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Tekelec Buys Time in Q4

Light Reading
News Analysis
Light Reading
2/25/2005

Tekelec Inc.'s (Nasdaq: TKLC) core signaling business grew 39 percent in the fourth quarter of 2004, buying the Calabasas, Calif.-based company more time to grow its fledgling soft-switching business.

Tekelec earned a fourth-quarter 2004 profit of $13.3 million, or 18 cents per diluted share, on revenues of $116 million, compared with earnings of $7.3 million, or 11 cents a share, on revenues of $75 million during the year-ago quarter.

Analysts seemed pleased with the earnings -- they had expected profits of 17 cents a share on revenues of $115.5 million, according to Thomson First Call.

Not all investors seemed so happy, though. Tekelec stock was trading down $1.69 to $18 in early morning trading Friday.

The full report of Tekelec’s quarterly earnings was delayed by a Securities and Exchange Commission (SEC) inquiry into the acquisition of its Santera subsidiary. But, after a bit of back and forth, the inquiry was resolved and the original revenue numbers the company reported Feb. 9 were confirmed as correct.

For full-year 2004, Tekelec reported earnings of $37.6 million, compared to $18.5 million in 2003. Revenue for the full year was $397.1 million, compared to $263.7 million in 2003; analysts had expected $396.7 million.

Most folks see softswitches as Tekelec’s future; and Tekelec has acquired three next-gen voice switching companies -- Taqua, Santera, and VocalData Inc. -- to quickly put itself in contention in that market. Of Tekelec’s $20.4 million in revenue from its switching business during the quarter, sales of Santera gear contributed $16.8 million, sales of Taqua equipment contributed $2.2 million, and sales of VocalData equipment added $1.4 million.

Santera’s revenues grew 32 percent, but the subsidiary has yet to post a profit. Tekelec CEO Fred Lax told analysts Santera would break even in the third quarter of 2005.

Lax also told analysts that a fifth Tier 1 carrier, this time in France, has begun trials of its switching equipment. “It’s not a ‘win’ per se, but we feel pretty good about the trial and it will likely result in a full deployment,” Lax says. Four of the carriers currently testing the switches are wireless carriers.

The worry about Tekelec is that growth of the signaling business is expected to flatten out over the coming quarters. In theory, the next-gen switching business will take over. Lax says he expects growth of the signaling business to slow to the mid-teens this year.

But gross margins from the signaling business are consistently around 75 percent, while gross margins in the switching business are usually in the mid-50s, according to Tekelec. So overall gross margins will surely decline as the revenue mix becomes more weighted toward switching revenue, says Janney Montgomery Scott LLC analyst Bill Gildea.

Much of the reason for the strong performance in the signaling business over the past year is increased sales to international customers. “Fred Lax said that he would like to get international business to contribute 40 percent of revenue, and he has put together a pretty good start -- it’s at 31 percent right now,” says Gildea.

The earnings announcement comes as Tekelec announces a new five-year contract with the Services division of SBC Communications Inc. (NYSE: SBC), in which that company will deploy approximately 20 of its Eagle 5 signaling systems. Lax hopes the win will provide an entrée for his company to also begin selling its softswitches to SBC. “We went in and displaced the incumbent,” Lax says. “That certainly gives us a beachhead to work from.”

Tekelec expects revenues of $114 million to $117 million in the first quarter of 2005, while analysts are expecting revenues of $113.9 million.

— Mark Sullivan, Reporter, Light Reading

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