10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended April 1, 2006

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

For the transition period from                      to                     

Commission file number 000-27312

TOLLGRADE COMMUNICATIONS, INC.

(Exact name of registrant as specified in its charter)

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

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

412-820-1400
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  þ     No  o

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

Large Accelerated Filer o Accelerated Filer  þ  Non-accelerated filer  o

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

Yes  o  No þ

As of April 1, 2006, there were 13,246,308 shares of the Registrant’s Common Stock, $0.20 par value per share, and no shares of the Registrant’s Preferred Stock, $1.00 par value per share, outstanding.

TOLLGRADE COMMUNICATIONS, INC.

Quarterly Report on Form 10-Q
For the Quarter Ended April 1, 2006
Table of Contents

	PAGE NO.
PART I. FINANCIAL INFORMATION
Item 1 Condensed Consolidated Financial Statements (unaudited):
Condensed Consolidated Balance Sheets as of April 1, 2006 and December 31, 2005		3
Condensed Consolidated Statements of Operations for the three month periods ended April 1, 2006 and March 26, 2005		4
Condensed Consolidated Statement of Changes in Shareholders’ Equity for the three month period ended April 1, 2006		5
Condensed Consolidated Statements of Cash Flows for the three month periods ended April 1, 2006 and March 26, 2005		6
Notes to Condensed Consolidated Financial Statements		7
Report of Independent Registered Public Accounting Firm		17
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3 Quantitative and Qualitative Disclosures about Market Risk		33
Item 4 Controls and Procedures		33
PART II. OTHER INFORMATION
Item 1A Risk Factors		34
Item 2 Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities		45
Item 6 Exhibits		45
SIGNATURES		46
EXHIBIT INDEX		47
Exhibit 10.1
Exhibit 10.2
Exhibit 15
Exhibit 31.1
Exhibit 31.2
Exhibit 32
EX-10.1
EX-10.2
EX-15
EX-31.1
EX-31.2
EX-32

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PART I. FINANCIAL INFORMATION

Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands except par value) (Unaudited)

	April 1, 2006			December 31, 2005*
ASSETS
Current assets:
Cash and cash equivalents	$	41,190		$	49,421
Short-term investments		17,576			18,010
Accounts receivable:
Trade, net of allowance for doubtful accounts of $477 in 2006 and $465 in 2005		15,659			9,456
Other		1,451			1,406
Inventories		11,974			9,934
Prepaid expenses and other current assets		1,417			1,397
Deferred tax assets and refundable income tax		1,356			1,803
Total current assets		90,623			91,427
Property and equipment, net		6,376			6,390
Deferred tax assets		48			46
Intangibles, net		44,150			43,616
Goodwill		23,335			21,562
Receivable from officer		152			153
Other assets		127			135
Total assets	$	164,811		$	163,329
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,904		$	1,262
Accrued warranty		2,247			2,220
Accrued expenses		1,659			2,579
Accrued salaries and wages		266			660
Accrued royalties payable		618			581
Income taxes payable		197			869
Deferred income		3,655			2,450
Total current liabilities		11,546			10,621
Deferred tax liabilities		2,463			2,447
Total liabilities		14,009			13,068
Commitments and contingent liabilities		—			—
Shareholders’ equity:
Preferred stock, $1.00 par value; Authorized shares, 10,000; issued shares, -0- in 2006 and 2005		—			—
Common stock, $.20 par value; authorized shares, 50,000; issued shares, 13,708 in 2006 and 13,664 in 2005		2,742			2,733
Additional paid-in capital		72,065			71,469
Treasury stock, at cost, 462 shares in 2006 and 2005		(4,791	)		(4,791	)
Retained earnings		80,786			80,850
Total shareholders’ equity		150,802			150,261
Total liabilities and shareholders’ equity	$	164,811		$	163,329

* Amounts derived from audited financial statements presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005

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

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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

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

	Three Months Ended
	April 1, 2006			March 26, 2005
Revenues:
Products	$	14,497		$	11,980
Services		3,110			2,295
Total revenues:		17,607			14,275
Cost of sales:
Products		7,625			6,052
Services		1,059			796
Amortization of intangibles		977			714
Total cost of sales		9,661			7,562
Gross profit		7,946			6,713
Operating expenses:
Selling and marketing		2,686			2,238
General and administrative		2,320			1,835
Research and development		3,659			3,396
Retirement expense		—			775
Total operating expense		8,665			8,244
Loss from operations		(719	)		(1,531	)
Other income:
Interest income:		627			262
Loss before taxes		(92	)		(1,269	)
Benefit from income taxes		(28	)		(424	)
Net loss	$	(64	)	$	(845	)
Loss per share information:
Weighted average shares of common stock and equivalents:
Basic		13,214			13,161
Diluted		13,214			13,161
Net loss per common share:
Basic	$	0.00		$	(0.06	)
Diluted	$	0.00		$	(0.06	)

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

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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
For the Three Months Ended April 1, 2006
(In thousands) (Unaudited)

									Additional
	Preferred Stock				Common Stock				Paid-In		Treasury			Retained
	Shares		Amount		Shares		Amount		Capital		Stock			Earnings			Total
Balance at December 31, 2005		—	$	—		13,664	$	2,733	$	71,469	$	(4,791	)	$	80,850		$	150,261
Exercise of common stock options		—		—		44		9		390		—			—			399
Tax benefit from exercise of stock options		—		—		—		—		91		—			—			91
Stock-based compensation expense		—		—		—		—		115		—			—			115
Net loss		—		—		—		—		—		—			(64	)		(64	)
Balance at April 1, 2006		—	$	—		13,708	$	2,742	$	72,065	$	(4,791	)	$	80,786		$	150,802

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

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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) (Unaudited)

	Three Months Ended
	April 1, 2006			March 26, 2005
Cash flows from operating activities :
Net loss	$	(64	)	$	(845	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		1,520			1,368
Compensation expense related to stock plans		115			—
Deferred income taxes		(190	)		(437	)
Provision for losses on inventory		(18	)		57
Provision (credit) for allowance for doubtful accounts		12			(17	)
Changes in assets and liabilities (net of acquired business):
(Increase) decrease in accounts receivable-trade		(4,388	)		1,847
Increase in accounts receivable-other		(45	)		(600	)
Increase in inventory		(922	)		(1,226	)
(Increase) decrease in prepaid expenses and other assets		(11	)		762
Decrease in refundable taxes		651			312
Increase in accounts payable		1,015			234
Increase (decrease) in accrued warranty		27			(20	)
Increase (decrease) in accrued expenses and deferred income		110			(282	)
Increase (decrease) in accrued royalties payable		37			(299	)
Decrease in accrued salaries and wages		(394	)		(119	)
(Decrease) increase in income taxes payable		(672	)		12
Net cash (used in) provided by operating activities		(3,217	)		747
Cash flows from investing activities:
Purchase of Emerson test system business		(5,501	)		—
Purchase of short-term investments		(2,136	)		(10,391	)
Redemption/maturity of short-term investments		2,570			500
Capital expenditures, including capitalized software		(437	)		(344	)
Net cash used in investing activities		(5,504	)		(10,235	)
Cash flows from financing activities:
Proceeds from exercise of stock options		399			—
Tax benefit from exercise of stock options		91			—
Net cash provided by financing activities		490			—
Net decrease in cash and cash equivalents		(8,231	)		(9,488	)
Cash and cash equivalents at beginning of period		49,421			32,622
Cash and cash equivalents at end of period	$	41,190		$	23,134

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

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

We report our quarterly results for the first three interim periods based on fiscal quarters ending on Saturdays and for the fourth interim period ending on December 31. For the periods presented herein, our fiscal quarters ended April 1, 2006 (13 weeks) and March 26, 2005 (12 weeks). The accompanying unaudited condensed consolidated financial statements included herein have been prepared by Tollgrade Communications, Inc. (the “Company” or “Tollgrade”) in accordance with accounting principles generally accepted in the United States of America for interim financial information and Article 10 of Regulation S-X. The condensed consolidated financial statements as of and for the three-month period ended April 1, 2006 should be read in conjunction with the Company’s consolidated financial statements (and notes thereto) included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. Accordingly, the accompanying condensed consolidated financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements, although the Company believes that the disclosures are adequate to make the information presented not misleading. In the opinion of Company management, all adjustments considered necessary for a fair statement of the accompanying condensed consolidated financial statements have been included, and all adjustments are of a normal and recurring nature. Operating results for the three-month period ended April 1, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006.

With respect to the unaudited financial information of the Company for each of the three-month periods ended April 1, 2006 and March 26, 2005, included in this Form 10-Q, PricewaterhouseCoopers LLP (“PwC”) reported that they have applied limited procedures in accordance with professional standards for a review of such information. However, their report dated May 7, 2006 appearing herein, states that they did not audit and they do not express an opinion on that unaudited financial information. Accordingly, the degree of reliance on their report on such information should be restricted in light of the limited nature of the review procedures applied. PwC is not subject to the liability provisions of Section 11 of the Securities Act of 1933 (Act) for their report on the unaudited financial information because that report is not a “report” within the meaning of Sections 7 and 11 of the Act.

RECLASSIFICATIONS

Certain reclassifications have been made to prior year amounts to conform to the current year presentation.

SEGMENT INFORMATION

The Company follows the provisions of SFAS No. 131, “Disclosure 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. On February 24, 2006, the Company purchased certain assets and assumed certain liabilities associated with the test systems business unit of Emerson Network Power, Energy Systems, North America, Inc. (“Emerson”). This acquisition is currently being integrated into the Company and will be consolidated into our current product

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offerings. Following the Emerson acquisition, the Company will continue to manage and operate its business as one operating segment.

NEW ACCOUNTING STANDARDS

In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statement No. 133 and 140,” which simplifies accounting for certain hybrid financial instruments by permitting fair value remeasurement for any hybrid instrument that contains an embedded derivative that otherwise would require bifurcation and eliminates a restriction on the passive derivative instruments acquired, issued or subject to remeasurement (new basis) event occurring after the beginning of an entity’s fiscal year that begins after September 15, 2006. The adoption of SFAS No. 155 will have no impact on our results of operation or our financial position.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets – an amendment of FASB No. 140,” which establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities by requiring that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. SFAS No. 156 is effective as of the beginning of an entity’s fiscal year that begins after September 15, 2006. The adoption of SFAS No. 156 will have no impact on our results of operation or our financial position.

2. ACCOUNTING FOR STOCK-BASED COMPENSATION

Stock-Based Compensation Expense

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payments awards made to employees and directors for employee stock options, based on estimated fair values. The Company previously accounted for the stock-based compensation under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”) related to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R).

The Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Company’s year 2006. The Company’s Condensed Consolidated Financial Statements as of and for the three months ended April 1, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective application transition method, the Company’s Condensed Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) for the three months ended April 1, 2006 was $0.1 million, which consisted of stock-based compensation expense related to employee stock options.

SFAS 123(R) requires companies to estimate the fair value of share-based payments awards on the

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date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Condensed Consolidated Statement of Operations. Prior to the adoption of SFAS 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25. Under the intrinsic value method, no stock-based compensation expense had been recognized in the Company’s Consolidated Statement of Operations, because the exercise price of the Company’s stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant.

Stock-based compensation expense recognized in the Company’s Condensed Consolidated Statement of Operations for the quarter ended April 1, 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123. We have not granted any employee stock options during the first quarter of 2006. If options would be granted after December 31, 2005, compensation expense would be measured based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R).

On November 10, 2005, the FASB issued FASB Staff Position No. SFAS 123(R)-3 “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards.” The Company is evaluating the alternative transition method provided in the FASB Staff Position for calculating the tax effects of stock-based compensation pursuant to SFAS 123(R). The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC pool”) related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and Consolidated Statements of Cash Flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption SFAS 123(R).

Pro forma information under SFAS 123 for periods prior to January 1, 2006

Prior to January 1, 2006, the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25. The following table illustrates the effect on net income and earnings per share for the quarter ended March 26, 2005 based on the fair value method set forth in SFAS No. 123.

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	Three Months Ended
	March 26, 2005
	(in thousands)
Net loss	$	(845	)
Less: Total stock-based compensation determined under the fair value method for all awards, net of related tax		(2	)
Pro forma net loss	$	(847	)
Loss per share:
Basic	$	(0.06	)
Basic – pro forma	$	(0.06	)
Diluted	$	(0.06	)
Diluted – pro forma	$	(0.06	)

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 exercise 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 over a two-year period with one-third vested upon grant and expire ten years from the date of grant.

