-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Wm7ffM+ovxCdFan0a0GK+8pfs3Vvmrx/avZTV1IKEHO6xb14cjo/+KBVthwRn20Z xE8xGDM6/bkqbP45eq7j9Q== /in/edgar/work/20000811/0000950128-00-001056/0000950128-00-001056.txt : 20000921 0000950128-00-001056.hdr.sgml : 20000921 ACCESSION NUMBER: 0000950128-00-001056 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20000701 FILED AS OF DATE: 20000811 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TOLLGRADE COMMUNICATIONS INC \PA\ CENTRAL INDEX KEY: 0001002531 STANDARD INDUSTRIAL CLASSIFICATION: [7385 ] IRS NUMBER: 251537134 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-27312 FILM NUMBER: 692337 BUSINESS ADDRESS: STREET 1: 493 NIXON RD CITY: CHESWICK STATE: PA ZIP: 15024 BUSINESS PHONE: 4122742156 10-Q 1 e10-q.txt TOLLGRADE COMMUNICATIONS, INC., FORM 10-Q 1 -------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC ------------------------------- FORM 10-Q (Mark One) [X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended July 1, 2000 [ ] 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 0-27312 TOLLGRADE COMMUNICATIONS, INC. (Exact Name of Registrant as Specified in its Charter) PENNSYLVANIA 25-1537134 (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification Number) 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 X No --- --- As of July 31, 2000, there were 13,238,198 shares of the Registrant's Common Stock, $0.20 par value per share, and no shares of the Registrant's Preferred Stock, $1.00 par value per share, outstanding. - -------------------------------------------------------------------------------- 2 This report consists of a total of 21 pages. The exhibit index is on page 20. TOLLGRADE COMMUNICATIONS, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JULY 1, 2000 TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO. -------- ITEM 1 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS: CONDENSED CONSOLIDATED BALANCE SHEETS AS OF JULY 1, 2000 AND DECEMBER 31, 1999 ............3 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE-MONTH AND SIX MONTH PERIODS ENDED JULY 1, 2000 AND JUNE 26, 1999...............................................4 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX-MONTH PERIODS ENDED JULY 1, 2000 AND JUNE 26, 1999 ............................................................5 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.......................................6 REVIEW REPORT OF INDEPENDENT ACCOUNTANTS...................................................9 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION................................................................................ 10 PART II. OTHER INFORMATION ITEM 1 LEGAL PROCEEDINGS.........................................................................18 ITEM 2 CHANGES IN SECURITIES.....................................................................18 ITEM 3 DEFAULTS UPON SENIOR SECURITIES...........................................................18 ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......................................18 ITEM 5 OTHER INFORMATION.........................................................................18 ITEM 6 EXHIBITS AND REPORTS FILED ON FORM 8-K....................................................18 SIGNATURE...............................................................................................19 EXHIBIT INDEX...........................................................................................20
2 3 PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED) DECEMBER 31, JULY 1, 2000 1999 ====================================================================================================================== ASSETS CURRENT ASSETS: Cash and cash equivalents $20,773,332 $15,555,810 Short term investments 24,666,179 13,516,676 Accounts receivable: Trade 12,499,628 10,865,244 Other 682,900 335,155 Inventories 21,635,260 17,335,747 Prepaid expenses and deposits 369,957 461,934 Deferred and refundable tax assets 6,040,628 575,251 - ---------------------------------------------------------------------------------------------------------------------- TOTAL CURRENT ASSETS 86,667,884 58,645,817 Long term investments 3,225,000 2,850,000 Property and equipment, net 5,707,918 4,337,115 Deferred tax assets 367,626 367,626 Patents and other assets 53,009 1,396 ====================================================================================================================== TOTAL ASSETS $96,021,437 $66,201,954 ====================================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 1,507,651 $ 911,769 Accrued expenses 963,684 1,222,866 Accrued salaries and wages 1,725,894 2,209,473 Royalties payable 1,265,889 793,689 Income taxes payable 688,601 2,443,609 Deferred income 105,000 1,106,483 - ---------------------------------------------------------------------------------------------------------------------- TOTAL CURRENT LIABILITIES 6,256,719 8,687,889 Deferred tax liabilities 9,950 9,950 - ---------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES 6,266,669 8,697,839 Shareholders' equity: Common stock, $.20 par value; authorized shares, 50,000,000; issued shares, 13,030,561 and 12,102,280, respectively 2,606,112 2,420,456 Additional paid-in capital 48,515,072 28,828,568 Treasury stock, at cost, 386,800 shares, respectively (3,164,975) (3,164,975) Retained earnings 41,798,559 29,420,066 - ---------------------------------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 89,754,768 57,504,115 ====================================================================================================================== TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $96,021,437 $66,201,954 ======================================================================================================================
