FORM 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 March 28, 2009


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		25-1537134
(State or other jurisdiction		(I.R.S. Employer
of incorporation or organization)		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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o No o

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


Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company 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 25, 2009, there were 12,680,664 shares of the Registrant’s Common Stock, $0.20 par value per share, outstanding, and no shares of the Registrant’s Preferred Stock, $1.00 par value per share, outstanding.

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)


	March 28, 2009			December 31, 2008		*

ASSETS
Current assets:
Cash and cash equivalents	$	59,572		$	57,976
Short-term investments		451			2,419
Accounts receivable:
Trade, net of allowance for doubtful accounts of $442 in 2009 and $377 in 2008		12,691			10,560
Other		273			668
Inventories		10,161			10,673
Prepaid expenses and deposits		1,209			1,449
Deferred income taxes		461			453

Total current assets		84,818			84,198
Property and equipment, net		2,545			2,953
Intangibles		35,983			36,853
Deferred tax assets		78			81
Other assets		261			262

Total assets	$	123,685		$	124,347

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	1,281		$	1,265
Accrued warranty		1,433			1,590
Accrued expenses		2,285			1,655
Accrued salaries and wages		272			363
Accrued royalties payable		112			299
Income taxes payable		143			268
Deferred revenue		3,711			3,283

Total current liabilities		9,237			8,723
Pension obligation		883			889
Deferred tax liabilities		1,802			1,792
Other tax liabilities		541			489

Total liabilities		12,463			11,893

Commitments and contingencies

Shareholders’ equity:
Common stock, $0.20 par value; 50,000 authorized shares, issued shares, 13,735 in 2009 and 13,733 in 2008		2,744			2,744
Additional paid-in capital		74,230			73,923
Treasury stock, at cost, 1,072 shares in 2009 and 2008		(8,081	)		(8,081	)
Retained earnings		44,526			45,748

Accumulated other comprehensive loss		(2,197	)		(1,880	)

Total shareholders’ equity		111,222			112,454

Total liabilities and shareholders’ equity	$	123,685		$	124,347


*		Amounts derived from audited financial statements presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008

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

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

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


	Three Months Ended
	March 28,			March 29,
	2009			2008

Revenues:
Products	$	7,114		$	7,139
Services		4,931			6,045

Total revenues		12,045			13,184

Cost of sales:
Products		3,450			3,616
Services		1,579			1,986
Amortization		698			1,014
Severance		183			21
Intangible impairment		59			3,291
Inventory impairment		—			738

Total cost of sales		5,969			10,666

Gross profit		6,076			2,518

Operating expenses:
Selling and marketing		1,993			2,435
General and administrative		2,575			2,579
Research and development		2,545			3,616
Severance		63			435
Impairment long lived assets		143			—

Total operating expenses		7,319			9,065

Loss from operations		(1,243	)		(6,547	)
Interest income		118			492

Loss before income taxes		(1,125	)		(6,055	)
Provision for income taxes		97			449

Net loss	$	(1,222	)	$	(6,504	)

Loss per share information:
Weighted average shares of common stock and equivalents:
Basic		12,679			13,158
Diluted		12,679			13,158

Net loss per common share:
Basic	$	(0.10	)	$	(0.49	)
Diluted	$	(0.10	)	$	(0.49	)

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

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands) (Unaudited)


	Three Months Ended
	March 28, 2009			March 29, 2008

Cash flows from operating activities :
Net loss	$	(1,222	)	$	(6,504	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Impairment loss		202			3,291
Depreciation and amortization		1,037			1,480
Compensation expense related to stock plans		307			(23	)
Valuation allowance		—			187
Deferred income taxes		64			28
Restructuring and inventory write-down		—			761
Provision for losses on inventory		40			61
Provision for allowance for doubtful accounts		79			37
Changes in assets and liabilities:
Accounts receivable-trade		(2,639	)		(602	)
Accounts receivable-other		1,040			401
Inventories		472			(475	)
Prepaid expenses and other assets		234			(25	)
Accounts payable		338			(1,542	)
Accrued warranty		(156	)		(295	)
Accrued expenses and deferred income		242			426
Accrued royalties payable		(188	)		(596	)
Income taxes payable		(112	)		228

Net cash used in operating activities		(262	)		(3,162	)

Cash flows from investing activities:
Purchase of short-term investments		—			(2,186	)
Redemption/maturity of short-term investments		1,968			464
Capital expenditures, including capitalized software		(86	)		(275	)
Sale of assets held for sale		—			198

Net cash provided by (used in) investing activities		1,882			(1,799	)

Net increase (decrease) in cash and cash equivalents		1,620			(4,961	)
Effect of exchange rate changes on cash and cash equivalents		(24	)		264
Cash and cash equivalents at beginning of period		57,976			58,222

Cash and cash equivalents at end of period	$	59,572		$	53,525

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

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(In thousands) (Unaudited)


													Accumulated
													Other						Other
	Common Stock				Additional		Treasury			Retained			Comprehensive						Comprehensive
	Shares		Amount		Paid-In		Stock			Earnings			Loss			Total			Loss

Balance at December 31, 2008		13,733	$	2,744	$	73,923	$	(8,081	)	$	45,748		$	(1,880	)	$	112,454

Compensation expense for options and restricted stock, net		2		—		307		—			—			—			307

Foreign currency translation		—		—		—		—			—			(317	)		(317	)	$	(317	)

Net loss		—		—		—		—			(1,222	)		—			(1,222	)		(1,222	)


Comprehensive income		—		—		—		—						—					$	(1,539	)


Balance at March 28, 2009		13,735	$	2,744	$	74,230	$	(8,081	)	$	44,526		$	(2,197	)	$	111,222

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

NOTES TO THE UNAUDITED 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 March 28, 2009 (13 weeks) and March 29, 2008 (13 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 unaudited condensed consolidated financial statements as of and for the three month period ended March 28, 2009 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, 2008. Accordingly, the accompanying unaudited 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 unaudited 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 March 28, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

