FORM 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)


þ		Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 27, 2009


o		Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission File Number: 000-27312

TOLLGRADE COMMUNICATIONS, INC.

(Exact name of registrant as specified in its charter)


Pennsylvania (State or other jurisdiction of incorporation or organization)		25-1537134 (I.R.S. Employer Identification No.)

493 Nixon Rd.
Cheswick, PA 15024
(Address of principal executive offices, including zip code)

412-820-1400
(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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

As of July 25, 2009, there were 12,682,234 shares of the Registrant’s Common Stock, $0.20 par value per share, outstanding, and no shares of the Registrant’s Preferred Stock, $1.00 par value per share, outstanding.

PART I. FINANCIAL INFORMATION

Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value) (Unaudited)


	June 27, 2009			December 31, 2008

ASSETS
Current assets:
Cash and cash equivalents	$	63,718		$	57,976
Short-term investments		199			2,419
Accounts receivable:
Trade, net of allowance for doubtful accounts of $284 in 2009 and $222 in 2008		10,427			9,361
Other		1,097			632
Inventories		6,420			7,843
Prepaid expenses and deposits		1,034			1,200
Deferred and refundable tax assets		337			453
Current assets related to discontinued operations		—			4,314

Total current assets		83,232			84,198
Property and equipment, net		3,394			2,661
Intangibles		35,548			36,678
Deferred tax assets		65			81
Other assets		441			262
Noncurrent assets related to discontinued operations		—			467

Total assets	$	122,680		$	124,347

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	779		$	1,198
Accrued warranty		653			927
Accrued expenses		2,429			1,514
Accrued salaries and wages		547			363
Accrued royalties payable		55			284
Income taxes payable		253			267
Deferred revenue		3,742			3,024
Current liabilities related to discontinued operations		—			1,146

Total current liabilities		8,458			8,723
Pension obligation		971			889
Deferred tax liabilities		1,758			1,792
Other tax liabilities		606			489

Total liabilities		11,793			11,893

Commitments and contingencies

Shareholders’ equity:
Common stock, $0.20 par value; 50,000 authorized shares, issued shares, 13,754 in 2009 and 13,733 in 2008		2,744			2,744
Additional paid-in capital		74,468			73,923
Treasury stock, at cost, 1,072 shares in 2009 and 2008		(8,081	)		(8,081	)
Retained earnings		43,016			45,748
Accumulated other comprehensive loss		(1,260	)		(1,880	)

Total shareholders’ equity		110,887			112,454

Total liabilities and shareholders’ equity	$	122,680		$	124,347

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data) (Unaudited)


	Three Months Ended						Six Months Ended
	June 27,			June 28,			June 27,			June 28,
	2009			2008			2009			2008

Revenues:
Products	$	4,141		$	6,433		$	9,970		$	12,000
Services		6,502			5,681			10,990			11,303

Total revenues		10,643			12,114			20,960			23,303

Cost of sales:
Products		2,769			3,203			5,554			5,943
Services		1,935			1,806			3,359			3,646
Amortization		649			782			1,290			1,581
Impairment		—			—			—			202
Inventory write-down		—			—			—			738
Restructuring / severance		93			—			276			16

Total cost of sales		5,446			5,791			10,479			12,126

Gross profit		5,197			6,323			10,481			11,177

Operating expenses:
Selling and marketing		1,628			1,728			3,283			3,690
General and administrative		2,839			2,237			5,414			4,798
Research and development		2,405			2,593			4,441			5,564
Restructuring / severance		3			47			66			453

Total operating expenses		6,875			6,605			13,204			14,505

Loss from operations		(1,678	)		(282	)		(2,723	)		(3,328	)
Other income		391			310			509			799

(Loss) income before income taxes		(1,287	)		28			(2,214	)		(2,529	)
Provision for income taxes		198			200			295			649

Loss from continuing operations		(1,485	)		(172	)		(2,509	)		(3,178	)

Loss from discontinued operations, net of income taxes		(24	)		(83	)		(223	)		(3,581	)

Net loss	$	(1,509	)	$	(255	)	$	(2,732	)	$	(6,759	)


Earnings per share information:
Weighted average shares of common stock and equivalents:
Basic		12,681			13,158			12,680			13,158
Diluted		12,681			13,158			12,680			13,158

Loss per common and common equivalent shares from continuing operations:
Basic	$	(0.12	)	$	(0.01	)	$	(0.20	)	$	(0.24	)
Diluted	$	(0.12	)	$	(0.01	)	$	(0.20	)	$	(0.24	)

Loss per common and common equivalent shares from discontinued operations:
Basic	$	0.00		$	(0.01	)	$	(0.02	)	$	(0.27	)
Diluted	$	0.00		$	(0.01	)	$	(0.02	)	$	(0.27	)

Net loss per common and common equivalent shares:
Basic	$	(0.12	)	$	(0.02	)	$	(0.22	)	$	(0.51	)
Diluted	$	(0.12	)	$	(0.02	)	$	(0.22	)	$	(0.51	)

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands) (Unaudited)


	Six Months Ended
	June 27, 2009			June 28, 2008

Cash flows from operating activities :
Net loss	$	(2,732	)	$	(6,759	)
Loss from discontinued operations		223			3,581
Adjustments to reconcile net loss to net cash provided by operating activities
Impairment of goodwill & intangible assets		—			202
Depreciation and amortization		1,850			2,328
Stock-based compensation expense		545			157
Valuation allowance		—			129
Deferred income taxes		180			19
Restructuring and inventory write-down		—			770
Provision for losses on inventory		226			175
Provision for allowance for doubtful accounts		66			31
Changes in assets and liabilities:
Accounts receivable-trade		(1,049	)		767
Accounts receivable-other		307			492
Inventories		1,197			(165	)
Prepaid expenses and other assets		388			199
Accounts payable		561			(3,057	)
Accrued warranty		(274	)		(109	)
Accrued expenses and deferred income		(496	)		1,619
Accrued royalties payable		(230	)		(600	)
Income taxes payable		(19	)		517

Net cash provided by operating activities of discontinued operations		12			3

Net cash provided by operating activities		755			299

Cash flows from investing activities:
Proceeds on sale of cable product line		3,012			—
Proceeds from note receivable		17			—
Purchase of short-term investments		—			(2,274	)
Redemption/maturity of short-term investments		2,220			464
Purchase of assets		(300	)		—
Capital expenditure		(399	)		(399	)
Sale of assets held for sale		—			262

Net cash used in investing activities of discontinued operations		(57	)		(3	)

Net cash provided by (used in) investing activities		4,493			(1,950	)

Net increase (decrease) in cash and cash equivalents		5,248			(1,651	)
Effect of exchange rate changes on cash and cash equivalents		494			309
Cash and cash equivalents, beginning of period		57,976			58,222

Cash and cash equivalents, end of period	$	63,718		$	56,880

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(In thousands) (Unaudited)


													Accumulated
													Other
	Common Stock				Additional		Treasury			Retained			Comprehensive						Comprehensive
	Shares		Amount		Paid-In		Stock			Earnings			Loss			Total			Loss

Balance at December 31, 2008		13,733	$	2,744	$	73,923	$	(8,081	)	$	45,748		$	(1,880	)	$	112,454
Compensation expense for options and restricted stock, net		2		—		545		—			—			—			545

Foreign currency translation		—		—		—		—			—			620			620		$	620
Net loss		—		—		—		—			(2,732	)		—			(2,732	)		(2,732	)

Comprehensive income		—		—		—		—			—			—			—		$	(2,112	)

Balance at June 27, 2009		13,735	$	2,744	$	74,468	$	(8,081	)	$	43,016		$	(1,260	)	$	110,887

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

We report our quarterly results for the first three interim periods based on fiscal quarters ending on Saturdays and for the fourth interim period ending on December 31. For the periods presented herein, our fiscal quarters ended June 27, 2009 (13 weeks) and June 28, 2008 (13 weeks). The accompanying unaudited condensed consolidated financial statements included herein have been prepared by Tollgrade Communications, Inc. (the “Company” or “Tollgrade”) in accordance with accounting principles generally accepted in the United States of America for interim financial information and Article 10 of Regulation S-X. The unaudited condensed consolidated financial statements as of and for the three and six month periods ended June 27, 2009 should be read in conjunction with the Company’s consolidated financial statements (and notes thereto) included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. Accordingly, the accompanying unaudited condensed consolidated financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements, although the Company believes that the disclosures are adequate to make the information presented not misleading. In the opinion of Company management, all adjustments considered necessary for a fair statement of the accompanying unaudited condensed consolidated financial statements have been included, and all adjustments are of a normal and recurring nature. Operating results for the three and six month periods ended June 27, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

On January 1, 2009, the Company adopted SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51,” (SFAS 160). SFAS 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This standard defines a noncontrolling interest, previously called a minority interest, as the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. SFAS 160 requires, among other items, that a noncontrolling interest be included in the consolidated statement of financial position within equity separate from the parent’s equity; consolidated net income be reported at amounts inclusive of both the parent’s and noncontrolling interest’s shares and, separately, the amounts of consolidated net income attributable to the parent and noncontrolling interest all on the consolidated statement of operations; and if a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be measured at fair value and a gain or loss be recognized in net income based on such fair value. The adoption of SFAS 160 had no impact on the Company’s consolidated financial statements.

On January 1, 2009, the Company adopted SFAS No. 141 (revised 2007), “Business Combinations,” (SFAS 141(R)), which replaces SFAS No. 141, “Business Combinations,” (SFAS 141) but retains the fundamental requirements in SFAS 141, including that the purchase method be used for all business combinations and for an acquirer to be identified for each business combination. This standard defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control instead of the date that the consideration is transferred. SFAS 141(R) requires an acquirer in a business combination,

including business combinations achieved in stages (step acquisition), to recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. Additionally, SFAS 141(R) requires acquisition-related costs to be expensed in the period in which the costs are incurred and the services are received instead of including such costs as part of the acquisition price. The impact of the adoption of SFAS 141(R) will depend on the nature and extent of business combinations occurring on or after the effective date.

On January 1, 2009, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements,” (SFAS 157) as it relates to nonfinancial assets and nonfinancial liabilities that are not recognized or disclosed at fair value in the financial statements on at least an annual basis. SFAS 157 defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America (GAAP), and expands disclosures about fair value measurements. The provisions of this standard apply to other accounting pronouncements that require or permit fair value measurements and are to be applied prospectively with limited exceptions. See Note 6 for the effect of the adoption of SFAS 157, as it relates to nonfinancial assets and nonfinancial liabilities, on the Company’s consolidated financial statements. The provisions of SFAS 157 will be applied at such time a fair value measurement of a nonfinancial asset or nonfinancial liability is required, which may result in a fair value that is materially different than would have been calculated prior to the adoption of SFAS 157.

On January 1, 2009, the Company adopted FASB Staff Position (FSP) No. FAS 142-3, “Determination of the Useful Life of Intangible Assets,” (FSP FAS 142-3). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets,” (SFAS 142) in order to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R) and other GAAP. The adoption of FSP FAS 142-3 had no impact on the Financial Statements.

On January 1, 2009, the Company adopted FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” (FSP EITF 03-6-1). FSP EITF 03-6-1 states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. The adoption of FSP EITF 03-6-1 had no impact on the Financial Statements.

In April 2009, the FASB issued FASB Staff Position (“FSP”) FAS No. 107-1 and Accounting Principles Board (“APB”) Opinion No. 28-1, Interim Disclosures about Fair Value of Financial Instruments (FSP FAS No. 107-1 and APB Opinion No. 28-1), which amends the disclosure requirements of SFAS No. 107 and APB Opinion No. 28 and requires disclosure about the fair value of its financial instruments whenever it issues summarized financial information for interim reporting periods. FSP FAS No. 107-1 and APB Opinion No. 28-1 are effective for financial statements issued for interim reporting periods ending after June 15, 2009. The adoption of FSP FAS No. 107-1 and APB Opinion No. 28-1 resulted in the Company’s inclusion of the appropriate disclosures in the condensed consolidated financial statements.

In April 2009, the FASB issued FSP FAS No. 115-2 and FAS No. 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (FSP FAS No. 115-2 and FAS No. 124-2), which amends SFAS No. 115 and FSP FAS No. 115-1 and FSP FAS No. 124-1 and conforms changes to other standards including EITF Issue No. 99-20 and AICPA Statement of Position (“SOP”) No. 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer,” and improves the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. FSP FAS No. 115-2 and FAS No. 124-2 are effective for interim and annual reporting periods ending after June 15, 2009. The adoption of FSP FAS No. 115-2 and FAS No. 124-2 had no impact on the Company’s consolidated financial statements.

In April 2009, the FASB issued FSP FAS No. 141R-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies” (“FSP FAS No. 141R-1”). FSP FAS No. 141R-1 amends the provisions in Statement No. 141R for the initial recognition and measurement, subsequent measurement and accounting, and disclosures for assets and liabilities arising from contingencies in business combinations. FSP FAS No. 141R-1 eliminates the distinction between contractual and non-contractual contingencies, including the initial recognition and measurement criteria in Statement No. 141R and instead carries forward most of the provisions in Statement No. 141, “Business Combinations,” for acquired contingencies. FSP FAS 141R-1 is effective for assets and liabilities arising from contingencies in business combinations that occur after January 1, 2009. The adoption of FSP FAS 141R-1 will have an impact on the consolidated financial statements, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of acquisitions consummated after January 1, 2009. It did not have an affect on the second quarter 2009 acquisition.

In April 2009, the FASB issued FSP FAS No. 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (FSP FAS No. 157-4), which provides additional guidance for estimating fair value in accordance with SFAS No. 157, “Fair Value Measurements,” when the volume and level of activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly and applies to all assets and liabilities within the scope of accounting pronouncements that require or permit fair value measurements, except in paragraphs 2 and 3 of SFAS No. 157. FSP FAS No. 157-4 is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of FSP FAS No. 157-4 had no impact on the Company’s consolidated financial statements.

