-----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, MDfPQVCSXgHPtM4FBz9+SlgPlUFW5LeO0lg+nxa+O1Em4XRAzJGAEIjIG9HTDdyw ZO7rwSFp1WQ+iXZwZErgtg== 0000950128-01-500474.txt : 20010820 0000950128-01-500474.hdr.sgml : 20010820 ACCESSION NUMBER: 0000950128-01-500474 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010630 FILED AS OF DATE: 20010817 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TOLLGRADE COMMUNICATIONS INC \PA\ CENTRAL INDEX KEY: 0001002531 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-TELEPHONE INTERCONNECT SYSTEMS [7385] IRS NUMBER: 251537134 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-27312 FILM NUMBER: 1717987 BUSINESS ADDRESS: STREET 1: 493 NIXON RD CITY: CHESWICK STATE: PA ZIP: 15024 BUSINESS PHONE: 4122742156 10-Q 1 j8993401e10-q.txt 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 June 30, 2001 [ ] 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, 2001, there were 13,452,451 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. - -------------------------------------------------------------------------------- This report consists of a total of 24 pages. The exhibit index is on page 23. 2 TOLLGRADE COMMUNICATIONS, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2001 TABLE OF CONTENTS PART I. FINANCIAL INFORMATION PAGE NO. -------- ITEM 1 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS: CONDENSED CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2001 AND DECEMBER 31, 2000 ...........3 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE-MONTH AND SIX-MONTH PERIODS ENDED JUNE 30, 2001 AND JULY 1, 2000.....................................4 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 2001 AND JULY 1, 2000.......................................................5 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.......................................6 REVIEW REPORT OF INDEPENDENT ACCOUNTANTS..................................................10 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION...................................................................... 11 PART II. OTHER INFORMATION ITEM 1 LEGAL PROCEEDINGS.........................................................................20 ITEM 2 CHANGES IN SECURITIES.....................................................................20 ITEM 3 DEFAULTS UPON SENIOR SECURITIES...........................................................20 ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......................................20 ITEM 5 OTHER INFORMATION.........................................................................20 ITEM 6 EXHIBITS AND REPORTS FILED ON FORM 8-K....................................................21 SIGNATURE...............................................................................................22 EXHIBIT INDEX...........................................................................................23
2 3 PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED) DECEMBER 31, JUNE 30, 2001 2000 - ------------------------------------------------------------------------------------------------------------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 42,808,632 $ 30,423,783 Short-term investments 33,607,909 28,405,655 Accounts receivable: Trade 17,278,181 18,775,643 Other 911,988 813,809 Inventories 24,980,398 30,499,482 Prepaid expenses and deposits 536,243 787,098 Refundable taxes due 633,402 8,950,672 Deferred tax assets 1,031,219 983,246 - ------------------------------------------------------------------------------------------------------------------- TOTAL CURRENT ASSETS 121,787,972 119,639,388 Long-term investments 7,310,000 2,750,000 Property and equipment, net 7,772,251 6,503,923 Deferred tax assets 2,582,182 2,380,828 Patents ----- 417 =================================================================================================================== TOTAL ASSETS $ 139,452,405 $ 131,274,556 =================================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $497,508 $ 1,874,328 Accrued expenses 2,249,891 1,937,589 Accrued salaries and wages 528,486 2,813,433 Royalties payable 1,083,843 1,142,478 Income taxes payable 533,242 636,938 Deferred income 100,000 100,000 - ------------------------------------------------------------------------------------------------------------------- TOTAL CURRENT LIABILITIES 4,992,970 8,504,766 Deferred tax liabilities 9,950 9,950 - ------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES 5,002,920 8,514,716 Shareholders' equity: Common stock, $.20 par value; authorized shares, 50,000,000; issued shares, 13,451,951 and 13,329,264, respectively 2,690,390 2,665,853 Additional paid-in capital 68,450,241 66,343,728 Treasury stock, at cost, 386,800 shares, in 2001 and 2000, respectively (3,164,975) (3,164,975) Retained earnings 66,473,829 56,915,234 - ------------------------------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 134,449,485 122,759,840 =================================================================================================================== TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 139,452,405 $ 131,274,556 ===================================================================================================================