On January 1, 2009, the Company adopted SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51,” (SFAS 160). SFAS 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This standard defines a noncontrolling interest, previously called a minority interest, as the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. SFAS 160 requires, among other items, that a noncontrolling interest be included in the consolidated statement of financial position within equity separate from the parent’s equity; consolidated net income to be reported at amounts inclusive of both the parent’s and noncontrolling interest’s shares and, separately, the amounts of consolidated net income attributable to the parent and noncontrolling interest all on the consolidated statement of operations; and if a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be measured at fair value and a gain or loss be recognized in net income based on such fair value. The adoption of SFAS 160 had no impact on the Company’s consolidated financial statements.

combinations and for an acquirer to be identified for each business combination. This standard defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control instead of the date that the consideration is transferred. SFAS 141(R) requires an acquirer in a business combination, including business combinations achieved in stages (step acquisition), to recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. Additionally, SFAS 141(R) requires acquisition-related costs to be expensed in the period in which the costs are incurred and the services are received instead of including such costs as part of the acquisition price. The impact of the adoption of SFAS 141R will depend on the nature and extent of business combinations occurring on or after the effective date.

On January 1, 2009, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements,” (SFAS 157) as it relates to nonfinancial assets and nonfinancial liabilities that are not recognized or disclosed at fair value in the financial statements on at least an annual basis. SFAS 157 defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America (GAAP), and expands disclosures about fair value measurements. The provisions of this standard apply to other accounting pronouncements that require or permit fair value measurements and are to be applied prospectively with limited exceptions. See Note 5 for the effect of the adoption of SFAS 157, as it relates to nonfinancial assets and nonfinancial liabilities, on the Company’s consolidated financial statements. The provisions of SFAS 157 will be applied at such time a fair value measurement of a nonfinancial asset or nonfinancial liability is required, which may result in a fair value that is materially different than would have been calculated prior to the adoption of SFAS 157.

On January 1, 2009, the Company adopted FASB Staff Position (FSP) No. FAS 142-3, “Determination of the Useful Life of Intangible Assets,” (FSP FAS 142-3). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets,” (SFAS 142) in order to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R) and other GAAP. The adoption of FSP FAS 142-3 had no impact on the Financial Statements.

On January 1, 2009, the Company adopted FSP No. EITF 03-6-1, “ Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities, ” (FSP EITF 03-6-1). FSP EITF 03-6-1 states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. The adoption of FSP EITF 03-6-1 had no impact on the Financial Statements.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In April 2009, the FASB issued FASB Staff Position (“FSP”) FAS No. 107-1 and Accounting Principles Board (“APB”) Opinion No. 28-1,Interim Disclosures about Fair Value of Financial Instruments(“FSP FAS No. 107-1 and APB Opinion No. 28-1”), which amends the disclosure requirements of SFAS No. 107 and APB Opinion No. 28 and requires disclosure about the fair value of its financial instruments whenever it issues summarized financial information for interim reporting periods. FSP FAS No. 107-1 and APB Opinion No. 28-1 are effective for financial statements issued for interim reporting periods ending after June 15, 2009. The Company is currently evaluating the impact of the adoption of FSP FAS No. 107-1 and APB Opinion No. 28-1 on its consolidated financial statements.

In April 2009, the FASB issued FSP FAS No. 115-2 and FAS No. 124-2,Recognition and Presentation of Other-Than-Temporary Impairments(“FSP FAS No. 115-2 and FAS No. 124-2”), which amends SFAS No. 115 and FSP FAS No. 115-1 and FSP FAS No. 124-1 and conforms changes to other standards including EITF Issue No. 99-20 and AICPA Statement of Position (“SOP”) No. 03-3,Accounting for Certain Loans or Debt Securities Acquired in a Transfer,and improves the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. FSP FAS No. 115-2 and FAS No. 124-2 are effective for interim and annual reporting periods ending after June 15, 2009. The Company is currently evaluating the impact of the adoption of FSP FAS No. 115-2 and FAS No. 124-2 on its consolidated financial statements.

In April 2009, the FASB issued FSP FAS No. 157-4,Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly(“FSP FAS No. 157-4”), which provides additional guidance for estimating fair value in accordance with SFAS No. 157,Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly and applies to all assets and liabilities within the scope of accounting pronouncements that require or permit fair value measurements, except in paragraphs 2 and 3 of SFAS No. 157. FSP FAS No. 157-4 is effective for interim and annual reporting periods ending after June 15, 2009. The Company is currently evaluating the impact of the adoption of FSP FAS No. 157-4 on its consolidated financial statements.

In December 2008, the FASB issued FSP 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets.” FSP 132(R)-1 amends SFAS 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. This FSP is effective for fiscal years ending after December 15, 2009. The Company does not expect this adoption to have a material impact on our financial statements.

2. FAIR VALUE MEASUREMENTS

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:

	•		Level 1 — Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

	•		Level 2 — Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means; and

	•		Level 3 — Inputs that are both significant to the fair value measurement and unobservable.

The fair value of cash equivalents was $50.2 million and $48.0 million at March 28, 2009 and December 31, 2008, respectively. These financial instruments are classified in Level 1 of the fair value hierarchy.

3. STOCK COMPENSATION PLANS AND ACCOUNTING FOR STOCK-BASED COMPENSATION EXPENSE

The Plans

The Company currently sponsors one active stock compensation plan. In March 2006, the Company adopted the 2006 Amended and Restated Long-Term Incentive Compensation Plan (the “2006 Plan”), which was approved by the shareholders on May 9, 2006 and effectively replaced the 1995 Long-Term Incentive Plan, which by its terms does not allow grants to be made after October 15, 2005. The 2006 Plan provides that participants may be directors, officers and other employees. The 2006 Plan authorized up to 1,300,000 shares available for grant. The 1998 Employee Incentive Plan (the “1998 Plan”) by its terms does not allow grants to be made after January 29, 2008.