In May 2009, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 165, “Subsequent Events” (SFAS No. 165). The statement establishes principles and requirements for subsequent events. The standard also sets forth the period after the balance sheet date during which management shall evaluate events/transactions that may occur for potential recognition or disclosure in its financial statements. SFAS No. 165 is effective for interim or annual financial periods ending after June 15, 2009. The Company has evaluated subsequent events in accordance with SFAS No. 165 from its interim balance sheet date of June 27, 2009, through August 6, 2009, and concluded that no events or transactions require disclosure or recognition in its financial statements.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In December 2008, the FASB issued FSP 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets.” FSP 132(R)-1 amends SFAS 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. This FSP is effective for fiscal years ending after December 15, 2009. The Company does not expect this adoption to have a material impact on our financial statements.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, “Amendments to FASB Interpretation No. 46(R)” (FAS 167). FAS 167 requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This Statement is effective for fiscal years beginning on or after November 15, 2009. The Company is currently evaluating the impact of the adoption of FAS 167 on its financial position and results of operations.

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles; a replacement of FASB Statement No. 162” (SFAS 168). SFAS 168 establishes the FASB Accounting Standards Codification as the source of authoritative GAAP recognized by the FASB to be applied by non-governmental entities in the preparation of financial statements in conformity with GAAP. Rules and interpretative releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. SFAS 168 is effective for interim and annual periods ending after September 15, 2009. SFAS 168 will not have a material impact on the Company’s consolidated financial statements when adopted.

2. ACQUISITIONS AND DISCONTINUED OPERATIONS

On April 15, 2009, the Company entered into a new, multi-year managed services agreement with a leading global network equipment provider, pursuant to which the Company will provide customer support and engineering services capabilities. In connection with the agreement, the Company paid $0.3 million for certain assets and employees of a division of the global network equipment provider. The acquisition was recorded under the purchase method of accounting in accordance with the provisions of SFAS 141(R), “Business Combinations.” Accordingly, the results of operations of the acquired assets are included in the second quarter 2009 consolidated financial statements of the Company.

On May 27, 2009, the Company completed the sale of its cable product line to private equity buyers in Pittsburgh. The total consideration received by the Company for the sale was $3.4 million, $3.0 million in cash proceeds and $0.4 million in a note receivable. This will allow the Company to continue to focus its business on its core telecommunications markets and customers as the cable product line no longer supported the Company’s refocused growth strategy.

In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long Lived Assets,” the assets and liabilities, results of operations and cash flows of the cable product line have been classified as discontinued operations in the Condensed Consolidated Financial Statements for all periods presented through the date of sale. Cash flows for cable have been segregated in the Condensed Consolidated Statement of Cash Flows as separate line items within operating, investing and financing activities.

In accordance with Emerging Issues Task Force (EITF) Issue no. 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144 in Determining Whether to Report Discontinued Operations,” the Company determined that the operations and cash flows of the cable product line have been eliminated from the ongoing operations of the Company as a result of the disposal transaction and that the Company will not have any significant continuing involvement in the buyer’s operations.

The following table details selected financial information for the cable product line included within discontinued operations:


	Three Months Ended						Six Months Ended
	June 27,			June 28,			June 27,			June 28,
	2009			2008			2009			2008

Revenues:
Products	$	1,111		$	2,057		$	2,376		$	3,631
Services		259			425			723			847

		1,370			2,482			3,099			4,478

Loss from discontinued operations
Loss from discontinued operations, before tax		(24	)		(83	)		(223	)		(3,581	)
Income tax expense		—			—			—			—

Loss from discontinued operations, net of tax		(24	)		(83	)		(223	)		(3,581	)

The major classes of assets and liabilities related to discontinued operations are as follows:


	December 31, 2008

ASSETS
Accounts receivable trade, net of allowance for doubtful accounts	$	1,166
Accounts receivable other		36
Inventories		2,830
Prepaid expenses		249
Property and equipment, net		292
Intangibles and capitalized software, net		175

Assets related to discontinued operations		4,748



LIABILITIES

Accounts payable	$	66
Accrued warranty		664
Accrued expenses		142
Accrued royalties		15
Deferred revenue		259

Liabilities related to discontinued operations		1,146

3. FAIR VALUE MEASUREMENTS

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the

lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:

•

Level 1 — Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

•

Level 2 — Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means; and

•

Level 3 — Inputs that are both significant to the fair value measurement and unobservable.

The fair value of cash equivalents was $53.7 million and $48.0 million at June 27, 2009 and December 31, 2008, respectively. These financial instruments are classified in Level 1 of the fair value hierarchy.

4. STOCK COMPENSATION PLANS AND ACCOUNTING FOR STOCK-BASED COMPENSATION EXPENSE

The Plans

The Company currently sponsors one active stock compensation plan. In March 2006, the Company adopted the 2006 Amended and Restated Long-Term Incentive Compensation Plan (the “2006 Plan”), which was approved by the shareholders on May 9, 2006 and effectively replaced the 1995 Long-Term Incentive Plan, which by its terms does not allow grants to be made after October 15, 2005. The 2006 Plan provides that participants may be directors, officers and other employees. The 2006 Plan authorized up to 1,300,000 shares available for grant. The 1998 Employee Incentive Plan (the “1998 Plan”) by its terms does not allow grants to be made after January 29, 2008. On May 6, 2009, the Board of Directors approved, subject to shareholder approval, an amendment to the 2006 Plan to increase the number of shares authorized thereunder from 1,300,000 to 2,800,000. The amendment was proposed for shareholder approval at the Company’s 2009 Annual Meeting of Shareholders held on August 5, 2009. Final results of voting on that proposal have not yet been determined.

Under the 2006 Plan, participants may be granted various types of equity awards, including restricted shares and/or options to purchase shares of the Company’s common stock. The grant price on any such shares or options is equal to the quoted fair market value of the Company’s shares at the date of the grant, as defined in the 2006 Plan. Restricted shares will vest in accordance with the terms of the applicable award agreement and the 2006 Plan. The 2006 Plan requires that non-performance-based restricted stock grants to employees vest in not less than three years, while performance-based restricted stock grants may vest after one year. Grants of restricted stock to directors may vest after one year. Options granted generally vest over time. Historically, such period has typically been two years with one-third vested at the date of grant, one-third at the end of one year, and one-third at the end of two years. Beginning in December 2007, stock option grants have been made with vesting over three years, with one-third of such grants vesting at the end of each year following the date of grant.

Stock-Based Compensation Expense

During the first quarter of 2009, the Compensation Committee of the Board of Directors approved the grant of a total of 394,000 stock options and 2,351 restricted shares under the 2006 Plan. Of these grants, 30,000 stock options and 2,351 restricted shares were issued to non-employee directors and the remaining 364,000 stock options were issued to employees, including the CEO and other key executive officers. The stock options granted to non-employee directors vested immediately upon issuance. The restricted share award granted to one non-employee director gave the director the right to receive the shares one year following the date of grant, regardless of whether the director is still serving on the Board of Directors, unless the director was removed from the Board for cause during that time. During the one year restriction period, the director can vote the restricted shares, but is not permitted to trade them. The stock options granted to employees vest over a three year period, with one-third vesting on each anniversary of the grant date.

During the second quarter of 2009, the Compensation Committee of the Board of Directors approved the grant of a total of 25,000 stock options to certain key employees in connection with their hiring or promotion. No restricted shares were granted in the second quarter of 2009. The stock options granted to employees vest over a three year period, with one-third vesting on each anniversary of the grant date.

Total stock-based compensation expense recognized from continuing operations under SFAS 123(R) for the three and six month periods ended June 27, 2009 was an expense of $0.2 million and $0.5 million, respectively. Total stock-based compensation expense recognized from continuing operations under SFAS 123(R) for the three and six month periods ended June 28, 2008 was $0.5 million and less than $0.1 million, respectively. The unamortized stock-based compensation expense from continuing operations related to stock options and restricted stock totaled $1.7 million at June 27, 2009.

Total stock-based compensation expense recognized from discontinued operations under SFAS 123(R) for the three and six month periods ended June 27, 2009 and June 28, 2008 was an expense of less then $0.1 million for each period.


	Shares Authorized But Not Granted
	June 27, 2009		December 31, 2008

2006 Long-Term Incentive Compensation Plan		1,259,603		1,220,106

Transactions involving stock options under the Company’s various plans and otherwise are summarized below:

Number of

Range of

Weighted Average

Option Prices

Exercise Price

Outstanding, December 31, 2008

1,605,490

3.27 - 159.19

23.08

Granted

419,000

5.32-5.38

5.38

Exercised

—

Cancelled/Forfeited/Expired

(164,155

)

5.38-117.34

18.09

Outstanding, June 27, 2009

1,860,335

3.27-159.19

19.54

5. SEVERANCE

During the second quarter of 2009, the Company made the decision to reduce its production staffing. The total severance expense associated with this action recorded in the second quarter 2009 was $0.1 million. No additional expense is expected.

During the first quarter of 2009, the Company announced a restructuring program which included the realignment of existing resources to new projects, reductions in the Company’s field services and sales staffing and other reduction activities. The total severance expense associated with the program recorded in the first quarter 2009 was $0.2 million. No additional expense is expected.

During the first quarter of 2008, the Company announced a restructuring program which included the realignment of existing resources to new projects, reductions in the Company’s engineering staff, changes in field services and sales staffing and a reduction in the number of senior management positions. The total severance expense associated with the restructuring program recorded in the first quarter of 2008 was $0.5 million. No additional expense is expected.

6. INTANGIBLE ASSETS

The following information is provided regarding the Company’s intangible assets and goodwill (in thousands):

June 27, 2009

Useful

(Unaudited)

Life

Accumulated

Amortizing Intangible Assets:

(Years)

Gross

Amortization

Impairments

Net

Post warranty service agreements

6-50

37,789

4,628

—

33,161

Technology

3-10

14,001

12,132

—

1,869

Customer relationships

5-10

930

535

—

395

Tradenames and other

3-10

538

415

—

123

Total Intangible Assets

53,258

17,710

—

35,548


			December 31, 2008
			(unaudited)
	Useful				Accumulated
Amortizing Intangible Assets:	Life (Years)		Gross		Amortization		Impairments		Net

Post warranty service agreements		6-50	$	37,563	$	3,752	$	—	$	33,811
Technology		2-10		13,987		11,700		30		2,257
Customer relationships		5-15		904		334		112		458
Tradenames and other		0.5-10		534		323		59		152


Total Intangible Assets			$	52,988	$	16,109	$	201	$	36,678

Impairments

Long-Lived Assets

The Company performs impairment reviews of its long-lived assets upon a change in business conditions or upon the occurrence of a triggering event.

During the first quarter 2009, the Company recorded an impairment of long-lived assets of $0.2 million as a result of a triggering event. The triggering event, which occurred subsequent to the end of the quarter but prior to reporting our quarterly results, was that it became probable that the Company would sell substantially all of the assets of its cable product line. The Company considered the likelihood of the sale and recorded the charge based on a comparison of the negotiated price to the net carrying value of the cable product line assets. The impairment was based on market information that would be considered Level 2 in the fair value hierarchy.

The Company currently estimates amortization expense to be $1.3 million for the remainder of 2009 and $2.2 million, $1.7 million, $1.2 million, $1.1 million and $28.0 million for the years ended December 31, 2010, 2011, 2012 and 2013 and thereafter, respectively.

7. INVENTORIES

Inventories consisted of the following (in thousands):


				Year Ended
	June 27,2009			December 31, 2008
	(Unaudited)			(Unaudited)

Raw materials	$	4,063		$	4,621
Work in process		1,926			3,142
Finished goods		2,357			1,782

		8,346			9,545


Reserves for slow moving and obsolete inventory		(1,926	)		(1,702	)

	$	6,420		$	7,843

8. PRODUCT WARRANTY

Activity in the warranty accrual is as follows (in thousands):


	Six Months Ended			Year Ended
	June 27, 2009			December 31, 2008
	(Unaudited)			(Unaudited)
Balance at the beginning of the period	$	927		$	1,147
Accruals for warranties issued during the period		248			1,683
Settlements during the period		(522	)		(1,903	)

Balance at the end of the period	$	653		$	927

9. PER SHARE INFORMATION

Net (loss) income per share has been computed in accordance with the provisions of SFAS No. 128, “Earnings Per Share” for all periods presented. SFAS No. 128 requires companies with complex capital structures to report earnings per share on a basic and diluted basis. Basic earnings per share is computed using the weighted average number of shares outstanding during the period, while diluted earnings per share is calculated to reflect the potential dilution that occurs related to issuance of capital stock option grants. The three and six month periods ended June 27, 2009 and June 28, 2008 do not include the effect of dilutive securities due to the net loss reported in such period, which would make those securities anti-dilutive to the earnings per share calculation.

A reconciliation of net loss per share is as follows (in thousands, except per share data):


	Three Months Ended			Six Months Ended
	June 27, 2009			June 27, 2009
	(Unaudited)			(Unaudited)
Loss from continuing operations	$	(1,485	)	$	(2,509	)
Loss from discontinued operations, net of income taxes		(24	)		(223	)
Net loss from operations		(1,509	)		(2,732	)
Common and common equivalent shares:
Weighted average common shares outstanding		12,681			12,680
Effect of dilutive securities — stock options		—			—



Loss per share from continuing operations:

Basic	$	(0.12	)	$	(0.20	)

Diluted	$	(0.12	)	$	(0.20	)



Loss per share from discontinued operations:
Basic	$	(0.00	)	$	(0.02	)

Diluted	$	(0.00	)	$	(0.02	)


	Three Months Ended			Six Months Ended
	June 28, 2008			June 28, 2008
	(Unaudited)			(Unaudited)
Loss from continuing operations	$	(172	)	$	(3,178	)
Loss from discontinued operations, net of income taxes		(83	)		(3,581	)
Net loss from operations		(255	)		(6,759	)
Common and common equivalent shares:
Weighted average common shares outstanding		13,158			13,158
Effect of dilutive securities — stock options		—			—



Loss per share from continuing operations:

Basic	$	(0.01	)	$	(0.24	)

Diluted	$	(0.01	)	$	(0.24	)



Loss per share from discontinued operations
Basic	$	(0.01	)	$	(0.27	)

Diluted	$	(0.01	)	$	(0.27	)

As of June 27, 2009, 1.7 million equivalent shares were anti-dilutive. No equivalent shares were anti-dilutive at June 28, 2008. Basic earnings per share are calculated on the actual number of weighted average common shares outstanding for the period, while diluted earnings per share must include the effect of any dilutive securities. As the Company reported a loss in both quarterly periods, the effect of any dilutive securities was excluded from the calculation of diluted earnings per share.

10. CONTINGENCIES AND COMMITMENTS

of the office leases include provisions for possible adjustments in annual future rental commitments relating to excess taxes, excess maintenance costs that may occur and increases in rent based on the consumer price index and based on increases in our annual lease commitments; however, none of these commitments are material.