By its terms, shares were no longer available for grant under the Company’s 1995 Long-Term Incentive Compensation Plan beyond October 15, 2005. In March 2006, the Company’s Board of Directors adopted a new, 2006 Long-Term Incentive Compensation Plan, subject to shareholder approval. The plan was approved by the shareholders on May 9, 2006, and provides up to 1,300,000 shares available for grant. The 1998 Employee Incentive Compensation Plan is still an active plan and the aggregate number of shares of the Company’s Common Stock which were reserved under it is 990,000 shares, subject to proportionate adjustments in the event of stock splits and similar events. All full-time active employees of the Company, excluding officers and directors, are eligible to participate in the 1998 Plan. The shares authorized but not granted under this Plan and otherwise were as follows:

	Shares Authorized But Not Granted
	April 1, 2006		December 31, 2005
1995 Long-Term Incentive Compensation Plan		N/A		N/A
1998 Employee Incentive Compensation Plan		108,388		107,054

Transactions involving stock options under the Company’s 1995 Long-Term Incentive Compensation Plan and 1998 Employee Incentive Compensation Plan and otherwise are summarized below:

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	Number of					Weighted Average
	Shares			Range of Options Price		Exercise Price
Outstanding, December 31, 2005		1,780,137		$	7.28 – 159.19	$	26.87
Granted		—			—		—
Exercised		(44,318	)	$	7.56 – 12.55		9.01
Cancelled		(261,684	)		7.28 – 55.90		12.80
Outstanding, April 1, 2006		1,474,135			7.28 – 159.19		29.90
				Number of Shares
Options exercisable at:
December 31, 2004					1,629,607
December 31, 2005					1,605,113
April 1, 2006					1,299,211

The following table summarizes the status of stock options, outstanding and exercisable, at April 1, 2006:

	Stock Options Outstanding						Stock Options Exercisable
			Weighted
	Number		Average		Weighted		Number		Weighted
Range of	Outstanding as		Remaining		Average		Exercisable		Average
Exercise Prices	of 04/01/06		Contractual Life		Exercise Price		As of 04/01/06		Exercise Price
7.28		51,000		2.71		7.28		51,000		7.28
7.29 – 9.49		428,918		7.36		8.53		254,660		8.45
9.50 – 12.55		139,467		5.11		11.41		138,801		11.41
12.56 – 15.84		127,100		4.34		13.94		127,100		13.94
15.85 – 21.93		195,000		5.52		19.64		195,000		19.64
21.94 – 28.40		162,250		5.56		27.87		162,250		27.87
28.41 – 55.90		211,350		5.10		43.56		211,350		43.56
55.91 – 103.59		10,000		4.46		97.25		10,000		97.25
103.60 – 117.34		133,000		4.38		117.34		133,000		117.34
117.35 – 159.19		16,050		4.28		159.19		16,050		159.19
Total		1,474,135		5.64		29.90		1,299,211		32.77

3. ACQUISITION

On February 24, 2006, Tollgrade acquired certain assets and assumed certain liabilities associated with the test systems business unit of Emerson for $5.5 million in cash. The acquisition was recorded under the purchase method of accounting in accordance with the provisions of SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets,” and accordingly, the results of operations of the acquired Emerson test systems business from February 24, 2006 forward are included in the consolidated financial statements of the Company. The Company has made a preliminary allocation of the purchase price to the fair value of assets acquired and liabilities assumed. The purchase price allocation was made on a preliminary basis and remains subject to change based on the final valuations of acquired intangible assets other than goodwill. The Asset Purchase Agreement requires the final purchase price to be calculated and agreed to by the Company and Emerson based on the closing net assets as of the date of the acquisition; the Company is currently reviewing the closing net asset statement in accordance with that agreement and any adjustments in the finalization of the

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purchase price may be material. All intangible assets will be deductible for tax purposes over a fifteen year period.

The following summarizes the current estimated fair values as of the date of the acquisition (in thousands):

Accounts Receivable		$	1,825
Inventories			1,100
Property and Equipment			129
Intangible Assets:
Customer Relationship	724
Tradename	120
Purchased Technology	475
Sales Order Backlog	156
Goodwill	1,773
Total Assets Acquired			6,302
Deferred Income			175
Accounts Payable			626
Total Liabilities			801
Net Assets Acquired		$	5,501

The following condensed pro forma results of operations reflect the pro forma combination of the Company and the acquired Emerson test systems business as if the combination occurred as of the beginning of each of the periods presented on January 1, 2005. Revenues for the periods prior to the Company’s ownership were based on historical information provided by Emerson. The pro forma financial information is presented for comparative purposes only and is not necessarily indicative of the operating results that actually would have been incurred had the Emerson acquisition been consummated on January 1, 2005. In addition, these results are not intended to be projections of future results.

	(In Thousands, Except Per Share Data).
	Unaudited Pro Forma			Unaudited Pro Forma
	April 1, 2006			March 26, 2005
Revenues	$	19,173		$	17,647
Loss from Operations	$	(981	)	$	(1,663	)
Net Loss	$	(236	)	$	(934	)
Diluted earnings per share	$	(0.02	)	$	(0.07	)

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4. INTANGIBLE ASSETS

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

	Useful				April 1, 2006						December 31, 2005
	Life				Accumulated						Accumulated
	(Years)		Gross		Amortization		Net		Gross		Amortization		Net
Amortizing Intangible Assets:
Post Warranty Service Agreements		50	$	32,000	$	320	$	31,680	$	32,000	$	160	$	31,840
Technology		5-10		17,998		10,857		7,141		17,487		10,212		7,275
Customer Relationships		5-10		3,374		531		2,843		2,650		449		2,201
Purchased Backlog		1		156		86		70		—		—		—
Tradename		3		120		4		116		—		—		—
Non-Amortizing Intangible Assets:
Tradenames				2,300				2,300		2,300		—		2,300
Total Intangible Assets			$	55,948	$	11,798	$	44,150	$	54,437	$	10,821	$	43,616
Goodwill			$	23,335			$	23,335	$	21,562			$	21,562

On February 24, 2006, the Company acquired certain assets and assumed certain liabilities associated with the test systems business of Emerson for $5.5 million in cash. Based on our preliminary purchase price allocation, we have established $0.7 million in customer relationship intangible assets and technology related intangible assets of $0.5 million both of which have a useful life of five years, tradename of $0.1 million which has a life of three years and purchased sales order backlog which is expected to be consumed over the remainder of 2006.

Finite lived intangible assets are generally amortized on a straight-line basis with the exception of any customer relationship assets and software related intangible assets. The customer relationship assets are amortized utilizing an accelerated method which reflects the pattern in which the economic benefits of the customer relationship asset are consumed or otherwise used. Software-related intangible assets are amortized based on the greater of the amount computed using the ratio that current gross revenues bear to the total of current and anticipated future gross revenues for that product, or the straight-line method over the remaining estimated economic life. All amortization of intangible assets is recorded in cost of goods sold.

The Company currently estimates its total amortization expense to be $2.6 million for the remaining nine months of 2006 and $2.5 million, $2.2 million, $2.0 million, $1.9 million, and $30.7 million for the years ended December 31, 2007, 2008, 2009, 2010, and thereafter, respectively.

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5. INVENTORY

Inventory consisted of the following (in thousands):

	April 1, 2006			December 31, 2005
Raw materials	$	5,963		$	5,712
Work in process		4,415			3,449
Finished goods		3,673			2,868
		14,051			12,029
Reserve for slow moving and obsolete inventory		(2,077	)		(2,095	)
	$	11,974		$	9,934

6. SHORT-TERM INVESTMENTS

Short-term investments at April 1, 2006 and December 31, 2005 primarily consisted of individual municipal bonds stated at cost, which approximated market value. These securities have maturities of more than three months and less than one year from the date of purchase and/or contain a callable provision in which bonds can be called within one year from date of purchase. A portion of the Company’s portfolio consists of auction rate securities. These instruments are classified as short-term investments and have original maturities that typically range from twenty to twenty-five years, but have an interest rate that resets every seven days. The market values of the instruments approximate cost. The primary investment purpose is to provide a return on investment of funds held for future business purposes, including acquisitions and capital expenditures. Realized gains and losses are computed using the specific identification method.

7. RETIREMENT EXPENSE

On January 17, 2005, the Company entered into an Agreement with Christian L. Allison, the Company’s former Chief Executive Officer and former member of the Board of the Company (the “Agreement”). Under the terms of the Agreement, Mr. Allison resigned effective as of January 18, 2005 (the “Retirement Date”), as director and executive officer of the Company and any and all other positions he held with the Company or its subsidiaries or other affiliates. The Company recorded a charge in the first quarter of 2005 related to Mr. Allison’s retirement of approximately $0.8 million.

8. PER SHARE INFORMATION

Net loss per share has been computed in accordance with the provisions of SFAS No. 128, “Earnings Per Share” for all periods presented. SFAS No. 128 requires companies with complex capital structures to report earnings per share on a basic and diluted basis. Basic earnings per share is computed using the weighted average number of shares outstanding during the period, while diluted earnings per share is calculated to reflect the potential dilution that occurs related to issuance of capital stock option grants. The three months ended April 1, 2006 and March 26, 2005 do not include the effect of dilutive securities due to the net loss reported in each of those periods which would make those securities anti-dilutive to the earnings per share calculation.

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

	Three Months Ended			Three Months Ended
	April 1, 2006			March 26, 2005
Net loss	$	(64	)	$	(845	)
Common and common equivalent shares:
Weighted average common shares outstanding		13,214			13,161
Effect of dilutive securities – stock options		—			—
		13,214			13,161
Loss per share:
Basic	$	0.00		$	(0.06	)
Diluted	$	0.00		$	(0.06	)

9. RECEIVABLE FROM OFFICER

In July 2001, the Company provided a loan for $0.2 million under a promissory note to an officer of the Company. The note provides for interest at 5% per annum with repayment under various conditions but no later than May 20, 2008. The loan is secured by 40,200 shares of common stock in the name of Acterna, LLC as collateral, which currently have no value. The balance of the loan at April 1, 2006 and December 31, 2005 was $152,000 and $153,000, respectively. The loan has not been modified since its original issuance.

10. 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 expected cost of providing services within the agreed-upon warranty period.

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

	Three Months Ended			Year Ended
	April 1, 2006			December 31, 2005
Balance at the beginning of the period	$	2,220		$	2,081
Accruals for warranties issued during the period		366			1,502
Settlements during the period		(339	)		(1,363	)
Balance at the end of the period	$	2,247		$	2,220

During 2005, settlements included a $0.2 million change in estimate of certain warranty reserves.

11. CONTINGENCIES AND COMMITMENTS

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

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12. MAJOR CUSTOMERS AND INTERNATIONAL SALES

The Company’s primary customers for its telecommunications products and services are the four Regional Bell Operating Companies (RBOCs), certain major independent telephone companies and several digital loop carrier (“DLC”) equipment manufacturers. Of these major customer groups, the RBOCs are the most significant; for the first quarter of 2006, sales to the RBOCs accounted for approximately 28.6% of the Company’s total revenue, compared to approximately 32.6% of total revenue for the first quarter of 2005. Sales to one of the four RBOC customers individually exceeded 10% of the Company’s total revenue and comprised 13.4% of the Company’s total revenue for the first quarter of 2006. Additionally, we had sales to one telecommunications Original Equipment Manufacturer (“OEM”) that exceeded 10% of first quarter 2006 revenue and comprised 23.7% of the Company’s first quarter 2006 revenue.

International sales represented approximately $3.4 million or 19.3% of the Company’s total revenue for the quarter ended April 1, 2006, compared to $2.6 million, or 18.2%, in the first quarter 2005. Our international sales were primarily in three geographic areas based upon customer location for the quarter ended April 1, 2006: the Americas (excluding the United States); Europe, the Middle East and Africa (EMEA); and Asia. Sales for the Americas were approximately $1.6 million, sales for EMEA were $1.6 million and sales in Asia were $0.2 million.

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders
of Tollgrade Communications, Inc.:

We have reviewed the accompanying condensed consolidated balance sheet of Tollgrade Communications, Inc. as of April 1, 2006, and the related condensed consolidated statements of operations for each of the three-month periods ended April 1, 2006 and March 26, 2005 and the condensed consolidated statement of changes in shareholders’ equity for the three-month period ended April 1, 2006 and the condensed consolidated statements of cash flows for the three-month periods ended April 1, 2006 and March 26, 2005. These interim financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2005, and the related consolidated statements of operations and changes in shareholders’ equity, and of cash flows for the year then ended, management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005 and the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005; and in our report dated March 2, 2006, we expressed unqualified opinions thereon. The consolidated financial statements and management’s assessment of the effectiveness of internal control over financial reporting referred to above are not presented herein. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2005, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.

PricewaterhouseCoopers LLP
Pittsburgh, PA
May 4, 2006

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

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

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

The statements contained in this Quarterly Report on Form 10-Q, including, but not limited to those contained in Item 2- Management’s Discussion and Analysis of Results of Operations and Financial Condition, along with statements in other reports filed with the Securities and Exchange Commission (the “SEC”), external documents and oral presentations, which are not historical facts are considered “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 statements, may be expressed in a variety of ways, including the use of forward-looking terminology such as “will,” “believes,” “intends,” “expects,” “plans,” “could” or “may,” or the negatives thereof, other variations thereon or comparable terminology. The Company does not undertake any obligation to publicly update any forward-looking statements.

These forward-looking statements and other forward-looking statements contained in other public disclosures of the Company which make reference to the cautionary factors contained in this Form 10-Q are based on assumptions that involve risks and uncertainties and are subject to change. These risks, uncertainties and other factors may cause actual results, performance or achievements to differ materially from anticipated future results, performance or achievements expressed or implied by such forward looking statement, as a result of various factors, including those described in Item 1A under “Risk Factors.”. The factors discussed herein may not be exhaustive. Therefore, the factors discussed herein should be read together with other reports and documents that are filed by the Company with the SEC from time to time, which may supplement, modify, supersede or update the factors listed in this document.

OVERVIEW

About the Company

Tollgrade 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 and now the hardware and software acquired in the Emerson acquisition, focus on helping local exchange carriers conduct the full range of fault diagnosis along with the ability to pre-qualify, 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

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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.

About its customers

The Company’s primary customers for its telecommunications products and services are the four Regional Bell Operating Companies (RBOCs), certain major independent telephone companies and several digital loop carrier (“DLC”) equipment manufacturers. Of these major customer groups, the RBOCs are the most significant; for the quarter ended April 1, 2006, sales to the RBOCs accounted for approximately 28.6% the Company’s total revenue, compared to approximately 32.6% of total revenue for the first quarter of 2005. Sales to one of the four RBOC customers individually exceeded 10% of the Company’s total revenue for the first quarter of 2006, and was approximately 13.4% of the Company’s total revenue for the three months ended April 1, 2006. The Company continues to be highly dependent on the four RBOCs for a significant portion of its total revenue, but such dependency has generally declined in recent years due to changes in the Company’s product mix from our legacy MCU^® products to our cable hardware and software products as well as other non-MCU related telecommunications products.

The Company’s cable products are sold to a customer base which ranges from small cable operators to certain of the largest cable equipment manufacturers and cable operators in the world. The Company’s total revenue related to cable product sales to one Cable Original Equipment Manufacturer (“OEM”) customer was 23.7% and 17.6% for the quarter ended April 1, 2006 and March 26, 2005, respectively.

