of MGTS-related development services and third-party
data diagnostics products, partially offset by lower Chameleon product sales.
Revenues in Europe increased by $1.2 million, or 102%, due to higher EAGLE STP
and MGTS product sales. Other international revenues increased by $6.3 million,
or 279%, due primarily to a large EAGLE STP sale in South Africa.

The impact of exchange rate fluctuations on currency translations
decreased revenues by $826,000, or 2%, and decreased net income by $13,000, or
less than 1%, in the second quarter of 1998.

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 switching and intelligent network diagnostics products, particularly
the EAGLE STP product, and new applications for the EAGLE STP. The Company
expects that switching product sales will continue to grow in 1998 both in
dollars and as a percentage of total revenues, although at a lower rate of
growth than in 1997.

Gross Profit. Gross profit as a percentage of revenues increased to
67.1% in the second quarter of 1998 compared with 64.1% in the second quarter of
1997. Overall gross profit percentage benefited from higher switching product
margins due to sales of larger EAGLE STP systems combined with increased
revenues from STP software and upgrades, and improved manufacturing efficiencies
as a result of higher sales volumes.

Research and Development. Research and development expenses increased
overall by $1.0 million, or 21%, and decreased as a percentage of revenue to 14%
in the second quarter of 1998 from 19% in the second quarter of 1997. The dollar
increase was attributable principally to increased expenses incurred in
connection with the hiring of additional personnel for product development and
enhancements primarily for switching and intelligent network diagnostics
products. Based on expected revenues and expense levels, the Company believes
that research and development expenses will continue to be higher in dollars and
lower as a percentage of total revenues for the remainder of 1998 when compared
with 1997.

Selling, General and Administrative Expenses. Although selling, general
and administrative expenses increased by $2.7 million, or 35%, such expenses
decreased as a percentage of revenues to 25% in the second quarter of 1998 from
32% in the second quarter of 1997. The dollar increase was primarily due to
increased personnel and commission expenses incurred as a result of the higher
sales levels. Based on expected revenues and expense levels, the Company
believes that selling, general and administrative expenses will continue to be
higher in dollars and lower as a percentage of total revenues for the remainder
of 1998 when compared with 1997.

14
Interest Income. Interest income increased by $637,000, or 124%, during
the second quarter of 1998 due primarily to higher cash and investment balances
compared to the second quarter of 1997.

Income Taxes. For the second quarter of 1998, an estimated effective tax
rate of 38% was applied as compared with an effective tax rate of 12% for the
second quarter of 1997, and represented federal, state and foreign taxes on the
Company's income reduced primarily by research and development and foreign tax
credits. The provision for the second quarter of 1997 was principally foreign
taxes on the income of the Company's Japanese subsidiary and the provision for
taxes on the Company's U.S. taxable income at the federal alternative minimum
tax rate and applicable state taxes, and reflected the Company's ability to
utilize a portion of its prior years' U.S. loss carryforwards.

The Company expects that its effective tax rate for the remainder of
1998 should approximate 38%; however, changes in assumptions regarding the
Company's ability to utilize its deferred income tax assets and the level of
various tax credits generated during 1998 may cause the effective tax rate to
vary.

SIX MONTHS ENDED JUNE 30, 1998 COMPARED WITH THE SIX MONTHS ENDED
JUNE 30, 1997

Revenues. The Company's revenues increased by $32.2 million, or 71%,
during the first six months of 1998 due to higher sales primarily of network
switching products and secondarily of intelligent network diagnostics products.

Revenues from switching products increased by $27.7 million, or 128%, to
$49.4 million primarily due to increased EAGLE STP market acceptance worldwide
including substantially higher international sales and higher sales of EAGLE STP
features, software enhancements and upgrades to the Company's larger EAGLE STP
installed base.

Revenues from intelligent network diagnostics products increased by $5.8
million, or 36%, to $21.7 million, due primarily to sales of MGTS-related
development services in Japan and continued strong demand for the Company's MGTS
products worldwide.

Revenues from data network diagnostics products decreased by $1.3
million, or 16%, due primarily to lower second quarter sales of the Company's
Chameleon products, particularly in Japan, partially offset by increased sales
of third party data diagnostics products in Japan by the Company's Japanese
subsidiary.

15
Revenues in North America increased by $14.6 million, or 46%, primarily
as a result of higher EAGLE STP sales. Sales in Japan increased by $2.9 million,
or 36%, due to higher sales of MGTS-related development services and third party
data diagnostics products, partially offset by lower Chameleon product sales.
Revenues in Europe increased by $1.6 million, or 66%, due primarily to higher
MGTS and EAGLE STP product sales. Other international revenues increased by
$13.2 million, or 368%, due primarily to large EAGLE STP sales in South Africa.