Future minimum lease payments under operating leases having initial or remaining non-cancellable lease terms in excess of one year are as follows (in thousands):


	At June 27, 2009
2009 (remaining period)	$	494
2010		633
2011		492
2012		325
2013		—
Thereafter		—

	$	1,944

The lease expense for the three and six month periods ended June 27, 2009 and June 28, 2008 was $0.2 million and $0.4 million and $0.3 million and $0.6 million, respectively.

In addition, the Company is, from time to time, party to various legal claims and disputes, either asserted or unasserted, which arise in the ordinary course of business. While the final resolution of these matters cannot be predicted with certainty, the Company does not believe that the outcome of any of these claims will have a material adverse effect on the Company’s consolidated financial position, or annual results of operations or cash flow.

11. INCOME TAXES

For the second quarters of 2009 and 2008, income tax expense was primarily related to foreign income tax obligations generated by profitable operations in foreign jurisdictions, as well as adjustments to reserves for uncertain tax positions. Additionally, the Company established a valuation allowance against U.S. federal, state and certain foreign net operating losses incurred in the second quarter of 2008 as the tax benefit was deemed more likely than not to be unrealizable in future periods. The foreign deferred tax benefit recorded in the second quarters of 2009 and 2008 relates primarily to temporary differences arising as a result of differentials between book and tax lives of intangible assets.

The Company had unrecognized tax benefits (including penalties and interest) of $0.6 million and $0.5 million on June 27, 2009 and December 31, 2008, respectively, all of which, if recorded, would impact the 2009 annual effective tax rate. It is reasonably possible that the amount of unrecognized tax benefits could change by less than $0.1 million in the next 12 months primarily due to tax examinations and the expiration of statutes related to specific tax positions.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of June 27, 2009 and December 31, 2008, the Company has an insignificant amount of accrued interest related to uncertain tax positions in both foreign and domestic jurisdictions.

As of June 27, 2009, the tax years that remain subject to examination by major jurisdiction generally are:


United States — Federal		2005 and forward
United States — State		2005 and forward
Europe		2007 and forward

At June 27, 2009, the Company intends to permanently reinvest accumulated earnings in foreign subsidiaries. As a result, deferred taxes have not been provided on foreign earnings at June 27, 2009. If the Company’s intention changes and such amounts are expected to be repatriated, deferred taxes will be provided.

12. MAJOR CUSTOMERS AND INTERNATIONAL SALES

The Company’s customers include the top telecom providers and numerous independent telecom and broadband providers around the world. Our primary customers for our telco products and services are large domestic and European telecommunications service providers. The Company tracks its telco sales by two large customer groups, the first of which includes Qwest, AT&T and Verizon (referred to herein as large domestic carriers), and the second of which includes certain large international telephone service providers in Europe, namely British Telecom, Royal KPN N.V., Belgacom S.A., Deutsche Telecom AG (T-Com) and Telefónica O2 Czech Republic, a.s. (collectively referred to herein as the “European Telcos”). For the second quarter of 2009, sales to the large domestic customers accounted for approximately 35.8% of the Company’s total revenue, compared to approximately 25.9% of total revenue for the second quarter of 2008. Sales to AT&T individually exceeded 10% of the Company’s total revenue and comprised 19.6% of the Company’s total revenue for the second quarter of 2009, compared to 14.4% of the Company’s total revenue for the second quarter of 2008. Sales in the second quarter of 2009 and 2008 to the European Telcos accounted for approximately 20.7% and 33.0% respectively, of total revenue. As of June 27, 2009, the Company had approximately $2.8 million of accounts receivable with two customers, each of which individually exceeded 10% of our June 27, 2009 receivable balances. As of December 31, 2008, the Company had approximately $4.5 million of accounts receivable with three customers, each of which individually exceeded 10% of our December 31, 2008 receivable balances.

In the second quarter of 2009, we entered into a new, multi-year managed services contract with a large global network equipment provider to provide customer support and engineering services. For the second quarter of 2009, sales to this customer were $1.5 million, or 14.2% of total revenue.

For the six months ended June 27, 2009 and June 28, 2008, sales to the large domestic customers accounted for approximately 43.7% and 30.6%, respectively, of the Company’s total revenue. Sales to AT&T comprised approximately 24.6% and 18.8% of the Company’s total revenue for the six months ended June 27, 2009 and June 28, 2008, respectively. Sales for the six months ended June 27, 2009 and June 28, 2008 to the European Telcos accounted for approximately 22.8% and 33.6% of total revenue, respectively.

International sales represented approximately $3.8 million or 35.8% of the Company’s total revenue for the quarter ended June 27, 2009, compared to $6.5 million or 53.7% for the quarter ended June 28,

2008. Our international sales were primarily in three geographic areas based upon customer location for the quarters ended June 27, 2009 and June 28, 2008: the Americas (excluding the United States); Europe, the Middle East and Africa (“EMEA”); and Asia. Sales for the Americas were approximately $1.0 million and $0.6 million, sales for EMEA were $2.5 million and $5.1 million, and sales in Asia were approximately $0.3 million and $0.8 million for the quarters ended June 27, 2009 and June 28, 2008, respectively.

International sales represented approximately $7.5 million, or 35.7% of the Company’s total revenue for the six months ended June 27, 2009 compared to $12.1 million, or 51.9%, for the six months ended June 28, 2008. Our international sales were primarily in three geographic areas based upon customer location for the six months ended June 27, 2009: the Americas (excluding the United States); EMEA; and Asia. Sales in the Americas were approximately $1.7 million and $1.0 million, sales in EMEA were approximately $5.3 million and $10.3 million, and sales in Asia were approximately $0.5 million and $0.8 million for the six months ended June 27, 2009 and the six months ended June 28, 2008, respectively.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and Notes thereto appearing elsewhere in this report.

CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.

This MD&A should be read in conjunction with our annual report on Form 10-K, as amended by Form 10-K/A, for the year ended December 31, 2008 (the “Form 10-K”).

Certain statements contained in this MD&A and elsewhere in this report are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties. These statements relate to future events or our future financial performance. In some cases, forward-looking statements can be identified by terminology such as “believe,” “expect,” “intend,” “may,” “will,” “should,” “could,” “potential,” “continue,” “estimate,” “plan,” or “anticipate,” or the negatives thereof, other variations thereon or compatible terminology. These statements involve a number of risks and uncertainties. Actual events or results may differ materially from any forward-looking statement as a result of various factors, including those described in Part II, Item 1A below under “Risk Factors.”

Cable Product Line

On May 27, 2009 we completed the sale of our cable product line for consideration of approximately $3.2 million, subject to adjustment for certain items pursuant to the terms of the agreement. The cable product line no longer supported the Company’s refocused growth strategy and the divestiture allows the Company to continue to focus its business on our core telecommunications markets and customers. Unless otherwise indicated, references to “revenues” and “earnings” throughout this Management’s Discussion & Analysis refer to revenues and earnings from continuing operations and do not include revenue and earnings from the discontinued cable product line. Similarly, discussion of other matters in our Condensed Consolidated Financial Statements refers to continuing operations unless otherwise indicated. The results from the divested product line are reported in discontinued operations.

Overview

Several trends continued across the Company’s markets that affected our performance in the second quarter of 2009.

Our customers continued to be impacted by the current economic environment, as businesses and consumers looked for ways to reduce their expenditures. Capital and operating expense budgets of our customers continued to be under pressure as they look to balance potential lower revenues as a result of the global recession. The Company has felt the impacts of the recession in quarterly sales levels, but also in the delay of customers’ capital expense decisions for new projects and deployments.

Our traditional customer base of incumbent telephone carriers (especially the large domestic and European carriers) continue to divert their spending from legacy networks as they focus their capital spending on wireless and next-generation wireline projects such as fiber to the home/curb/premise,

IPTV, and DSL services. Customer traditional copper line loss is being driven by competition from wireless and cable providers and also the elimination of second phone lines due to DSL penetration. This has resulted in reduced demand for our copper-based products.

In response to these conditions and trends our customers are attempting to reduce their costs, including by reducing the prices of services they purchase under long term service contracts. As a result, each time a contract is scheduled for renewal, we must demonstrate to our customers the value of the entire system and the costs saved by maintaining and even extending the system capabilities. We successfully completed the renewal of maintenance contracts with three existing large customers in recent months. Two of the contracts were renewed for 3-year extensions and one was renewed for a 5-year extension. In total, the contracts represent more than $5 million dollars a year in maintenance revenue. While these discussions took an extended period of time, we held firm on our pricing rationale. We believe that the successful outcome of these negotiations demonstrates that our customers recognized the value that we provide to maximize their customer satisfaction and lower their operational costs.

Negotiations for the renewal of a service agreement with another large customer whose contract expired on June 30, 2009 has yet to be finalized, which has impacted our backlog figures since we do not include any expected revenue from this source in our backlog at June 27, 2009. We are currently working to finalize the renewal of the contract that expired in June and expect to complete the negotiations during the third quarter of 2009. We also have two further agreements that will expire at the end of 2009. We expect to commence negotiations for the renewal of these contracts in the third quarter of 2009.

As described in the Form 10-K, management completed a comprehensive strategic review of all our businesses in 2008 to address the trends affecting our business. As a result of the review, we determined that the appropriate strategy for the Company included focusing our strategic efforts and resources on the substantial and growing telecom service assurance market, where we have a significant installed customer base, and use this position to expand into adjacent markets. Our refocused strategy allows us to leverage our strong embedded base of customers, and enhance the value of our long term relationships and services agreements. We have been implementing our refocused growth strategy since October of 2008 and have achieved a significant number of milestones in our strategic plan, including:

Developing a comprehensive strategic plan to focus on our core expertise in service assurance and adjacent markets;

Selling off non-core assets that do not support our refocused strategy;

Bolstering cash reserves to more than $63 million;

Authorizing a $15 million stock buyback program;

Reducing corporate overhead by streamlining operations; and

Making key management changes to strengthen our functional expertise.

The Company expects that this strategy will position it for long-term growth, a return to profitability, and market leadership and increasing returns for investors.

Products

Services

Our services offerings include software maintenance and support for our operating support systems (“OSS”) offerings and hardware maintenance for the test probes, and our professional services, which are designed to ensure that all of the components of our customers’ test systems operate properly. The primary customers for our maintenance and professional services offerings are the large domestic carriers and international customers. We have a number of large service agreements with these customers which cover software and, in some cases, hardware maintenance for our products.

Historically, our services business was comprised of the more traditional POTS-based testability services, and the revenue stream was largely project-based and as such, difficult to predict. During the last few years, and primarily as a result of the Broadband Test Division acquisition, the services business has moved toward more contract-based software maintenance services, the revenue from which is more predictable. Because of this trend, our focus on our software applications as part of our refined strategy, and the decline in revenues from our other product lines, we expect services to continue to comprise a larger percentage of our revenue in the future. During the second quarter of 2009, we completed negotiations for the renewal of two multi-year software maintenance agreements which were open at the end of the first quarter of 2009.

In addition, we also entered into a new, multi-year managed services contract with a large global network equipment provider to provide customer support and engineering services. Under this new, multi-year managed services agreement, we will provide customer support and engineering services capabilities. The agreement is an important addition to our services business and is a logical step for us as we offer an expanded portfolio of services to our current customers as well as new customers.

Telecommunications Test and Measurement Products

Our proprietary telecommunications test and measurement products, which include our System Test and MCU^® products, enable telephone companies to qualify and troubleshoot broadband DSL and IP services and remotely diagnose problems in POTS lines. Most DSL lines today provide broadband Internet access for residential and business customers, fed from a central or remote office Digital Subscriber Line Access Multiplexer (“DSLAM”) and configured with either a shared POTS voice service or “unbundled” from the voice switch entirely (in the case of a competitive local exchange carriers (“CLECs”) service offering). Our systems can be used to qualify loops for DSL service as well as ongoing maintenance and repair of these “IP” lines. As telecommunications service providers transition their offerings to IP networks and services (voice, video and data), we are in the process of upgrading Tollgrade’s test systems to support the testing of these services. POTS lines provide traditional voice service as well as connections for communication devices such as computer modems and fax machines. POTS excludes non-switched and private lines, such as data communications service lines, commonly referred to as “special services.”

An important aspect of efficiently maintaining a telecommunications network is the ability to remotely test, diagnose and locate any service-affecting problems within that network. Tollgrade’s System Test Products are made up of a centralized test operating system integrated into the customers’ repair handling database systems, and remote test hardware located at telephone companies’ central and remote offices. These systems enable local exchange carriers to conduct a full range of fault

diagnostics in the “local loop,” the portion of the telephone network that connects end users to the central office. In addition, line test systems provide the capability to remotely qualify, deploy and maintain services such as DSL and Integrated Services Digital Network (“ISDN”) services which are carried over POTS lines. These test systems reduce the time needed to identify and resolve problems, eliminating or reducing the costs of dispatching a technician to the problem site. Most POTS line test systems, however, were designed only for use over copper wire line; as a result, traditional test systems could not access local loops in which fiber-optic technology had been introduced. Our MCU product line, which is used primarily by large domestic carriers, solved this problem, extending LoopCare™ testing from the central office to the fiber-fed remote Digital Loop Carrier (“DLC”) lines by mimicking a digital bypass pair, which is essentially a telephone circuit that connects central test and measurement devices to the copper circuits close to the customer, i.e., “the last mile.”

We believe our DigiTest^® system is well positioned for the present and future of telecommunication network testing, combining our line test system with a next generation test platform to provide a complete test system solution for POTS and DSL local loop prequalification and in-service testing.

During 2008, the Company determined after a thorough strategic review process to reposition itself with a greater focus on its service assurance offerings. The Company intends to build upon the strength of its System Test Products, which are at the center of our service assurance offerings, but with a greater emphasis on expanding our service assurance software solutions. Our System Test product software offerings include four separate OSS: LoopCare, 4TEL™, Celerity™, and LTSC™, each having an established installed base. LoopCare is also the primary application for broadband DSL testing and can be architected to overlay 4TEL and LTSC to add this functionality to the existing line test application with the addition of the DigiTest measurement platform. We plan to leverage our incumbencies with our installed base of software customers, and extend testing coverage to next generation network architectures. The implementation of our strategy initially will expand upon existing customer requests for enhanced features and capabilities. With regard to our software development activities, we have been planning, architecting, coding, and are now into the testing phase to deliver our new software platform. We expect to announce general availability of our first release of the platform this fall and will formally launch the offering in September.