PRODUCTS

TELECOMMUNICATION TEST SYSTEMS

Our proprietary telecommunications test and measurement products enable the telephone companies to use their existing line test systems to remotely diagnose problems in POTS lines containing both copper and fiber optics as well as qualify and troubleshoot problems on broadband DSL lines. POTS lines provide traditional voice service as well as connections for popular communication devices such as computer modems and fax machines. POTS excludes non-switched and private lines, such as data communications service lines, commonly referred to as “special services.” POTS lines still comprise the vast majority lines in service today throughout the world. The Company also sells LoopCare™ and DigiTest^®, and hopes to sell N(x)Test™, N(x)DSL-3™, and LTSC™, the products acquired in the recent Emerson acquisition, to carriers that do not yet have POTS and DSL test systems, as well as those seeking to replace older generation test systems. The objective is for the carrier to eliminate false dispatches while providing high quality troubleshooting of problems for its subscribers.

DigiTest and LoopCare; N(x)Test, N(x)DSL-3 and LTSC

Our DigiTest system electrically measures the characteristics of a copper telephone circuit and reports those measurements to our LoopCare Operation Support System (OSS). The LoopCare OSS, in turn, analyzes that measurement data and creates an easy-to-understand fault description. At the same time, the LoopCare system can generate a dispatch to a work center so that a repairman can fix the problem. LoopCare and DigiTest also can determine whether the customer line is suitable for DSL services.

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DigiTest can also serve as a replacement for aging Loop Test Systems (LTS) equipment ubiquitously deployed in current POTS networks. In addition, upgrades to DigiTest hardware can provide troubleshooting for DSL service problems.

LoopCare has remained the major incumbent OSS utilized by the RBOCs for over twenty-five years to test the integrity and quality of their POTS network infrastructure. The LoopCare OSS, which we offer both as part of the DigiTest system and as a stand-alone software product that can interface with certain other test heads on the market, currently manages testing operations for more than 75% of the copper pairs in the United States, and is the qualification, installation and maintenance tool used to troubleshoot more than 150 million POTS, ISDN and DSL subscribers worldwide.

The DigiTest system also has available direct Ethernet connectivity to Digital Measurement Node (DMN) test heads and our next generation broadband test platform, DigiTest EDGE^®. Through Ethernet connections, the LoopCare OSS can communicate directly with remotely deployed DigiTest hardware, allowing it to manage up to four DMNs and eight simultaneous test sessions through a single Internet Protocol (IP) address. DigiTest EDGE provides a global platform for broadband test applications, by combining a narrowband and wideband metallic testing platform with DSL, Asynchronous Transfer Mode (ATM), IP, T-1 and Hypertext Transfer Protocol (HTTP) performance tests. In addition, LoopCare, working in conjunction with the DigiTest hardware and using innovative insertion loss measurements, can provide a customer with highly accurate predictions of potential DSL connect speeds. These test capabilities, when managed by our LoopCare OSS, enable service providers to accurately isolate a DSL problem between customer’s premises, the local exchange carrier’s local loop and Digital Subscriber Line Access Multiplexer (DSLAM) serving network, and the Internet service provider’s data network.

Our DigiTest family of products also includes the DigiTest HUB™, our next generation central office test platform designed to support multiple testing and assurance environments. The DigiTest HUB addresses emerging broadband testing requirements, but also retains interfaces to legacy equipment, allowing for a seamless migration from traditional to packet-based delivery of services and allowing service providers to continue automated, mass-market processes. The DigiTest HUB is a modular 12-slot chassis for medium to large Central Office applications from where a variety of services emanate. Plug-in modules can be added, as required to support POTS and DSL Layer 1-7. Test plug-in resources can be shared to multiple network elements by the use of a module that multiplexes the test access path. This includes sharing a test resource to remote access elements as fiber is driven further out into the network in topologies such as FTTx. When coupled with our LoopCare OSS, the DigiTest HUB serves the testing needs of both legacy and evolving broadband networks to facilitate a low-cost, asset-preserving transition.

In addition to the LoopCare OSS software sold as part of the DigiTest system, we also sell new LoopCare features to existing customers and the base LoopCare OSS as a stand-alone product to LECs for use with test heads other than our DigiTest hardware. LoopCare feature products include:

• the Common Object Request Broker Architecture (CORBA)-based Application Programming Interface;

• Benchmark Data Base;

• DSL Testing;

• the Advanced Testhead Feature Package;

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• Batch Testing;

• Fax Unalert;

• Loop Length Reporting;

• Enabling Flow Through by Re-Classification of VER 55-58 Codes;

• LoopCare TCP/IP Communications Network; and

• Testing Voice Services in a Broadband Passive Optical Network (bPON).

• Multi-DSL Prequalification Features; and

• Breakthrough CPE and Fast Answering CPA Suppression.

Our recently acquired N(x)Test product is a next-generation, modular, subscriber loop measurement unit, which utilizes an open architecture, standard interfaces and DSP measurement technology. The N(x)Test unit can address broadband testing, standard demand and interactive testing and OSS-controlled ALT batch processing on subscriber loops, as well as expanded testing capability related to the pre-qualification of loops for DSL services through the network element. The N(x)DSL-3 test unit provides higher layer testing capability for various DSL services a customer may deploy. N(x)DSL-3 can be coupled with N(x)Test, providing the ability to conduct a full range of POTS and DSL testing, or used as a stand-alone, DSL-only test head. Our LTSC, Line Test Systems Controller, is a software package with multi-tasking capabilities that can stand alone or become an integrated process to an existing OSS in order to provide a totally integrated line testing platform for the customer’s operations. Designed with an open architecture, the LTSC system provides client/server access to the N(x)Test/N(x)DSL-3 systems deployed within the customer’s network in order to maintain the Quality Of Service for typical POTS as well as DSL services as the customer migrate towards a Next Generation Network.

MCU

Our MCU products plug into DLC systems, the large network transmission systems used by telephone companies to link the copper and fiber-optic portions of the local loop. MCU products allow our customers to extend their line testing capabilities to all of their POTS lines served by a DLC system regardless of whether the system is fed by a copper or fiber optic link. DLC systems, which are located at telephone companies’ central offices and at remote sites within local user areas, effectively multiplex the services of a single fiber-optic line into multiple copper lines. In many instances, several DLC systems are located at a single remote site to create multiple local loops that serve several thousand different end-user homes and businesses. Generally, for every DLC remote site, customers will deploy at least two MCU line-testing products.

CABLE TESTING PRODUCTS

The Company’s Cheetah™ performance and status monitoring products provide a broad network assurance solution for the Broadband Hybrid Fiber Coax (HFC) distribution system found in the cable television industry. Our Cheetah products gather status information and report on critical components within the cable network. The Company’s monitoring systems include complete hardware and software solutions that enable efficient HFC plant status monitoring. By providing a constant, proactive view of the health and status of outside plant transmission systems, our products can reduce operating costs and increase subscriber satisfaction.

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Our cable offerings currently consist of our proprietary CheetahLight™ (formerly LIGHTHOUSE^®) and CheetahNet™ (formerly NetMentor™) software systems and maintenance, our Cheetah XD™ Broadband Assurance Software and maintenance head-end controllers, return path switch hardware, both proprietary and DOCSIS^®-based and Euro-DOCSIS™-based transponders and other equipment which gather status and performance reports from power supplies, line amplifiers and fiber optic nodes. In 2003, we entered into a separate agreement with Alpha, the leading supplier of power management products to the cable industry, initially to serve as the exclusive provider of IP-based Data Over Cable Service Interface Specifications (DOCSIS) status monitoring equipment for its power supply systems. This agreement contains an initial term which expires in November 2007 and automatically renews on an annual basis thereafter unless terminated. In November 2005, this agreement was modified to make the right to sell the external version of the product non-exclusive, allowing us to sell that product directly to end customers.

SERVICES

Our Services offerings include software maintenance as well as professional services, which are designed to make sure that all of the components of our customers’ voice test systems operate properly. The Services business was considerably expanded upon the acquisition of software maintenance relationships related to the LoopCare and CheetahNet software product lines and with our internal development of the Cheetah XD™ software. Our Services business has shifted away from traditional MCU-based services, which have been replaced by more project-specific business. As a result, revenues from Services have become less predictable.

BACKLOG

Our backlog consists of firm customer purchase orders and signed software maintenance agreements. As of April 1, 2006, the Company had backlog of approximately $13.2 million compared to $14.7 million as of December 31, 2005 and $14.1 million as of March 26, 2005. The decrease in the backlog from December 31, 2005 is attributed to a lower hardware backlog. The backlog at April 1, 2006 and December 31, 2005 include approximately $6.1 million and $6.2 million, respectively, related to software maintenance contracts, which are earned and recognized as income on a straight-line basis during the remaining term of the underlying agreements. The Company’s policy is to include a maximum of twelve months revenue from multi-year maintenance agreements in reported backlog.

We have entered into LoopCare software maintenance agreements with all four RBOCs. Two of these agreements expire December 31, 2006, while the other two agreements expire on December 31, 2007 and December 31, 2008, respectively.

Management expects that approximately 40% of the current backlog will be recognized as revenue in the second quarter of 2006. 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. Although these fluctuations could impact short-term results, they are not necessarily indicative of long-term trends in sales of our products.

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OPERATING SEGMENT

We have determined that our business has one operating segment, test assurance. All product sales relate to the business of testing infrastructure and networks for the telecommunications and cable television industries. Our products have similar production processes, and are sold through comparable distribution channels and means to similar types and classes of customers already in, or entering into, the telecommunications and cable businesses.

INTERNATIONAL SALES

International sales represented approximately $3.4 million, or 19.3% of the Company’s total revenue for the quarter ended April 1, 2006, compared to $2.6 million, or 18.2%, for the quarter ended March 26, 2005. Our international sales have increased year over year, and our marketing activity in international markets has expanded. We continue to evaluate opportunities in the international market that will enhance our international presence and growth. Through our OEM relationships with Lucent and Telesciences, we have experienced some success selling our DigiTest and LoopCare products into certain international markets. Additionally, on February 24, 2006, the Company acquired certain assets and assumed liabilities associated with the test system business unit of the Emerson Network Power, Energy Systems, North America, Inc. We believe this acquisition will enhance our international sales opportunities. As part of that acquisition, the Company assumed an agreement to provide the LTSC software and N(x)Test and associated hardware to Romtelecom in Romania. That project carries significant technical and commercial acceptance risk. Also, the Company currently sells these and other products to Ericcson on an as-ordered basis for resale to providers in the United Kingdom, and is hoping to put in place an agreement to formalize that relationship.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

Our financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. The application of certain of these accounting principles is more critical than others in gaining an understanding of the basis upon which our financial statements have been prepared. We deem the following accounting policies to involve critical accounting estimates.

Revenue Recognition

We market and sell test system hardware and related software to the telecommunications and cable television industries. The Company follows Staff Accounting Bulletin (SAB) 104, “Revenue Recognition” for hardware and software sales. This bulletin requires, among other things, that revenue should be recognized only when title has transferred and risk of loss has passed to a customer with the capability to pay, and that there are no significant remaining obligations of the Company related to the sale. The majority of our hardware sales are made to RBOCs and other large customers. Delivery terms of hardware sales are predominantly FOB origin. Where title and risk of loss do not pass to the customer until the product reaches the customer’s delivery site, revenue is deferred unless the Company can objectively determine delivery occurred before the end of the applicable reporting period. Revenue is recognized for these customers upon shipment against a valid purchase order. We reduce collection risk by requiring letters of credit or other payment guarantees for significant sales to new customers and/or those in weak financial condition.

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For perpetual software license fees and maintenance revenue, we follow the AICPA’s Statement of Position (SOP) 97-2, “Software Revenue Recognition.” 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. We require a customer purchase order or other written agreement to document the terms of a software order and written, unqualified acceptance from the customer prior to revenue recognition. In certain limited cases, however, agreements provide for automatic customer acceptance after the passage of time from a pre-determined event and we have relied on these provisions for an indication of the timing of revenue recognition. In isolated cases for orders of custom software, or orders that require significant software customization, we employ contract accounting using the percentage-of-completion method, whereby revenue is recognized based on costs incurred to date compared to total estimated contract cost in accordance with SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” The revenue for orders with multiple deliverables such as hardware, software and/or installation or other services may be separated into stand-alone fair values if not already documented in the purchase order or agreement and where list prices or other objective evidence of fair value exists to support such allocation, in accordance with the provisions of Emerging Issues Task Force (EITF) Issue 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Revenue will not be recognized for any single element until all elements considered essential to the functionality of the delivered elements under the contract are delivered and accepted.

The recognition of revenue under EITF 00-21 requires certain judgment by management. If any undelivered elements, which can include hardware, software or services, are essential to the functionality of the system as defined in the contract, revenue will not be recorded until all of the items considered essential are delivered as one unit of accounting. Our internal policy requires that we obtain a written acceptance from our customers for each specific customer situation where new products are sold. Revenue will not be recorded until written acceptance is received from the customer. Although infrequent, in some situations contingencies will be noted by the customer on the written acceptance. In these situations, management will use judgment to determine the importance of such contingencies for recognizing revenue related to the sale. The Company’s general practice is to defer revenue recognition unless these contingencies are inconsequential.

Our LoopCare and other software customers usually enter into separate agreements for software maintenance upon expiration of the stated software warranty period. Maintenance agreements include software upgrades and bug fixes as they become available; however, newly developed features must be purchased separately. Post-warranty maintenance for new features is either included under the current maintenance agreement without additional charge, and is considered in the maintenance agreement fees, or is separately charged upon expiration of the warranty. Depending upon the timing of the enhancement purchase and the length of the maintenance agreement, we must evaluate whether or not a portion of a perpetual right to use fee should be treated as post contract support to be deferred and recognized over the remaining life of the maintenance agreement.

Software maintenance revenue is recognized on a straight-line basis over the period the respective arrangements are in effect. Revenue recognition, especially for software products, involves critical judgments and decisions that can result in material effects to reported net income.

