-----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, UetsXtEKS4wDsEKK27qW4LcNSPFL0rWc4BTDoA+rMlUmxqf2Hfp3uGQPj+NQV62W vc4y9IPqk8o3igYb5Nb9CQ== 0000950128-01-500679.txt : 20020410 0000950128-01-500679.hdr.sgml : 20020410 ACCESSION NUMBER: 0000950128-01-500679 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011113 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: 1782678 BUSINESS ADDRESS: STREET 1: 493 NIXON RD CITY: CHESWICK STATE: PA ZIP: 15024 BUSINESS PHONE: 4122742156 10-Q 1 j9134701e10-q.txt FORM 10-Q 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 September 29, 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 October 25, 2001, there were 13,456,017 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 25 pages. The exhibit index is on page 24. TOLLGRADE COMMUNICATIONS, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 29, 2001 TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO. - ------- --------------------- -------- ITEM 1 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS: CONDENSED CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 29, 2001 AND DECEMBER 31, 2000 .................................................................. 3 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE-MONTH AND NINE-MONTH PERIODS ENDED SEPTEMBER 29, 2001 AND SEPTEMBER 30, 2000.................. 4 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 29, 2001 AND SEPTEMBER 30, 2000................................. 5 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.................................... 6 REVIEW REPORT OF INDEPENDENT ACCOUNTANTS................................................ 11 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION... 12 PART II. OTHER INFORMATION ITEM 1 LEGAL PROCEEDINGS...................................................................... 23 ITEM 2 CHANGES IN SECURITIES.................................................................. 23 ITEM 3 DEFAULTS UPON SENIOR SECURITIES........................................................ 23 ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................................... 23 ITEM 5 OTHER INFORMATION...................................................................... 23 ITEM 6 EXHIBITS AND REPORTS FILED ON FORM 8-K................................................. 23 SIGNATURE........................................................................................ 24 EXHIBIT INDEX.................................................................................... 25
2 PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED) SEPTEMBER 29, DECEMBER 31, 2001 2000 - --------------------------------------------------------------------------------------------------------------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 80,430,325 $ 30,423,783 Short-term investments 11,049,292 28,405,655 Accounts receivable: Trade 12,409,465 18,775,643 Other 375,417 813,809 Inventories 23,070,681 30,499,482 Prepaid expenses and deposits 395,784 787,098 Prepaid and refundable taxes 533,402 8,950,672 Deferred tax assets 975,118 983,246 - --------------------------------------------------------------------------------------------------------------------- TOTAL CURRENT ASSETS 129,239,484 119,639,388 Long-term investments 1,455,000 2,750,000 Property and equipment, net 7,427,307 6,503,923 Deferred tax assets 2,657,479 2,380,828 Other assets 328,991 417 ===================================================================================================================== TOTAL ASSETS $ 141,108,261 $ 131,274,556 ===================================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 228,866 $ 1,874,328 Accrued expenses 2,634,980 1,937,589 Accrued salaries and wages 772,500 2,813,433 Royalties payable 339,238 1,142,478 Income taxes payable 430,427 636,938 Deferred income 120,000 100,000 - --------------------------------------------------------------------------------------------------------------------- TOTAL CURRENT LIABILITIES 4,526,011 8,504,766 Deferred tax liabilities 9,950 9,950 - --------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES 4,535,961 8,514,716 Shareholders' equity: Common stock, $.20 par value; authorized shares, 50,000,000; issued shares, 13,453,351 and 13,329,264, respectively 2,690,670 2,665,853 Additional paid-in capital 68,442,922 66,343,728 Treasury stock, at cost, 386,800 shares, in 2001 and 2000, respectively (3,164,975) (3,164,975) Retained earnings 68,603,683 56,915,234 - --------------------------------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 136,572,300 122,759,840 ===================================================================================================================== TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 141,108,261 $ 131,274,556 =====================================================================================================================
The accompanying notes are an integral part of the condensed consolidated financial statements. 3 TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
FOR THE FOR THE THREE MONTHS ENDED NINE MONTHS ENDED ----------------------------- ----------------------------- SEPTEMBER 29, SEPTEMBER 30, SEPTEMBER 29, SEPTEMBER 30, 2001 2000 2001 2000 =============================================================================================================================== REVENUES $16,037,957 $29,787,819 $65,804,126 $81,872,064 COST OF SALES 7,666,181 10,840,558 29,506,014 30,625,600 - ----------------------------------------------------------------------------------------------------------------------------- GROSS PROFIT 8,371,776 18,947,261 36,298,112 51,246,464 - ----------------------------------------------------------------------------------------------------------------------------- OPERATING EXPENSES: Selling and marketing 2,022,930 3,439,953 6,965,250 8,851,097 General and administrative 1,019,748 1,591,603 3,612,046 4,464,660 Research and development 2,638,680 3,178,081 8,747,326 8,866,844 Severance and related expense -- -- 400,000 -- - ----------------------------------------------------------------------------------------------------------------------------- TOTAL OPERATING EXPENSES 5,681,358 8,209,637 19,724,622 22,182,601 INCOME FROM OPERATIONS 2,690,418 10,737,624 16,573,490 29,063,863 Interest and other income, net 800,436 661,917 2,497,971 1,677,171 - ----------------------------------------------------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 3,490,854 11,399,541 19,071,461 30,741,034 Provision for income taxes 1,361,000 4,104,000 7,383,012 11,067,000 =============================================================================================================================== NET INCOME $ 2,129,854 $ 7,295,541 $11,688,449 $19,674,034 =============================================================================================================================== EARNINGS PER SHARE INFORMATION: Weighted average shares of common stock and equivalents: Basic 13,065,809 12,821,132 13,017,819 12,536,510 Diluted 13,377,544 13,460,481 13,392,507 13,314,988 - ----------------------------------------------------------------------------------------------------------------------------- Net income per common and common equivalent shares: Basic $ .16 $ .57 $ .90 $ 1.57 Diluted $ .16 $ .54 $ .87 $ 1.48
The accompanying notes are an integral part of the condensed consolidated financial statements. 4 TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine Months Ended Sept. 29, 2001 Sept. 30, 2000 ============================================================================================================================ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 11,688,449 $ 19,674,034 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,738,537 1,331,410 Tax benefit from exercise of stock options 1,065,801 9,883,835 Refund of income taxes paid 8,417,270 -- Deferred income taxes (268,523) (114,785) Provision for losses on inventory 164,963 391,152 Provision for allowance for doubtful accounts 175,000 3,393 Changes in assets and liabilities: Decrease (increase) in accounts receivable-trade 6,191,178 (3,231,161) Decrease (increase) in accounts receivable-other 438,392 (341,361) Decrease (increase) in inventories 7,263,838 (9,186,255) Decrease (increase) in prepaid expenses and other assets 391,314 (49,586) (Decrease) increase in accounts payable (1,645,462) 2,344,950 Increase (decrease) in accrued expenses and deferred income 717,391 (914,516) (Decrease) increase in accrued salaries and wages (2,040,933) 607,754 Decrease in royalties payable (803,240) (47,710) Decrease in income taxes payable (206,511) (1,838,214) - -------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 33,287,464 18,512,940 - -------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Redemption/maturity of investments 46,473,811 14,427,752 Purchase of investments (27,822,448) (23,366,913) Capital expenditures (2,661,504) (2,930,048) Investments in other assets (328,991) -- - -------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) investing activities 15,660,868 (11,869,209) - -------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from exercise of stock options 1,058,210 11,046,256 - -------------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 1,058,210 11,046,256 - -------------------------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 50,006,542 17,689,987 Cash and cash equivalents at beginning of period 30,423,783 15,555,810 - -------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 80,430,325 $ 33,245,797 ==========================================================================================================================
The accompanying notes are an integral part of the condensed consolidated financial statements. 5 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 nine-month periods ended September 29, 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 nine-month periods ended September 29, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. 2. INVENTORIES At September 29, 2001 and December 31, 2000, inventories consisted of the following:
(Unaudited) September 29, December 31, 2001 2000 ------------ ------------ Raw materials .............. $ 12,285,770 $ 14,885,196 Work in progress ........... 7,159,894 12,981,052 Finished goods ............. 4,641,017 3,718,234 ------------ ------------ 24,086,681 31,584,482 Reserves for slow moving and obsolete inventory (1,016,000) (1,085,000) ------------ ------------ $ 23,070,681 $ 30,499,482 ============ ============
3. SHORT-TERM AND LONG-TERM INVESTMENTS 6 Short-term investments at September 29, 2001 and December 31, 2000 consisted of individual municipal bonds stated at cost, which approximated market value. These securities have maturities 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) September 29, December 31, 2001 2000 ---------------------------- ------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ----------- ----------- ----------- ----------- Financial assets: Cash and cash equivalents .......... $80,430,325 $80,430,325 $30,423,783 $30,423,783 Short-term and long-term investments 12,504,292 12,515,450 31,155,655 31,104,323 ----------- ----------- ----------- ----------- $92,934,617 $92,945,775 $61,579,438 $61,528,106 =========== =========== =========== ===========
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 (unaudited):
Three Months Three Months Nine Months Nine Months Ended Ended Ended Ended September 29, September 30, September 29, September 30, 2001 2000 2001 2000 ========================================================================================================================== Net income ...................................... $ 2,129,854 $ 7,295,541 $11,688,449 $19,674,034 ========================================================================================================================== Common and common equivalent shares: Weighted average number of common shares outstanding during the period ............................... 13,065,809 12,821,132 13,017,819 12,536,510 Common shares issuable upon exercise of outstanding stock options: Diluted ...................................... 311,735 639,349 374,688 778,478 Common and common equivalent shares Outstanding during the period: - ------------------------------------------------------------------------------------------------------------------------- Diluted ...................................... 13,377,544 13,460,481 13,392,507 13,314,988 ========================================================================================================================== Earnings per share data Net income per common and common Equivalent shares: Basic ........................................... $ .16 $ .57 $ .90 $ 1.57 Diluted ......................................... $ .16 $ .54 $ .87 $ 1.48
8 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, which resulted principally 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 2001, the company received $8,417,270 in federal income tax refunds associated with prior year taxes paid. The remaining current prepaid and refundable taxes are prepaid state income taxes and it is anticipated that these amounts will be refunded to the Company during the fourth quarter of 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 an additional 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 September 29, 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 annualized pre-tax savings. 8. SUBSEQUENT EVENT On September 28, 2001, the Company entered into an Asset Purchase Agreement (the "Agreement") in accordance with which, subject to certain closing conditions, it would acquire certain assets and assume certain liabilities of the MLT/LoopCare(TM) product business from Lucent Technologies, Inc. ("Lucent") for approximately $60,000,000 in cash. Tollgrade closed on this transaction on September 30, 2001 after meeting all conditions of closing. The assets consisted principally of existing contracts, software and related computer equipment, while the liabilities were principally related to software warranties currently under contract. Tollgrade used available cash and short-term investments to finance the acquisition. LoopCare is the Plain Old Telephone Services ("POTS") test system used universally by the Regional Bell Operating Companies. The LoopCare acquisition will be recorded under the purchase method of accounting and accordingly, the results of operations of the LoopCare business for the period beginning October 1, 2001, forward will be included in the consolidated financial statements of the Company. The purchase 9 price allocation is currently under evaluation and is expected to be finalized by the end of the fourth quarter. 9. ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 established accounting and reporting standards for business combinations. SFAS No. 142 established accounting and reporting standards for acquired goodwill and other intangible assets, specifically how they should be treated upon and subsequent to their acquisition. Both SFAS No. 141 and SFAS No. 142 are required to be applied in fiscal years beginning after December 15, 2001; however, early adoption is permitted. SFAS 142 statements contain provisions which require that these statements be applied to all business combinations initiated after June 30, 2001. Therefore, the Company is expecting to adopt SFAS N0. 141 and SFAS No. 142 during the fourth quarter of fiscal year 2001 as it relates to its recent acquisition. On August 15, 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." On October 4, 2001, FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The Company is presently evaluating the impact these statements may have on the Company. 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 September 29, 2001, and the related condensed consolidated statements of operations for each of the three-month and nine-month periods ended September 29, 2001 and September 30, 2000 and the condensed consolidated statements of cash flows for the nine- month periods ended September 29, 2001 and September 30, 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 October 9, 2001 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: - - Customers' ability to meet established purchase forecasts and their own growth projections; - - The ability of certain customers to maintain financial strength and access to capital; - - The ability for sales and marketing partners to meet their own performance objectives and provide vendor financing to certain local exchange carriers; - - Customers' seasonal buying patterns and the risk of order cancellations; - - Risk of shortage of key components and possibility of limited source of supply; - - Manufacturing delays and availability of manufacturing capacity; - - Intense competition in the market for the Company's products; - - 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; - - Possibility of product defects; - - The potential of having excess inventory and risk of parts' obsolescence should demand for the Company's products decrease substantially; and - - Government regulation. 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 following overview discussion excludes the recent acquisition of the LoopCare product business from Lucent (see section entitled Subsequent Event for a discussion of this acquisition). 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 78% of the Company's revenue for the third quarter ended September 29, 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"), and 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 4% of the Company's revenue for the third quarter of 2001. In addition, the Company's 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 DAU accounted for approximately 6% 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 6% of the Company's revenue for the third quarter of 2001. The Company's Professional Services business offers various 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 6% of the Company's revenue for the third 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 third quarter ended 13 September 29, 2001, approximately 74% of the Company's total revenue was generated from sales to these four RBOCs. During the third quarter of 2001, sales to one RBOC exceeded 10% of consolidated revenues, accounting for approximately 63% of consolidated revenues. 