The impact of exchange rate fluctuations on currency translations
decreased revenues by $1.2 million, or 1%, and decreased net income by $39,000,
or less than 1%, in the first six months of 1998.

Gross Profit. Gross profit as a percentage of revenues increased to
67.2% in the first six months of 1998 compared with 65.6% in the first six
months of 1997, due to higher switching product margins attributable primarily
to sales of larger EAGLE STP systems and increased revenues from STP software
and upgrades, and improved manufacturing efficiencies due to higher sales
volumes.

Research and Development. Although research and development expenses
increased overall by $2.1 million, or 23%, such expenses decreased as a
percentage of revenue to 15% in the first six months of 1998 from 20% in the
first six months of 1997. The dollar increase was attributable principally to
increased expenses incurred in connection with the hiring of additional
personnel for product development and enhancements primarily for switching and
intelligent network diagnostics products.

Selling, General and Administrative Expenses. Although selling, general
and administrative expenses increased by $4.8 million, or 31%, such expenses
decreased as a percentage of revenues to 26% in the first six months of 1998
from 34% in the first six months of 1997. The dollar increase was due primarily
to increased personnel and commission expenses incurred as a result of the
higher sales levels.

Insurance Recovery. During the first quarter of 1998, the Company
recorded the proceeds from the settlement of an insurance claim in the amount of
approximately $1.7 million, net of applicable costs. The net proceeds were
recorded as a decrease in operating expenses in the first quarter of 1998.

Interest Income. Interest income increased by $1.1 million, or 107%,
during the first six months of 1998 due primarily to higher cash and investment
balances compared to the first six months of 1997.

Income Taxes. For the first six months of 1998, an estimated effective tax
rate of 38% was applied as compared with an effective tax rate of 20% for the
first six months of 1997, and represented federal, state and foreign taxes on
the Company's income reduced primarily by research and development and foreign
tax credits. The provision for 1997 was principally foreign taxes on the income
of the Company's Japanese subsidiary and the provision for taxes on the
Company's U.S.

16
taxable income at the federal alternative minimum tax rate and applicable state
taxes, and reflected the Company's ability to utilize a portion of its prior
years' U.S. loss carryforwards.

LIQUIDITY AND CAPITAL RESOURCES

During the six-month period ended June 30, 1998, cash and cash
equivalents increased by $14.5 million to $53.2 million, after a net transfer of
approximately $8.4 million to short-term and long-term investments. Operating
activities, net of the effects of exchange rate changes on cash, provided $20.4
million. Financing activities, which represented proceeds from the issuance of
Common Stock upon the exercise of options and warrants, provided $5.2 million,
and $2.7 million was used for capital expenditures.

Accounts receivable, including amounts due from related parties,
increased by 25% during the first six months of 1998 due primarily to higher
international sales in the second quarter of 1998 compared to the fourth quarter
of 1997, which typically carry longer payment terms. Trade accounts payable and
accrued expenses increased by 42% and 41%, respectively, during the first six
months of 1998, primarily due to the timing of purchases, and accrued payroll
decreased by 44% primarily due to the payment in 1998 of 1997 employee bonuses.
Deferred revenues increased by 13% during the first six months of 1998 primarily
as a result of the timing of EAGLE STP installations and related revenues.

Capital expenditures of $2.7 million during the first six months of 1998
represented the planned addition of equipment principally for research and
development, manufacturing operations and facility expansion.

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 $2.5 million with interest at the Japanese prime
rate (1.625% at June 30, 1998) plus 0.125% per annum which expire between
November 20, 1998 and March 31, 1999, if not renewed. There have been no
borrowings under these lines of credit.

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.

17
The Company believes that existing working capital, funds generated from
operations and 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 June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 131 establishes standards
for public enterprises' reporting of 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;
however, the interim reporting provisions of SFAS No. 131 are not required to be
applied in the initial year of adoption. Management is currently evaluating the
requirements of SFAS No. 131.

READINESS FOR YEAR 2000

As the year 2000 approaches, a critical industry-wide issue has emerged
regarding how existing application software programs and operating systems can
accommodate the year 2000 date value. The Company is currently conducting a
comprehensive review of its computer systems, products and significant vendors
to identify the systems and products which could be affected by this issue.
Based on the results of the review conducted to date, management does not
anticipate that the Company will incur significant remediation expenses or be
required to invest heavily in computer system or product improvements in order
to be year 2000 compliant. To the extent the Company's products, systems or
significant vendors are not fully year 2000 compliant, there can be no assurance
that such noncompliance will not result in product failures, systems
interruptions or significant costs necessary to update software that, alone or
in the aggregate, would not have a material adverse effect on the Company's
business, financial condition, results of operations, cash flows or business
prospects.