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Goodwill and Intangible Assets

At April 1, 2006, we had net intangible assets of $44.2 million including capitalized software and Goodwill of $23.3 million primarily resulting from the acquisitions of the LoopCare in September 2001, Cheetah in February 2003 and the test business of Emerson in February of 2006. In connection with these acquisitions, we utilized the 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 indefinite-lived intangible assets, not be amortized for financial reporting purposes. Finite lived intangible assets are generally amortized on a straight-line basis, with the exception of any customer base assets and software related intangible assets. The customer base assets are amortized utilizing an accelerated method which reflects the pattern in which the economic benefits of the customer base asset are consumed or otherwise used. Software related intangible assets are amortized based on the greater of the amount computed using the ratio that current gross revenues bear to the total of current and anticipated future gross revenues for that product or the straight-line method over the remaining estimated economic life.

In connection with the assets acquired in the LoopCare transaction, intangible assets of $45.1 million were identified with residual goodwill of $16.6 million. These include Developed Product Software valued at $7.3 million and LoopCare Base Software valued at $4.5 million. Both have been determined to have finite useful lives of five years and ten years, respectively and are being amortized over those periods. Also identified were intangible assets related to the LoopCare trade name of $1.3 million and Post-Warranty Service Agreements of $32.0 million. Because of the longevity of the LoopCare trade name and the stability, level of embedment, and unique dependence of the RBOCs on the post warranty maintenance services, these intangible assets were determined to have indefinite useful lives at the acquisition date. With regard to the Post-Warranty Maintenance Service Agreements, during the fourth quarter of 2005 management determined that events and circumstances which supported the indefinite life of this asset had changed. More specifically, during the fourth quarter of 2005 one of the Company’s key customers disclosed that its FTTP initiative had exceeded 5% of its subscriber base, which indicates that the intangible asset related to the Post-Warranty Service Agreements may not have an indefinite useful life. This development as well as circumstances surrounding recent post-warranty contract renewals, on a combined basis led the Company to conclude that in accordance with SFAS No. 142 a finite useful life should be assigned and the intangible asset should be amortized on a prospective basis beginning October 1, 2005. Management currently believes that the hybrid fiber/copper network currently deployed by the RBOCs, which is tested by the underlying LoopCare Base Software, will exist for at least an additional 50 years. Management has therefore assigned a useful life to this asset of 50 years.

In the Cheetah acquisition, intangible assets of $7.8 million were identified with residual goodwill of $4.9 million. The intangible assets consist of the Cheetah Base Software valued at $2.9 million, the Cheetah Customer Base valued at $2.7 million, Proprietary Technology valued at $1.0 million, and Cheetah Maintenance Agreements valued at $0.2 million. The Cheetah Base Software, Proprietary Technology, and Cheetah Maintenance Agreements were determined to have useful lives of ten years, while the Cheetah Customer Base whose value is based on discounted cash flows generated on hardware sales which typically continue five years beyond the sale of the corresponding Base Software, was assigned a useful life of 15 years. A Cheetah trademark asset valued at $1.0 million was

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identified and determined to have an indefinite useful life.

On February 24, 2006 we acquired certain assets and assumed certain liabilities associated with the test business of Emerson Network Power, Energy Systems, North America, Inc. for $5.5 million in cash. As of April 1, 2006, we performed a preliminary allocation of the purchase price to the net assets acquired and have determined a preliminary estimate of useful life. The preliminary purchase price allocation remains subject to change based on the final valuation of acquired intangible assets other than goodwill. The Asset Purchase Agreement requires the final purchase price to be calculated and agreed to by the Company and Emerson based on the Closing Net Assets as of the date of the acquisition; we are currently reviewing the Closing Net Asset Statement in accordance with the agreement and any adjustments in the finalization of the purchase price may be material. Based on our preliminary purchase price allocation we have identified $0.7 million of customer relationship intangible assets and $0.5 million in technology related intangible assets both having an estimated life of five years. We also have identified $0.1 million associated with a tradename that is expected to have a useful life of 3 years. Finally we allocated $0.2 million of purchase price to the sales order backlog that was acquired which is expected to be consumed over the remainder of 2006. Based on the preliminary purchase price allocation goodwill is approximately $1.8 million.

Sensitivity Analysis:

Certain portions of the telecom market serviced by the Company’s products are evolving and, when appropriate, management reviews the impact of such changes on the key assumptions underlying the valuation of each of its intangible assets. Technological advances, as well as potential changes in strategic direction by any of the Company’s key telecom or cable customers, could result in an impairment or substantial reduction in one or more of the estimated lives over which the respective intangible asset(s) is/are currently being amortized. The following table lists intangible assets with a remaining life at April 1, 2006 of at least one year and that have a net book value exceeding $0.1 million:

	Years
							Twelve-month
	Original		Remaining Life at		Carrying Value at		Rolling Projected
Asset Description	Life		4/1/06		4/1/06		Amortization
LoopCare
Base Software		10		5.50	$	2.5	$	0.5
Post-Warranty
Maintenance Service
Agreements		50		49.50		31.7		0.6
Cheetah
Base Software		10		6.75		2.0		0.3
Proprietary Technology		10		6.75		0.7		0.1
Customer Base		15		11.75		2.1		0.3
Emerson
Proprietary Technology		5		5		0.5		0.1
Customer Relationship		5		5		0.7		0.2
Other		3-5		3		0.5		0.1
					$	40.7	$	2.2

In the event that the Company would reevaluate the above estimated useful lives in the future due to changed events and circumstances, annual amortization would increase based on the respective intangible asset’s carrying value and revised remaining useful life.

Reviews for Impairment:

Goodwill and certain other intangible assets, determined to have an indefinite life, are not amortized. Instead, these assets are reviewed for impairment at least annually or more frequently if events or changes in circumstance indicate that the carrying value of such assets may not be recoverable. During these reviews for impairment of indefinite lived assets, other than goodwill, we review any changes in facts and circumstances which would impact the estimated useful life of the asset. We perform our annual impairment tests on December 31st of each year. With respect to goodwill, we have determined that we have one reporting unit. Our goodwill impairment test indicated no impairment in 2005 or in prior years. Indefinite lived intangible assets are valued using the relief from royalty method with no residual value. For indefinite lived intangible assets, our annual impairment tests indicated no impairment and the results of our review of useful lives, based on current events and circumstances, continue to support the indefinite lives.

We review our finite lived intangible assets and their related useful lives whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable, including a change in the competitive landscape; any internal decisions to pursue new or different technology strategies; a loss of a significant customer; or a significant change in the market place including changes in the prices paid for our products or changes in the size of the market for our products. An impairment results if the carrying value of the asset exceeds the sum of the future undiscounted cash flows expected to result from the use and disposition of the asset or the period of economic benefit has changed. If impairment were indicated, the amount of the impairment would be determined by comparing the carrying value of the asset group to the fair value of the asset group. Fair value is generally determined by calculating the present value of the estimated future cash flows using an appropriate discount rate. The projection of the future cash flows and the selection of a discount rate require significant management judgment. The key assumptions that management must estimate include sales volume, prices, inflation, product costs, capital expenditures and sales and marketing costs. For developed technology, we also must estimate the likelihood of both pursuing a particular strategy and the level of expected market adoption.

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If the estimate of an intangible asset’s remaining useful life would be changed, the remaining carrying amount of the intangible asset would be amortized prospectively over the revised remaining useful life.

This testing relative to impairments involves critical accounting estimates and estimates of revenues and cash flows. However these expectations may not be realized and future events and market conditions might indicate material impairment of value that could result in material charges to net income. Such a future situation would not, however, in and of itself affect our cash flow or liquidity.

Inventory Valuation

We utilize a standard cost system that approximates first-in, first-out costing of the products. Standards are monitored monthly and changes are made on individual parts if warranted; otherwise standard costs are updated on all parts annually, normally in November of each year. Excess capacity is not included in the standard cost of inventory. We evaluate our inventories on a monthly basis for slow moving, excess and obsolete stock on hand. The carrying value of such inventory that is determined not to be realizable is reduced, in whole or in part, by a charge to cost of sales and reduction of the inventory value in the financial statements. The evaluation process, which has been consistently followed, relies in large part on a review of inventory items that have not been sold, purchased or used in production within a one-year period. Management also reviews, where appropriate, inventory products that do not meet this threshold but which may be unrealizable due to discontinuance of products, evolving technologies, loss of certain customers or other known factors. As a result of this comprehensive review process, an adjustment to the reserve for slow moving and obsolete inventory is normally made monthly. Inventory identified as obsolete is also discarded from time to time when circumstances warrant.

Inventory realization is considered a critical accounting estimate since it relies in large part on management judgments as to future events and differing judgments could materially affect reported net income.

Allowance for Doubtful Accounts

The allowance is based on our assessment of the collectibility of customer accounts. We regularly review the allowance by considering factors such as historical experience, credit quality, age of the accounts receivable balances, and current conditions that may affect a customer’s ability to pay.

If a major customer’s creditworthiness deteriorates, or if actual defaults are higher than our historical experience, or if other circumstances arise, our estimates of the recoverability of amounts due to us could be overstated, and an additional allowance could be required, which could have an adverse impact on our revenue.

Income Taxes

We follow the provisions of SFAS No. 109, “Accounting for Income Taxes,” in reporting the effects of income taxes in our consolidated financial statements. Deferred tax assets and liabilities 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. We periodically evaluate all remaining deferred tax assets based on our current outlook and as of April 1, 2006 we believe all remaining assets will be utilized. There

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have been no significant changes in our state net operating losses or valuation allowances during the current quarter.

Warranty

We provide warranty coverage on our various products. Terms of coverage range from up to one year on software to two to five years for hardware products. We review products returned for repair under warranty on a quarterly basis and adjust the accrual for future warranty costs based upon cumulative returns experience. We also evaluate special warranty problems for products with high return rates to correct the underlying causes and, where deemed necessary, to provide additional warranty expense for expected higher returns of these products. Warranty costs associated with software sales are also accrued based on the projected hours to be incurred during the warranty period (normally three months). The accounting for warranty costs involves critical estimates and judgments that can have a material effect on net income.

These areas involving critical accounting estimates are periodically reviewed and discussed with the Audit Committee of our Board of Directors.

RESULTS OF OPERATIONS

FIRST QUARTER OF 2006 COMPARED TO FIRST QUARTER OF 2005

Revenues

The Company’s revenues for the first quarter of 2006 were $17.6 million, an increase of $3.3 million, or 23.3%, compared to revenues of $14.3 million reported for the first quarter of 2005.

Overall sales of cable hardware and software products increased $1.4 million from $4.8 million during the first quarter of 2005 to $6.2 million in the first quarter of 2006. During the first quarter of 2006, we experienced strong sales of our DOCSIS-based transponders. Many of our customers are demanding products that meet the DOCSIS standards, and we have generally experienced an increase in sales of our DOCSIS-based transponder products. The sales of our DOCSIS-based transponders generated lower margins than have historically been achieved with our proprietary cable equipment. We continue to design differentiating technologies that we believe will increase the value and revenue opportunities for our related software and enhanced VoIP service assurance products. Cable hardware and software product sales amounted to 35.2% and 33.5% of total first quarter 2006 and 2005 revenue, respectively.

Sales of the Company’s DigiTest system products, which include LoopCare software, were $3.7 million in the first quarter of 2006, an increase of $0.8 million, compared to the first quarter of 2005 of $2.9 million. DigiTest revenue was favorably affected by CLEC and ILEC customers continuing to purchase DigiTest products to augment their expanding networks as well as RBOC LTS modernization initiatives and rollout of DSL pre-qualification programs. DigiTest system sales accounted for 21.0% and 20.3% of total revenues for the first quarter of 2006 and 2005, respectively.

Sales of MCUs during the first quarter of 2006 were $3.3 million, down slightly from $3.4 reported in first quarter of 2005. Sales of MCU products direct to end user customers were down 32%, but nearly

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offset by an increase in sales to OEM customers. As a result, MCU sales represented 18.8% of total first quarter 2006 revenues compared to 23.8% for the first quarter of 2005.

We expect MCU sales for the foreseeable future to continue to account for a meaningful portion of the Company’s revenue. However, as a result of the continuing maturation of this product line, the RBOCs’ trend of limiting capital spending in their traditional POTS networks and the evolution of the transmission network toward end to end fiber, the Company believes revenues from this product line will continue to decline over time.

Service revenues, which include installation oversight and project management services provided to RBOC and other customers and fees for LoopCare and Cheetah software maintenance, increased to $3.2 million in the first quarter of 2006, an increase of $0.9 million from $2.3 million recorded in the first quarter of 2005. Service revenues amounted to 18.2% and 16.1% of total first quarter 2006 and 2005 revenue, respectively. The increase is primarily attributed to the delay in the execution of a software maintenance agreement with one of our RBOC customers in the first quarter of 2005.

Sales of LoopCare software products separate and unrelated to DigiTest system products were $0.5 million in the first quarter of 2006 compared with $0.9 million recorded in the first quarter of 2005. The LoopCare software product line, which involves software license fees that individually are significant in amount, typically has long and unpredictable sales, purchase approval and acceptance cycles. When making a purchase decision for LoopCare software, our customers generally must complete a full technical evaluation of the software and develop a favorable business case within their organization. As a result, revenue from this product line can fluctuate significantly on a quarter by quarter basis. LoopCare software product sales comprised 2.8% of total revenues during the first quarter of 2006 compared to 6.3% in the first quarter of 2005.

Sales to the Company’s newly acquired Emerson Test Systems product line, which became part of the Company on February 24, 2006, were $0.7 million in the first quarter 2006 and amounted to 4.0% of revenues in the first quarter of 2006.

Gross Profit

Gross profit for the first quarter of 2006 increased $1.2 million, or 18.4%, to $7.9 million. The increase in gross profit is attributed primarily to additional sales of cable hardware and software products, increased DigiTest sales and an increase in service revenue and software maintenance revenue. During the first quarter of 2005 one of our RBOC customers did not have an executed maintenance agreement and thus no maintenance revenue was recorded for that customer. During the first quarter of 2006 we had in place executed maintenance agreements with all four RBOC customers. As a percentage of sales, gross profit for the quarter was 45.1% versus 47.0% for the year ago period. Gross margin, as a percentage of sales, decreased in the first quarter compared to the previous year’s first quarter due to increased sales of lower margin cable products, lower sales of our software products and the dilutive effects of the Emerson acquisition. The gross margins of our cable products currently are generally lower than the Company’s historical average margins. Our gross margins are extremely sensitive to product mix and can vary significantly from quarter to quarter. Certain product cost reductions efforts are currently underway; however, to the extent cable products constitute a significant portion of our near-term future revenue, we would expect our gross margins to be generally lower than historical levels.