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 third quarter of 2001 included certain sales incentive-based MCU orders and shipments that were made late in the third quarter which could affect product sales in the fourth 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 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 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. Additionally, on October 18, 2001, the Company announced that it 14 has entered into a strategic alliance with Acterna (the world's largest provider of test and management solutions for optical transport, access and cable networks, and the second largest communication test company overall) to help improve the installation, deployment and management of DSL services worldwide. Under the terms of the agreement, Acterna and the Company will jointly develop and market DSL remote test solutions for provisioning and maintenance of service provider networks worldwide. The first joint offering from this alliance is expected to be available in the first quarter of 2002. The Company believes that the continued downturn in the U.S. economy during 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. In addition, on October 17, 2001 Sprint Corporation announced the discontinuation of their Integrated On-demand Network ("ION") project. Historically, Sprint Corporation has been a material customer for the Company's DigiTest products for this ION project. Although the Company will continue to strive to market and sell its DigiTest products to other customers, the loss of sales to the Sprint ION project could materially and adversely affect the Company. The Company's key Lighthouse customers, that 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 fourth 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 17% for the third 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 - THIRD QUARTER REVENUES Revenues for the third quarter of 2001 of $16,037,957 were $13,749,862, or 46.2%, lower than the revenues of $29,787,819 reported for the third quarter of 2000. The revenue performance for the current quarter versus the prior year period include: - - A decrease in revenues for the third quarter of 2001 was primarily attributable to a decrease in unit volume sales of core MCU line testing products. Sales to SBC were comparable between periods due to strong sales of certain MCU products to Ameritech, related to the restoration testability initiatives of that customer's network. Additionally, the Company's OEM resellers shipped fewer next-generation Digital Loop Carrier (DLC) systems, which affected related MCU products sales to these customers. Overall sales of the Company's core MCU products comprised 78.0% of the total quarterly revenues. - - The current quarter included decreased shipments of the Company's next generation DigiTest system products to Sprint USA and to authorized resellers for resale to CLECs. Sales of DigiTest products represented 3.6% of total revenue for the quarter. 15 - - Continued shipments of the Company's DAU product to Sprint USA. Sales of DAU represented 6.4% of revenue for the quarter. - - Sales of the Company's Professional Services business increased between periods, primarily from installation oversight and project management services provided to the Ameritech region of SBC associated with their restoration of testability levels previously mentioned. Sales of Professional Services represented 6.0% of third quarter 2001 revenue. - - Sales of the LIGHTHOUSE product decreased between periods as a result of the slow-down by certain cable customers in deploying cable status monitoring systems. The current quarter included initial modest shipments of the LIGHTHOUSE system to AOL Time Warner Corporation. Sales of the Company's LIGHTHOUSE Cable Status Monitoring system represented 5.7% of third quarter 2001 revenue. The third quarter 2001 revenue included certain sales incentive-based MCU orders and shipments that occurred late in the quarter. These sales incentives included bulk sales of MCU's to both SBC and BellSouth. The Company believes that these bulk purchases of MCUs 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 MCUs 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 MCUs in the fourth quarter of 2001 could be affected. 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 third quarter of 2001 was $8,371,776 compared to $18,947,261 for the third quarter of 2000, representing a decrease of $10,575,485, or 55.8%. Gross profit as a percentage of revenues decreased to 52.2% in the third quarter of 2001, compared to 63.6% 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, certain product warranty reserves, as well as the product mix of sales. 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 third quarter of 2001 was $2,022,930 compared to $3,439,953 for the third quarter of 2000. This decrease of $1,417,023, or 41.2%, is primarily due to reduced discretionary spending on general advertising, promotion and related marketing activities as well as reduced salaries and related costs associated the workforce reduction and the realignment of costs initiated in the second quarter of 2001. As a percentage of revenues, selling and marketing expenses increased to 12.6% in the third quarter of 2001 from 11.5% in the third quarter of 2000. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense for the third quarter of 2001 was $1,019,748, a decrease of $571,855, or 35.9%, from the $1,591,603 recorded in the third quarter of 2000. The decrease in general and administrative expense primarily reflects the decrease in salaries and related costs associated with the workforce reduction and the realignment of costs initiated in the second quarter of 2001, reduced expenditures on professional services and reduced recruiting-related costs. As a percentage of revenues, general and administrative expenses increased to 6.4% in the third quarter of 2001 from 5.3% in the third quarter of 2000. 16 RESEARCH AND DEVELOPMENT EXPENSE Research and development expense in the third quarter of 2001 was $2,638,680, a decrease of $539,401, or 17.0%, over the $3,178,081 recorded in the third quarter of 2000. The decrease in research and development expense is primarily associated with the decrease in salaries and related costs associated with the workforce reduction and the realignment of costs initiated in the second quarter of 2001, as well as a reduction in certain project-related costs for materials and supplies. As a percentage of revenues, research and development expense increased to 16.5% in the third quarter of 2001 from 10.7% in the third quarter of 2000. INTEREST AND OTHER INCOME Interest and other income consists primarily of interest income. For the third quarter of 2001, interest and other income was $800,436 compared to $661,917 for the third quarter of 2000, representing an increase of $138,519, or 20.9%. 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 third quarter of 2001 was $1,361,000, a decrease of $2,743,000, or 66.8%, from the $4,104,000 for the third quarter of 2000. The effective income tax rate for the third quarter of 2001 was approximately 39.0% of pretax income compared to the 36.0% effective income tax rate for the third 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 third quarter of 2001 was $2,129,854, a decrease of $5,165,687, or 70.8%, from the $7,295,541 recorded in the third quarter of 2000. Basic and diluted earnings per common share of $.16 for the third quarter of 2001 decreased by $.41 and $.38, or 71.9% and 70.4%, from the $.57 and $.54, respectively, earned in the third quarter of 2000. Basic and diluted weighted average common and common equivalent shares outstanding were 13,065,809 and 13,377,544, respectively, in the third quarter of 2001 compared to 12,821,132 and 13,460,481, respectively, in the third quarter of 2000. As a percentage of revenues, net income for the third quarter of 2001 decreased to 13.3% compared to the 24.5% for the third quarter of 2000. 17 RESULTS OF OPERATIONS YEAR-TO-DATE REVENUES For the first nine months of 2001, revenues were $65,804,126 compared to $81,872,064 for the first nine months of 2000, representing a decrease of $16,067,938, or 19.6%. The revenue performance for the first nine months of 2001 versus the comparable prior year period include: - - The decrease in revenues for the first nine months of 2001 was primarily attributable to a decrease in unit volume sales of core MCU line testing products primarily to Qwest, BellSouth and certain CLEC customers as a result of slower deployments, due to continuing budget restrictions causing these customers to reduce their MCU purchases. In addition, sales of OEM-related MCU products decreased primarily as a result of certain OEM resellers shipping fewer next-generation DLC systems to their end customers. Overall sales of the Company's core MCU comprised 71.6% of the total revenues for the first nine months of 2001. - - The first nine months of 2001 included decreased shipments of the Company's next generation DigiTest system products to Sprint USA, SBC Telecom, Inc. (a CLEC subsidiary of SBC) and to certain resellers for resale to other CLECs between periods. Sales of DigiTest products represented 14.8% of total revenue for the first nine months of 2001. - - Sales of the Company's new DAU product to Sprint USA, as well as to Lucent for deployment within a certain CLEC continued and represented 6.1% of the first nine months of 2001 revenues. - - 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. Sales of the Company's LIGHTHOUSE Cable Status Monitoring system represented 4.2% of the first nine months of 2001 revenue. - - Sales of the Company's Professional Services business increased between periods, primarily from installation oversight and project management services provided to the Ameritech region of SBC associated with their restoration of testability levels previously mentioned. Sales of Professional Services represented 3.2% of the first nine months of 2001 revenue. 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 nine months of 2001 was $36,298,112 compared to $51,246,464 for the first nine months of 2000, representing a decrease of $14,948,352, or 29.2%. Gross profit as a percentage of revenues decreased to 55.2% in the first nine months of 2001 compared to 62.6% 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 during the period 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. 18 SELLING AND MARKETING EXPENSE Selling and marketing expense for the first nine months of 2001 was $6,965,250 compared to $8,851,097 for the first nine months of 2000. This decrease of $1,885,847, or 21.3%, 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 workforce reduction and the realignment of costs initiated in the second quarter of 2001. As a percentage of revenues, selling and marketing expenses decreased to 10.6% in the first nine months of 2001 from 10.8% in the same period last year. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense for the first nine months of 2001 was $3,612,046, a decrease of $852,614, or 19.1%, from the $4,464,660 recorded for the first nine months of 2000. The decrease in general and administrative expense primarily reflects reduced expenditures on professional services, recruiting and travel offset, somewhat, by an increase in the reserve for bad debts. As a percentage of revenues, general and administrative expenses were 5.5% in the first nine months, which is consistent with the same period last year. RESEARCH AND DEVELOPMENT EXPENSE Research and development expense in the first nine months of 2001 was $8,747,326, a decrease of $119,518, or 1.3%, over the $8,866,844 recorded in the first nine months of 2000. The decrease is primarily associated with a decrease in certain performance-based compensation reserves as well as project and travel related expenses, offset somewhat by additional personnel and associated costs to support product development. As a percentage of revenues, research and development expenses increased to 13.3% in the first nine months of 2001 from 10.8% during the first nine months of 2001. 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 $291,000 for involuntary termination benefits and other associated costs during the second and third quarter of 2001. The Company 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 first nine months of 2001, interest and other income was $2,497,971 compared to $1,677,171 for the first nine months of 2000, representing an increase of $820,800, or 48.9%. 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 first nine months of 2001 was $7,383,012, a decrease of $3,683,988, or 33.3%, from the $11,067,000 for the first nine months of 2000. The effective income tax rate for the nine months 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. 19 NET INCOME AND EARNINGS PER SHARE As a result of the above factors, net income for the first nine months of 2001 was $11,688,449, a decrease of $7,985,585, or 40.6%, from the $19,674,034 recorded in the first nine months of 2000. Basic and diluted earnings per common share of $.90 and $.87, respectively, for the first nine months of 2001 decreased by $.67 and $.61, or 42.7% and 41.2%, from the $1.57 and $1.48, respectively, earned in the first nine months of 2000. The first nine months 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 13,017,819 and 13,392,507, respectively, in the first nine months of 2001 compared to 12,536,510 and 13,314,988, respectively, in the first nine months of 2000. As a percentage of revenues, net income for the first nine months of 2001 decreased to 17.8% compared to the 24.0% for the first nine months of 2000. LIQUIDITY AND CAPITAL RESOURCES At September 29, 2001, the Company had working capital of $124,713,472, which represented an increase of $13,578,850, or 12.2%, 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 $2,661,504. The Capital expenditures for the first nine months of 2001 include approximately $1,622,657 associated with the purchase of certain land parcels that surround the current leased facility in Cheswick Pennsylvania. 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 an additional 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 September 29, 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, based on twelve months rolling revenue, was 47 and 61 days as of September 29, 2001 and December 31, 2000, respectively. The Company's inventory turnover ratio was 1.7 and 1.8 turns as of September 29, 2001 and December 31, 2000, respectively. Approximately $2,000,000 in inventory was returned to vendors for credit during the first nine months 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 20 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. SUBSEQUENT EVENT On September 30, 2001, the Company completed the acquisition of the software assets of the MLT/LoopCare(TM) test system business from Lucent Technologies, Inc. ("Lucent") for approximately $60,000,000 in cash. The transaction was consummated pursuant to an Asset Purchase Agreement, entered into on September 28, 2001. The assets consisted principally of software and related computer equipment. The equipment was used by Lucent in support of the software and Tollgrade presently intends to continue to use the equipment for the same purpose. The purchase price of $60,000,000 in cash was arrived at by negotiation among the parties. Tollgrade used available cash and short-term investments to finance the acquisition. LoopCare is the Plain Old Telephone Services ("POTS") test system used by all of the Regional Bell Operating Companies. The testing system measures loop parameters, gathers provisioning and operational information from the network elements, and analyzes data. The software products include the Mechanized Loop Testing (MLT) system that currently tests more than 140 million lines in telecommunication networks worldwide, LoopCare which incorporates the expertise derived from the MLT system supports xDSL, ISDN, POTS and coin service on local metallic wire and DLC loops. The LoopCare solution, which currently works with the Company's existing DigiTest test system platform, includes the measurement of the metallic parameters of the loop to detect shorts, grounds, opens, or other metallic faults that could affect DSL service; measure the broadband spectral density of the noise on the loop; identify the location and length of bridged taps that affect DSL service; predict the downstream and upstream data rate that the loop can support; recommend the most effective remedial action to improve the data rate on lines that cannot support the rate requested by the subscriber. The revenues of this business include initial Right To Use ("RTU") fees, as well as fees associated with annual maintenance contracts. These maintenance fees are based upon various service levels selected by the customer. The Company plans to recognize revenue from the RTU fees in accordance with the American Institute of Certified Public Accountants Statement of Position ("SOP") 97-2, "Software Revenue Recognition" and SOP 98-9 "Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions. When the arrangement with the customer includes future obligations for which fair value does not exist or when customer acceptance is required, revenue is recognized when those obligations have been met or customer acceptance has been received. The customer's network planning and purchase decisions for these software systems normally involve a significant commitment of its resources and a lengthy evaluation and qualification process. Revenue from maintenance support services will be deferred based upon the fair value of the program and then recognized on a straight-line basis over the period of the maintenance contract. The Company may experience fluctuations in its RTU and maintenance fees in future periods. As the Company cannot predict such future events or business conditions the Company's results may be adversely affected by these trends. The LoopCare acquisition will be recorded under the purchase method of accounting and accordingly, the results of operations of LoopCare for the period beginning September 30, 2001, forward will be included in the consolidated financial statements of the Company. BACKLOG 21 The Company's backlog consists of firm customer purchase orders. As of September 29, 2001, the Company had a backlog of $3,604,105 compared to $8,224,460 at December 31, 2000 and $14,412,165 at September 30, 2000. Approximately 77% of the current backlog is currently scheduled to be sold in the fourth 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. 22 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 None. 