The accompanying notes are an integral part of the condensed consolidated financial statements 3 4 TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
============================================================================================================================== FOR THE FOR THE THREE MONTHS ENDED SIX MONTHS ENDED JULY 1, 2000 JUNE 26, 1999 JULY 1, 2000 JUNE 26, 1999 ============================================================================================================================== REVENUES $29,666,710 $14,269,719 $52,084,245 $25,390,064 COST OF PRODUCT SALES 11,413,382 5,902,774 19,785,042 10,654,718 - ------------------------------------------------------------------------------------------------------------------------------ GROSS PROFIT 18,253,328 8,366,945 32,299,203 14,735,346 - ------------------------------------------------------------------------------------------------------------------------------ OPERATING EXPENSES: Selling and marketing 3,027,461 1,767,547 5,411,144 3,165,988 General and administrative 1,495,334 964,933 2,873,057 2,013,369 Research and development 3,098,095 2,157,980 5,688,763 4,033,658 - ------------------------------------------------------------------------------------------------------------------------------ TOTAL OPERATING EXPENSES 7,620,890 4,890,460 13,972,964 9,213,015 - ------------------------------------------------------------------------------------------------------------------------------ INCOME FROM OPERATIONS 10,632,438 3,476,485 18,326,239 5,522,331 Interest and other income, net 545,441 236,549 1,015,254 507,763 - ------------------------------------------------------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES 11,177,879 3,713,034 19,341,493 6,030,094 Provision for income taxes 4,024,000 1,339,855 6,963,000 2,170,855 ============================================================================================================================== NET INCOME $ 7,153,879 $ 2,373,179 $12,378,493 $ 3,859,239 ============================================================================================================================== EARNINGS PER SHARE INFORMATION: Weighted average shares of common stock and equivalents: Basic 12,562,822 11,537,850 12,392,619 11,556,466 Diluted 13,318,461 11,611,886 13,217,634 11,683,552 - ------------------------------------------------------------------------------------------------------------------------------ Net income per common and common equivalent shares: Basic $ .57 $ .21 $1.00 $ .33 Diluted $ .54 $ .20 $ .94 $ .33 ==============================================================================================================================
The accompanying notes are an integral part of the condensed consolidated financial statements. 4 5 TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six Months Ended July 1, 2000 June 26, 1999 ======================================================================================================================= CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 12,378,493 $ 3,859,239 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 846,460 541,794 Changes in assets and liabilities: Increase in accounts receivable-trade (1,634,384) (4,140,812) (Increase) decrease in accounts receivable-other (347,745) 98,872 Increase in inventories (4,299,513) (1,674,160) Decrease in prepaid expenses and other assets 40,364 7,194 Increase in accounts payable 595,882 495,925 Decrease in accrued expenses and deferred income (1,260,665) (457,419) Increase in royalties payable 472,200 233,027 (Decrease) increase in accrued salaries and wages (483,579) 43,764 (Decrease) increase in income taxes payable (3,052,958) 228,103 - ----------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) operating activities 3,254,555 (764,473) - ----------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Redemption/maturity of investments 4,624,648 5,689,303 Purchase of investments (16,149,151) (1,960,877) Capital expenditures (2,217,263) (750,324) Purchase of treasury stock -- (1,375,688) - ----------------------------------------------------------------------------------------------------------------------- Net cash (used in) provided by investing activities (13,741,766) 1,602,414 - ----------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from exercise of stock options including related tax 15,704,733 517,200 benefits - ----------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 15,704,733 517,200 - --------------------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 5,217,522 1,355,141 Cash and cash equivalents at beginning of period 15,555,810 8,311,353 - ----------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 20,773,332 $9,666,494 =======================================================================================================================
The accompanying notes are an integral part of the condensed consolidated financial statements. 5 6 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements included herein have been prepared by Tollgrade Communications, Inc. (the "Company") in accordance with generally accepted accounting principles for the interim financial information and Article 10 of Regulation S-X. The condensed consolidated financial statements as of and for the three-month and six-month periods ended July 1, 2000 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, 1999. Accordingly, the accompanying condensed consolidated financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements, although the Company believes that the disclosures are adequate to make the information presented not misleading. In the opinion of the Company's management, all adjustments considered necessary for a fair presentation of the accompanying condensed consolidated financial statements have been included, and all adjustments are of a normal and recurring nature. Operating results for the three-month and six- month periods ended July 1, 2000 are not necessarily indicative of the results that may be expected for the year ending December 31, 2000. 2. INVENTORIES At July 1, 2000 and December 31, 1999, inventories consisted of the following:
(Unaudited) July 1, December 31, 2000 1999 ----------- ----------- Raw materials ..................................... $ 9,697,971 $ 8,173,299 Work in progress................................... 10,133,908 7,410,203 Finished goods..................................... 1,803,381 1,752,245 ----------- ----------- $21,635,260 $17,335,747 =========== ===========
3. SHORT-TERM AND LONG-TERM INVESTMENTS Short-term investments at July 1, 2000 and December 31, 1999 consisted of individual municipal bonds stated at cost, which approximated market value. These securities have a maturity of one year or less at date of purchase and/or contain a callable provision in which the bonds can be called within one year from date of purchase. Long-term investments are comprised of individual municipal bonds with a maturity of more than one year but less than eighteen months and are stated at cost, which approximated market value. The primary investment purpose is to provide a reserve for future business purposes, including possible acquisitions and capital expenditures and to meet working capital requirements. Realized gains and losses are computed using the specific identification method. 6 7 4. INCOME PER COMMON SHARE Net income per share is calculated by dividing net income by the weighted average number of common shares plus incremental common stock equivalent shares (shares issuable upon exercise of stock options). Incremental common stock equivalent shares are calculated for each measurement period based on the treasury stock method, which uses the monthly average market price per share. The calculation of net income per common and common equivalent shares follows:
Three Months Three Months Six Months Six Months Ended Ended Ended Ended July 1, 2000 June 26, 1999 July 1, 2000 June 26, 1999 ======================================================================================================================= Net income............................... $ 7,153,879 $ 2,373,179 $12,378,493 $ 3,859,239 =========== =========== =========== =========== Common and common equivalent shares: Weighted average number of common shares outstanding during the period.................. 12,562,822 11,537,850 12,392,619 11,556,466 Common shares issuable upon exercise of outstanding stock options Diluted................... 755,639 74,036 825,015 127,086 ----------- ----------- ----------- ----------- Common and common equivalent shares outstanding during the period Diluted................... 13,318,461 11,611,886 13,217,634 11,683,552 =========== =========== =========== =========== Earnings per share data Net income per common and common equivalent shares Basic..................... $0.57 $0.21 $1.00 $0.33 Diluted................... $0.54 $0.20 $0.94 $0.33
7 8 5. DEFERRED AND REFUNDABLE TAX ASSETS The Company's current deferred and refundable tax assets as of July 1, 2000 includes a tax benefit of $5,465,377 for compensation expense resulting from the exercising of certain nonstatutory stock options by various directors, officers and other employees under the Company's various stock option programs during the first six months of 2000. The Company is entitled to a tax deduction in the current tax year ending December 31, 2000 equal to the difference between the fair market value of the shares received by the option holders upon exercise and the exercise price of the nonstatutory stock options. It is anticipated that these deductions will be utilized over the next twelve-month period either through elimination of income taxes payable or refund of prior taxes paid. 8 9 REVIEW REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors of Tollgrade Communications, Inc.: We have reviewed the accompanying condensed consolidated balance sheet of Tollgrade Communications, Inc. and subsidiaries as of July 1, 2000, and the related condensed consolidated statements of operations for each of the three- month and six- month periods ended July 1, 2000 and June 26, 1999 and the condensed consolidated statement of cash flows for the six- month periods ended July 1, 2000 and June 26, 1999. These financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements for them to be in conformity with generally accepted accounting principles. We previously audited, in accordance with auditing standards generally accepted in the United States, the consolidated balance sheet of Tollgrade Communications, Inc. and subsidiaries as of December 31, 1999 and the related consolidated statements of operations, shareholders' equity and cash flows for the year then ended (not presented herein); and in our report dated January 24, 2000, except for Note 2, which is as of March 20, 2000, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 1999, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived. /s/ PricewaterhouseCoopers LLP Pittsburgh, Pennsylvania July 11, 2000 9 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following discussion should be read in conjunction with the 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. The statements contained in the following Management's Discussion and