-----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, DF26tDV0jeJ8Fkz2rm/vtGAckZhv11iAU6qQcdzW0MY75i+Pj0bRsH4kIyFIDrOG qW9EcvD+RvV5VbdYO5wv/w== 0000950128-02-000303.txt : 20020415 0000950128-02-000303.hdr.sgml : 20020415 ACCESSION NUMBER: 0000950128-02-000303 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020322 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-27312 FILM NUMBER: 02581896 BUSINESS ADDRESS: STREET 1: 493 NIXON RD CITY: CHESWICK STATE: PA ZIP: 15024 BUSINESS PHONE: 4122742156 10-K 1 j9338001e10-k.txt TOLLGRADE COMMUNICATIONS, INC. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001 COMMISSION FILE NUMBER 0-27312 TOLLGRADE COMMUNICATIONS, INC. (Exact name of registrant as specified in its charter) PENNSYLVANIA 25-1537134 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 493 NIXON ROAD, CHESWICK, PENNSYLVANIA 15024 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 412-820-1400 SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, PAR VALUE $.20 PER SHARE (Title of Class) Indicate by a 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 Registration was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ------ The Registrant estimates that as of March 8, 2002, the aggregate market value of shares of the Registrant's Common Stock held by non-affiliates (excluding for purposes of this calculation only, 118,279 shares of Common Stock held of record or beneficially by the executive officers and directors of the Registrant as a group) of the Registrant was $326,326,085. As of March 8, 2002, the Registrant had outstanding 13,547,336 shares of its Common Stock. DOCUMENTS INCORPORATED BY REFERENCE
Parts of Form 10-K into which Document Document is incorporated - -------- ------------------------ Portions of the Annual Report to Shareholders for the year ended December 31, 2001 II and IV Portions of the Proxy Statement to be distributed in connection with the 2002 Annual Meeting of Shareholders III
PART I CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. The statements contained in this Annual Report on Form 10-K, specifically those contained in Item 1 Business and Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operation, and statements incorporated by reference into this Form 10-K from the 2001 Annual Report to Shareholders, along with statements in other reports filed with the Securities and Exchange Commission, external documents and oral presentations, 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: general economic conditions and the economic conditions of the telecommunications industry; 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 of sales and marketing partners to meet their own performance objectives (and, in certain cases, continue to provide vendor financing to certain local exchange carriers); customer's 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 all markets for the Company's products; uncertain pace and scope of 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 and a small number of large customers; the Company's dependence on key employees and upon proprietary rights; difficulties in managing the Company's growth; the Company's dependence upon certain suppliers; risks of third party claims of infringement; risk of product defects; and changes in government regulation affecting the business of the Company and its customers. The Company does not undertake any obligation to publicly update any forward-looking statements. ITEM 1. BUSINESS. The Company was incorporated in Pennsylvania in 1986 and began operations in 1988. Its principal offices are located at 493 Nixon Road, Cheswick, Pennsylvania 15024 and its telephone number is (412) 820-1400. The Company designs, engineers, markets and supports test system, test access and status monitoring products for the telecommunications and cable television industries. The Company's telecommunications proprietary test access products enable telephone companies to use their existing line test systems to remotely diagnose problems in "Plain Old Telephone Service" ("POTS") lines containing both copper and fiber optics. POTS lines comprise the vast majority of lines in service today throughout the world. In addition to traditional voice service, POTS includes lines for popular devices such as computer modems and fax machines. POTS excludes the more complex lines, such as data communications service lines, commonly referred to as "special services." In general, POTS line test systems, which are located at telephone companies' central offices, focus on helping local exchange carriers conduct the full range of fault diagnosis in the "local loop", which is the portion of the telephone network which connects end users to a telephone company's central office. In addition, these line test systems have the ability to remotely qualify, deploy and maintain next generation services that include Digital Subscriber Line ("DSL") service and Integrated Services Digital Network ("ISDN") service. These test systems reduce the time needed to identify and resolve problems and eliminate or reduce the cost of dispatching a technician to the problem site. Most POTS line test systems were designed for use over copper wireline only, so that the introduction of fiber-optic technology into the local loop renders it inaccessible to these test systems. The Company's MCU(R) products solve this problem by extending test-system access 2 through the fiber-optic portion into the copper portion of the local loop. In addition, the Company's DigiTest(R) system is designed to provide complete hardware testing for POTS and local loop prequalification and in-service testing for DSL service. The Company's LIGHTHOUSE(R) cable status monitoring system provides a broad testing solution for the Broadband Hybrid Fiber Coax distribution system found in the cable television industry. This status monitoring system gathers status information and reports on strategic components within the cable network. On September 30, 2001, the Company acquired certain assets and assumed certain liabilities of the LoopCare(TM) product line from Lucent Technologies, Inc. ("Lucent") for approximately $62,000,000 in cash. The assets consisted principally of rights to existing contracts, software and related computer equipment, while the liabilities were related principally to deferred revenues and warranties currently under contract. The LoopCare product software integrates with and enhances the value of the Company's hardware products, resulting in what the Company believes to be a significant competitive advantage in the market place. The Company used available cash and short-term investments to finance the acquisition. The offices for the newly acquired LoopCare product line are located at 685 Route 202/206 South, Bridgewater, New Jersey 08807 and its telephone number is 908-243-3900. Products. The Company's MCU products plug into the digital loop carrier ("DLC") systems that are large systems manufactured by equipment vendors such as Lucent (formerly part of AT&T), that are used by telephone companies to link the copper and fiber-optic portions of the local loop. DLC systems are located at the telephone company central offices and at remote sites within a local user area, and effectively multiplex the services of the copper lines into a single fiber-optic line. In many instances, several DLC systems are located at a single remote site to serve several thousand different end-user homes and offices. Generally, for every DLC remote site, at least two MCU line-testing products are deployed. To ensure compatibility of the MCU with these DLC systems, the Company pays royalties pursuant to license agreements for the use of proprietary design integrated circuits ("PDICs"). The PDICs are the design and property of the DLC system manufacturer from which they are purchased. The Company maintains license agreements with and pays royalties to Lucent Technologies, Fujitsu Network Transmission Systems, Inc., NEC America, Inc. and Reliance Comm/Tec Corporation. In general, one of these agreements contains a term of indefinite duration and the others contain automatic renewal provisions (unless earlier terminated) for periods of between one and five years. The Company also has a license agreement containing royalty provisions with Adtran, Inc. No royalties have been payable under this agreement to date. The Company incurred $1,896,000, $2,507,000 and $1,827,000 respectively in 1999, 2000 and 2001 as royalties under the license agreements, which royalties are calculated either based on a percentage of the list price of the MCU products or a fixed amount per unit that incorporates the technology licensed under each such agreement. Certain of the license agreements require the Company to maintain the confidentiality of the licensor's proprietary information and/or the terms and conditions of the agreement itself. In addition, the Company maintains license agreements that do not contain royalty provisions with Advanced Fibre Communications, Alcatel USA Sourcing, L.P. (formerly DSC Technologies Corporation), UTSTARCOM, Inc., Next Level Communications and SAGEM SA (a French corporation). The expiration dates of these agreements range at various times between September 2002 and November 2004, with renewal provisions (unless earlier terminated) for periods of one or more years. Future license agreements entered into by the Company may contain terms comparable to, or materially different than, the terms of existing agreements as competitive and other conditions warrant. The loss of PDICs license agreements or the inability of the Company to maintain an adequate supply of PDICs could have a material adverse effect on the Company's business. Other MCU technology is also used with home and business alarm systems. As with home service line testing, home alarm systems must be monitored from the alarm company's headquarters along a hybrid copper and fiber-optic line. The Company's alarm-related MCU products are used to facilitate the transport of analog alarm signals from subscriber homes to alarm company monitoring stations across the hybrid telephone network. These units plug into equipment at both central office and remote locations. MCU products and related hardware accounted for more than 74%, 70% and 68% of the Company's sales in 1999, 2000 and 2001, respectively. The Company's next-generation DigiTest centralized network test platform provides a complete system solution for POTS and ISDN services. In addition, the DigiTest system provides a full range of features that enable local exchange carriers to prequalify and maintain their networks for DSL service. With the acquisition of the LoopCare Software Product Line, the Company now owns LoopCare software which is the major Operation Support System ("OSS") 3 utilized by the Regional Bell Operating Companies for over twenty five years to test the integrity and quality of their POTS network infrastructure. The DigiTest system serves as an integral component of this OSS system that allows for request and retrieval of precise measurement results that form the basis for state-of-the-art fault diagnosis for both traditional narrowband and wideband applications. DigiTest's compact digital measurement unit ("DMU") which resides in the central office, acts as the test head in the test system, with the ability to determine subscriber line characteristics with network diagnostic functions including load coil detection, loop length measurement and longitudinal balance for Single-Ended Loop Qualification ("SELQ"). DigiTest's digital wideband unit ("DWU") next-generation testing platform enables single-ended loop qualification by identifying and locating bridged taps and measuring crosstalk and wideband noise, all important factors in the prequalification and in-service maintenance of local loops for DSL service. The DigiTest system also includes the Digital Measurement Node ("DMN"), which consists of a metal-chassis, backplane and an alarm/fuse card which is used to house the DMU and DWU. The Company's DigiTest system hardware has also been optimized to work with and support the OSS system owned by Nortel Networks Corporation. In connection therewith, the Company pays royalties pursuant to a license agreement for the use of certain network interface information to Nortel Networks Corporation. The current terms of this agreement expires in July 2002, and contains automatic renewal provisions (unless earlier terminated) for periods of one year each. The Company incurred $116,000, $404,000 and $6,000 respectively in 1999, 2000 and 2001 as royalties under this license agreement, which royalties are calculated based on a percentage of the sale price of the DMU and certain DWU units that incorporate the technology licensed under the agreement. The license agreement requires the Company to maintain the confidentiality of the licensor's proprietary information and/or the terms and conditions of the agreement itself. The Company markets and sells its DigiTest products directly as well as through certain continuing OEM arrangements with Lucent Technologies and Nortel Networks Corporation. The Company has also entered into a license agreement with Acterna, LLP for certain technology related to its DigiTest products and will pay royalties and licenses for use of such technology on a fixed per unit basis. This license agreement will expire by its terms (unless earlier terminated) in 2008. In addition to the OSS software, the newly acquired LoopCare Product Business has several features which enhance the performance, listing and analysis of telecommunication service providing copper line loops. These include the Common Object Request Broker Architecture (CORBA), the Application Programming Interface (API), Benchmark Data Base, DSL Testing, the Advanced Testhead Feature Package, and LoopCare TCP/IP Communications Network (LTCN). The Company's cable products consist of a complete cable status monitoring system that provides a comprehensive testing solution for the Broadband Hybrid Fiber Coax distribution system. The status monitoring system consists of 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. The Company has entered into license agreements with C-COR.net Corp. (formerly C-COR Electronics, Inc., a cable television systems developer) and Alpha Technologies, Inc., under which the Company provides its status monitoring transponder technology that is incorporated into those companies' cable network management systems. The Company, under certain other business arrangements, also markets and sells its cable products directly as well as through various OEM customers such as ANTEC and Motorola (formerly General Instrument). The cornerstone of the Company's Professional Services business is the Testability Improvement Initiatives. These services may offer the customer the opportunity to make dramatic improvements in testability levels, while training their own staffs in targeted geographic regions over a defined period of time. In this way, the customers' internal repair technicians can make use of automated systems to diagnose and repair subscriber loop problems, thereby automatically eliminating the need for the involvement of several highly trained people to do so. The service offering was expanded upon the acquisition of software maintenance contracts related to the LoopCare software product line. Product and Technology Development. The Company's product development personnel are organized into teams, each of which is effectively dedicated to a specific product line(s) or technology. Each product team also implements the Company's ongoing value engineering programs that are designed to replace the Company's products with successive generations having additional features and/or lower costs. The Company continuously monitors developing technologies in order to introduce products as defined standards and markets emerge. In addition, the Company continues to investigate the development of new applications for its MCU technology and other technologies to service the 4 telecommunications industry. During 1999 and 2000, research and development expenses were approximately $8,757,000 and $12,456,000 respectively. During 2001, research and development expenses were $12,428,000 including those research and development costs relating to the newly acquired LoopCare product business. Proprietary Rights. The names "Tollgrade(R)", "MCU(R)", "LIGHTHOUSE(R)", "DigiTest(R)", "Telaccord(R)" and "MICRO-BANK(R)", and the Company's corporate logo are registered trademarks of the Company. LoopCare(TM) and MLT(TM) are common law trademarks of the Company. "Team TollgradeSM" is a common law service mark of the Company. The Company has obtained three United States patents on the MCU products with expiration dates ranging from 2010 to 2014, one United States patent on a cable product that expires in 2016 and two United States patents on other telecommunications technology, which expire in 2018. In addition, the Company has one U.S. provisional, five United States, four Canada and two international patent cooperation treaty ("PCT") patent applications pending. The Company will seek additional patents from time to time related to its research and development activities. The Company protects its trademarks, patents, inventions, trade secrets, and other proprietary rights by contract, trademark, copyright and patent registration, and internal security. Customers. The Company's primary telecommunication customers are the four regional Bell operating companies ("RBOCs"), which are Verizon Communications, BellSouth Corporation, SBC Communications, Inc., and Qwest, Inc., as well as major independent telephone companies. Sales in 2001 to Verizon Communications, BellSouth Corporation and SBC Communications, Inc. accounted for approximately 14%, 14%, 38%, respectively of total revenues. In addition, sales to Sprint USA accounted for approximately 10% of the Company's sales in 2001. The Company's primary cable products are sold on a direct basis as well as to certain cable Original Equipment Manufacturer ("OEM") customers such as C-COR.net Corp., ANTEC Corporation and Motorola, Inc. Sales of the Company's cable products in 2001 were approximately 4% of total revenues. The Company's relationships with its customers are material to the Company's business, and the loss of any such relationship could have a material adverse effect on the Company's business. Manufacturing. The Company's manufacturing operations consist primarily of quality control, functional testing, final assembly, burn-in and shipping. The Company is ISO 9001 registered from the British Standards Institution, Inc. ISO 9000 is a harmonized set of standards that define quality assurance management. Written by the International Organization for Standardization (ISO), it is recognized throughout the United States, Canada, the European Union and Japan. To be registered, the Company develops and maintains internal documentation and processes to support the production of quality products to ensure customer satisfaction. The Company utilizes two key independent subcontractors to perform a majority of the circuit board assembly and in-circuit testing work on its products. The Company also utilizes other subassembly contractors on a more limited basis. The loss of the subcontractors could cause delays in the Company's ability to meet production obligations and could have a material adverse effect on the Company's results of operations. In addition, shortages of raw material to, or production capacity constraints at, the Company's subcontractors could negatively affect the Company's ability to meet its production obligations and result in increased prices for affected parts. Any such reduction may result in delays in shipments of the Company's products or increases in the price of components, either of which could have a material adverse impact on the Company. The Company currently procures all of its components from outside suppliers. Generally, the Company uses industry standard components for its products. Application specific integrated circuits (ASICs) are a key component to the manufacturing process and are custom made to the Company's specifications. Although the Company has generally been able to obtain ASICs on a timely basis, a delay in the delivery of these components could have a material adverse impact on the Company. Backlog. The Company's backlog at December 31, 2001 was approximately $4.9 million, as compared to approximately $8.2 million at December 31, 2000. The Company's backlog consists of firm customer purchase orders for the Company's various products. 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. 5 Competitive Conditions. The market for telecommunications and cable television equipment is highly competitive. The deciding competitive factors in the Company's market include price, product features, performance, reliability, service and support, breadth of product line, technical documentation and prompt delivery. The Company believes that it competes favorably on all of these factors, and certain of its products have proprietary or patented features. The Company also attempts to enter into development agreements for its MCU products with the manufacturers of DLC and other complex systems, which serves to ensure compatibility for its products. Competition would increase if new companies enter the Company's product markets or existing competitors expand their product lines. For instance, the telecommunications reform legislation has lifted the restrictions that previously prevented the RBOCs from manufacturing telecommunications equipment. Pursuant to this legislative reform, the RBOCs, which are the Company's largest customers, may become competitors of the Company in the markets served by the Company. For the Company's line-testing MCU devices, the primary competitive technologies are the remote monitoring units made by Teradyne, Inc. and the Harris Communications Product Division of Harris Communications, Inc. In addition, the Anritsu Wiltron Test and Measurement Group, a division of Anritsu Corporation, offers the Wiltron LoopMATE, a modular remote test head, which competes with the Company's POTS testing capabilities. The Company believes the MCU is simpler and less costly to install and permits the full complement of centralized testing to be performed as quickly and accurately as with copper by-pass wiring. The alarm-related MCU product's primary competitor is the Turbo 2000 unit made by ANTEC Corporation. The primary competitors for the Company's DigiTest product line include Harris Corporation, Hekimian Laboratories, Porta Systems Corp., Teradyne, Inc. and Turnstone Systems, Inc. For the Company's cable products, the primary competitors for status monitoring are Acterna Corporation, AM Communications, Inc., Harmonic, Inc. and Scientific Atlanta, Inc. Employees. At December 31, 2001, the Company had 341 full-time employees, all in the United States. None of the Company's employees are represented by a collective bargaining agreement. Government Regulation. The telecommunications industry is subject to regulation in the United States and other countries. Federal and state regulatory agencies, including the FCC and various state public utility commissions and public service commissions, regulate most of the Company's domestic customers. While such regulation does not typically affect the Company directly, the effects of such regulations on the Company's customers may, in turn, adversely impact the Company's business and operating results. Governmental authorities also have promulgated regulations which, among other things, set installation and equipment standards for private telecommunications systems and require that all newly installed hardware be registered and meet certain government standards. ITEM 2. PROPERTIES. The Company's headquarters and principal administrative, engineering, manufacturing, warehouse and maintenance facilities are located in Cheswick, Pennsylvania. The Company occupies a 111,600 square foot facility. The Company occupies its current facilities under a lease that expires in December 2002 with an option to renew the term of the lease for one additional period of three years. The Company has acquired certain land parcels that surround the current leased facility for the possible expansion of parking and/or new building structures that the Company believes will provide adequate space to support future operations and sales growth, if necessary. In addition, the Company leases 18,778 square foot of space in Bridgewater, New Jersey. The lease was entered into on October 24, 2001, commenced on January 21, 2002 and will expire on January 21, 2007. This facility provides workspace for the administrative and engineering personnel of the LoopCare Product Line. ITEM 3. LEGAL PROCEEDINGS. There are currently no outstanding or pending material legal proceedings with respect to the Company or its business. 6 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. During the fourth quarter of 2001, there were no matters submitted to a vote of security holders through solicitation of proxies or otherwise. 7 EXECUTIVE OFFICERS OF THE COMPANY Information relating to the executive officers of the Company as of January 31, 2002 is set forth below: Christian L. Allison Chairman of the Board since April 1998; Chief Executive Officer; also Treasurer from May 1992 until April 1997; also President from October 1993 until January 2001; Age 40. Sara M. Antol General Counsel since December 2000; Secretary; Chief Counsel from April 1996 until December 2000; Age 40. Richard A. Bair, Jr. Executive Vice President, Engineering/Testing since August 2000; Vice President Engineering, DigiTest from June 2000 until August 2000; Engineering Manager from April 1999 until August 2000; prior thereto, Senior Design Engineer from March 1996 until April 1999; Age 39. Wylie E. Estcheid Executive Vice President, Business Development, OSS since September 2001; Senior Vice President and General Manager of Telco Access Products (a manufacturer of telecommunications products) from October 2000 until September 2001; Vice President, Network Engineering Midwest Division of SBC (a provider of telecommunication services) from December 1999 until October 2000; prior thereto, Vice President, Service Integration and Delivery of Ameritech (a provider of telecommunication services) from February 1996 until December 1999; Age 52. Rocco L. Flaminio Vice Chairman and Chief Technology Officer; Executive Vice President; Age 77. Carol M. Franklin General Manager, Software Products Division since July 2001; Director of Order Management Development of Lucent Technologies from May 2000 until July 2001; Director for Integration Test of Lucent Technologies from September 1999 until May 2000; Director for Starter Solutions for Emerging Carriers and Internet Customer Care of Lucent Technologies (a manufacturer of communication systems, software and products and formerly AT&T Bell Laboratories) from February 1999 until August 1999; prior thereto, Product Realization Leader of Lucent Technologies from February 1996 until January 1999; Age 50. Samuel C. Knoch Chief Financial Officer; Treasurer since April 1997; Age 45. Joseph G. O'Brien Senior Vice President, Human Resources since October 1997; Director of Employee Development from April 1997 until October 1997; prior thereto, Coordinator, Elderberry Junction, Goodwill Industries (a charitable organization) from May 1995 until April 1997; Age 42. Mark B. Peterson President since January 2001; Executive Vice President, Sales and Marketing from November 1999 until January 2001; Executive Vice President, Sales from October 1997 until November 1999; prior thereto, Testing Application Group product manager (MLT and Switched Access Remote Test Systems (SARTS) product lines) of Lucent Technologies (a manufacturer of communication systems, software and products and formerly AT&T Bell Laboratories) from October 1995 until October 1997; Age 41. Gregory L. Quiggle Executive Vice President, Marketing since August 2001; Director of Marketing,
8 Loop Products Acterna LLC (formerly, Telecommunications Techniques Corporation, or TTC, a global communications equipment company) from May, 1998 until August 1998; prior thereto, Product Line Manager, TTC from May 1996 until May 1998; Age 33. Matthew J. Rosgone Executive Vice President, Operations since September 2001; Senior Vice President, Purchasing/Manufacturing from July 1998 until September 2001; prior thereto, Vice President, Purchasing from July 1996 until July 1998; Age 33. Charles J. Shearer Controller since February 2002; prior thereto, Controller of Resource Investments, Inc. (a privately held real estate investment and management company) from February 1979 until January 2002; Age 57. Richard A. Skaare Executive Vice President, Organizational Development and Communications since June 2001; Vice President of Marketing, Ed-e.com & Knowledge Planet (two related eLearning companies) from August 1999 until December 2000; prior thereto, Director, Global Communication, AMP Incorporated (a manufacturer of a broad range of electronic equipment) from January 1994 until May 1999; Age 53. Roger A. Smith Executive Vice President, Technology since June 2000; Senior Vice President, Test Systems from July 1998 until June 2000; prior thereto, Senior Software Development Engineer of Caldon Inc. (a manufacturer of ultrasonic flow meters for nuclear power industry); Age 41. Stephanie M. Wedge Vice President, Professional Services since November 1999; Sales Executive, Professional Services, Inacom Corporation (reseller and integrator of client/server solutions for messaging) from February, 1998 until November 1999; prior thereto, Sales Manager, Business Development, Digital Equipment Corporation (a manufacturer and integrator of mid-frame computers); Age 45.
9 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS. Information relating to the market for the Company's Common Stock and other matters related to the holders thereof is set forth under the caption "Common Stock Market Price" on page 32 of the Company's 2001 Annual Report to Shareholders and is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA. A summary of selected financial data for the Company, including each of the last five fiscal years in the period ended December 31, 2001, is set forth under the caption "Selected Consolidated Financial Data" on page 8 of the Company's 2001 Annual Report to Shareholders and is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION. A discussion of the Company's results of operations and financial condition is set forth under the caption "Management's Discussion and Analysis of Results of Operations and Financial Condition" on pages 9 through 15 of the Company's 2001 Annual Report to Shareholders and is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The Company's consolidated financial statements, together with the report thereon of PricewaterhouseCoopers LLP, are set forth on pages 17 through 31 of the Company's 2001 Annual Report to Shareholders and are incorporated herein by reference. Such financial statements and supplementary data are listed in Part IV Item 14(a) (1), Exhibits, Financial Statement Schedules, and Reports on Form 8-K. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 10 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. In addition to the information reported in Part I of this Form 10-K, under the caption "Executive Officers of the Company," the information required by this item appears beneath the caption "Election of Directors" in the Company's definitive Proxy Statement for its 2002 Annual Meeting of Shareholders and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION. Information relating to executive compensation is set forth beneath the caption "Executive Compensation" in the Company's definitive Proxy Statement for its 2002 Annual Meeting of Shareholders and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Information relating to the security ownership of beneficial owners of 5% or more of the Common Stock and of the executive officers and directors of the Company is set forth under the caption "Stock Ownership of Management and Certain Beneficial Owners" in the Company's definitive Proxy Statement for its 2002 Annual Meeting of Shareholders and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Information relating to certain relationships and related transactions is set forth beneath the caption "Certain Relationships and Related Transactions" in the Company's definitive Proxy Statement for its 2002 Annual Meeting of Shareholders and is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a)(1) The following financial statements and supplementary data are incorporated in Item 8 of Part II of this Form 10-K by reference to pages 16 through 31 of the Company's 2001 Annual Report to Shareholders, which are incorporated herein by reference: Statement of Management's Responsibility for Financial Reporting, dated January 21, 2002 Report of Independent Accountants, dated January 21, 2002 Consolidated Balance Sheets at December 31, 2000 and 2001 Consolidated Statements of Operations for each of the three years in the period ended December 31, 2001 Consolidated Statements of Changes in Shareholders' Equity for each of the three years ended December 31, 2001 Consolidated Statements of Cash Flows for each of the three years ended December 31, 2001 Notes to Consolidated Financial Statements Statements of Operations Data by Quarter (a)(2) The following financial statement schedule is included herewith on page 17 and made a part hereof: Schedule II (Valuation and Qualifying Accounts) (a)(3) The following exhibits are included herewith and made a part hereof: 11
Exhibit Number Description - ------ ----------- 3.1 Amended and Restated Articles of Incorporation of the Company, as amended through May 6, 1998 (conformed copy), filed as Exhibit 3.1 to the Annual Report of Tollgrade Communications, Inc. on Form 10-K for the year ended December 31, 1998 (the "1998 Form 10-K"). 3.1a Statement with Respect to Shares dated July 23, 1996 (conformed copy), filed as Exhibit 3.1a to the 1998 Form 10-K and incorporated herein by reference thereto. 3.2 Amended and Restated Bylaws of the Company, filed as Exhibit 3.2 to the Report on Form 10-Q of the Company filed on August 10, 1999 and incorporated herein by reference thereto. 4.1 Rights Agreement, dated as of July 23, 1996 between the Company and Chase Mellon Shareholder Services, L.L.C., filed as Exhibit 1 to the Company's Registration Statement on Form 8-A and incorporated herein by reference thereto. 10.1 Common Stock Purchase Agreement dated November 7, 1994, between the Company and the investors listed on Schedule A thereto (attachments and exhibits omitted), filed as Exhibit 10.1 to the Company's Registration Statement on Form S-1 (the "S-1") and incorporated herein by reference thereto. 10.2* 1995 Long-Term Incentive Compensation Plan, amended and restated as of January 24, 2002, filed as Exhibit B to the Company's 2002 Proxy Statement and incorporated herein by reference thereto. 10.3 License Agreement, dated August 24, 1993 between Fujitsu Network Transmission Systems, Inc. and the Company, filed as Exhibit 10.4 to the S-1 and incorporated herein by reference thereto. 10.4 License Agreement, dated September 26, 1994 between NEC America, Inc. and the Company, filed as Exhibit 10.5 to the S-1 and incorporated herein by reference thereto. 10.5 Interface License Agreement, dated March 22, 1995 between Northern Telecom Inc. and the Company, filed as Exhibit 10.7 to the S-1 and incorporated herein by reference thereto. 10.6 Technical Information Agreement, dated February 1, 1993 between Lucent Technologies, Inc. (formerly American Telephone and Telegraph Company) and the Company, filed as Exhibit 10.8 to the S-1 and incorporated herein by reference thereto. 10.7 Technology License Agreement, dated November 16, 1994 between Alcatel USA (formerly DSC Technologies Corporation) and the Company, filed as Exhibit 10.12 to the S-1 and incorporated herein by reference thereto. 10.8 License Agreement, dated August 24, 1993 between Reliance Comm/Tec Corporation and the Company, filed as Exhibit 10.13 to the S-1 and incorporated herein by reference thereto. 10.9* Employment Agreement, dated as of December 13, 1995, between the Company and Christian L. Allison, filed as Exhibit 10.11 to the Annual Report of the Company on Form 10-K for the year ended December 31, 1995 (the "1995 Form 10-K"). 10.10* Stock Option Agreement entered into December 14, 1995 between the Company and R. Craig Allison, together with a schedule listing substantially identical agreements with Gordon P. Anderson, Jeffrey Blake, John H. Guelcher, Richard H. Heibel, Joseph T. Messina and Douglas T. Halliday, filed as Exhibit 10.14 to the 1995 Form 10-K.