Our legacy MCU products plug into DLC systems, the large network transmission systems used by telephone companies to link the copper and fiber-optic portions of the local loop. MCU products allow our customers to extend their line testing capabilities to all of their POTS lines served by a DLC system regardless of whether the system is fed by a copper or fiber optic link. DLC systems, which are located at telephone companies’ central offices and at remote sites within local user areas, effectively multiplex the services of a single fiber-optic line into multiple copper lines. In many instances, several DLC systems are located at a single remote site to create multiple local loops that serve several thousand different end-user homes and businesses. Generally, for every DLC remote site, customers will deploy at least two MCU line-testing products. One of three patents for our legacy MCU products will expire during 2010, and we expect that the loss of this patent protection will permit greater competition within this market segment that could cause our revenues from this product line to decline.

Electric Utility Monitoring Products

The Company’s new product development effort, the LightHouse™ product line, is being designed to provide power grid monitoring capabilities to electric utilities. Research and investment throughout 2007 and 2008 enabled the general availability of the first release of the product line during the first

quarter of 2009. The test system solution currently consists of line mounted sensors, aggregators, and centralized software providing an end to end solution for power providers to efficiently monitor their overhead distribution circuits in real time. A LightHouse sensor, mounted directly on the electrical conductor, will continuously monitor key circuit parameters and transmit data over a wireless network to a central location, reducing time of detecting a problem on the grid, identifying its location and restoring service. LightHouse is intended as an innovative means for electric power utilities to deploy technology to provide real-time grid intelligence to detect faults and help minimize the impact of outages while optimizing the utilization of assets. The system is designed to improve the overall efficiency of energy delivery, improve customer satisfaction and improve the financial performance of the electric utilities.

During the quarter and since our general availability of the Lighthouse solution in February, we have upgraded many of our current trial systems with new hardware and software. While the trials continue to receive positive response, we are still awaiting feedback on deployment decisions and timing. We have new trials planned and are in preparation stages with customers to design the trial system configurations for their networks.

Our Customers

The Company’s customers range from the top telecom providers, to numerous independent telecom, and broadband providers around the world. Our primary customers for our telco products and services are large domestic and European telecommunications service providers. The Company tracks its telco sales by two large customer groups, the first of which includes Qwest, AT&T and Verizon (referred to herein as large domestic carriers), and the second of which includes certain large international telephone service providers in Europe, namely British Telecom, Royal KPN N.V., Belgacom S.A., Deutsche Telecom AG (T-Com) and Telefónica O2 Czech Republic, a.s. (collectively referred to herein as the “European Telcos”). For the second quarter of 2009, sales to the large domestic customers accounted for approximately 35.8% of the Company’s total revenue, compared to approximately 25.9% of total revenue for the second quarter of 2008. Sales to AT&T individually exceeded 10% of the Company’s total revenue and comprised 19.6% of the Company’s total revenue for the second quarter of 2009, compared to 14.4% of the Company’s total revenue for the second quarter of 2008. Sales in the second quarter of 2009 and 2008 to the European Telcos accounted for approximately 20.7% and 33.0% respectively, of total revenue.

For the three months ended June 27, 2009, sales to customers in the Americas (excluding the United States) were approximately $1.0 million or 24.9% of international sales; sales to customers in EMEA were $2.5 million or 66.3% of international sales; and sales to customers in Asia Pacific were $0.3 million or 8.8% of international sales. For the three months ended June 28, 2008, sales to customers in the Americas (excluding the United States) were approximately $0.6 million or 9.9% of international sales; sales to customers in EMEA were $5.1 million or 78.2% of international sales; and sales to customers in Asia Pacific were $0.8 million or 11.9% of international sales.

For the six months ended June 27, 2009 and June 28, 2008, sales to the large domestic customers accounted for approximately 43.7% and 30.6%, respectively, of the Company’s total revenue. Sales to AT&T comprised approximately 24.6% and 18.8% of the Company’s total revenue for the six months ended June 27, 2009 and June 28, 2008, respectively. Sales for the six months ended June 27, 2009 to the European Telcos accounted for approximately 22.8% of total revenue. International sales represented approximately $7.5 million, or 35.7% of the Company’s total revenue for the six months

ended June 27, 2009 compared to $12.1 million, or 51.9%, for the six months ended June 28, 2008. Our international sales were primarily in three geographic areas based upon customer location for the six months ended June 27, 2009: the Americas (excluding the United States); EMEA; and Asia. Sales in the Americas were approximately $1.7 million and $1.0 million, sales in EMEA were approximately $5.3 million and $10.3 million, and sales in Asia were approximately $0.5 million and $0.8 million for the six months ended June 27, 2009 and the six months ended June 28, 2008, respectively.

Backlog

The Company’s order backlog for firm customer purchase orders and signed software maintenance contracts was $17.7 million as of June 27, 2009, compared to a backlog of $15.1 million as of December 31, 2008. The backlog at June 27, 2009 and December 31, 2008 included approximately $15.6 million and $12.0 million, respectively, related to software maintenance contracts and, beginning in the second quarter of 2009, also our managed services contract. Our backlog specifically for software maintenance contracts has declined sequentially from the first quarter 2009 even with the renewal of the software maintenance agreements that were completed in the second quarter 2009 because three additional major software support agreements have expired or will expire within the next six months. Because one of these contracts expired at the end of June 2009, the backlog figure does not include any amount from that customer. We are currently working to finalize the renewal of the contract that expired in June and expect to complete negotiations during the third quarter 2009. The other two contracts expire at the end of 2009.

On a sequential basis, backlog increased from $12.0 million dollars at March 28, 2009 primarily due to the managed services contract as well as the maintenance renewals signed in the second quarter. The order backlog includes only twelve months of revenue from maintenance agreements and the managed services contract.

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

On January 1, 2009, the Company adopted SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51,” (SFAS 160). SFAS 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This standard defines a noncontrolling interest, previously called a minority interest, as the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. SFAS 160 requires, among other items, that a noncontrolling interest be included in the consolidated statement of financial position within equity separate from the parent’s equity; consolidated net income to be reported at amounts inclusive of both the parent’s and noncontrolling interest’s shares and, separately, the amounts of consolidated net income attributable to the parent and noncontrolling interest all on the consolidated statement of operations; and if a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be measured at fair value and a gain or loss be recognized in net income based on such fair value. The adoption of SFAS 160 had no impact on the Company’s consolidated financial statements.

the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control instead of the date that the consideration is transferred. SFAS 141(R) requires an acquirer in a business combination, including business combinations achieved in stages (step acquisition), to recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. Additionally, SFAS 141(R) requires acquisition-related costs to be expensed in the period in which the costs are incurred and the services are received instead of including such costs as part of the acquisition price. The impact of the adoption of SFAS 141(R) will depend on the nature and extent of business combinations occurring on or after the effective date.

In April 2009, the FASB issued FASB Staff Position (FSP) FAS No. 107-1 and Accounting Principles Board (APB) Opinion No. 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (FSP FAS No. 107-1 and APB Opinion No. 28-1), which amends the disclosure requirements of SFAS No. 107 and APB Opinion No. 28 and requires disclosure about the fair value of its financial instruments whenever it issues summarized financial information for interim reporting periods. FSP FAS No. 107-1 and APB Opinion No. 28-1 are effective for financial statements issued for interim

reporting periods ending after June 15, 2009. The adoption of FSP FAS No. 107-1 and APB Opinion No. 28-1 resulted in the Company’s inclusion of the appropriate disclosures in the condensed consolidated financial statements.

In April 2009, the FASB issued FSP FAS No. 115-2 and FAS No. 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (FSP FAS No. 115-2 and FAS No. 124-2), which amends SFAS No. 115 and FSP FAS No. 115-1 and FSP FAS No. 124-1 and conforms changes to other standards including EITF Issue No. 99-20 and AICPA Statement of Position (SOP) No. 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer,” and improves the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. FSP FAS No. 115-2 and FAS No. 124-2 are effective for interim and annual reporting periods ending after June 15, 2009. The adoption of FSP FAS No. 115-2 and FAS No. 124-2 had no impact on the Company’s consolidated financial statements.

In May 2009, FASB issued Statement of Financial Accounting Standards (SFAS) No. 165, “Subsequent Events” (SFAS No. 165). The statement establishes principles and requirements for subsequent events. The standard also sets forth the period after the balance sheet date during which management shall evaluate events/transactions that may occur for potential recognition or disclosure in its financial statements. SFAS No. 165 is effective for interim or annual financial periods ending after June 15, 2009. The Company has evaluated subsequent events in accordance with SFAS No. 165 from its interim balance sheet date of June 27, 2009, through August 6, 2009, and concluded that no events or transactions require disclosure or recognition in its financial statements.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles; a replacement of FASB Statement No. 162” (SFAS 168). SFAS 168 establishes the FASB Accounting Standards Codification as the source of authoritative GAAP recognized by the FASB to be applied by non-governmental entities. Rules and interpretative releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. SFAS 168 is effective for interim and annual periods ending after September 15, 2009. SFAS 168 will not have a material impact on the Company’s consolidated financial statements when adopted.

Application of Critical Accounting Policies

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Therefore, the determination of estimates requires the exercise of judgment based on various assumptions and other factors such as historical experience, economic conditions, and in some cases, actuarial techniques. Actual results may differ from those estimates. A discussion of market risks affecting the Company can be found in “Quantitative and Qualitative Disclosures about Market Risk” in this Quarterly Report on Form 10-Q.

A summary of the Company’s significant accounting policies are included in the Notes to Consolidated Financial Statements and in the critical accounting policies in Management’s Discussion and Analysis included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. Management believes that the application of these policies on a consistent basis enables the Company to provide useful and reliable financial information about the company’s operating results and financial condition. There were no changes to our critical accounting policies during the second quarter of 2009.

RESULTS OF OPERATIONS FROM CONTINUING OPERATIONS

THREE MONTHS ENDED JUNE 27, 2009 COMPARED TO THREE MONTHS ENDED JUNE 28, 2008

Revenues

The Company’s revenues for the second quarter of 2009 were $10.6 million compared to revenues of $12.1 million for the second quarter of 2008.

Services revenue consists of software maintenance and managed services agreements and installation oversight and product management services provided to customers. Services revenue was approximately $6.5 million in the second quarter of 2009 compared to $5.7 million for the second quarter of 2008, an increase of 0.8 million or 14.0%. The increase was primarily attributable to a new multi-year managed services agreement that we completed in the second quarter 2009. The increase driven by the new managed services agreement was offset, in part, by the effect of changes in foreign exchange rates. Services revenue amounted to 61.3% and 47.1% of total second quarter 2009 and 2008 revenue, respectively. Because of our focus on our software applications as part of our refocused strategy, and the decline in revenues from our traditional product lines, we expect Services to continue to comprise a larger percentage of our revenue in the future.

Sales of the Company’s system test products were $3.3 million in the second quarter of 2009, a decrease of $1.9 million, compared to sales in the second quarter of 2008 of $5.2 million. System test products revenue included sales of DigiTest products including DigiTest ICE™, LDU™ and N(x)Test™ test probe hardware products as well as custom software applications and licenses. Second quarter 2009 sales of system test hardware products were lower largely as a result of the completion of a major international hardware contract in 2008. Overall, System Test hardware sales were challenged by soft customer capital expense spending given the tough economic environment. The System Test product line revenue accounted for 31.2% and 43.0% of total second quarter of 2009 and 2008 revenue, respectively.

Sales of MCUs during the second quarter of 2009 were $0.8 million, compared to $1.2 million reported in second quarter of 2008. MCU sales from both periods in 2009 and 2008 were extremely low. The $0.4 or 33.3% million decrease in the second quarter 2009 compared to second quarter 2008 was attributable to lower capital spending by domestic telecom operators due to the current global economic downturn. MCU sales represented 7.5% of total second quarter 2009 revenues, compared to 9.9% for the second quarter of 2008.

We expect MCU sales to continue to contribute to the Company’s revenue for the foreseeable future, but such sales may fluctuate somewhat unpredictably on a quarterly basis. Nevertheless, as this product line continues to mature, the Company believes revenues from this product line will continue declining over time.

Gross Profit

Gross profit for the second quarter of 2009 was $5.2 million compared to $6.3 million in the second quarter of 2008. The second quarter of 2009 included $0.1 million of severance charges. The severance charge was due to a planned action that was taken in the beginning of the third quarter 2009.

Because the decision to take the action was made in the second quarter 2009, the cost was accrued as a second quarter 2009 expense. The lower gross profit percentage of sales is primarily attributable to lower manufacturing volumes and product mix. As a percentage of sales, gross profit for the second quarter of 2009 was 48.8% versus 52.2% for the second quarter of 2008.

Selling and Marketing Expense

Selling and marketing expense, which consists primarily of payroll related costs, consulting expenses and travel costs, decreased $0.1 million, or 5.8%, to $1.6 million for the second quarter of 2009. The decrease is primarily attributable to continued efforts by management to control costs. As a percentage of revenues, selling and marketing expenses increased to 15.3% in the second quarter of 2009 from 14.3% in the second quarter of 2008.

General and Administrative Expense

General and administrative expense, which consists primarily of salaries and payroll related costs, insurance expense and professional services fees, increased $0.6 million, or 26.9%, to $2.8 million for the second quarter of 2009. The increase is a result of expense of $0.3 million incurred by the Company in connection with the contested election of directors at the 2009 Annual Meeting and expenses totaling $0.5 million of due diligence costs related to a potential acquisition that was not pursued beyond the due diligence stage. As a percentage of revenues, general and administrative expenses increased to 26.7% in the second quarter of 2009 from 18.5% in the second quarter of 2008.

Research and Development Expense

Research and development expense, which includes costs associated with ongoing customer support and consists primarily of salaries and payroll related costs, decreased $0.2 million, or 7.3%, to $2.4 million in the second quarter of 2009. The second quarter 2009 decline is primarily attributable to management’s cost control efforts and the effect of foreign currency exchange. While development efforts associated with the Company’s customer-funded application services products are allocated to cost of sales, this allocation did not affect the fluctuation in research and development in the second quarter, 2009. As a percentage of revenues, research and development expense for the second quarter of 2009 increased slightly to 22.6% compared to 21.4% for the second quarter of 2008.