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 (b) Reports on Form 8-K: The Company filed one Current Report on Form 8-K during the quarter ended September 29, 2001. On September 20, 2001, the Company disclosed certain information in the form 8-K pursuant to Regulation FD (17 CFR 243.100-243.103). 23 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: November 13, 2001 /S/ CHRISTIAN L. ALLISON ------------------------------------- CHRISTIAN L. ALLISON CHAIRMAN AND CHIEF EXECUTIVE OFFICER Dated: November 13, 2001 /S/ SAMUEL C. KNOCH ------------------------------------- SAMUEL C. KNOCH CHIEF FINANCIAL OFFICER AND TREASURER Dated: November 13, 2001 S/ BRADLEY N. DINGER ------------------------------------- BRADLEY N. DINGER CONTROLLER 24 EXHIBIT INDEX (Pursuant to Item 601 of Regulation S-K) Exhibit Number Description ------ ----------- 10.2 Tollgrade Communications, Inc. 1995 Employee Incentive Compensation Plan (as amended through May 3, 2001). 10.25 Tollgrade Communications, Inc. 1998 Employee Incentive Compensation Plan (as amended through May 3, 2001). 10.26 Asset Purchase Agreement by and between Lucent Technologies and Tollgrade Communications, Inc. dated September 28, 2001, incorporated by reference to the Company's 8-K filed on October 15, 2001. 15 Letter re unaudited interim financial information 25 EX-10.2 3 j9134701ex10-2.txt 1995 EMPLOYEE COMPENSATION PLAN EXHIBIT 10.2 TOLLGRADE COMMUNICATIONS, INC. 1995 Long-Term Incentive Compensation Plan (AS AMENDED THROUGH MAY 3, 2001) ARTICLE 1. ESTABLISHMENT, OBJECTIVES, AND DURATION 1.1 ESTABLISHMENT OF THE PLAN. Tollgrade Communications, Inc., a Pennsylvania corporation (hereinafter referred to as the "Company"), hereby establishes an incentive compensation plan to be known as the "Tollgrade Communications, Inc. Long-Term Incentive Compensation Plan" (hereinafter referred to as the "Plan"), as set forth in this document. The Plan permits the grant of Nonqualified Stock Options, Incentive Stock Options, Stock Appreciation Rights, Restricted Stock, Performance Shares and Performance Units. Subject to approval by the Company's stockholders, the Plan shall become effective as of November 15, 1995 (the "Effective Date") and shall remain in effect as provided in Section 1.3 hereof. 1.2 OBJECTIVES OF THE PLAN. The objectives of the Plan are to optimize the profitability and growth of the Company through incentives which are consistent with the Company's goals and which link the personal interests of Participants to those of the Company's stockholders; to provide Participants with an incentive for excellence in individual performance; and to promote teamwork among Participants. The Plan is further intended to provide flexibility to the Company in its ability to motivate, attract and retain the services of Participants who make significant contributions to the Company's success and to allow Participants to share in the success of the Company. 1.3 DURATION OF THE PLAN. The Plan was adopted by the Board of Directors on October 16, 1995, subject to approval by the Company's stockholders, and shall commence on the Effective Date, as described in Section 1.1 hereof, and shall remain in effect, subject to the right of the Board of Directors to amend or terminate the Plan at any time pursuant to Article 15 hereof, until all Shares subject to it shall have been purchased or acquired according to the Plan's provisions. However, in no event may an Award be granted under the Plan on or after October 15, 2005. ARTICLE 2. DEFINITIONS WHENEVER USED IN THE PLAN, THE FOLLOWING TERMS SHALL HAVE THE MEANINGS SET FORTH BELOW, AND WHEN THE MEANING IS INTENDED, THE INITIAL LETTER OF THE WORD SHALL BE CAPITALIZED: 2.1 "APPROPRIATE ADMINISTRATOR" means, in the case of any Awards to Employees, the Committee, and in the case of any Awards to Nonemployee Directors, the Board. 2.2 "AWARD" means, individually or collectively, a grant under this Plan of Nonqualified Stock Options, Incentive Stock Options, Stock Appreciation Rights, Restricted Stock, Performance Shares or Performance Units. 2.3 "AWARD AGREEMENT" means an agreement entered into by the Company and each Participant setting forth the terms and provisions applicable to Awards granted under this Plan. 2.4 "BENEFICIAL OWNER" OR "BENEFICIAL OWNERSHIP" shall have the meaning ascribed to such term in Rule 13d-3 of the General Rules and Regulations under the Exchange Act. 28 2.5 "BOARD" OR "BOARD OF DIRECTORS" means the Board of Directors of the Company. 2.6 "CAUSE" shall mean with respect to the termination of an Employee's employment, unless otherwise determined by the Committee at the time of the grant of the Award (i) in the case where there is no employment agreement, change of control agreement or similar agreement in effect between the Employee and the Company at the time of the grant of the Award (or where there is such an agreement but it does not define "cause" or words of like import), termination due to an Employee's dishonesty, fraud, conviction of a felony, insubordination, willful misconduct, refusal to perform services, or unsatisfactory performance of his or her duties for the Company as determined by the Committee in its sole discretion; or (ii) in the case where there is an employment agreement, change in control agreement or similar agreement in effect between the Employee and the Company at the time of the grant of the Award that defines "cause" (or words of like import), as defined under such agreement. 2.7 "CHANGE IN CONTROL" of the Company shall be deemed to have occurred (as of a particular day, as specified by the Board) if the Board, by a majority vote, agrees that a Change in Control has occurred, or is about to occur. Such a change shall not include, however, a restructuring, reorganization, merger, or other change in capitalization in which the Persons who own an interest in the Company on the Effective Date (the "Current Owners") (or any individual or entity which receives from a Current Owner an interest in the Company through will or the laws of descent and distribution) maintain more than a fifty percent (50%) interest in the resultant entity. Regardless of the Board's vote, a Change in Control will be deemed to have occurred as of the first day any one (1) or more of the following paragraphs shall have been satisfied: (a) Any Person (other than the Person in control of the Company as of the Effective Date of the Plan, or other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company, or a corporation owned directly or indirectly by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company), becomes the Beneficial Owner, directly or indirectly, of securities of the Company representing more than fifty percent (50%) of the combined voting power of the Company's then outstanding securities; or (b) The stockholders of the Company approve: (i) A plan of complete liquidation of the Company; or (ii) An agreement for the sale or disposition of all or substantially all of the Company's assets (other than one in which in the stockholders of the Company, as determined immediately prior to such transaction, hold, directly or indirectly, as determined immediately following such transaction, a majority of the voting power of each surviving, resulting or acquiring corporation which, immediately following such transaction, holds more than 10% of the consolidated assets of the Company immediately prior to the transaction); or (iii)A merger, consolidation, or reorganization of the Company with or involving any other corporation, other than a merger, consolidation, or reorganization that would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least fifty percent (50%) of the combined voting power of the voting securities of the Company (or 29 such surviving entity) outstanding immediately after such merger, consolidation, or reorganization. However, in no event shall a Change in Control be deemed to have occurred, with respect to a Participant, if that Participant is part of a purchasing group, which consummates the Change in Control transaction. The Participant shall be deemed "part of a purchasing group" for purposes of the preceding sentence if the Participant is an equity participant or has agreed to become an equity participant in the purchasing company or group (except for (i) passive ownership of less than five percent (5%) of the voting equity securities of the purchasing company; or (ii) ownership of equity participation in the purchasing company or group which is otherwise deemed not to be significant, as determined prior to the Change in Control by a majority of the nonemployee continuing Directors). 2.8 "CODE" means the Internal Revenue Code of 1986, as amended from time to time. 2.9 "COMMITTEE" means the Compensation Committee of the Board, as specified in Article 3 herein, or such other Committee appointed by the Board to administer the Plan with respect to grants of Awards. 2.10 "COMPANY" means Tollgrade Communications, Inc., a Pennsylvania corporation, and any successor thereto as provided in Article 18 herein. 2.11 "DIRECTOR" means any individual who is a member of the Board of Directors of the Company. 2.12 "EFFECTIVE DATE" shall have the meaning ascribed to such term in Section 1.1 hereof. 2.13 "EMPLOYEE" means any full-time, active employee of the Company. Directors who are not employed by the Company shall not be considered Employees under this Plan. 2.14 "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended from time to time, or any successor act thereto. 2.15 "FAIR MARKET VALUE" shall be the mean between the following prices, as applicable, for the date as of which fair market value is to be determined as quoted in The Wall Street Journal (or in such other reliable publication as the Committee, in its discretion, may determine to rely upon): (i) if the Common Stock is listed on the New York Stock Exchange, the highest and lowest sales prices per share of the Common Stock as quoted in the NYSE Composite Transactions listing for such date, (ii) if the Common Stock is not listed on such exchange, the highest and lowest sales prices per share of Common Stock for such date on (or on any composite index including) the principal United States securities exchange registered under the 1934 Act on which the Common Stock is listed or (iii) if the Common Stock is not listed on any such exchange, the highest and lowest sales prices per share of the Common Stock for such date on the National Association of Securities Dealers Automated Quotations System or any successor system then in use ("NASDAQ"). If there are no such sale price quotations for the date as of which fair market value is to be determined but there are such sale price quotations within a reasonable period both before and after such date, then fair market value shall be determined by taking a weighted average of the means between the highest and lowest sales prices per share of the Common Stock as so quoted on the nearest date before and the nearest date after the date as of which fair market value is to be determined. The average should be weighted inversely by the respective numbers of trading days between the selling dates and the date as of which fair market value is to be determined. If there are no such sale price quotations on or within a reasonable period both before and after the date as of which fair market value is to be determined, then fair market value of the 30 Common Stock shall be the mean between the bona fide bid and asked prices per share of Common Stock as so quoted for such date on NASDAQ, or if none, the weighted average of the means between such bona fide bid and asked prices on the nearest trading date before and the nearest trading date after the date as of which fair market value is to be determined, if both such dates are within a reasonable period. The average is to be determined in the manner described above in this Section 2.15. If the fair market value of the Common Stock cannot be determined on any basis previously set forth in this Section 2.15 for the date as of which fair market value is to be determined, the Committee shall in good faith determine the fair market value of the Common Stock on such date. Fair market value shall be determined without regard to any restriction other than a restriction which, by its terms, will never lapse. 2.16 "FREESTANDING SAR" means an SAR that is granted independently of any Options, as described in Article 7 herein. 2.17 "INCENTIVE STOCK OPTION" OR "ISO" means an option to purchase Shares granted under Article 6 herein and which is designated as an Incentive Stock Option and which is intended to meet the requirements of Code Section 422. 2.18 "INSIDER" shall mean an individual who, immediately prior to the grant of any Award, owns stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company. For purposes of this Section 2.18, an individual (i) shall be considered as owning not only Shares of stock owned individually but also all Shares of stock that are at the time owned, directly or indirectly, by or for the spouse, ancestors, lineal descendants and brothers and sisters (whether by whole or half blood) of such individual and (ii) shall be considered as owning proportionately any Shares owned, directly or indirectly, by or for any corporation, partnership, estate or trust in which such individual is a stockholder, partner or beneficiary. 2.19 "NAMED EXECUTIVE OFFICER" means a Participant who, as of the date of vesting and/or payout of an Award, as applicable, is one of the group of "covered employees," as defined in the regulations promulgated under Code Section 162(m), or any successor statute. 2.20 "NONEMPLOYEE DIRECTOR" means an individual who is a member of the Board of Directors of the Company but who is not an Employee of the Company. 2.21 "NONQUALIFIED STOCK OPTION" OR "NQSO" means an option to purchase Shares granted under Article 6 herein and which is not intended to meet the requirements of Code Section 422. 2.22 "OPTION" means an Incentive Stock Option or a Nonqualified Stock Option, as described in Article 6 herein. 2.23 "OPTION PRICE" means the price at which a Share may be purchased by a Participant pursuant to an Option. 2.24 "PARTICIPANT" means an Employee or a Nonemployee Director who has outstanding an Award granted under the Plan. 2.25 PERFORMANCE-BASED EXCEPTION" means the performance-based exception from the tax deductibility limitations of Code Section 162(m). 2.26 "PERFORMANCE SHARE" means an Award granted to a Participant, as described in Article 9 herein. 2.27 "PERFORMANCE UNIT" means an Award granted to a Participant, as described in Article 9 herein. 31 2.28 "PERIOD OF RESTRICTION" means the period during which the transfer of Shares of Restricted Stock is limited in some way (based on the passage of time, the achievement of performance goals, or upon the occurrence of other events as determined by the Appropriate Administrator, at its discretion), and the Shares are subject to a substantial risk of forfeiture, as provided in Article 8 herein. 2.29 "PERSON" shall have the meaning ascribed to such term in Section 3(a)(9) of the Exchange Act and used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) thereof. 2.30 "RESTRICTED STOCK" means an Award granted to a Participant pursuant to Article 8 herein. 2.31 "RETIREMENT" shall mean any voluntary termination of employment by an Employee following the attainment of age 65. 2.32 "SHARES" means the shares of Common Stock of the Company. 2.33 "STOCK APPRECIATION RIGHT" OR "SAR" means an Award, granted alone or in connection with a related Option, designated as an SAR, pursuant to the terms of Article 7 herein. 2.34 "TANDEM SAR" means an SAR that is granted in connection with a related Option pursuant to Article 7 herein, the exercise of which shall require forfeiture of the right to purchase a Share under the related Option (and when a share is purchased under the Option, the Tandem SAR shall similarly be canceled). Article 3. Administration 3.1 THE COMMITTEE. Except as set forth in Section 3.5 below, the Plan shall be administered by the Compensation Committee of the Board, or by any other Committee appointed by the Board consisting of not less than two (2) Directors who (i) are "non-employee" directors and otherwise meet the "disinterested administration" rules of Rule 16b-3 under the Exchange Act and (ii) are "outside directors" under Section 162(m)(4)(C) of the Code, or any successor provision. The members of the Committee shall be appointed from time to time by, and shall serve at the discretion of, the Board of Directors. 3.2 AUTHORITY OF THE COMMITTEE. Except as set forth in Section 3.4 below, except as limited by law or by the Articles of Incorporation or Bylaws of the Company, and subject to the provisions herein, the Committee shall have full power to grant Options (with or without SARs) and to award Restricted Stock, Performance Shares and Performance Units as described herein and to determine the Employees to whom any such Award shall be made and the number of Shares to be covered thereby; determine the sizes and types of Awards; determine the terms and conditions of Awards in a manner consistent with the Plan; construe and interpret the Plan and any agreement or instrument entered into under the Plan as they apply to Employees; and establish, amend, or waive rules and regulations for the Plan's administration as they apply to Employees; and (subject to the provisions of Article 15 herein) amend the terms and conditions of any outstanding Award except for Incentive Stock Options to the extent such terms and conditions are within the discretion of the Committee as provided in the Plan. Further, the Committee shall make all other determinations, which may be necessary or advisable for the administration of the Plan, as the Plan applies to Employees. As permitted by law the Committee may delegate its authority as identified herein. 3.3 DECISIONS BINDING. All determinations and decisions made by the Committee pursuant to the provisions of the Plan and all related orders and resolutions of the Board shall be 32 final, conclusive and binding on all persons, including the Company, its stockholders, Employees, Participants, and their estates and beneficiaries. 