Analysis of Results of Operations and Financial Condition which are not historical 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. These forward-looking statements represent Tollgrade Communications, Inc.'s (the "Company") present expectations or beliefs concerning future events. The Company cautions that such statements must be qualified by important factors that could cause actual earnings and other results to differ materially from those achieved in the past or those expected by the Company. These statements as to management's beliefs, strategies, plans, expectations or opinions in connection with Company performance, are based on a number of assumptions concerning future conditions that may ultimately prove to be inaccurate. Such statements must be qualified by important factors that could cause actual earnings and other results to differ materially from those achieved in the past or those expected by the Company. These include: rapid technological change along with the need to continually develop new products and gain customer acceptance and approval; the Company's dependence on a relatively narrow range of products; competition; the Company's dependence on key employees; difficulties in managing the Company's growth; the Company's dependence upon a small number of large customers and certain suppliers; the Company's dependence upon proprietary rights; risks of third party claims of infringement; and government regulation. OVERVIEW The Company was organized in 1986 and began operations in 1988. The Company designs, engineers, markets and supports test system, test access and status monitoring products for the telecommunications and cable television industries. The Company's telecommunications proprietary test access products enable telephone companies to use their existing line test systems to remotely diagnose problems in "Plain Old Telephone Service" ("POTS") lines containing both copper and fiber optics. The Company's MCU(R) product line, which includes POTS line testing as well as alarm-related products, represented approximately 67% of the Company's revenue for the second quarter ended July 1, 2000 and will continue to account for a majority of the Company's revenues for the foreseeable future. The Company's DigiTest(R) centralized network test system platform focuses on helping local exchange carriers conduct the full range of fault diagnosis, along with the ability to qualify, deploy and maintain next generation services that include Digital Subscriber Line ("DSL") service and Integrated Services Digital Network ("ISDN") service. The Company's DigiTest system is designed to provide complete hardware testing for POTS and local loop prequalification for DSL services. The system currently consists of three integrated pieces of hardware - the Digital Measurement Node ("DMN"), the Digital Measurement Unit ("DMU"), and the Digital Wideband Unit 10 11 ("DWU"). When used in an integrated fashion, the DigiTest system will permit local exchange carriers to perform a complete array of central office testing including POTS, DSL line prequalification, bridged tap detection, data rate prediction, and in-service wideband testing. Sales of the DigiTest product line accounted for approximately 23% of the Company's revenue for the second quarter of 2000. The Company's LIGHTHOUSE(R) cable products consist of a complete cable status monitoring system that provides a broad testing solution for the Broadband Hybrid Fiber Coax distribution system. The status monitoring system includes a host for user interface, control and configuration; a headend controller for managing network communications; and transponders that are strategically located within the cable network to gather status reports from power supplies, line amplifiers and fiber-optic nodes. Sales of the LIGHTHOUSE product line accounted for approximately 8% of the Company's revenue for the second quarter of 2000. Through the second quarter of 2000, the Company continued to build upon and extend its Professional Services offering to customers. The cornerstone of the Company's Professional Services offering is the Testability Improvement Initiatives. These services may offer the customer the opportunity to make dramatic improvements in testability levels, while training their own staffs in targeted geographic regions over a defined period of time. By making improvements in the customers digital loop carrier ("DLC") testability levels, the customers internal repair technicians can make use of automated systems to diagnose and repair subscriber loop problems thereby automatically eliminating the need for the involvement of several highly trained people to test and diagnose line problems. The Professional Services business levels continued to increase in the second quarter of 2000 but are not yet considered material to the Company's revenue. The Company's telecommunication product sales are primarily to the four Regional Bell Operating Companies ("RBOCs") as well as major independent telephone companies and to certain digital loop carrier ("DLC") equipment manufacturers. For the second quarter ended July 1, 2000, approximately 55% of the Company's total revenue was generated from sales to these four RBOCs, the two largest of which comprised approximately 36% of revenues. The Company markets and sells its cable products directly, as well as through various Original Equipment Manufacturer ("OEM") arrangements with cable network equipment manufacturers. The Company presently has one such OEM arrangement under contract and works under less formal arrangements with several other OEM partners. The Company's operating results have fluctuated and may continue to fluctuate as a result of