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Selling and Marketing Expense

Selling and marketing expense, which consists primarily of payroll related costs, consulting expense and travel costs, increased $0.4 million, or 20.0%, to $2.7 million for the first quarter of 2006. The increase is associated with an increase in salaries and wages due to cost of living increases in addition to the Emerson acquisition, commissions, SFAS 123(R) expense and travel costs associated with our focus on international business and a trade show that normally occurs in the second quarter in the current quarter. As a percentage of revenues, selling and marketing expenses increased from 15.3% in the first quarter of 2006 to 15.7% in the first quarter of 2005.

General and Administrative Expense

General and administrative expense, which consists primarily of payroll related costs, insurance expense and professional services, increased by $0.5 million, or 26.4%, to $2.3 million for the first quarter of 2006. The increase is primarily attributed to an increase in professional services, salaries and wages and SFAS 123(R). As a percentage of revenues, general and administrative expenses increased from 12.8% in the first quarter of 2005 to 13.2% in the first quarter of 2006.

Research and Development Expense

Research and development expense, which consists primarily of payroll related costs and depreciation expense increased by $0.3 million or 7.7% to $3.7 million in the first quarter of 2006. The increase in research and development expense is associated with increased salaries and wages and travel costs associated with international opportunities. As a percentage of revenues, research and development expense for the first quarter of 2006 was 20.8% down from 23.8% for the first quarter of 2005.

Retirement Expense

On January 17, 2005, the Company entered into an Agreement with Christian L. Allison, the Company’s former Chief Executive Officer and former member of the Board of the Company (the “Agreement”). Under the terms of the Agreement, Mr. Allison resigned effective as of January 18, 2005 (the “Retirement Date”), as director and executive officer of the Company and any and all other positions he held with the Company or its subsidiaries or other affiliates. The Company recorded a total charge in the first quarter of 2005 related to Mr. Allison’s retirement of approximately $0.8 million.

Interest and Other Income

Interest and other income, comprised primarily of interest income in both quarterly periods, for the first quarter of 2006 was $0.6 million, an increase of $0.4 million from the first quarter of 2005. The increase is due to higher yields on our investments.

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Benefit from Income Taxes

Income taxes for the first quarter of 2006 included a benefit of under $0.1 million due to the current quarter pretax loss. The provision for income taxes in the first quarter of 2005 was also a benefit of $0.4 million. The effective income tax rate for the first quarter of 2006 was a benefit of 30% compared to a benefit of 33% in the first quarter of 2005. The decrease in the effective rate is attributed to the proportional impact of certain permanent items. While we have made our best estimate of our effective rate for 2006, based on the Company’s operating results and permanent differences, we believe it is possible that our effective income tax rate could vary during the remainder of 2006. We expect our 2006 full year effective tax rate to be approximately 30%.

Net Loss and Loss Per Share

For the first quarter of 2006, our basic and diluted loss per common share was breakeven compared to net loss of $0.06 per basic common share and diluted common share recorded in the prior year quarter. Basic and diluted weighted average common and common equivalent shares outstanding were 13.2 million in the first quarter of 2006 and 2005. The three months ended April 1, 2006 and March 26, 2005 do not include the effect of dilutive securities due to the current quarter net loss which would make those securities anti-dilutive to the earnings per share calculation.

LIQUIDITY AND CAPITAL RESOURCES

Net cash used by operating activities for the three months ended April 1, 2006 was $3.2 million compared to net cash provided of $0.8 million for the same period in the prior year. The decrease in net cash provided is attributed to an increase in accounts receivable due to the timing of sales.

The Company had working capital of $79.1 million at April 1, 2006, a decrease of $1.7 million, from $80.8 million of working capital as of December 31, 2005. As of December 31, 2005, we had approximately $67.4 million in cash, cash equivalent and short term investments. The decrease in cash, cash equivalents and short term investments from December 31, 2005 to April 1, 2006 is primarily attributed to the $5.5 million purchase of the Emerson test business unit and an increase in accounts receivable that are related to the timing of sales.

Cash used in investing activities decreased from $10.2 million for the three months ended March 26, 2005 to $5.5 million for the three months ended April 1, 2006. The change is attributed to a reduction in purchases of short-term investments, offset by the fact that during the first quarter of 2006, we purchased the test business unit from Emerson for $5.5 million in cash. As of April 1, 2006, the Company had $58.8 million of cash, cash equivalents and short-term investments that are unrestricted and available for corporate purposes, including acquisitions and other general working capital requirements.

The Company has in place a five-year $25.0 million Unsecured Revolving Credit Facility (the “Facility”) with a bank. Under the terms of the Facility, the proceeds must be used for general corporate purposes, working capital needs, and in connection with certain acquisitions. The Facility contains certain standard covenants with which we must comply, including a minimum fixed charge ratio, a minimum defined level of tangible net worth and a restriction on the amount of capital

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expenditures that can be made on an annual basis. A maximum leverage ratio restricts our total borrowings to approximately $25.0 million during the first quarter of 2006. Commitment fees are payable quarterly at an annual rate of 0.25% of the unused commitment. The Facility was amended in February 2003 in connection with our acquisition of the Cheetah product line to adjust the determination of base net worth. As of April 1, 2006 and currently, there are no outstanding borrowings under the Facility, and we are in compliance with all debt covenants. We do not anticipate any short-term borrowings for working capital as we believe our cash reserves and internally generated funds will be sufficient to sustain working capital requirements for the foreseeable future. The Company expects to incur capital expenditures totaling approximately $3.0 million in 2006 including projects for test fixtures related to the manufacturing process and purchases of computer and office equipment.

The Company has in place a stock repurchase program, which is more fully described in Part II, Item 2(e) of this Report. At management’s discretion, the Company may repurchase shares under this program, however, the number of shares and the timing of such purchases has not presently been determined. Any such purchases would be made using existing cash and short-term investments. No shares were repurchased under this program in the three months ended April 1, 2006.

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

RELATED PARTY TRANSACTION

Gregory Quiggle was hired by the Company as Executive Vice President of Marketing on August 13, 2001. In connection with the recruitment of Mr. Quiggle, the Company made a loan to Mr. Quiggle in the amount of $210,000 pursuant to a Promissory Note (the “Note”) with interest accruing at 5% per annum. The remaining outstanding balance of $152,000 is due and payable on or before the earlier of (i) May 2, 2008, (ii) the date of termination of Mr. Quiggle’s employment with the Company, or (iii) the date that Mr. Quiggle sells or otherwise transfers ownership of all or a portion of 40,200 shares of common stock in the name of Acterna LLC, which shares are being held by the Company as collateral for payment of the Note. Presently, the shares of stock being held as collateral have no value. The Note has not been modified since its issuance.

KEY RATIOS

The Company’s days sales outstanding (DSO) in accounts receivable trade, based on the past twelve months rolling revenue, was 85 and 59 days as of April 1, 2006 and March 26, 2005, respectively. The change was attributable to the timing of sales as well as the effect of the Emerson acquisition. The Company’s inventory turnover ratio was 2.6 and 2.1 turns at April 1, 2006 and March 26, 2005, respectively.

NEW ACCOUNTING STANDARDS

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statement No. 133 and 140,” which simplifies accounting for certain hybrid financial instruments by permitting fair value remeasurement for any hybrid instrument

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that contains an embedded derivative that otherwise would require bifurcation and eliminates a restriction on the passive derivative instruments acquired, issued or subject to remeasurement (new basis) event occurring after the beginning of an entity’s fiscal year that begins after September 15, 2006. The adoption of SFAS No. 155 will have no impact on our results of operation or our financial position.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets – an amendment of FASB No. 140,” which establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities by requiring that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. SFAS No. 156 is effective as of the beginning of an entity’s fiscal year that begins after September 15, 2006. The adoption of SFAS No. 156 will have no impact on our results of operation or our financial position.

Item 3. 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 will not be materially affected by changes in interest rates, due to the nature and short-term investment horizon for which these securities are invested.

Item 4. CONTROLS AND PROCEDURES

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

There were no changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that occurred during the fiscal quarter ended April 1, 2006 that have materially affected or are reasonably likely to materially affect these controls.

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PART II. OTHER INFORMATION

Item 1A. RISK FACTORS

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

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

We depend upon a few major customers for a significant portion of our revenues. We expect to derive a significant portion of our revenues from a limited number of telecommunications customers in the future, and we expect that revenues from this sector may continue to decline. The loss of any of these customers would significantly reduce our revenues and net income. Currently, we face this issue as our projects in Saudi Arabia and South Africa are close to completion, and there are no assurances that we will have continuing revenue streams from these customers or be successful in replacing that lost revenue stream. Furthermore, decreases in the capital budgets of these customers could lead to their reduced demand for our products, which could in turn have a material adverse affect on our business and results of operation. The capital budgets of our RBOC customers, as well as many of our other customers, are dictated by a number of factors, most of which are beyond our control, including:

• the conditions of the telecommunications market and the economy in general;

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

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

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

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

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

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

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

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

Our operating results have in the past been subject to quarter to quarter fluctuations, and we expect that these fluctuations will continue, and may increase in magnitude, in future periods. Demand for our products is driven by many factors, including the availability of funding in customers’ capital budgets.

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There is a trend for some of our customers to place large orders near the end of a quarter or fiscal year, in part to spend remaining available capital budget funds. Seasonal fluctuations in customer demand for our products driven by budgetary and other reasons can create corresponding fluctuations in period-to-period revenues, and we therefore cannot assure you that our results in one period are necessarily indicative of our revenues in any future period. In addition, the number and timing of large individual sales has been difficult for us to predict, and large individual sales have, in some cases, occurred in quarters subsequent to those we anticipated, or have not occurred at all. The loss or deferral of one or more significant sales in a quarter could harm our operating results. It is possible that in some quarters our operating results will be below the expectations of public market analysts or investors. In such events, or in the event adverse conditions prevail, the market price of our common stock may decline significantly.

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

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

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

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

A large portion of our sales have historically been attributable to our MCU products. We expect that

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

Although we are unable to predict future prices for our MCU products, we expect that prices for these products will continue to be subject to significant downward pressure in certain markets for the reasons described above. Accordingly, our ability to maintain or increase revenues will be dependent on our ability to expand our customer base, increase unit sales volumes of these products and to successfully develop, introduce and sell new products such as our cable and software products. We cannot assure you that we will be able to expand our customer base, increase unit sales volumes of existing products or develop, introduce and/or sell new products.

Our Services business is subject to a trend of reduced capital spending by our major customers.

Our Services business, which includes software maintenance as well as professional services, is sensitive to the decline in our RBOC customers’ capital investment in their traditional voice services, which tends to drive the professional services. Furthermore, the timing of the extension or renewal of certain of the more significant software maintenance agreements can have a major impact on the Company’s Services revenues for any particular fiscal quarter or year. We are also experiencing intense pricing pressure from many of our larger software maintenance customers, as they continue to attempt to reduce their own internal costs. Accordingly, our ability to maintain historical levels or increase levels of Services revenues cannot be assured, and in fact, such levels may continue to decrease.

We have emphasized our network assurance and testing solutions and cable status monitoring products.

We acquired the LoopCare software and Cheetah product lines in 2001 and 2003, respectively. A substantial portion of our research and development expenses currently relates to these products. Further, we recently completed the acquisition of the wireline test system unit of Emerson Network Power. We have adjusted our business model to focus heavily on our cable performance and status monitoring products. In addition, sales of our legacy cable products are declining as the market for these products evolves. We are actively engaged in research to improve and expand our cable products, including research and development of VoIP solutions. Our cable products have lower margins than our MCU, LoopCare and DigiTest system products. If sales of our cable testing products do not increase or are not accepted in the marketplace, or if our research and development activities do not produce marketable products that are both competitive and accepted by our customers, our overall revenues and profitability will be adversely affected.

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In addition, although software products generally generate higher margin returns for us than our hardware products, the initial development costs of software applications, coupled with the inherent problems with pricing software, can make it difficult to assess the potential profitability of new software products. Unless we acquire proprietary software, we must internally develop any new software products. Software development is a relatively expensive and lengthy process. In addition, because it is customary in our industry to sell perpetual enterprise licenses that cover an entire customer’s operations, it can be difficult to assess at the time of sale the exact price that we should charge for a particular license.

The sale of our products is dependent upon our ability to satisfy the proprietary requirements of our customers and to respond to rapid technological change, including evolving industry-wide standards.

We depend upon a relatively narrow range of products for the majority of our revenue. Our success in marketing our products is dependent upon their continued acceptance by our customers. In some cases, our customers require that our products meet their own proprietary requirements. If we are unable to satisfy such requirements, or forecast and adapt to changes in such requirements, our business could be materially harmed.

Rapid technological change, including evolving industry standards, could render our products obsolete. The adoption of industry-wide standards, such as the HMS and DOCSIS cable standards, may result in the elimination of or reductions in the demand for many of our proprietary products, such as our Cheetah head-end hardware products and other Cheetah products. Furthermore, standards for new services and technologies continue to evolve, requiring us to continually modify our products or to develop new versions to meet these new standards. Certain of these certifications are limited in scope, which may require that the product be recertified if any modifications to hardware or firmware are made. If we are unable to forecast the demand for, and to develop new products or to adapt our existing products to meet, these evolving standards and other technological innovations, or if our products and services do not gain the acceptance of our customers, there could be a negative effect on our revenues for sales of such products.

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

Our customers have historically been subject to a number of governmental regulations, many of which have been repealed or amended as a result of the passage of The Telecommunications Act of 1996. Deregulatory efforts have affected and likely will continue to affect our customers in several ways, including the introduction of competitive forces into the local telephone markets and the imposition (or removal) of controls on the pricing of services. These and other regulatory changes may limit the scope of our customers’ deployments of future services and budgets for capital expenditures, which could significantly reduce the demand for our products.