Other Income

Other income for the second quarter of 2009 was $0.4 million compared to $0.3 million for the second quarter of 2008. The increase was due to an insurance settlement that occurred during the period of $0.2 million. Excluding the insurance proceeds, other income, which is due primarily to interest earnings on the Company’s cash and cash equivalents and short-term investments, would have decreased in the second quarter 2009 compared to the second quarter 2008 due to declines in prevailing interest rates.

Income Taxes

Income taxes for the second quarter of 2009 were $0.2 million. The second quarter of 2009 and second quarter of 2008 income tax expense primarily relates to foreign income tax obligations generated by profitable operations in certain foreign jurisdictions, as well as adjustments to reserves for uncertain tax positions in all

jurisdictions. The Company recorded a valuation allowance against U.S. federal, state and certain foreign net operating losses from continuing and discontinued operations incurred in the second quarter of 2009 as the tax benefit generated from those losses was deemed to be likely unrealizable in future periods. The effective tax rate on the loss from continuing operations decreased to 15.4% for the second quarter 2009 from 714.3% for the second quarter 2008.

Loss from Continuing Operations and Loss Per Share from Continuing Operations

Loss for the second quarter of 2009 increased $1.3 million to a net loss of $1.5 million compared to a net loss of $0.2 million for the second quarter 2008. For the second quarter of 2009, the Company incurred a basic and diluted loss from continuing operations per common share of ($0.12), compared to a loss of ($0.01) per basic and diluted common share recorded in the second quarter of 2008. Basic and diluted weighted average common and common equivalent shares outstanding were 12.7 million for the second quarter of 2009.

SIX MONTHS ENDED JUNE 27, 2009 COMPARED TO SIX MONTHS ENDED JUNE 28, 2008

Revenues

The Company’s revenues for the six months ended June 27, 2009 were $21.0 million compared to revenues of $23.3 million for the six months ended June 28, 2008.

Services revenue consists of software maintenance and managed services agreements and installation oversight and product management services provided to customers. Services revenue was approximately $11.0 million for the six months ended June 27, 2009 compared to $11.3 million for the six months ended June 28, 2008. The decline is primarily attributable to declines in repairs revenue, foreign currency translation differences due to the strength of the U.S. dollar compared to the prior quarter and the consolidation of certain LoopCare-related software maintenance contracts. Services revenue amounted to 52.4% and 48.5% of total revenue for the six months ended June 27, 2009 and June 28, 2008, respectively.

Sales of the Company’s System Test product line were $6.9 million for the six months ended June 27, 2009, a decrease of $3.1 million, compared to sales for the six months ended June 28, 2008 of $10.0 million. Revenue for the six months ended June 27, 2009 included sales of DigiTest products including DigiTest ICE, LDU and N(x)Test test probe hardware products as well as custom software applications and licenses. Sales of System Test products for the six months ended June 27, 2009 were lower largely as a result of the completion of a major international hardware contract in 2008. The System Test product line revenue accounted for 32.8% and 42.9% of total revenue for the six months ended June 27, 2009 and June 28, 2008, respectively.

Sales of MCUs during the six months ended June 27, 2009 were $3.1 million, compared to $2.0 million reported for the six months ended June 28, 2008. The $1.1 million increase in the six months ended June 27, 2009 was attributable to several large domestic telecom operators deploying testability initiatives in the first quarter 2009. MCU sales represented 14.8% of total revenue for the six months ended June 27, 2009, compared to 8.6% of total revenue for the six months ended June 28, 2008.

Gross Profit

Gross profit for the six months ended June 27, 2009 was $10.5 million compared to $11.2 million for the six months ended June 28, 2008. The six months ended June 27, 2009 included $0.3 million of severance expense compared to expenses totaling $1.0 million related to an inventory write-down as well as impairment of certain intangible assets and severance expense for the six months ended June 28, 2008. As a percentage of sales, gross profit for the six months ended June 27, 2009 was 50.0% versus 48.0% for the six months ended June 28, 2008.

Selling and Marketing Expense

Selling and marketing expense, which consists primarily of salaries and payroll related costs, consulting expenses and travel costs, decreased $0.4 million, or 11.0%, to $3.3 million for the six months ended June 27, 2009. The decrease is primarily associated with savings benefits from cost reduction initiatives initiated during the six months ended June 28, 2008. As a percentage of revenues, selling and marketing expenses decreased slightly to 15.7% for the six months ended June 27, 2009 from 15.8% for the six months ended June 28, 2008.

General and Administrative Expense

General and administrative expense, which consists primarily of payroll related costs, insurance expense and professional services fees, increased $0.6 million, or 12.8%, to $5.4 million for the six months ended June 27, 2009. The increase is a result of expense incurred by the Company in connection with the contested election of directors at the 2009 Annual Meeting and expenses related to due diligence costs of a potential acquisition that was not pursued beyond the due diligence stage. As a percentage of revenues, general and administrative expenses increased to 25.8% in the six months ended June 27, 2009 from 20.6% in the six months ended June 28, 2008.

Research and Development Expense

Research and development expense, which includes costs associated with ongoing customer support and consists primarily of salaries and payroll-related costs, decreased $1.1 million, or 20.2%, to $4.4 million in the six months ended June 27, 2009. The six months ended June 27, 2009 decline is attributable to the restructuring program implemented during the six months ended June 28, 2008 as well as the strong performance of our application services products. Development efforts associated with the Company’s customer-funded application services products are allocated to cost of sales. As such, the size of application services revenue causes this allocation of resources to fluctuate on a quarterly basis. As a percentage of revenues, research and development expense for the six months ended June 27, 2009 decreased slightly to 21.2% compared to 23.9% for the six months ended June 28, 2008.

Severance Expense

During the six months ended June 27, 2009, the Company implemented certain initiatives aimed at increasing efficiency and decreasing costs, which included reductions in its professional services, operations and marketing staff. During the six months ended June 27, 2009, the Company recorded severance expenses associated with these initiatives of $0.1 million.

The restructuring program announced by the Company during the first quarter of 2008 was completed in 2008 and no additional expense associated with this program was recorded in the second quarter of 2009.

Other Income

Other income for the six months ended June 27, 2009 was $0.5 million compared to $0.8 million for the six months ended June 28, 2008. Other income, which is primarily interest earnings on the Company’s cash and cash equivalents and short-term investments, decreased for the six months ended June 27, 2009 due to declines in prevailing interest rates.

Income Taxes

Income taxes for the six months ended June 27, 2009 were $0.3 million. The six months ended June 27, 2009 income tax expense primarily relates to foreign income tax obligations generated by profitable operations in certain foreign jurisdictions. The Company continued to record a valuation allowance against U.S. federal, state and certain foreign net operating losses from continuing and discontinued operations incurred in the six months ended June 27, 2009 as the tax benefit generated from those losses was deemed to be likely unrealizable in future periods. The effective tax rate on the loss from continuing operations decreased to 13.3% for the six months ended June 27, 2009 from 25.7% for the six months ended June 28, 2008.

Loss from Continuing Operations and Loss Per Share from Continuing Operations

Loss for the six months ended June 27, 2009 decreased $0.7 million or 21.1% to net loss of $2.5 million compared to a net loss of $3.2 million for the six months ended June 28, 2008. For the six months ended June 27, 2009, the Company’s basic and diluted loss from continuing operations per common share was ($0.20), compared to a loss of ($0.24) per basic and diluted common share recorded in the six months ended June 28, 2008. Basic and diluted weighted average common and common equivalent shares outstanding were 12.7 million for the six months ended June 27, 2009.

LIQUIDITY AND CAPITAL RESOURCES

We have historically met our working capital and capital expenditure requirements, including funding for expansion of operations, through net cash flows provided by operating activities. Our principal source of liquidity is our operating cash flows. There are no material restrictions on the ability to transfer and remit funds among our international affiliated companies.

The Company had working capital of $74.8 million at June 27, 2009, a decrease of $0.7 million from $75.5 million of working capital as of December 31, 2008. As of June 27, 2009, we had approximately $63.9 million in cash, cash equivalent and short term investments, which are available for corporate purposes, including acquisitions and other general working capital requirements.

Net cash provided by operating activities for the six months ended June 27, 2009 was $0.8 million compared to net cash provided of $0.3 million for the same period in the prior year. The change in net cash related to operating activities is largely attributable to less cash usage as a result of cost saving initiatives as well as changes in working capital.

Cash provided by investing activities was $4.5 million for the six months ended June 27, 2009 compared to cash used in investing activities of $2.0 million for the six months ended June 28, 2008. The cash provided for the six months ended June 27, 2009 was primarily due to the proceeds from the sale of the cable product line and the redemption of short-term investments.

The Company has a significant receivable from an international customer that we have, to date, been unable to collect, and we may be forced to bring legal action in a foreign jurisdiction in order to enforce payment. Although we believe that the merits of the claim are in the Company’s favor, there can be no assurance of success in any litigation to enforce payment.

The Company is party with a bank to a three-year $25.0 million Unsecured Revolving Credit Facility (the “Facility”), which includes a $2.0 million letter of credit sub-facility, expiring on December 19, 2009. In accordance with the terms of the Facility, the proceeds must be used for general corporate purposes, working capital needs, and in connection with certain acquisitions, as defined. The Facility contains certain standard covenants with which the Company must comply, including a minimum fixed charge coverage ratio, a minimum defined level of tangible net worth and a restriction on the amount of capital expenditures that can be made on an annual basis, among others. Our borrowings are limited by the calculation of our maximum leverage ratio, which is calculated on a quarterly basis. Interest is payable on any revolving credit amounts utilized under the Facility at prime, or the prevailing Euro rate plus 0.75% to 1.5% depending on the ratio of consolidated total indebtedness of the Borrower and its subsidiaries to consolidated EBITDA. Letter of credit fees are payable on letters of credit outstanding quarterly at the rate of 0.75% to 1.5% depending on the ratio of consolidated total indebtedness of the Borrower and its subsidiaries to consolidated EBITDA, and annually at the rate of 1/8% beginning with letter of credit issuance. Commitment fees are payable quarterly at the rate of 0.25% per annum on the average unused commitment. As of June 27, 2009 and currently, there are no outstanding borrowings under the Facility, and we are in compliance with all debt covenants. We do not anticipate any short-term borrowings for working capital as we believe our cash reserves and internally generated funds will be sufficient to sustain working capital requirements for the foreseeable future.

Our financial position enables us to meet our cash requirements for operations and capital expansion programs.

KEY RATIOS

The Company’s days sales outstanding (DSO) in accounts receivable trade, based on the past twelve months rolling revenue, was 75 and 85 days as of June 27, 2009 and June 28, 2008, respectively. The decrease is due to improved collections, as a higher percentage of the Company’s sales are from multi-year contracts which tend to be paid within contractual terms. The Company’s inventory turnover ratio was 3.0 and 2.4 turns at June 27, 2009 and June 28, 2008, respectively.

COMMITMENTS AND CONTRACTUAL OBLIGATIONS

The Company leases office space and equipment under agreements which are accounted for as operating leases. The office lease for our Cheswick, Pennsylvania facility was extended on May 22, 2009 and expires on March 31, 2010. The lease for our Piscataway, New Jersey location expires on April 30, 2012. As a result of the Broadband Test Division acquisition, we have leases in Bracknell, United Kingdom; Kontich, Belgium; and Wuppertal, Germany, which expire on December 24, 2012, April 1, 2012, and January 31, 2010, respectively. The Company is also involved in various month-to-month leases for research and development and office equipment at all five locations. In addition, one of the office leases include provisions for possible adjustments in annual future rental commitments relating to excess taxes, excess maintenance costs that may occur and increases in rent based on the consumer price index and based on increases in our annual lease commitments; however, none of these commitments are material.

Included in the commitment schedule below are certain pension obligations. As a result of our acquisition of the Broadband Test Division, we assumed defined benefit pension plans for our employees based in our German, Belgian and Netherlands locations. Net periodic pension expense for these plans recorded from the date of the acquisition through June 27, 2009 was insignificant. The total pension obligation as of June 27, 2009 was approximately $1.0 million. The increase in pension obligation from December 31, 2008 through June 27, 2009 primarily relates to increases in the Company’s benefit obligation due to increases in the related employees’ years of service.

Minimum annual future commitments as of June 27, 2009 are (in thousands):


	Payments due by period
	Total		2009		2010		2011		2012		2013		Thereafter

Operating Lease Obligations	$	1,757	$	467	$	580	$	439	$	271	$	—	$	—

Purchase Obligations		8		8		—		—		—		—		—

FIN 48 Obligations		604		—		604		—		—		—		—

Pension Obligations		971		—		—		—		—		—		971

Total	$	3,340	$	475	$	1,184	$	439	$	271	$	—	$	971

The lease expense for the three and six month periods ended June 27, 2009 was $0.2 million and $0.4 million, respectively. The lease expense for the three and six month periods ended June 28, 2008 was $0.3 and $0.6 million, respectively.

these matters cannot be predicted with certainty, the Company does not believe that the outcome of any of these claims will have a material adverse effect on the Company’s consolidated financial position, or annual results of operations or cash flow.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our current investment policy limits our investments in financial instruments to cash and cash equivalents, individual municipal bonds and corporate and government bonds. The use of financial derivatives and preferred and common stocks is strictly prohibited. We believe that our risk is minimized through proper diversification along with the requirements that the securities must be of investment grade with an average rating of “A” or better by Standard & Poor’s. We hold our investment securities to maturity and believe that earnings and cash flows are not materially affected by changes in interest rates, due to the nature and short-term investment horizon for which these securities are invested.

Item 4. CONTROLS AND PROCEDURES

The Chief Executive Officer and the Chief Financial Officer of the Company (its principal executive officer and principal financial officer, respectively) have concluded, based on their evaluation as of the end of the period covered by this report, that the Company’s disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934 are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

There were no changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that occurred during the fiscal quarter ended June 27, 2009 that have materially affected or are reasonably likely to materially affect these controls.

PART II. OTHER INFORMATION

Item 1A. RISK FACTORS

We wish to caution each reader of this Form 10-Q to consider the following factors and other factors discussed herein and in other past reports, including but not limited to prior year Form 10-K and quarterly Form 10-Q reports filed with the SEC. Our business and results of operations could be materially affected by any of the following risks. The factors discussed herein are not exhaustive. Therefore, the factors contained herein should be read together with other reports and documents that we file with the SEC from time to time, which may supplement, modify, supersede or update the factors listed in this document.