Under the 2006 Plan, participants may be granted various types of equity awards, including restricted shares and/or options to purchase shares of the Company’s common stock. The grant price on any

such shares or options is equal to the quoted fair market value of the Company’s shares at the date of the grant, as defined in the 2006 Plan. Restricted shares will vest in accordance with the terms of the applicable award agreement and the 2006 Plan. The 2006 Plan requires that non-performance-based restricted stock grants to employees vest in not less than three years, while performance-based restricted stock grants may vest after one year. Grants of restricted stock to directors may vest after one year. Options granted generally vest over time. Historically, such period has typically been two years with one-third vested at the date of grant, one-third at the end of one year, and one-third at the end of two years. Beginning in December 2007, stock option grants have been made with vesting over three years, with one-third of such grants vesting at the end of each year following the date of grant.

Stock-Based Compensation Expense

During the first quarter of 2009, the Board of Directors approved the grant of a total of 394,000 stock options and 2,351 restricted shares under the 2006 Plan. Of these grants, 30,000 stock options and 2,351 restricted shares were issued to non-employee directors and the remaining 364,000 stock options were issued to employees, including the CEO and other key executive officers. The stock options granted to non-employee directors vested immediately upon issuance. The restricted share award granted to one non-employee director gave the director the right to receive the shares one year following the date of grant, regardless of whether the director is still serving on the Board of Directors, unless the director was removed from the Board for cause during that time. During the one year restriction period, the director can vote the restricted shares, but is not permitted to trade them. The stock options granted to employees vest over a three year period, with one-third vesting on each anniversary of the grant date.

Total stock-based compensation expense recognized under SFAS 123(R) for the three month periods ended March 28, 2009 and March 29, 2008 was an expense of $0.3 million and a credit of less than $(0.1) million, respectively. The unamortized stock-based compensation expense related to stock options and restricted stock totaled $1.9 million at March 28, 2009.


	Shares Authorized But Not Granted
	March 28, 2009		December 31, 2008

2006 Long-Term Incentive Compensation Plan		106,904		459,039

Transactions involving stock options under the Company’s various plans and otherwise are summarized below:

Number of

Range of

Weighted Average

Option Prices

Exercise Price

Outstanding, December 31, 2008

1,605,490

3.27 - 159.19

23.08

Granted

394,000

5.38

Exercised

—

Cancelled/Forfeited/Expired

(104,964

)

6.57-117.34

24.57

Outstanding, March 28, 2009

1,894,526

3.27 - $159.19

19.32

4. SEVERANCE

During the first quarter of 2009, the Company announced a restructuring program which included the realignment of existing resources to new projects, reductions in the Company’s field services and sales staffing and other reduction activities. The total severance expense associated with the program recorded in the first quarter 2009 was $0.2 million. No additional expense is expected.

During the first quarter of 2008, the Company announced a restructuring program which included the realignment of existing resources to new projects, reductions in the Company’s engineering staff, changes in field services and sales staffing and a reduction in the number of senior management positions. The total severance expense associated with the restructuring program recorded in the first quarter of 2008 was $0.5 million.

5. INTANGIBLE ASSETS

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

March 28, 2009

Useful

(Unaudited)

Life

Accumulated

(Years)

Gross

Amortization

Impairments

Net

Amortizing Intangible Assets:

Post warranty service agreements

6-50

37,429

4,107

—

33,322

Technology

0.25-10

18,755

16,621

2,094

Customer relationships

5-15

3,541

3,129

—

412

Tradenames and other

0.25-10

807

633

155

Total Intangible Assets

60,532

24,490

35,983


	Useful		December 31, 2008
	Life				Accumulated
	(Years)		Gross		Amortization		Impairments		Net

Amortizing Intangible Assets:
Post warranty service agreements		6-50	$	37,563	$	3,752	$	—	$	33,811
Technology		2-10		18,762		14,979		1,396		2,387
Customer relationships		5-15		3,554		1,420		1,676		458
Tradenames and other		0.5-10		809		393		219		197


Total Intangible Assets			$	60,688	$	20,544	$	3,291	$	36,853

Impairments

Long-Lived Assets

The Company performs impairment reviews of its long-lived assets upon a change in business conditions or upon the occurrence of a triggering event.

During the first quarter 2009, the Company recorded an impairment of long-lived assets of $0.2 million as a result of a triggering event. The triggering event which occurred subsequent to the end of the quarter, but prior to reporting our quarterly results was that it became probable that the Company would sell substantially all of the assets of its cable product line. The Company considered the likelihood of the sale and recorded the charge based on a comparison of the negotiated price to the net carrying value of the cable product line assets. The impairment was based on market information that would be considered Level 2 in the fair value hierarchy.

Due to the Company’s lower than expected operating results for the first quarter of 2008, subsequent to quarter-end, management undertook a review of its revenue and earnings expectations for the remainder of the year. As a result of this review, management made significant revisions to its 2008 financial outlook. These revisions were based on lower than expected first quarter results and deepening concerns about the impact of further deteriorations in general economic conditions and its effect on the markets that we serve. As a result, the Company performed an analysis of its long-lived assets in accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-lived Assets.” As a result of this analysis, we determined that certain customer and technology assets primarily related to our cable and certain other products were impaired, and an impairment loss of $3.3 million was recorded for the first quarter of 2008 to reflect these assets at their fair market value.

The Company currently estimates amortization expense, to be $2.0 million for the remainder of 2009 and $2.2 million, $1.7 million, $1.2 million, $1.0 million and $27.9 million for the years ended December 31, 2010, 2011, 2012 and 2013 and thereafter, respectively.