18
"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995

The statements which are not historical facts contained in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations are forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995 that reflect the current belief,
expectations or intent of the Company's management. These statements are subject
to and 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 certain
of the Company's other Securities and Exchange Commission filings. Actual
results may differ materially from those expressed or implied in such
forward-looking statements.

19
PART II -- OTHER INFORMATION

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

(a) On May 15, 1998, the Company held its 1998 Annual Meeting of
Shareholders (the "Annual Meeting").

(b) At the Annual Meeting, the following persons were elected as
directors of the Company. The number of votes cast for each director, as well as
the number of votes withheld, are listed opposite each director's name.

NAME OF DIRECTOR VOTES CAST FOR DIRECTOR VOTES WITHHELD
- ---------------- ----------------------- --------------

Robert V. Adams 42,651,260 1,432,774
Jean-Claude Asscher 43,628,580 455,454
Daniel L. Brenner 43,628,580 455,454
Michael L. Margolis 43,628,580 455,454
Howard Oringer 43,628,580 455,454
Jon F. Rager 43,628,580 455,454

(c) At the Annual Meeting, the shareholders approved, with 35,775,316
votes cast in favor and 8,266,742 votes cast against, an amendment to the
Company's 1994 Stock Option Plan increasing the aggregate number of shares of
Common Stock authorized for issuance thereunder from 12,000,000 to 14,000,000.
There were 41,976 abstentions and no broker nonvotes with respect to this
matter.

(d) At the Annual Meeting, with 44,013,812 votes cast in favor, the
shareholders ratified the appointment of Coopers & Lybrand L.L.P. (now known as
PricewaterhouseCoopers LLP) as independent accountants of the Company for the
year ending December 31, 1998. 20,778 votes were cast against such ratification,
and there were 49,444 abstentions with respect to this matter.

All share numbers referenced above have been retroactively adjusted to
reflect the two-for-one stock split of the Company's common stock distributed
July 6, 1998 to shareholders of record on June 19, 1998.

ITEM 5. OTHER INFORMATION

Notice of any shareholder proposal to be presented at the Company's Annual
Meeting of Shareholders to be held in 1999 that is not submitted to the Company
pursuant to SEC Rule 14a-8 will be considered untimely if not received by the
Company on or before February 20, 1999.

20
PART II -- OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

3.1 Amended and Restated Articles of Incorporation of the
Registrant

10.1 Employment Offer Letter dated April 1, 1998 between the
Registrant and Ronald W. Buckly

10.2 Credit Agreement dated October 22, 1996 between the Registrant
and Imperial Bank (1), as amended by First Amendment to Credit
Agreement dated July 15, 1998, together with Promissory Note of
the Registrant dated July 15, 1998

10.3 1994 Stock Option Plan, including forms of stock option
agreements(2), as amended February 4, 1995(3), March 3, 1995(3),
January 27, 1996(4), February 26, 1997(5), March 19, 1997(5)
and March 20, 1998

27.1 Financial Data Schedule (provided for the information of the
Securities and Exchange Commission only)

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

(1) Incorporated by reference to the Registrants Annual Report on Form
10-K (File No. 0-15135) for the year ended December 31, 1997.

(2) Incorporated by reference to the Registrant's Registration Statement
on Form S-8 (Registration No. 33-82124) filed with the Commission on
July 28, 1994.

(3) Incorporated by reference to the Registrant's Registration Statement
on Form S-8 (Registration No. 33-60611) filed with the Commission on
June 27, 1995.

(4) Incorporated by reference to the Registrant's Registration Statement
on Form S-8 (Registration No. 333-05933) filed with the Commission
on June 13, 1996.

(5) Incorporated by reference to the Registrant's Registration Statement
on Form S-8 (Registration No. 333-28887) filed with the Commission
on June 10, 1997.

21
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

August 13, 1998

/s/ Michael L. Margolis
-------------------------------------
Michael L. Margolis
President and Chief Executive Officer
(Duly authorized officer)

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

22
INDEX TO EXHIBITS

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

3.1 Amended and Restated Articles of Incorporation of the Registrant

10.1 Employment Offer Letter dated April 1, 1998 between the
Registrant and Ronald W. Buckly

10.2 First Amendment to Credit Agreement dated July 15, 1998, between
the Registrant and Imperial Bank, together with Promissory Note
of the Registrant dated July 15, 1998

10.3 Amendment to 1994 Stock Option Plan dated March 20, 1998

27.1 Financial Data Schedule (provided for the information of the
Securities and Exchange Commission only)