12 10.11* Form of Stock Option Agreement dated December 14, 1995 and December 29, 1995 for Non-Statutory Stock Options granted under the 1995 Long-Term Incentive Compensation Plan, filed as Exhibit 10.15 to the Annual Report of the Company on Form 10-K for the year ended December 31, 1996 (the "1996 Form 10-K"). 10.12* Form of Stock Option Agreement for Non-Statutory Stock Options granted under the 1995 Long-Term Incentive Compensation Plan, filed as Exhibit 10.2 to the Report on Form 10-Q of the Company filed on November 12, 1996. 10.13* Form of Non-employee Stock Option Agreement entered into December 13, 1996 and December 30, 1997 between the Company and Lawrence Arduini, filed as Exhibit 10.19 to the 1996 Form 10-K. 10.14* Amendment to Employment Agreement, dated as of December 13, 1996, between the Company and Christian L. Allison, filed as Exhibit 10.20 to the 1996 Form 10-K. 10.15* Amendment to Employment Agreement, dated as of December 13, 1997, between the Company and Christian L. Allison, filed as Exhibit 10.21 to the Annual Report of the Company on Form 10-K for the year ended December 31, 1997 (the "1997 Form 10-K"). 10.16 Amendment, dated February 21, 1997, to Technical Information Agreement relating to Metallic Channel Units Types A and B, dated February 1,1993, between American Telephone and Telegraph Company (AT&T) (licensor) and the Company (licensee) incorporated by reference to Exhibit 10.3 to the Report on Form 10-Q of the Company filed on November 10, 1997. 10.17* Form of Non-employee Director Stock Option Agreement with respect to the Company's 1995 Long-Term Incentive Compensation Plan, filed as Exhibit 10.25 to the 1997 Form 10-K. 10.18* Amendment to Employment Agreement, dated as of December 30, 1998, between the Company and Christian L. Allison, filed as Exhibit 10.28 to the 1998 Form 10-K. 10.19* Amendment to Employment Agreement, dated as of January 18, 2000, between the Company and Christian L. Allison, filed as Exhibit 10.25 to the 1999 Form 10-K. 10.20* Change in Control Agreement, entered into February 9, 2000 between the Company and Sara M. Antol, together with a schedule listing substantially identical agreements with Robert Cornelia, Ruth Dilts, Bradley Dinger, Rocco Flamino, Mark Frey, Samuel Knoch, James Price, and Matthew Rosgone, filed as Exhibit 10.26 to the 1999 Form 10-K. 10.21* Change in Control Agreement, entered into December 20, 1999 between the Company and Scott Robbins, filed as Exhibit 10.27 to the 1999 Form 10-K. 10.22* Change in Control Agreement, entered into August 10, 2000 between the Company and Stephen M. Garda, filed as Exhibit 10.30 to the Report on Form 10-Q of the Company filed on November 13, 2000. 10.23* Amendment to Employment Agreement, dated as of January 3, 2001, between the Company and Christian L. Allison, filed as Exhibit 10.23 to the Annual Report of the Company on Form 10-K for the year ended December 31, 2000 (the " 2000 Form 10-K"). 10.24* Change in Control Agreement, entered into January 19, 2001 between the Company and Joseph G.
13 O'Brien, together with a schedule listing substantially identical agreements with Lawrence J. Fey, William J. Gumbert, Gary L. Gump, Michael D. McSparrin, Timothy D. O'Brien, Mark B. Peterson, Roger A. Smith and Jeffrey J. Tatusko, filed as Exhibit 10.24 to the 2000 Form 10-K. 10.25* 1998 Employee Incentive Compensation Plan, amended and restated as of January 24, 2002, filed herewith. 10.26 Asset Purchase Agreement by and between Lucent Technologies, Inc. and Tollgrade Communications, Inc. dated September 28, 2001, filed as Exhibit 2.1 to the Company's report on Form 8-K filed on October 15, 2001. 10.27* Amendment to Employment Agreement, dated as of January 10, 2002, between the Company and Christian L. Allison, filed herewith. 10.28* Change in Control Agreement, entered into October 30, 2001 between the Company and Richard Skaare, together with a schedule listing substantially identical agreements with Wylie Etscheid, Carol M. Franklin and Gregory Quiggle, filed herewith. 10.29* Change in Control Agreement, entered into January 2, 2002 between the Company and Charles L. Geier, Jr., filed herewith. 10.30* Change in Control Agreement, entered into January 2, 2002 between the Company and James D. Coleman, filed herewith. 13.1 Company's 2001 Annual Report to Shareholders, filed herewith. 21.1 List of subsidiaries of the Company, filed as Exhibit 21.1 to the S-1 and incorporated herein by reference thereto. 23.1 Consent of PricewaterhouseCoopers LLP, filed herewith.
* Management contract or compensatory plan, contract or arrangement required to be filed by item 601(b)(10)(iii) of Regulation S-K. The Company agrees to furnish to the Commission upon request copies of all instruments not listed above which define the rights of holders of long-term debt of the Company. Copies of the exhibits filed as part of this Form 10-K are available at a cost of $.20 per page to any shareholder of record upon written request to the Secretary, Tollgrade Communications, Inc., 493 Nixon Road, Cheswick, Pennsylvania 15024. (b) Reports on Form 8-K filed during the quarter ended December 31, 2001: Two reports on Form 8-K were filed by the Company during the quarter ended December 31, 2001. The first was filed on October 15, 2001, and an amendment to the Form 8-K initially filed by the Company on September 20, 2001 was filed on December 14, 2001. 14 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized as of March 22, 2002. TOLLGRADE COMMUNICATIONS, INC. By /s/CHRISTIAN L. ALLISON ---------------------------- Christian L. Allison Chairman and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities indicated as of March 22, 2002.
SIGNATURE TITLE --------- ----- /s/Christian L. Allison Director, Chairman and Chief - ------------------------------------------------------------------------ Executive Officer, Christian L. Allison (Principal Executive Officer) /s/James J. Barnes Director - ------------------------------------------------------------------------ James J. Barnes /s/Daniel P. Barry Director - ------------------------------------------------------------------------ Daniel P. Barry /s/David S. Egan Director - ------------------------------------------------------------------------ David S. Egan /s/Rocco L. Flaminio Director, Vice Chairman - ------------------------------------------------------------------------ and Chief Technology Officer Rocco L. Flaminio /s/Richard H. Heibel, M.D. Director - ------------------------------------------------------------------------ Richard H. Heibel, M.D. /s/Robert W. Kampmeinert Director - ------------------------------------------------------------------------ Robert W. Kampmeinert /s/Samuel C. Knoch Chief Financial Officer and Treasurer - ------------------------------------------------------------------------ (Principal Financial Officer) Samuel C. Knoch /s/Charles J. Shearer Controller - ------------------------------------------------------------------------ (Principal Accounting Officer) Charles J. Shearer
15 Report of Independent Accountants on Financial Statement Schedule To the Board of Directors of Tollgrade Communications, Inc.: Our audits of the consolidated financial statements referred to in our report dated January 21, 2002 appearing in the 2001 Annual Report to Shareholders of Tollgrade Communications, Inc. (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedule listed in Item 14(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ PRICEWATERHOUSECOOPERS LLP Pittsburgh, Pennsylvania January 21, 2002 16 SCHEDULE II TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 1999, 2000 and 2001 (In thousands)
Col. A Col. B Col. C Col. D Col. E - ------ --------- ------ ------ ------ Balance at Additions Beginning Charged to Charged to Balance at of Year Expense Other Accounts Deductions End of Year ------- -------- -------------- ---------- ------------ Inventory reserve: Year ended December 31, 1999 $267 $393 $ -- $ -- $660 Year ended December 31, 2000 660 743 -- (318) 1,085 Year ended December 31, 2001 1,085 300 -- (274) 1,111 Allowance for doubtful accounts: Year ended December 31, 1999 $100 $100 $ -- $(19) $181 Year ended December 31, 2000 181 22 -- (3) 200 Year ended December 31, 2001 200 175 -- -- 375 Warranty reserve: Year ended December 31, 1999 $435 $165 $ -- $ -- $600 Year ended December 31, 2000 600 588 -- (143) 1,045 Year ended December 31, 2001 1,045 1,157 (19) (153) 2,068
17 EXHIBIT INDEX (Pursuant to Item 601 of Regulation S-K)
Exhibit Number Description - ------ ----------- 3.1 Amended and Restated Articles of Incorporation of the Company, as amended through May 6, 1998 (conformed copy), filed as Exhibit 3.1 to the Annual Report of Tollgrade Communications, Inc. on Form 10-K for the year ended December 31, 1998 (the "1998 Form 10-K"). * 3.1a Statement with Respect to Shares dated July 23, 1996 (conformed copy), filed as Exhibit 3.1a to the 1998 Form 10-K. * 3.2 Amended and Restated Bylaws of the Company, filed as Exhibit 3.2 to the Report on Form 10-Q of the Company filed on August 10, 1999 and incorporated herein by reference thereto. * 4.1 Rights Agreement dated as of July 23, 1996 between the Company and Chase Mellon Shareholder Services, L.L.C., filed as Exhibit 1 to the Company's Registration Statement on Form 8-A and incorporated herein by reference thereto. * 10.1 Common Stock Purchase Agreement dated November 7, 1994, between the Company and the investors listed on Schedule A thereto (attachments and exhibits omitted), filed as Exhibit 10.1 to the Company's Registration Statement on Form S-1 (the "S-1") and incorporated herein by reference thereto. * 10.2 1995 Long-Term Incentive Compensation Plan, amended and restated as of January 24, 2002, filed as Exhibit B to the Company's 2002 Proxy Statement and incorporated herein by reference thereto. * 10.3 License Agreement, dated August 24, 1993 between Fujitsu Network Transmission Systems, Inc. and the Company, filed as Exhibit 10.4 to the S-1 and incorporated herein by reference thereto. * 10.4 License Agreement, dated September 26, 1994 between NEC America, Inc. and the Company, filed as Exhibit 10.5 to the S-1 and incorporated herein by reference thereto. *
18 10.5 Interface License Agreement, dated March 22, 1995 between Northern Telecom Inc. and the Company, filed as Exhibit 10.7 to the S-1 and incorporated herein by reference thereto. * 10.6 Technical Information Agreement, dated February 1, 1993 between Lucent Technoliges, Inc. (formerly American Telephone and Telegraph Company) and the Company, filed as Exhibit 10.8 to the S-1 and incorporated herein by reference thereto. * 10.7 Technology License Agreement, dated November 16, 1994 between Alcatel USA (formerly DSC Technologies Corporation) and the Company, filed as Exhibit 10.12 to the S-1 and incorporated herein by reference thereto. * 10.8 License Agreement, dated August 24, 1993 between Reliance Comm/Tec Corporation and the Company, filed as Exhibit 10.13 to the S-1 and incorporated herein by reference thereto. * 10.9 Employment Agreement, dated as of December 13, 1995, between the Company and Christian L. Allison, filed as Exhibit 10.11 to the Annual Report of the Company on Form 10-K for the year ended December 31, 1995 (the "1995 Form 10-K"). * 10.10 Stock Option Agreement entered into December 14, 1995 between the Company and R. Craig Allison, together with a schedule listing substantially identical agreements with Gordon P. Anderson, Jeffrey Blake, John H. Guelcher, Richard H. Heibel, Joseph T. Messina and Douglas T. Halliday, filed as Exhibit 10.14 to the 1995 Form 10-K. * 10.11 Form of Stock Option Agreement dated December 14, 1995 and December 29, 1995 for Non-Statutory Stock Options granted under the 1995 Long-Term Incentive Compensation Plan, filed as Exhibit 10.15 to the Annual Report of the Company on Form 10-K for the year ended December 31, 1996 (the "1996 Form 10-K"). * 10.12 Form of Stock Option Agreement for Non-Statutory Stock Options granted under the 1995 Long Term Incentive Compensation Plan, filed as Exhibit 10.2 to the Report On Form 10-Q of the Company filed on November 12, 1996. * 10.13 Form of Non-employee Stock Option Agreement entered into December 13, 1996 and December 30, 1997 between the Company and Lawrence Arduini, filed as Exhibit 10.19 to the 1996 Form 10-K. *
19 10.14 Amendment to Employment Agreement, dated as of December 13, 1996, between the Company and Christian L. Allison, filed as Exhibit 10.20 of the 1996 Form 10-K. * 10.15 Amendment to Employment Agreement, dated as of December 13, 1997, between the Company and Christian L. Allison, filed as Exhibit 10.21 to the Annual Report of the Company on Form 10-K for the year ended December 31, 1997 (the "1997 Form 10-K"). * 10.16 Amendment, dated February 21, 1997, to Technical Information Agreement relating to Metallic Channel Units Types A and B, dated February 1, 1993, between American Telephone and Telegraph Company (AT&T) (licensor) and the Company (licensee) incorporated by reference to Exhibit 10.3 to the Report on Form 10-Q of the Company filed on November 10, 1997. * 10.17 Form of Non-employee Director Stock Option Agreement with respect to the Company's 1995 Long-Term Incentive Compensation Plan, filed as Exhibit 10.25 to the 1997 Form 10-K. * 10.18 Amendment to Employment Agreement, dated as of December 30, 1998, between the Company and Christian L. Allison, filed as Exhibit 10.28 to the 1998 Form 10-K. * 10.19 Amendment to Employment Agreement, dated as of January 18, 2000, between the Company and Christian L. Allison, filed as Exhibit 10.25 to the 1999 Form 10-K. * 10.20 Change in Control Agreement, entered into February 9, 2000 between the Company and Sara M. Antol, together with a schedule listing substantially identical agreements with Robert Cornelia, Ruth Dilts, Bradley Dinger, Rocco Flamino, Mark Frey, Samuel Knoch, James Price and Matthew Rosgone, filed as Exhibit 10.26 to the 1999 Form 10-K. * 10.21 Change in Control Agreement, entered into December 20, 1999 between the Company and Scott Robbins, filed as Exhibit 10.27 to the 1999 Form 10-K. * 10.22 Change in Control Agreement, entered into August 10, 2000 between the Company and Stephen M. Garda, filed as Exhibit 10.30 to the Report on Form 10-Q of the Company filed on November 13, 2000. * 10.23 Amendment to Employment Agreement, dated as of January 3, 2001, between the Company and Christian L. Allison, filed as Exhibit 10.23 to the Annual Report of the Company on Form 10-K for the year ended December 31, 2000 (the "2000 Form 10-K"). * 10.24 Change in Control Agreement, entered into January 19, 2001 between the Company and Joseph G. O'Brien, together with a schedule listing substantially identical agreements with Lawrence J. Fey, William J. Gumbert, Gary L. Gump, Michael D. McSparrin, Timothy D. O'Brien, Mark B. Peterson, Roger A. Smith and Jeffrey J. Tatusko, filed as Exhibit 10.24 to the 2000 Form 10-K. *
20 10.25 1998 Employee Incentive Compensation Plan, amended and restated as of January 24, 2002 filed herewith. 10.26 Asset Purchase Agreement by and between Lucent Technologies, Inc. and Tollgrade Communications, Inc. dated September 28, 2001, filed as Exhibit 2.1 to the Company's Report on Form 8-K filed on October 15, 2001. * 10.27 Amendment to Employment Agreement, dated as of January 10, 2002, between the Company and Christian L. Allison, filed herewith. 10.28 Change in Control Agreement, entered into October 30, 2001 between the Company and Richard Skaare, together with a schedule listing substantially identical agreements with Wylie Etscheid, Carol M. Franklin, and Gregory Quiggle, filed herewith. 10.29 Change in Control Agreement, entered into January 2, 2002, between the Company and Charles J. Geier, Jr., filed herewith. 10.30 Change in Control Agreement, entered into January 2, 2002 between the Company and James D. Coleman, filed herewith. 13.1 Company's 2001 Annual Report to Shareholders, filed herewith. 21.1 List of subsidiaries of the Company, filed as Exhibit 21.1 to the S-1 and incorporated herein by reference thereto. * 23.1 Consent of PricewaterhouseCoopers LLP, filed herewith.