6. INVENTORIES

Inventories consisted of the following (in thousands):


	March 28, 2009
	(Unaudited)			December 31, 2008

Raw materials	$	5,993		$	6,225
Work in process		2,462			3,296
Finished goods		4,084			3,492

		12,539			13,013


Reserves for slow moving and obsolete inventory		(2,378	)		(2,340	)

	$	10,161		$	10,673

During the first quarter 2008, the Company announced a restructuring program which included a $0.7 million charge for inventory associated with products that were no longer part of the Company’s future strategic focus. A similar charge did not occur in the first quarter 2009.

7. PRODUCT WARRANTY

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


	Three Months Ended
	March 28, 2009			Year Ended
	(Unaudited)			December 31, 2008
Balance at the beginning of the period	$	1,590		$	1,937
Accruals for warranties issued during the period		194			1,789
Settlements during the period		(351	)		(2,136	)

Balance at the end of the period	$	1,433		$	1,590

8. PER SHARE INFORMATION

Net (loss) income 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 month period ended March 28, 2009 and March 29, 2008 does not include the effect of dilutive securities due to the net loss reported in such period, which would make those securities anti-dilutive to the earnings per share calculation.

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


	Three Months Ended			Three Months Ended
	March 28, 2009			March 29, 2008
	(Unaudited)			(Unaudited)
Net loss	$	(1,222	)	$	(6,504	)
Common and common equivalent shares:
Weighted average common shares outstanding		12,679			13,158
Effect of dilutive securities — stock options		—			—

		12,679			13,158


Loss per share:
Basic	$	(0.10	)	$	(0.49	)

Diluted	$	(0.10	)	$	(0.49	)

As of March 28, 2009 and March 29, 2008, 1,691,720 and 1,802,918 of equivalent shares, respectively, were anti-dilutive. Basic earnings per share are calculated on the actual number of weighted average common shares outstanding for the period, while diluted earnings per share must include the effect of any dilutive securities. As the Company reported a loss in both quarterly periods, the effect of any dilutive securities was excluded from the calculation of diluted earnings per share.

9. CONTINGENCIES AND COMMITMENTS

The Company leases office space and equipment under agreements which are accounted for as operating leases. The office lease for our Cheswick, Pennsylvania facility expires on June 30, 2009. The lease for our Piscataway, New Jersey location expires on April 30, 2012. As a result of the Broadband Test Division acquisition, the Company has leases in Bracknell, United Kingdom; Kontich, Belgium; and Wuppertal, Germany, which expire on December 24, 2012, April 1, 2012, and January 31, 2010, respectively. The Company is also involved in various month-to-month leases for research and development and office equipment at all five locations. In addition, one of the office leases include provisions for possible adjustments in annual future rental commitments relating to excess taxes, excess maintenance costs that may occur and increases in rent based on the consumer price index and based on increases in our annual lease commitments; however, none of these commitments are material.

Future minimum lease payments under operating leases having initial or remaining non-cancellable lease terms in excess of one year are as follows (in thousands):


	At March 28, 2009
2009 (remaining period)	$	577
2010		571
2011		538
2012		371
2013		—
Thereafter		—

	$	2,057

The lease expense for the three month period ended March 28, 2009 and March 29, 2008 was $0.2 million and $0.3 million, respectively.

In addition, 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.

10. INCOME TAXES

For the first quarters of 2009 and 2008, income tax expense was primarily related to foreign income tax obligations generated by profitable operations in foreign jurisdictions, as well as adjustments to reserves for uncertain tax positions. Additionally, the Company established a valuation allowance against U.S. federal, state and certain foreign net operating losses incurred in the first quarter of 2008 as the tax benefit was deemed more likely than not to be unrealizable in future periods. The foreign deferred tax benefit recorded in the first quarters of 2009 and 2008 relates primarily to temporary differences arising as a result of differentials between book and tax lives of intangible assets.

The Company had unrecognized tax benefits (excluding penalties and interest) of $0.5 million on both March 28, 2009 and December 31, 2008, all of which, if recorded, would impact the 2009 annual effective tax rate. It is reasonably possible that the amount of unrecognized tax benefits could change by less than $0.1 million in the next 12 months primarily due to tax examinations and the expiration of statutes related to specific tax positions.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of March 28, 2009, the Company has an insignificant amount of accrued interest related to uncertain tax positions in both foreign and domestic jurisdictions.

As of March 28, 2009, the tax years that remain subject to examination by major jurisdiction generally are:


United States — Federal		2005 and forward
United States — State		2005 and forward
Europe		2007 and forward

At March 28, 2009, the Company intends to permanently reinvest accumulated earnings in foreign subsidiaries. As a result, deferred taxes have not been provided on foreign earnings at March 28, 2009. If the Company’s intention changes and such amounts are expected to be repatriated, deferred taxes will be provided.

11. MAJOR CUSTOMERS AND INTERNATIONAL SALES

The Company’s customers range from the top telecom and cable providers, to numerous independent telecom, cable and broadband providers around the world. Our primary customers for our telco products and services are large domestic and European telecommunications service providers. The Company tracks its telco sales by two large customer groups, the first of which includes Qwest, AT&T and Verizon (referred to herein as large domestic carriers), and the second of which includes certain large international telephone service providers in Europe, namely British Telecom, Royal KPN N.V., Belgacom S.A., Deutsche Telecom AG (T-Com) and Telefónica O2 Czech Republic, a.s. (collectively referred to herein as the “European Telcos”). For the first quarter of 2009, sales to the large domestic customers accounted for approximately 44.4% of the Company’s total revenue, compared to approximately 30.4% of total revenue for the first quarter of 2008. Sales to AT&T individually exceeded 10% of the Company’s total revenue and comprised 25.5% of the Company’s total revenue for the first quarter of 2009, compared to 20.0% of the Company’s total revenue for the first quarter of 2008. Sales in the first quarter of 2009 and 2008 to the European Telcos accounted for approximately 21.4% and 29.1% respectively, of total revenue. As of March 28, 2009, the Company had approximately $5.0 million of accounts receivable with three customers, each of which individually exceeded 10% of our March 28, 2009 receivable balances. As of December 31, 2008, the Company had approximately $4.5 million of accounts receivable with three customers, each of which individually exceeded 10% of our December 31, 2008 receivable balances.