Moreover, as the Federal Communications Commission (FCC) adopts new and amends existing regulations, and as the courts analyze the FCC’s authority to do so, our customers cannot accurately predict the rules by which they will be able to compete in their respective markets. Changes in the

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telecommunications regulatory environment could, among other results, increase our costs of doing business, require our customers to share assets with competitors or prevent the Company or our customers from engaging in business activities they may wish to conduct, which could adversely affect our future results.

Our limited ability to protect our proprietary information and technology may adversely affect our ability to compete.

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

Our products could infringe the intellectual property rights of others, and resulting claims against us could be costly and require us to enter into disadvantageous license or royalty arrangements.

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

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

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

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We depend upon a limited number of third party subcontractors to manufacture certain aspects of our products. Furthermore, the components of our hardware products are procured from a limited number of outside suppliers, and some critical components may be single-sourced. Our reliance upon such third party contractors involve several additional risks, including reduced control over manufacturing costs, delivery times, reliability and quality components. Although our products generally use industry standard products, some parts, such as ASICs, are custom-made to our specifications. If we were to encounter a shortage of key manufacturing components from limited sources of supply, or experience manufacturing delays caused by reduced manufacturing capacity or integration issues related to our acquisition of the Emerson product line, the loss of key assembly subcontractors or other factors, we could experience lost revenues, increased costs, delays in, cancellations or rescheduling of orders or shipments, any of which would materially harm our business.

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

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

We have completed, and may pursue additional acquisitions, which will complicate our management tasks and could result in substantial expenditures.

We have completed, and we may pursue additional acquisitions of companies, product lines and technologies as part of our efforts to enhance our existing products, to introduce new products and to fulfill changing customer requirements. Acquisitions involve numerous risks, including the disruption of our business, exposure to assumed or unknown liabilities of the acquired target, and the failure to integrate successfully the operations and products of acquired businesses. Goodwill arising from acquisitions may result in significant impairment charges against our operating results in one or more future periods. Furthermore, we may never achieve the anticipated results or benefits of an acquisition, such as increased market share or the successful development and sales of a new product. The effects of any of these risks could materially harm our business and reduce our future results of operations.

We recently completed our first significant acquisition involving international business and customers. In addition to the risks identified in the foregoing paragraph, the Emerson acquisition is subject to additional risks due to its international scope. Our ability to integrate this business may be particularly challenging due to the unique topology of international telecommunications networks, as well as requirements of doing business in particular countries. Further, our ability to sell certain products internationally will be reliant upon certain key manufacturing relationships and we may be unable to

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continue those relationships. Also, revenue forecasts for the Emerson acquisition are dependant on a few large customer projects and contracts, which bear significant deployment, acceptance and subsequent revenue recognition risks, which may all adversely affect the Company’s ability to make this acquisition accretive in 2006.

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

The carrying value of certain of our intangible assets, consisting primarily of goodwill related to our acquisitions from Lucent Technologies, Inc., JDS Uniphase (formerly, Acterna, LLC) and Emerson, could become impaired by changing market conditions. Statement of Financial Accounting Standards No. 142 (“SFAS 142”) requires goodwill and intangible assets with indefinite lives to be measured for impairment at least annually or more frequently if events and circumstances indicate that the carrying value of such assets may not be recoverable. We perform annual impairment tests on December 31 of each year. We have determined that we have one reporting unit and test goodwill for impairment by comparing the fair value of the Company’s equity, which we estimate based on the quoted market price of our common stock and an estimated control premium, to the Company’s book value. Our last required measurement date was December 31, 2005, at which time our test indicated no impairment. Interim impairment tests are required by SFAS 142 if certain events or changes in business conditions occur and we could be required to record an impairment charge in the period in which any impairment is determined, which could adversely affect future results.

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

Our future sales in international markets are subject to numerous risks and uncertainties, including local economic and labor conditions, political instability including terrorism and other acts of war or hostility, unexpected changes in the regulatory environment, trade protection measures, tax laws, our ability to market current or develop new products suitable for international markets, difficulties with deployments and acceptances of products, obtaining and maintaining successful distribution and resale channels and foreign currency exchange rates. These risks will be evident with the customer contracts assumed as part of the Emerson acquisition, which are subject to a number of specific risks and uncertainties, such as potential political instability, difficulty in deployment of products, risks from customized product requirements, difficulty of obtaining proper acceptances and delays caused by third party elements of the project. These specific risks, or an overall reduction in the demand for or the sales of our products in international markets, could adversely affect future results.

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

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

40

or that the degree of compliance with the policies or procedures may deteriorate.

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

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

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

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

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

The markets for some of our products are very competitive. Some of our competitors may have greater technological, financial, manufacturing, sales and marketing, and personnel resources than we have. As a result, these competitors may have an advantage in responding more rapidly or effectively to changes in industry standards or technologies. Competition is particularly difficult in the cable markets, due to the introduction of the DOCSIS standard, which allows customers to purchase system components from multiple vendors. Moreover, better financed competitors may be better able to withstand the pricing pressures that increased competition may bring. If our introduction of improved products or services is not timely or well received, or if our competitors reduce their prices for products that are comparable to ours, demand for our products and services could be adversely affected. Recent competition from certain network element providers offering chip-based testing functionality may also intensify the pricing pressure for our telco products and adversely affect future revenues from such products. We also face increasing pressure from certain of our RBOC customers on software maintenance agreements, as they continue to divert spending from legacy networks to next generation network elements.

We may also compete directly with our customers. Generally, we sell our products either directly or

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

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

Our success depends on our ability to attract, retain and motivate the key management and technical personnel necessary to implement our business plan and to grow our business. Despite the adverse economic conditions of the past several years, competition for certain specific technical and management skill sets is intense. If we are unable to identify and hire the personnel that we need to succeed, or if one or more of our present key employees were to cease to be associated with the Company, our future results could be adversely affected.

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

We have derived a substantial amount of our revenues from sales of products and related services to the telecommunications industry. The telecommunications industry has experienced significant growth and consolidation in the past few years, although, over recent years, trends indicate that capital spending by this industry has decreased and may continue to decrease in the future as a result of a general decline in economic growth in local and international markets. In particular, RBOC and large ILEC customers have been adversely affected by subscriber line losses and the after-effects of overspending in 1999 and 2000 as well as by competition from cable and wireless carriers and other carriers entering the local telephone service market. Certain emerging carriers also continue to be hampered by financial instability caused in large part by a lack of access to capital. In the event of further significant slowdown in capital spending of the telecommunications industry, our business would be adversely affected. Furthermore, as a result of industry consolidation, there may be fewer potential customers requiring our software in the future. Larger, consolidated telecommunications companies may also use their purchasing power to create pressure on the prices and the margins we could realize. We cannot be certain that consolidations in, or a slowdown in the growth of, the telecommunication industry will not harm our business.

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

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

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

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We have historically and will continue to undertake certain cost reduction efforts as they relate to the manufacturing of certain of our products, in an attempt to improve profit margins for those products. These actions could have long term adverse effects on our business. There are several risks inherent in our efforts to bring our cost base in line with the current environment by reducing our workforce. These include the risk that we will not be successful in achieving our planned cost reductions, and that even if we are successful in doing so, we will still not be able to reduce expenditures quickly enough to see a positive profitability effect and may have to undertake further restructuring initiatives that would entail additional charges and create additional risks. In addition, there is the risk that cost-cutting initiatives will impair our ability to effectively develop and market products and remain competitive. Also, our attempts to reduce the base costs of certain or our products may not be successful. Each of the above measures could have long-term effects on our business by reducing our pool of talent, decreasing or slowing improvements in our products, making it more difficult for us to respond to customers, limiting our ability to increase production quickly if and when the demand for our products increases and limiting our ability to hire and retain key personnel. These circumstances could cause our earnings to be lower than they otherwise might be.

We rely on software that we have licensed from third-party developers to perform key functions in our products and we rely on certain hardware sourced through OEM channels.

We rely on software that we license from third parties, including software that is integrated with internally developed software and used in our products to perform key functions. We also rely on certain hardware that is sold to us on a private-label OEM basis. We could lose the right to use this software or the software and/or hardware could be made available to us only on commercially unreasonable terms. Although we believe that, in most cases, alternative software or hardware is available from other third-party suppliers or internal developments, the loss of or inability to maintain any of these software licenses or the inability of the third parties to enhance in a timely and cost-effective manner their products in response to changing customer needs, industry standards or technological developments could result in delays or reductions in product shipments by us until equivalent software could be developed internally or identified, licensed and integrated, which would harm our business.

We are affected by a pattern of product price decline in certain markets, which can harm our business.

Because our cable products generate lower margins for us than our proprietary MCU and software offerings, an increase in the percentage of our sales of existing cable-related products will result in lower profitability. Furthermore, as consolidations within the cable industry and the adoption of the DOCSIS standards have caused and could continue to cause pricing pressure as our competitors’ lower product pricing, our revenues have been and may continue to be adversely affected. Although we have developed DOCSIS-based hardware and our relationship with our OEM partner is one that we believe will prominently position us to succeed in the marketing of DOCSIS-based products, these products will likely generate lower margins than have historically been generated by our proprietary technology. As a result, as our business shifts from our higher margin proprietary products to lower margin cable offerings and standardized products for which we have competition, we will need to sell greater volumes of our products to maintain our profitability.

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Our common stock price may be extremely volatile.

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

• General market and economic conditions;

• Changes in the telecommunications industry;

• Actual or anticipated variations in operating results;

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

• Changes in financial estimates or recommendations by stock market analysts regarding us or our competitors;

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

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

• Additions or departures of key personnel; and

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

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

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

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

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Item 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES

On December 15, 2005, our Board of Directors authorized the continuation through December 31, 2006 of a share repurchase program which expired on December 31, 2005. Under this extension, we can repurchase a total of one million shares of our common stock before December 31, 2006. Since the initial repurchase program was instituted in April 1997, and as of December 31, 2005, the Company has repurchased 0.5 million shares of common stock. The repurchased shares are authorized to be utilized under certain employee benefit programs. At our discretion we will determine the number of shares and the timing of such purchases, which will be made using existing cash and short-term investments. No shares were repurchased under this program in the first quarter ended April 1, 2006.

Item 6. EXHIBITS

(a) Exhibits:

The following exhibits are being filed with this report:

Exhibit
Number	Description
10.1	Management Incentive Compensation Plan, filed herewith
10.2	Extension Agreement, dated March 22, 2006, between Tollgrade Communications, Inc. and Bulova Technologies EMS, LLC, filed herewith
15	Letter re audited interim financial information
31.1	Certification of Chief Executive Officer, filed herewith
31.2	Certification of Chief Financial Officer, filed herewith
32	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18.U.S.C. Section 350, filed herewith

™LoopCare is a trademark of Tollgrade Communications, Inc.

™Cheetah is a trademark of Tollgrade Communications, Inc.

™HUB is a trademark of Tollgrade Communications, Inc.

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

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

™LTSC is a trademark of Tollgrade Communications, Inc.

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

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

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

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

^®DOCSIS is a registered trademark of Cable Television Laboratories, Inc.

All other trademarks are the property of their respective owners.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	Tollgrade Communications, Inc.
	(Registrant)
Dated: May 10, 2006	/s/ Mark B. Peterson
	Mark B. Peterson
	Chief Executive Officer
Dated: May 10, 2006	/s/ Samuel C. Knoch
	Samuel C. Knoch
	Chief Financial Officer and Treasurer
Dated: May 10, 2006	/s/ Sean M. Reilly
	Sean M. Reilly
	Controller

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EXHIBIT INDEX

(Pursuant to Item 601 of Regulation S-K)

Exhibit
Number	Description
10.1	Management Incentive Compensation Plan, filed herewith
10.2	Extension Agreement, dated March 22, 2006, between Tollgrade Communications, Inc. and Bulova Technologies EMS, LLC, filed herewith
15	Letter re audited interim financial information
31.1	Certification of Chief Executive Officer, filed herewith
31.2	Certification of Chief Financial Officer, filed herewith
32	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18.U.S.C. Section 350, filed herewith

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EX-10.1

Exhibit 10.1

TOLLGRADE COMMUNICATIONS, INC.

MANAGEMENT INCENTIVE COMPENSATION PLAN

EFFECTIVE JANUARY 1, 1997

Prepared By:	Samuel C. Knoch
	November 27, 1996

Amended effective: 10/15/97; 1/29/98; 12/17/98; 1/28/99; 5/6/99; 7/15/99; 10/14/99; 1/25/01

TOLLGRADE COMMUNICATIONS, INC.

MANAGEMENT INCENTIVE COMPENSATION PLAN

TABLE OF CONTENTS

		Page
ARTICLE I	OBJECTIVES
Section 1.01	Objectives	1
ARTICLE II	DEFINITIONS
Section 2.01	Definitions	2
ARTICLE III	ADMINISTRATION OF THE PLAN
Section 3.01	Committee and Agents	4
Section 3.02	Rules and Regulations	4
Section 3.03	Quorum	4
Section 3.04	Plan Interpretation	4
Section 3.05	Notice of Participation	4
Section 3.06	Costs	4
Section 3.07	Unsecured Creditor	4
Section 3.08	Authority of Board and Committee	5
Section 3.09	Amendment, Modification or Termination	5
Section 3.10	Claim and Appeal Procedure	5
ARTICLE IV	PARTICIPATION ELIGIBILITY
Section 4.01	Designation of Groups	7
Section 4.02	Termination of Employment	7
Section 4.03	Death, Retirement, Disability, Leave of Absence or Transfer	7
Section 4.04	Directors	7
Section 4.05	New Participants	7
Section 4.06	New Participating Entities	7

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ARTICLE V	DETERMINATION OF INCENTIVE COMPENSATION AWARD AND DISCRETIONARY BONUS
Section 5.01	Required Financial Performance Levels	9
Section 5.02	Performance Criteria	9
Section 5.03	Determination of Salary Percentage and Allocation of Performance Criteria	10
Section 5.04	Determination of Incentive Compensation Award	10
Section 5.05	Determination of Discretionary Bonus	10
ARTICLE VI	PAYMENT FOR PARTICIPANTS
Section 6.01	Timing of Payment	11
Section 6.02	Payment in Common Stock	11
Section 6.03	Beneficiary Designation	12
ARTICLE VII	MISCELLANEOUS PROVISIONS
Section 7.01	No Recourse	13
Section 7.02	Expense	13
Section 7.03	Merger or Consolidation	13
Section 7.04	Legal Costs	13
Section 7.05	Gender and Number	13
Section 7.06	Construction	13
Section 7.07	Non-alienation	13
Section 7.08	No Employment Rights	14
Section 7.09	Minor or Incompetent	14
Section 7.10	Illegal or Invalid Provision	14

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ARTICLE I

OBJECTIVES

     Section 1.01 — Objectives. The Plan was originally adopted and was and continues to be, designed to achieve the following objectives:

(a) Increase the profitability and growth of the Company in a manner which is consistent with the goals of the Company, its stockholders and its employees.