* Incorporated by reference. 21 EX-10.25 3 j9338001ex10-25.txt 1998 EMPLOYEE INCENTIVE COMPENSATION PLAN EXHIBIT 10.25 TOLLGRADE COMMUNICATIONS, INC. 1998 EMPLOYEE INCENTIVE COMPENSATION PLAN (AS AMENDED THROUGH JANUARY 24, 2002) 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 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. 22 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. 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. 23 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. 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 Nonqualified 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). 24 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 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 25 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 990,000; 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 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. 26 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 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; 27 (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 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. 28 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. 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 29 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. 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. 30 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 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 31 (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 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. 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. 32 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. 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. 33 EX-10.27 4 j9338001ex10-27.txt ASSET PURCHASE AGREEMENT EXHIBIT 10.27 AMENDMENT THIS AMENDMENT, dated as of January 10, 2002 and effective as of December 13, 2001 (the "Amendment") is entered into between TOLLGRADE COMMUNICATIONS, INC. ("Tollgrade") and CHRISTIAN L. ALLISON (the "Executive"). AMENDMENT TO AGREEMENT WHEREAS, Tollgrade and the Executive entered into an Agreement dated as of the 13th day of December, 1995, as amended, governing the employment of Executive and certain benefits to be received by Executive in the event his employment is terminated (collectively, the "Agreement"); and WHEREAS, Tollgrade and the Executive desire to amend the Agreement upon the terms and conditions stated in this Amendment. NOW, THEREFORE, in consideration of the promises and the faithful performance of the mutual covenants herein contained, and intending to be legally bound hereby, Tollgrade and the Executive agree as follows: 1. Capitalized terms used herein and not otherwise defined shall have the meaning assigned to them in the Agreement. 2. The Agreement shall be amended to extend the salary terms as currently in effect until December 13, 2002. 3. Except as modified by this Amendment, the provisions of the Agreement shall remain in full force and effect. IN WITNESS WHEREOF, the parties have executed this Amendment as of the date first written above. TOLLGRADE COMMUNICATIONS, INC. By: ------------------------ ------------------------------------ Title: Christian L. Allison --------------------- 34 EX-10.28 5 j9338001ex10-28.txt CHANGE IN CONTROL AGREEMENT EXHIBIT 10.28 AGREEMENT This Agreement, made as of the 30th day of October, 2001 by and between TOLLGRADE COMMUNICATIONS, INC., a Pennsylvania corporation (the "Corporation") and RICHARD SKAARE (the "Executive"). WITNESSETH: WHEREAS, the Board of Directors of the Corporation has determined that it is in the best interests of the Corporation to enter into this Agreement with the Executive to provide for compensation of the Executive upon termination of employment under certain circumstances relating to a change in control of the Corporation; and WHEREAS, the Executive desires to obtain such benefits in the event the Executive's employment is terminated under the circumstances provided herein. NOW, THEREFORE, in consideration of the covenants and premises contained herein, and intending to be legally bound hereby, the parties hereto agree as follows: 1. DEFINITION OF TERMS. The following terms when used in this Agreement shall have the meaning hereafter set forth: "ANNUAL SALARY ADJUSTMENT PERCENTAGE" shall mean the mean average percentage increase in base salary for all elected officers of the Corporation during the two full calendar years immediately preceding the time to which such percentage is being applied; provided however, that if after a Change-in-Control, as hereinafter defined, there should be a significant change in the number of elected officers of the Corporation or in the manner in which they are compensated, then the foregoing definition shall be changed by substituting for the phrase "elected officers of the Corporation" the phrase "persons then performing the functions formerly performed by the elected officers of the Corporation." "CAUSE FOR TERMINATION" shall mean: (a) the deliberate and intentional failure by the Executive to devote substantially his entire business time and best efforts to the performance of his duties (other than any such failure resulting from the Executive's incapacity due to physical or mental illness or disability) after a demand for substantial performance is delivered to the Executive by the Board of Directors which specifically identifies the manner in which the Board of Directors believes that the Executive has not substantially performed his duties, or (b) willfully engaging by the Executive in conduct which constitutes a fraud against the Corporation or a material breach of this Agreement, or (c) the Executive's conviction of any crime which constitutes a felony. For purposes of this definition, no act, or failure to act, on the Executive's part shall be considered "deliberate and intentional" or "willfully" unless done, or omitted to be done, by the Executive not in good faith and without reasonable belief that his action or omission was in the best interests of the Corporation. "CHANGE-IN-CONTROL" shall mean the determination (which may be made effective as of a particular date specified by the Board of Directors of the Corporation) by the Board of Directors of the Corporation, made by a 35 majority vote 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 Corporation on the date hereof (the "Current Owners")(or any individual or entity which receives from a Current Owner an interest in the Corporation through will or the laws of descent and distribution) maintain more than a sixty-five percent (65%) interest in the resultant entity. Regardless of the Board's vote or whether or not the Board votes, a Change-in-Control will be deemed to have occurred as of the first day any one (1) or more of the following subparagraphs shall have been satisfied: (a) Any Person (other than the Person in control of the Corporation as of the date of this Agreement, or other than a trustee or other fiduciary holding securities under an employee benefit plan of the Corporation, or a corporation owned directly or indirectly by the stockholders of the Corporation in substantially the same proportions as their ownership of stock of the Corporation), becomes the beneficial owner, directly or indirectly, of securities of the Corporation representing more than thirty five percent (35%) of the combined voting power of the Corporation's then outstanding securities; or (b) The stockholders of the Corporation approve: (i) A plan of complete liquidation of the Corporation; (ii) An agreement for the sale or disposition of all or substantially all of the Corporation's assets; or (iii) A merger, consolidation, or reorganization of the Corporation with or involving any other corporation, other than a merger, consolidation, or reorganization that would result in the voting securities of the Corporation outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least sixty-five percent (65%) of the combined voting power of the voting securities of the Corporation (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 the Executive, if the Executive is part of a purchasing group which consummates the Change-in-Control transaction. The Executive shall be deemed "part of the purchasing group" for purposes of the preceding sentence if the Executive 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 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 non-employee continuing Directors of the Board of Directors of the Corporation). "DATE OF TERMINATION" shall mean: (a) if the Executive's employment is terminated for Disability, the date that a Notice of Termination is given to the Executive; (b) if the Executive terminates due to his death or Retirement, the date of death or Retirement, respectively; (c) if the Executive decides to terminate employment upon Good Reason for Termination, the date following such decision specified by the Corporation after it has been notified of the Executive's decision to terminate employment; or 36 (d) if the Executive's employment is terminated for any other reason, the date on which such termination becomes effective pursuant to a Notice of Termination. "DISABILITY" shall mean such incapacity due to physical or mental illness or injury as causes the Executive to be unable to perform his duties with the Corporation during 180 consecutive days. "GOOD REASON FOR TERMINATION" shall mean the occurrence of: (a) without the Executive's express written consent, the assignment to the Executive of any duties materially and substantially inconsistent with his positions, duties, responsibilities and status with the Corporation immediately prior to a Change-in-Control, or a material change in his reporting responsibilities, titles or offices as in effect immediately prior to a Change-in-Control, or any removal of the Executive from or any failure to re-elect the Executive to any of such positions, except in connection with the termination of the Executive's employment due to Cause for Termination, Disability or Retirement (as hereinafter defined) or as a result of the Executive's death; (b) (i) a reduction by the Corporation prior to a Change-in-Control in the Executive's base salary unless such reduction is the result of the Board of Directors of the Corporation determining that the Executive has not adequately discharged his duties; (ii) a reduction by the Corporation after a Change-in-Control in the Executive's base salary as in effect immediately prior to any Change-in-Control or a failure by the Corporation after a Change-in-Control to increase the Executive's base salary by the Annual Salary Adjustment Percentage; (c) a failure by the Corporation to continue to provide incentive compensation comparable to that provided by the Corporation immediately prior to any Change-in-Control; (d) a failure by the Corporation after a Change-in-Control to continue in effect any benefit or compensation plan, stock option plan, pension plan, life insurance plan, health and accident plan or disability plan in which the Executive is participating immediately prior thereto (provided, however, that there shall not be deemed to be any such failure if the Corporation substitutes for the discontinued plan, a plan providing the Executive with substantially similar benefits) or the taking of any action by the Corporation which would adversely affect the Executive's participation in or materially reduce the Executive's benefits under any of such plans or deprive the Executive of any material fringe benefit enjoyed by the Executive immediately prior to a Change-in-Control (provided, however, that any act or failure to act by the Corporation that is on a plan-wide basis, i.e., it similarly affects all employees of the Corporation or all employees eligible to participate in any such plan, as the case may be, shall not constitute Good Reason for Termination); (e) the failure of the Corporation to obtain the assumption of this Agreement by any successor as contemplated in SECTION 10(c) hereof; (f) any purported termination of the employment of the Executive by the Corporation which is not (i) due to the Executive's Disability, Retirement (as hereinafter defined) or Cause for Termination, or (ii) effected as a Notice of Termination, as defined herein; or (g) the Corporation's requiring the Executive to be based anywhere other than the Corporation's executive offices at which the Executive has his principal office immediately prior to a Change-in-Control or executive offices located within 50 miles of the location of the Corporation's executive offices 37 immediately prior to a Change-in-Control, except for required travel on the Corporation's business to an extent substantially consistent with the Executive's present business travel obligations. "NOTICE OF TERMINATION" shall mean a written statement which sets forth the specific reason for termination and, if such is claimed to be a Cause for Termination or Good Reason for Termination, in reasonable detail the facts and circumstances which indicate that such is Cause for Termination or Good Reason for Termination. "OPTIONS" shall mean any stock options issued pursuant to any present or future stock option plan of the Corporation. "PERSON" shall have the meaning ascribed to such term in Section 3(a)(9) of the Securities Exchange Act of 1934, as in effect on the date hereof and used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) thereof. "RETIREMENT" shall mean the termination of the Executive's employment after age 65 or in accordance with any mandatory retirement arrangement with respect to an earlier age agreed to by the Executive. "STOCK APPRECIATION RIGHT" shall mean any stock appreciation rights issued pursuant to any stock option plan of the Corporation or any future stock appreciation rights plan. 2. TERMS OF EMPLOYMENT. The Executive acknowledges that this Agreement does not constitute an employment contract and that the Executive's employment relationship with the Corporation is at-will and not for any particular period. Rather, this Agreement is only intended to set forth certain liquidated damages to be paid in the event of termination of the Executive upon the terms and conditions specified herein. 3. TERM OF AGREEMENT. The initial term of this Agreement shall be for a period of four (4) years. Upon expiration of the initial term, the Company shall, in its sole discretion, determine whether this Agreement shall be renewed upon such terms it deems advisable. 4. PAYMENTS FOLLOWING TERMINATION OF EMPLOYMENT UPON A CHANGE-IN-CONTROL. (a) If the Executive's employment with the Corporation shall be terminated: (i) due to the Executive's death, (ii) by the Executive other than the Executive's having terminated for Good Reason for Termination following a Change-in-Control, or (iii) by the Corporation due to Cause for Termination or for Disability or Retirement, then the Corporation shall have no obligations to the Executive other than to pay the Executive any unpaid portion of base salary due until the Date of Termination and any other sums due in accordance with the then various policies, practices and benefit plans of the Corporation. (b) If the Executive's employment with the Corporation shall have terminated during the period commencing six months prior to the date of a Change-in-Control and ending on the third anniversary of a Change-in-Control other than in the circumstances described in subsection (a) above, then the Corporation shall pay on or before the fifth day following the Date of Termination (or if the Date of Termination preceded the date of the Change-in-Control, on or before the fifth day following the date of the Change-in-Control), to the Executive the following sums: (i) in cash any unpaid portion of the Executive's full base salary for the period from the last period for which the Executive was paid to the Date of Termination, or the date of the Change-in-Control, as the case may be; and 38 (ii) an amount in cash as liquidated damages for lost future renumeration equal to the product obtained by multiplying (A) the lesser of (1) two, or (2) a number equal to the number of calendar months remaining from the Date of Termination to the date on which the Executive is 65 years of age (or, if earlier, the age agreed to by the Executive pursuant to any prior arrangement) divided by twelve, or (3) a number equal to the greater of (i) one (1.0) or (ii) thirty six (36) less the number of completed months commencing after the date of the Change-in-Control during which the Executive was employed by the Corporation and did not have Good Reason for Termination times (iii) one-twelfth (1/12) times (B) the sum of (1) the greater of (i) the Executive's annual base salary for the year in effect on the Date of Termination (provided that in the case of Termination for Good Reason by the Executive the date immediately preceding the date of the earliest event which gave rise to the Termination for Good Reason by the Executive shall be used instead of the Date of Termination) or (ii) the Executive's annual base salary for the year in effect on the date of the Change-in-Control; plus (2) the greater of (i) the average annual cash award received by the Executive as incentive compensation or bonus for one calendar year immediately preceding the Date of Termination (provided that in the case of Termination for Good Reason by the Executive the date immediately preceding the date of the event which gave rise to the Termination for Good Reason by the Executive shall be used instead of the Date of Termination) or (ii) the average annual cash award received by the Executive as incentive compensation or bonus for one calendar year immediately preceding the date of the Change-in-Control. 39 5. OUTPLACEMENT SERVICES. If the Executive's employment with the Corporation should terminate under circumstances as to entitle the Executive to receive payment hereunder, the Corporation shall reimburse the Executive for any reasonable fees or other costs incurred by the Executive during the two (2) years following the Date of Termination in retaining executive placement agencies, up to a maximum dollar amount not to exceed fifteen percent (15%) of the Executive's base salary at the time of such termination. Such reimbursement shall be made within five (5) days following the Executive's presentment of bills or other evidence of the costs incurred with executive placement agencies. 6. TAX IMPLICATIONS. If any payment due to the Executive pursuant to this Agreement result in a tax being imposed on the Executive pursuant to Section 4999 of the Internal Revenue Code of 1954, as amended, or any successor provision ("Section 4999"), then the Corporation shall, at the Executive's option, either (i) reduce the total payments payable to the Executive to the maximum amount payable without incurring the Section 4999 tax, or (ii) pay to the Executive the total amount payable, with the understanding that Section 4999 tax will be due on that total amount. 7. BENEFITS. If the Executive's employment with the Corporation should terminate under circumstances as to entitle the Executive to receive payment hereunder, the Executive shall also be deemed, for purposes of medical insurance, pension and other benefits of the Corporation, to have remained in the continuous employment of the Corporation for the two (2) year period following the Date of Termination and shall be entitled to all of the medical insurance, pension or other benefits provided by the Corporation as if the Executive had so remained in the employment of the Corporation. If, for any reason, whether by law or provisions of the Corporation's employee medical insurance, pension or other benefit plans, or otherwise any benefits which the Executive would be entitled to under this SECTION 6 cannot be paid pursuant to such employee benefit plans, then the Corporation contractually agrees to pay the Executive the difference between the benefits which the Executive would have received in accordance with this Section if the relevant employee medical insurance, pension or other benefit plan could have paid such benefit and the amount of benefits, if any, actually paid by such employee medical insurance, pension or other benefit plan. The Corporation shall not be required to fund its obligation to pay the foregoing difference. 8. OTHER EMPLOYMENT. In the event of termination under the circumstances contemplated in SECTION 4(b) hereunder, the Executive shall have no duty to seek any other employment after termination of his employment with the Corporation and the Corporation hereby waives and agrees not to raise or use any defense based upon the position that the Executive had a duty to mitigate or reduce the amounts due him hereunder by seeking other employment whether suitable or unsuitable and should the Executive obtain other employment, then the only effect of such on the obligations of the Corporation shall be that the Corporation shall be entitled to credit against any payments that would otherwise be made pursuant to SECTION 7 hereof, any comparable payments to which the executive is entitled under the employee benefit plans maintained by the Executive's other employer or employers in connection with services to such employer or employers after termination of this employment with the Corporation. 9. STOCK APPRECIATION RIGHTS AND OPTIONS. If the Executive's employment should terminate under circumstances as to entitle the Executive to receive payment hereunder, then with respect to any standing Stock Appreciation Rights and/or Options which did not immediately become exercisable upon the occurrence of a Change-in-Control, such Stock Appreciation Right or Option shall be automatically vested and remain outstanding in accordance with its terms and be exercisable thereafter until the stated expiration date of such Stock Appreciation Right or Option. 40 10. MISCELLANEOUS. (a) This Agreement shall be construed under the laws of the Commonwealth of Pennsylvania. (b) This Agreement constitutes the entire understanding of the parties hereto with respect to the subject matter hereof and may only be amended or modified by written agreement signed by the parties hereto. This Agreement specifically supercedes the agreement entered into between the Corporation and the Executive dated as of August 5, 1996 with respect to the subject matter hereof, and by the execution of this Agreement, the previous agreement is hereby terminated and of no further force and effect. (c) The Corporation will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Corporation, by agreement in form and substance satisfactory to the Executive, to expressly assume and agree to perform this Agreement in the same manner required of the Corporation and to perform it as if no such succession had taken place. As used in this Agreement, "Corporation" shall mean the Corporation as hereinbefore defined and any successor to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this subsection (c) or which otherwise becomes bound by all of the terms and provisions of this Agreement by operation of law. (d) This Agreement shall inure to the benefit of and be enforceable by the Executive and the Corporation and their respective legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive should die while any amounts would still be payable to him hereunder if he had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to his devisee, legatee or other designee or, if there be no such designee, to his estate. (e) Any notice or other communication provided for in this Agreement shall be in writing and, unless otherwise expressly stated herein, shall be deemed to have been duly given if mailed by United States registered mail, return receipt requested, postage prepaid, addressed in the case of the Executive to his office at the Corporation with a copy to his residence and in the case of the Corporation to its principal executive offices, attention to the Chief Executive Officer. (f) No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the Executive and approved by resolution of the Board of Directors of the Corporation. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. (g) The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or unenforceability of any other provision of this Agreement, which shall remain in full force and effect. If any provision hereof shall be deemed invalid or unenforceable, either in whole or in part, this Agreement shall be deemed amended to delete or modify, as necessary, the offending provision and to alter the bounds thereof in order to render it valid and enforceable. (h) This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which taken together will constitute one and the same instrument. (i) If litigation should be brought to enforce, interpret or challenge any provision contained herein, the prevailing party shall be entitled to its reasonable attorney's fees and disbursements and other costs incurred in such litigation and, if a money judgment be rendered in favor of the Executive, to interest on any such money judgment obtained calculated at the prime rate of interest in effect from time to time at Mellon Bank, N.A., from the date that the payment should have been made or damages incurred under this Agreement. 41 IN WITNESS WHEREOF, this Agreement has been executed on the date first above written. ATTEST TOLLGRADE COMMUNICATIONS, INC. By: - -------------------- ---------------------------- Title -------------------------------- WITNESS EXECUTIVE - -------------------- -------------------------- Richard Skaare 42 SCHEDULE 10.28 Change in Control Agreements dated October 30, 2001 were entered into between the Company and Wylie Etscheid, Carol M. Franklin and Gregory Quiggle. 43 EX-10.29 6 j9338001ex10-29.txt CHANGE IN CONTROL AGREEMENT EXHIBIT 10.29 AGREEMENT This Agreement, made as of the _____ day of January, 2002 by and between TOLLGRADE COMMUNICATIONS, INC., a Pennsylvania corporation (the "Corporation") and CHARLES L. GEIER, JR. (the "Executive"). WITNESSETH: WHEREAS, the Board of Directors of the Corporation has determined that it is in the best interests of the Corporation to enter into this Agreement with the Executive to provide for compensation of the Executive upon termination of employment under certain circumstances relating to a change in control of the Corporation; and WHEREAS, the Executive desires to obtain such benefits in the event the Executive's employment is terminated under the circumstances provided herein. NOW, THEREFORE, in consideration of the covenants and premises contained herein, and intending to be legally bound hereby, the parties hereto agree as follows: 1. DEFINITION OF TERMS. The following terms when used in this Agreement shall have the meaning hereafter set forth: "ANNUAL SALARY ADJUSTMENT PERCENTAGE" shall mean the mean average percentage increase in base salary for all elected officers of the Corporation during the two full calendar years immediately preceding the time to which such percentage is being applied; provided however, that if after a Change-in-Control, as hereinafter defined, there should be a significant change in the number of elected officers of the Corporation or in the manner in which they are compensated, then the foregoing definition shall be changed by substituting for the phrase "elected officers of the Corporation" the phrase "persons then performing the functions formerly performed by the elected officers of the Corporation." "CAUSE FOR TERMINATION" shall mean: (a) the deliberate and intentional failure by the Executive to devote substantially his entire business time and best efforts to the performance of his duties (other than any such failure resulting from the Executive's incapacity due to physical or mental illness or disability) after a demand for substantial performance is delivered to the Executive by the Board of Directors which specifically identifies the manner in which the Board of Directors believes that the Executive has not substantially performed his duties, or (b) willfully engaging by the Executive in conduct which constitutes a fraud against the Corporation or a material breach of this Agreement, or (c) the Executive's conviction of any crime which constitutes a felony. For purposes of this definition, no act, or failure to act, on the Executive's part shall be considered "deliberate and intentional" or "willfully" unless done, or omitted to be done, by the Executive not in good faith and without reasonable belief that his action or omission was in the best interests of the Corporation. "CHANGE-IN-CONTROL" shall mean the determination (which may be made effective as of a particular date specified by the Board of Directors of the Corporation) by the Board of Directors of the Corporation, made by a 44 majority vote 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 Corporation on the date hereof (the "Current Owners")(or any individual or entity which receives from a Current Owner an interest in the Corporation through will or the laws of descent and distribution) maintain more than a sixty-five percent (65%) interest in the resultant entity. Regardless of the Board's vote or whether or not the Board votes, a Change-in-Control will be deemed to have occurred as of the first day any one (1) or more of the following subparagraphs shall have been satisfied: (a) Any Person (other than the Person in control of the Corporation as of the date of this Agreement, or other than a trustee or other fiduciary holding securities under an employee benefit plan of the Corporation, or a corporation owned directly or indirectly by the stockholders of the Corporation in substantially the same proportions as their ownership of stock of the Corporation), becomes the beneficial owner, directly or indirectly, of securities of the Corporation representing more than thirty five percent (35%) of the combined voting power of the Corporation's then outstanding securities; or (b) The stockholders of the Corporation approve: (i) A plan of complete liquidation of the Corporation; (iii) An agreement for the sale or disposition of all or substantially all of the Corporation's assets; or (iii) A merger, consolidation, or reorganization of the Corporation with or involving any other corporation, other than a merger, consolidation, or reorganization that would result in the voting securities of the Corporation outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least sixty-five percent (65%) of the combined voting power of the voting securities of the Corporation (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 the Executive, if the Executive is part of a purchasing group which consummates the Change-in-Control transaction. The Executive shall be deemed "part of the purchasing group" for purposes of the preceding sentence if the Executive 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 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 non-employee continuing Directors of the Board of Directors of the Corporation). "DATE OF TERMINATION" shall mean: (a) if the Executive's employment is terminated for Disability, the date that a Notice of Termination is given to the Executive; (b) if the Executive terminates due to his death or Retirement, the date of death or Retirement, respectively; (c) if the Executive decides to terminate employment upon Good Reason for Termination, the date following such decision specified by the Corporation after it has been notified of the Executive's decision to terminate employment; or (d) if the Executive's employment is terminated for any other reason, the date on which such termination becomes effective pursuant to a Notice of Termination. 45 "DISABILITY" shall mean such incapacity due to physical or mental illness or injury as causes the Executive to be unable to perform his duties with the Corporation during 180 consecutive days. "GOOD REASON FOR TERMINATION" shall mean the occurrence of: (a) without the Executive's express written consent, the assignment to the Executive of any duties materially and substantially inconsistent with his positions, duties, responsibilities and status with the Corporation immediately prior to a Change-in-Control, or a material change in his reporting responsibilities, titles or offices as in effect immediately prior to a Change-in-Control, or any removal of the Executive from or any failure to re-elect the Executive to any of such positions, except in connection with the termination of the Executive's employment due to Cause for Termination, Disability or Retirement (as hereinafter defined) or as a result of the Executive's death; (b) (i) a reduction by the Corporation prior to a Change-in-Control in the Executive's base salary unless such reduction is the result of the Board of Directors of the Corporation determining that the Executive has not adequately discharged his duties; (ii) a reduction by the Corporation after a Change-in-Control in the Executive's base salary as in effect immediately prior to any Change-in-Control or a failure by the Corporation after a Change-in-Control to increase the Executive's base salary by the Annual Salary Adjustment Percentage; (c) a failure by the Corporation to continue to provide incentive compensation comparable to that provided by the Corporation immediately prior to any Change-in-Control; (d) a failure by the Corporation after a Change-in-Control to continue in effect any benefit or compensation plan, stock option plan, pension plan, life insurance plan, health and accident plan or disability plan in which the Executive is participating immediately prior thereto (provided, however, that there shall not be deemed to be any such failure if the Corporation substitutes for the discontinued plan, a plan providing the Executive with substantially similar benefits) or the taking of any action by the Corporation which would adversely affect the Executive's participation in or materially reduce the Executive's benefits under any of such plans or deprive the Executive of any material fringe benefit enjoyed by the Executive immediately prior to a Change-in-Control (provided, however, that any act or failure to act by the Corporation that is on a plan-wide basis, i.e., it similarly affects all employees of the Corporation or all employees eligible to participate in any such plan, as the case may be, shall not constitute Good Reason for Termination); (e) the failure of the Corporation to obtain the assumption of this Agreement by any successor as contemplated in SECTION 10(c) hereof; (f) any purported termination of the employment of the Executive by the Corporation which is not (i) due to the Executive's Disability, Retirement (as hereinafter defined) or Cause for Termination, or (ii) effected as a Notice of Termination, as defined herein; or (g) the Corporation's requiring the Executive to be based anywhere other than the Corporation's executive offices at which the Executive has his principal office immediately prior to a Change-in-Control or executive offices located within 50 miles of the location of the Corporation's executive offices immediately prior to a Change-in-Control, except for required travel on the Corporation's business to an extent substantially consistent with the Executive's present business travel obligations. 46 "NOTICE OF TERMINATION" shall mean a written statement which sets forth the specific reason for termination and, if such is claimed to be a Cause for Termination or Good Reason for Termination, in reasonable detail the facts and circumstances which indicate that such is Cause for Termination or Good Reason for Termination. "OPTIONS" shall mean any stock options issued pursuant to any present or future stock option plan of the Corporation. "PERSON" shall have the meaning ascribed to such term in Section 3(a)(9) of the Securities Exchange Act of 1934, as in effect on the date hereof and used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) thereof. "RETIREMENT" shall mean the termination of the Executive's employment after age 65 or in accordance with any mandatory retirement arrangement with respect to an earlier age agreed to by the Executive. "STOCK APPRECIATION RIGHT" shall mean any stock appreciation rights issued pursuant to any stock option plan of the Corporation or any future stock appreciation rights plan. 2. TERMS OF EMPLOYMENT. The Executive acknowledges that this Agreement does not constitute an employment contract and that the Executive's employment relationship with the Corporation is at-will and not for any particular period. Rather, this Agreement is only intended to set forth certain liquidated damages to be paid in the event of termination of the Executive upon the terms and conditions specified herein. 3. TERM OF AGREEMENT. The initial term of this Agreement shall be for a period of four (4) years. Upon expiration of the initial term, the Company shall, in its sole discretion, determine whether this Agreement shall be renewed upon such terms it deems advisable. 4. PAYMENTS FOLLOWING TERMINATION OF EMPLOYMENT UPON A CHANGE-IN-CONTROL. (a) If the Executive's employment with the Corporation shall be terminated: (i) due to the Executive's death, (ii) by the Executive other than the Executive's having terminated for Good Reason for Termination following a Change-in-Control, or (iii) by the Corporation due to Cause for Termination or for Disability or Retirement, then the Corporation shall have no obligations to the Executive other than to pay the Executive any unpaid portion of base salary due until the Date of Termination and any other sums due in accordance with the then various policies, practices and benefit plans of the Corporation. (b) If the Executive's employment with the Corporation shall have terminated during the period commencing six months prior to the date of a Change-in-Control and ending on the third anniversary of a Change-in-Control other than in the circumstances described in subsection (a) above, then the Corporation shall pay on or before the fifth day following the Date of Termination (or if the Date of Termination preceded the date of the Change-in-Control, on or before the fifth day following the date of the Change-in-Control), to the Executive the following sums: (i) in cash any unpaid portion of the Executive's full base salary for the period from the last period for which the Executive was paid to the Date of Termination, or the date of the Change-in-Control, as the case may be; and 47 (ii) an amount in cash as liquidated damages for lost future remuneration equal to the product obtained by multiplying (A) the lesser of (1) two, or (2) a number equal to the number of calendar months remaining from the Date of Termination to the date on which the Executive is 65 years of age (or, if earlier, the age agreed to by the Executive pursuant to any prior arrangement) divided by twelve, or (3) a number equal to the greater of (i) one (1.0) or (ii) thirty six (36) less the number of completed months commencing after the date of the Change-in-Control during which the Executive was employed by the Corporation and did not have Good Reason for Termination times (iii) one-twelfth (1/12) times (B) the sum of (1) the greater of (i) the Executive's annual base salary for the year in effect on the Date of Termination (provided that in the case of Termination for Good Reason by the Executive the date immediately preceding the date of the earliest event which gave rise to the Termination for Good Reason by the Executive shall be used instead of the Date of Termination) or (ii) the Executive's annual base salary for the year in effect on the date of the Change-in-Control; plus (2) the greater of (i) the average annual cash award received by the Executive as incentive compensation or bonus for one calendar year immediately preceding the Date of Termination (provided that in the case of Termination for Good Reason by the Executive the date immediately preceding the date of the event which gave rise to the Termination for Good Reason by the Executive shall be used instead of the Date of Termination) or (ii) the average annual cash award received by the Executive as incentive compensation or bonus for one calendar year immediately preceding the date of the Change-in-Control. 48 5. OUTPLACEMENT SERVICES. If the Executive's employment with the Corporation should terminate under circumstances as to entitle the Executive to receive payment hereunder, the Corporation shall reimburse the Executive for any reasonable fees or other costs incurred by the Executive during the two (2) years following the Date of Termination in retaining executive placement agencies, up to a maximum dollar amount not to exceed fifteen percent (15%) of the Executive's base salary at the time of such termination. Such reimbursement shall be made within five (5) days following the Executive's presentment of bills or other evidence of the costs incurred with executive placement agencies. 