various factors, including the timing of orders from and shipments to the RBOCs. This timing is particularly sensitive to various business factors within each of the RBOCs including the RBOCs relationships with their various organized labor groups. Certain contracts concerning Verizon Communications ("Verizon") (formerly Bell Atlantic) organized employees expired on August 6, 2000 and are now the subject of ongoing negotiations. Such contracts cover the majority of Verizons union employees associated with the former Bell Atlantic. These employees have entered into a formal work stoppage against Verizon. The Company provides Verizon with certain of its MCU products, as well as its professional service offerings that improve their DLC testability levels within certain of their regions. Verizon represented slightly less than 10% of the Company's total 11 12 revenues during the first six months of 2000. The Company believes the effect of a short-term work stoppage on its operations will not be significant. However, should the labor dispute persist on a longer term basis the Company's operations may be unfavorably impacted, but the extent is not determinable at this time. In addition, the markets for the Company's new products, specifically DigiTest and LIGHTHOUSE, are highly competitive, beyond the competition historically seen in the Company's MCU markets. Due to the rapidly evolving market in which these products compete, additional competitors with significant market presence and financial resources could further intensify the competition for these products. The Company believes that recent changes within the telecommunication marketplace, including industry consolidation, as well as the Company's ability to successfully penetrate certain new markets, have resulted in some discounting and more favorable terms granted to certain customers of the Company. In addition, the Company experienced certain customer demands to consolidate product purchases which have translated into large bulk orders. Although the Company will continue to strive to meet the demands of its customers, which include delivery of quality products at an acceptable price and on acceptable terms, there are no assurances that the Company will be successful in negotiating acceptable terms and conditions pertaining to these large orders. Additionally, recent consolidations among the RBOCs, and their ability to consolidate their inventory and product procurement systems could cause fluctuations or delays in the Company's order patterns. Also, recent efforts in the cable status monitoring industry to standardize transponders among status monitoring systems could cause pricing pressure as well as affect deployment within certain customers of the Company's cable products. These standards, if adopted by the standards setting body, are expected to become final in the year 2000 and may affect the Company's revenues from such products in subsequent periods. The Company cannot predict such future events or business conditions and the Company's results may be adversely affected by these industry trends in the primary markets its serves. Although international sales to date have not been significant, the Company believes that certain international markets may offer opportunities. However, the international telephony markets differ from those found domestically due to the different types and configurations of equipment used by those international communication companies to provide services. In addition, certain competitive elements also are found internationally which do not exist in the Company's domestic markets. These factors, when combined, have made entrance into these international markets very difficult. From time to time, the Company has utilized the professional services of various marketing consultants to assist in defining the Company's international market opportunities. With the assistance of these consultants and through direct marketing efforts by the Company, it has been determined that its present MCU technology offers limited opportunities in certain international markets for competitive and other technological reasons. These markets include China (other than through an existing OEM relationship), Europe and the Pac Rim countries. There can be no assurance that any continued efforts by the Company will be successful or that the Company will achieve significant international sales. The Company believes that continued growth will depend on its ability to design and engineer new products and, therefore, spends a significant amount on research and development. Research and development expenses as a percent of revenues were approximately 10% for the second quarter ended July 1, 2000. The Company expects its research and development expenses to continue at significant levels. 12 13 RESULTS OF OPERATIONS - SECOND QUARTER REVENUES Revenues for the second quarter of 2000 of $29,666,710 were $15,396,991, or 107.9%, higher than the revenues of $14,269,719 reported for the second quarter of 1999. The increase in revenues for the second quarter of 2000 was primarily attributable to an increase in unit volume sales of core MCU line testing products to SBC Communications, Inc. (including Ameritech, Pacific Bell and SNET) associated with that company's continued effort to improve testability in their multi-state region, as well as to the CLEC markets and those sold on an Original Equipment Manufacturer (OEM) basis. The current quarter also included increased shipments of the Company's next generation DigiTest system products primarily to Sprint under the Company's purchase agreement with Sprint North Supply, as well as to Nortel Networks for deployment into the CLEC markets, including