International sales represented approximately $4.3 million or 35.8% of the Company’s total revenue for the quarter ended March 28, 2009, compared to $6.1 million or 46.2% for the quarter ended March 29, 2008. Our international sales were primarily in three geographic areas based upon customer location for the quarters ended March 28, 2009 and March 29, 2008: the Americas (excluding the United States); Europe, the Middle East and Africa (“EMEA”); and Asia. Sales for the Americas were approximately $1.3 million and $0.7 million, sales for EMEA were $2.8 million and $5.3 million, and sales in Asia were approximately $0.2 million and $0.1 million for the quarters ended March 28, 2009 and March 29, 2008.

12. SUBSEQUENT EVENTS

On April 15, 2009, the Company announced that it had entered into a new multi-year managed services agreement with a leading global network equipment provider. Under the terms of the agreement, the Company will provide customer support and engineering services capabilities. Based upon the achievement of certain specified service levels, the agreement provides for expected contract revenue of approximately $20 million over its four-year term, which may be reduced due to the application of service level credits or if the expected underlying customer revenues do not materialize. Pursuant to this agreement, the Company hired 21 additional employees and purchased specified assets for use in performing the services, for a purchase price of $300,000.

On May 1, 2009, the Company entered into an agreement with Cheetah Technologies, L.P. (“Buyer”) to sell substantially all of the assets of the Company’s cable industry status monitoring product line. The sale price is $3,150,000, subject to adjustment for certain items pursuant to the terms of the agreement. $2,750,000 of the price is payable in cash at closing and $400,000 is payable under the terms of a Company-held note payable over a period of two years. The agreement contains customary representations, warranties and covenants, as well as indemnification provisions subject to specified limitations, and closing of the transaction is subject to completion of certain customary closing conditions. The agreement provides that the transaction is to close within ten business days after completion of the closing conditions or May 15, 2009, unless closing is delayed in accordance with the agreement.

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

The following discussion should be read in conjunction with the Unaudited 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.

This MD&A should be read in conjunction with our annual report on Form 10-K, as amended by Form 10-K/A, for the year ended December 31, 2008 (the “Form 10-K”).

Certain statements contained in this MD&A and elsewhere in this report are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended that involve risks and uncertainties. These statements relate to future events or our future financial performance. In some cases, forward-looking statements can be identified by terminology such as “believe,” “expect,” “intend,” “may,” “will,” “should,” “could,” “potential,” “continue,” “estimate,” “plan,” or “anticipate,” or the negatives thereof, other variations thereon or compatible terminology. These statements involve a number of risks and uncertainties. Actual events or results may differ materially from any forward-looking statement as a result of various factors, including those described in Part II, Item 1A below under “Risk Factors.”

Overview

Several trends continued across the Company’s markets that affected our performance in the first quarter of 2009.

Our customers continued to be impacted by the current economic environment, as businesses and consumers looked for ways to reduce their expenditures. Capital and operating expense budgets of our customers continued to be under pressure as they look to balance potential lower revenues as a result of the recession in the United States and international economies.

Our traditional customer base of incumbent telephone carriers (especially the large domestic carriers) continued to divert their spending from legacy networks as they focused their capital spending on wireless and next-generation wireline projects such as fiber to the home/curb/premise, IPTV, and DSL services. Customer line loss is being driven by competition from wireless and cable providers and also the elimination of second phone lines due to DSL penetration. This has resulted in reduced demand for our copper-based products.

In response to these conditions and trends our customers are attempting to reduce their costs, including by reducing the prices of services they purchase from under long term service contracts. As a result, each time a contract is scheduled for renewal, we must show our customers the value of the entire system and the costs saved by maintaining and even extending the system capabilities. Negotiations for the renewal of service agreements with two large customers whose contracts expired on December 31, 2008 have yet to be finalized and the absence of revenue from these sources adversely affected our revenue in the first quarter of 2009.

As described in the Form 10-K, management completed a comprehensive strategic review of all our businesses in 2008 to address these trends. As a result of the review, we determined that the appropriate strategy for the Company included focusing our strategic efforts and resources on the substantial and growing telecom service assurance market, where we have a significant installed customer base, and use this position to expand into adjacent markets and developing an integrated software platform that will serve multiple applications and products for the telecom industry including the next-generation IP service assurance market.

Products

Services

Our services offerings include software maintenance and support for our operating support systems (“OSS”) offerings and hardware maintenance for the test probes, as well as our professional services, which are designed to ensure that all of the components of our customers’ test systems operate properly. The primary customers for our services offerings are the large domestic carriers and international customers. We have a number of large service agreements with these customers which cover both software and hardware maintenance for our products. Historically, our services business was comprised of the more traditional POTS-based testability services, and the revenue stream was largely project-based and as such, difficult to predict. During the last few years, and primarily as a result of the Broadband Test Division acquisition, the services business has moved toward more contract-based software maintenance services, the revenue from which is more predictable. Because of this increase, our focus on our software applications as part of our refined strategy, and the decline in revenues from our other product lines, we expect services to continue to comprise a larger percentage of our revenue in the future. During the first quarter of 2009 we finalized a multi-year software maintenance agreement for one of the three major software maintenance contract renewals which were open at the end of 2008. In addition, we also entered into a new, multi-year managed services contract with a large global network equipment provider to provide customer support and engineering services.