6. TAX IMPLICATIONS. If any payment due to the Executive pursuant to this Agreement result in a tax being imposed on the Executive pursuant to Section 4999 of the Internal Revenue Code of 1954, as amended, or any successor provision ("Section 4999"), then the Corporation shall, at the Executive's option, either (i) reduce the total payments payable to the Executive to the maximum amount payable without incurring the Section 4999 tax, or (ii) pay to the Executive the total amount payable, with the understanding that Section 4999 tax will be due on that total amount. 7. BENEFITS. If the Executive's employment with the Corporation should terminate under circumstances as to entitle the Executive to receive payment hereunder, the Executive shall also be deemed, for purposes of medical insurance, pension and other benefits of the Corporation, to have remained in the continuous employment of the Corporation for the two (2) year period following the Date of Termination and shall be entitled to all of the medical insurance, pension or other benefits provided by the Corporation as if the Executive had so remained in the employment of the Corporation. If, for any reason, whether by law or provisions of the Corporation's employee medical insurance, pension or other benefit plans, or otherwise any benefits which the Executive would be entitled to under this SECTION 6 cannot be paid pursuant to such employee benefit plans, then the Corporation contractually agrees to pay the Executive the difference between the benefits which the Executive would have received in accordance with this Section if the relevant employee medical insurance, pension or other benefit plan could have paid such benefit and the amount of benefits, if any, actually paid by such employee medical insurance, pension or other benefit plan. The Corporation shall not be required to fund its obligation to pay the foregoing difference. 8. OTHER EMPLOYMENT. In the event of termination under the circumstances contemplated in SECTION 4(b) hereunder, the Executive shall have no duty to seek any other employment after termination of his employment with the Corporation and the Corporation hereby waives and agrees not to raise or use any defense based upon the position that the Executive had a duty to mitigate or reduce the amounts due him hereunder by seeking other employment whether suitable or unsuitable and should the Executive obtain other employment, then the only effect of such on the obligations of the Corporation shall be that the Corporation shall be entitled to credit against any payments that would otherwise be made pursuant to SECTION 7 hereof, any comparable payments to which the executive is entitled under the employee benefit plans maintained by the Executive's other employer or employers in connection with services to such employer or employers after termination of this employment with the Corporation. 9. STOCK APPRECIATION RIGHTS AND OPTIONS. If the Executive's employment should terminate under circumstances as to entitle the Executive to receive payment hereunder, then with respect to any standing Stock Appreciation Rights and/or Options which did not immediately become exercisable upon the occurrence of a Change-in-Control, such Stock Appreciation Right or Option shall be automatically vested and remain outstanding in accordance with its terms and be exercisable thereafter until the stated expiration date of such Stock Appreciation Right or Option. 49 10. MISCELLANEOUS. (a) This Agreement shall be construed under the laws of the Commonwealth of Pennsylvania. (b) This Agreement constitutes the entire understanding of the parties hereto with respect to the subject matter hereof and may only be amended or modified by written agreement signed by the parties hereto. This Agreement specifically supercedes the agreement entered into between the Corporation and the Executive dated as of August 5, 1996 with respect to the subject matter hereof, and by the execution of this Agreement, the previous agreement is hereby terminated and of no further force and effect. (c) The Corporation will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Corporation, by agreement in form and substance satisfactory to the Executive, to expressly assume and agree to perform this Agreement in the same manner required of the Corporation and to perform it as if no such succession had taken place. As used in this Agreement, "Corporation" shall mean the Corporation as hereinbefore defined and any successor to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this subsection (c) or which otherwise becomes bound by all of the terms and provisions of this Agreement by operation of law. (d) This Agreement shall inure to the benefit of and be enforceable by the Executive and the Corporation and their respective legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive should die while any amounts would still be payable to him hereunder if he had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to his devisee, legatee or other designee or, if there be no such designee, to his estate. (e) Any notice or other communication provided for in this Agreement shall be in writing and, unless otherwise expressly stated herein, shall be deemed to have been duly given if mailed by United States registered mail, return receipt requested, postage prepaid, addressed in the case of the Executive to his office at the Corporation with a copy to his residence and in the case of the Corporation to its principal executive offices, attention to the Chief Executive Officer. (f) No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the Executive and approved by resolution of the Board of Directors of the Corporation. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. (g) The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or unenforceability of any other provision of this Agreement, which shall remain in full force and effect. If any provision hereof shall be deemed invalid or unenforceable, either in whole or in part, this Agreement shall be deemed amended to delete or modify, as necessary, the offending provision and to alter the bounds thereof in order to render it valid and enforceable. (h) This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which taken together will constitute one and the same instrument. (i) If litigation should be brought to enforce, interpret or challenge any provision contained herein, the prevailing party shall be entitled to its reasonable attorney's fees and disbursements and other costs incurred in such litigation and, if a money judgment be rendered in favor of the Executive, to interest on any such money judgment obtained calculated at the prime rate of interest in effect from time to time at Mellon Bank, N.A., from the date that the payment should have been made or damages incurred under this Agreement. 50 IN WITNESS WHEREOF, this Agreement has been executed on the date first above written. ATTEST TOLLGRADE COMMUNICATIONS, INC. By: - -------------------- -------------------------- Title ------------------------------- WITNESS EXECUTIVE - ----------------------- -------------------------- Charles L. Geier, Jr. 51 EX-10.30 7 j9338001ex10-30.txt CHANGE IN CONTROL AGREEMENT EXHIBIT 10.30 AGREEMENT This Agreement, made as of the _____ day of January, 2002 by and between TOLLGRADE COMMUNICATIONS, INC., a Pennsylvania corporation (the "Corporation") and JAMES D. COLEMAN (the "Executive"). WITNESSETH: WHEREAS, the Board of Directors of the Corporation has determined that it is in the best interests of the Corporation to enter into this Agreement with the Executive to provide for compensation of the Executive upon termination of employment under certain circumstances relating to a change in control of the Corporation; and WHEREAS, the Executive desires to obtain such benefits in the event the Executive's employment is terminated under the circumstances provided herein. NOW, THEREFORE, in consideration of the covenants and premises contained herein, and intending to be legally bound hereby, the parties hereto agree as follows: 1. DEFINITION OF TERMS. The following terms when used in this Agreement shall have the meaning hereafter set forth: "ANNUAL SALARY ADJUSTMENT PERCENTAGE" shall mean the mean average percentage increase in base salary for all elected officers of the Corporation during the two full calendar years immediately preceding the time to which such percentage is being applied; provided however, that if after a Change-in-Control, as hereinafter defined, there should be a significant change in the number of elected officers of the Corporation or in the manner in which they are compensated, then the foregoing definition shall be changed by substituting for the phrase "elected officers of the Corporation" the phrase "persons then performing the functions formerly performed by the elected officers of the Corporation." "CAUSE FOR TERMINATION" shall mean: (a) the deliberate and intentional failure by the Executive to devote substantially his entire business time and best efforts to the performance of his duties (other than any such failure resulting from the Executive's incapacity due to physical or mental illness or disability) after a demand for substantial performance is delivered to the Executive by the Board of Directors which specifically identifies the manner in which the Board of Directors believes that the Executive has not substantially performed his duties, or (b) willfully engaging by the Executive in conduct which constitutes a fraud against the Corporation or a material breach of this Agreement, or (c) the Executive's conviction of any crime which constitutes a felony. For purposes of this definition, no act, or failure to act, on the Executive's part shall be considered "deliberate and intentional" or "willfully" unless done, or omitted to be done, by the Executive not in good faith and without reasonable belief that his action or omission was in the best interests of the Corporation. 52 "CHANGE-IN-CONTROL" shall mean the determination (which may be made effective as of a particular date specified by the Board of Directors of the Corporation) by the Board of Directors of the Corporation, made by a majority vote 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 Corporation on the date hereof (the "Current Owners")(or any individual or entity which receives from a Current Owner an interest in the Corporation through will or the laws of descent and distribution) maintain more than a sixty-five percent (65%) interest in the resultant entity. Regardless of the Board's vote or whether or not the Board votes, a Change-in-Control will be deemed to have occurred as of the first day any one (1) or more of the following subparagraphs shall have been satisfied: (a) Any Person (other than the Person in control of the Corporation as of the date of this Agreement, or other than a trustee or other fiduciary holding securities under an employee benefit plan of the Corporation, or a corporation owned directly or indirectly by the stockholders of the Corporation in substantially the same proportions as their ownership of stock of the Corporation), becomes the beneficial owner, directly or indirectly, of securities of the Corporation representing more than thirty five percent (35%) of the combined voting power of the Corporation's then outstanding securities; or (b) The stockholders of the Corporation approve: (i) A plan of complete liquidation of the Corporation; (iv) An agreement for the sale or disposition of all or substantially all of the Corporation's assets; or (iii) A merger, consolidation, or reorganization of the Corporation with or involving any other corporation, other than a merger, consolidation, or reorganization that would result in the voting securities of the Corporation outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least sixty-five percent (65%) of the combined voting power of the voting securities of the Corporation (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 the Executive, if the Executive is part of a purchasing group which consummates the Change-in-Control transaction. The Executive shall be deemed "part of the purchasing group" for purposes of the preceding sentence if the Executive 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 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 non-employee continuing Directors of the Board of Directors of the Corporation). "DATE OF TERMINATION" shall mean: (a) if the Executive's employment is terminated for Disability, the date that a Notice of Termination is given to the Executive; (b) if the Executive terminates due to his death or Retirement, the date of death or Retirement, respectively; (c) if the Executive decides to terminate employment upon Good Reason for Termination, the date following such decision specified by the Corporation after it has been notified of the Executive's decision to terminate employment; or 53 (d) if the Executive's employment is terminated for any other reason, the date on which such termination becomes effective pursuant to a Notice of Termination. "DISABILITY" shall mean such incapacity due to physical or mental illness or injury as causes the Executive to be unable to perform his duties with the Corporation during 180 consecutive days. "GOOD REASON FOR TERMINATION" shall mean the occurrence of: (a) without the Executive's express written consent, the assignment to the Executive of any duties materially and substantially inconsistent with his positions, duties, responsibilities and status with the Corporation immediately prior to a Change-in-Control, or a material change in his reporting responsibilities, titles or offices as in effect immediately prior to a Change-in-Control, or any removal of the Executive from or any failure to re-elect the Executive to any of such positions, except in connection with the termination of the Executive's employment due to Cause for Termination, Disability or Retirement (as hereinafter defined) or as a result of the Executive's death; (b) (i) a reduction by the Corporation prior to a Change-in-Control in the Executive's base salary unless such reduction is the result of the Board of Directors of the Corporation determining that the Executive has not adequately discharged his duties; (ii) a reduction by the Corporation after a Change-in-Control in the Executive's base salary as in effect immediately prior to any Change-in-Control or a failure by the Corporation after a Change-in-Control to increase the Executive's base salary by the Annual Salary Adjustment Percentage; (c) a failure by the Corporation to continue to provide incentive compensation comparable to that provided by the Corporation immediately prior to any Change-in-Control; (d) a failure by the Corporation after a Change-in-Control to continue in effect any benefit or compensation plan, stock option plan, pension plan, life insurance plan, health and accident plan or disability plan in which the Executive is participating immediately prior thereto (provided, however, that there shall not be deemed to be any such failure if the Corporation substitutes for the discontinued plan, a plan providing the Executive with substantially similar benefits) or the taking of any action by the Corporation which would adversely affect the Executive's participation in or materially reduce the Executive's benefits under any of such plans or deprive the Executive of any material fringe benefit enjoyed by the Executive immediately prior to a Change-in-Control (provided, however, that any act or failure to act by the Corporation that is on a plan-wide basis, i.e., it similarly affects all employees of the Corporation or all employees eligible to participate in any such plan, as the case may be, shall not constitute Good Reason for Termination); (e) the failure of the Corporation to obtain the assumption of this Agreement by any successor as contemplated in SECTION 10(c) hereof; (f) any purported termination of the employment of the Executive by the Corporation which is not (i) due to the Executive's Disability, Retirement (as hereinafter defined) or Cause for Termination, or (ii) effected as a Notice of Termination, as defined herein; or (g) the Corporation's requiring the Executive to be based anywhere other than the Corporation's executive offices at which the Executive has his principal office immediately prior to a Change-in-Control or executive offices located within 50 miles of the location of the Corporation's executive offices immediately prior to a Change-in-Control, except for required travel on the Corporation's business to an extent substantially consistent with the Executive's present business travel obligations. 54 "NOTICE OF TERMINATION" shall mean a written statement which sets forth the specific reason for termination and, if such is claimed to be a Cause for Termination or Good Reason for Termination, in reasonable detail the facts and circumstances which indicate that such is Cause for Termination or Good Reason for Termination. "OPTIONS" shall mean any stock options issued pursuant to any present or future stock option plan of the Corporation. "PERSON" shall have the meaning ascribed to such term in Section 3(a)(9) of the Securities Exchange Act of 1934, as in effect on the date hereof and used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) thereof. "RETIREMENT" shall mean the termination of the Executive's employment after age 65 or in accordance with any mandatory retirement arrangement with respect to an earlier age agreed to by the Executive. "STOCK APPRECIATION RIGHT" shall mean any stock appreciation rights issued pursuant to any stock option plan of the Corporation or any future stock appreciation rights plan. 2. TERMS OF EMPLOYMENT. The Executive acknowledges that this Agreement does not constitute an employment contract and that the Executive's employment relationship with the Corporation is at-will and not for any particular period. Rather, this Agreement is only intended to set forth certain liquidated damages to be paid in the event of termination of the Executive upon the terms and conditions specified herein. 3. TERM OF AGREEMENT. The initial term of this Agreement shall be for a period of four (4) years. Upon expiration of the initial term, the Company shall, in its sole discretion, determine whether this Agreement shall be renewed upon such terms it deems advisable. 4. PAYMENTS FOLLOWING TERMINATION OF EMPLOYMENT UPON A CHANGE-IN-CONTROL. (a) If the Executive's employment with the Corporation shall be terminated: (i) due to the Executive's death, (ii) by the Executive other than the Executive's having terminated for Good Reason for Termination following a Change-in-Control, or (iii) by the Corporation due to Cause for Termination or for Disability or Retirement, then the Corporation shall have no obligations to the Executive other than to pay the Executive any unpaid portion of base salary due until the Date of Termination and any other sums due in accordance with the then various policies, practices and benefit plans of the Corporation. (b) If the Executive's employment with the Corporation shall have terminated during the period commencing six months prior to the date of a Change-in-Control and ending on the third anniversary of a Change-in-Control other than in the circumstances described in subsection (a) above, then the Corporation shall pay on or before the fifth day following the Date of Termination (or if the Date of Termination preceded the date of the Change-in-Control, on or before the fifth day following the date of the Change-in-Control), to the Executive the following sums: (i) in cash any unpaid portion of the Executive's full base salary for the period from the last period for which the Executive was paid to the Date of Termination, or the date of the Change-in-Control, as the case may be; and 55 (ii) an amount in cash as liquidated damages for lost future renumeration equal to the product obtained by multiplying (A) the lesser of (1) two, or (2) a number equal to the number of calendar months remaining from the Date of Termination to the date on which the Executive is 65 years of age (or, if earlier, the age agreed to by the Executive pursuant to any prior arrangement) divided by twelve, or (3) a number equal to the greater of (i) one (1.0) or (ii) thirty six (36) less the number of completed months commencing after the date of the Change-in-Control during which the Executive was employed by the Corporation and did not have Good Reason for Termination times (iii) one-twelfth (1/12) times (B) the sum of (1) the greater of (i) the Executive's annual base salary for the year in effect on the Date of Termination (provided that in the case of Termination for Good Reason by the Executive the date immediately preceding the date of the earliest event which gave rise to the Termination for Good Reason by the Executive shall be used instead of the Date of Termination) or (ii) the Executive's annual base salary for the year in effect on the date of the Change-in-Control; plus (2) the greater of (i) the average annual cash award received by the Executive as incentive compensation or bonus for one calendar year immediately preceding the Date of Termination (provided that in the case of Termination for Good Reason by the Executive the date immediately preceding the date of the event which gave rise to the Termination for Good Reason by the Executive shall be used instead of the Date of Termination) or (ii) the average annual cash award received by the Executive as incentive compensation or bonus for one calendar year immediately preceding the date of the Change-in-Control. 56 5. OUTPLACEMENT SERVICES. If the Executive's employment with the Corporation should terminate under circumstances as to entitle the Executive to receive payment hereunder, the Corporation shall reimburse the Executive for any reasonable fees or other costs incurred by the Executive during the two (2) years following the Date of Termination in retaining executive placement agencies, up to a maximum dollar amount not to exceed fifteen percent (15%) of the Executive's base salary at the time of such termination. Such reimbursement shall be made within five (5) days following the Executive's presentment of bills or other evidence of the costs incurred with executive placement agencies. 6. TAX IMPLICATIONS. If any payment due to the Executive pursuant to this Agreement result in a tax being imposed on the Executive pursuant to Section 4999 of the Internal Revenue Code of 1954, as amended, or any successor provision ("Section 4999"), then the Corporation shall, at the Executive's option, either (i) reduce the total payments payable to the Executive to the maximum amount payable without incurring the Section 4999 tax, or (ii) pay to the Executive the total amount payable, with the understanding that Section 4999 tax will be due on that total amount. 7. BENEFITS. If the Executive's employment with the Corporation should terminate under circumstances as to entitle the Executive to receive payment hereunder, the Executive shall also be deemed, for purposes of medical insurance, pension and other benefits of the Corporation, to have remained in the continuous employment of the Corporation for the two (2) year period following the Date of Termination and shall be entitled to all of the medical insurance, pension or other benefits provided by the Corporation as if the Executive had so remained in the employment of the Corporation. If, for any reason, whether by law or provisions of the Corporation's employee medical insurance, pension or other benefit plans, or otherwise any benefits which the Executive would be entitled to under this SECTION 6 cannot be paid pursuant to such employee benefit plans, then the Corporation contractually agrees to pay the Executive the difference between the benefits which the Executive would have received in accordance with this Section if the relevant employee medical insurance, pension or other benefit plan could have paid such benefit and the amount of benefits, if any, actually paid by such employee medical insurance, pension or other benefit plan. The Corporation shall not be required to fund its obligation to pay the foregoing difference. 8. OTHER EMPLOYMENT. In the event of termination under the circumstances contemplated in SECTION 4(b) hereunder, the Executive shall have no duty to seek any other employment after termination of his employment with the Corporation and the Corporation hereby waives and agrees not to raise or use any defense based upon the position that the Executive had a duty to mitigate or reduce the amounts due him hereunder by seeking other employment whether suitable or unsuitable and should the Executive obtain other employment, then the only effect of such on the obligations of the Corporation shall be that the Corporation shall be entitled to credit against any payments that would otherwise be made pursuant to SECTION 7 hereof, any comparable payments to which the executive is entitled under the employee benefit plans maintained by the Executive's other employer or employers in connection with services to such employer or employers after termination of this employment with the Corporation. 9. STOCK APPRECIATION RIGHTS AND OPTIONS. If the Executive's employment should terminate under circumstances as to entitle the Executive to receive payment hereunder, then with respect to any standing Stock Appreciation Rights and/or Options which did not immediately become exercisable upon the occurrence of a Change-in-Control, such Stock Appreciation Right or Option shall be automatically vested and remain outstanding in accordance with its terms and be exercisable thereafter until the stated expiration date of such Stock Appreciation Right or Option. 57 10. MISCELLANEOUS. (a) This Agreement shall be construed under the laws of the Commonwealth of Pennsylvania. (b) This Agreement constitutes the entire understanding of the parties hereto with respect to the subject matter hereof and may only be amended or modified by written agreement signed by the parties hereto. This Agreement specifically supercedes the agreement entered into between the Corporation and the Executive dated as of August 5, 1996 with respect to the subject matter hereof, and by the execution of this Agreement, the previous agreement is hereby terminated and of no further force and effect. (c) The Corporation will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Corporation, by agreement in form and substance satisfactory to the Executive, to expressly assume and agree to perform this Agreement in the same manner required of the Corporation and to perform it as if no such succession had taken place. As used in this Agreement, "Corporation" shall mean the Corporation as hereinbefore defined and any successor to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this subsection (c) or which otherwise becomes bound by all of the terms and provisions of this Agreement by operation of law. (d) This Agreement shall inure to the benefit of and be enforceable by the Executive and the Corporation and their respective legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive should die while any amounts would still be payable to him hereunder if he had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to his devisee, legatee or other designee or, if there be no such designee, to his estate. (e) Any notice or other communication provided for in this Agreement shall be in writing and, unless otherwise expressly stated herein, shall be deemed to have been duly given if mailed by United States registered mail, return receipt requested, postage prepaid, addressed in the case of the Executive to his office at the Corporation with a copy to his residence and in the case of the Corporation to its principal executive offices, attention to the Chief Executive Officer. (f) No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the Executive and approved by resolution of the Board of Directors of the Corporation. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. (g) The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or unenforceability of any other provision of this Agreement, which shall remain in full force and effect. If any provision hereof shall be deemed invalid or unenforceable, either in whole or in part, this Agreement shall be deemed amended to delete or modify, as necessary, the offending provision and to alter the bounds thereof in order to render it valid and enforceable. (h) This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which taken together will constitute one and the same instrument. (i) If litigation should be brought to enforce, interpret or challenge any provision contained herein, the prevailing party shall be entitled to its reasonable attorney's fees and disbursements and other costs incurred in such litigation and, if a money judgment be rendered in favor of the Executive, to interest on any such money judgment obtained calculated at the prime rate of interest in effect from time to time at Mellon Bank, N.A., from the date that the payment should have been made or damages incurred under this Agreement. 58 IN WITNESS WHEREOF, this Agreement has been executed on the date first above written. ATTEST TOLLGRADE COMMUNICATIONS, INC. By: - ---------------------- ------------------------ Title ---------------------------- WITNESS EXECUTIVE - ------------------- --------------------------- James D. Coleman 59 EX-13.1 8 j9338001ex13-1.txt 2001 ANNUAL REPORT Exhibit 13.1 [PHOTO] DRIVING CONSUMER BROADBAND ASSURANCE TOLLGRADE COMMUNICATIONS, INC. 2001 ANNUAL REPORT ================================================================================ [PHOTO] DRIVING CONSUMER BROADBAND ASSURANCE Video on Demand...High-Speed Data Transmission... Digital Subscriber Line...Video Phones. These buzzwords all revolve around a single technology: Broadband. Broadband is the leading-edge technology of tomorrow that utilizes the maximum amount of bandwidth available to support numerous voice, video and data channels simultaneously. It's also a technology that we believe should be treated as a consumer service. And assuring consumer communications networks is what Tollgrade is all about. Curiously, the marketplace has been slow to respond to this emerging technology. Part of the reason for the slower-than-expected growth of broadband has been the struggle that service providers have had with wide-scale DSL deployment. The sudden slowdown of the Competitive Local Exchange Carrier (CLEC) industry, which had been a driving force behind DSL deployment, certainly has limited the competitive push. At the same time, broadband technology must also overcome the fact that it has proven too costly and manpower-intensive for Incumbent Local Exchange Carriers (ILECs) to efficiently deliver to the consumer marketplace. We believe that using tried-and-true consumer network assurance approaches will be the key to successful roll-out of these services. Additionally, over the long-term, there will likely be a move to converge private line (medium and large businesses) and consumer networks into a single IP/ATM architecture. There is an increased focus on providing the best maintenance processes for mature networks. Finally, the industry is seeing an increased emergence of passive optical networks, which has rejuvenated interest in "fiber-to-the-curb," or "broadband edge," applications. These market drivers, coupled with an intense demand for products that reduce deployment costs, indicate that the broadband world is ripe with opportunity. As a premier provider of leading-edge test and management solutions for consumer networks, Tollgrade has positioned itself to contribute significantly to this next phase of the communication evolution. ================================================================================ - -------------------------------------------------------------------------------- 2001 FINANCIAL HIGHLIGHTS
(In thousands, except per share data and number of employees) December 31, 2000 DECEMBER 31, 2001 OPERATIONS Total Revenues $ 114,426 $ 82,239 - -------------------------------------------------------------------------------- Net Income $ 27,495 $ 13,675 - -------------------------------------------------------------------------------- Earnings Per Share -- Diluted $ 2.06 $ 1.02 - -------------------------------------------------------------------------------- Weighted Average Shares of Common Stock and Equivalents 13,359,270 13,412,037 - -------------------------------------------------------------------------------- Number of Employees 411 341 - -------------------------------------------------------------------------------- FINANCIAL POSITION Total Assets $ 131,275 $ 146,630 - -------------------------------------------------------------------------------- Working Capital $ 111,135 $ 67,628 - -------------------------------------------------------------------------------- Shareholders' Equity $ 122,760 $ 140,139 - --------------------------------------------------------------------------------
TABLE OF CONTENTS 2001 Financial Highlights...............1 Letter to Shareholders..................2 Driving Broadband Assurance to the Consumer Marketplace...........4 Selected Consolidated Financial Data....8 Management's Discussion and Analysis of Results of Operations and Financial Condition...............9 Statement of Management's Responsibility for Financial Reporting............................16 Report of Independent Accountants......17 Consolidated Financial Statements......18 Notes to the Consolidated Financial Statements.................22 Shareholder Information...............IBC Board of Directors, Executive Council and Officers......IBC
REVENUES (DOLLARS IN THOUSANDS) 1997 $45,421* 1998 $46,277* 1999 $61,111 2000 $114,426 2001 $82,239 *Includes license fees of $250 and $150, respectively
NET INCOME (DOLLARS IN THOUSANDS) 1997 $6,883 1998 $6,967 1999 $10,623 2000 $27,495 2001 $13,675
DILUTED EARNINGS PER SHARE 1997 $0.58 1998 $0.58 1999 $0.89 2000 $2.06 2001 $1.02
- -------------------------------------------------------------------------------- 1 ================================================================================ "WE EVOLVED FROM BEING A NICHE PLAYER TO A MAJOR SYSTEM PROVIDER BY ACQUIRING LOOPCARE." - -------------------------------------------------------------------------------- [PHOTO] DEAR SHAREHOLDER, 2001 was a tough year for everyone in the telecommunications equipment industry. Fortunately, we weathered the storm by continuing to focus on products and services that help our customers reduce costs and effectively deploy new services. Rather than contracting into our shell and deviating from our strategy, Tollgrade chose to use this time to build for the consumer broadband future. Specifically, we evolved from a niche player to a major system provider by acquiring the LoopCare(TM) OSS (Operations Support System) product from Lucent Technologies and positioning it with our MCU(R) products, DigiTest(R) system and Professional Services programs to provide a total solution strategy for assuring POTS (Plain Old Telephone Services) and consumer broadband networks. We also remained resolute on focusing on our core competency -- maintaining the quality of consumer communications networks. RATHER THAN CONTRACTING INTO OUR SHELL AND DEVIATING FROM OUR STRATEGY, TOLLGRADE CHOSE TO USE THIS TIME TO BUILD FOR THE CONSUMER BROADBAND FUTURE. To achieve our long-term goals, we've also retrenched our staff and made significant additions to our management team. In addition, we formed new, non-exclusive distribution agreements with Lucent and Acterna to grow our business internationally. Our organization also focused on a core group of product development initiatives tied to specific market segments and major industry trends related to the consumer broadband world. In 2001, our revenue was $82.2 million and our earnings per share was $1.02. Gross profit was 56 percent of revenue; operating expenses came in at 32 percent. We invested more in research and development as a result of adding more than 30 developers through the LoopCare acquisition. EBITDA was 27 percent of revenue, income from operations was approximately 24 percent of revenue and net income a healthy 17 percent of revenue. Last year we embarked upon a significant testability improvement initiative in the former Ameritech region of SBC. This led to a record year of MCU product sales in the region as well as significant Professional Services work. We also undertook a successful testability program in Verizon. In SBC, we shipped our first DigiTest systems to the region as part of a major MLT-1 replacement effort. This included the sale of our ATP (Advanced Test Package) feature for our LoopCare OSS. In addition, our balance sheet remains strong. Despite spending more than $62 million for LoopCare, we ended the year with $38.7 million in cash and investments. We have no debt. The purchase of LoopCare in 2001 was arguably the most significant event in our company's history. LoopCare controls the testing of approximately 143 million of the 180 million total POTS telephone lines in the United States. Globally, you can add another 8 million lines to the mix. By incorporating LoopCare into our product menu, we now offer a total test and management solution, which can be economically scalable for both the largest RBOCs (Regional Bell Operating Companies) and the smallest CLECs (Competitive Local Exchange Carriers). - -------------------------------------------------------------------------------- 2 ================================================================================ - -------------------------------------------------------------------------------- Teaming LoopCare with DigiTest creates a powerful end-to-end network assurance solution for POTS, as well as consumer broadband services, such as DSL (Digital Subscriber Line). In addition, we gained a highly experienced team of software developers and engineers and added a seasoned leader in Carol Franklin, our general manager of software products, who brings nearly 30 years of extensive industry experience. We also added several other key executives, including Greg Quiggle, who joined us from Acterna, as executive vice president of marketing; Wylie Etscheid, executive vice president of business development for software products, who brought more than 30 years of progressive RBOC experience; and Richard Skaare, executive vice president of organizational development and communication, who was formerly the head of global communications at AMP Incorporated. TEAMING LOOPCARE WITH DIGITEST CREATES A POWERFUL END-TO-END NETWORK ASSURANCE SOLUTION FOR POTS, AS WELL AS CONSUMER BROADBAND SERVICES, SUCH AS DSL. 2001 also marked the promotion of Matt Rosgone to executive vice president, operations and Mark Peterson to president. Matt is the grease that keeps the wheels of our production function turning. Mark continues to do a great job as he focuses his efforts on overseeing all of our sales channels. With these things in place, we seek to achieve the following goals in 2002: First, we want to maintain our franchise as the testability improvement leader through our Professional Services programs. These efforts, coupled with broadband edge device growth, sustain MCU sales. Second, we will focus on implementing our LTS POTS test head replacement program among key RBOC customers as a means of upgrading their networks for consumer broadband services. Third, we want to position DigiTest and LoopCare as the system of choice for DSL pre-qualification and wideband testing. Fourth, we intend to introduce a solution for DSL testing at remote DLC(Digital Loop Carrier) sites. This product will leverage embedded MCU products with state-of-the-art DigiTest wideband technology. Fifth, we want to continue to expand our opportunities in the international marketplace through our relationships with Acterna, Lucent and Nortel. Sixth, we will continue to develop embedded test elements for the broadband edge market. 2001 REVENUES BY PRODUCT (PERCENTAGE OF 2001 REVENUE) [PIE CHART] MCU Products 67.8% DigiTest 14.5% LoopCare 5.4%* TELACCORD(TM)/DAU 4.9% LIGHTHOUSE 3.7% Professional Services 3.5% Other 0.2% * Reflects sales during the 4th quarter 2001 only.