(b) Provide executive compensation which is competitive with other high-tech companies and provide the potential for payment of meaningful cash awards.

(c) Attract and retain personnel of outstanding ability and encourage excellence in the performance of individual responsibilities.

(d) Motivate and reward those members of management who contribute to the success of the Company.

(e) Allow the flexibility which permits revision and strengthening from time to time to reflect changing organizational goals and objectives.

     The intent of this Plan, which is effective as of January 1, 1997, is profit enhancement through quality performance.

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ARTICLE II

DEFINITIONS

     Section 2.01 — Definitions. As used herein, the following words and phrases shall have the meanings below, unless the context clearly indicates otherwise:

(a)	“Award Year” shall mean a calendar year beginning on or after January 1, 1997.
(b)	“Beneficiary” shall mean the person or persons, natural or legal, designated in writing by the Participant to receive any benefits under the Plan which may become payable in the event of the Participant’s death or, if none is designated or surviving at the time of the Participant’s death, the Participant’s surviving spouse shall be the Beneficiary or, if there is no surviving spouse, then the Participant’s surviving children shall share equally or, if none, then the estate of the Participant shall be the Beneficiary.
(c)	“Board” shall mean the Board of Directors of Tollgrade Communications, Inc.
(d)	“Committee” shall mean the Compensation Committee of the Board.
(e)	“Company” shall mean the corporate entity of Tollgrade Communications, Inc. without regard to any subsidiaries thereof, unless further amended by the Board at a subsequent date to include another Participating Entity, as defined.
(f)	“Disability” shall mean the total and permanent disability of a Participant, as defined by any welfare benefit plan maintained by the Company or a Participating Entity which is applicable to the Participant, as in effect at the time of determination.
(g)	“Employee” shall mean any full-time or part time (meaning, for purposes of this Plan, an employee working twenty four (24) or more hours per week) common law employee of Tollgrade Communications, Inc. or a Participating Entity.
(h)	“ERISA” shall mean the Employment Retirement Income Security Act of 1974, as amended from time to time.
(i)	“Fair Market Value” shall mean the fair market value of one share of Tollgrade Communications, Inc. Common Stock as determined pursuant to Section 6.02.
(j)	“Financial Performance” shall mean the financial performance of Tollgrade Communications, Inc. and/or a Participating Entity as determined from time to time by the Committee or its delegate.

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(k)	“Group” shall mean the group to which a Participant is assigned in accordance with Section 4.01.
(l)	“Incentive Compensation Award” shall mean the dollar amount of compensation awarded to a Participant for an Award Year as determined under Article V of the Plan.
(m)	“Participant” shall mean any Employee who has been designated by the Committee to be a participant in the Plan in accordance with Section 3.05, and only for as long as such designation remains in effect.
(n)	“Participating Entity” shall mean a subsidiary of an affiliate or other affiliated entity of the Company which elects to participate in the Plan with respect to its Employees and is approved by the Board to participate in the Plan, with such status as a Participating Entity and participation in the Plan ceasing automatically on the date the subsidiary or affiliate ceases to be a subsidiary or affiliate of the Company.
(o)	“Plan”: shall mean the Management Incentive Compensation Plan, effective January 1, 1997, as set forth herein, and as it may be amended from time to time hereafter.
(p)	“Salary” shall mean the Participant’s base salary and overtime payments from Tollgrade Communications, Inc. or a Participating Entity.

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ARTICLE III

ADMINISTRATION OF THE PLAN

     Section 3.01 — Committee and Agents. Full power and authority to administer the Plan shall be vested in the Committee. The Committee may appoint a secretary who may, but need not be, a member of the Committee. The Committee may also employ such other agents as it deems appropriate to assist it with the administration of the Plan.

     Section 3.02 — Rules and Regulations. The Committee shall, from time to time, establish rules, forms and procedures of general application for the administration of the Plan.

     Section 3.03 — Quorum. A majority of the members of the Committee shall constitute a quorum for purposes of transacting business relating to the Plan. The acts of a majority of the members present (in person, or by conference telephone) at any meeting of the Committee at which there is a quorum shall be valid acts of the Committee. Acts reduced to and approved unanimously in writing by all of the Committee members shall also be valid acts.

     Section 3.04 — Plan Interpretation. The Committee shall have the full power and authority to construe and interpret the Plan, and make all determinations of Incentive Compensation Awards under the Plan, approve all Employees who are to participate in the Plan, determine the Group to which a Participant is assigned under Section 4.01, and determine all facts and other issues relating to claims and appeals under the Plan.

     Section 3.05 — Notice of Participation. The Committee shall send a written notice, in the form prescribed by the Committee or its delegate, informing the Employee that he or she has been selected to be a Participant in the Plan and specifying the period for which such designation is to remain in effect. No Employee shall have the right to become a Participant and shall not be a Participant until the date specified in the notice. Furthermore, being designated a Participant does not guarantee an Employee that an Incentive Compensation Award will be earned or paid.

     Section 3.06 — Costs. All costs and expenses involved in the administration of the Plan shall be borne by the Company or the Participating Entity.

     Section 3.07 — Unsecured Creditor. The Plan constitutes a mere promise by Tollgrade Communications, Inc. or the Participating Entity to make benefit payments in the future. The Company and the Participating Entities obligations under the Plan shall be unfunded and unsecured promises to pay. The Company and the Participating Entities shall not be obligated under any circumstance to fund their respective financial obligations under the Plan. Any of them may, in its discretion, set aside funds in a trust or other vehicle, subject to the claims of its creditors, in order to assist it in meeting its obligations under the Plan, if such arrangement will not cause the Plan to be

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considered a funded deferred compensation plan under ERISA, or the Internal Revenue Code of 1986, as amended, and provided, further, that any trust created by the Company or a Participating Entity and any assets held by such trust to assist the Company or the Participating Entity in meeting its obligations under the Plan will conform to the terms of the model trust, as described in Rev. Proc. 92-64, 1992-2 C.B. 422. To the extent that any Participant or Beneficiary or other person acquires a right to receive payments under the Plan, such right shall be no greater than the right, and each Participant and Beneficiary shall at all times have the status of a general unsecured creditor of the Participating Entity.

     Section 3.08 — Authority of Board and Committee. Any determination or action of the Committee or the Board and the records of the Committee shall be final, conclusive and binding on all Participants and Beneficiaries, and their beneficiaries, heirs, personal representatives, executors and administrators, and upon the Company, the Participating Entities and all other persons having or claiming to have any right or interest in or under the Plan. No Participant shall participate in any decision of the Board or the Committee which directly or indirectly affects the Plan.

     Section 3.09 — Amendment, Modification or Termination. The Board, in its sole discretion, may amend, modify or terminate the Plan at any time.

     Section 3.10 — Claims and Appeal Procedure.

(a)

In the event of a claim by a Participant or a Participant’s Beneficiary for or in respect of any benefit under the Plan or the method of payment thereof, such Participant or Beneficiary shall present the reason for his claims in writing to the Committee, in c/o the Secretary, if applicable, or such other person or entity designated and communicated by the Committee. The Committee, shall, within ninety (90) days after the receipt of such written claim, send written notification to the Participant or Beneficiary as to its disposition, unless special circumstance require an extension of time for processing the claim. If such an extension of time for processing is required, written notice of the extension shall be furnished to the claimant prior to the termination of the initial ninety (90) day period. In no event, shall such extension exceed a period of ninety (90) days from the end of such initial period. The extension notice shall indicate the special circumstances requiring an extension of time and the date by which the Committee expects to render the final decision.

In the event the claim is wholly or partially denied, the written notification shall state the specific reason or reasons for the denial, include specific references to pertinent Plan provisions on which the denial is based, provide an explanation of any additional material or information necessary for the Participant or Beneficiary to perfect the claim and a statement of why such material or information is necessary, and set forth the procedure by which the Participant or Beneficiary may appeal the denial of the claim. If the claim has not been granted and notice is not furnished within the time period specified in the preceding paragraph, the claim shall be deemed denied for the purpose of proceeding to appeal in accordance with paragraph (b) below.

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(b)	In the event a Participant or Beneficiary wishes to appeal the denial of his claim, he may request a review of such denial by making written application to the Committee, in c/o the Secretary, if applicable, or such other person or entity designated and communicated by the Committee, within sixty (60) days after receipt of the written notice of denial (or the date on which such claim is deemed denied if written notice is not received within the applicable time period specified in paragraph (a) above). Such Participant or Beneficiary (or his duly authorized representative) may, upon written request to the Committee, review documents which are pertinent to such claim, and submit in writing issues and comments in support of his position.
	Within sixty (60) days after receipt of the written appeal (unless an extension of time is necessary due to special circumstances or is agreed to by the parties, but in no event more than one hundred and twenty (120) days after such receipt), the Committee shall notify the Participant or Beneficiary of its final decision. Such final decision shall be in writing and shall include specific reasons for the decision, written in a manner calculated to be understood by the claimant, and specific references to the pertinent Plan provisions on which the decision is based. If an extension of time for review is required because of special circumstances, written notice of the extension shall be furnished to the claimant prior to the commencement of the extension. If the claim has not been granted and written notice is not provided within the time period specified above, the appeal shall be deemed denied.
(c)	If a Participant or Beneficiary does not follow the procedures set forth in paragraphs (a) and (b) above, he shall be deemed to have waived his right to appeal benefit determinations under the Plan. In addition, the decisions, actions and records of the Committee shall be conclusive and binding upon the Company, the Participating Entities and all persons having or claiming to have any right or interest in or under the Plan.

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ARTICLE IV

PARTICIPANT ELIGIBILITY

     Section 4.01 — Designation of Groups. An Employee who is designated by the Committee as a Participant for an Award Year shall be a member of a Group, as determined from time to time by the Committee or its delegate. With respect to a Participant who moves from one Group to another during an Award Year, such Participant shall be treated as a member of each Group for the period of time in that Group during the Award Year and the Participant’s actual Salary for the period in each Group shall be used to calculate the Incentive Compensation Award applicable for the period of time in each Group.

     Section 4.02 — Termination of Employment. A Participant who voluntarily or involuntarily terminates employment with the Company and all Participating Entities prior to the end of an Award Year or subsequent to the end of an Award Year but prior to the time that Incentive Compensation Awards for such award year are paid by the Company will forfeit any right to an Incentive Compensation Award for the Award Year during which termination occurs, except as otherwise provided in Section 4.03 below or as otherwise determined by the Committee or its delegate.

     Section 4.03 — Death, Retirement, Disability, Leave of Absence or Transfer. If, during an Award Year, a Participant dies, retires, becomes disabled, is granted a leave of absence, or is transferred to a non-Participating Entity or out of all Groups, the Committee may, at its discretion or under such uniform rules as it may prescribe, make a partial or full Incentive Compensation Award to the Participant for the Award Year.

     Section 4.04 — Directors. A member of the Board who is not an Employee in one of the Groups may not participate in the Plan.

     Section 4.05 — New Participants. Except as otherwise provided in this Section 4.05, an Employee who is not a Participant as of the first day of an Award Year shall not become a Participant for that Award Year. New Employees of the Company or a Participating Entity hired during an Award Year, and Employees promoted to a Group during the Award Year who were not eligible to participate in the Plan at the beginning of the Award Year, may become a Participant during an Award Year and participate in the Plan for such Award Year on a pro-rata basis if the Employee becomes a Participant effective not later than (6) months after the beginning of the Award Year. Notwithstanding the above, the Committee, in its discretion, may provide in writing that a new Employee or an Employee promoted to a Group during an Award Year, shall join the Plan more than six months after the beginning of an Award Year and shall specify in such writing the basis in which the New Employee or an Employee promoted to a Group during an Award Year, shall be eligible for an Incentive Compensation Award for the first Award Year.

     Section 4.06 — New Participating Entities. Except as otherwise provided in this Section 4.06, a Participating Entity may only join the Plan as of the first day of an Award Year. New Participating Entities acquired during an Award Year, or otherwise not participating in the Plan at the beginning of

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the Award Year, may become a Participating Entity during an Award Year and participate in the Plan for such Award Year on a pro-rata basis, or other basis specified by the Committee, if the Participating Entity joins the Plan effective not later than six (6) months after the beginning of the Award Year. Notwithstanding the above, the Committee, in its sole discretion, may provide in writing that a Participating Entity shall join the Plan more than six (6) months after the beginning of an Award Year and shall specify in such writing the basis on which the Participating Entity’s Participants shall be eligible for an Incentive Compensation Award for the first Award Year.

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ARTICLE V

DETERMINATION OF INCENTIVE COMPENSATION AWARD
AND DISCRETIONARY BONUS

     Section 5.01 — Required Financial Performance Levels. In order for an Incentive Compensation Award to be made for an Award Year, the following performance levels must be met:

(a)	The minimum level of Financial Performance, including the effect of any amounts calculated as due under this or any other Incentive Compensation Plan, as established by the Committee for an Award Year for Tollgrade Communications, Inc. or a Participating Entity, must be met before any Incentive Compensation Award based on Tollgrade Communications, Inc.’s or such Participating Entity’s Financial Performance can be made.
(b)	Tollgrade Communication, Inc.’s financial Performance for the Award Year must be at least ninety (90) percent (or such other percentage established by the Committee) of the minimum level of Financial Performance established for Tollgrade Communications, Inc. Under (a) above.
(c)	The Committee shall establish from time to time and communicate to Participants the performance rating required to apply the minimum, maximum and other intermediate percentages within the performance criteria established under Section 5.02 for purposes of calculating the Incentive Compensation Award for an Award Year; provided, however, that notwithstanding any other provision of the Plan to the contrary, any Participant who receives a rating of “unsatisfactory” on any performance appraisal report during an Award Year shall be ineligible for an Incentive Compensation Award for that Award Year, and any Participant who receives a rating of “improvement needed” on any performance appraisal report during an Award Year shall be eligible for all or part of any Incentive Compensation Award for that Award Year only if approved by the Committee upon recommendation of the Company’s management.