Telecommunications Test and Measurement Products

Our proprietary telecommunications test and measurement products, which include our System Test and MCU® products, enable telephone companies to qualify and troubleshoot broadband DSL and IP services and remotely diagnose problems in POTS lines. Most DSL lines today provide broadband Internet access for residential and business customers, fed from a central or remote office Digital Subscriber Line Access Multiplexer (“DSLAM”) and configured with either a shared POTS voice service or “unbundled” from the voice switch entirely (in the case of a competitive local exchange carriers (“CLECs”) service offering). Our systems can be used to qualify loops for DSL service as well as ongoing maintenance and repair of these “IP” lines. As telecommunications service providers move to all IP networks and services (voice, video and data), Tollgrade’s test systems are positioned to be upgraded to support the testing of these services. POTS lines provide traditional voice service as well as connections for 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.”

An important aspect of efficiently maintaining a telecommunications network is the ability to remotely test, diagnose and locate any service-affecting problems within that network. Tollgrade’s System Test Products are made up of a centralized test operating system integrated into the customers’ repair handling database systems, and remote test hardware located at telephone companies’ central and remote offices. These systems enable local exchange carriers to conduct a full range of fault diagnostics in the “local loop,” the portion of the telephone network that connects end users to the central office. In addition, line test systems provide the capability to remotely qualify, deploy and maintain services such as DSL and Integrated Services Digital Network (“ISDN”) services which are carried over POTS lines. These test systems reduce the time needed to identify and resolve problems, eliminating or reducing the costs of dispatching a technician to the problem site. Most POTS line test systems, however, were designed only for use over copper wire line; as a result, traditional test systems could not access local loops in which fiber-optic technology had been introduced. Our MCU product line, which is used primarily by large domestic carriers, solved this problem, extending LoopCare™ testing from the central office to the fiber-fed remote Digital Loop Carrier (“DLC”) lines by mimicking a digital bypass pair, which is essentially a telephone circuit that connects central test and measurement devices to the copper circuits close to the customer, i.e., “the last mile.”

We believe our DigiTest system is well positioned for the present and future of telecommunication network testing, combining our line test system with a next generation test platform to provide a complete test system solution for POTS and DSL local loop prequalification and in-service testing.

During 2008, the Company determined after a thorough strategic review process to reposition itself with a greater focus on its service assurance offerings. The Company intends to build upon the strength of its System Test Products, which are at the center of our service assurance offerings, but with a greater emphasis on expanding our service assurance software solutions. Our System Test product software offerings include four separate OSS: LoopCare, 4TEL, Celerity, and LTSC™, each having an established installed base. LoopCare is also the primary application for broadband DSL testing and can be architected to overlay 4TEL and LTSC to add this functionality to the existing line test application with the addition of the DigiTest measurement platform. We plan to leverage these software incumbencies, and extend testing coverage to next generation network architectures. The implementation of our strategy initially will expand upon existing customer requests for enhanced features and capabilities.

Our legacy 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. One of three patents for our legacy MCU products will expire during 2010, and we expect that the loss of this patent protection will permit greater competition within this market segment that could cause our revenues from this product line to decline.

Cable Testing Products

The Company’s Cheetah performance and status monitoring products provide a broad network assurance solution for the broadband 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, the products can reduce operating costs and increase subscriber satisfaction. Our cable offerings consist of CheetahXD™ broadband assurance software, our proprietary CheetahNet™ (formerly NetMentor™) software systems, maintenance, head-end controllers, return path switch hardware, both proprietary and DOCSIS^® -based transponders and other equipment which gather status and performance reports from power supplies, line amplifiers and fiber optic nodes. Our CheetahIP/HFC service assurance solution allows cable operators to proactively test and monitor VoIP using hardware test probes and software analysis tools. By layering VoIP test point software on to DOCSIS-based transponders, the HFC access network is populated with a Tollgrade test probe that is controlled by a software management system, placing active on-demand and batch VoIP test calls point-to-point across the network for remote fault diagnosis.

We continued to explore strategic opportunities with our cable business during the first quarter of 2009, and on May 1, 2009, the Company entered into an agreement with Cheetah Technologies, L.P. to sell substantially all of the assets of the Company’s cable status monitoring product line (the “Agreement”) for a sale price of $3,150,000, subject to adjustment for certain items pursuant to the terms of the Agreement. Closing of the transaction is subject to completion of certain customary closing conditions. The Agreement provides that the transaction is to close within ten business days after completion of the closing conditions or no later than May 15, 2009, unless closing is delayed in accordance with the Agreement.

Electric Utility Monitoring Products

The Company’s new product development effort, the LightHouse product line, is being designed to provide power grid monitoring capabilities to electric utilities. Research and investment throughout 2007 and 2008 enabled the general availability of the first release of the product line during the first quarter of 2009. The test system solution currently consists of line mounted sensors, aggregators, and centralized software providing an end to end solution for power providers to efficiently monitor their overhead distribution circuits in real time. A LightHouse sensor, mounted directly on the electrical conductor, will continuously monitor key circuit parameters and transmit data over a wireless network to a central location, reducing time of detecting a problem on the grid, identifying its location and restoring service. LightHouse is intended as an innovative means for electric power utilities to deploy technology to provide real-time grid intelligence to detect faults and help minimize the impact of outages while optimizing the utilization of assets. The system is designed to improve the overall efficiency of energy delivery, improve customer satisfaction and improve the financial performance of the electric utilities.

Our Customers

Company tracks its telco sales by two large customer groups, the first of which includes Qwest, AT&T and Verizon (referred to herein as large domestic carriers), and the second of which includes certain large international telephone service providers in Europe, namely British Telecom, Royal KPN N.V., Belgacom S.A., Deutsche Telecom AG (T-Com) and Telefónica O2 Czech Republic, a.s. (collectively referred to herein as the “European Telcos”). For the first quarter of 2009, sales to the large domestic customers accounted for approximately 44.4% of the Company’s total revenue, compared to approximately 30.4% of total revenue for the first quarter of 2008. Sales to AT&T individually exceeded 10% of the Company’s total revenue and comprised 25.5% of the Company’s total revenue for the first quarter of 2009, compared to 20.0% of the Company’s total revenue for the first quarter of 2008. Sales in the first quarter of 2009 and 2008 to the European Telcos accounted for approximately 21.4% and 29.1% respectively, of total revenue. For the three months ended March 28, 2009, sales to customers in the Americas (excluding the United States) were approximately $1.3 million or 30.2% of international sales; sales to customers in EMEA were $2.8 million or 65.1% of international sales; and sales to customers in Asia Pacific were $0.2 million or 4.7% of international sales. For the three months ended March 29, 2008, sales to customers in the Americas (excluding the United States) were approximately $0.7 million or 11.5% of international sales; sales to customers in EMEA were $5.3 million or 86.9% of international sales; and sales to customers in Asia Pacific were $0.1 million or 1.6% of international sales.