We've outlined our strategy for accomplishing these goals on the following pages. As a premier provider of leading-edge test and management solutions, we are intent on managing the company for the long-term by providing network assurance products with a vision for the broadband future. On behalf of everyone at our company, please accept our thanks for your continued support. Very truly yours, /s/ CHRISTIAN L. ALLISON CHRIS ALLISON CHAIRMAN AND CHIEF EXECUTIVE OFFICER - -------------------------------------------------------------------------------- 3 DRIVING BROADBAND ASSURANCE TO THE CONSUMER MARKETPLACE - -------------------------------------------------------------------------------- In 2001, Tollgrade reorganized its internal structure and focused on the consumer broadband marketplace. As part of this initiative, the company added to its leadership team by blending key external additions with an already deep team of existing managers. The result is a diverse executive council (shown in the photographs on the following pages) that is responsible for establishing Tollgrade's strategic focus on consumer broadband assurance. A FOCUS ON CONSUMER BROADBAND ASSURANCE Tollgrade Communications develops network assurance products to better enable telephone and cable operators to efficiently manage their networks in an age of increased competition, continually evolving technology and ongoing pressure to control or reduce costs. [PHOTO] Tollgrade's leading-edge test and management solutions allow customers to: - - Competitively roll out digital broadband services; - - Fully leverage investments in existing network equipment; and - - Effectively utilize state-of-the-art technology for installing and remotely administering, testing and repairing traditional network infrastructure. While initial heavy demand for broadband services had slowed in recent years, there are signs that interest in these services is once again on the rise. DSL lines in service in North America rose to nearly 5.5 million at the end of 2001. In the United States, about 10 percent of the homes currently get broadband -- up from almost none in 1998. And, according to figures compiled by the Federal Communications Commission, the rate of adoption for broadband services compares favorably with the rollout of other consumer electronic products such as color televisions, cellular phones and compact disc players. Thus, as demand for broadband services increases, Tollgrade will provide a means for service providers to utilize traditional consumer network assurance approaches for the successful delivery of consumer broadband services. LEADING-EDGE PRODUCTS AND SERVICES With the recent acquisition of Lucent's LoopCare(TM) Test Operations Support System (OSS), Tollgrade has transformed itself from a hardware-based test and measurement company to a full-system provider of test and management solutions for network assurance. [PHOTO] Focused on telecommunications Local Exchange Carriers (LECs), including the Regional Bell Operating Companies (RBOCs), LoopCare works in concert with DigiTest(R) and MCU(R) measurement hardware to manage the test process for over 75 percent of the copper facilities in North America. In addition, Tollgrade's LIGHTHOUSE(R) cable monitoring system combines hardware and software to efficiently monitor the Broadband Hybrid-Fiber/Coax (HFC) system of major cable operators. Both systems are focused on efficiently managing the local access network. Tollgrade's solutions enable service providers to drive new service deployments while limiting operating expenses and capital investments. Tollgrade also complements its hardware and software products with Professional Services that help companies implement new technologies, migrate to new test access platforms and maintain current network operations. These services result in rapid deployment of new services, quicker integration with existing infrastructure and optimization of current network elements. ANTICIPATING NETWORK NEEDS While the basic premise of all communications networks is essentially the same, most service providers optimize their networks for a specific customer base. For example, the residential telephony marketplace, served by a CONSUMER ACCESS NETWORK, requires support for an extremely high volume of low-speed connections while the business subscriber marketplace, served by a - -------------------------------------------------------------------------------- 4 ================================================================================ - -------------------------------------------------------------------------------- "THE PURCHASE OF LOOPCARE IN 2001 WAS ARGUABLY THE MOST SIGNIFICANT EVENT IN OUR COMPANY'S HISTORY." - - CHRIS ALLISON, CHAIRMAN AND CEO "LONG-TERM, THE PRIVATE-LINE AND CONSUMER ACCESS NETWORKS WILL CONVERGE INTO A SINGLE, IP/ATM ARCHITECTURE." - - MARK PETERSON, PRESIDENT [PHOTO] (l to r): Chris Allison, Chairman & CEO; Mark Peterson, President; Matt Rosgone, EVP, Operations; Rocky Flaminio, Vice Chairman & CTO; Sam Knoch, CFO. PRIVATE-LINE ACCESS NETWORK, requires support for a lower volume of very high-speed connections. Furthermore, these same networks are then enhanced for the delivery of voice, data and/or video services. Recognizing these marketplace dynamics, the foundation of Tollgrade's 2002 marketing strategy is a detailed market segmentation model focusing on the unique needs of these individual network architectures. CONSUMER ACCESS NETWORK This network requires remote test solutions for service providers that deliver voice and data services to the residential and small business mass market. [CHART] As the illustration above indicates, the heart of the consumer access architecture is the Public Switched Telephone Network (PSTN). Often handling millions of subscribers on a single voice switch, the Consumer Access Network provides connections that range from basic "life-line" all the way up to complex, multi-line voice services. Low-speed data services have traditionally been offered to these subscribers via the same PSTN. However, the need for higher-speed connections, such as DSL, has driven the deployment of separate, Asynchronous Transfer Mode (ATM)-based overlay networks that are much more efficient for converged voice/data/video traffic. The price sensitivity of this market demands a test and management solution that minimizes dispatches. Doing so enables service providers to responsively meet the needs of a demanding consumer while minimizing costly operating expenses. With the recent acquisition of LoopCare, Tollgrade has emerged as a leader within the Consumer Access Test and Management marketplace. Currently managing the test process for the majority of Plain Old Telephone Service (POTS) lines in North America, Tollgrade is uniquely positioned to help service providers transition their existing subscriber base to a host of innovative digital voice and data services, such as DSL. By upgrading their existing Loop Test System (LTS) infrastructure, service providers can further optimize current POTS installation and maintenance processes while supporting new service deployments. Providing this upgrade path -- through both product development and industry partnerships -- is the focus of Tollgrade's DIGITAL LTS and PATCH THE POTS HOLES strategies. "Digital LTS" will enable service providers to competitively roll out DSL services by upgrading test and measurement infrastructure. "Patch the POTS Holes" will focus on utilizing Tollgrade technology to optimize remote testability and automated flow-through processes for the installation and maintenance of legacy POTS equipment. - -------------------------------------------------------------------------------- 5 ================================================================================ DRIVING BROADBAND ASSURANCE TO THE CONSUMER MARKETPLACE - -------------------------------------------------------------------------------- PRIVATE-LINE ACCESS NETWORK This network requires remote test solutions for service providers that deliver high-speed communications services -- including voice, data, and video -- to medium and large businesses. [CHART] Understanding that these business customers often require fixed connections between multiple locations, the private-line architecture has been traditionally based on a non-switched network of Time Division Multiplexers (TDM) and Digital Cross-Connect Systems (DCS). Offering more efficient use of highly valuable bandwidth and simplified provisioning, most Private-Line Networks have evolved in recent years to rely upon an ATM infrastructure -- replacing a fixed TDM path with Permanent Virtual Circuit (PVC). In this marketplace, the need for flawless service quality far exceeds any other. In fact, a vast majority of today's businesses simply can't function without vital communications services. As a result, Private-Line test and management solutions must focus on quickly diagnosing complex network problems - -- often involving multiple service providers and networks around the world -- regardless of the cost. Unlike the consumer marketplace, a trouble within the Private-Line Network can easily cost the business customer -- and service provider -- thousands of dollars every hour. Although Tollgrade is not currently a full system provider for the Private-Line test and management marketplace, it has focused heavily on enabling broadband deployments through key industry relationships. Specifically, Tollgrade develops broadband-focused test solutions that are integrated with industry leading network element and Private-Line test manufacturers. Leveraging its breakthrough copper test platform, the Integrated Measurement Unit (IMU), Tollgrade's IMU ANYWHERE initiative focuses on playing an integral role for test and management solutions developed in conjunction with industry leaders such as Lucent, Nortel, Alcatel, and Acterna. These solutions are aimed at providing the optimal price/performance product for the network edge. "THE MOST ECONOMICAL WAY TO MANAGE DSL DEPLOYMENT IS NOT AS A SPECIAL SERVICE, BUT RATHER AS A CONSUMER, MASS MARKET SERVICE." - - WYLIE ETSCHEID EVP, NEW BUSINESS DEVELOPMENT "WITH MORE THAN 20 YEARS OF PROGRESSIVE DEVELOPMENT BEHIND IT, LOOPCARE PROVIDES A COMPLETE LOOP SERVICE ASSURANCE SYSTEM FOR POTS AND BROADBAND SERVICES LIKE DSL." - - CAROL FRANKLIN, GM, SOFTWARE PRODUCTS [PHOTO] (l to r): Roger Smith, EVP, Technology; Jim Price, SVP, Systems Engineering; Rich Bair, EVP, Engineering & Testing; Wylie Etscheid, EVP, Business Development; Carol Franklin, GM, Software Products - -------------------------------------------------------------------------------- 6 ================================================================================ DRIVING BROADBAND ASSURANCE TO THE CONSUMER MARKETPLACE - -------------------------------------------------------------------------------- "WE'RE SEEING A SHIFT IN THE MARKETPLACE FROM BUILDING CAPACITY IN THE NETWORK CORE TO FILLING CAPACITY AT THE NETWORK EDGE." - - GREG QUIGGLE EVP, MARKETING "INVESTING IN TESTABILITY MAKES SENSE BECAUSE GOOD TESTING REDUCES COMMUNICATIONS COMPANIES' COSTS AND KEEPS CUSTOMERS SATISFIED." - - STEPHANIE WEDGE VP, PROFESSIONAL SERVICES [PHOTO] (l to r): Stephanie Wedge, VP, Professional Services; Joe O'Brien, SVP, Human Resources; Rich Skaare, EVP, Organizational Development & Communication; Sara Antol, General Counsel; Greg Quiggle, EVP, Marketing CABLE BROADBAND NETWORK This network requires remote test solutions for service providers that deliver video and data services to the residential marketplace. [CHART] The Cable Broadband Network is optimized for the delivery of high-quality video broadcasts. Recent transitions to a digital HFC architecture have enabled this same video network to provide extremely cost-effective data services, such as high-speed Internet access. Minimizing dispatches is the focus of a Cable Broad- band test solution. Doing so, however, requires the unique ability to isolate troubles without invoking intrusive tests. Through disciplined investments in the LIGHTHOUSE product family, Tollgrade has obtained a technology leadership position within the Cable Broadband marketplace. Continued digital network build-outs, combined with new cable monitoring interoperability standards, are creating numerous opportunities to leverage this leadership position. Tollgrade's strategy, known as ELEPHANT GUN, focuses on aiming an intensified sales and marketing campaign at premier cable service providers. THE IP/ATM INFRASTRUCTURE... A COMMON NETWORK ELEMENT Whether a Consumer Access, Private-Line, or Cable Broadband Network, the industry is transitioning to a unified IP/ATM soft network infrastructure. This transition will create a common set of challenges to service providers. Remote verification and trouble isolation in a "virtual" network will continue to require new and innovative test and management processes. The DIGITAL WITHOUT A DISPATCH initiative is focused on providing support for these new IP/ATM processes across Tollgrade's Telecommunications and Cable Broadband solutions. PROFESSIONAL SERVICES... BRINGING IT ALL TOGETHER Service providers face many obstacles in today's turbulent economic times. Network expertise has been challenged as a result of workforce reductions and increased pressure to reduce costs by automating test processes. Tollgrade's Professional Services can develop testability programs to meet these challenges by offering a variety of programs that support the planning, implementation, deployment and maintenance phases of a network's lifecycle. These programs have been successful because they are managed by some of the most highly skilled individuals in the industry. These Tollgrade employees have intimate first-hand network organization knowledge gained from years of experience in the RBOC testing environment. - -------------------------------------------------------------------------------- 7 ================================================================================ SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data of the Company as of December 31, 1997, 1998, 1999, 2000, 2001 and for the years then ended is derived from audited consolidated financial statements of the Company.
(In Thousands, Except Per Share Data and Number of Employees) Years Ended December 31, 1997 1998 1999 2000 2001 - --------------------------------------------------------------------------------------------------------------- STATEMENTS OF OPERATIONS DATA: Revenues: Products $ 45,421 $ 46,277 $ 60,031 $111,957 $77,612 Services -- -- 1,080 2,469 4,627 - --------------------------------------------------------------------------------------------------------------- 45,421 46,277 61,111 114,426 82,239 Cost of sales: Products 20,104 19,620 24,298 40,680 33,134 Services -- -- 716 1,958 2,555 Amortization -- -- -- -- 365 - --------------------------------------------------------------------------------------------------------------- 20,104 19,620 25,014 42,638 36,054 - --------------------------------------------------------------------------------------------------------------- Gross profit 25,317 26,657 36,097 71,788 46,185 - --------------------------------------------------------------------------------------------------------------- Operating expenses: Selling and marketing 5,446 5,704 7,006 12,289 9,160 General and administrative 3,768 4,128 4,723 6,216 4,827 Research and development 5,945 6,880 8,757 12,456 12,428 Severance and related expense -- -- -- -- 291 - --------------------------------------------------------------------------------------------------------------- Total operating expense 15,159 16,712 20,486 30,961 26,706 - --------------------------------------------------------------------------------------------------------------- Income from operations 10,158 9,945 15,611 40,827 19,479 Other income, net 899 1,062 949 2,525 2,796 - --------------------------------------------------------------------------------------------------------------- Income before taxes 11,057 11,007 16,560 43,352 22,275 Provision for income taxes 4,174 4,040 5,937 15,857 8,600 - --------------------------------------------------------------------------------------------------------------- Net income $ 6,883 $ 6,967 $ 10,623 $ 27,495 $ 13,675 - --------------------------------------------------------------------------------------------------------------- EARNINGS PER SHARE INFORMATION: Net income per common share: (1) Basic $ 0.61 $ 0.60 $ 0.92 $ 2.18 $ 1.05 - --------------------------------------------------------------------------------------------------------------- Diluted $ 0.58 $ 0.58 $ 0.89 $ 2.06 $ 1.02 - --------------------------------------------------------------------------------------------------------------- Weighted average shares of common stock and equivalents: Basic 11,372 11,683 11,574 12,636 13,038 - --------------------------------------------------------------------------------------------------------------- Diluted 11,923 11,933 11,959 13,359 13,412 - ---------------------------------------------------------------------------------------------------------------
As of December 31, 1997 1998 1999 2000 2001 - --------------------------------------------------------------------------------------------------------------- BALANCE SHEET DATA: Working capital $ 34,570 $ 40,539 $ 49,958 $111,135 $ 67,628 Total assets 43,713 49,865 66,202 131,275 146,630 Shareholders' equity 38,101 45,696 57,504 122,760 140,139 1997 1998 1999 2000 2001 - --------------------------------------------------------------------------------------------------------------- OTHER DATA: (2) Number of employees at year end 205 230 282 411 341 Average revenue per employee $ 222 $ 201 $ 217 $ 278 $ 241 - ---------------------------------------------------------------------------------------------------------------
(1) 1998 includes $.02 per share related to the after-tax effect of net key man life insurance proceeds associated with the death of the Company's former Chairman R. Craig Allison. (2) Data is unaudited and not derived from Company's audited financial statements. 8 ================================================================================ MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following discussion should be read in conjunction with the "Selected Consolidated Financial Statements" and notes thereto appearing elsewhere in this Annual Report to Shareholders. CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. The statements contained in this Annual Report to Shareholders, specifically those 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: - - General economic conditions and the economic conditions of the telecommunications industry; - - 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 of sales and marketing partners to meet their own performance objectives (and, in certain cases, continue to provide vendor financing to certain local exchange carriers); - - Customers' seasonal buying patterns and the risk of order cancellations; - - Risk of shortage of key manufacturing components and possibility of limited source of supply; - - Manufacturing delays and availability of manufacturing capacity; - - Intense competition in all markets for the Company's products; - - Uncertain pace and scope of 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 and a small number of large customers; - - The Company's dependence on key employees and upon proprietary rights; - - Difficulties in managing the Company's growth; - - The Company's dependence upon certain suppliers; - - Risks of third party claims of infringement; - - Risk of product defects; and - - Changes in government regulation affecting the business of the Company and its customers. The Company does not undertake any obligation to publicly update any forward-looking statements. 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. Effective September 30, 2001, the Company purchased certain assets of the LoopCare(TM) product business from Lucent Technologies, Inc. ("Lucent"). These assets consisted of LoopCare software base code and developed enhancements, as well as the rights to existing maintenance contracts for the LoopCare software. Effective September 30, 2001, revenues from the sales of either software base code or developed enhancements are reported as part of the Company's revenues attributable to test system products to which they synergistically relate, while the revenues from existing and any new maintenance contracts are reflected as part of the Company's Professional Services revenues. Refer to the Liquidity and Capital Resources section on page 14 for further discussion regarding this acquisition. The Company has determined that its business has one reportable segment in the test assurance industry. All product sales are considered components of the business of testing infrastructure and networks for the telecommunications and cable television industries. While the Company does internally develop sales results and other financial results associated with the various product categories, this information is not considered sufficient for segment reporting purposes nor does the chief operating decision maker make critical decisions based solely on this information. Its products and services have similar economic characteristics, the same or similar production processes and are sold to similar types or classes of customers in, or entering into, the telecommunications business through similar distribution means. The LoopCare software product line business was acquired by the Company to broaden its DigiTest(R) test platform into a system level offering. 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 68% of the Company's revenue for the year ended December 31, 2001 and will continue to account for a majority of the Company's revenues for the foreseeable future. The Company's DigiTest centralized network test system platform, which includes the LoopCare software base code and developed enhancements, 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 the complete solution for testing POTS and performing local loop prequalification for DSL services. The system currently consists of the comprehensive LoopCare diagnostic software, as well as three integrated pieces of hardware, the Digital Measurement Node ("DMN"), the Digital Measurement Unit ("DMU"), and the Digital Wideband Unit ("DWU"). 9 ================================================================================ MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION When used in an integrated fashion, the DigiTest system permits 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, including $2.8 million of LoopCare software license right-to-use fees since September 30, 2001, accounted for approximately 18% of the Company's revenue for the year ended December 31, 2001. 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 4% of the Company's revenue for the year ended December 31, 2001. In 2001, sales of the Company's Digital Access Unit ("DAU") were approximately 5% of the Company's revenue. This access product was being sold primarily to Sprint in connection with its recently discontinued IONProject. Through 2001, the Company continued to build upon and extend its Professional Services offering to customers. The cornerstone of the Company's Professional Services business is the Testability Improvement Initiatives. These services may offer the customer the opportunity to make dramatic improvements in testability levels, while training their own staffs in targeted geographic regions over a defined period of time. In this way, the customers' internal repair technicians can make use of automated systems to diagnose and repair subscriber loop problems, thereby automatically eliminating the need for the involvement of several highly trained people to do so. The service offering was expanded upon the acquisition of software maintenance contracts related to the LoopCare software product line. Including these software maintenance revenues of $1.7 million since September 30, 2001, annual Professional Services revenue accounted for approximately 6.0% of the Company's revenue for the year ended December 31, 2001. The Company's telecommunications product and services sales are primarily to the four Regional Bell Operating Companies ("RBOCs"), as well as major independent telephone companies and to certain equipment manufacturers. For the year ended December 31, 2001, approximately 71% of the Company's total revenue was generated from sales to the RBOCs, the three largest of which individually comprised approximately 38%, 14% and 14%, or a combined 66%, of total revenue. In addition, one major independent telephone company contributed approximately 10.4% of the Company's total revenue. The Company markets and sells its products directly, as well as through various Original Equipment Manufacturer ("OEM") and reseller arrangements. The Company's operating results have fluctuated and may continue to fluctuate as a result of various factors, including the timing of orders from, shipments to, and acceptance of software by the RBOCs and significant independent telephone companies. This timing is particularly sensitive to various business factors within each of the company's significant customers including their relationships with their various organized labor groups. In addition, the markets for the Company's DigiTest and LIGHTHOUSE products 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. In addition, certain customers have consolidated product purchases that have translated into large bulk orders. Although the Company will continue to strive to meet the demands of its customers, which include delivery of quality products at an acceptable price and on acceptable terms, there are no assurances that the Company will be successful in negotiating acceptable terms and conditions in its purchase orders or its customer purchase agreements. Additionally, continuing consolidation efforts among the RBOCs, and their ability to consolidate their inventory and product procurement systems could cause fluctuations or delays in the Company's order patterns. Also, recent efforts in the cable industry to consolidate as well as 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 were adopted by the standards setting body in the year 2001 and may adversely affect the Company's revenues from such products in the year 2002 and in subsequent periods. In addition, markets for the Company's LIGHTHOUSE products have been, and may continue to be, difficult for the foreseeable future. The Company cannot predict such future events or business conditions and the Company's results could be adversely affected by these industry trends in the primary markets its serves. Although international sales to date have not been significant, the Company believes that certain international markets may offer opportunities. The addition of the LoopCare software product line may provide further opportunities to penetrate this market. 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 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. The Company continues to evaluate opportunities for its other products in international markets. However, there can be no assurance that any continued efforts by the Company will be successful or that the Company will achieve significant international sales. The Company believes that continued growth will depend, 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 percent of revenues were approximately 15% for the year ended December 31, 2001. The Company believes that the economic climate will continue to be one of challenge and uncertainty. In response to such uncertainty, effective April 2001, the Company eliminated approximately 80 positions resulting in $4.3 million of annual savings for which the Company received the pro-rata benefit in 2001. In addition, the Company believes that future growth will be affected as a result of an overall continued economic slowdown whereby customers may become even more conservative in their ordering patterns and quantities, and certain emerging carriers will continue to be hampered by financial instability. Due to this uncertainty, the Company will continue to evaluate its investments 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION in production, marketing and research and development expenses and monitor, control or decrease expense levels, as appropriate. CRITICAL ACCOUNTING POLICIES The Company's financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. Certain of these accounting principles are more important than others in gaining an understanding of the basis upon which the Company's financial statements have been prepared. The Company considers the following accounting principles to be critical to the preparation of its consolidated financial statements: Revenue Recognition -- The Company markets and sells POTS and broadband test system hardware, and, since the September 30, 2001 acquisition of LoopCare, related software. For hardware sales, the Company follows Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB 101"). This bulletin requires, among other things, that revenue only be recognized when title has transferred and risk of loss has passed to a customer with the capability to pay, and that there be no significant remaining obligations related to the sale on the part of the Company. For software perpetual license fee and maintenance revenue, the Company follows the AICPA's Statement of Position "Software Revenue Recognition" SOP 97-2 and related modifications. This statement requires that software license fee revenue be recorded only when evidence of a sales arrangement exists, the software has been delivered, and a customer with the capacity to pay has accepted the software leaving no significant obligations on the part of the Company to perform. Software maintenance revenue is recognized on a straight-line basis over the period the respective arrangements are in effect. The Company also performs testability consulting work in its Professional Services group on a time and material basis. Revenue for this work is recognized on an accrual basis as the work is performed and costs are incurred. Segment Information -- The Company applies Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments of an Enterprise and Related Information." The Company markets and sells several products, but each have the same or similar economic characteristics, production processes, are subject to similar regulatory environments, and are sold to the same or similar types or classes of customers through the same distribution process. The chief decision maker allocates resources on the whole, rather than on the parts, of the Company's business. Therefore, the Company has determined that it has one operating segment and reports its business activities as such. Acquisition and Related Intangible Assets -- The Company made a significant acquisition of assets and assumed certain liabilities of the LoopCare product line from Lucent effective September 30, 2001. Consideration paid was $62.0 million including deal-related costs. This acquisition was recorded in accordance with the transitional guidance of SFAS No. 141 which required the transaction to be recorded under the purchase method of accounting. This method requires that the purchase price be allocated to identifiable tangible and intangible assets, with any excess allocated to goodwill. As this transaction involved primarily the acquisition of intellectual property and contractual rights, a substantial portion of the purchase price was allocated to intangible assets and goodwill. With regard to the establishment of fair value for the intangible assets under the transitional guidance of SFAS No. 141, and for guidance as to how these intangible assets should be viewed in light of the transitional rules of SFAS No. 142, the Company engaged a valuation consultant who is independent of the management and owners of the Company. This independent valuation consultant assisted the Company in determining that approximately $45.8 million of the $62.0 million purchase price was allocable to specific intangible assets at the date of acquisition. Due to the fact that the LoopCare software has been utilized for over 25 years by the Company's key customers, as well as being deeply integrated into their basic quality control systems, it was determined under the transitional guidance of SFASNo. 