3.4 NON-COMPETITION. If a grantee of an Option, Restricted Stock, Performance Units or Performance Shares (i) engages in the operation or management of a business (whether as owner, partner, officer, director, employee or otherwise and whether during or after termination of employment) which is in competition with the Company, (ii) induces or attempts to induce any customer, supplier, licensee or other individual, corporation or other business organization having a business relationship with the Company to cease doing business with the Company or in any way interferes with the relationship between any such customer, supplier, licensee or other person and the Company or (iii) solicits any employee of the Company to leave the employment thereof or in any way interferes with the relationship of such employee with the Company, the Appropriate Administrator, in its discretion, may immediately terminate all outstanding Options held by the grantee, declare forfeited all Restricted Stock held by the grantee as to which the restrictions have not yet lapsed and/or immediately cancel any award of Performance Units or Performance Shares. Whether a grantee has engaged in any of the activities referred to in the preceding sentence which would cause the outstanding Options to be terminated, and/or the Restricted Stock to be forfeited and/or any award of Performance Units or Performance Shares to be cancelled shall be determined, in its discretion, by the Appropriate Administrator, and any such determination by the Appropriate Administrator shall be final and binding. 3.5 GRANTS TO NONEMPLOYEE DIRECTORS. Notwithstanding the foregoing, unless otherwise determined by the Board, the Board shall grant Nonqualified Stock Options (with or without SARs) and award Restricted Stock, Performance Shares and Performance Units, and otherwise exercise the same authority as the Committee as described in Section 3.2 above, with respect to Nonemployee Directors. ARTICLE 4. SHARES SUBJECT TO THE PLAN AND MAXIMUM AWARDS 4.1 NUMBER OF SHARES AVAILABLE FOR GRANTS. Subject to adjustment as provided in Section 4.3 herein, the number of Shares hereby reserved for issuance to Participants under the Plan shall be 2,485,000; provided however, that, of that total, the maximum number of Shares of Restricted Stock granted pursuant to Article 8 herein, shall be 300,000. The following rules shall apply to grants of such Awards under the Plan: (a) The maximum aggregate number of Shares that may be granted or that may vest, as applicable, pursuant to any Award held by any one Named Executive Officer shall be 200,000 during any calendar year of the term of the Plan; (b) The maximum aggregate cash payout received during any fiscal year by any one Named Executive Officer with respect to Awards granted shall be $1 million. 4.2 LAPSED AWARDS. If any Award granted under this Plan is canceled, terminates, expires, or lapses for any reason (with the exception of the termination of a Tandem SAR upon exercise of the related Option, or the termination of a related Option upon exercise of the corresponding Tandem SAR), any Shares subject to such Award again shall be available for the grant of an Award under the Plan. 4.3 ADJUSTMENTS IN AUTHORIZED SHARES. In the event of any change in corporate capitalization, such as a stock split, or a corporate transaction, such as any merger, consolidation, separation, including a spin-off, or other distribution of stock or property of the Company, any reorganization (whether or not such reorganization comes within the definition of such term in Code Section 368) or any partial or complete liquidation of 33 the Company, such adjustment shall be made in the number and class of Shares which may be delivered under Section 4.1 and as to the number of Shares which may be awarded under the Plan to any Named Executive Officer during the term of the Plan, and in the number and class of and/or price of Shares subject to outstanding Awards granted under the Plan, as may be determined to be appropriate and equitable by the Committee, in its sole discretion, to prevent dilution or enlargement of rights; provided, however, that the number of Shares subject to any Award shall always be a whole number. ARTICLE 5. ELIGIBILITY AND PARTICIPATION 5.1 ELIGIBILITY. Persons eligible to participate in this Plan include all Employees of the Company (including, but not limited to, Employees who are members of the Board, covered employees as defined in Section 162(m)(3) of the Code, or any successor provision) and all Nonemployee Directors of the Company. 5.2 ACTUAL PARTICIPATION. Subject to the provisions of the Plan, the Committee may, from time to time, select from all eligible Employees those to whom Awards shall be granted and shall determine the nature and amount of each Award and the Board may, from time to time, select from all eligible Nonemployee Directors those to whom Awards shall be granted and shall determine the nature and amount of each Award. ARTICLE 6. STOCK OPTIONS 6.1 GRANT OF OPTIONS. Subject to the terms and provisions of the Plan, the Committee may grant Incentive Stock Options or Nonqualified Stock Options or both types of Options (but not in tandem) to Employees and the Board may grant Nonqualified Stock Options to Nonemployee Directors in such number, and upon such terms, and at any time and from time to time as shall be determined by the Appropriate Administrator. 6.2 AWARD AGREEMENT. Each Option grant shall be evidenced by an Award Agreement that shall specify the Option Price, the duration of the Option, the number of Shares to which the Option pertains, and such other provisions as the Appropriate Administrator shall determine. The Award Agreement also shall specify whether the Option is intended to be an ISO within the meaning of Code Section 422, or an NQSO whose grant is intended not to fall under the provisions of Code Section 422. 6.3 OPTION PRICE. The Option Price at which each Option may be exercised shall be no less than one hundred percent (100%) of the fair market value per share of the Common Stock covered by the Option on the date of grant, except that in the case of an Incentive Stock Option granted to an Insider, the option price shall not be less than one hundred ten percent (110%) of such fair market value on the date of grant. For purposes of this Section 6.3, the fair market value of the Common Stock shall be as determined in Section 2.15 6.4 DURATION OF OPTIONS. Each Option granted to a Participant shall expire at such time as the Appropriate Administrator shall determine at the time of grant; provided, however, that no Option shall be exercisable after the expiration of ten years (five years in the case of an Incentive Stock Option granted to an Insider) from the date of grant. 6.5 EXERCISE OF OPTIONS. Options granted under this Article 6 shall be exercisable at such times and be subject to such restrictions and conditions as the Appropriate Administrator shall in each instance approve, which need not be the same for each grant or for each Participant. Notwithstanding any other provision contained in the Plan or in any Award Agreement referred to in Section 2.3, but subject to the possible exercise of the Committee's discretion contemplated in the last sentence of this paragraph, the aggregate fair market value, determined as provided in Section 2.15 on the date of grant, of the Shares with respect to which Incentive Stock Options are exercisable for the first time by an Employee during any calendar year under all plans of the corporation employing such 34 Employee, any parent or subsidiary corporation of such corporation and any predecessor corporation of any such corporation shall not exceed $100,000. If the date on which one or more of such Incentive Stock Options could first be exercised would be accelerated pursuant to any provision of the Plan or any Award Agreement, and the acceleration of such exercise date would result in a violation of the limitation set forth in the preceding sentence, then, notwithstanding any such provision, but subject to the provisions of the next succeeding sentence, the exercise dates of such Incentive Stock Options shall be accelerated only to the date or dates, if any, that do not result in a violation of such limitation and, in such event, the exercise dates of the Incentive Stock Options with the lowest Option Prices shall be accelerated to the earliest such dates. The Committee may, in its discretion, authorize the acceleration of the exercise date of one or more Incentive Stock Options even if such acceleration would violate the $100,000 limitation set forth in the first sentence of this paragraph and even if such Incentive Stock Options are thereby converted in whole or in part to Nonqualified Stock Options. 6.6 PAYMENT. Options granted under this Article 6 shall be exercised by the delivery of a written notice of exercise to the Company, setting forth the number of Shares with respect to which the Option is to be exercised, accompanied by full payment for the Shares. The Option Price upon exercise of any Option shall be payable to the Company in full either: (a) in cash in United States dollars (including check, bank draft or money order), or (b) by tendering previously acquired Shares having an aggregate Fair Market Value at the time of exercise equal to the total Option Price, or (c) by a combination of (a) and (b). The Company will also cooperate with any person exercising an Option who participates in a cashless exercise program of a broker or other agent under which all or part of the Shares received upon exercise of the Option are sold through the broker or other agent or under which the broker or other agent makes a loan to such person. Notwithstanding the foregoing, unless the Appropriate Administrator, in its discretion, shall otherwise determine at the time of grant in the case of an Incentive Stock Option, or at any time in the case of a Nonqualified Stock Option, the exercise of the Option shall not be deemed to occur and no Shares of Common Stock will be issued by the Company upon exercise of the Option until the Company has received payment of the Option Price in full. 6.7 RESTRICTIONS ON SHARE TRANSFERABILITY. The Appropriate Administrator may impose such restrictions on any Shares acquired pursuant to the exercise of an Option granted under this Article 6 as it may deem advisable, including, without limitation, restrictions under applicable Federal securities laws, under the requirements of any stock exchange or market upon which such Shares are then listed and/or traded, and under any blue sky or state securities laws applicable to such Shares. 6.8 TERMINATION OF EMPLOYMENT. Subject to the provisions of Section 6.5 in the case of Incentive Stock Options, unless the Committee, in its discretion, shall otherwise determine: (i) If the employment of an Employee who is not disabled within the meaning of Section 422(c)(6) of the Code (a "Disabled Grantee") is voluntarily terminated with the consent of the Company or an Employee retires under any retirement plan of the Company, any outstanding Incentive Stock Option held by such Employee shall be exercisable by the Employee (but only to the extent exercisable by the Employee immediately prior to the termination of employment) at any time prior to the expiration date of such Incentive Stock Option or within three months after the date of termination of employment, whichever is the shorter period; (ii) If the employment of an Employee who is not a Disabled Grantee is voluntarily terminated with the consent of the Company or an Employee retires under any retirement plan of the Company, any outstanding Nonqualified Stock Option held by such Employee shall be exercisable by the Employee (but only to the extent 35 exercisable by the Employee immediately prior to the termination of employment) at any time prior to the expiration date of such Nonqualified Stock Option or within one year after the date of termination of employment, whichever is the shorter period; (iii) If the employment of an Employee who is a Disabled Grantee is voluntarily terminated with the consent of the Company, any outstanding Option held by such Employee shall be exercisable by the Employee in full (whether or not so exercisable by the Employee immediately prior to the termination of employment) at any time prior to the expiration date of such Option or within one year after the date of termination of employment, whichever is the shorter period; (iv) Following the death of an Employee during employment, any outstanding Option held by the Employee at the time of death shall be exercisable in full (whether or not so exercisable by the Employee immediately prior to the death of the Employee) by the person entitled to do so under the Will of the Employee, or, if the Employee shall fail to make testamentary disposition of the stock option or shall die intestate, by the legal representative of the Employee at any time prior to the expiration date of such stock option or within one year after the date of death of the Employee, whichever is the shorter period; (v) Following the death of an Employee after termination of employment during a period when an Option is exercisable, the Option shall be exercisable by such person entitled to do so under the Will of the Employee by such legal representative (but only to the extent exercisable by the Employee immediately prior to the termination of employment) at any time prior to the expiration date of such Option or within one year after the date of death, whichever is the shorter period; (vi) Unless the exercise period of a stock option following termination of employment has been extended as provided in Section 14.1, if the employment of an Employee terminates for any reason other than voluntary termination with the consent of the Company, retirement under any retirement plan of the Company or death, all outstanding Options held by the Employee at the time of such termination of employment shall automatically terminate. provided, however, that if the employment of an Employee is involuntarily terminated by the Company without Cause, any Option held by such Employee at the time of such termination that was granted to Employee on or after May 3, 2001, shall be exercisable by the Employee (but only to the extent exercisable by the Employee immediately prior to the termination of employment) at any time prior to the expiration date of such Option or within one year after the date of termination of employment, whichever is the shorter period. Whether termination of employment is a voluntary termination with the consent of the Company or an involuntary termination with or without cause shall be determined, in its discretion, by the Committee and any such determination by the Committee shall be final and binding. 6.9 TERMINATION OF BOARD SERVICE. Unless the Board, in its discretion, shall otherwise determine: (i) If a Nonemployee Director ceases to be a Director of the Company for any reason other than resignation, removal for cause or death, any then outstanding stock option held by such Nonemployee Director shall be exercisable by the Nonemployee Director (but only to the extent exercisable by the Nonemployee Director immediately prior to ceasing to be a Director) at any time prior to the 36 expiration date of such stock option or within one year after the date the Nonemployee Director ceases to be a Director, whichever is the shorter period; (ii) If during his or her term of office as a Director a Nonemployee Director resigns from the Board (which shall not include not standing for reelection at the end of his or her then current term) or is removed from office for cause, any then outstanding stock option held by such Nonemployee Director shall be exercisable by the Nonemployee Director (but only to the extent exercisable by the Nonemployee Director immediately prior to ceasing to be a Director) at any time prior to the expiration date of such stock option or within 90 days after the date of resignation or removal, whichever is the shorter period; (iii) Following the death of a Nonemployee Director during service as a Director of the Company, any outstanding stock option held by the Nonemployee Director at the time of death (whether or not exercisable by the Nonemployee Director immediately prior to death) shall be exercisable by the person entitled to do so under the Will of the Nonemployee Director, or, if the Nonemployee Director shall fail to make testamentary disposition of the stock option or shall die intestate, by the legal representative of the Nonemployee Director, at any time prior to the expiration date of such stock option or within one year after the date of death, whichever is the shorter period; (iv) Following the death of a Nonemployee Director after ceasing to be a Director, any outstanding stock option held by such Nonemployee Director at the time of death shall be exercisable (but only to the extent exercisable by the Nonemployee Director immediately prior to death) by such person entitled to do so under the Will of the Nonemployee Director or by such legal representative at any time prior to the expiration date of such stock option or within one year after the date of death, whichever is the shorter period. Interpretation of the foregoing shall be done by the Board and any determination by the Board shall be final and binding. 6.10 NONTRANSFERABILITY OF OPTIONS. No Option granted under the Plan may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by Will or if the Participant dies intestate by the laws of descent and distribution of the state of domicile of the Participant at the time of death. Further, all Options granted to a Participant under the Plan shall be exercisable during his or her lifetime only by such Participant. ARTICLE 7. STOCK APPRECIATION RIGHTS 7.1 GRANT OF SARS. Subject to the terms and conditions of the Plan, SARs may be granted to Participants at any time and from time to time as shall be determined by the Appropriate Administrator, provided however that any SAR granted in conjunction with an Incentive Stock Option may only be granted at the time the related Incentive Stock Option is granted. The Appropriate Administrator may grant Freestanding SARs, Tandem SARs, or any combination of these forms of SARs. The Appropriate Administrator shall have complete discretion in determining the number of SARs granted to each Participant (subject to Article 4 herein) and, consistent with the provisions of the Plan, in determining the terms and conditions pertaining to such SARs. The grant price of a Freestanding SAR shall equal the Fair Market Value of a Share on the date of grant of the SAR. The grant price of Tandem SARs shall equal the Option Price of the related Option, as provided in Section 6.3. 