Our Services business is subject to a trend of reduced capital spending for our products by our major customers and possible delays in, or the inability to complete, negotiation and execution of

purchase and service agreements with new or existing customers could significantly impact business results and possibly result in impairment charges in the future.

Our Services business, which includes software maintenance and professional services, as well as our managed services offerings, is sensitive to the decline in our large carrier customers’ capital investment in their traditional voice services, which tends to drive the professional services. Furthermore, the timing of the extension or renewal of certain of the more significant software maintenance agreements can have a materially adverse impact on the Company’s Services revenues for any particular fiscal quarter or year. We are also experiencing intense pricing pressure from many of our larger software maintenance customers, as they continue to attempt to reduce their own internal costs to substantiate the value of our long term service contracts. We believe that our services and our software systems provide significant value to our customers, however, each time a contract is scheduled for renewal, we must show our customers the value of the entire system and the costs saved by maintaining and even extending the system capabilities. To date, we have been able to renegotiate most of our major contracts as they become subject to renewal and substantially maintain existing pricing and terms through these efforts, however, if we are not successful in the future, such failure would potentially have significant adverse effects on our business. Accordingly, our ability to maintain historical levels from traditional sources or increase levels of Services revenues cannot be assured, and in fact, such levels may decrease. We are currently engaged in negotiation of a software maintenance agreement that expired in June, and two additional contracts are scheduled to expire during the fourth quarter of 2009. If the negotiations for these or any other significant maintenance contract that becomes subject to renewal are not successful, the agreements may not be renewed at all or may be renewed on terms that are not as favorable to the Company as the former arrangements. In either event, the revenue and profitability of our Services offerings could be materially adversely affected, which could result in an impairment charge to the corresponding intangible assets on our balance sheet in future periods.

Our future growth depends to a large extent upon our ability to reposition the Company with a greater focus on our service assurance testing offerings to the telecom market.

As a result of the strategic review of our business in 2008, we determined that the Company should reposition itself with a greater focus on its service assurance offerings to the telecom market, and our software testing solutions in particular. Specifically, we are developing an integrated software platform to serve multiple applications and products specifically for the telecommunications industry in the IP service assurance market which we believe will grow rapidly in the foreseeable future. To implement our strategy and exploit this opportunity, we are creating new software products and enter into strategic partnerships so that we can maximize the potential of our incumbent position with customers and our long term relationships.

There can be no assurance that we will be able to reposition the Company in the manner described above or that, if we are successful, the repositioning will result in the benefits and opportunities that we expect. The development of new software solutions is an uncertain and potentially expensive process and requires that we accurately anticipate technological and market trends so that we can deliver products in a timely manner. We may not be successful in completing the development of the new platform or, if we do so, we may not be able to commercialize the product in a timely manner or achieve market acceptance. In addition, although software products generally generate higher margin returns for us than our hardware products, the initial development costs of software applications, coupled with the inherent problems with pricing software, can make it difficult to assess the potential

profitability of new software products. In addition, because it is customary in our industry to sell perpetual enterprise licenses that cover a customer’s entire operations, it can be difficult to assess at the time of sale the appropriate price that we should charge for a particular license. If we fail to set appropriate prices for our software licenses, our profitability could be adversely affected.

In addition, the potential market growth rate may not be as significant as we expect or could develop in unforeseen directions. For example, the commercial availability of competing products may affect the extent or timing of market acceptance of our solutions. Furthermore, we may not be successful in forming the strategic alliances contemplated by our new strategy. We may not identify the right partners or our partners could fail to perform their obligations and the partnership may fail to develop as expected. As a result of these and other factors, we may not be able to implement our strategy and our ability to exploit our incumbent position in the manner contemplated by our strategic repositioning would be materially and adversely affected.

We are currently testing our new software platform and expect to formally launch the offering in the third quarter of 2009. There can be no assurance that the launch will occur within our scheduled timeframe or that the launch will not be delayed due to unanticipated testing results and other factors. In addition, even if the test results are positive the offering may not be commercially successful in the near term due to the anticipated length of the sales cycle and the other factors discussed above or at all.

Our cost reduction plans may be ineffective or may limit our ability to compete.

During the first quarter of 2009, the Company announced a restructuring program which included the realignment of existing resources to new projects, reductions in the Company’s field services and sales staffing and other reduction activities, and on July 6, 2009, the Company announced a restructuring program which included reductions in the Company’s production staffing. In addition, during 2008, we implemented a series of initiatives designed to increase efficiency and reduce costs and to focus our core business on our test and measurement expertise. These initiatives included reductions of staff, alignment of investments and a completion of the integration plans from recent acquisitions, including Emerson and Broadband Test Division. Although we have experienced some cost savings from these programs and initiatives and we believe that these actions will continue to reduce costs, they may not be sufficient to achieve the required operational efficiencies that will enable us to respond more quickly to changes in the market or result in the improvements in our business that we anticipate or be sufficient to offset a decline in our revenue. In such event, we may be forced to take additional cost-reducing initiatives, which may negatively impact quarterly earnings and profitability as we account for severance and other related costs. In addition, there is the risk that such measures could have long-term effects on our business by reducing our pool of talent, decreasing or slowing improvements in our products, making it more difficult for us to respond to customers, limiting our ability to increase production quickly if and when the demand for our products increases and limiting our ability to hire and retain key personnel. These circumstances could cause our earnings to be lower than they otherwise might be.

Potential continuing uncertainty resulting from the contested election of directors at our 2009 Annual Meeting of Shareholders, and from any resulting changes to the composition of our Board of Directors and its committees, may adversely affect our business.

On February 11, 2009, affiliates of Ramius LLC (together with all affiliates and associates thereof, the “Ramius Group”) notified the Company of their intention to nominate, and solicit proxies for the

election of, four nominees at the Company’s 2009 Annual Meeting of Shareholders (the “Annual Meeting”), and, on or about June 24, 2009, the Ramius Group issued a proxy statement and related materials soliciting proxies in opposition to the Company’s nominees for the election of a competing slate of directors at the Annual Meeting, including three new director nominees selected by the Ramius Group. The Annual Meeting was held on August 5, 2009; however, the results of voting have not been certified as of the filing of this report, although, based on the preliminary results, we expect that all three of the Ramius Group nominees will be elected. The prospect of and, if they are elected, the actual election to the Board of some or all of the candidates nominated by the Ramius Group may lead to uncertainty among our employees, customers, and suppliers regarding the future direction of the Company’s business under the new Board, including without limitation the ability of the Company to continue to execute its current strategic plan and pursue research and development and other strategic initiatives, and such uncertainty may adversely affect our business. In addition, the costs associated with the proxy contest, and the continued distraction to the Company’s management resulting from the proxy contest, may adversely affect our business and our results of operations.

Failure to achieve the maximum revenues under our new managed services contract could have an adverse effect on our revenues and results of operations.

During the second quarter of 2009, we entered into a multi-year, managed services contract with a leading global network equipment provider, pursuant to which the Company will provide customer support and engineering services capabilities. In connection with the agreement, the Company hired twenty-one employees. The inability to successfully integrate and/or retain the hired employees and to integrate the tools and resources acquired as part of the agreement into our services business would have an adverse impact on our ability to realize the potential revenue opportunities under the agreement. In addition, under the terms of the managed services contract, we may not achieve the full revenue potential of the contract in the event that (i) the Company fails to meet certain specified service level requirements in the contract, and subsequently, service level credits reducing payments to the Company are applied, (ii) the network equipment provider terminates the contract for the Company’s failure to perform in accordance with its terms; and (iii) fees payable to the Company are reduced due to revenues from the network equipment provider’s customer agreements declining more rapidly than anticipated. Additionally, the Company’s overall profitability may be negatively impacted in the event the Company is required to incur unanticipated expenses to satisfy obligations assumed under the managed services agreement.

A continuing downturn in the global economy may adversely affect our revenues, results of operations and financial condition.

Demand for our products and services is increasingly dependent upon the rate of growth in the global economy. If current economic conditions continue, customer demand for our products and services could be even more adversely affected than experienced to date, which in turn could adversely affect our revenues, results of operations and financial condition. Many factors could continue to adversely affect regional or global economic growth. Some of these factors include:

	•		poor availability of credit,

	•		continued recession in the United States economy and other countries that we serve,

	•		fluctuation in the value of the U.S. dollar relative to foreign currencies in jurisdictions where we transact business,

	•		significant act of terrorism which disrupts global trade or consumer confidence,

	•		geopolitical tensions including war and civil unrest, and

	•		reduced levels of economic activity or disruption of domestic or international transportation.

The recent challenging economic conditions also may impair the ability of our customers to pay for products and services they have purchased or otherwise constrict our customers’ spending on our products and services. As a result, revenues may decline and reserves for doubtful accounts and write-offs of accounts receivable may increase. In particular, the Company has a significant receivable from an international customer that we have, to date, been unable to collect, and we may be forced to bring court action in a foreign jurisdiction in order to enforce payment. Although we believe that the merits of the claim are in the Company’s favor, there can be no assurance of success in any litigation to enforce payment, and we may occur additional expenses in connection with the litigation and other collection efforts that we are unable to recover. In addition, certain of our contracts are paid or make payments in foreign currencies, and continued decrease in the exchange rate of the U.S. dollar relative to these currencies could further reduce our revenues, and such impact could be material.

We maintain an investment portfolio, consisting of cash, cash equivalents and investments in individual municipal bonds, and corporate and government bonds. These investments are subject to general credit, liquidity, market, and interest rate risks. If the global credit market continues to deteriorate, our investment portfolio may be impacted and we could determine that some of our investments have experienced an other-than-temporary decline in fair value, requiring an impairment charge which could adversely impact our financial results.

We are dependent upon our ability to attract, retain and motivate our key personnel.

Our success depends on our ability to attract, retain and motivate our key management personnel, including the Company’s CEO, CFO, senior management team members, and key engineers, necessary to implement our business plan and to grow our business. Despite the adverse economic conditions of the past several years, competition for certain specific technical and management skill sets is intense. If we are unable to identify and hire the personnel that we need to succeed, or if one or more of our present key employees were to cease to be associated with the Company, our future results could be adversely affected. Furthermore, since 2007 we have experienced a number of changes in our senior management positions, both as part of the restructuring initiatives and otherwise, including a new CEO during 2007 and a new CFO during 2008. Although we believe we have taken appropriate measures to address the impact of these changes, there is the risk that such changes could impact our business, which could negatively affect operating results.

We depend upon a few major customers for a majority of our revenues, and the loss of any of these customers, or the substantial reduction in the products or services that they purchase from us, would significantly reduce our revenues and net income.

We currently depend upon a few major customers for a significant portion of our revenues and we expect to continue to derive a significant portion of our revenues from a limited number of customers in the future. The loss of any of these customers or a substantial reduction in the products or services that they purchase from us or our inability to renew services agreements with customers and to do so upon terms at least as favorable to the Company as current agreements would significantly reduce our

revenues and net income. Furthermore, diversions in the capital spending of certain of these customers to new network elements have and could continue to lead to their reduced demand for our products, which could in turn have a material adverse affect on our business and results of operation. The capital spending of our large domestic carrier customers, as well as many of our other customers and potential customers, are dictated by a number of factors, most of which are beyond our control, including:

	•		the conditions of the communications market and the weakening economy in general;

	•		subscriber line loss and related reduced demand for wireline telecommunications services;

	•		changes or shifts in the technology utilized in the networks;

	•		labor disputes between our customers and their collective bargaining units;

	•		the failure of our customers to meet established purchase forecasts and growth projections;

	•		competition among the large domestic carriers, competitive exchange carriers and wireless telecommunications and cable providers; and

	•		reorganizations, including management changes, at one or more of our customers or potential customers.

If the financial condition of one or more of our major customers should deteriorate, or if they have difficulty acquiring investment capital or reduce their capital expenditures due to any of these or other factors, a substantial decrease in our revenues would likely result.

Our operating results may vary from quarter to quarter, causing our stock price to fluctuate.

Our operating results have in the past been subject to quarter to quarter fluctuations, and we expect that these fluctuations will continue, and may increase in magnitude, in future periods. Demand for our products is driven by many factors, including the availability of funding for our products in customers’ capital budgets. Some of our customers place large orders near the end of a quarter or fiscal year, in part to spend remaining available capital budget funds. Seasonal fluctuations in customer demand for our products driven by budgetary and other reasons can create corresponding fluctuations in period-to-period revenues, and we therefore cannot assure you that our results in one period are necessarily indicative of our revenues in any future period. In addition, the number and timing of large individual sales and the ability to obtain acceptances of those sales, where applicable, has been difficult for us to predict, and large individual sales have, in some cases, occurred in quarters subsequent to those we anticipated, or have not occurred at all. The loss or deferral of one or more significant sales in a quarter could harm our operating results. It is possible that in some quarters our operating results will be below the expectations of investors. In such events, or in the event adverse conditions prevail, the market price of our common stock may decline significantly.

We may experience reduced product sales caused by customers transitioning their access network service assurance solutions.

Certain of our larger customers are in the process of upgrading their access networks, and continue transitioning and upgrading their service assurance solutions for these networks. This has and may continue to adversely impact revenues from our testing products. Further, these customers may decide not to adopt our technologies for their service assurance needs, which would have a significant adverse affect on revenues for those products.

We have completed, and may pursue additional acquisitions, which could result in the disruption of our current business, difficulties related to the integration of acquired businesses, and substantial expenditures.

We have completed, and we may pursue additional acquisitions of companies, product lines and technologies as part of our strategic efforts to realign our resources around growth opportunities in current, adjacent and new markets, to enhance our existing products, to introduce new products and to fulfill changing customer requirements. The consideration for any such acquisition may be cash or stock, or a combination of such forms of consideration, and the payment of such consideration may result in a reduction in our cash balance and/or the issuance of additional shares which may dilute the interest of our existing shareholders. Acquisitions involve numerous risks, including the disruption of our business, exposure to assumed or unknown liabilities of the acquired target, and the failure to integrate successfully the operations and products of acquired businesses. International acquisitions provide specific challenges due to the unique topology of international telecommunications networks, as well as requirements of doing business in particular countries. Further, our ability to sell certain products internationally depends upon our ability to maintain certain key manufacturing relationships and we may not be able to continue those relationships. Goodwill arising from acquisitions may result in significant impairment charges against our operating results in one or more future periods. Furthermore, we may never achieve the anticipated results or benefits of an acquisition, such as increased market share or the successful development and sales of a new product. The effects of any of these risks could materially harm our business and reduce our future results of operations and cause our stock price to decline.