142 that $38.5 million of these intangible assets had indefinite lives at the date of acquisition and would not be subject to amortization. The Company will fully adopt the provisions of SFAS Nos. 141 and 142 effective January 1, 2002; non-amortizable intangibles and goodwill will be evaluated under SFAS No. 142 as required in 2002. Income Taxes -- The Company follows the provisions of SFAS No. 109, "Accounting for Income Taxes," in reporting the effects of income taxes in its consolidated financial statements. Temporary differences between book and taxable income result in deferred taxes in the Company's consolidated financial statements. The Company believes all of its deferred tax assets are realizable at their present recorded values, and, hence, believes there are no requirements to provide any allowances against such assets. Investments -- The Company follows SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," with regard to accounting for its short- and long-term investments. All of these investments are held in at least investment-grade municipal bonds and are accounted for as "held-to-maturity" securities and reflected in the consolidated balance sheet at amortized cost. YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000 REVENUES Revenues for the year ended December 31, 2001 were $82.2 million, and were $32.2 million or 28.1% lower than the revenues of $114.4 million for the year ended December 31, 2000. The decrease in revenues is primarily associated with a decrease in the unit volume sales of traditional MCU products, the Company's DigiTest system, and the Company's LIGHTHOUSE Cable Status Monitoring System, offset slightly by an increase in billings related to the Company's Professional Services business. During 2001, the sales of the Company's MCU product line decreased by approximately $24.6 million, or 30.6%. This decrease in sales of the MCU product line resulted primarily from decreased sales to Qwest as that company's testability initiative matured. In addition, MCU sales decreased to SBC Communications, Inc. (including Ameritech, Pacific Bell and SNET) during 2001 primarily as a result of a slowdown in the rollout of Project Pronto, that company's broadband initiative. Also contributing to the decrease in MCU sales during 2001 were decreased sales of core MCU products to BellSouth and Verizon primarily associated with slowdowns in programs to upgrade select DLC systems within certain regions with MCU technology. The MCU product line accounted for approximately 67.8% of the current year revenues. During 2001, the sales of the Company's DigiTest product line, including $2.8 million of LoopCare software, decreased by approximately $6.4 million, or 30.4%. This decrease in DigiTest sales was primarily the result of decreased direct shipments during 2001 to Sprint USA and SBC Telecom, Inc., which is the Competitive Local Exchange Carrier ("CLEC") subsidiary of SBC. The decline in sales of DigiTest to Sprint occurred in connection with Sprint's decision to discontinue its IONProject, while SBC Telecom, Inc. substantially curtailed its plan for expansion. In addition, reduced sales of DigiTest to Nortel Networks and Lucent for deployment into the domestic CLEC markets, as well as reduced sales to Verizon for the replacement of certain 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Lucent Loop Testing System ("LTS") test head trunks for qualification of copper lines for Digital Subscriber Line ("DSL") service, contributed to the overall decrease in DigiTest sales during the current year. This was offset somewhat by direct sales of DigiTest to SBC Communications, Inc. for MLT-1 replacement, as well as sales to Nortel in anticipation of distribution in the international market. Overall, DigiTest sales accounted for approximately 17.8% of the current year revenues. Revenues from the Company's Professional Services group in 2001 increased by $2.2 million, or 87.4%. This includes $1.7 million of software maintenance fees associated with the LoopCare acquisition. The Company is continuing to expand its service offerings in order to provide its customer base with a full complement of expertise. Professional Services revenue accounted for 5.6% of current year revenues. During 2001, sales of the Company's Digital Access Unit increased by approximately $3.4 million, from $.6 million in the prior year. This product was developed to provide cost-effective test access in applications where it had not been provided for by the equipment manufacturer, and was primarily being sold to Sprint for use in its recently discontinued IONProject. Overall, sales of the Company's DAUwere approximately 4.9% of the Company's revenues. During 2001, sales of the Company's LIGHTHOUSE Cable Status Monitoring System decreased by approximately $6.8 million, or 69.2%. This decrease was primarily a result of decreased product sales to RCN Corporation and AT&T Broadband as a result of their decisions to delay purchases of cable related equipment. Overall, sales of the LIGHTHOUSE Cable Status Monitoring System accounted for approximately 3.7% of the current year revenues. Revenues from the LoopCare product line in the three-month period ended December 31, 2001 were $4.5 million, comprised of $2.8 million in license right-to-use fees and $1.7 million of maintenance fees. Gross margins on these revenues are substantially higher than other product lines of the Company, and the resulting impact on earnings was material for this period and the year. Offsetting these revenue increases were declines for the year and the fourth quarter in the Company's traditional MCU-related products as less purchasing incentives were offered by the Company as well as a continued general softening in the Company's test access markets. The Company expects the softness in its core equipment markets to continue for the foreseeable future as its key customers continue to restrict their capital budgets. The Company's strategy will be to supplement declining revenues from traditional MCU and related equipment product lines with LoopCare software license right-to-use fee revenue. As these software license products generally have long development and selling cycles, creating possibly significant revenue variations, there can be no assurance that the Company will be successful in the implementation of this strategy. Management continues to believe that there is a possibility that customer requirements for certain important MCU products which are utilized in legacy DLC systems may be satisfied at some point. In order to reduce associated risks, the Company is focusing on the development of new product lines to attempt to meet the other requirements of customers. GROSS PROFIT Gross profit for 2001 was $46.2 million compared to $71.8 million for 2000, representing a decrease of $25.6 million, or 35.7%. Gross profit as a percentage of revenues decreased to 56.2% for 2001 compared to 62.7% for 2000. The overall decrease in gross profit resulted primarily from the decreased sales levels, while the decline in gross margin as a percentage of sales was a result of decreased production volumes and associated decreases in cost absorption levels. To maintain the current gross margin levels, the Company will need to maintain pricing and gain further cost reductions. Gross margin levels will also depend on the actual mix of products sold. The LoopCare software product line carries higher gross margins and the Company's cable products carry lower gross margins than those earned historically on the Company's telecommunication products. In addition, if sales of the Company's DigiTest product line increases on an OEM or reseller basis, the overall margins would decline slightly as a result of a greater mix of lower-margin OEM sales versus direct sales. SELLING AND MARKETING EXPENSE Selling and marketing expenses consist primarily of personnel costs as well as commissions and travel expenses of direct sales and marketing personnel, and costs associated with various promotions and related marketing programs. Selling and marketing expense for 2001 was $9.2 million, or 11.1% of revenues, compared to $12.3 million, or 10.7% of revenues for 2000. This decrease of $3.1 million, or 25.5%, is primarily due to a decrease in the number of sales and marketing personnel due to a reduction in personnel in April 2001, a decrease in incentives and commissions associated with the lower sales levels, and cost reductions in the areas of advertising, promotion and related marketing activities. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expenses consist primarily of personnel costs for finance, administrative and general management personnel as well as accounting and legal expenses. General and administrative expense for 2001 was $4.8 million, or 5.9% of revenues, compared to $6.2 million, or 5.4% of revenues for 2000. This decrease of $1.4 million, or 22.3%, is primarily attributable to a decrease in employee recruiting-related expenditures, decreased incentive compensation, as well as a decrease in certain professional service and consulting fees. RESEARCH AND DEVELOPMENT EXPENSE Research and development expenses consist primarily of personnel costs and costs associated with the development of new products and technologies, including DigiTest and LIGHTHOUSE, and enhancing features of existing products. Research and development expense for 2001 was $12.4 million, or 15.1%, of revenues, compared to $12.5 million, or 10.9%, of revenues for 2000. This decrease of $.1 million was principally due to a reduction of engineering personnel in April 2001, offset by the additional personnel acquired as part of the LoopCare acquisition. The Company expenses all research and development costs as they are incurred. OTHER INCOME AND EXPENSE Other income, which consists primarily of interest income, was $2.8 million for 2001 compared to $2.5 million for 2000. The increase of $.3 million, or 10.7%, is primarily attributable to an increase in funds available for investment between periods. PROVISIONS FOR INCOME TAXES The Company's effective tax rate for 2001 was 38.6% of income before income taxes, compared to the 36.6% rate in 2000. The increase in the effective income tax rate was primarily due to higher relative levels of income taxes associated with expanding business activities. NET INCOME AND EARNINGS PER SHARE For the year ended December 31, 2001, net income was $13.7 million compared to $27.5 million for the year ended December 31, 2000, representing a decrease of $13.8 million, or 50.3%. Diluted earnings per common share of $1.02 for 2001 decreased by 50.5%, or 12 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION $1.04, from the $2.06 earned in 2000. Diluted weighted average shares of common stock and equivalents outstanding were 13,412,037 in 2001 compared to 13,359,270 in 2000. This increase in the diluted weighted average shares of common stock and equivalents outstanding is primarily the result of the effect on 2001 of exercised stock options. As a percentage of revenues, net income for 2001 decreased to 16.6% from 24.0% in 2000. YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999 REVENUES Revenues for the year ended December 31, 2000 were $114.4 million, and were $53.3 million or 87.2% higher than the revenues of $61.1 million for the year ended December 31, 1999. The increase in revenues was primarily associated with an increase in the unit volume sales of core MCU products, increased sales associated with the Company's next generation DigiTest system, increased sales of the Company's LIGHTHOUSE Cable Status Monitoring System, as well as increased billings related to the Company's Professional Services business. During 2000, the Company increased the sales of its MCU product line by approximately $32.8 million, or 68.9%. This increase in sales of the MCU product line resulted primarily from increased sales to SBC Communications, Inc. (including Ameritech, Pacific Bell, and SNET) associated with Project Pronto, that company's broadband initiative. In addition, MCU sales increased to Verizon (formerly Bell Atlantic) during 2000 primarily as a result of certain ongoing remediation programs launched by the Company to improve Verizon's MLT testability and flow-through capabilities. Also contributing to the increase in MCU sales during 2000 were increased sales of core MCU products to BellSouth primarily associated with a program to upgrade select DLC systems within certain regions from remote terminal test devices to MCU technology. The MCU product line accounted for approximately 70.2% of revenues for the year. During 2000, the sales of the Company's DigiTest product line increased by approximately $14.4 million, or 218.4%. This increase in DigiTest sales was primarily the result of increased direct shipments during 2000 to Sprint USA and SBC Telecom, Inc., which is the Competitive Local Exchange Carrier ("CLEC") subsidiary of SBC. In addition, sales of DigiTest to Nortel Networks and Lucent for deployment into the CLEC markets, as well as sales to Verizon for the replacement of certain Lucent Loop Testing System ("LTS") test head trunks for qualification of copper lines for Digital Subscriber Line ("DSL") service, contributed to the overall increase in DigiTest sales during the current year. Overall, DigiTest sales accounted for approximately 18.4% of the current year revenues. During 2000, the sales of the Company's LIGHTHOUSE Cable Status Monitoring System increased by approximately $5.5 million, or 126.9%. This increase was primarily a result of increased product sales to RCN Corporation, offset slightly by a decrease in sales during the current year to AT&T Broadband as a result of their decision to delay purchases of cable related equipment. Overall, sales of the LIGHTHOUSE Cable Status Monitoring System accounted for approximately 8.6% of the current year revenues. GROSS PROFIT Gross profit for 2000 was $71.8 million compared to $36.1 million for 1999, representing an increase of $35.7 million, or 98.9%. Gross profit as a percentage of revenues increased to 62.7% for 2000 compared to 59.1% for 1999. The overall increase in gross profit resulted primarily from the increased sales levels, while improvements in gross margin as a percentage of sales were a result of a favorable sales mix in relation to higher-margined products, as well as increased sales volumes and associated manufacturing efficiencies. Maintaining the Company's current gross margin levels is contingent on its ability to negotiate price increases and gain further cost reductions. Furthermore, continuing gross margin levels will depend on the actual mix of products sold which will include the effect of the Company's cable products that carry lower gross margins than earned historically on the Company's telecommunication products. In addition, if the sales mix of the Company's DigiTest product line increases with partner companies, such as Nortel Networks or Lucent, the overall margins would decline slightly as a result of a greater mix of lower-margin OEM sales versus direct sales. SELLING AND MARKETING EXPENSE Selling and marketing expenses consist primarily of personnel costs as well as commissions and travel expenses of direct sales and marketing personnel, and costs associated with various promotions and related marketing programs. Selling and marketing expense for 2000 was $12.3 million, or 10.7% of revenues, compared to $7.0 million, or 11.5% of revenues for 1999. This increase of $5.3 million, or 75.4%, was primarily due to an increase in the number of sales and marketing personnel to support new product introductions and enhance customer support, as well as an increase in commissions associated with the increased sales level and increased expenditures on advertising, promotion and related marketing activities. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expenses consist primarily of personnel costs for finance, administrative and general management personnel as well as accounting and legal expenses. General and administrative expense for 2000 was $6.2 million, or 5.4% of revenues, compared to $4.7 million, or 7.7% of revenues for 1999. This increase of $1.5 million, or 31.6%, was primarily attributable to an increase in employee recruiting- related expenditures, increased legal expenses as well as an increase in certain professional service and consulting fees. RESEARCH AND DEVELOPMENT EXPENSE Research and development expenses consist primarily of personnel costs and costs associated with the development of new products and technologies, including DigiTest and LIGHTHOUSE, and enhancing features of existing products. Research and development expense for 2000 was $12.5 million, or 10.9%, of revenues, compared to $8.8 million, or 14.3%, of revenues for 1999. This increase of $3.7 million, or 42.3%, was principally due to the addition of personnel to support new product development activities and the project costs associated with product development. The Company expenses all research and development costs as they are incurred. OTHER INCOME AND EXPENSE Other income, which consists primarily of interest income, was $2.5 million for 2000 compared to $1.0 million for 1999. The increase of $1.5 million, or 166.2%, was primarily attributable to an increase in funds available for investment between periods. PROVISIONS FOR INCOME TAXES The Company's effective tax rate for 2000 was 36.6% of income before income taxes, compared to the 35.9% rate in 1999. The increase in the effective income tax rate was primarily due to higher relative levels of state income taxes associated with expanding business activities. 13 ================================================================================ MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NET INCOME AND EARNINGS PER SHARE For the year ended December 31, 2000, net income was $27.5 million compared to $10.6 million for the year ended December 31, 1999, representing an increase of $16.9 million, or 158.8%. Diluted earnings per common share of $2.06 for 2000 increased by 131.5%, or $1.17, from the $.89 earned in 1999. Diluted weighted average shares of common stock and equivalents outstanding were 13,359,270 in 2000 compared to 11,958,976 in 1999. This increase in the diluted weighted average shares of common stock and equivalents outstanding was primarily the result of the effect of an increase in the average share price of common stock between periods. As a percentage of revenues, net income for 2000 increased to 24.0% from 17.4% in 1999. LIQUIDITY AND CAPITAL RESOURCES On September 30, 2001, the Company completed the acquisition of the software assets of LoopCare from Lucent for approximately $62,000,000 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 the Company presently intends to continue to use the equipment for the same purpose. The Company 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 test 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 151 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, measures the metallic parameters of the loop to detect shorts, grounds, opens, or other metallic faults that could affect DSL service; measures the broadband spectral density of the noise on the loop; identifies the location and length of bridged taps that affect DSL service; predicts the downstream and upstream data rate that the loop can support; and recommends the most effective remedial action to improve the data rate on lines that cannot support the rate requested by the subscriber. The revenues from this product line include perpetual 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 recognizes revenue from the RTU fees in accordance with the American Institute of Certified Public Accountants Statement of Position ("SOP") 97-2, "Software Revenue Recognition," SOP 98-9 "Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions," and Emerging Issues Task Force Issue 01-03. 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 and collection is assured. 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 and then recognized on a straight-line basis over the period of the maintenance contract. The Company may experience fluctuations in its RTU 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 has been recorded in accordance with the transitional guidance of Statement of Financial Accounting Standards (SFAS) No. 141 under the purchase method of accounting and, accordingly, the results of operations of LoopCare for the period beginning September 30, 2001 forward, have been included in the consolidated financial statements of the Company. Independent valuation consultants assisted management in its determination of the fair values of certain intangible assets acquired. Intangible assets valued at September 30, 2001 include the LoopCare trade name ($1.3 million), base software ($5.2 million), capitalized software costs on developed software ($7.3 million), and post warranty maintenance service agreements ($32.0 million). Of the intangible assets identified, only capitalized software costs on developed software of $7.3 million have been determined to have a definite life, which has been estimated at five years, and will be amortized over that period. The remaining intangibles, which amount to $38.5 million, have been determined to have indefinite lives due to the degree of integration and resulting dependency on the related software and intellectual property by the Company's key customers who have utilized the software for over 25 years. If circumstances would change such that these intangible assets were, in fact, collectively determined to have a definite life, the accounting rules would require that these assets be amortized over such lives and, although such amortization would represent a non-cash charge, it would be material to the Company's consolidated statements of operations. The Company has followed the transitionary provisions of SFAS No. 142, and will evaluate all intangibles including goodwill periodically, in accordance with that accounting standard. The Company had working capital of $67.6 million as of December 31, 2001 compared to working capital of $111.1 million as of December 31, 2000. The decrease of $43.5 million, or 39.2%, can be attributed to operating cash flow (income from operations before depreciation and amortization) offset by the purchase of the LoopCare business product line for $62.0 million, including deal-related expenses, in cash. Significant changes during 2001 in the composite elements of working capital include a substantial decrease in accounts receivable-trade and inventories due to a substantial decline in sales activities due to current overall economic conditions, and corresponding adjustments made by the Company in forecasted production volumes to meet such lowered demands. In addition, as expected in 2001, the Company received $7.7 million of net tax refunds due largely to net operating loss carrybacks resulting from the exercise of certain of the Company's nonstatutory stock options and the associated tax deductions related thereto. As of December 31, 2001, the Company had $38.7 million of cash and cash equivalents, short-term investments and long-term investments, which are unrestricted and available for corporate purposes, including acquisitions and other general working capital requirements. In addition, effective December 20, 2001, the Company executed a five-year $25.0 million Unsecured Revolving Credit Facility (the "Facility") with a bank. In accordance with the terms of the Facility, the proceeds must be used for general corporate purposes, working capital needs, and in connection with certain acquisitions, as defined. The Facility contains certain standard covenants with which the Company must comply, including a minimum fixed charge ratio, a minimum defined level of tangible net worth and a restriction on the amount of capital expenditures that can be made on an annual basis, among others. 14 ================================================================================ MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Commitment fees are payable quarterly at 0.25% of the unused commitment. As of December 31, 2001, there were no outstanding borrowings under the Facility. No borrowings for working capital are currently anticipated, as the Company believes internally generated funds will be sufficient to sustain working capital requirements for the foreseeable future. The Company made capital expenditures of $3.5 million in 2001, primarily related to the acquisition of land adjacent to the Company's current manufacturing facility, as well as production test equipment and fixtures. Capital expenditures were $4.5 million and $2.3 million for 2000 and 1999, respectively, and were primarily related to upgrades to the IT infrastructure, office equipment, test fixtures and development systems, tooling and leasehold improvements. Planned capital expenditures for 2002 are anticipated to total approximately $4.1 million. These planned capital projects include test fixtures and development systems, and computer and office equipment. The Board of Directors has authorized the continuation of a share repurchase program it started in 1997. Under the current extension, the Company may repurchase a total of one million shares of its common stock before December 31, 2002. Since the initial repurchase program was instituted in April of 1997, and as of December 31, 2001, the Company has repurchased 382,400 shares of common stock. The repurchased shares are authorized to be utilized under certain employee benefit programs. The number of shares the Company intends to purchase and the time of such purchases will be determined by the Company at its discretion. The Company will use existing cash and short-term investments to finance the purchases. The impact of inflation on both the Company's financial position and the results of operations have been minimal and are not expected to adversely affect 2002 results. The Company's financial position enables it to meet cash requirements for operations and capital expansion programs. COMMITMENTS The Company has commitments under various non-cancelable leases; these leases relate primarily to real estate in Cheswick, Pennsylvania and Bridgewater, New Jersey which house the Company's operations. Rentals due beyond December 31, 2001 under these agreements amount to $1.1 million in 2002 and approximately $0.5 million annually through 2006. The Company also entered into a line of credit Facility discussed in the "Liquidity and Capital Resources" section of this MDA. Commitment fees associated with this Facility are as outlined in that discussion. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's current investment policy limits its investments in financial instruments to cash and cash equivalents, individual municipal bonds, and corporate and government bonds. The use of financial derivatives and preferred and common stocks is strictly prohibited. The Company believes it minimizes its risk through proper diversification along with the requirements that the securities must be of investment grade with an average rating of "A" or better by Standard &Poor's. The Company holds its investment securities to maturity and believes that earnings and cash flows are not materially affected by changes in interest rates, due to the nature and short-term investment horizon for which these securities are invested. KEY RATIOS The Company's days sales outstanding ("DSOs") in accounts receivable trade, based on twelve months rolling revenue, was 43 and 61 days as of December 31, 2001 and December 31, 2000, respectively. The Company's inventory turnover ratio was 1.3 and 1.8 turns for December 31, 2001 and December 31, 2000, respectively. Approximately $2,000,000 in inventory was returned to the Company's component vendors for credit during 2001 associated with a program addressed to decrease on hand inventory levels commensurate with current sales levels. BACKLOG As of December 31, 2001, the Company's backlog was $4.9 million compared to the backlog at December 31, 2000 of $8.2 million. The Company's backlog consists of firm customer purchase orders for the Company's various products. The Company believes that customers are returning to a more typical seasonal-based ordering pattern where the first quarter of the year is typically lower than the preceding quarter. The shippable backlog entering the first quarter of 2001 is lower than 2000 levels. 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, management believes these fluctuations are not necessarily indicative of long-term trends in sales of the Company's products. ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes standards for reporting information about various derivative financial instruments and accounting for their change in fair value. The Company does not hold or issue derivative instruments for hedging purposes and therefore the adoption of this standard in 2000 did not have a material effect on the consolidated financial position or results of operations of the Company. In December 1999, the Staff of the Securities and Exchange Commission issued Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB 101"), which provides guidance related to revenue recognition. The Company has adopted this standard in 2000 and doing so did not have a material effect on its business, results of operations and financial condition. In July 2001, the FASB issued 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. Both statements contain transitional provisions which require that these statements be applied to all business combinations initiated after June 30, 2001. The Company followed the transitional provisions of SFAS No. 141 and SFAS No. 142 during the fourth quarter of fiscal year 2001 as it related to its recent acquisition of the LoopCare product line. The Company will adopt the full provisions of these statements on January 1, 2002. The Company does not believe the adoption of these standards will have a material effect on its financial statements. On August 15, 2001, the 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 will adopt these statements on January 1, 2003 and is presently evaluating the impact they may have on the Company. 15 ================================================================================ TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES STATEMENT OF MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING The accompanying consolidated financial statements of Tollgrade Communications, Inc. and Subsidiaries have been prepared by management, who are responsible for their integrity and objectivity. The statements have been prepared in conformity with generally accepted accounting principles and include amounts based on management's best estimates and judgments. Financial information elsewhere in this Annual Report is consistent with that in the financial statements. Management has established and maintains a system of internal control designed to provide reasonable assurance that assets are safeguarded and that the financial records reflect the authorized transactions of the Company. The system of internal control includes widely communicated statements of policies and business practices that are designed to require all employees to maintain high ethical standards in the conduct of Company affairs. The internal controls are augmented by organizational arrangements that provide for appropriate delegation of authority and division of responsibility. The financial statements have been audited by PricewaterhouseCoopers LLP, Independent Accountants. As part of their audit of the Company's 2001 financial statements, PricewaterhouseCoopers LLP considered the Company's system of internal control to the extent they deemed necessary to determine the nature, timing and extent of their audit tests. The Report of Independent Accountants follows. The Board of Directors pursues its responsibility for the Company's financial reporting through its Audit Committee, which is composed entirely of outside directors. The Audit Committee has met periodically with the Independent Public Accountants and management. The Independent Public Accountants had direct access to the Audit Committee, with and without the presence of management representatives, to discuss the results of their audit work and their comments on the adequacy of internal accounting controls and the quality of financial reporting. /s/ CHRISTIAN L. ALLISON Christian L. Allison Chairman and Chief Executive Officer /s/ SAMUEL C. KNOCH Samuel C. Knoch Chief Financial Officer and Treasurer January 21, 2002 16 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Tollgrade Communications, Inc. and Subsidiaries: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, changes in shareholders' equity and cash flows present fairly, in all material respects, the financial position of Tollgrade Communications, Inc. and its subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PRICEWATERHOUSECOOPERS LLP /s/ PRICEWATERHOUSECOOPERS LLP Pittsburgh, Pennsylvania January 21, 2002 17 Tollgrade Communications, Inc. and Subsidiaries Consolidated Balance Sheets