     Section 5.02 — Performance Criteria.

(a)	The Incentive Compensation Award for a Participant may be calculated in part on the basis of Financial Performance and in part on the basis of the Financial Performance of the Participating Entity who employs the Participant.
(b)	In addition to the Financial Performance criteria referred to in paragraph (a) above, the Incentive Compensation Award for a Participant may be calculated in part based on the Participant’s individual performance and/or performance of the Participant’s job unit, the levels of which will be measured by general criteria (e.g., revenues,

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	margins, cost management, quality, customer service, etc.) and in part may consist of a discretionary piece based on the Participant’s individual performance measured by personal behavioral criteria (e.g. attitude, teamwork, etc.). Guidelines for determining the requirements for achieving the various performance levels (e.g., Outstanding, Meets Expectations, etc.) will be developed by the Committee or its delegate and communicated to Participants from time to time during the Award Year.
(c)	The Committee may, in its sole discretion, change or eliminate the performance criteria referred to in paragraphs (a) or (b) above, and may establish new or additional performance criteria, from time to time, provided that the applicable performance criteria are communicated to affected Participants.
(d)	the specific Group and Performance criteria in effect as of October 15, 1997, and until further amended by the Committee, is as set forth in Appendix I to this Plan.

     Section 5.03 — Determination of Salary Percentage and Allocation of Performance Criteria. The Committee shall determine and, itself or through its delegate, communicate to Participants from time to time the percentage of a Participant’s Salary to be taken into account for purposes of determining a Participant’s Incentive Compensation Award for an Award Year. The Committee shall also determine and, itself or through its delegate, communicate to Participants the percentages of the performance criteria established under Section 5.02 above which are applicable to Participants in each Group, and for this purpose may subdivide each Group into Participants and Participating Entity Participants, or such other subgroups as it may determine.

     Section 5.04 — Determination of Incentive Compensation Award. The amount of a Participant’s Incentive Compensation Award for an Award Year, if any, shall be determined by the Committee or its delegate in accordance with the terms of the Plan and shall be communicated in writing to the Participant on or before March 15th of the next year.

     Section 5.05 — Determination of Discretionary Bonus. The Committee may grant, from time to time in its sole discretion, a bonus to any Participant based on any criteria it determines. Such bonus, if specifically designated by the Committee as payable under this Plan, shall be subject to such provisions of the Plan as it shall specify.

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ARTICLE VI

PAYMENT TO PARTICIPANTS

     Section 6.01 — Timing of Payment. An Incentive Compensation Award for an Award Year shall be paid to the Participant, or in the case of death to the Participant’s Beneficiary, on or before March 15th of the next year.

     Section 6.02 — Payment in Common Stock. Consistent with the provisions of the Tollgrade Communications, Inc. Common Stock Incentive Plan (TCIP) or any similar plan in effect from time to time, and at the discretion of the Compensation Committee which administers the TCIP (the “Committee”), Incentive Compensation Awards payable under any Section of this Article VI may be paid in whole or in part in shares of Tollgrade Communications, Inc. Common Stock. The number of shares of Common Stock to be paid would be determined by dividing the cash payment which would otherwise be made by the Fair Market Value on the date on which the payment is to be made. Any fractional shares shall be paid in cash. A Participant shall be considered, on the date as of which Fair Market Value is determined for purposes of the stock distribution, as a shareholder of Tollgrade Communications, Inc. with respect to the shares to be distributed.

     For purposes of this Section 6.02, Fair Market Value is 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 or its delegate, in its discretion, may determine to rely upon):

(a)	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,
(b)	if the Common Stock is not listed on the New York Stock 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 Securities Exchange Act of 1934 on which the Common Stock is listed, or
(c)	if the Common Stock is not listed on any exchange referred to in paragraphs (a) or (b) above, 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 sales 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 the Fair Market Value shall be determined by taking a weighted average of the means

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between the highest and lowest sales prices per share of the Common Stock as so quoted on the nearest date before and the nearest date after the date as of which Fair Market Value is to be determined. The average should be weighted inversely by the respective numbers of trading days between the selling dates and the date as of which Fair Market Value is to be determined. If there are no such sale price quotations on or within a reasonable period both before and after the date as of which Fair Market Value is to be determined, then Fair Market Value 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 in the manner described above in this Section 6.02.

     If the Fair Market Value of the Common Stock cannot be determined on the basis previously set forth in this Section 6.02 on the date as of which Fair Market Value is to be determined, the TCIP Committee or its delegate 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.

     Section 6.03 — Beneficiary Designation. A Participant may file with the Committee or its delegate a completed designation of Beneficiary Form as prescribed by the Committee or its delegate. Such designation may be made, revoked or changed by the Participant at any time before death. Such designation of Beneficiary will not be effective and supersedes all prior designations until it is received and acknowledged by the Committee or its delegate. If the Committee has any doubt as to the proper Beneficiary to receive payments hereunder, the Committee shall have the right to withhold such payments until the matter is finally adjudicated. However, any payment made in good faith shall fully discharge the Committee, the Participating Entities and the Board from all further obligations with respect to that payment.

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ARTICLE VII

MISCELLANEOUS PROVISIONS

     Section 7.01 — No Recourse. If the Financial Performance taken into account for determination of an Incentive Compensation Award is found to be incorrect by the Company’s independent certified public accountants and was more than the correct amount, there shall be no recourse by the Company against any person or estate. However, the Company shall have the right to correct such error by reducing by the entire excess amount any subsequent payments yet to be made under the Plan for all Award Years.

     Section 7.02 — Expense. Incentive Compensation Awards shall be treated as an expense for book purposes in the fiscal year of the Company or the Participating Entity, as applicable, in which the Incentive Compensation Award is earned by a Participant, as opposed to subsequent fiscal year(s) during which the Incentive Compensation Award is paid.

     Section 7.03 — Merger or Consolidation. All obligations for amounts earned but not yet paid under this Plan shall survive any merger, consolidation or sale of all or substantially all of Tollgrade Communications, Inc. Or a Participating Entity’s assets to any entity, and be the liability of the successor to the merger or consolidation or the purchaser of assets.

     Section 7.04 — Legal Costs. A Participant will be reimbursed by the Company (or its successor) for any and all expenses incurred in successfully enforcing, by judgment of a court of competent jurisdiction and after all appeals have been exhausted, the Participant’s right to receive payments under the terms of this Plan.

     Section 7.05 — Gender and Number. The masculine pronoun whenever used in the Plan shall include the feminine and vice versa. The singular shall include the plural and the plural shall include the singular whenever used herein unless the context requires otherwise.

     Section 7.06 — Construction. The provisions of the Plan shall be construed, administered and governed by the laws of the Commonwealth of Pennsylvania, including its statute of limitations provisions, to the extent not preempted by ERISA or other applicable Federal law. Titles of Articles and Sections of the Plan are for convenience of reference only and are not to be taken into account when construing and interpreting the provisions of the Plan.

     Section 7.07 — Non-alienation. Except as may be required by law, neither the Participant nor any Beneficiary shall have the right to, directly or indirectly, alienate, assign, transfer, pledge, anticipate or encumber (except by reason of death) any amount that is or may be payable hereunder, including in respect of any liability of a Participant or Beneficiary for alimony or other payments for the support of a spouse, former spouse, child or other dependent, prior to actually being received by the Participant or Beneficiary hereunder, nor shall the Participant’s or Beneficiary’s rights to benefit payments under the Plan be subject in any manner to anticipation, alienation, sale, transfer,

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assignment, pledge, encumbrance, attachment, or garnishment by creditors of the Participant or Beneficiary or to the debts, contracts, liabilities, engagements, or torts of any Participant or Beneficiary, or transfer by operation of law in the event of bankruptcy or insolvency of the Participant or any Beneficiary, or any legal process.

     Section 7.08 — No Employment Rights. Neither the adoption of the Plan nor any provision of the Plan shall be construed as a contract of employment between the Company or a Participating Entity and any Employee or Participant, or as a guarantee or right of any Employee or Participant to future or continued employment with the Company or a Participating Entity, or as a limitation on the right of the Company or a Participating Entity to discharge any of its Employees with or without cause. Specifically, designation as a Participant does not create any rights, and no rights are created under the Plan, with respect to continued or future employment or conditions of employment.

     Section 7.09 — Minor or Incompetent. If the Committee determines that any Participant or Beneficiary entitled to a payment under the Plan is a minor or incompetent by reason of physical or mental disability, it may, in its sole discretion, cause any payment thereafter becoming due to such person to be made to any other person for his benefit, without responsibility to follow application of amounts so paid. Payments made pursuant to this provision shall completely discharge the Participating Entities, the Plan, the Committee and the Board.

     Section 7.10 — Illegal or Invalid Provision. In case any provision of the Plan shall be held illegal or invalid for any reason, such illegal or invalid provision shall not affect the remaining parts of the Plan, but the Plan shall be construed and enforced without regard to such illegal or invalid provision.

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EX-10.2

Exhibit 10.2

Extension Agreement

     This Extension Agreement is dated as of March 22, 2006 between Tollgrade Communications, Inc., having an address at 493 Nixon Road, Cheswick, PA 15024 (“Tollgrade”) and Bulova Technologies EMS LLC, with an address at 3900 W. Sarno Rd., Melbourne, FL 32934 (“Bulova Technologies”).

     WHEREAS, Tollgrade (as successor in interest to Acterna Corporation) and Bulova Technologies (as successor in interest to Dictaphone Corporation’s Electronic Manufacturing Services Division) are parties to a Supply Agreement dated July 25, 2002, which sets forth the terms pursuant to which Bulova Technologies manufactures and supplies to Tollgrade, and Tollgrade purchases from Bulova, certain products (the “Supply Agreement”);

     WHEREAS, the Supply Agreement was initially scheduled to expire on July 24, 2004, and has been successively extended through March 31, 2006;

     WHEREAS, Tollgrade and Bulova Technologies desire to replace the Supply Agreement with a new supply agreement, but have not yet completed negotiations with respect to such new supply agreement; and

     WHEREAS, Tollgrade and Bulova Technologies desire to further extend the term of the Supply Agreement through September 30, 2006 or until a new supply agreement is executed, if sooner;

     NOW THEREFORE, in consideration of the premises contained herein and for other good and valuable consideration, the parties agree as follows:

     1.  Extension of Supply Agreement. The parties hereby agree that the Supply Agreement is hereby extended through September 30, 2006 or until such time as the parties execute a new supply agreement, if sooner.

     2. Miscellaneous. Except as extended hereby, the provisions of the Supply Agreement shall remain in full force and effect. This Extension Agreement will be governed in all respects by the laws of the Commonwealth of Pennsylvania without reference to any choice of law provisions. This Extension Agreement may be executed in any number of counterparts and by the different parties hereto on separate counterparts, each of which, when so executed, shall be deemed an original, but all such counterparts shall constitute but one and the same instrument.

     IN WITNESS WHEREOF, the parties have hereunto set their hands the date first above written.

TOLLGRADE COMMUNICATIONS, INC.		BULOVA TECHNOLOGIES EMS LLC
By:	/s/ Jennifer M. Reinke	By:	/s/ James Davis
Name: Jennifer M. Reinke		Name: James Davis
Title: Assistant Secretary		Title: President

EX-15

Exhibit 15

May 9, 2006

Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549

     RE: Tollgrade Communications, Inc.

1)	Form S-8 (Registration No. 333-4290, 333-65502, 333-83007 and 333-95965) 1995 Long-Term Incentive Plan and Individual Stock Options Granted to Certain Directors and Employees Prior to the Adoption of the Plan
2)	Form S-8 (Registration No. 333-52907, 333-55470 and 333-096969) 1998 Employee Incentive Compensation Plan

Commissioners:

We are aware that our report dated May 4, 2006 on our review of interim financial information of Tollgrade Communications, Inc. for the three-month periods ended April 1, 2006 and March 26, 2005 and included in the Company’s quarterly report on Form 10-Q for the quarter ended April 1, 2006 is incorporated by reference in its Registration Statements referred to above.

Very truly yours

/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP

48

EX-31.1

Exhibit 31.1

Rule 13a – 14(a) CERTIFICATION OF CHIEF EXECUTIVE OFFICER

I, Mark B. Peterson, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of Tollgrade Communications, Inc.
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 10, 2006

/s/ Mark B. Peterson

Name: Mark B. Peterson

Title: Chief Executive Officer

49

EX-31.2

Exhibit 31.2

Rule 13a – 14(a) CERTIFICATION OF CHIEF FINANCIAL OFFICER

I, Samuel C. Knoch, certify that:

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

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

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

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

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

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

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

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

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

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

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

Date: May 10, 2006

/s/ Samuel C. Knoch


Name: Samuel C. Knoch
Title: Chief Financial Officer

50

EX-32

Exhibit 32

Rule 13a – 14(b) CERTIFICATIONS OF CHIEF EXECUTIVE OFFICER
AND CHIEF FINANCIAL OFFICER

     Pursuant to 18 U.S.C.§1350, the undersigned officers of Tollgrade Communications, Inc. (the “Corporation”), hereby certify that the Corporation’s Quarterly Report on Form 10-Q for the quarter ended April 1, 2006 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934 and that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation.

Dated: May 10, 2006

/s/ Mark B. Peterson

Name: Mark B. Peterson
Title: Chief Executive Officer

/s/ Samuel C. Knoch

Name: Samuel C. Knoch
Title: Chief Financial Officer

51