37 7.2 EXERCISE OF TANDEM SARS. Tandem SARs may be exercised for all or part of the Shares subject to the related Option upon the surrender of the right to exercise the equivalent portion of the related Option. A Tandem SAR may be exercised only with respect to the Shares for which its related Option is then exercisable. Notwithstanding any other provision of this Plan to the contrary, with respect to a Tandem SAR granted in connection with an ISO: (i) the Tandem SAR will expire no later than the expiration of the underlying ISO; (ii) the value of the payout with respect to the Tandem SAR may be for no more than one hundred percent (100%) of the difference between the Option Price of the underlying ISO and the Fair Market Value of the Shares subject to the underlying ISO at the time the Tandem SAR is exercised; and (iii) the Tandem SAR may be exercised only when the Fair Market Value of the Shares subject to the ISO exceeds the Option Price of the ISO. 7.3 EXERCISE OF FREESTANDING SARS. Freestanding SARs may be exercised upon whatever terms and conditions the Appropriate Administrator, in its sole discretion, imposes upon them. 7.4 SAR AGREEMENT. Each SAR grant shall be evidenced by an Award Agreement that shall specify the grant price, the term of the SAR, and such other provisions as the Appropriate Administrator shall determine. 7.5 TERM OF SARS. Except as otherwise provided in Section 7.2 in the case of a Tandem SAR granted in conjunction with an ISO, the term of an SAR granted under the Plan shall be determined by the Appropriate Administrator, in its sole discretion; provided, however, that such term shall not exceed ten (10) years. 7.6 PAYMENT OF SAR AMOUNT. Upon exercise of an SAR, a Participant shall be entitled to receive payment from the Company in an amount determined by multiplying: (a) The difference between the Fair Market Value of a Share on the date of exercise over the grant price; by (b) The number of Shares with respect to which the SAR is exercised. At the discretion of the Appropriate Administrator, the payment upon SAR exercise may be in cash, in Shares of equivalent value, or in some combination thereof. 7.7 RULE 16B-3 REQUIREMENTS. Notwithstanding any other provision of the Plan, the Appropriate Administrator may impose such conditions on exercise of an SAR as may be required to satisfy the requirements of Section 16 of the Exchange Act (or any successor rule). 7.8 TERMINATION OF EMPLOYMENT. Each SAR Award Agreement shall set forth the extent to which the Participant shall have the right to exercise the SAR following termination of the Participant's employment with the Company and/or its Subsidiaries or the Participant's termination of Board Service, as the case may be. Such provisions shall be determined in the sole discretion of the Appropriate Administrator, shall be included in the Award Agreement entered into with Participants, need not be uniform among all SARs issued pursuant to the Plan, and may reflect distinctions based on the reasons for termination of such employment or service. 7.9 NONTRANSFERABILITY OF SARS. No SAR granted under the Plan may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will or, if the grantee dies intestate, by the laws of descent and distribution of the state of domicile of the grantee at the time of death. Further, all SARs granted to a Participant under the Plan shall be exercisable during his or her lifetime only by such Participant. 38 ARTICLE 8. RESTRICTED STOCK 8.1 GRANT OF RESTRICTED STOCK. Subject to the terms and provisions of the Plan, the Appropriate Administrator, at any time and from time to time, may grant Shares of Restricted Stock to Participants in such amounts as the Appropriate Administrator shall determine. 8.2 RESTRICTED STOCK AGREEMENT. Each Restricted Stock grant shall be evidenced by a Restricted Stock Award Agreement that shall specify the Period(s) of Restriction, the number of Shares of Restricted Stock granted, and such other provisions as the Appropriate Administrator shall determine. 8.3 TRANSFERABILITY. Except as provided in this Article 8, the Shares of Restricted Stock granted herein may not be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated until the end of the applicable Period of Restriction established by the Appropriate Administrator and specified in the Restricted Stock Award Agreement, or upon earlier satisfaction of any other conditions, as specified by the Appropriate Administrator in its sole discretion and set forth in the Restricted Stock Award Agreement. All rights with respect to the Restricted Stock granted to a Participant under the Plan shall be available during his or her lifetime only to such Participant. 8.4 OTHER RESTRICTIONS. Subject to Article 11 herein, the Appropriate Administrator shall impose such other conditions and/or restrictions on any Shares of Restricted Stock granted pursuant to the Plan as it may deem advisable including, without limitation, a requirement that Participants pay a stipulated purchase price for each Share of Restricted Stock, restrictions based upon the achievement of specific performance goals (Company-wide, divisional, and/or individual), time-based restrictions on vesting following the attainment of the performance goals, and/or restrictions under applicable Federal or state securities laws. The Company shall retain the certificates representing Shares of Restricted Stock in the Company's possession until such time as all conditions and/or restrictions applicable to such Shares have been satisfied. Except as otherwise provided in this Article 8, Shares of Restricted Stock covered by each Restricted Stock grant made under the Plan shall become freely transferable by the Participant after the last day of the applicable Period of Restriction. 8.5 VOTING RIGHTS. During the Period of Restriction, Participants holding Shares of Restricted Stock granted hereunder may exercise full voting rights with respect to those Shares. 8.6 DIVIDENDS AND OTHER DISTRIBUTIONS. During the Period of Restriction, Participants holding Shares of Restricted Stock granted hereunder may be credited with regular cash dividends paid with respect to the underlying Shares while they are so held. The Appropriate Administrator may apply any restrictions to the dividends that the Appropriate Administrator deems appropriate. Without limiting the generality of the preceding sentence, if the grant or vesting of Restricted Shares granted to a Named Executive Officer is designed to comply with the requirements of the Performance-Based Exception, the Committee may apply any restrictions it deems appropriate to the payment of dividends declared with respect to such Restricted Shares, such that the dividends and/or the Restricted Shares maintain eligibility for the Performance-Based Exception. In the event that any dividend constitutes a "derivative security" or an "equity security" pursuant to Rule 16(a) under the Exchange Act, such dividend shall be subject to a vesting period equal to the remaining vesting period of the Shares of Restricted Stock with respect to which the dividend is paid. 39 8.7 TERMINATION OF EMPLOYMENT. Each Restricted Stock Award Agreement shall set forth the extent to which the Participant shall have the right to receive unvested Restricted Shares following termination of the Participant's employment with the Company or service on the Board, as the case may be. Such provisions shall be determined in the sole discretion of the Appropriate Administrator, shall be included in the Award Agreement entered into with each Participant, need not be uniform among all Shares of Restricted Stock issued pursuant to the Plan, and may reflect distinctions based on the reasons for termination of such employment or service; provided, however that, except in the cases of terminations connected with a Change in Control and terminations by reason of death or disability the vesting of Shares of Restricted Stock which qualify for the Performance-Based Exception and which are held by Named Executive Officers shall occur at the time they otherwise would have, but for the employment termination. ARTICLE 9. PERFORMANCE UNITS AND PERFORMANCE SHARES 9.1 GRANT OF PERFORMANCE UNITS/SHARES. Subject to the terms of the Plan, Performance Units and/or Performance Shares may be granted to Participants in such amounts and upon such terms, and at any time and from time to time, as shall be determined by the Appropriate Administrator. 9.2 VALUE OF PERFORMANCE UNITS/SHARES. Each Performance Unit shall have an initial value that is established by the Appropriate Administrator at the time of grant. Each Performance Share shall have an initial value equal to the Fair Market Value of a Share on the date of grant. The Appropriate Administrator shall set performance goals in its discretion which, depending on the extent to which they are met, will determine the number and/or value of Performance Units/Shares that will be paid out to the Participant. For purposes of this Article 9, the time period during which the performance goals must be met shall be called a "Performance Period." 9.3 EARNING OF PERFORMANCE UNITS/SHARES. Subject to the terms of this Plan, after the applicable Performance Period has ended, the holder of Performance Units/Shares shall be entitled to receive payout on the number and value of Performance Units/Shares earned by the Participant over the Performance Period, to be determined as a function of the extent to which the corresponding performance goals have been achieved. 9.4 FORM AND TIMING OF PAYMENT OF PERFORMANCE UNITS/SHARES. Payment of earned Performance Units/Shares shall be made in a single lump sum within seventy-five (75) calendar days following the close of the applicable Performance Period. Subject to the terms of this Plan, the Appropriate Administrator, in its sole discretion, may pay earned Performance Units/Shares in the form of cash or in Shares (or in a combination thereof) which have an aggregate Fair Market Value equal to the value of the earned Performance Units/Shares at the close of the applicable Performance Period. Such Shares may be granted subject to any restrictions deemed appropriate by the Appropriate Administrator. At the discretion of the Appropriate Administrator, Participants may be entitled to receive any dividends declared with respect to Shares which have been earned in connection with grants of Performance Units and/or Performance Shares which have been earned, but not yet distributed to Participants (such dividends shall be subject to the same accrual, forfeiture, and payout restrictions as apply to dividends earned with respect to Shares of Restricted Stock, as set forth in Section 8.6 herein). In addition, Participants may, at the discretion of the Appropriate Administrator, be entitled to exercise their voting rights with respect to such Shares. 9.5 TERMINATION OF EMPLOYMENT DUE TO DEATH, DISABILITY, OR RETIREMENT. Unless determined otherwise by the Appropriate Administrator and set forth in the Participant's Award Agreement, in the event the employment or the Board service of a Participant is terminated by reason of death, disability, or Retirement during a Performance Period, the 40 Participant shall receive a payout of the Performance Units/Shares which is prorated, as specified by the Appropriate Administrator in its discretion. Payment of earned Performance Units/Shares shall be made at a time specified by the Appropriate Administrator in its sole discretion and set forth in the Participant's Award Agreement. Notwithstanding the foregoing, with respect to Named Executive Officers who retire during a Performance Period, payments shall be made at the same time as payments are made to Participants who did not terminate employment during the applicable Performance Period. 9.6 TERMINATION OF EMPLOYMENT OR BOARD SERVICE FOR OTHER REASONS. In the event that a Participant's employment or Board service terminates for any reason other than those reasons set forth in Section 9.5 herein, all Performance Units/Shares shall be forfeited by the Participant to the Company unless determined otherwise by the Appropriate Administrator, as set forth in the Participant's Award Agreement. 9.7 NONTRANSFERABILITY. Performance Units/Shares may not be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will or if the grantee dies intestate by the laws of descent and distribution of the state of domicile of the grantee at the time of death. Further, a Participant's rights under the Plan shall be exercisable during the Participant's lifetime only by the Participant or the Participant's legal representative. ARTICLE 10. PERFORMANCE MEASURES Unless and until the Appropriate Administrator proposes for shareholder vote and shareholders approve a change in the general performance measures set forth in this Article 10, the attainment of which may determine the degree of payout and/or vesting with respect to Awards to Named Executive Officers which are designed to qualify for the Performance Based Exception, the performance measure(s) to be used for purposes of such grants shall be chosen from among the following alternatives: (a) Revenues of the Company or any specified division; (b) Percentage increase over a specified period in revenues of the Company or any specified division; (c) Expenses or any designated category of expenses of the Company or any specified division; (d) Percentage decrease over a specified period in expenses or any designated category of expenses of the Company or any specified division; (e) Pretax or after-tax income of the Company or any specified division; and (f) Percentage increase over a specified period in pretax or after-tax income of the Company or any specified division. The Appropriate Administrator shall have the discretion to adjust the determinations of the degree of attainment of the preestablished performance goals; provided, however, that Awards which are designed to qualify for the Performance Based Exception, and which are held by Named Executive Officers, may not be adjusted upward (the Committee shall retain the discretion to adjust such Awards downward). In the event that applicable tax and/or securities laws change to permit the Appropriate Administrator discretion to alter the governing performance measures without obtaining shareholder approval of such changes, the Appropriate Administrator shall have sole discretion to make such changes without obtaining shareholder approval. In addition, in the event that the Appropriate Administrator determines that it is advisable to grant Awards, which shall not qualify 41 for the Performance-Based Exception, the Appropriate Administrator may make such grants without satisfying the requirements of Code Section 162(m). ARTICLE 11. BENEFICIARY DESIGNATION Each Participant under the Plan may, from time to time, name any beneficiary or beneficiaries (who may be named contingently or successively) to whom any benefit under the Plan is to be paid in case of his or her death before he or she receives any or all of such benefit. Each such designation shall revoke all prior designations by the same Participant, shall be in a form prescribed by the Company, and will be effective only when filed by the Participant in writing with the Company during the Participant's lifetime. In the absence of any such designation, benefits remaining unpaid at the Participant's death shall be paid to the Participant's estate. ARTICLE 12. DEFERRALS The Committee may permit or require a Participant to defer such Participant's receipt of the payment of cash or the delivery of Shares that would otherwise be due to such Participant by virtue of the exercise of an Option or SAR, the lapse or waiver of restrictions with respect to Restricted Stock, or the satisfaction of any requirements or goals with respect to Performance Units/Shares. If any such deferral election is required or permitted, the Appropriate Administrator shall, in its sole discretion, establish rules and procedures for such payment deferrals. ARTICLE 13. RIGHTS OF EMPLOYEES AND NONEMPLOYEE DIRECTORS 13.1 EMPLOYMENT AND BOARD SERVICE. Nothing in the Plan shall interfere with or limit in any way the right of the Company to terminate any Participant's employment at any time, nor confer upon any Participant any right to continue in the employ of the Company, nor shall it confer any right to a person to continue as a Director of the Company or interfere in any way with the rights of shareholders of the Company or the Board to elect and remove Directors. 13.2 PARTICIPATION. No Employee or Nonemployee Director shall have the right to be selected to receive an Award under this Plan, or, having been so selected, to be selected to receive a future Award. ARTICLE 14. CHANGE IN CONTROL 14.1 TREATMENT OF OUTSTANDING AWARDS. Upon the occurrence of a Change in Control, unless otherwise specifically prohibited under applicable laws, or by the rules and regulations of any governing governmental agencies or national securities exchanges: (a) Any and all Options and SARs granted hereunder shall become immediately exercisable, and shall remain exercisable throughout their entire term; (b) Any restriction periods and restrictions imposed on Restricted Shares shall lapse; (c) The target payout opportunities attainable under all outstanding Awards of Restricted Stock, Performance Units and Performance Shares shall be deemed to have been fully earned for the entire Performance Period(s) as of the effective date of the Change in Control. The vesting of all Awards denominated in Shares shall be accelerated as of the effective date of the Change in Control, and there shall be paid out in cash to Participants within thirty (30) days following the effective date of the Change in Control an amount equal to one hundred percent (100%) of all targeted cash payout opportunities associated with outstanding cash-based Awards; and 42 (d) Subject to Article 15 herein, the Appropriate Administrator shall have the authority to make any modifications to the Awards as determined by the Appropriate Administrator to be appropriate before the effective date of the Change in Control. 