ASSETS December 31, 2000 DECEMBER 31, 2001 - ------------------------------------------------------------------------------------------------------------------------------ Current assets: Cash and cash equivalents $ 30,423,783 $ 32,105,845 Short-term investments 28,405,655 6,489,323 Accounts receivable: Trade 18,775,643 9,296,551 Other 813,809 320,501 Inventories 30,499,482 22,183,616 Prepaid expenses and deposits 787,098 916,723 Refundable income taxes 8,950,672 1,396,736 Deferred tax assets 983,246 1,116,756 - ------------------------------------------------------------------------------------------------------------------------------ Total current assets 119,639,388 73,826,051 Long-term investments 2,750,000 150,000 Property and equipment, net 6,503,923 8,012,546 Deferred tax assets 2,380,828 2,812,987 Intangibles -- 38,500,000 Goodwill -- 16,161,763 Capitalized software costs, net -- 6,935,000 Other assets 417 231,614 - ------------------------------------------------------------------------------------------------------------------------------ Total assets $ 131,274,556 $ 146,629,961 - ------------------------------------------------------------------------------------------------------------------------------ LIABILITIES AND SHAREHOLDERS' EQUITY - ------------------------------------------------------------------------------------------------------------------------------ Current liabilities: Accounts payable $ 1,874,328 $ 805,398 Accrued warranty 1,045,000 2,068,000 Accrued expenses 892,589 691,697 Accrued salaries and wages 2,813,433 329,126 Accrued royalties payable 1,142,478 397,451 Income taxes payable 636,938 1,433,554 Deferred income 100,000 472,674 - ------------------------------------------------------------------------------------------------------------------------------ Total current liabilities 8,504,766 6,197,900 Deferred tax liabilities 9,950 293,477 - ------------------------------------------------------------------------------------------------------------------------------ Total liabilities 8,514,716 6,491,377 Commitments and contingent liabilities -- -- Shareholders' equity: Preferred stock, $1.00 par value; authorized shares, 10,000,000; issued shares, -0- in 2000 and 2001 -- -- Common stock, $.20 par value--authorized shares, 50,000,000; issued shares, 13,329,264 in 2000 and 13,513,119 in 2001 2,665,853 2,702,624 Additional paid-in capital 66,343,728 70,010,254 Treasury stock, at cost, 386,800 shares in 2000 and 2001 (3,164,975) (3,164,975) Retained earnings 56,915,234 70,590,681 - ------------------------------------------------------------------------------------------------------------------------------ Total shareholders' equity 122,759,840 140,138,584 - ------------------------------------------------------------------------------------------------------------------------------ Total liabilities and shareholders' equity $ 131,274,556 $ 146,629,961 - ------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial statements. 18 Tollgrade Communications, Inc. and Subsidiaries Consolidated Statements of Operations
Years Ended December 31, 1999 2000 2001 - --------------------------------------------------------------------------------------------------------------------------------- Revenues: Products $ 60,031,005 $ 111,957,560 $ 77,611,861 Services 1,080,098 2,468,537 4,627,210 - --------------------------------------------------------------------------------------------------------------------------------- 61,111,103 114,426,097 82,239,071 Cost of sales: Products 24,298,741 40,680,034 33,134,366 Services 715,677 1,957,945 2,555,039 Amortization -- -- 365,000 - --------------------------------------------------------------------------------------------------------------------------------- 25,014,418 42,637,979 36,054,405 - --------------------------------------------------------------------------------------------------------------------------------- Gross profit 36,096,685 71,788,118 46,184,666 - --------------------------------------------------------------------------------------------------------------------------------- Operating expenses: Selling and marketing 7,006,118 12,288,646 9,159,227 General and administrative 4,722,970 6,216,427 4,827,120 Research and development 8,756,551 12,456,337 12,427,859 Severance and related expense -- -- 291,401 - --------------------------------------------------------------------------------------------------------------------------------- Total operating expense 20,485,639 30,961,410 26,705,607 - --------------------------------------------------------------------------------------------------------------------------------- Income from operations 15,611,046 40,826,708 19,479,059 Other (expense) income: Interest expense (1,549) -- -- Interest and other income 950,380 2,525,460 2,796,213 - --------------------------------------------------------------------------------------------------------------------------------- Total other income (expense) 948,831 2,525,460 2,796,213 - --------------------------------------------------------------------------------------------------------------------------------- Income before taxes 16,559,877 43,352,168 22,275,272 Provision for income taxes 5,937,000 15,857,000 8,599,825 - --------------------------------------------------------------------------------------------------------------------------------- Net income $ 10,622,877 $ 27,495,168 $ 13,675,447 - --------------------------------------------------------------------------------------------------------------------------------- EARNINGS PER SHARE INFORMATION: - --------------------------------------------------------------------------------------------------------------------------------- Weighted average shares of common stock and equivalents: Basic 11,573,580 12,636,284 13,037,906 Diluted 11,958,976 13,359,270 13,412,037 - --------------------------------------------------------------------------------------------------------------------------------- Net income per common share: Basic $ 0.92 $ 2.18 $ 1.05 Diluted $ 0.89 $ 2.06 $ 1.02 - ---------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial statements. 19 Tollgrade Communications, Inc. and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity
Additional Preferred Stock Common Stock Paid-in Shares Amount Shares Amount Capital - -------------------------------------------------------------------------------------------------------- Balance at December 31, 1998 -- $ -- 11,840,928 $2,368,186 $26,319,679 Exercise of common stock options -- -- 261,352 52,270 2,123,652 Tax benefit from exercise of stock options -- -- -- -- 385,237 Purchase of treasury stock -- -- -- -- -- Net income -- -- -- -- -- - -------------------------------------------------------------------------------------------------------- Balance at December 31, 1999 -- -- 12,102,280 2,420,456 28,828,568 Exercise of common stock options -- -- 1,226,984 245,397 11,580,460 Tax benefit from exercise of stock options -- -- -- -- 25,934,700 Net income -- -- -- -- -- - -------------------------------------------------------------------------------------------------------- Balance at December 31, 2000 -- -- 13,329,264 2,665,853 66,343,728 EXERCISE OF COMMON STOCK OPTIONS -- -- 183,855 36,771 1,626,764 TAX BENEFIT FROM EXERCISE OF STOCK OPTIONS -- -- -- -- 2,039,762 NET INCOME -- -- -- -- -- - -------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2001 -- $ -- 13,513,119 $2,702,624 $70,010,254 - --------------------------------------------------------------------------------------------------------
Treasury Retained Stock Earnings Total - --------------------------------------------------------------------------------------- Balance at December 31, 1998 $(1,789,287) $18,797,189 $45,695,767 Exercise of common stock options -- -- 2,175,922 Tax benefit from exercise of stock options -- -- 385,237 Purchase of treasury stock (1,375,688) -- (1,375,688) Net income -- 10,622,877 10,622,877 - --------------------------------------------------------------------------------------- Balance at December 31, 1999 (3,164,975) 29,420,066 57,504,115 Exercise of common stock options -- -- 11,825,857 Tax benefit from exercise of stock options -- -- 25,934,700 Net income -- 27,495,168 27,495,168 - --------------------------------------------------------------------------------------- Balance at December 31, 2000 (3,164,975) 56,915,234 122,759,840 EXERCISE OF COMMON STOCK OPTIONS -- -- 1,663,535 TAX BENEFIT FROM EXERCISE OF STOCK OPTIONS -- -- 2,039,762 NET INCOME -- 13,675,447 13,675,447 - --------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2001 $(3,164,975) $70,590,681 $140,138,584 - ---------------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial statements. 20 Tollgrade Communications, Inc. and Subsidiaries Consolidated Statements of Cash Flows
Years Ended December 31, 1999 2000 2001 - ----------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 10,622,877 $ 27,495,168 $ 13,675,447 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,252,743 1,910,245 2,692,322 Tax benefit from exercise of stock options 385,237 15,044,372 2,039,762 Refundable income taxes paid -- -- 7,714,229 Deferred income taxes (253,512) (481,541) (442,435) Provision for losses on inventory 393,000 743,129 299,845 Provision for allowance for doubtful accounts 100,000 22,189 175,000 Changes in assets and liabilities: Decrease (increase) in accounts receivable -- trade (3,077,184) (7,932,588) 9,304,092 Decrease (increase) in accounts receivable -- other (34,475) (478,654) 1,390,808 Decrease (increase) in inventory (4,526,976) (13,906,864) 8,016,021 (Increase) decrease in prepaid expenses and deposits (109,521) (325,164) 7,875 (Decrease) increase in accounts payable 224,690 962,559 (1,068,929) Increase (decrease) in accrued expenses and deferred income 1,160,928 (291,760) (80,218) (Decrease) increase in accrued royalties payable 80,718 348,789 (745,027) (Decrease) increase in accrued salaries and wages 1,407,565 603,960 (2,484,307) Increase (decrease) in income taxes payable 1,655,130 (1,806,671) 796,616 - ----------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 9,281,220 21,907,169 41,291,101 - ----------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Purchase of investments (15,183,124) (38,637,741) (29,030,595) Redemption/maturity of investments 14,618,612 23,848,762 53,546,927 Capital expenditures (2,272,485) (4,076,074) (3,528,528) Investments in other assets -- -- (231,615) Purchase of treasury stock (1,375,688) -- -- Purchase of LoopCare business from Lucent -- -- (62,028,763) - ----------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (4,212,685) (18,865,053) (41,272,574) - ----------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Proceeds from the exercise of stock options 2,175,922 11,825,857 1,663,535 - ----------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 2,175,922 11,825,857 1,663,535 - ----------------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 7,244,457 14,867,973 1,682,062 - ----------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at beginning of period 8,311,353 15,555,810 30,423,783 - ----------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 15,555,810 $ 30,423,783 $ 32,105,845 - ----------------------------------------------------------------------------------------------------------------- Supplemental disclosure of cash flow information: Cash paid during the year for interest $ 1,549 $ -- $ -- Cash paid during the year for income taxes $ 4,078,830 $ 3,145,422 $ 6,801,560 - ----------------------------------------------------------------------------------------------------------------- Supplemental disclosure of non-cash activity: Acquisition related receivable $ -- $ -- $ 897,000 Tax benefit from the exercise of stock options $ -- $ 10,890,328 $ -- - -----------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial statements. 21 TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION, BUSINESS AND BASIS OF PRESENTATION Tollgrade Communications, Inc. (the Company) designs, engineers, markets and supports test system, test access and status monitoring products and test software for the telecommunications and cable television industries. The Company's telecommunications proprietary test access products enable telephone companies to use their existing line test systems to remotely diagnose problems in Plain Old Telephone Service (POTS) lines containing both copper and fiber optics. The Company's test system products, specifically the DigiTest test platform, focus on helping local exchange carriers conduct the full range of fault diagnosis along with the ability to prequalify, deploy and maintain next-generation services including Digital Subscriber Line service. The Company's cable products consist of a complete cable status monitoring system that provides a comprehensive testing solution for the Broadband Hybrid Fiber Coax distribution system. The status monitoring system consists of 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. The Company was organized in 1986 and began operations in 1988. The Company acquired, for cash, the LoopCare product line business, effective September 30, 2001. See Note 2. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expense during the reporting period. Actual results could differ from those estimates. PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated. CASH AND CASH EQUIVALENTS The Company considers highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Substantially all of the Company's cash and cash equivalents are maintained at one financial institution. No collateral or security is provided on these deposits, other than $100,000 of deposits per financial institution insured by the Federal Deposit Insurance Corporation. INVESTMENTS Short-term investments at December 31, 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 amortized 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 Company classifies its investment in all debt securities as "held to maturity" as the Company has the positive intent and ability to hold the securities to maturity which is in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities." INVENTORIES Inventories are stated at the lower of cost or market, with cost determined on the first-in, first-out method. The Company provides appropriate reserves for any inventory deemed slow moving or obsolete. PROPERTY AND EQUIPMENT Property and equipment is stated at cost and depreciated on a straight-line method over the estimated useful lives. Leasehold improvements are amortized over the related lease period or the estimated useful life, whichever is shorter. The cost of renewals and betterments that extend the lives or productive capacities of properties is capitalized. Expenditures for normal repairs and maintenance are charged to operations as incurred. The cost of property and equipment retired or otherwise disposed of and the related accumulated depreciation or amortization are removed from the accounts, and any resulting gain or loss is reflected in current operations. Major maintenance costs are expensed as incurred. 22 PRODUCT WARRANTY The Company records estimated warranty costs on the accrual basis of accounting. These reserves are based on applying historical returns to the current level of product shipments and the cost experience associated therewith. In the case of software, the reserves are based on the cost of performing specification updates. REVENUE RECOGNITION Revenue from product sales is recognized at the time of shipment when both risk of loss and title has transferred to the customer, which coincides with shipment of related products, and collection is reasonably assured. Software license revenue is recognized in accordance with the AICPA's Statement of Position ("SOP") 97-2, "Software Revenue Recognition," SOP 98-9 "Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain Transactions," and Emerging Issues Task Force Issue 01-03. Revenue from software license, which is comprised of fees for perpetual licenses derived from contracts with corporate customers, is recognized when persuasive evidence of an arrangement exists, upon delivery of the product, acceptance by the customer and receipt of a signed notice indicating that no significant Company obligations exist, the fee is fixed or determinable, and collectibility is probable. Revenue from Professional Services (testability consulting) is recognized upon services being rendered. Reimbursement for out-of-pocket costs is recognized as revenue and simultaneously recognized as the cost of product sales. Revenue from Professional Services also includes revenue from maintenance agreements. Maintenance revenue is generally recognized on a straight-line basis over the life of the related agreement, which is typically one year. Customer advances and amounts due from customers in excess of revenue recognized are recorded as deferred income. Revenue for license and royalty fees is recognized when earned. In December 1999, the Staff of the Securities and Exchange Commission issued Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB 101"), which provides guidance related to revenue recognition. The Company has adopted this standard in 2000 and the impact did not have a material effect on its business, results of operations and financial condition. IMPAIRMENT OF LONG-LIVED ASSETS Long-lived assets and intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of an impairment loss for long-lived assets and certain identifiable intangible assets that management expects to hold and use is based on the fair value of the asset. RESEARCH AND DEVELOPMENT COSTS Research and development costs are charged to operations as incurred. CAPITALIZED SOFTWARE DEVELOPMENT COSTS Any costs incurred to establish the technological feasibility of software to be sold or otherwise marketed are expensed as research and development costs. Costs incurred subsequent to the establishment of technological feasibility, and prior to the general availability of the product to the public are capitalized and subsequently amortized under the straight-line method. The Company defines technological feasibility as coding and testing in accordance with detailed program designs. INCOME TAXES The Company follows the provisions of SFAS No. 109, "Accounting for Income Taxes" (SFAS 109). Under SFAS 109, deferred tax liabilities and assets are determined based on the "temporary differences'' between the financial statement carrying amounts and the tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. SEGMENT INFORMATION The Company follows the provisions of SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information, Financial Reporting for Segments of a Business." This statement establishes standards for reporting information about operating segments, products and services, geographic areas and major customers in annual and interim financial statements. The Company manages and operates its business as one segment. 23 DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes standards for reporting information about various derivative financial instruments and accounting for their change in fair value. The Company does not hold or issue derivative instruments for hedging purposes and therefore this standard in 2001 did not have a material effect on the consolidated financial position or results of operations of the Company. 2. ACQUISITION On September 30, 2001, the Company acquired certain assets and assumed certain liabilities of the LoopCare(TM) Product line from Lucent Technologies, Inc. ("Lucent") for approximately $62,029,000 in cash which includes approximately $2,200,000 of acquisition-related costs. The LoopCare software product integrates with and enhances the value of the Company's core products, resulting in a significant competitive advantage in the marketplace. The assets consisted principally of rights to existing contracts, software and related computer equipment, while the liabilities were principally related to software warranties currently under contract and deferred income which results from customer contractual billings and advances in excess of revenue recognized in income. The finalization of the purchase price with the seller has not been completed and is subject to negotiation between the parties. The Company does not believe that the final adjusted price will vary materially from recorded amounts. The Company 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 has been recorded under the purchase method of accounting and, accordingly, the results of operations of the LoopCare business since October 1, 2001 have been included in the consolidated financial statements. The following summarizes the estimated fair values at the date of acquisition: Current assets $ 855,000 Property and equipment, net 307,000 Intangible assets: LoopCare trade name $ 1,300,000 Base software 5,200,000 Developed product software 7,300,000 Post warranty maintenance service agreements 32,000,000 45,800,000 ---------- Goodwill 16,161,763 -------------------------------------------------------------------------------------------------------------- Total assets acquired $ 63,123,763 -------------------------------------------------------------------------------------------------------------- Deferred income (1,076,000) Warranty reserve (19,000) -------------------------------------------------------------------------------------------------------------- Total liabilities assumed (1,095,000) -------------------------------------------------------------------------------------------------------------- NET ASSETS ACQUIRED $ 62,028,763 --------------------------------------------------------------------------------------------------------------
An independent valuation consultant assisted management in its determination of fair value assigned to certain intangible assets other than goodwill. Discounted future cash flow models were utilized where appropriate. The base software has a historically long life cycle and the Company intends to maintain the software and to continue to develop new LoopCare features. Consequently, it was assumed that the base software and the LoopCare trade name have an indefinitely long life. This software has been in use and embedded within the Company's key customers' operating systems for over 25 years. Similarly, the maintenance service agreements are expected to generate revenues into perpetuity and are assumed to have an indefinite life. The developed product software is estimated to have a useful life of approximately five years and the Company believes it can continue to market the product over that period. Rapid development of improved replacement products is not expected due to the relatively small customer base and the cost to develop new software. The Company has utilized the transitional guidance of Statement of Financial Accounting Standards (SFAS) No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets" which were issued in July 2001. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 and that goodwill, as well as any intangible assets believed to have an indefinite useful life, shall not be amortized for financial reporting purposes. Based on the aforementioned and the Company's belief that there are no legal, regulatory, contractual, competitive or economic limitations on the useful lives of the LoopCare trade name, the base software and the maintenance service agreements, these assets are deemed to have an indefinite useful life and, along with goodwill, are not being amortized. In addition, based on the foregoing analysis, the developed product software is being amortized over five years. For tax purposes, the Company is amortizing all intangible assets over 15 years. 24 SFAS No. 142 also provides that entities evaluate the remaining useful lives of intangible assets determined to have indefinite useful lives periodically to determine whether events and circumstances continue to support an indefinite useful life and that such assets be tested at least annually for impairment of value. Any determined impairment in value from the carrying amounts shall result in an impairment loss to the extent of that excess. The effective date and transition rules of SFAS No. 142 require that the Company develop a methodology to measure impairment of the intangible assets by June 30, 2002 and to begin to measure for impairment of value by December 31, 2002. The following condensed proforma results of operations reflect the proforma combination of the Company and the acquired LoopCare business as if the combination occurred on January 1, 2000:
(In Thousands, Except Per Share Data) Proforma December 31, 2000 December 31, 2001 - ---------------------------------------------------------------------------------------------------- Revenues $ 127,916 $ 95,629 - ---------------------------------------------------------------------------------------------------- Income from operations $ 45,465 $ 23,728 - ---------------------------------------------------------------------------------------------------- Net income $ 26,774 $ 15,610 - ---------------------------------------------------------------------------------------------------- Net income per common share: Basic $ 2.12 $ 1.20 - ---------------------------------------------------------------------------------------------------- Diluted $ 2.00 $ 1.16 - ----------------------------------------------------------------------------------------------------
The results of operations for the LoopCare product line business included above include the twelve-month periods ending September 30, 2000 and 2001. Other proforma adjustments include an estimated allocation of selling, general and administrative expenses to the LoopCare operations based upon budgeted costs for 2002 and proforma amortization of the developed product software over five years. Proforma adjustments were also made to take into account the cost of money in connection with the acquisition costs. This was projected by reducing interest income at historical earning rates for working capital deemed to have been available to apply to the acquisition costs and projecting interest expense on borrowed funds for residual acquisition costs at the historical prime rates of interest plus 1.5%. Adjustments were also made to reflect the tax consequences of the foregoing proforma adjustments. 3. INVENTORIES Inventories consisted of the following:
December 31, 2000 DECEMBER 31, 2001 - ----------------------------------------------------------------------------------------------------- Raw materials $ 14,885,196 $ 11,697,886 Work in process 12,981,052 6,443,549 Finished goods 3,718,234 5,153,181 - ----------------------------------------------------------------------------------------------------- $ 31,584,482 $ 23,294,616 - ----------------------------------------------------------------------------------------------------- Reserves for slow moving and obsolete inventory (1,085,000) (1,111,000) - ----------------------------------------------------------------------------------------------------- $ 30,499,482 $ 22,183,616 - -----------------------------------------------------------------------------------------------------
4. PROPERTY AND EQUIPMENT Property and equipment consisted of the following:
Years December 31, 2000 DECEMBER 31, 2001 - --------------------------------------------------------------------------------------------------------------------------- Test equipment and tooling 3-5 $ 5,900,085 $ 6,617,117 Office equipment and fixtures 5-7 4,735,551 5,853,773 Leasehold improvements 1-6 2,059,764 2,036,329 - --------------------------------------------------------------------------------------------------------------------------- 12,695,400 14,507,219 Less accumulated depreciation and amortization 6,191,477 8,117,330 - --------------------------------------------------------------------------------------------------------------------------- Subtotal $ 6,503,923 $ 6,389,889 - --------------------------------------------------------------------------------------------------------------------------- Land $ -- $ 1,622,657 - --------------------------------------------------------------------------------------------------------------------------- $ 6,503,923 $ 8,012,546 - ---------------------------------------------------------------------------------------------------------------------------
25 5. SHAREHOLDERS' EQUITY COMMON STOCK The Company has 50,000,000 authorized shares which have a par value of $.20 per share. As of December 31, 2000 and 2001, there were 13,329,264 and 13,513,119 issued shares, respectively. 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. Prior to this extension, the Company had repurchased 382,400 shares of common stock. The Company was authorized to repurchase a total of one million shares of its common stock before December 31, 2001. Through December 31, 2001, no additional shares were repurchased under this extended program. On January 24, 2002, the Board of Directors authorized the continuation of the share repurchase program under which the Company may repurchase a total of one million shares of its common stock before December 31, 2002. STOCK COMPENSATION PLANS Under the Company's stock compensation plans, directors, officers and other employees may be granted options to purchase shares of the Company's common stock. The option price on all outstanding options is equal to the fair market value of the stock at the date of the grant, as defined. The options generally vest ratably over a two-year period, with one-third vested upon grant. The Company's option programs cover all employees and are used to attract and retain qualified personnel in all positions. On February 19, 1999, the Board of Directors approved a proposal to increase the number of shares under the 1995 Long-Term Incentive Compensation Plan ("the 1995 Plan") by 230,000 shares, with a corresponding cancellation of a simlar number of shares under the 1998 Employee Incentive Compensation Plan ("the 1998 Plan"). The shareholders approved this action on May 6, 1999. On December 14, 2000, the Board of Directors of the Company approved a proposal to increase the number of shares available under the 1998 Plan by 200,000 shares, from 740,000 to 940,000 shares. On May 23, 2001, the shareholders approved an amendment to the Company's 1995 Plan, as adopted by the Board of Directors on January 25, 2001, to increase the number of shares available under the Plan by 275,000 shares, from 2,210,000 to 2,485,000. The aggregate number of shares of the Company's Common Stock which may be issued under the 1995 Plan and the 1998 Plan is 2,485,000 and 940,000 shares, respectively, subject to proportionate adjustment in the event of stock splits and similar events. On January 24, 2002, the Board of Directors approved a proposal to increase the number of shares available under the 1998 Plan by 50,000 shares, from 940,000 to 990,000 shares. That same date, the Board also approved a proposal to increase the number of shares available under the 1995 Plan by 200,000. Such increase is subject to shareholder approval at the Company's annual meeting, to be held May 7, 2002. The maximum number of shares which may be awarded under the 1995 Plan to any one Named Executive Officer during any calendar year of the life of the plan is 200,000 shares. All full-time active employees of the Company, excluding officers and directors, are eligible to participate in the 1998 Plan. The Company has 1,836,384 total shares reserved under the option plans. The shares authorized but not granted under these plans at December 31, 2000 and 2001 were as follows:
Shares Authorized But Not Granted December 31, 2000 DECEMBER 31, 2001 - ------------------------------------------------------------------------------------------------------------------- 1995 Long-Term Incentive Compensation Plan 193,373 161,182 1998 Employee Incentive Compensation Plan 188,626 1,572 - ------------------------------------------------------------------------------------------------------------------- Total 381,999 162,754 - -------------------------------------------------------------------------------------------------------------------
The Company has adopted the disclosure-only provisions of SFAS No. 123 "Accounting for Stock-Based Compensation," but applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its plans. If the Company had elected to recognize compensation cost for these stock options based on the fair value at the grant dates for awards granted under those plans in 1999, 2000 and 2001 consistent with the method prescribed by SFAS No. 123, net income and earnings per share would have been changed to the pro forma amounts indicated below:
Years Ended December 31, 1999 2000 2001 - -------------------------------------------------------------------------------------------------------------------- Net income As reported $ 10,622,877 $ 27,495,168 $ 13,675,447 Pro forma $ 8,889,233 $ 19,734,070 $ 6,732,052 - -------------------------------------------------------------------------------------------------------------------- Diluted earnings per share As reported $ .89 $ 2.06 $ 1.02 Pro forma $ .74 $ 1.48 $ .50 - --------------------------------------------------------------------------------------------------------------------