Backlog

The Company’s order backlog for firm customer purchase orders and signed software maintenance contracts was $13.0 million as of March 28, 2009, compared to a backlog of $16.3 million as of December 31, 2008. The backlog at March 28, 2009 and December 31, 2008 included approximately $9.7 million and $12.1 million, respectively, related to software maintenance contracts, which is primarily earned and recognized as income on a straight-line basis during the remaining terms of these agreements. During the first quarter 2009, the Company finalized a multi-year software maintenance agreement for one of the three major software maintenance contract renewals which had not been completed at the end of 2008. Expected revenue from that signed software maintenance agreement is included in the backlog as of March 28, 2009; however, revenues from the two other agreements that are still under negotiation are not included in backlog.

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

The adoption of SFAS 160 had no impact on the Company’s consolidated financial statements.

On January 1, 2009, the Company adopted SFAS No. 141 (revised 2007), “Business Combinations,” (SFAS 141(R)), which replaces SFAS No. 141, “Business Combinations,” (SFAS 141) but retains the fundamental requirements in SFAS 141, including that the purchase method be used for all business combinations and for an acquirer to be identified for each business combination. This standard defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control instead of the date that the consideration is transferred. SFAS 141(R) requires an acquirer in a business combination, including business combinations achieved in stages (step acquisition), to recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. Additionally, SFAS 141(R) requires acquisition-related costs to be expensed in the period in which the costs are incurred and the services are received instead of including such costs as part of the acquisition price. The impact of the adoption of SFAS 141R will depend on the nature and extent of business combinations occurring on or after the effective date.

On January 1, 2009, the Company adopted FASB Staff Position (FSP) No. FAS 142-3, “Determination of the Useful Life of Intangible Assets,” (FSP FAS 142-3). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets,” (SFAS 142) in order to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141 (R) and other GAAP. The adoption of FSP FAS 142-3 had no impact on the Financial Statements.

On January 1, 2009, the Company adopted FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” (FSP EITF 03-6-1). FSP EITF 03-6-1 states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. The adoption of FSP EITF 03-6-1 had no impact on the Financial Statements.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In April 2009, the FASB issued FASB Staff Position (“FSP”) FAS No. 107-1 and Accounting Principles Board (“APB”) Opinion No. 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP FAS No. 107-1 and APB Opinion No. 28-1”), which amends the disclosure requirements of SFAS No. 107 and APB Opinion No. 28 and requires disclosure about the fair value of its financial instruments whenever it issues summarized financial information for interim reporting periods. FSP FAS No. 107-1 and APB Opinion No. 28-1 are effective for financial statements issued for interim reporting periods ending after June 15, 2009. The Company is currently evaluating the impact of the adoption of FSP FAS No. 107-1 and APB Opinion No. 28-1 on its consolidated financial statements.

In April 2009, the FASB issued FSP FAS No. 115-2 and FAS No. 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP FAS No. 115-2 and FAS No. 124-2”), which amends SFAS No. 115 and FSP FAS No. 115-1 and FSP FAS No. 124-1 and conforms changes to other standards including EITF Issue No. 99-20 and AICPA Statement of Position (“SOP”) No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer, and improves the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. FSP FAS No. 115-2 and FAS No. 124-2 are effective for interim and annual reporting periods ending after June 15, 2009. The Company is currently evaluating the impact of the adoption of FSP FAS No. 115-2 and FAS No. 124-2 on its consolidated financial statements.

In April 2009, the FASB issued FSP FAS No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP FAS No. 157-4”), which provides additional guidance for estimating fair value in accordance with SFAS No. 157, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly and applies to all assets and liabilities within the scope of accounting pronouncements that require or permit fair value measurements, except in paragraphs 2 and 3 of SFAS No. 157. FSP FAS No. 157-4 is effective for interim and annual reporting periods ending after June 15, 2009. The Company is currently evaluating the impact of the adoption of FSP FAS No. 157-4 on its consolidated financial statements.

In December 2008, the FASB issued FSP 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets.” FSP 132(R)-1 amends SFAS 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. This FSP is effective for fiscal years ending after December 15, 2009. The Company does not expect this adoption to have a material impact on our financial statements.

Application of Critical Accounting Policies

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Therefore, the determination of estimates requires the exercise of judgment based on various assumptions and other factors such as historical experience, economic conditions, and in some cases, actuarial techniques. Actual results may differ from those estimates. A discussion of market risks affecting the Company can be found in “Quantitative and Qualitative Disclosures about Market Risk” in this Quarterly Report on Form 10-Q.

A summary of the Company’s significant accounting policies are included in the Notes to Consolidated Financial Statements and in the critical accounting policies in Management’s Discussion and Analysis included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. Management believes that the application of these policies on a consistent basis enables the Company to provide useful and reliable financial information about the company’s operating results and financial condition. There were no changes to our critical accounting policies during the first quarter of 2009.

RESULTS OF OPERATIONS

FIRST QUARTER OF 2009 COMPARED TO FIRST QUARTER OF 2008

Revenues

The Company’s revenues for the first quarter of 2009 were $12.0 million compared to revenues of $13.2 million for the first quarter of 2008.