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 ------------------------------- -------------------------------- JUNE 30, 2001 JULY 1, 2000 JUNE 30, 2001 JULY 1, 2000 - ------------------------------------------------------------------------------------------------------------------------------ REVENUES $21,776,167 $29,666,710 $49,766,169 $52,084,245 COST OF SALES 9,565,550 11,413,382 21,839,833 19,785,042 - ------------------------------------------------------------------------------------------------------------------------------ GROSS PROFIT 12,210,617 18,253,328 27,926,336 32,299,203 - ------------------------------------------------------------------------------------------------------------------------------ OPERATING EXPENSES: Selling and marketing 2,492,496 3,027,461 4,942,320 5,411,144 General and administrative 1,062,146 1,495,334 2,592,298 2,873,057 Research and development 2,749,105 3,098,095 6,108,646 5,688,763 Severance and related expense 400,000 ----- 400,000 ----- - ------------------------------------------------------------------------------------------------------------------------------ TOTAL OPERATING EXPENSES 6,703,747 7,620,890 14,043,264 13,972,964 INCOME FROM OPERATIONS 5,506,870 10,632,438 13,883,072 18,326,239 Interest and other income, net 790,558 545,441 1,697,535 1,015,254 - ------------------------------------------------------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES 6,297,428 11,177,879 15,580,607 19,341,493 Provision for income taxes 2,494,002 4,024,000 6,022,012 6,963,000 ============================================================================================================================== NET INCOME $ 3,803,426 $ 7,153,879 $ 9,558,595 $ 12,378,493 ============================================================================================================================== EARNINGS PER SHARE INFORMATION: Weighted average shares of common stock and equivalents: Basic 13,028,498 12,562,822 12,993,558 12,392,619 Diluted 13,404,290 13,318,461 13,391,030 13,217,634 - ------------------------------------------------------------------------------------------------------------------------------ Net income per common and common equivalent shares: Basic $ .29 $ .57 $ .74 $ 1.00 Diluted $ .28 $ .54 $ .71 $ .94 ==============================================================================================================================
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 June 30, 2001 July 1, 2000 - --------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 9,558,595 $12,378,493 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,167,907 846,460 Tax benefit from exercise of stock options 1,085,812 6,963,000 Refund of income taxes paid 8,317,270 ----- Deferred income taxes (249,327) ----- Provision for losses on inventory 10,341 251,196 Provision for allowance for doubtful accounts 175,000 ----- Changes in assets and liabilities: Decrease (increase) in accounts receivable-trade 1,322,462 (1,634,384) Increase in accounts receivable-other (98,179) (347,745) Decrease (increase) in inventories 5,508,743 (4,550,709) Decrease in prepaid expenses and other assets 250,855 40,364 (Decrease) increase in accounts payable (1,376,820) 595,882 Increase (decrease) in accrued expenses and deferred income 312,302 (1,260,665) Decrease in accrued salaries and wages (2,284,947) (483,579) (Decrease) increase in royalties payable (58,635) 472,200 Decrease in income taxes payable (103,696) (3,052,958) - --------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 23,537,683 10,217,555 - --------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Redemption/maturity of investments 15,206,244 4,624,648 Purchase of investments (24,968,498) (16,149,151) Capital expenditures (2,435,818) (2,217,263) - --------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (12,198,072) (13,741,766) - --------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from exercise of stock options 1,045,238 8,741,733 - --------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 1,045,238 8,741,733 - --------------------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 12,384,849 5,217,522 Cash and cash equivalents at beginning of period 30,423,783 15,555,810 - --------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $42,808,632 $20,773,332 - ---------------------------------------------------------------------------------------------------------------------
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 accounting principles generally accepted in the United States of America for 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 June 30, 2001 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, 2000. Accordingly, the accompanying 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 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 June 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. The accompanying condensed consolidated statement of cash flows for the six months ended July 1, 2000 has been reclassified to reflect tax benefits arising from the exercise of stock options as an operating cash flow rather than a financing cash flow in accordance with Emerging Issues Task Force Issue 00-15. The effect of the reclassification was to increase cash flows from operations and decrease cash flows from financing for the six -months ended July 1, 2000 by $6,963,000. 2. INVENTORIES At June 30, 2001 and December 31, 2000, inventories consisted of the following:
(Unaudited) June 30, December 31, 2001 2000 ----------- ----------- Raw materials .............................................. $13,420,025 $14,885,196 Work in progress ........................................... 8,346,054 12,981,052 Finished goods ............................................. 4,212,319 3,718,234 ----------- ----------- 25,978,398 31,584,482 Reserves for slow moving and obsolete inventory ...................................... (998,000) (1,085,000) ----------- ----------- $24,980,398 $30,499,482 =========== ===========
7 7 3. SHORT-TERM AND LONG-TERM INVESTMENTS Short-term investments at June 30, 2001 and December 31, 2000 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 acquisitions and capital expenditures. Realized gains and losses are computed using the specific identification method. The estimated fair values of the Company's financial instruments are as follows:
(Unaudited) June 30, December 31, 2001 2000 --------------------------- -------------------------- Carrying Fair Carrying Fair Amount Value Amount Value Financial assets: Cash and cash equivalents ................ $42,808,632 $42,808,632 $30,423,783 $30,423,783 Short-term and long-term investments...... 40,917,909 40,761,402 31,155,655 31,104,323 ----------- ----------- ----------- ----------- $83,726,541 $83,570,034 $61,579,438 $61,528,106 =========== =========== =========== ===========
7 8 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 (unaudited):
- --------------------------------------------------------------------------------------------------------------------------- Three Months Three Months Six Months Six Months Ended Ended Ended Ended June 30, 2001 July 1, 2000 June 30, 2001 July 1, 2000 - --------------------------------------------------------------------------------------------------------------------------- Net income ............................ $ 3,803,426 $ 7,153,879 $ 9,558,595 $12,378,493 =========================================================================================================================== Common and common equivalent shares: Weighted average number of common shares outstanding during the period ..................... 13,028,498 12,562,822 12,993,558 12,392,619 Common shares issuable upon exercise of outstanding stock options: Diluted ............................ 375,792 755,639 397,472 825,015 Common and common equivalent shares Outstanding during the period: - --------------------------------------------------------------------------------------------------------------------------- Diluted ............................ 13,404,290 13,318,461 13,391,030 13,217,634 =========================================================================================================================== Earnings per share data Net income per common and common Equivalent shares: Basic .............................. $ .29 $ .57 $ .74 $ 1.00 Diluted ............................ $ .28 $ .54 $ .71 $ .94
8 9 5. DEFERRED AND REFUNDABLE TAX ASSETS The Company's current refundable tax assets as of December 31, 2000 included a tax benefit of $8,950,672 resulting from the exercising of certain nonstatutory stock options by various directors, officers and other employees under the Company's stock option programs during 2000. The Company was entitled to a tax deduction in the tax year ended 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. During the first half of 2001, the company received $8,317,270 in federal income tax refunds associated with prior year taxes paid. The remaining current refundable taxes are state income taxes and it is anticipated that these amounts will be utilized or refunded to the Company during 2001. 6. STOCK REPURCHASE PROGRAM On April 19, 2001, the Company announced its Board of Directors authorized the continuation of a share repurchase program that was originally initiated on April 22, 1997. Under the current extension, the Company may repurchase a total of one million shares of its common stock before December 31, 2001. The number of shares that the Company intends to purchase and the time of such purchases will be determined by the Company at its discretion. The Company plans to use existing cash and short-term investments to finance any such purchases. As of June 30, 2001, no shares have been repurchased under this program. Prior to the aforementioned stock repurchase program extension, the Company had repurchased 382,400 shares of common stock. These repurchased shares are intended to provide stock under certain employee benefit programs. 7. SEVERANCE AND RELATED EXPENSE On April 19, 2001, the Company announced a restructuring program to implement certain cost reduction initiatives that included the elimination of approximately 80 positions within the general and administrative, research and development and support areas. As a result of the restructuring program, the Company recorded a pre-tax charge for severance, outplacement and other related costs of $400,000 during the second quarter. This realignment is estimated to generate approximately $4,300,000 in annual pre-tax savings. During the second quarter of 2001, all terminations of identified personnel were completed. The Company paid approximately $266,000 for involuntary termination benefits and other associated costs. The remaining balance of $134,000 is estimated to be paid over the second half of 2001. 