14.2 ACCELERATION OF AWARD VESTING. Notwithstanding any provision of this Plan or any Award Agreement provision to the contrary, the Appropriate Administrator, in its sole and exclusive discretion, shall have the power at any time to accelerate the vesting of any Award granted under the Plan to a Participant, including without limitation acceleration to such a date that would result in said Awards becoming immediately vested, except that the Appropriate Administrator shall not have the authority to accelerate any Award that would otherwise qualify for the Performance-Based Exception in any manner that would cause the Award to fail to qualify as such. 14.3 TERMINATION, AMENDMENT, AND MODIFICATIONS OF CHANGE IN CONTROL PROVISIONS. Notwithstanding any other provision of this Plan or any Award Agreement provision, the provisions of this Article 14 may not be terminated, amended, or modified on or after the date of a Change in Control to affect adversely any Award theretofore granted under the Plan without the prior written consent of the Participant with respect to said Participant's outstanding Awards; provided, however, the Board of Directors, upon recommendation of the Committee, may terminate, amend, or modify this Article 14 at any time and from time to time prior to the date of a Change in Control. ARTICLE 15. AMENDMENT, MODIFICATION, AND TERMINATION 15.1 AMENDMENT, MODIFICATION, AND TERMINATION. The Board may at any time and from time to time, alter, amend, suspend or terminate the Plan in whole or in part; provided, however, that no amendment which requires shareholder approval in order for the Plan to continue to comply with Rule 16b-3 under the Exchange Act, including any successor to such Rule, shall be effective unless such amendment shall be approved by the requisite vote of shareholders of the Company entitled to vote thereon. 15.2 ADJUSTMENT OF AWARDS UPON THE OCCURRENCE OF CERTAIN UNUSUAL OR NONRECURRING EVENTS. The Committee may make adjustments in the terms and conditions of, and the criteria included in, Awards in recognition of unusual or nonrecurring events (including, without limitation, the events described in Section 4.3 hereof) affecting the Company or the financial statements of the Company or of changes in applicable laws, regulations, or accounting principles, whenever the Committee determines that such adjustments are appropriate in order to prevent dilution or enlargement of the benefits or potential benefits intended to be made available under the Plan; provided that no such adjustment shall be authorized to the extent that such authority would be inconsistent with the Plan's meeting the requirements of Section 162(m) of the Code, as from time to time amended. 15.3 AWARDS PREVIOUSLY GRANTED. No termination, amendment, or modification of the Plan shall adversely affect in any material way any Award previously granted under the Plan, without the written consent of the Participant holding such Award. 15.4 COMPLIANCE WITH CODE SECTION 162(M). Compliance with Code Section 162(m). At all times when Code Section 162(m) is applicable, all Awards granted under this Plan shall comply with the requirements of Code Section 162(m); provided, however, that in the event the Committee determines that such compliance is not desired with respect to any Award or Awards available for grant under the Plan, then compliance with Code Section 162(m) will not be required. In addition, in the event that changes are made to Code Section 162(m) to permit greater flexibility with respect to any Award or Awards 43 available under the Plan, the Committee may, subject to this Article 15, make any adjustments it deems appropriate. ARTICLE 16. WITHHOLDING 16.1 TAX WITHHOLDING. The Company shall have the power and the right to deduct or withhold, or require an Employee to remit to the Company, an amount sufficient to satisfy Federal, state, and local taxes, domestic or foreign, required by law or regulation to be withheld with respect to any taxable event arising as a result of this Plan. 16.2 SHARE WITHHOLDING. With respect to withholding required upon the exercise of Options or SARs, upon the lapse of restrictions on Restricted Stock, or upon any other taxable event arising as a result of Awards granted hereunder, Employees may elect, subject to the approval of the Committee, to satisfy the withholding requirement, in whole or in part, by having the Company withhold Shares having a Fair Market Value on the date the tax is to be determined equal to the minimum statutory total tax which could be imposed on the action. All such elections shall be irrevocable, made in writing, signed by the Employee, and shall be subject to any restrictions or limitations that the Committee, in its sole discretion, deems appropriate. ARTICLE 17. INDEMNIFICATION Each person who is or shall have been a member of the Committee, or of the Board, shall be indemnified and held harmless by the Company against and from any loss, cost, liability or expense that may be imposed upon or reasonably incurred by him or her in connection with or resulting from any claim, action, suit, or proceeding to which he or she may be a party or in which he or she may be involved by reason of any action taken or failure to act under the Plan and against and from any and all amounts paid by him or her in settlement thereof, with the Company's approval, or paid by him or her in satisfaction of any judgment in any such action, suit, or proceeding against him or her, provided he or she shall give the Company an opportunity at its own expense, to handle and defend the same before he or she undertakes to handle and defend it on his or her own behalf. The foregoing right of indemnification shall not be exclusive of any other rights of indemnification to which such persons may be entitled under the Company's Articles of Incorporation or Bylaws, as a matter of law, or otherwise, or any power that the Company may have to indemnify them or hold them harmless. ARTICLE 18. SUCCESSOR All obligations of the Company under the Plan with respect to Awards granted hereunder shall be binding on any successor to the Company, whether the existence of such successor is the result of a direct or indirect purchase, merger, consolidation, or otherwise, of all or substantially all of the business and/or assets of the Company. ARTICLE 19. LEGAL CONSTRUCTION 19.1 GENDER AND NUMBER. Except where otherwise indicated by the context, any masculine term used herein also shall include the feminine; the plural shall include the singular and the singular shall include the plural. 19.2 SEVERABILITY. In the event any provision of the Plan shall be held illegal or invalid for any reason, the illegality or invalidity shall not affect the remaining parts of the Plan, and the Plan shall be construed and enforced as if the illegal or invalid provision had not been included. ARTICLE 20. REQUIREMENTS OF LAW. The granting of Awards and the issuance of Shares under the Plan shall be subject to all applicable 44 laws, rules, and regulations, and to such approvals by any governmental agencies or national securities exchanges as may be required. ARTICLE 21. SECURITIES LAW COMPLIANCE. With respect to (i) a Director of the Company, (ii) an executive officer of the Company or other person who is required to file reports pursuant to the rules promulgated under Section 16 of the Exchange Act and (iii) Insiders, transactions under this Plan are intended to comply with all applicable conditions or Rule 16b-3 or its successors under the Exchange Act. To the extent any provision of the Plan or action by the Appropriate Administrator fails to so comply, it shall be deemed null and void, to the extent permitted by law and deemed advisable by the Appropriate Administrator. ARTICLE 22. GOVERNING LAW. To the extent not preempted by Federal law, the Plan and all agreements hereunder, shall be construed in accordance with and governed by the laws of the Commonwealth of Pennsylvania. 46 EX-10.25 4 j9134701ex10-25.txt 1998 EMPLOYEE INCENTIVE PLAN EXHIBIT 10.25 TOLLGRADE COMMUNICATIONS, INC. 1998 EMPLOYEE INCENTIVE COMPENSATION PLAN (AS AMENDED THROUGH MAY 3, 2001) ARTICLE 1. ESTABLISHMENT, OBJECTIVES AND DURATION. 1.1 ESTABLISHMENT OF THE PLAN. Tollgrade Communications, Inc., a Pennsylvania corporation (hereinafter referred to as the "Company"), hereby establishes an incentive compensation plan for all employees excluding officers and directors of the Company, to be known as the "Tollgrade Communications, Inc. 1998 Employee Incentive Compensation Plan" (hereinafter referred to as the "Plan"), as set forth in this document. The Plan permits the grant of Nonqualified Stock Options, Stock Appreciation Rights, Restricted Stock, Performance Shares and Performance Units. The Plan shall be effective as of January 29, 1998 (the "Effective Date") and shall remain in effect as provided in SECTION 1.3 hereof. 1.2 OBJECTIVES OF THE PLAN. The objectives of the Plan are to optimize the profitability and growth of the Company through incentives which are consistent with the Company's goals and which link the personal interests of Employees to those of the Company's stockholders; to provide Employees with an incentive for excellence in individual performance; and to promote teamwork among Employees. The Plan is further intended to provide flexibility to the Company in its ability to motivate, attract, and retain the services of Employees who make significant contributions to the Company's success and allow Employees to share in the success of the Company. 1.3 DURATION OF THE PLAN. The Plan was adopted by the Board of Directors on January 29, 1998, and shall commence on the Effective Date, as described in SECTION 1.1 hereof, and shall remain in effect, subject to the right of the Board of Directors to amend or terminate the Plan at any time pursuant to ARTICLE 14 hereof, until all Shares subject to it shall have been purchased or acquired according to the Plan's provisions. However, in no event shall an Award be granted under the Plan on or after January 29, 2008. ARTICLE 2. DEFINITIONS Whenever used in the Plan, the following terms shall have the meanings set forth below, and when the meaning is intended, the initial letter of the word shall be capitalized: 2.1 "AWARD" means, individually or collectively, a grant under this Plan of Nonqualified Stock Options, Stock Appreciation Rights, Restricted Stock, Performance Shares or Performance Units. 2.2 "AWARD AGREEMENT" means an agreement entered into by the Company and each Employee setting forth the terms and provisions applicable to Awards granted under this Plan. 2.3 "BENEFICIAL OWNER" OR "BENEFICIAL OWNERSHIP" shall have the meaning ascribed to such term in Rule 13d-3 of the General Rules and Regulations under the Exchange Act. 2.4 "BOARD" OR "BOARD OF DIRECTORS" means the Board of Directors of the Company. 2.5 "CAUSE" shall mean with respect to the termination of an Employee's employment, unless otherwise determined by the Committee at the time of the grant of the Award (i) in the case where there is no employment agreement, change of control agreement or similar agreement in effect between the Employee and the Company at the time of the grant of the Award (or where there is such an agreement but it does not define "cause" or words of like import), termination due to an Employee's dishonesty, fraud, conviction of a felony, insubordination, willful misconduct, refusal to perform services, or unsatisfactory 46 performance of his or her duties for the Company as determined by the Committee in its sole discretion; or (ii) in the case where there is an employment agreement, change in control agreement or similar agreement in effect between the Employee and the Company at the time of the grant of the Award that defines "cause" (or words of like import), as defined under such agreement. 2.6 "CHANGE IN CONTROL" of the Company shall be deemed to have occurred (as of a particular day, as specified by the Board) if the Board, by a majority vote, agrees that a Change in Control has occurred, or is about to occur. Such a change shall not include, however, a restructuring, reorganization, merger or other change in capitalization in which the Persons who own an interest in the Company on the Effective Date (the "Current Owners") (or any individual or entity which received from a Current Owner an interest in the Company through will or the laws of descent and distribution) maintain more than a fifty percent (50%) interest in the resultant entity. Regardless of the Board's vote, a Change in Control will be deemed to have occurred as of the first day any one (1) or more of the following paragraphs shall have been satisfied: (a) Any Person (other than the Person in control of the Company as of the Effective Date of the Plan, or other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company, or a corporation owned directly or indirectly by the stockholders of the Company in substantially the same proportions as their ownership of stock in the Company), becomes the Beneficial Owner, directly or indirectly, of securities of the Company representing more than fifty percent (50%) of the combined voting power of the Company's then outstanding securities; or (b) The stockholders of the Company approve: (i) A plan of complete liquidation of the Company; or (ii) An agreement for the sale or disposition of all or substantially all of the Company's assets (other than one in which the stockholders of the Company, as determined immediately prior to such transaction, hold, directly or indirectly, as determined immediately following such transaction, a majority of the voting power of each surviving, resulting or acquiring corporation which, immediately following such transaction, holds more than 10% of the consolidated assets of the Company immediately prior to the transaction); or (iii) A merger, consolidation, or reorganization of the Company with or involving any other corporation, other than a merger, consolidation, or reorganization that would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least fifty percent (50%) of the combined voting power of the voting securities of the Company (or such surviving entity) outstanding immediately after such merger, consolidation or reorganization. However, in no event shall a Change in Control be deemed to have occurred, with respect to a Employee, if that Employee is part of a purchasing group which consummates the Change in Control transaction. The Employee shall be deemed "part of a purchasing group" for purposes of the preceding sentence if the Employee is an equity participant or has agreed to become an equity participant in the purchasing company or group (except for (i) passive ownership of less than five percent (5%) of the voting equity securities of the purchasing company; or (ii) ownership of equity participation in the purchasing company or group which is otherwise deemed not to be significant, as determined prior to the Change in Control by a majority of the nonemployee continuing Directors). 2.7 "CODE" means the Internal Revenue Code of 1986, as amended from time to time. 2.8 "COMMITTEE" means the Compensation Committee of the Board, as specified in ARTICLE 3 herein, or such other Committee appointed by the Board to administer the Plan with respect to grants of Awards. 47 2.9 "COMPANY" means Tollgrade Communications, Inc., a Pennsylvania corporation, any successor thereto as provided in ARTICLE 17 herein. 2.10 "DIRECTOR" means any individual who is a member of the Board of Directors of the Company. 2.11 "EFFECTIVE DATE" shall have the meaning ascribed to such term in SECTION 1.1 hereof. 2.12 "EMPLOYEE" means any full-time active employee of the Company who is not an Officer, as defined in SECTION 2.18 hereof. Directors shall not be considered employees under the Plan. 2.13 "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended from time to time, or any successor act thereto. 2.14 "FAIR MARKET VALUE" shall be the mean between the following prices, as applicable, for the date as of which fair market value is to be determined as quoted in The Wall Street Journal (or in such other reliable publication as the Committee, in its discretion, may determine to rely upon): (i) if the Common Stock is listed on the New York Stock Exchange, the highest and lowest sales prices per share of the Common Stock as quoted in the NYSE Composite Transactions listing for such date, (ii) if the Common Stock is not listed on such exchange, the highest and lowest sales prices per share of Common Stock for such date on (or on any composite index including) the principal united States securities exchange registered under the 1934 Act on which the Common Stock is listed or (iii) if the Common Stock is not listed on such exchange, the highest and lowest sales prices per share of the Common Stock for such date on the National Association of Securities Dealers Automated Quotations System or any successor system then in use ("NASDAQ"). If there are no such sale price quotations for the date as of which fair market value is to be determined but there are such sale price quotations within a reasonable period both before and after such date, then fair market value shall be determined by taking a weighted average of the means between the highest and lowest sales prices per share of the Common Stock as so quoted on the nearest date before and the nearest date after the date as of which fair market value is to be determined. The average should be weighted inversely by the respective number of trading days between the selling dates and the date as of which fair market value is to be determined. If there are no such sale prices quotations on or within a reasonable period both before and after the date as of which fair market value is to be determined, then fair market value of the Common Stock shall be the mean between the bona fide bid and asked prices per share of Common Stock as so quoted for such date on NASDAQ, or if none, the weighted average of the means between such bona fide bid and asked prices on the nearest trading date before and the nearest trading date after the date as of which fair market value is to be determined, if both such dates are within a reasonable period. The average is to be determined in the manner described above in this SECTION 2.14. If the fair market value of the Common Stock cannot be determined on any basis previously set forth in this SECTION 214 for the date as of which fair market value is to be determined, the Committee shall in good faith determine the fair market value of the Common Stock on such date. Fair market value shall be determined without regard to any restriction other than a restriction which, by its terms, will never lapse. 2.15 "FREESTANDING SAR" means an SAR that is granted independently of any Options, as described in ARTICLE 7 herein. 