TriVergent Communications and ATI. Current quarter sales include approximately $3,600,000 of revenue related to orders shipped prior to April 1, 2000 which were pending receipt of final third party certifications and customer acceptance. All such certifications and customer acceptance notifications were received in the second quarter. In addition, the current quarter includes increased sales of the Company's LIGHTHOUSE Cable Status Monitoring System to RCN Corporation and AT&T Broadband and Internet Services (AT&T BIS), as well as to ANTEC, an Original Equipment Manufacturer of cable network products. Additionally, the current quarter also included increased billings related to the Company's Professional Service business. Periodic fluctuations in customer orders and backlog result from a variety of factors, including but not limited to the timing of significant orders and shipments, and are not necessarily indicative of long-term trends in sales of the Company's products. GROSS PROFIT Gross profit for the second quarter of 2000 was $18,253,328 compared to $8,366,945 for the second quarter of 1999, representing an increase of $9,886,383, or 118.2%. Gross profit as a percentage of revenues increased to 61.5% in the second quarter of 2000, compared to 58.6% in the same quarter last year. The overall increase in gross profit resulted primarily from the increased sales levels, while improvements in gross margin as a percentage of sales were a result of a favorable sales mix and associated manufacturing efficiencies related to increased production levels. SELLING AND MARKETING EXPENSE Selling and marketing expense for the second quarter of 2000 was $3,027,461 compared to $1,767,547 for the second quarter of 1999. This increase of $1,259,914, or 71.3%, is primarily due to an increase in the number of sales and marketing personnel to support new product introductions and enhance customer support, as well as an increase in commissions associated with the increased sales level during the current quarter. In addition, the current quarter includes increased spending on advertising, promotion and related marketing activities. As a percentage of revenues, selling and marketing expenses decreased to 10.2% in the second quarter of 2000 from 12.4% in the second quarter of 1999. 13 14 GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense for the second quarter of 2000 was $1,495,334, an increase of $530,401, or 55.0%, from the $964,933 recorded in the second quarter of 1999. The increase in general and administrative expense primarily reflects increases in certain performance-based compensation reserves associated with the Company's management incentive compensation program, certain professional service fees, as well as various recruiting-related expenditures. As a percentage of revenues, general and administrative expenses decreased to 5.0% in the second quarter of 2000 from 6.8% in the second quarter of 1999. RESEARCH AND DEVELOPMENT EXPENSE Research and development expense in the second quarter of 2000 was $3,098,095, an increase of $940,115, or 43.6%, over the $2,157,980 recorded in the second quarter of 1999. The increase is primarily associated with additional personnel and related development costs associated with developing new products and new technologies and enhancing features of existing products. The new personnel were hired for positions in design engineering, hardware and software development, engineering support, and test engineering. In addition, research and development expenses reflect an increase in certain performance-based compensation reserves associated with the Company's management incentive compensation program. As a percentage of revenues, research and development expense decreased to 10.4% in the second quarter of 2000 from 15.1% in the second quarter of 1999. INTEREST AND OTHER INCOME Interest and other income consists primarily of interest income. For the second quarter of 2000, interest and other income was $545,441 compared to $236,549 for the second quarter of 1999, representing an increase of $308,892, or 130.6%. This increase is primarily a result of additional funds available for investment purposes during the current period. PROVISION FOR INCOME TAXES The provision for income taxes for the second quarter of 2000 was $4,024,000, an increase of $2,684,145, or 200.3%, from the $1,339,855 for the second quarter of 1999. The effective income tax rate for the second quarter of 2000 was approximately 36.0% of pretax income, which is comparable to the effective tax rate for the second quarter of 1999. NET INCOME AND EARNINGS PER SHARE As a result of the above factors, net income for the second quarter of 2000 was $7,153,879, an increase of $4,780,700, or 201.4%, from the $2,373,179 recorded in the second quarter of 1999. Basic and diluted earnings per common share of $.57 and $.54, respectively, for the second quarter of 2000 increased by $.36 and $.34, or 171.4% and 170.0%, from the $.21 and $.20, respectively, earned in the second quarter of 1999. Basic and diluted weighted average common and common equivalent shares outstanding were 12,562,822 and 13,318,461, respectively, in the second quarter of 2000 compared to 11,537,850 and 11,611,886, respectively, in the second quarter of 1999. The increase in the weighted average equivalent shares resulted from an increase in the average share price between periods. As a percentage of revenues, net income for the second quarter of 2000 increased to 24.1% compared to the 16.6% for the second quarter of 1999. 