The failure of acquired assets to meet expectations, or a decline in our fair value determined by market prices of our stock, could indicate impairment of our intangible assets and result in impairment charges.

Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) addresses financial accounting and reporting for the impairment or disposal of long-lived assets and requires that these assets be measured for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. During 2008 and 2007, based on our assessment that triggering events had occurred, we performed the required recoverability tests of SFAS 144 and determined that certain long-lived assets were impaired. The occurrence of further triggering events could result in additional impairments.

The sale of our products is dependent upon our ability to satisfy the proprietary requirements of our customers.

We depend upon a relatively narrow range of products for the majority of our revenue. Our success in marketing our products is dependent upon their continued acceptance by our customers. In some cases, our customers require that our products meet their own proprietary requirements. If we are unable to satisfy such requirements, or forecast and adapt to changes in such requirements, our business could be materially harmed. In addition, we introduced new products during 2008, including the DigiTest ICE and the first version of the LightHouse™ products. The rate of acceptance of these new products could be delayed by, or fail to achieve, among other factors, extended testing or acceptance periods or requests for custom or modified engineering of such products to conform to customer requirements.

The sale of our products is dependent on our ability to respond to rapid technological change and may be adversely affected by the development, and acceptance by our customers, of new technologies which may compete with or reduce the demand for our products.

Changes in network architecture experienced by our customers in the telephony market have and may continue to negatively affect our ability to sell products in these markets. Although we are addressing these changes with modifications to our existing products, if customers do not accept this new product technology, our revenues could be adversely affected. Further, we are experiencing competition from the internal Information Technology (“IT”) departments of our own carrier customers. In the past, we offered solutions consisting of hardware probes, coupled with a centralized software platform that analyzed the data pulled from the probes and determined the appropriate dispatch statement or issue identification statement. As the capabilities of new infrastructure equipment increases, test and monitoring software platforms are increasingly taking advantage of the available data from the infrastructure equipment. At the same time, many of our larger customers have captive development capabilities in their own IT organizations. These IT teams can develop competing software systems to our offerings, which could adversely affect our ability to sell our products to those customers, which could negatively impact overall revenues from such products.

Furthermore, the development of new technologies which compete with or reduce the demand for our products, and the adoption of such technologies by our customers, could adversely affect sales of our products. For example, as our products generally serve the wireline marketplace, to the extent wireline customers migrate to wireless technologies, there may be reduced demand for our products. In addition, we face new competition as testing functions that were once only available with purpose-built test systems are now available as integrated components of network elements. To the extent our customers adopt such new technology in place of our telecommunications products, the sales of our telecommunications products may be adversely affected. Such competition may also increase pricing pressure for our telecommunications products and adversely affect the revenues from such products.

Our reliance on third parties to manufacture certain aspects of our products involves risks, including delays in product shipments and reduced control over product quality.

We depend upon a limited number of third party contract manufacturers to manufacture certain elements of our products. Furthermore, the components of our hardware products are procured from a limited number of outside suppliers. Although our products generally use industry standard products, some parts, such as ASICs, are custom-made to our specifications. Our reliance upon such third party contractors involve several risks, including reduced control over manufacturing costs, delivery times, reliability and quality of components. If we were to encounter a shortage of key manufacturing components from limited sources of supply, or experience manufacturing delays caused by reduced manufacturing capacity, inability of our contract manufacturers to procure raw materials, the loss of key assembly subcontractors, difficulties associated with the transition to our new contract manufacturers or other factors, we could experience lost revenues, increased costs, delays in, cancellations or rescheduling of orders or shipments, any of which would materially harm our business.

Our future sales in international markets are subject to numerous risks and uncertainties.

As a result of our acquisition of BTD and domestic market conditions, our business is becoming more dependent upon international markets. Our future sales in international markets are subject to

numerous risks and uncertainties, including local economic and labor conditions, political instability including terrorism and other acts of war or hostility, unexpected changes in the regulatory environment, trade protection measures, tax laws, our ability to market current or develop new products suitable for international markets, difficulties with deployments and acceptances of products, obtaining and maintaining successful distribution and resale channels, changes in tariffs and foreign currency exchange rates, and longer payment cycles. These specific risks, or an overall reduction in the demand for or the sales of our products in international markets, could adversely affect future results.

We face intense competition, which could result in our losing market share or experiencing a decline in our gross margins.

The markets for some of our products are very competitive. Some of our competitors have greater technological, financial, manufacturing, sales and marketing, and personnel resources than we have. As a result, these competitors may have an advantage in responding more rapidly or effectively to changes in industry standards or technologies. We are facing competition with our IP-based testing solutions, and many competitive technologies, encompassing both hardware and software, are available in these markets. Moreover, better financed competitors may be better able to withstand the pricing pressures that increased competition may bring. If our introduction of improved products or services is not timely or well received, or if our competitors reduce their prices for products that are comparable to ours, demand for our products and services could be adversely affected. Recent competition from certain network element providers offering chip-based testing functionality may also intensify the pricing pressure for our telecommunications products and adversely affect future revenues from such products. We also face increasing pressure from certain of our large domestic carrier customers on software maintenance agreements, as they continue to divert spending from legacy networks to next generation network elements.

We may also compete directly with our customers. Generally, we sell our products either directly or indirectly through OEM channels and other means to end-user telecommunications service providers. It is possible that our customers, as the result of bankruptcy or other rationales for dismantling network equipment, could attempt to resell our products. The successful development of such a secondary market for our products by a third party could negatively affect demand for our products, reducing our future revenues.

Our future results are dependent on our ability to establish, maintain and expand our distribution channels and our existing third-party distributors.

We market and sell certain of our products, including our DigiTest and Cheetah product lines and certain of the acquired Broadband Test Division products, through domestic and international OEM relationships. Our future results are dependent on our ability to establish, maintain and expand third party relationships with OEM as well as other marketing and sales distribution channels. If, however, the third parties with whom we have entered into such OEM and other arrangements should fail to meet their contractual obligations, cease doing, or reduce the amount of their business with us or otherwise fail to meet their own performance objectives, customer demand for our products could be adversely affected, which would have an adverse effect on our revenues.

The sales cycle for our system products is long, and the delay or failure to complete one or more large transactions in a quarter could cause our operating results to fall below our expectations.

The sales cycle for our system products is highly customer specific and can vary from a few weeks to many months. The system requirements of customers is highly dependent on many factors, including but not limited to their projections of business growth, capital budgets and anticipated cost savings from implementation of the system. Our delay or failure to complete one or more large transactions in a quarter could harm our operating results. Our systems involve significant capital commitments by customers. Potential customers generally commit significant resources to an evaluation of available enterprise software and system testing solutions and require us to expend substantial time, effort and money educating them about the value of our solutions. System sales often require an extensive sales effort throughout a customer’s organization because decisions to acquire software licenses and associated system hardware involve the evaluation of the products by a significant number of customer personnel in various functional and geographic areas, each often having specific and conflicting requirements. A variety of factors, including actions by competitors and other factors over which we have little or no control, may cause potential customers to favor a particular supplier or to delay or forego a purchase.

Many of the Company’s products must comply with significant governmental and industry-based regulations, certifications, standards and protocols, some of which evolve as new technologies are deployed. Compliance with such regulations, certifications, standards and protocols may prove costly and time-consuming for the Company, and the Company cannot provide assurance that its products will continue to meet these standards in the future. In addition, regulatory compliance may present barriers to entry in particular markets or reduce the profitability of the Company’s product offerings. Such regulations, certifications, standards and protocols may also adversely affect the industries in which we compete, limit the number of potential customers for the Company’s products and services or otherwise have a material adverse effect on its business, financial condition and results of operations. Failure to comply, or delays in compliance, with such regulations, standards and protocols or delays in receipt of such certifications could delay the introduction of new products or cause the Company’s existing products to become obsolete.

We depend on sales of our MCU products for a meaningful portion of our revenues, but this product is mature and its sales will continue to decline.

A large portion of our sales have historically been attributable to our MCU products. We expect that our MCU products may continue to account for a meaningful percentage of our revenues for the foreseeable future. However, these sales are declining and our three patents for our MCU products will expire between 2010 and 2014. MCU sales largely depend upon the rate of deployment of new, and the retrofitting of existing, DLC systems in the United States. Installation and replacement of DLC systems are, in turn, driven by a number of factors, including the availability of capital resources and the demand for new or better POTS. Our customers have begun to implement next generation network improvements such as Fiber-to-the-Premises (“FTTP”), which do not require the use of our MCU products as does the present hybrid POTS network. If our major customers fail to continue to build out their DSL networks and other projects requiring DLC deployments, or if we otherwise satisfy the domestic telecommunications market’s demand for MCUs, our MCU sales will continue to decline and our future results would be materially and adversely affected.

Although we are unable to predict future prices for our MCU products, we expect that prices for these products will continue to be subject to significant downward pressure in certain markets for the reasons described above. Accordingly, our ability to maintain or increase revenues will be dependent on our ability to expand our customer base, increase unit sales volumes of these products and to successfully,

develop, introduce and sell new products. We cannot assure you that we will be able to expand our customer base, increase unit sales volumes of existing products or develop, introduce and/or sell new products. Further, the loss of patent protection for these products might allow competition within this market segment, which, if successful, could cause our revenues from this product line to be materially adversely affected.

The continued adoption of industry-wide standards in the telecommunications market could have a material adverse effect on our profitability.

We are actively engaged in research to improve and expand our product offerings, including research and development to reduce product costs while providing enhancements; however, with the rise of industry-wide standards, among other factors, a number of our products have faced increased pricing pressure, driving lower margins. If sales of our network assurance and testing solutions do not increase, decrease rapidly, or are not accepted in the marketplace, or if our research and development activities do not produce marketable products that are both competitive and accepted by our customers, our overall revenues and profitability will be adversely affected.

The presence of available open source software could adversely affect our ability to maximize revenue from software products.

An emerging risk to our software development efforts is the presence of available open source software, which can allow our competitors and/or our customers to piece together a non-proprietary software solution relatively quickly. To the extent they are successful in developing software that meets their feature and benefit needs, revenue from our proprietary software could be adversely affected. Further, to the extent we incorporate open source into our software products, our ability to maximize revenue from our software products could be adversely impacted.

If our development efforts with respect to our LightHouse system fail to result in products which meet our customers’ needs, or if our customers fail to accept our new products, our revenues will be adversely affected.

We have recently introduced the first version of our LightHouse centralized remote monitoring system for the electric utility industry. The successful development, introduction and commercial success of this new technology will depend on a number of factors, including our ability to meet customer requirements, the existence of competitive products in the market, our timely and efficient completion of product design and implementation of manufacturing and manufacturing processes, our ability to meet product cost targets generating acceptable margins, timely remediation of product performance issues, if any, identified during testing, product performance at customer locations, differentiation of our product from our competitors’ products, and management of customer expectations concerning product capabilities and life cycles.

Our customers are subject to an evolving governmental regulatory environment that could significantly reduce the demand for our products or increase our costs of doing business.

Our customers have historically been subject to a number of governmental regulations, many of which have been repealed or amended as a result of the passage of The Telecommunications Act of 1996. Deregulatory efforts have affected and likely will continue to affect our customers in several ways, including the introduction of competitive forces into the local telephone markets and the imposition (or

removal) of controls on the pricing of services. These and other regulatory changes may limit the scope of our customers’ deployments of future services and budgets for capital expenditures, which could significantly reduce the demand for our products.

Moreover, as the FCC adopts new and amends existing regulations, and as the courts analyze the FCC’s authority to do so, our customers cannot accurately predict the rules which will regulate their conduct in their respective markets. Changes in the telecommunications regulatory environment could, among other results, increase our costs of doing business, require our customers to share assets with competitors or prevent the Company or our customers from engaging in business activities they may wish to conduct, which could adversely affect our future results.

Our limited ability to protect our proprietary information and technology may adversely affect our ability to compete, and our products could infringe upon the intellectual property rights of others, resulting in claims against us the results of which could be costly.

Many of our products consist entirely or partly of proprietary technology owned by us. Although we seek to protect our technology through a combination of copyrights, trade secret laws, contractual obligations and patents, these protections may not be sufficient to prevent the wrongful appropriation of our intellectual property, nor will they prevent our competitors from independently developing technologies that are substantially equivalent or superior to our proprietary technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the United States. In order to defend our proprietary rights in the technology utilized in our products from third party infringement, we may be required to institute legal proceedings. If we are unable to successfully assert and defend our proprietary rights in the technology utilized in our products, our future results could be adversely affected.

Although we attempt to avoid infringing known proprietary rights of third parties in our product development efforts, we may become subject to legal proceedings and claims for alleged infringement from time to time in the ordinary course of business. Any claims relating to the infringement of third-party proprietary rights, even if not meritorious, could result in costly litigation, divert management’s attention and resources, require us to reengineer or cease sales of our products or require us to enter into royalty or license agreements which are not advantageous to us. In addition, parties making claims may be able to obtain an injunction, which could prevent us from selling our products in the United States or abroad.

The success of some of our products is dependent on our ability to maintain licenses to technology from the manufacturers of systems with which our products must be compatible.

Some of our products require that we license technology from manufacturers of systems with which our products must be compatible. The success of our proprietary MCU products, in particular, rely upon our ability to acquire and maintain licensing arrangements with the various manufacturers of DLC systems for the Proprietary Design Integrated Circuits (“PDICs”) unique to each. Although most of our PDIC licensing agreements have perpetual renewal terms, all of them can be terminated by either party. If we are unable to obtain the PDICs necessary for our MCU products to be compatible with a particular DLC system, we may be unable to satisfy the needs of our customers. Furthermore, future PDIC license agreements may contain terms comparable to, or materially different than, the terms of existing agreements, as dictated by competitive or other conditions. The loss of these PDIC

license agreements, or our inability to maintain an adequate supply of PDICs on acceptable terms, could have a material adverse effect on our business.

If we are unable to satisfy our customers’ specific product quality, certification or network requirements, our business could be disrupted and our financial condition could be harmed.

Our customers demand that our products meet stringent quality, performance and reliability standards. We have, from time to time, experienced problems in satisfying such standards. Defects or failures have in the past, and may in the future occur relating to our product quality, performance and reliability. From time to time, our customers also require us to implement specific changes to our products to allow these products to operate within their specific network configurations. If we are unable to remedy these failures or defects or if we cannot affect such required product modifications, we could experience lost revenues, increased costs, including inventory write-offs, warranty expense and costs associated with customer support, delays in or cancellations or rescheduling of orders or shipments and product returns or discounts, any of which would harm our business.