9 10 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Tollgrade Communications, Inc. and subsidiaries: We have reviewed the accompanying condensed consolidated balance sheet of Tollgrade Communications, Inc. and its subsidiaries as of June 30, 2001, and the related condensed consolidated statements of operations for each of the three-month and six-month periods ended June 30, 2001 and July 1, 2000 and the condensed consolidated statement of cash flows for the six month periods ended June 30, 2001 and July 1, 2000. 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 accounting principles generally accepted in the United States of America. We previously audited in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of Tollgrade Communications, Inc. and subsidiaries as of December 31, 2000, 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 19, 2001, except for the last paragraph of Note 1, as to which the date is August 14, 2001 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, 2000, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived. PricewaterhouseCoopers LLP Pittsburgh, Pennsylvania August 14, 2001 10 11 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: o Customers' ability to meet established purchase forecasts and their own growth projections; o The ability of certain customers to maintain financial strength and access to capital; o The ability for sales and marketing partners to meet their own performance objectives and provide vendor financing to certain local exchange carriers; o Customers' seasonal buying patterns and the risk of order cancellations; o Risk of shortage of key components and possibility of limited source of supply; o Manufacturing delays and availability of manufacturing capacity; o Intense competition in the market for the Company's products; o Rapid technological change along with the need to continually develop new products and gain customer acceptance and approval; o The company's dependence on a relatively narrow range of products; o Competition; o The company's dependence on key employees; o Difficulties in managing the Company's growth; o The Company's dependence upon a small number of large customers and certain suppliers; o The Company's dependence upon proprietary rights; o Risks of third party claims of infringement; o Possibility of product defects; o The potential of having excess inventory and risk of parts' obsolescence should demand for the Company's products decrease unexpectedly; and o Government regulation. 11 12 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 69% of the Company's revenue for the second quarter ended June 30, 2001. The Company's MCU product line 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"), the Digital Wideband Unit ("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 19% of the Company's revenue for the second quarter of 2001. In addition, the Company's new DigiTest Access Unit ("DAU") provides automated test access of locally non-switched, two wire circuits and helps facilitate the line sharing or the spectral unbundling process for both incumbent (ILEC) and competitive local exchange carriers (CLECs). Sales of the test access products accounted for approximately 7% of total revenue for the current quarter. 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 2% of the Company's revenue for the second quarter of 2001. Through the second quarter of 2001, the Company continued to provide 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 improvements in testability levels, while training their own staffs in targeted geographic regions over a defined period of time. By making improvements in the customer's digital loop carrier ("DLC") testability levels, the customer's 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. Sales of the Professional Services business accounted for approximately 3% of the Company's revenue for the second quarter of 2001. The Company's telecommunication product sales and services 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 12 13 June 30, 2001, approximately 68% of the Company's total revenue was generated from sales to these four RBOCs. During the second quarter of 2001, sales to three RBOCs individually exceeded 10% of consolidated revenues and on a combined basis, comprised approximately 61% of the Company's revenue for the second quarter of 2001. In addition, sales to Sprint USA accounted for approximately 23% of the Company's revenues for the second quarter of 2001. Due to the Company's present dependency on these key customers, the loss of one or more of them as a customer or the reduction of orders for the Company's products by them, could materially and adversely affect the Company. 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 and other key customers. This timing is particularly sensitive to various business factors within each of the RBOCs, including the RBOCs relationships with their organized labor groups. In addition, the markets for the Company's new products, specifically DigiTest and LIGHTHOUSE, are highly competitive. 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. The Company's operating results for the second quarter of 2001 reflect several significant sales incentive-based MCU orders and shipments that were made late in the second quarter which could affect product sales in the third quarter. The continued success of the Company's Professional Services business will be vital to maintaining a solid rate of MCU deployments in the near-term. 