2.16 "INSIDER" shall mean an individual who, immediately prior to the grant of any Award, owns stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock for the Company. For purposes of this SECTION 2.16, an individual (i) shall be considered as owning not only Shares of Stock owned individually but also all Shares of stock that are at the time owned, directly or indirectly, by or for the spouse, ancestors, lineal descendants and bothers and sisters (whether by whole or half blood) of such individual and (ii) shall be considered as owning proportionately any Shares owned, directly or indirectly, by or for any corporation, partnership, estate or trust in which such individual is a stockholder, partner or beneficiary. 2.17 "NONQUALIFIED STOCK OPTION" OR "NQSO" means an option to purchase Shares granted under ARTICLE 6 herein and which is not intended to meet the requirements of Code Section 422. 48 2.18 "OFFICER" means any person serving as an officer on behalf of the Company, as defined in the Company's bylaws and by requirements of Pennsylvania corporate law, and by the requirements of the rules of the National Association of Securities Dealers, Inc. 2.19 "OPTION" means a Nonqualifed Stock Option, as described in ARTICLE 6 herein. 2.20 "OPTION PRICE" means the price at which a Share may be purchased by a Employee pursuant to an Option. 2.21 "PERFORMANCE-BASED EXCEPTION" means the performance-based exception from the tax deductibility limitations of Code Section 162(m). 2.22 "PERFORMANCE SHARE" means an Award granted to an Employee, as described in ARTICLE 9 herein. 2.23 "PERFORMANCE UNIT" means an award granted to an Employee, as described in ARTICLE 9 herein. 2.24 "PERIOD OF RESTRICTION" means the period during which the transfer of Shares of Restricted Stock is limited in some way (based upon the passage of time, the achievement of performance goals, or upon the occurrence of other events as determined by the Committee, at its discretion), and the Shares are subject to a substantial risk of forfeiture, as provided in ARTICLE 8 herein. 2.25 "PERSON" shall have the meaning ascribed to such term in Section 3(a)(9) of the Exchange Act and used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) thereof. 2.26 "RESTRICTED STOCK" means an award granted to an Employee pursuant to ARTICLE 8 herein. 2.27 "RETIREMENT" shall mean any voluntary termination of employment by an Employee following the attainment of age 65. 2.28 "SHARES" means the shares of Common Stock of the Company. 2.29 "STOCK APPRECIATION RIGHT" OR "SAR" means an Award, granted alone or in connection with a related Option, designated as an SAR, pursuant to the terms of ARTICLE 7 herein. 2.30 "TANDEM SAR" means an SAR that is granted in connection with a related Option pursuant to ARTICLE 7 herein, the exercise of which shall require forfeiture of the right to purchase a Share under the related Option (and when a Share is purchased under the Option, the Tandem SAR shall similarly be canceled). ARTICLE 3. ADMINISTRATION 3.1 THE COMMITTEE. Except as set forth in SECTION 3.5 below, the Plan shall be administered by the Compensation Committee of the Board, or by any other Committee appointed by the Board consisting of not less than two (2) Directors who (i) are "non-employee" directors and otherwise meet the "disinterested administration" rules of Rule 16b-3 under the Exchange Act and (ii) are "outside directors" under Section 162(m)(4)(C) of the Code, or any successor provision. The members of the Committee shall be appointed from time to time by, and shall serve at the discretion of, the Board of Directors. 3.2 AUTHORITY OF THE COMMITTEE. Except as set forth in SECTION 3.4 below, except as limited by law or by the Articles of Incorporation or Bylaws of the Company, and subject to the provisions herein, the Committee shall have full power to grant Options (with or without SARs) and to award Restricted Stock, Performance Shares and Performance Units as described herein and to determine the Employees to whom any such award shall be made and the number of Shares to be covered thereby; determine the sizes and types of Awards; determine terms and conditions of Awards in a manner consistent with the Plan; construe and interpret the Plan and any agreement or instrument entered into under the Plan as they apply to Employees; and (subject to the provisions of ARTICLE 14 herein) amend the terms and conditions of any outstanding Award to the extent such terms and conditions are within the discretion of the Committee as provided in the Plan. Further, the Committee shall make all other determinations which may be necessary 49 or advisable for the administration of the Plan, as the Plan applies to Employees. As permitted by law the Committee may delegate its authority as identified herein. 3.3 DECISIONS BINDING. All determinations and decisions made by the Committee pursuant to the provisions of the Plan and all related orders and resolutions of the Board shall be final, conclusive and binding on all persons, including the Company, its stockholders, Employees, and their estates and beneficiaries. 3.4 NON-COMPETITION. If a grantee of an Option, Restricted Stock, Performance Units or Performance Shares (i) engages in the operation or management of a business (whether as owner, partner, officer, director, employee or otherwise and whether during or after employment) which is in competition with the Company, (ii) induces or attempts to induce any customer, supplier, licensee or other individual, corporation or other business organization having a business relationship with the Company to cease doing business with the Company or any in any way interferes with the relationship between any such customer, supplier, licensee or other person and the Company or (iii) solicits any employee of the Company to leave the employment thereof or in any way interferes with the relationship of such employee with the Company, the Committee, in its discretion, may immediately terminate all outstanding Options held by the grantee, declare forfeited all Restricted Stock held by the grantee as to which the restrictions have not yet lapsed and/or immediately cancel any award of Performance Units or Performance Shares. Whether a grantee has engaged in any of the activities referred to in the preceding sentence which would cause the outstanding Options to be terminated, and/or the Restricted Stock to be forfeited and/or any award of Performance Units or Performance Shares to be canceled shall be determined, in its discretion, by the Committee, and any such determination by the Committee shall be final and binding. ARTICLE 4. SHARES SUBJECT TO THE PLAN 4.1 NUMBER OF SHARES AVAILABLE FOR GRANTS. Subject to adjustment as provided in SECTION 4.3 herein, the number of Shares hereby reserved for issuance to Employees under the Plan shall be 940,000; provided that, of that total, the maximum number of Shares of Restricted Stock granted pursuant to ARTICLE 8 herein, shall be 50,000. 4.2 LAPSED AWARDS. If any Award granted under this Plan is canceled, terminates, expires or lapses for any reason (with the exception of termination of a Tandem SAR upon exercise of the related Option, or the termination of a related Option upon exercise of the corresponding Tandem SAR), any Shares subject to such Award shall again be available for the grant of an Award under the Plan. 4.3 ADJUSTMENTS IN AUTHORIZED SHARES. In the event of any change in corporate capitalization, such as a stock split, or a corporate transaction, such as any merger, consolidation, separation, including a spin-off, or other distribution of stock or property of the Company, any reorganization (whether or nor such reorganization comes within the definition of such term in Code Section 368) or any partial or complete liquidation of the Company, such adjustment shall be made in the number and class of Shares which may be delivered under SECTION 4.1 and in the number and class of and/or price of Shares subject to outstanding Awards granted under the Plan, and in the number and class of and/or price of Shares subject to outstanding Awards granted under the Plan, as may be determined to be appropriate and equitable by the Committee, in its sole discretion, to prevent dilution or enlargement of rights; provided, however, that the number of Shares subject to any Award shall always be a whole number. ARTICLE 5. ELIGIBILITY AND PARTICIPATION 5.1 ELIGIBILITY. Persons eligible to participate in this Plan shall include all Employees of the Company, excluding Officers and Directors. 5.2 ACTUAL PARTICIPATION. Subject to the provisions of the Plan, the Committee may, from time to time, select from all eligible Employees those to whom Awards shall be granted and shall determine the nature and amount of each Award. ARTICLE 6. STOCK OPTIONS 50 6.1 GRANT OF OPTIONS. Subject to the terms and provisions of the Plan, the Committee may grant Nonqualified Stock Options in such number, and upon such terms, and at any time and from time to time as shall be determined by the Committee. 6.2 AWARD AGREEMENT. Each Option shall be evidenced by an Award Agreement that shall specify the Option Price, the duration of the Option, the number of Shares to which the Option pertains, and such other provisions as the Committee shall determine. 6.3 OPTION PRICE. The Option Price at which each Option may be exercised shall be no less than one hundred percent (100%) of the fair market value per share of the Common Stock covered by the Option on the date of grant. For purposes of this SECTION 6.3, the fair market value of the Common Stock shall be as determined in SECTION 2.15. 6.4 DURATION OF OPTIONS. Each Option granted to an Employee shall expire at such time as the Committee shall determine at the time of grant; provided, however, that no Option shall be exercisable after the expiration of ten years from the date of grant. 6.5 EXERCISE OF OPTIONS. Options granted under this Article 6 shall be exercisable at such times and be subject to such restrictions and conditions as the Committee shall in each instance approve, which need not be the same for each grant or for each Employee. 6.6 PAYMENT. Options granted under this Article 6 shall be exercised by the delivery of a written notice of exercise to the Company, setting forth the number of Shares with respect to which the Option is to be exercised, accompanied by full payment for the Shares. The Option Price upon exercise of the Option shall be payable to the Company in full either: (a) in cash in United States Dollars (including check, bank draft or money order), or (b) by tendering previously acquired Shares having an aggregate Fair Market Value at the time of exercise equal to the total Option Price, or (c) by a combination of (a) and (b). The Company will also cooperate with any person exercising an Option who participates in a cashless exercise program of a broker or other agent under which all or part of the Shares received upon exercise of the Option are sold through the broker or other agent or under which the broker or other agent makes a loan to such person. Notwithstanding the foregoing, unless the Committee, in its discretion, shall otherwise determine at the time of grant the exercise of the Option shall not be deemed to occur and no Shares of Common Stock will be issued by the Company upon exercise of the Option until the Company has received payment of the Option Price in full. 6.7 RESTRICTIONS ON SHARE TRANSFERABILITY. The Committee may impose restrictions on any Shares acquired pursuant to the exercise of an Option granted under this ARTICLE 6 as it may deem advisable, including, without limitation, restrictions under applicable Federal securities laws, under the requirements of any stock exchange or market upon which such Shares are then listed and/or traded, and under any blue sky or other state securities laws applicable to such Shares. 6.8 TERMINATION OF EMPLOYMENT. Unless the Committee, in its discretion, shall otherwise determine: (i) If the employment of an Employee who is not disabled within the meaning of Section 422(c)(6) of the Code (a "Disabled Grantee") is voluntarily terminated with the consent of the Company or an Employee retires under any retirement plan of the Company, any Option held by such Employee shall be exercisable by the Employee (but only to the extent exercisable by the Employee immediately prior to the termination of employment) at any time prior to the expiration date of such Option or within one year after the date of termination, whichever is the shorter period; (ii) If the employment of an Employee who is a Disabled Grantee is voluntarily terminated with the consent of the Company, any outstanding Option held by such Employee shall be exercisable by the Employee in full (whether or not so exercisable by the Employee immediately prior to the termination of employment) at 51 any time prior to the expiration date of such Option or within one year after the date of termination of employment, whichever is the shorter period; (iii) Following the death of an Employee during employment, any outstanding Option held by the Employee at the time of death shall be exercisable in full (whether or not so exercisable by the Employee immediately prior to the death of the Employee) by the person entitled to do so under the Will of the Employee, or, if the Employee shall fail to make testamentary disposition of the stock option or shall die intestate, by the legal representative of the Employee at any time prior to the expiration date of such stock option or within one year after the date of death of the Employee, whichever is the shorter period; (iv) Following the death of an Employee after termination of employment during the period when an Option is exercisable, the Option shall be exercisable by such person entitled to do so under the Will of the Employee by such legal representative (but only to the extent exercisable by the Employee immediately prior to the termination of employment) at any time prior to the expiration date of such Option or within one year after the date of death, whichever is the shorter period; (v) Unless the exercise period of a stock option following termination of employment has been extended as provided in SECTION 13.1, if the employment of an Employee terminates for any reason other than voluntary termination with the consent of the Company, retirement under any retirement plan of the Company or death, all outstanding Options held by the Employee at the time of such termination of employment shall automatically terminate ; provided, however, that if the employment of an Employee is involuntarily terminated by the Company without Cause, any Option held by such Employee at the time of such termination that was granted to Employee on or after May 3, 2001, shall be exercisable by the Employee (but only to the extent exercisable by the Employee immediately prior to the termination of employment) at any time prior to the expiration date of such Option or within one year after the date of termination of employment, whichever is the shorter period. Whether termination of employment is a voluntary termination with the consent of the Company or an involuntary termination with or without cause shall be determined, in its discretion, by the Committee and any such determination by the Committee shall be final and binding. 6.9 NONTRANSFERABILITY OF OPTIONS. No Option granted under the Plan may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by Will or if the Employee dies intestate by the laws of descent and distribution of the state of domicile of the Employee at the time of death. Further, all Options granted to an Employee under the Plan shall be exercisable during his or her lifetime only by the Employee. ARTICLE 7. STOCK APPRECIATION RIGHTS 7.1 GRANT OF SARS. Subject to the terms and conditions of the Plan, SARs may be granted to Employees at any time and from time to time as shall be determined by the Committee. The Committee may grant Freestanding SARs, Tandem SARs, or any combination of these forms of SARs. The Committee shall have complete discretion in determining the number of SARs granted to each Employee (subject to ARTICLE 4 herein) and, consistent with the provisions of the Plan, in determining the terms and conditions pertaining to such SARs. The grant price of a Freestanding SAR shall equal the Fair Market Value of a Share on the date of grant of the SAR. The grant price of Tandem SARs shall equal the Option Price of the related Option, as provided in SECTION 6.3. 7.2 EXERCISE OF TANDEM SARS. Tandem SARs may be exercised for all or part of the Shares subject to the related Option upon the surrender of the right to exercise the equivalent portion of the related Option. A 52 Tandem SAR may be exercised only with respect to the Shares for which its related Option is then exercisable. 7.3 EXERCISE OF FREESTANDING SARS. Freestanding SARs may be exercised upon whatever terms the Committee, in its sole discretion, imposes upon them. 7.4 SAR AGREEMENT. Each SAR grant shall be evidenced by an Award Agreement that shall specify the grant price, the term of the SAR, and such other provisions as the Committee shall determine. 7.5 TERM OF SARS. The term of an SAR granted under the Plan shall be determined by the Committee, in its sole discretion; provided however, that such term shall not exceed ten (10) years. 7.6 PAYMENT OF SAR AMOUNT. Upon exercise of an SAR, an Employee shall be entitled to receive payment from the Company in an amount determined by multiplying: (a) the difference between the Fair Market Value of a Share on the date of exercise over the grant price; by (b) the number of Shares with respect to which the SAR is granted. At the discretion of the Committee, the payment upon SAR exercise may be in cash, in Shares of equivalent value, or in some combination thereof. 7.7 RULE 16B-3 REQUIREMENTS. Notwithstanding any other provision of the Plan, the Committee may impose such conditions on the exercise of an SAR as may be required to satisfy the requirements of Section 16 of the Exchange Act (or any successor rule). 7.8 TERMINATION OF EMPLOYMENT. Each SAR Award Agreement shall set forth the extent to which the Employee shall have the right to exercise the SAR following termination of the Employee's employment with the Company and/or its Subsidiaries. Such provisions shall be determined in the sole discretion of the Committee, shall be included in the Award Agreement entered into with Employees, need not be uniform among all SARs issued pursuant to the Plan, and may reflect distinctions based on the reasons for termination of such employment. 