26 The fair value of the stock options used to compute pro forma net income and earnings per share disclosures is the estimated present value at grant date using the Black-Scholes option-pricing model with the following weighted average assumptions for 1999, 2000 and 2001: expected volatility of 51.9% in 1999, 77.0% in 2000 and 87.7% in 2001; a risk-free interest rate of 4.97% in 1999, 5.83% in 2000 and 3.65% in 2001; and an expected holding period of 4 years. Using the Black-Scholes option-pricing model, the weighted average fair value of stock options granted during 1999, 2000 and 2001, is $4.76, $58.36 and $17.84 per share, respectively. Transactions involving stock options under the Company's various stock option plans and otherwise are summarized below:
Weighted Average Number of Shares Range of Option Price Exercise Price - ----------------------------------------------------------------------------------------------------------------------------------- Outstanding, December 31, 1998 2,122,439 $ 6.00000 - $ 13.56250 $ 9.08 Granted 432,000 7.50000 - 17.25000 10.41 Exercised (256,220) 6.00000 - 12.87500 8.30 Cancelled (103,196) 6.00000 - 13.56250 10.18 - ----------------------------------------------------------------------------------------------------------------------------------- Outstanding, December 31, 1999 2,195,023 6.00000 - 17.25000 9.38 Granted 416,625 51.62500 - 159.18750 95.84 Exercised (1,223,793) 6.00000 - 51.62500 9.59 Cancelled (24,615) 6.00000 - 159.18750 28.96 - ----------------------------------------------------------------------------------------------------------------------------------- Outstanding, December 31, 2000 1,363,240 6.00000 - 159.18750 35.25 Granted 560,650 20.53000 - 38.00000 27.60 Exercised (183,855) 6.00000 - 21.70000 9.05 Cancelled (66,405) 6.00000 - 159.18750 61.00 - ----------------------------------------------------------------------------------------------------------------------------------- OUTSTANDING, DECEMBER 31, 2001 1,673,630 $ 6.00000 - $159.18750 $ 34.55 - -----------------------------------------------------------------------------------------------------------------------------------
Weighted Average Options exercisable at: Number of Shares Exercise Price - ----------------------------------------------------------------------------------------------- December 31, 1999 1,660,425 $ 9.49 December 31, 2000 997,680 21.92 DECEMBER 31, 2001 1,219,648 $ 30.41 - -----------------------------------------------------------------------------------------------
The following table summarizes the status of the stock options, outstanding and exercisable, at December 31, 2001:
Stock Options Outstanding Stock Options Exercisable - ----------------------------------------------------------------------------------------------------------------------- Number Weighted Average Weighted Weighted Range of Exercise Outstanding Remaining Average Average Prices as of 12/31/01 Contractual Life Exercise Price Shares Exercise Price - ----------------------------------------------------------------------------------------------------------------------- $ 6.00000 - $ 7.28130 250,433 5.78 $ 6.78 250,433 $ 6.78 - ----------------------------------------------------------------------------------------------------------------------- $ 7.50000 - $ 9.26570 215,788 6.69 8.22 215,788 8.22 - ----------------------------------------------------------------------------------------------------------------------- $ 9.81250 - $ 12.87500 238,366 5.67 11.30 238,366 11.30 - ----------------------------------------------------------------------------------------------------------------------- $ 13.56250 - $ 21.92500 201,333 8.98 19.60 106,671 18.22 - ----------------------------------------------------------------------------------------------------------------------- $ 28.39500 - $ 28.39500 216,508 9.78 28.40 80,353 28.40 - ----------------------------------------------------------------------------------------------------------------------- $ 28.70000 - $ 38.00000 177,150 9.71 32.45 69,073 32.51 - ----------------------------------------------------------------------------------------------------------------------- $ 55.89850 - $ 71.87500 145,918 8.95 56.12 106,240 56.10 - ----------------------------------------------------------------------------------------------------------------------- $ 103.59375 - $ 103.59375 21,500 8.80 103.59 14,338 103.59 - ----------------------------------------------------------------------------------------------------------------------- $ 117.34400 - $ 117.34400 179,167 8.62 117.34 120,015 117.34 - ----------------------------------------------------------------------------------------------------------------------- $ 159.18750 - $ 159.18750 27,467 8.53 159.19 18,371 159.19 - ----------------------------------------------------------------------------------------------------------------------- TOTAL 1,673,630 7.87 $ 34.55 1,219,648 $ 30.41 - -----------------------------------------------------------------------------------------------------------------------
27 SERIES A JUNIOR PARTICIPATING PREFERRED STOCK PURCHASE RIGHTS In order to protect shareholder value in the event of an unsolicited offer to acquire the Company, on July 23, 1996, the Board of Directors of the Company declared a dividend of one preferred stock purchase right for each outstanding share of the Company's common stock. The dividend was payable on August 15, 1996 to shareholders of record as of that date. The aforementioned rights are exercisable only if a person or group acquires or announces an offer to acquire 20% or more of the Company's common stock. In such an event, each right will entitle shareholders to buy one-hundredth of a share of a new series of preferred stock at an exercise price of $115.00. Each one-hundredth of a share of the new preferred stock has terms designed to make it the economic and voting equivalent of one share of common stock. If a person or group acquires 20% or more of the Company's outstanding common stock, each right not owned by the person or group will entitle its holder to purchase at the right's exercise price a number of shares of the Company's common stock (or, at the option of the Company, the new preferred stock) having a market value of twice the exercise price. Further, at any time after a person or group acquires 20% or more (but less than 50%) of the outstanding common stock, the Board of Directors may at its option, exchange part or all of the rights (other than rights held by the acquiring person or group) for shares of the Company's common or preferred stock on a one-for-one basis. Each right further provides that if the Company is acquired in a merger or other business transaction, each right will entitle its holder to purchase, at the right's exercise price, a number of the acquiring company's common shares having a market value at that time of twice the exercise price. The Board of Directors is entitled to redeem the rights for one cent per right at any time before a 20% position has been acquired. The Board of Directors is also authorized to reduce the 20% thresholds referred to above to not less than 10%. 6. LICENSE AND ROYALTY FEES The Company has entered into several technology license agreements with certain major Digital Loop Carrier (DLC) vendors and major Operation Support System (OSS) equipment manufacturers under which the Company has been granted access to the licensor's patent technology and the right to manufacture and sell the patent technology in the Company's product line. The Company is obligated to pay royalty fees, as defined, through the terms of these license agreements. Under these agreements, license and royalty fees are due only upon purchase of the technology or shipment of units; there are no contingent payment provisions in any of these arrangements. Royalty fees of $2,011,930, $2,910,803 and $1,832,981 were incurred in 1999, 2000 and 2001, respectively, and are included in cost of product sales in the accompanying consolidated statements of operations. 7. INCOME TAXES The provision for income taxes consisted of the following:
Years Ended December 31, 1999 2000 2001 - -------------------------------------------------------------------------------------- Current: Federal $ 5,478,412 $ 14,212,441 $ 8,192,841 - -------------------------------------------------------------------------------------- State 712,100 2,126,100 849,419 - -------------------------------------------------------------------------------------- 6,190,512 16,338,541 9,042,260 - -------------------------------------------------------------------------------------- Deferred: Federal (221,011) (434,521) (355,700) State (32,501) (47,020) (86,735) - -------------------------------------------------------------------------------------- (253,512) (481,541) (442,435) - -------------------------------------------------------------------------------------- $ 5,937,000 $ 15,857,000 $ 8,599,825 - --------------------------------------------------------------------------------------
Reconciliations of the federal statutory rate to the effective tax rates are as follows:
Years Ended December 31, 1999 2000 2001 - -------------------------------------------------------------------------------------------------------------------- Federal statutory tax rate 34% 35% 35% State income taxes 3 5 3 Foreign sales corporation tax benefit (1) -- -- Other -- (3) 1 - -------------------------------------------------------------------------------------------------------------------- Effective tax rate 36% 37% 39% - --------------------------------------------------------------------------------------------------------------------
28 The components of and changes in the deferred tax assets and liabilities recorded in the accompanying balance sheets at December 31, 2000 and 2001 were as follows:
Deferred December 31, Expense December 31, 1999 (Credit) Other 2000 - ----------------------------------------------------------------------------------------------------------------- DEFERRED TAX ASSETS: Excess of tax basis over book basis for: Property and equipment $ 121,808 $ (63,082) $ -- $ 184,890 Inventory 247,182 (74,621) -- 321,803 Reserves recorded for: Warranty 234,000 (173,550) -- 407,550 Inventory 257,400 (165,750) -- 423,150 Allowance for doubtful accounts 70,670 (7,330) -- 78,000 Net operating loss carryforward 1,939,656 1,939,656 Other 11,817 2,792 -- 9,025 - ----------------------------------------------------------------------------------------------------------------- Total deferred tax assets $ 942,877 $ 3,364,074 - -----------------------------------------------------------------------------------------------------------------
Deferred Expense December 31, (Credit) Other 2001 - -------------------------------------------------------------------------------------------------- DEFERRED TAX ASSETS: Excess of tax basis over book basis for: Property and equipment $ (160,287) $ -- $ 345,177 Inventory (56,162) -- 377,965 Reserves recorded for: Warranty (398,970) -- 806,520 Inventory (10,140) -- 433,290 Allowance for doubtful accounts (68,250) -- 146,250 Net operating loss carryforward -- 160,293 1,779,363 Other (32,153) -- 41,178 - -------------------------------------------------------------------------------------------------- Total deferred tax assets $ 3,929,743 - --------------------------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES: Excess of book basis over tax basis for: Goodwill & Intangibles Property and equipment Other (9,950) (9,950) - ------------------------------------------------------------------------------------------------------------- Total deferred tax liabilities $ (9,950) $ (9,950) - ------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------- Net deferred taxes $ 932,927 $ (481,541) $ 1,939,656 $ 3,354,124 Reconciliation to the balance sheet: Current portion of deferred tax assets 575,251 983,246 Long-term portion of deferred tax liabilities (9,950) (9,950) - ------------------------------------------------------------------------------------------------------------- Long-term deferred tax asset $ 367,626 $ 2,380,828 - -------------------------------------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES: Excess of book basis over tax basis for: Goodwill & Intangibles 258,403 (258,403) Property and equipment 25,124 (25,124) Other (9,950) - ----------------------------------------------------------------------------------------------- Total deferred tax liabilities $ (293,477) - ----------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------- Net deferred taxes $ (442,435) $ 160,293 $ 3,636,266 Reconciliation to the balance sheet: Current portion of deferred tax assets 1,116,756 Long-term portion of deferred tax liabilities (293,477) - ----------------------------------------------------------------------------------------------- Long-term deferred tax asset $ 2,812,987 - -----------------------------------------------------------------------------------------------
The deferred tax asset from net operating loss carryforwards is applicable to Pennsylvania which allows a ten-year carryforward with a $2,000,000 cap on deductions each year. Unused carryforward losses will expire in 2010. 8. LINE OF CREDIT Effective December 20, 2001, the Company executed a five-year $25,000,000 Unsecured Revolving Credit Facility (the "Facility") with a bank. In accordance with the terms of the Facility, the proceeds must be used for general corporate purposes, working capital needs, and in connection with certain acquisitions, as defined. The Facility contains certain standard covenants with which the Company must comply, including a minimum fixed charge ratio, a minimum defined level of tangible net worth and a restriction on the amount of capital expenditures that can be made on an annual basis, among others. Interest is payable on any amounts utilized under the Facility at prime, or the prevailing Euro rate plus 1.0% to 1.5% depending on the fixed charge coverage ratio, at the option of the Company. Commitment fees are paid quarterly at the rate of 0.25% per annum on the average unused commitment. At December 31, 2001, there were no amounts outstanding under the Facility. 9. LEASE COMMITMENTS The Company leases office space and equipment under agreements which are accounted for as operating leases. The office lease for the Cheswick facility expires December 31, 2002 and may be extended for an additional 3 years. The equipment leases expire in August 2005 for the Cheswick facility and January 2007 for the Bridgewater facility. The Company is also involved in various month-to-month leases for research and development equipment. In addition, 29 the office lease includes provisions for possible adjustments in annual future rental commitments relating to excess taxes and excess maintenance costs that may occur.
Minimum annual future rental commitments under noncancelable leases as of December 31 are: 2002........................................................ $1,137,146 2003........................................................ 533,302 2004........................................................ 533,302 2005........................................................ 507,879 2006........................................................ 457,032
The rent expense for all lease commitments was $599,615, $731,320 and $890,943 in 1999, 2000 and 2001, respectively. In October of 2001, the Company entered into a lease agreement for a facility in Bridgewater, New Jersey. The lease commenced on January 21, 2002 and will expire on January 21, 2007. 10. MAJOR CUSTOMERS, REVENUE CONCENTRATION AND DEPENDENCE ON CERTAIN SUPPLIERS The Company designs, engineers, markets and supports test system, test access and status monitoring products for the telecommunications and cable television industries. Sales are concentrated primarily with the four Regional Bell Operating Companies (RBOCs) as well as major independent telephone companies and to certain digital loop carrier equipment manufacturers. Sales are primarily from the Company's metallic channel unit (MCU) product line. The MCU product line accounted for approximately 68% of the Company's net product sales for 2001. The Company expects that revenues from MCU products will continue to account for a majority of the Company's revenues for the foreseeable future. The DigiTest product line accounted for approximately 18% of the Company's net product sales for 2001. Sales to the RBOCs accounted for approximately 61%, 64% and 71% of the Company's net product sales for fiscal years 1999, 2000 and 2001, respectively. During fiscal years 1999 and 2000, sales to four RBOCs individually exceeded 10% of consolidated revenues and on a combined basis, comprised 61% (individually, 18%, 17%, 16% and 10%) and 64% (individually, 29%, 14%, 11% and 10%), respectively, of the Company's net product sales. During 2001, sales to three RBOCs individually exceeded 10% of consolidated revenues and, on a combined basis, comprised 66% (individually, 38%, 14% and 14%) of the Company's net product sales. Sales to an Original Equipment Manufacturer accounted for approximately 11%, 4% and 5% of the Company's net product sales for fiscal years 1999, 2000 and 2001, respectively. In addition, sales to a large independent carrier accounted for approximately 10%, 12% and 11% of the Company's net product sales for fiscal years 1999, 2000 and 2001, respectively. Due to the Company's present dependency on the RBOCs, the loss of one or more of the RBOCs as a customer, or the reduction of orders for the Company's products by the RBOCs, could materially and adversely affect the Company. The Company utilizes two key independent subcontractors to perform a majority of the circuit board assembly and in-circuit testing work on its products. The Company also utilizes other subassembly contractors on a more limited basis. The loss of the subcontractors could cause delays in the Company's ability to meet production obligations and could have a material adverse effect on the Company's results of operations. In addition, shortages of raw material to, or production capacity constraints at, the Company's subcontractors could negatively affect the Company's ability to meet its production obligations and result in increased prices for affected parts. Any such reduction may result in delays in shipments of the Company's products or increases in the price of components, either of which could have a material adverse impact on the Company. 11. EMPLOYEE BENEFIT PLANS The Company has a 401(k) benefit plan. Eligible employees, as defined in the plan, may contribute up to 20% of eligible compensation, not to exceed the statutory limit. The Company does not make matching contributions to the plan. 12. DEFERRED AND REFUNDABLE TAX ASSETS The Company's current refundable tax assets as of December 31, 2000 and 2001 include tax benefits of $8,950,672 and $1,396,736, respectively, resulting from the exercising of certain nonqualified stock options by various directors, officers and other employees under the Company's various stock option programs during 2000 and 2001. The Company is entitled to a tax deduction 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 nonqualified stock options. The Company received $8,417,270 in 2001 in federal and state refunds in taxes paid in prior years. It is anticipated that the current deferred and refundable tax assets as of December 31, 2001 will be substantially utilized in 2002 either through refunds of prior year taxes paid or the elimination of income taxes due. 30 13. 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. The restructuring program resulted in a pre-tax charge for severance, outplacement and other related costs of $291,000 in 2001. 14. RECENT 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 No. 142 statements contain provisions which require that these statements be applied to all business combinations initiated after June 30, 2001. The Company utilized the transitional guidance of SFAS No. 141 and SFAS No. 142 in connection with the LoopCare acquisition on September 30, 2001. The Company will adopt the full provisions of these statements on January 1, 2002. The Company does not believe the adoption of these standards will have a material effect on its financial statements. On August 15, 2001, the FASB issued SFASNo. 143, "Accounting for Asset Retirement Obligation." On October 4, 2001, FASB issued SFASNo. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The Company will adopt these statements on January 1, 2003 and is presently evaluating the impact they may have on the Company. 15. SHORT- AND LONG-TERM INVESTMENTS The estimated fair values of the Company's financial instruments are as follows:
December 31, 2000 DECEMBER 31, 2001 ---------------------------------------------------------------------------------------- Carrying Fair CARRYING FAIR Amount Value AMOUNT VALUE - ----------------------------------------------------------------------------------------------------------------------------------- Financial assets: Cash and cash equivalents $ 30,423,783 $ 30,423,783 $ 32,105,845 $ 32,105,845 Short-term and long-term investments 31,155,655 31,104,323 6,639,323 6,658,247 - ----------------------------------------------------------------------------------------------------------------------------------- $ 61,579,438 $ 61,528,106 $ 38,745,168 $ 38,764,092 - -----------------------------------------------------------------------------------------------------------------------------------
16. PER SHARE INFORMATION Net income per share has been computed in accordance with the provisions of SFAS No. 128, "Earnings Per Share" for all periods presented. On February 10, 2000, the Company's Board of Directors authorized a two-for-one stock split of the Company's common stock, payable in the form of a 100 percent stock dividend. On March 20, 2000, shareholders of record received one additional share of common stock for each share of common stock held of record on February 28, 2000. All share and per share information reflects the two-for-one split of the Company's common stock. SFASNo. 128 requires companies with complex capital structures to report earnings per share on a basic and diluted basis, as defined. Basic earnings per share are calculated on the actual number of weighted average common shares outstanding for the period, while diluted earnings per share must include the effect of any dilutive securities. All prior periods have been restated in accordance with SFAS No. 128. A reconciliation of earnings per share is as follows:
Years Ended December 31, 1999 2000 2001 - --------------------------------------------------------------------------------------------------------------------------------- Net Income $ 10,622,877 $ 27,495,168 $ 13,675,447 - --------------------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding 11,573,580 12,636,284 13,037,906 - --------------------------------------------------------------------------------------------------------------------------------- Effect of dilutive securities - stock options 385,396 722,986 374,131 - --------------------------------------------------------------------------------------------------------------------------------- 11,958,976 13,359,270 13,412,037 - --------------------------------------------------------------------------------------------------------------------------------- Earnings per share: Basic $ .92 $ 2.18 $ 1.05 - --------------------------------------------------------------------------------------------------------------------------------- Diluted $ .89 $ 2.06 $ 1.02 - ---------------------------------------------------------------------------------------------------------------------------------
31 STATEMENTS OF OPERATIONS DATA BY QUARTER The following table presents unaudited quarterly operating results for each of the Company's last eight fiscal quarters. This information has been prepared by the Company on a basis consistent with the Company's audited financial statements and includes all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for a fair presentation of the data. Such quarterly results are not necessarily indicative of the future results of operations. (In Thousands, Except Net Income Per Common Share Data) Quarter Ended (Unaudited)
March 31, June 30, Sept. 30, Dec. 31, 2000 2000 2000 2000 - ----------------------------------------------------------------------------------------- Revenues: Products $ 21,776 $ 29,074 $ 29,228 $ 31,882 Services 642 593 560 672 - ----------------------------------------------------------------------------------------- 22,418 29,667 29,788 32,554 Cost of Sales: Products 7,971 10,947 10,368 11,395 Services 401 467 473 617 Amortization of intangibles - ----------------------------------------------------------------------------------------- 8,372 11,414 10,841 12,012 - ----------------------------------------------------------------------------------------- Gross Profit 14,046 18,253 18,947 20,542 - ----------------------------------------------------------------------------------------- Operating Expenses: Selling and marketing 2,384 3,028 3,440 3,438 General and administrative 1,378 1,495 1,591 1,752 Research and development 2,590 3,098 3,178 3,589 Severance and related expense - ----------------------------------------------------------------------------------------- Total Operating Expense 6,352 7,621 8,209 8,779 - ----------------------------------------------------------------------------------------- Income from Operations 7,694 10,632 10,738 11,763 Other Income, Net 470 546 662 848 - ----------------------------------------------------------------------------------------- Income Before Taxes 8,164 11,178 11,400 12,611 Provision for Income Taxes 2,939 4,024 4,104 4,790 - ----------------------------------------------------------------------------------------- Net Income $ 5,225 $ 7,154 $ 7,296 $ 7,821 - ----------------------------------------------------------------------------------------- EARNINGS PER SHARE INFORMATION: Weighted average shares of common stock and equivalents: Basic 12,219 12,563 12,821 12,940 Diluted 13,546 13,318 13,460 13,434 Net income per common share: Basic $ 0.43 $ 0.57 $ 0.57 $ 0.60 Diluted $ 0.39 $ 0.54 $ 0.54 $ 0.58 - ----------------------------------------------------------------------------------------- MARCH 31, JUNE 30, SEPT. 30, DEC. 31, 2001 2001 2001 2001 - ------------------------------------------------------------------------------------------- Revenues: Products $ 27,464 $ 21,177 $ 15,077 $ 13,894 Services 526 599 961 2,541 - ------------------------------------------------------------------------------------------- 27,990 21,776 16,038 16,435 Cost of Sales: Products 11,851 9,047 7,158 5,076 Services 423 517 508 1,107 Amortization of intangibles 365 - ------------------------------------------------------------------------------------------- 12,274 9,564 7,666 6,548 - ------------------------------------------------------------------------------------------- Gross Profit 15,716 12,212 8,372 9,887 - ------------------------------------------------------------------------------------------- Operating Expenses: Selling and marketing 2,450 2,493 2,023 2,194 General and administrative 1,530 1,062 1,020 1,215 Research and development 3,360 2,749 2,639 3,681 Severance and related expense 400 (109) - ------------------------------------------------------------------------------------------- Total Operating Expense 7,340 6,704 5,682 6,981 - ------------------------------------------------------------------------------------------- Income from Operations 8,376 5,508 2,690 2,906 Other Income, Net 907 790 801 298 - ------------------------------------------------------------------------------------------- Income Before Taxes 9,283 6,298 3,491 3,204 Provision for Income Taxes 3,528 2,494 1,361 1,217 - ------------------------------------------------------------------------------------------- Net Income $ 5,755 $ 3,804 $ 2,130 $ 1,987 - ------------------------------------------------------------------------------------------- EARNINGS PER SHARE INFORMATION: Weighted average shares of common stock and equivalents: Basic 12,958 13,028 13,066 13,095 Diluted 13,377 13,404 13,378 13,472 Net income per common share: Basic $ 0.44 $ 0.29 $ 0.16 $ 0.15 Diluted $ 0.43 $ 0.28 $ 0.16 $ 0.15 - -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------- COMMON STOCK MARKET PRICES The Company's Common Stock has been included for quotation on The Nasdaq National Market System under the Nasdaq symbol "TLGD" since the Company's initial public offering in December 1995. The following table sets forth, for the periods indicated, the high and low sales prices for the Common Stock on such market:
High Low - ----------------------------------------------------- 2000: First Quarter $ 84.00 $ 16.06 Second Quarter 147.19 31.50 Third Quarter 168.88 78.63 Fourth Quarter 148.00 25.75 2001: FIRST QUARTER $ 52.50 $ 15.25 SECOND QUARTER 40.35 18.75 THIRD QUARTER 29.35 18.00 FOURTH QUARTER 34.55 18.45 - -----------------------------------------------------
At January 31, 2002, the Company had 190 holders of record of its Common Stock and 13,521,836 shares outstanding. The Company has never paid any dividends on its Common Stock and does not expect to pay cash dividends in the foreseeable future. 32 SHAREHOLDER INFORMATION SHAREHOLDERS ANNUAL MEETING The Annual Meeting of Shareholders of Tollgrade Communications, Inc., will be held at The Syria Mosque, 1877 Shriners Way, Cheswick, PA 15024, on Tuesday, May 7, 2002, at 1:30 p.m. Notice of the meeting and proxy materials were included with this Annual Report. TRANSFER AGENT AND SHAREHOLDER INQUIRIES The Company's transfer agent is Mellon Investor Services, L.L.C. Inquiries concerning transfer requirements, lost certificates and change of address should be directed to: Mellon Investor Services, L.L.C. P.O. Box 3315 South Hackensack, NJ 07606 or: 85 Challenger Road Ridgefield Park, NJ 07660 1-800-756-3353 TDDfor Hearing Impaired: 1-800-231-5469 Foreign Shareholders: 201-329-8660 TDDForeign Shareholders: 201-329-8354 www.mellon-investor.com. All other inquiries should be directed to: Tollgrade Communications, Inc. Investor Relations Department 493 Nixon Road Cheswick, PA 15024 1-800-878-3399 www.tollgrade.com. FORM 10-K A copy of the Tollgrade Communications, Inc. Form 10-K for 2001, which will be filed with the Securities and Exchange Commission during the first quarter of 2002, is available without attachments at no charge upon written request. Inquiries should be directed to the Investor Relations Department, Tollgrade Communications, Inc., 493 Nixon Road, Cheswick, PA 15024. INDEPENDENT AUDITORS PricewaterhouseCoopers LLP, Pittsburgh, Pennsylvania. COUNSEL Reed Smith LLP, Pittsburgh, Pennsylvania. STOCK MARKET LISTING Tollgrade Communications, Inc. is listed on The Nasdaq Stock Market.(SM) Symbol: TLGD. BOARD OF DIRECTORS [PHOTO] CHRIS ALLISON Chairman and Chief Executive Officer [PHOTO] JAMES J. BARNES Attorney at Law, Reed Smith LLP [PHOTO] DANIEL P.BARRY Private Investor, Director of Respironics, Inc. [PHOTO] ROBERT W. KAMPMEINERT Chairman, President and Chief Executive Officer, Parker/Hunter Incorporated [PHOTO] ROCCO L. FLAMINIO Vice Chairman and Chief Technology Officer [PHOTO] RICHARD H. HEIBEL, M.D. Board Certified Cardiologist (retired) [PHOTO] DAVID S.EGAN Chief Marketing Officer, Reed Smith LLP EXECUTIVE COUNCIL AND OFFICERS CHRIS ALLISON Chairman and Chief Executive Officer SARA M. ANTOL General Counsel and Corporate Secretary RICHARD A. BAIR, JR. Executive Vice President, Engineering and Testing WYLIE E. ETSCHEID, JR. Executive Vice President of Business Development, Software Products ROCCO L. FLAMINIO Vice Chairman and Chief Technology Officer CAROL M. FRANKLIN General Manager, Software Products SAMUEL C. KNOCH Chief Financial Officer and Treasurer JOSEPH G. O'BRIEN Senior Vice President, Human Resources MARK B. PETERSON President GREGORY L. QUIGGLE Executive Vice President, Marketing JAMES N. PRICE Senior Vice President, Systems Engineering MATTHEW J. ROSGONE Executive Vice President, Operations CHARLES J. SHEARER Controller RICHARD A. SKAARE Executive Vice President, Organizational Development and Communication ROGER A. SMITH Executive Vice President, Technology STEPHANIE M. WEDGE Vice President, Professional Services (R) TOLLGRADE, MCU, DigiTest and LIGHTHOUSE are registered trademarks of Tollgrade Communications, Inc. TM LoopCare and TELACCORD are trademarks of Tollgrade Communications, Inc. All other trademarks are the property of their respective owners. (C) 2002 Tollgrade Communications, Inc. All rights reserved. [TOLLGRADE LOGO] CORPORATE HEADQUARTERS 493 Nixon Road, Cheswick, PA 15024 - 1-800-878-3399 - www.tollgrade.com EX-23.1 9 j9338001ex23-1.txt CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Registration No. 333-4290, Registration No. 333-52907, Registration No. 333-83007 and Registration No. 333-55470) of Tollgrade Communications, Inc. and Subsidiaries of our report dated January 21, 2002 relating to the financial statements, which appears in the Annual Report to Shareholders, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated January 21, 2002 relating to the financial statement schedule, which appears in this Form 10-K. PricewaterhouseCoopers LLP Pittsburgh, Pennsylvania March 22, 2002 60 -----END PRIVACY-ENHANCED MESSAGE-----