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, continuing consolidation efforts among the RBOCs and cable television industry, and their ability to consolidate their inventory and product procurement systems could cause fluctuations or delays in the Company's order patterns. The timing of these orders is also sensitive to the RBOCs relationships with their various organized labor groups. 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 2001 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 it 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. However, the Company continues to 13 14 evaluate opportunities for its other products in international markets. 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 the continued downturn in the U.S. economy during the first half of 2001 has had a dramatic effect on capital spending across all industries, including the telecommunications and cable television industries. Several of the Company's key RBOC customers have announced capital spending reductions in 2001. The Company's key Lighthouse customers, which include AT&T Broadband and RCN Corporation, have announced capital spending deferrals until their current excess inventories are consumed. The Company believes that, as a result of the current economic environment as well as the items just mentioned, it is difficult to predict with any level of certainty revenues and earnings per share beyond the third quarter of 2001. The Company believes that continued growth will depend, in part, 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 percentage of revenues were approximately 13% for the second quarter of 2001. The Company believes that the near-term economic climate is one of challenge and uncertainty. In addition, the Company believes that future growth may be affected as a result of the economic slowdown whereby customers become more conservative in their ordering patterns and quantities, or that certain emerging carriers become financially unstable. Due to this uncertainty, the Company will evaluate its investments in marketing and research and development expenses and monitor, control or decrease expense levels as appropriate. RESULTS OF OPERATIONS - SECOND QUARTER REVENUES Revenues for the second quarter of 2001 of $21,776,167 were $7,890,543, or 26.6%, lower than the revenues of $29,666,710 reported for the second quarter of 2000. The decrease in revenues for the second quarter of 2001 was primarily attributable to a decrease in unit volume sales of core MCU line testing products to SBC Communications, Inc. (including Ameritech, Pacific Bell and SNET) due to a slow-down of that company's DSL rollout, called Project Pronto, a broadband initiative. Sales of MCU's to Qwest also decreased in the second quarter of 2001 as that company evaluates their testability improvement programs within their region. In addition, sales of OEM-related MCU products decreased as a result of cutbacks in deployments of certain next-generation Digital Loop Carrier (DLC) systems. The current quarter also included decreased shipments of the Company's next generation DigiTest system products to Sprint and Nortel Networks, while shipments of the Company's new DAU product to Sprint USA increased. Sales of the LIGHTHOUSE product also decreased between periods as a result of AT&T's Broadband's decision to delay purchases of cable-related equipment, as well as a slow-down by RCN Corporation in deploying cable status monitoring systems. The second quarter 2001 revenue did include certain significant sales incentive-based MCU orders and shipments that occurred late in the quarter. These sales incentives included bulk sales of MCU's to BellSouth, Verizon and Qwest. The Company believes that these bulk purchases of MCU's will ultimately help facilitate those customers ability to improve their regional testability rates upon deployment of these units. In certain cases, the Company will support the customer in deploying these MCU's within their respective regions. Due to the significance and timing of these MCU shipments and the Company's reliance on our customer's ability to successfully deploy these units in a timely fashion, the sales of MCU's in the third quarter of 2001 could be affected should these customers not place equivalent orders for MCU shipments during that period. Periodic fluctuations in customer orders and backlog result from a variety of 14 15 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 2001 was $12,210,617 compared to $18,253,328 for the second quarter of 2000, representing a decrease of $6,042,711, or 33.1%. Gross profit as a percentage of revenues decreased to 56.1% in the second quarter of 2001, compared to 61.5% in the same quarter last year. The overall decrease in gross profit as a percentage of sales resulted primarily from an increase in allocated unit costs arising from lower production volume, the impact of the sales incentive programs for bulk-buys of MCU's mentioned above, as well as the product mix of sales. The Company's gross margin continues to be highly sensitive to the mix of products sold. Revenues from the Company's DigiTest test platform, which is being marketed aggressively on both a direct and OEM sale basis, in what is becoming an extremely competitive environment, may become a larger portion of the Company's total revenues in 2001. To the extent that such increased DigiTest revenues are attributable either to OEM sales or to product deployment into applications downstream from the central office, the Company believes that actual overall margins may decline slightly from their current levels. SELLING AND MARKETING EXPENSE Selling and marketing expense for the second quarter of 2001 was $2,492,496 compared to $3,027,461 for the second quarter of 2000. This decrease of $534,965, or 17.7%, is primarily due to reduced discretionary spending on general advertising, promotion and related marketing activities as well as reduced salaries and related costs associated with the cost realignment. As a percentage of revenues, selling and marketing expenses increased to 11.4% in the second quarter of 2001 from 10.2% in the second quarter of 2000. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense for the second quarter of 2001 was $1,062,146, a decrease of $433,188, or 29.0%, from the $1,495,334 recorded in the second quarter of 2000. The decrease in general and administrative expense primarily reflects the decrease in salaries and related costs associated with the cost realignment, reduced expenditures on professional services and reduced recruiting-related costs. As a percentage of revenues, general and administrative expenses decreased to 4.9% in the second quarter of 2001 from 5.0% in the second quarter of 2000. RESEARCH AND DEVELOPMENT EXPENSE Research and development expense in the second quarter of 2001 was $2,749,105, a decrease of $348,990, or 11.3%, over the $3,098,095 recorded in the second quarter of 2000. The decrease is primarily associated with the decrease in salaries and related costs associated with the cost realignment as well as reductions in certain project-related costs for materials and supplies. As a percentage of revenues, research and development expense increased to 12.6% in the second quarter of 2001 from 10.4% in the second quarter of 2000. SEVERANCE AND RELATED EXPENSE On April 19, 2001, the Company announced a cost realignment initiative. The restructuring program resulted in workforce reduction charges of $400,000 related to the cost of severance and related benefits for the termination of approximately 80 employees, as well as exit costs consisting of consulting and legal fees. During the second quarter of 2001, all terminations of identified personnel were completed. The Company paid approximately $266,000 for involuntary termination benefits and other associated costs during the second quarter of 2001. The remaining portion of the severance and related reserve is expected to be utilized over the second half of 2001. The Company 15 16 expects annualized pre-tax savings of $4,300,000, or $.20 per share after-tax, associated with this cost realignment initiative. INTEREST AND OTHER INCOME Interest and other income consists primarily of interest income. For the second quarter of 2001, interest and other income was $790,558 compared to $545,441 for the second quarter of 2000, representing an increase of $245,117, or 44.9%. 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 2001 was $2,494,002, a decrease of $1,529,998, or 38.0%, from the $4,024,000 for the second quarter of 2000. The effective income tax rate for the second quarter of 2001was approximately 39.6% of pretax income compared to the 36.0% effective income tax rate for the second quarter of 2000. The increase in the effective income tax rate was primarily due to higher relative levels of state income taxes associated with expanding business activities. NET INCOME AND EARNINGS PER SHARE As a result of the above factors, net income for the second quarter of 2001 was $3,803,426, a decrease of $3,350,453, or 46.8%, from the $7,153,879 recorded in the second quarter of 2000. Basic and diluted earnings per common share of $.29 and $.28, respectively, for the second quarter of 2001 decreased by $.28 and $.26, or 49.1% and 48.1%, from the $.57 and $.54, respectively, earned in the second quarter of 2000. The second quarter of 2001 includes approximately $400,000, or $.02 per share after-tax, related to the charge for severance and related costs. Basic and diluted weighted average common and common equivalent shares outstanding were 13,028,498 and 13,404,290, respectively, in the second quarter of 2001 compared to 12,562,822 and 13,318,461, respectively, in the second quarter of 2000. As a percentage of revenues, net income for the second quarter of 2001 decreased to 17.5% compared to the 24.1% for the second quarter of 2000. 16 17 RESULTS OF OPERATIONS YEAR-TO-DATE REVENUES For the first six months of 2001, revenues were $49,766,169 compared to $52,084,245 for the first six months of 2000, representing a decrease of $2,318,076, or 4.5%. The decrease in revenues for the first six months of 2001 was primarily attributable to a decrease in unit volume sales of core MCU line testing products to SBC Communications, Inc. (including Ameritech, Pacific Bell and SNET) due to a slow-down of that company's DSL rollout, called Project Pronto, a broadband initiative. MCU-related sales to Qwest also decreased as that company evaluates their various testability improvement programs. In addition, sales of OEM-related MCU products decreased with cutbacks in some next-generation Digital Loop Carrier (DLC) systems deployments. As a result of certain of the Company's sales incentive programs, sales of MCU's to both Verizon and BellSouth increased as those customers work toward improving their regional testability rates. The first six months also included increased shipments of the Company's next generation DigiTest system products to Lucent and Nortel Networks, offset somewhat by decreased shipments to Sprint USA between periods. In addition, sales of the Company's new DAU product to Sprint USA continued. Sales of the LIGHTHOUSE product decreased between periods as a result of AT&T's Broadband's decision to delay purchases of cable related equipment, as well as a slow-down by RCN Corporation in deploying cable status monitoring systems. 