14 15 RESULTS OF OPERATIONS - YEAR TO DATE REVENUES For the first six months of 2000, revenues were $52,084,245 compared to $25,390,064 for the first six months of 1999, representing an increase of $26,694,181, or 105.1%. The increase in revenues for the first six months of 2000 was primarily attributable to an increase in unit volume sales of core MCU line testing products to SBC Communications, Inc. (including Ameritech, Pacific Bell and SNET), US West and Bell South. In addition, sales to the CLEC markets increased as well as those sold on an Original Equipment Manufacturer (OEM) basis. The first six months also includes increased shipments of the Company's next generation DigiTest system products primarily to Sprint under the Company's purchase agreement with Sprint North Supply, as well as to Nortel Networks for deployment into the CLEC markets, including TriVergent Communications and ATI. The first six months of 2000 sales include approximately $1,400,000 of revenue related to orders shipped prior to January 1, 2000 and an additional $2,200,000 shipped during the first quarter of 2000 which were pending receipt of final third party certifications and customer acceptance. All such certifications and customer acceptance notifications were received in the second quarter of 2000. Additionally, the first six months includes increased sales of the Company's LIGHTHOUSE Cable Status Monitoring System to RCN Corporation and AT&T Broadband and Internet Services (AT&T BIS), as well as to ANTEC, an Original Equipment Manufacturer of cable network products. Also, sales included increased billings related to the Company's Professional Service business. Periodic fluctuations in customer orders and backlog result from a variety of factors, including but not limited to the timing of significant orders and shipments, and are not necessarily indicative of long-term trends in sales of the Company's products. GROSS PROFIT Gross profit for the first six months of 2000 was $32,299,203, which represents an increase of $17,563,857, or 119.2%, from the $14,735,346 in the same period last year. As a percentage of revenues, gross profit increased to 62.0% in the first six months of 2000 compared to 58.0% in the same period for 1999. The overall increase in gross profit resulted primarily from increased sales levels, while improvements in gross margin as a percentage of sales were a result of a favorable sales mix and associated manufacturing efficiencies related to increased production levels. SELLING AND MARKETING EXPENSE For the first six months of 2000, selling and marketing expense totaled $5,411,144 compared to $3,165,988 for the first six months of 1999, representing an increase of $2,245,156 or 70.9%. The increase is primarily due to an increase in the number of sales and marketing personnel to support new product introductions and enhance customer support, as well as an increase in commissions associated with the increased sales level. In addition, selling and marketing expenses for the first six months of 2000 include increased spending on advertising, promotion and related marketing activities. As a percentage of revenue, selling and marketing expense decreased from 10.4% in the first six months of 2000 from 12.5% for the same period in 1999. 15 16 GENERAL AND ADMINISTRATIVE EXPENSE For the first six months of 2000, general and administrative expense totaled $2,873,057 compared to $2,013,369 for the first six months of 1999, representing an increase of $859,688, or 42.7%. The increase in general and administrative expense reflects an increase in certain performance-based compensation reserves associated with the Company's management incentive compensation program, certain professional service fees, as well as various employee recruiting-related expenditures. As a percentage of revenue, general and administrative expense decreased to 5.5% in the first six months of 2000 from 7.9% for the same period of 1999. RESEARCH AND DEVELOPMENT EXPENSE For the first six months of 2000, research and development expense totaled $5,688,763 compared to $4,033,658 for the first six months of 1999, representing an increase of $1,655,105, or 41.0%. This increase is primarily associated with additional personnel to support product development and an increase in certain performance-based compensation reserves associated with the Company's management incentive compensation program. As a percentage of revenue, research and development expense decreased to 10.9% in the first six months of 2000 from 15.9% for the same period of 1999. INTEREST AND OTHER INCOME For the first six months of 2000, interest and other income was $1,015,254 compared to $507,763 for the first six months of 1999, representing an increase of $507,491, or 99.9%. This increase is primarily attributable to an increase in funds available for investments during the first six months of 2000. PROVISION FOR INCOME TAXES The provision for income taxes for the first six months of 2000 was $6,963,000, which was an increase of $4,792,145, or 220.7%, from $2,170,855 for the first six months of 1999. The effective income tax rate for the first six months of 2000 was 36.0% of income before taxes, which was consistent with the rate in the prior year period. NET INCOME AND EARNINGS PER SHARE As a result of the above factors, net income for the first half of 2000 was $12,378,493, an increase of $8,519,254, or 220.7%, from the $3,859,239 recorded in the first six months of 1999. Basic and diluted earnings per common share of $1.00 and $.94, respectively, for the first half of 2000 increased by $.67 and $.61, or 203.0% and 184.8%, from the $.33 earned in the first half of 1999. Basic and diluted weighted average common and common equivalent shares outstanding were 12,392,619 and 13,217,634, respectively, in the first half of 2000 compared to 11,556,466 and 