If our accounting controls and procedures are circumvented or otherwise fail to achieve their intended purposes, our business could be seriously harmed.

We evaluate our disclosure controls and procedures as of the end of each fiscal quarter, and are annually reviewing and evaluating our internal controls over financial reporting in order to comply with SEC rules relating to internal control over financial reporting adopted pursuant to the Sarbanes-Oxley Act of 2002. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

If we ship products that contain defects, the market acceptance of our products and our reputation will be harmed and our customers could seek to recover their damages from us.

Our products, including the new software platform that we intend to launch in the third quarter 2009, are complex, and despite extensive testing, may contain defects or undetected errors or failures that may become apparent only after our products have been shipped to our customers and installed in their network or after product features or new versions are released. Any such defect, error or failure could result in failure of market acceptance of our products or damage to our reputation or relations with our customers, resulting in substantial costs for both the Company and our customers as well as the cancellation of orders, warranty costs and product returns. In addition, any defects, errors, misuse of our products or other potential problems within or out of our control that may arise from the use of our products could result in financial or other damages to our customers. Our customers could seek to have us pay for these losses. Although we maintain product liability insurance, it may not be adequate.

We may incur significant liabilities if we fail to comply with environmental regulations.

Failure to comply with environmental regulations in the jurisdictions in which we do business could result in penalties and damage to our reputation. In effect in the European Union are the directive on the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (the “RoHS Directive”) and the directive on Waste Electrical and Electronic Equipment (the “WEEE Directive”). Both the RoHS Directive and the WEEE Directive impact the form and manner in which

electronic equipment is imported, sold and handled in the European Union. Other jurisdictions, such as China, have followed the European Union’s lead in enacting legislation with respect to hazardous substances and waste removal. Although we have concluded that our test and measurement products fall outside the scope of the RoHS Directive, we have voluntarily undertaken to cause our next generation products to comply with its requirements. Ensuring compliance with the RoHS Directive, the WEEE Directive and similar legislation in other jurisdictions, and integrating compliance activities with our suppliers and customers could result in additional costs and disruption to operations and logistics and thus, could have a negative impact on our business, operations and financial condition. In addition, based on our conclusion that our test and measurement products do not fall within the scope of these Directives, we have determined not to take these compliance measures with respect to certain of our older, legacy products. Should our conclusions with respect to the applicability of the RoHS Directive to these products be challenged and fail to prevail, we may be subject to monetary and non-monetary penalties, and could suffer harm to our reputation or further decline in the sales of our legacy products.

Consolidations in, or a continued slowdown in, the telecommunications industry could harm our business.

We have derived a substantial amount of our revenues from sales of products and related services to the telecommunications industry. In recent quarters, capital spending in the telecommunications industry has decreased and may continue to decrease in the future as a result of the challenging general economic conditions prevailing in domestic and international markets. In particular, large carrier customers have been adversely affected by subscriber line losses as well as by competition from cable and wireless carriers and other carriers entering the local telephone service market. Certain emerging carriers also continue to be hampered by financial instability caused in large part by a lack of access to capital. In the event of continued or further significant decreases in capital spending of the telecommunications industry, our business would be adversely affected. Furthermore, as a result of industry consolidation, there may be fewer potential customers requiring our software in the future. Larger, consolidated telecommunications companies may also use their purchasing power to create pressure on the prices and the margins we could realize. We cannot be certain that consolidations in, or a slowdown in the growth of, the telecommunication industry will not harm our business.

Our expenses are relatively fixed in the short term, and we may be unable to adjust spending to compensate for unexpected revenue shortfalls.

We base our expense levels in part on forecasts of future orders and sales, which are extremely difficult to predict. A substantial portion of our operating expenses is related to personnel, facilities and sales and marketing. The level of spending for such expenses cannot be adjusted quickly and is, therefore, relatively fixed in the short term. Accordingly, our operating results will be harmed if revenues fall below our expectations in a particular quarter.

We rely on software that we license from third-party developers to perform key functions in our products.

We rely on software that we license from third parties, including software that is integrated with internally developed software and used in our products to perform key functions. We could lose the right to use this software or it could be made available to us only on commercially unreasonable terms. Although we believe that, in most cases, alternative software is available from other third-party

suppliers or internal developments, the loss of or inability to maintain any of these software licenses or the inability of the third parties to enhance in a timely and cost-effective manner their products in response to changing customer needs, industry standards or technological developments could delay or reduce our product shipments until equivalent software could be developed internally or identified, licensed and integrated, which would harm our business.

Our common stock price may be extremely volatile.

Our common stock price has been and is likely to continue to be highly volatile. The market price may vary in response to many factors, some of which are outside our control, including:

	•		General market and economic conditions;

	•		Changes in the telecommunications industry;

	•		Actual or anticipated variations in operating results;

	•		Announcements of technological innovations, new products or new services by us or by our competitors or customers;

	•		The fact that we no longer receive research coverage by sell-side market analysts;

	•		Announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures, capital commitments or other strategic announcements;

	•		Announcements by our customers regarding end market conditions and the status of existing and future infrastructure network deployments;

	•		Additions or departures of key personnel; and

	•		Future equity or debt offerings or our announcements of these offerings.

In addition, in recent years, the stock market in general, and The NASDAQ Global Select Market and the securities of technology companies in particular, have experienced extreme price and volume fluctuations. These fluctuations have often been unrelated or disproportionate to the operating performance of individual companies. These broad market fluctuations have in the past and may in the future materially and adversely affect our stock price, regardless of our operating results. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been initiated against such company. Such litigation could result in substantial costs and a diversion of our management’s attention and resources that could harm our business regardless of the outcome of such litigation.

We may be subject from time to time to legal proceedings, and any adverse determinations in these proceedings could materially harm our business.

We may from time to time be involved in various lawsuits and legal proceedings, which arise in the ordinary course of business. Litigation matters are inherently unpredictable, and we cannot predict the outcome of any such matters. If we ultimately lose or settle a case, we may be liable for monetary damages and other costs of litigation. Even if we are entirely successful in a lawsuit, we may incur significant legal expenses and our management may expend significant time in the defense. An adverse resolution of a lawsuit or legal proceeding could negatively impact our financial position and results of operations.

We may have difficulty securing new financing upon the same or substantially similar terms.

The Company is party with a bank to a three-year $25.0 million Unsecured Revolving Credit Facility (the “Facility”), which includes a $2.0 million letter of credit sub-facility, expiring on December 19, 2009. We do not anticipate any short-term borrowings for working capital as we believe our cash reserves and internally generated funds will be sufficient to sustain working capital requirements in 2009. However, our needs may change in the future. Because the global capital and credit markets have been severely constrained, we may not be able to obtain replacement financing or, even if we are able to obtain replacement financing, such financing may not be upon the same or substantially similar terms or may contain more onerous debt covenants that may be difficult for the Company to achieve. Inability to obtain replacement financing in these circumstances could have a material adverse effect on our future financial condition and results of operations.

Our business may be interrupted and adversely affected if we are unable to secure and prepare new office space for our corporate headquarters prior to the expiration of our Cheswick lease.

The Company’s lease for its office space in Cheswick, Pennsylvania will expire on March 31, 2010. There can be no assurance that the Company will be successful in locating, securing and preparing new office space on or before such date, and we may be required to request a further extension of the existing lease. If the Company is unable to extend its lease beyond its expiration or to enter into a definitive agreement for new office space prior to such date, the Company may have to enter into a lease for new office space on terms which may be substantially less favorable than the terms of the Company’s existing lease. In addition, even if the Company does enter into a definitive agreement for the lease of new office space prior to the expiration of its current lease, the Company may need to expend substantial amounts of time and money in order to prepare the office space to meet the Company’s business needs and requirements, which could result in significant expenses to the Company and may delay our ability to relocate to the new location beyond the expiration of our lease. The Company could incur substantial additional fees and expenses in order to locate, secure and prepare new office space in a timely manner, including additional rent, construction and capital improvement costs associated with the Company’s technical and other facility requirements, which could adversely affect our future results.

Furthermore, if the Company is unable to locate, secure and prepare new office space on or before the expiration of its current lease and/or move out of its existing office space before such time, the Company may incur penalties from its existing landlord, additional expenses and fees associated with temporary office and storage space and related moving costs. All of the foregoing could result in substantial costs to the Company and could result in material interruption to the Company’s business and operations.

Item 6. EXHIBITS

(a) Exhibits:

The following exhibits are being filed with this report:


Exhibit
Number		Description
10.1		Purchase and Sale Agreement, by and among, Tollgrade Communications, Inc., a Pennsylvania corporation, Tollgrade Communications, Inc., a Delaware corporation, and Cheetah Technologies, L.P., a Pennsylvania limited partnership, dated as of May 1, 2009 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on May 5, 2009).

10.2		Tollgrade Communications, Inc. 2006 Long-Term Incentive Compensation Plan, as amended and restated on June 4, 2009 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on June 10, 2009).

10.3		Amendment of Lease, dated May 22, 2009, between the Regional Industrial Development Corporation of Southwestern Pennsylvania and Tollgrade Communications, Inc., filed herewith.

31.1		Certification of Chief Executive Officer, filed herewith.

31.2		Certification of Chief Financial Officer, filed herewith.

32		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18.U.S.C. Section 350, filed herewith.

™LoopCare is a trademark of Tollgrade Communications, Inc.

™ICE is a trademark of Tollgrade Communications, Inc.

™N(x)Test is a trademark of Tollgrade Communications, Inc.

™LTSC is a trademark of Tollgrade Communications, Inc.

^®Tollgrade is a registered trademark of Tollgrade Communications, Inc.

^®DigiTest is a registered trademark of Tollgrade Communications, Inc.

^®MCU is a registered trademark of Tollgrade Communications, Inc.

^®4TEL is a trademark of Tollgrade Communications, Inc.

^®Celerity is a trademark of Tollgrade Communications, Inc.

All other trademarks are the property of their respective owners.

EXHIBIT INDEX

(Pursuant to Item 601 of Regulation S-K)


Exhibit
Number		Description
10.1		Purchase and Sale Agreement, by and among, Tollgrade Communications, Inc., a Pennsylvania corporation, Tollgrade Communications, Inc., a Delaware corporation, and Cheetah Technologies, L.P., a Pennsylvania limited partnership, dated as of May 1, 2009 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on May 5, 2009).

10.2		Tollgrade Communications, Inc. 2006 Long-Term Incentive Compensation Plan, as amended and restated on June 4, 2009 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on June 10, 2009).

10.3		Amendment of Lease, dated May 22, 2009, between the Regional Industrial Development Corporation of Southwestern Pennsylvania and Tollgrade Communications, Inc., filed herewith.

31.1		Certification of Chief Executive Officer, filed herewith.

31.2		Certification of Chief Financial Officer, filed herewith.

32		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18.U.S.C. Section 350, filed herewith.


	PAGE
	NO.
PART I. FINANCIAL INFORMATION

Item 1 Condensed Consolidated Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets as of June 27, 2009 and December 31, 2008 (Unaudited)		3

Condensed Consolidated Statements of Operations for the three and six month periods ended June 27, 2009 and June 28, 2008 (Unaudited)		4

Condensed Consolidated Statements of Cash Flows for the six month periods ended June 27, 2009 and June 28, 2008 (Unaudited)		5

Condensed Consolidated Statements of Changes in Shareholders’ Equity for the six month period ended June 27, 2009 (Unaudited)		6

Notes to Condensed Consolidated Financial Statements (Unaudited)		7

Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations		21

Item 3 Quantitative and Qualitative Disclosures about Market Risk		37

Item 4 Controls and Procedures		37

PART II. OTHER INFORMATION

Item 1A Risk Factors		37

Item 6 Exhibits		53

SIGNATURES		54

EXHIBIT INDEX		55
EX-10.3
EX-31.1
EX-31.2
EX-32


	Tollgrade Communications, Inc. (Registrant)
Dated: August 6, 2009
	/s/ Joseph A. Ferrara
	Joseph A. Ferrara
	Chairman, Chief Executive Officer and President


Dated: August 6, 2009
	/s/ Gary W. Bogatay, Jr.
	Gary W. Bogatay, Jr.
	Chief Financial Officer and Treasurer


Attest:		REGIONAL INDUSTRIAL DEVELOPMENT CORPORATION OF SOUTHWESTERN PENNSYLVANIA

/s/ Colleen B. Poremski	By	/s/ Donald F. Smith

Colleen B. Poremski, Corp Secretary		Donald F. Smith, Jr., President

(Corporate Seal)


Attest:		TOLLGRADE COMMUNICATIONS, INC.

/s/ Jennifer M. Reinke	By	/s/ Joseph A. Ferrara

		Title: Chairman, CEO and President

(Corporate Seal)

	(a)		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	(b)		Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	(c)		Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	(d)		Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

	1.		The foregoing preamble clauses are incorporated herein by reference thereto.

	2.		Section 3, Term, of the Original Lease is amended to extend the term of the Original Lease on the same terms and conditions set forth in the Original Lease, except to the extent set forth in this Amendment. The new extended term (the “Extended Term”, which, together with the Term as defined in the Original Lease, shall be hereafter collectively known as the “Term”) shall begin July 1, 2009, continue for a period of nine (9) months, and terminate on March 31, 2010. Notwithstanding the above, Landlord reserves the right, by providing written notice to

	5.		Section 4, Base Rent, of the Original Lease shall reflect that monthly Base Rent amount during the approved Extended Term shall be at the then current rate being paid by Tenant immediately prior to the commencement of the Extended Term.

	6.		The terms and provisions of this Amendment shall modify and supersede all inconsistent terms and provisions of the Original Lease and shall not be deemed to be a consent to the

	7.		The Lease sets forth the entire agreement between the parties with respect to the matters set forth herein. There have been no additional oral or written representations or agreements. This Amendment shall not be deemed to grant any right to Tenant to further extend the Original Lease, except as otherwise set forth therein

	8.		This Amendment be executed in any number of counterparts, and by each of the parties on separate counterparts, each of which, when so executed, shall be deemed an original, but all of which shall constitute but one and the same instrument.

1.		I have reviewed this quarterly report on Form 10-Q of Tollgrade Communications, Inc.

2.		Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.		Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.		The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

	(a)		All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	(b)		Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.