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 2001 was $27,926,336 compared to $32,299,203 for the first six months of 2000, representing a decrease of $4,372,867, or 13.5%. Gross profit as a percentage of revenues decreased to 56.1% in the first six months of 2001 compared to 62.0% in the same period last year. The overall decrease in gross profit as a percentage of sales resulted primarily from an increase in allocated unit costs arising from lower production volume; the introduction of the new DAU product and lower margins associated with the sale of the Broadcast Program Channel Units during the first quarter of 2001. The Company's gross margin continues to be highly sensitive to the mix of products sold. SELLING AND MARKETING EXPENSE Selling and marketing expense for the first six months of 2001 was $4,942,320 compared to $5,411,144 for the first six months of 2000. This decrease of $468,824, or 8.7%, is primarily due to reduced discretionary spending on general advertising, promotion and related marketing activities as well as reduced salaries and related costs associated with the cost realignment. As a percentage of revenues, selling and marketing expenses decreased to 9.9% in the first six months of 2001 from 10.4% in the same period last year. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense for the first half of 2001 was $2,592,298, a decrease of $280,759, or 9.8%, from the $2,873,057 recorded for the first six months of 2000. The decrease in general and administrative expense primarily reflects reduced expenditures on professional services, decreased recruiting related costs and decreased travel expenditures. This decrease was offset somewhat by an increase in a contingency provision for potential bad debts. As a percentage of revenues, general and administrative expenses decreased to 5.2% in the first half of 2001 from 5.5% in the same period last year. 17 18 RESEARCH AND DEVELOPMENT EXPENSE Research and development expense in the first half of 2001 was $6,108,646, an increase of $419,883, or 7.4%, over the $5,688,763 recorded in the first half of 2000. The increase is primarily associated with additional personnel and associated costs to support product development offset somewhat by a decrease in certain performance-based compensation reserves. As a percentage of revenues, research and development expenses increased to 12.3% in the first half of 2001 from 10.9% during the first half of 2001. SEVERANCE AND RELATED EXPENSE Refer to the section entitled Results of Operations - Second Quarter for a discussion on severance and related expenses. INTEREST AND OTHER INCOME Interest and other income consists primarily of interest income. For the first half of 2001, interest and other income was $1,697,535 compared to $1,015,254 for the first half of 2000, representing an increase of $682,281, or 67.2%. 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 first half of 2001 was $6,022,012, a decrease of $940,988, or 13.5%, from the $6,963,000 for the first half of 2000. The effective income tax rate for the second quarter of 2001 was approximately 38.7% of pretax income compared to the 36.0% effective income tax rate for the prior year period. The increase in the effective income tax rate was primarily due to higher relative levels of state income taxes associated with expanding business activities. NET INCOME AND EARNINGS PER SHARE As a result of the above factors, net income for the first half of 2001 was $9,558,595, a decrease of $2,819,898, or 22.8%, from the $12,378,493 recorded in the first half of 2000. Basic and diluted earnings per common share of $.74 and $.71, respectively, for the first half of 2001 decreased by $.26 and $.23, or 26.0% and 24.5%, from the $1.00 and $.94, respectively, earned in the first half of 2000. The first half of 2001 includes approximately $400,000, or $.02 per share after-tax, related to the charge for severance and related costs that was recorded in the second quarter of 2001. Basic and diluted weighted average common and common equivalent shares outstanding were 12,993,558 and 13,391,030, respectively, in the first half of 2001 compared to 12,392,619 and 13,217,634, respectively, in the first half of 2000. As a percentage of revenues, net income for the first half of 2001 decreased to 19.2% compared to the 23.8% for the first half of 2000. LIQUIDITY AND CAPITAL RESOURCES At June 30, 2001, the Company had working capital of $116,795,001, which represented an increase of $5,660,379, or 5.1%, from the $111,134,622 of working capital as of December 31, 2000. The increase in working capital can be attributed primarily to net income and proceeds from the exercise of stock options exceeding the Company's requirements for purchases of property and equipment of $2,435,818. The Capital expenditures