11,683,552, respectively, in the first half of 1999. As a percentage of revenues, net income for the first half of 2000 increased to 23.8% compared to the 15.2% in the first half of 1999. LIQUIDITY AND CAPITAL RESOURCES At July 1, 2000, the Company had working capital of $80,411,165, which represented an increase of $30,453,237, or 61.0%, from the $49,957,928 of working capital as of December 31, 1999. The increase in working capital can be attributed primarily to operating cash flow (income from operations before depreciation and amortization) and proceeds from the exercise of stock options 16 17 including related tax benefits exceeding requirements for purchases of property and equipment. Significant components of the Company's change in working capital include an increase in inventories of $4,299,513 associated primarily with increases in raw materials and work-in-process to support the new product introductions of the Company's DigiTest and LIGHTHOUSE cable status monitoring system as well as an increase in MCU related inventory to support certain project related customer programs. Management believes that operating cash flow and cash reserves are adequate to finance currently planned capital expenditures and to meet the overall liquidity needs of the Company. BACKLOG The Company's backlog consists of firm customer purchase orders. As of July 1, 2000, the Company had a backlog of $11,591,177 compared to $12,115,608 at December 31, 1999 and $7,431,562 at June 26, 1999. The majority of the backlog is expected to be recognized as revenue in the third quarter of 2000. Periodic fluctuations in customer orders and backlog result from a variety of factors, including but not limited to the timing of significant orders and shipments, and are not necessarily indicative of long-term trends in sales of the Company's products. 17 18 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None. ITEM 2. CHANGES IN SECURITIES None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 4, 2000, the Company held its annual shareholders meeting. At the meeting, James J. Barnes and Rocco L. Flaminio were elected to the Board of Directors for a three-year term expiring at the annual meeting of shareholders in 2003. The terms of Directors Richard H. Heibel and Robert W. Kampmeinert also continued after the meeting and will expire at the annual meeting of shareholders in 2001. The terms of Directors Christian L. Allison, Daniel P. Barry, and David S. Egan also continued after the meeting and will expire at the annual meeting of shareholders in 2002. In addition, the Company's Articles of Incorporation were amended to increase the number of shares of Common Stock authorized for issuance by the Company to fifty million. Also, the shareholders ratified the appointment of PricewaterhouseCoopers LLP as the Company's independent auditors for fiscal year 2000. The results of the voting were as follows:
Total Votes Cast For Against Withheld Abstained ---------- --- ------- -------- --------- Election of Directors: James J. Barnes 5,489,976 5,253,658 -- 236,318 -- Rocco L. Flaminio 5,489,976 5,268,553 -- 221,423 -- Amendment of Articles of Incorporation 5,489,976 5,212,302 257,639 -- 20,035 Ratification of Appointment of PricewaterhouseCoopers LLP 5,489,976 5,453,560 32,724 -- 3,692
ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: The following exhibits are being filed with this report: Exhibit Number Description ------ ----------- 15 Letter re unaudited interim financial information 27 Financial Data Schedule 18 19 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. TOLLGRADE COMMUNICATIONS, INC. (REGISTRANT) Dated: August 11, 2000 /s/ CHRISTIAN L. ALLISON ------------------------------------------------ CHRISTIAN L. ALLISON CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER Dated: August 11, 2000 /s/ SAMUEL C. KNOCH ------------------------------------------------ SAMUEL C. KNOCH CHIEF FINANCIAL OFFICER AND TREASURER Dated: August 11, 2000 /s/ BRADLEY N. DINGER ------------------------------------------------ BRADLEY N. DINGER CONTROLLER 19 20 EXHIBIT INDEX (Pursuant to Item 601 of Regulation S-K) Exhibit Number Description ------ ----------- 15 Letter re unaudited interim financial information 27 Financial Data Schedule 20 EX-15 2 ex15.txt LETTER RE UNAUDITED INTERIM FINANCIAL INFO 1 EXHIBIT 15 August 11, 2000 Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 RE: Tollgrade Communications, Inc. and subsidiaries 1). Form S-8 (Registration No. 333-4290) 1995 Long-Term Incentive Compensation Plan and Individual Stock Options Granted to Certain Directors and Employees Prior to the Adoption of the Plan 2). Form S-8 (Registration No. 333-52907) 1998 Employee Incentive Compensation Plan Ladies and gentlemen: We are aware that our report dated July 11, 2000 on our review of interim financial information of Tollgrade Communications, Inc. and subsidiaries as of and for the three month and six month period ended July 1, 2000 and in the Company's quarterly report on Form 10-Q for the quarter then ended is incorporated by reference in the registration statements referred to above. Very truly yours, /s/ PricewaterhouseCoopers LLP EX-27 3 ex27.txt FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q FOR THE SECOND QUARTER ENDED JULY 1, 2000, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0001002531 TOLLGRADE COMMUNICATIONS, INC. 3-MOS DEC-31-2000 APR-02-2000 JUL-01-2000 20,773,332 24,666,179 12,677,439 177,811 21,635,260 86,667,884 11,294,917 5,586,999 96,021,437 6,256,719 0 0 0 2,606,112 87,148,656 96,021,437 29,666,710 29,666,710 11,413,382 11,413,382 0 0 0 11,177,879 4,024,000 0 0 0 0 7,153,879 .57 .54
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