7.9 NONTRANSFERABILITY OF SARS. No SAR granted under the Plan may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will or, if the grantee dies intestate, by the laws of descent and distribution of the state of domicile of the grantee at the time of death. Further, all SARs granted to an Employee under the Plan shall be exercisable during his or her lifetime only by such Employee. ARTICLE 8. RESTRICTED STOCK 8.1 GRANT OF RESTRICTED STOCK. Subject to the terms and provisions of the Plan, the Committee, at any time and from time to time, may grant Shares of Restricted Stock to Employees in such amounts as the Committee shall determine. 8.2 RESTRICTED STOCK AGREEMENT. Each Restricted Stock grant shall be evidenced by a Restricted Stock Award Agreement that shall specify the Period(s) of Restriction, the number of Shares of Restricted Stock granted, and such other provisions as the Committee shall determine. 8.3 TRANSFERABILITY. Except as provided in this ARTICLE 8, the Shares of Restricted Stock granted herein may not be sold, transferred, pledged, assigned or otherwise alienated or hypothecated until the end of the applicable Period of Restriction established by the Committee and specified in the Restricted Stock Award Agreement, or upon earlier satisfaction of any other conditions, as specified by the Committee in its sole discretion and set forth in the Restricted Stock Award Agreement. All rights with respect to the Restricted Stock granted to an Employee under the Plan shall be available during his or her lifetime only to such Employee. 53 8.4 OTHER RESTRICTIONS. Subject to ARTICLE 10 herein, the Committee shall impose such other conditions and/or restrictions on any Shares of Restricted Stock granted pursuant to the Plan as it may deem advisable including, without limitation, a requirement that Employees pay a stipulated purchase price for each Share of Restricted Stock, restrictions based upon the achievement of specific performance goals (Company-wide, divisional, and/or individual), time-based restrictions on vesting following the attainment of the performance goals, and/or restrictions under applicable Federal or state securities laws. The Company shall retain the certificates representing Shares of Restricted Stock in the Company's possession until such time as all conditions and/or restrictions applicable to such Shares have been satisfied. Except as otherwise provided in this ARTICLE 8, Shares of Restricted Stock covered by each Restricted Stock grant made under the Plan shall become freely transferable by the Employee after the last day of the applicable Period of Restriction. 8.5 VOTING RIGHTS. During the Period of Restriction, Employees holding Shares of Restricted Stock granted hereunder may exercise full voting rights with respect to those Shares. 8.6 DIVIDENDS AND OTHER DISTRIBUTIONS. During the Period of Restriction, Employees holding Shares of Restricted Stock granted hereunder may be credited with regular cash dividends paid with respect to the underlying Shares while they are so held. The Committee may apply any restrictions to the dividends that the Committee deems appropriate. In the event that any dividend constitutes a "derivative security" or an "equity security" pursuant to Rule 16(a) under the Exchange Act, such dividend shall be subject to a vesting period equal to the remaining vesting period of the Shares of Restricted Stock with respect to which the dividend is paid. 8.7 TERMINATION OF EMPLOYMENT. Each Restricted Stock Award Agreement shall set forth the extent to which the Employee shall have the right to receive unvested Restricted Shares following termination of the Employee's employment with the Company. Such provisions shall be determined in the sole discretion of the Committee, shall be included in the Award Agreement entered into with each Employee, need not be uniform among all Shares of Restricted Stock issued pursuant to the Plan, and may reflect distinctions based upon the reasons for termination of such employment. ARTICLE 9. PERFORMANCE UNITS AND PERFORMANCE SHARES 9.1 GRANT OF PERFORMANCE UNITS/SHARES. Subject to the terms of the Plan, Performance Units and/or Performance Shares may be granted to Employees in such amounts and upon such terms, and at any time and from time to time, as shall be determined by the Committee. 9.2 VALUE OF PERFORMANCE UNITS/SHARES. Each Performance Unit shall have an initial value that is established by the Committee at the time of grant. Each Performance Share shall have an initial value equal to the Fair Market Value of a Share on the date of grant. The Committee shall set performance goals in its discretion which, depending upon the extent to which they are met, will determine the number and/or value of Performance Units/Shares that will be paid out to the Employee. For purposes of this ARTICLE 9, the time period during which the performance goals must be met shall be called a "Performance Period." 9.3 EARNING OF PERFORMANCE UNITS/SHARES. Subject to the terms of this Plan, after the applicable Performance Period has ended, the holder of Performance Units/Shares shall be entitled to receive payout on the number and value of Performance Units/Shares earned by the Employee over the Performance Period, to be determined as a function of the extent to which the corresponding performance goals have been achieved. 9.4 FORM AND TIMING OF PERFORMANCE UNITS/SHARES. Payment of earned Performance Units/Shares shall be made in a single lump sum within seventy-five (75) calendar days following the close of the applicable Performance Period. Subject to the terms of this Plan, the Committee, in its sole discretion, may pay earned Performance Units/Shares in the form of cash or Shares (or a combination thereof) which have an aggregate Fair Market Value equal to the value of the earned Performance Units/Shares at the close of the applicable Performance Period. Such Shares may be granted subject to any restrictions deemed appropriate by the Committee. 54 At the discretion of the Committee, Employees may be entitled to receive any dividends declared with respect to Shares which have been earned in connection with grants of Performance Units and/or Performance Shares which have been earned, but not yet distributed to Employees (such dividends shall be subject to the same accrual, forfeiture, and payout restrictions as apply to dividends earned with respect to Shares of Restricted Stock, as set forth in SECTION 8.6 herein). In addition, Employees may, at the discretion of the Committee, be entitled to exercise their voting rights with respect to such Shares. 9.5 TERMINATION OF EMPLOYMENT DUE TO DEATH, DISABILITY OR RETIREMENT. Unless otherwise determined by the Committee and set forth in the Employee's Award Agreement, in the event the employment of an Employee is terminated by reason of death, disability or Retirement during a Performance Period, the Employee shall receive a payout of the Performance Units/Shares which is prorated, as specified by the Committee in its discretion. Payment of earned Performance Units/Shares shall be made at a time specified by the Committee in its sole discretion and set forth in the Employee's Award Agreement. 9.6 TERMINATION OF EMPLOYMENT FOR OTHER REASONS. In the event that an Employee's employment terminates for any reason other than those reasons set forth in SECTION 9.5 herein, all Performance Units/Shares shall be forfeited by the Employee to the Company unless determined otherwise by the Committee, as set forth in the Employee's Award Agreement. 9.7 NONTRANSFERABILITY. Performance Units/Shares may not be sold, transferred, pledged, assigned or otherwise alienated or hypothecated, other than by will or if the grantee dies intestate by the laws of descent and distribution of the state of domicile of the grantee at the time of death. Further, an Employee's rights under the Plan shall be exercisable during the Employee's lifetime only by the Employee or the Employee's legal representative. ARTICLE 10. BENEFICIARY DESIGNATION Each Employee under the Plan may, from time to time, name any beneficiary or beneficiaries (who may be named contingently or successively) to whom any benefit under the Plan is to be paid in case of his or her death before he or she receives any or all of such benefit. Each such designation shall revoke all prior designations by the same Employee, shall be in a form prescribed by the Company, and will be effective only when filed by the Employee in writing with the Company during the Employee's lifetime. In the absence of any such designation, benefits remaining unpaid at the Employee's death shall be paid to the Employee's estate. ARTICLE 11. DEFERRALS The Committee may permit or require an Employee to defer such Employee's receipt of the payment of cash or the delivery of Shares that would otherwise be due to such Employee by virtue of the exercise of an Option or SAR, the lapse or waiver of restrictions with respect to Restricted Stock, or the satisfaction of any requirements or goals with respect to Performance Units/Shares. If any such deferral election is required or permitted, the Committee shall, in its sole discretion, establish rules and procedures for such payment deferrals. ARTICLE 12. RIGHTS OF EMPLOYEES 12.1 EMPLOYMENT. Nothing in the Plan shall interfere with or limit in any way the right of the Company to terminate any Employee's employment at any time, nor confer upon any Employee any right to continue in the employ of the Company. 12.2 PARTICIPATION. No Employee shall be entitled to have the right to be selected to receive an Award under this Plan, or having been so selected, to be selected to receive a future Award. ARTICLE 13. CHANGE IN CONTROL 55 13.1 TREATMENT OF OUTSTANDING AWARDS. Upon the occurrence of a Change in Control, unless otherwise specifically prohibited under applicable laws, or by the rules and regulations of any governing governmental agencies or national securities exchanges: (a) Any and all Options and SARs granted hereunder shall become immediately exercisable, and shall remain exercisable throughout their entire term; (b) Any restriction periods and restrictions imposed on Restricted Shares shall lapse; (c) The target payout opportunities attainable under all outstanding Awards of Restricted Stock, Performance Units and Performance Shares shall be deemed to have been fully earned for the entire Performance Period(s) as of the effective date of the Change in Control. The vesting of all Awards denominated in Shares shall be accelerated as of the effective date of the Change in Control, and there shall be paid out in cash to Employees within thirty (30) days following the effective date of the Change in Control an amount equal to one hundred percent (100%) of all targeted cash payout opportunities associated with outstanding cash-based Awards; and (d) Subject to ARTICLE 14 herein, the Committee shall have the authority to make any modifications to the Awards as determined by the Committee to be appropriate before the effective date of the Change in Control. 13.2 ACCELERATION OF AWARD VESTING. Notwithstanding any provision of this Plan or any Award Agreement provision to the contrary, the Committee, in its sole and exclusive discretion, shall have the power at any time to accelerate the vesting of any Award granted under the Plan to any Employee, including without limitation acceleration to such a date that would result in said Awards becoming immediately vested. 13.3 TERMINATION, AMENDMENT AND MODIFICATIONS OF CHANGE IN CONTROL PROVISIONS. Notwithstanding any other provision of this Plan or any Award Agreement provision, the provisions of this ARTICLE 13 may not be terminated, amended or modified on or after the date of a Change in Control to affect adversely any Award theretofore granted under the plan without the prior written consent of the Employee with respect to said Employee's outstanding Awards; provided, however, the Board of Directors, upon recommendation of the committee, may terminate, amend, or modify this ARTICLE 13 at any time and from time to time prior to the date of a Change in Control. ARTICLE 14. AMENDMENT, MODIFICATION AND TERMINATION 14.1 AMENDMENT, MODIFICATION AND TERMINATION. The Board may at any time and from time to time, alter, amend, suspend, or terminate the Plan in whole or in part. 14.2 ADJUSTMENT OF AWARDS UPON THE OCCURRENCE OF CERTAIN UNUSUAL OR NONRECURRING EVENTS. The Committee may make adjustments in the terms and conditions of, and the criteria included in, Awards in recognition of unusual or nonrecurring events (including, without limitation, the events described in SECTION 4.3 hereof) affecting the Company or the financial statements of the Company or of changes in applicable laws, regulations, or accounting principles, whenever the Committee determined that such adjustments are appropriate in order to prevent dilution or enlargement of the benefits or potential benefits intended to be made available under the Plan; provided that no such adjustment shall be authorized to the extent that such authority would be inconsistent with the Plan's meeting the requirements of Section 162(m) of the Code, as from time to time amended. 14.3 AWARDS PREVIOUSLY GRANTED. No termination, amendment, or modification of the Plan shall adversely affect in any material way any Award previously granted under the Plan, without the written consent of the Employee holding such Award. 14.4 COMPLIANCE WITH CODE 162(M). At all times when Code Section 162(m) is applicable, all Awards granted under this Plan shall comply with the requirements of Code Section 162(m); provided, however, that in the event the Committee determines that such compliance is not desired with respect to any Award or Awards available for grant under the Plan, then compliance with Code Section 162(m) will not be required. In addition, in the event that any changes are made to Code Section 162(m) to permit greater 56 flexibility with respect to any Award or Awards available under the Plan, the Committee may, subject to this ARTICLE 14, make any adjustments it deems appropriate. ARTICLE 15. WITHHOLDING 15.1 TAX WITHHOLDING. The Company shall have the power and the right to deduct or withhold, or require any Employee to remit to the Company, an amount sufficient to satisfy Federal, state and local taxes, domestic or foreign, required by law or regulation to be withheld with respect to any taxable event arising as a result of this Plan. 57 15.2 SHARE WITHHOLDING. With respect to withholding required upon the exercise of Options or SARs, upon the lapse of restrictions on Restricted Stock, or upon any other taxable event arising as a result of Awards granted hereunder, Employees may elect, subject to the approval of the Committee, to satisfy the withholding requirement, in whole or in part, by having the Company withhold Shares having a Fair Market Value on the date the tax is to be determined equal to the minimum statutory total tax which could be imposed on the action. All such elections shall be irrevocable, made in writing, signed by the Employee, and shall be subject to any restrictions or limitations that the Committee, in its sole discretion, may determine. ARTICLE 16. INDEMNIFICATION Each person who is or shall have been a member of the Committee, or of the Board, shall be indemnified and held harmless by the Company against and from any loss, cost, liability or expense that may be imposed upon or reasonably incurred by him or her in connection with or resulting from any claim, action, suit or proceeding to which he or she may be a party or in which he or she may be involved by reason of any action taken or failure to act under the Plan and against and from any and all amounts paid by him or her in settlement thereof, with the Company's approval, or paid by him or her in satisfaction of any judgment in any such action, suit or proceeding against him or her, provided he or she shall give the Company an opportunity at its own expense, to handle and defend the same before he or she undertakes to handle and defend it on his or her own behalf. The foregoing right of indemnification shall not be exclusive of any other right of indemnification to which such persons may be entitled under the Company's Articles of Incorporation or Bylaws, as a matter of law, or otherwise, or any power that the Company may have to indemnify them or hold them harmless. ARTICLE 17. SUCCESSOR All obligations of the Company under the Plan with respect to Awards granted hereunder shall be binding upon any successor to the Company, whether the existence of such successor is the result of a direct or indirect purchase, merger, consolidation, or otherwise, of all or substantially all of the business and/or assets of the Company. ARTICLE 18. LEGAL CONSTRUCTION 18.1 GENDER AND NUMBER. Except where otherwise indicated by the context, any masculine term used herein shall also include the feminine; the plural shall include the singular and the singular shall include the plural. 18.2 SEVERABILITY. In the event any provision of the Plan shall be held illegal or invalid for any reason, the illegality or invalidity shall not affect the remaining parts of the Plan, and the Plan shall be construed and enforced as if the illegal or invalid provision had not been included. 18.3 REQUIREMENTS OF LAW. The granting of Awards and the issuance of Shares under the Plan shall be subject to all applicable laws, rules, and regulations, and to such approvals by governmental agencies or national securities exchanges as may be required. 18.4 SECURITIES LAW COMPLIANCE. With respect to (i) any person who is required to file reports pursuant to the rules promulgated under Section 16 of the Exchange Act and (ii) insiders, transactions under this Plan are intended to comply with all applicable conditions of Rule 16b-3 or its successors under the Exchange Act. To the extent any provision of the Plan or action by the Committee fails to so comply, it will be deemed null and void to the extent permitted by law and deemed advisable by the Committee. 58 18.5 GOVERNING LAW. To the extent not preempted by Federal law, the Plan and all agreements hereunder, shall be construed in accordance with and governed by the laws of the Commonwealth of Pennsylvania. 59 EX-15 5 j9134701ex15.txt LETTER RE UNAUDITED INTERIM FINANICAL INFORMATION EXHIBIT 15 November 12, 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 October 9, 2001, on our review of interim financial information of Tollgrade Communications, Inc. and subsidiaries as of and for the three- month and nine-month periods ended September 29, 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-----