for the first half of 2001 include approximately $1,450,000 associated with the purchase of certain land parcels that surround the current leased facility. This purchase was made to provide for future expansion of parking and/or new building structures should they become necessary to support the business operation. On April 19, 2001, the Company announced its Board of Directors authorized the continuation of a share repurchase program it first started on April 22, 1997. Under the current extension, the Company may repurchase a total of one million shares of its common stock before December 31, 18 19 2001. The number of shares that the Company intends to purchase and the time of such purchases will be determined by the Company at its discretion. The Company plans to use existing cash and short-term investments to finance any such purchases. As of June 30, 2001, no shares have been repurchased under this program. Prior to the aforementioned stock repurchase program extension, the company had repurchased 382,400 shares of common stock. These repurchased shares are intended to provide stock under certain employee benefit programs. The Company's days sales outstanding ("DSO's") in accounts receivable trade was 58 and 61 days as of June 30, 2001 and December 31, 2000, respectively. The Company's inventory turnover ratio was 1.9 turns and 1.8 turns as of June 30, 2001 and December 31, 2000. Approximately $2,000,000 in inventory was returned to vendors for credit during the first half of 2001 associated with a program addressed to decrease on hand inventory levels commensurate with current sales levels. 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. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's current investment policy limits its 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. The Company believes it minimizes its risk 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. The Company holds its investment securities to maturity and believes 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. BACKLOG The Company's backlog consists of firm customer purchase orders. As of June 30, 2001, the Company had a backlog of $4,340,747 compared to $8,224,460 at December 31, 2000 and $11,591,177 at July 1, 2000. Approximately 61% of the current backlog is currently scheduled to be sold in the third quarter of 2001. 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. While these fluctuations could impact short-term results, they are not necessarily indicative of long-term trends in sales of the Company's products. 19 20 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 3, 2001, the Company held its annual shareholders meeting. At the meeting, Richard H. Heibel, M.D. and Robert W. Kampmeinert were elected to the Board of Directors for a three-year term expiring at the annual meeting of shareholders in 2004. 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. The terms of Directors James J. Barnes and Rocco L. Flaminio also continued after the meeting and will expire at the annual meeting of shareholders in 2003. In addition, the Company's 1995 Long-term Incentive Compensation Plan was amended to increase the number of shares of Common Stock authorized under the plan by 275,000 shares. Also, the shareholders ratified the appointment of PricewaterhouseCoopers LLP as the Company's independent auditors for fiscal year 2001. The results of the voting were as follows:
Total Votes Cast For Against Withheld Abstained ---- --- ------- -------- --------- Election of Directors: - --------------------- Richard H. Heibel, M.D. 11,865,329 11,406,738 ----- 458,591 ----- Robert W. Kampmeinert 11,865,329 10,992,353 ----- 872,976 ----- Amendment to the Company's 1995 Long-term Incentive Compensation Plan 11,865,329 9,651,326 2,165,910 ----- 48,093 Ratification of Appointment of 11,865,329 11,707,133 71,002 ----- 87,194 PricewaterhouseCoopers LLP
ITEM 5. OTHER INFORMATION None. 20 21 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 (b) Reports on Form 8-K: The Company did not file any Current Report on Form 8-K during the quarter ended June 30, 2001. 21 22 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 17, 2001 /S/ CHRISTIAN L. ALLISON ------------------------------------ CHRISTIAN L. ALLISON CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER Dated: August 17, 2001 /S/ SAMUEL C. KNOCH ------------------------------------ SAMUEL C. KNOCH CHIEF FINANCIAL OFFICER AND TREASURER Dated: August 17, 2001 /S/ BRADLEY N. DINGER ------------------------------------ BRADLEY N. DINGER CONTROLLER 22 23 EXHIBIT INDEX (Pursuant to Item 601 of Regulation S-K) Exhibit Number Description ------ ----------- 15 Letter re unaudited interim financial information 23 EX-15 3 j8993401ex15.txt LETTER RE UNAUDITED INTERIM FINANCIAL INFORMATION 1 EXHIBIT 15 August 14, 2001 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, Registration No. 333-83007 and Registration No. 333-65502) 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 and Registration No. 333-55470) 1998 Employee Incentive Compensation Plan Commissioners: We are aware that our report dated August 14, 2001, on our review of interim financial information of Tollgrade Communications, Inc. and subsidiaries as of and for the three- month and six-month periods ended June 30, 2001 and included 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 -----END PRIVACY-ENHANCED MESSAGE-----