Services revenue consists of installation oversight and product management services provided to customers and fees from software maintenance agreements and service applications. Services revenue was approximately $4.9 million in the first quarter of 2009 compared to $6.0 million for the first quarter of 2008. The decline is primarily attributable to foreign currency translation differences due to the strength of the U.S. dollar compared to the prior quarter, as well as the lack of contribution in the first quarter of 2009 from the major software maintenance contracts which expired at the end of 2008 and the renewals of which have not yet been finalized, as the Company continues to negotiate to achieve favorable terms. Services revenue amounted to 40.8% and 45.9% of total first quarter 2009 and 2008 revenue, respectively.

Sales of the Company’s System Test product line (including sales of stand-alone LoopCare software products, 4TEL and Celerity) were $3.5 million in the first quarter of 2009, a decrease of $1.2 million, compared to sales in the first quarter of 2008 of $4.7 million. First quarter 2009 revenue included sales of DigiTest® products including DigiTest ®ICE™, LDU™ and N(x)Test™ test probe hardware products as well as custom software applications and licenses. First quarter 2009 sales of DigiTest and LDU products were lower largely as a result of testability projects that contributed to revenue in the first quarter 2008 and the completion of a major hardware contract in the fourth quarter 2008. The System Test product line revenue accounted for 29.2% and 35.7% of total first quarter of 2009 and 2008 revenue, respectively.

Sales of MCUs during the first quarter of 2009 were $2.3 million, compared to $0.9 million reported in first quarter of 2008. The $1.4 million increase in the first quarter 2009 was attributable to several large domestic telecom operators deploying testability initiatives. MCU sales represented 19.2% of total first quarter 2009 revenues, compared to 6.5% for the first quarter of 2008.

We expect MCU sales to continue to contribute to the Company’s revenue for the foreseeable future, and such sales may fluctuate somewhat unpredictably on a quarterly basis. However, as this product line continues to mature, the Company believes revenues from this product line will continue to decline over time.

Sales of cable hardware and software products were $1.3 million in the first quarter of 2009, compared with $1.6 million in the first quarter of 2008. The quarter over quarter decline was due in part to shipments made near the end of the quarter for which customer acceptance was not yet received. Cable hardware and software product sales amounted to 10.8% and 11.9% of total first quarter 2009 and 2008 revenue, respectively.

Gross Profit

Gross profit for the first quarter of 2009 was $6.1 million compared to $2.5 million in the first quarter of 2008. The first quarter of 2009 included $0.2 million of severance charges and impairment of certain intangible assets compared to first quarter 2008 charges of $4.1 million related to impairment of certain intangible assets primarily from our cable testing products, as well as an inventory write-down. As a percentage of sales, gross profit for the first quarter of 2009 was 50.4% versus 19.1% for the first quarter of 2008.

Selling and Marketing Expense

Selling and marketing expense, which consists primarily of payroll related costs, consulting expenses and travel costs, decreased $0.4 million, or 18.2%, to $2.0 million for the first quarter of 2009. The decrease is primarily associated with savings benefits from cost reduction initiatives initiated during the end of the first quarter 2008. As a percentage of revenues, selling and marketing expenses decreased to 16.5% in the first quarter of 2009 from 18.5% in the first quarter of 2008.

General and Administrative Expense

General and administrative expense, which consists primarily of payroll related costs, insurance expense and professional services fees, remained flat for each of the three months ended March 28, 2009 and March 29, 2008. As a percentage of revenues, general and administrative expenses increased to 21.4% in the first quarter of 2009 from 19.6% in the first quarter of 2008.

Research and Development Expense

Research and development expense, which consists primarily of payroll-related costs, decreased $1.1 million, or 29.6%, to $2.5 million in the first quarter of 2009. The first quarter 2009 decline is attributable to the restructuring program implemented during the first quarter 2008 as well as the strong performance of our application services products. Development efforts associated with our

application services products, which involve customer-funded software development, are allocated to cost of sales. As such, this allocation of resources can cause research and development costs to fluctuate on a quarterly basis. As a percentage of revenues, research and development expense for the first quarter of 2009 decreased slightly to 21.1% compared to 27.4% for the first quarter of 2008.

Severance Expense

During the first quarter of 2009, the Company implemented certain initiatives aimed at increasing efficiency and decreasing costs, which included reductions in its professional services, operations and marketing staff. During the first quarter of 2009, the Company recorded severance expenses associated with these initiatives of $0.2 million. The restructuring program announced by the Company during the first quarter of 2008 was completed in 2008 and no additional expense associated with this program was recorded in the first quarter of 2009.

Interest Income

Interest income for the first quarter of 2009 was $0.1 million compared to $0.5 million for the first quarter of 2008. The decrease was due to the dramatic decline in interest rates as well as slightly lower average cash and short-term investment balances.

Income Taxes

Income taxes for the first quarter of 2009 were $0.1 million. The first quarter of 2009 income tax expense primarily relates to foreign income tax obligations generated by profitable operations in certain foreign jurisdictions, as well as adjustments to reserves for uncertain tax positions in all jurisdictions. Additionally, the Company continued to record a valuation allowance against U.S. federal, state and certain foreign net operating losses incurred in the first quarter of 2009 as the tax benefit was deemed more likely than not to be unrealizable in future periods. The effective tax rate increased to 8.6% for the three months ended March 28, 2009 from 7.4% for the three months ended March 29, 2008.

Net Loss and Loss Per Share

Net loss for the first quarter of 2009 decreased $5.3 million or 81.2% to net loss of $1.2 million compared to a net loss of $6.5 million for the first quarter 2008. For the first quarter of 2009, our basic and diluted earnings per common share was $(0.10), compared to $(0.49) per basic and diluted common share recorded in the first quarter of 2008. Basic and diluted weighted average common and common equivalent shares outstanding were 12.7 million for the first quarter of 2009.

LIQUIDITY AND CAPITAL RESOURCES

We have historically met our working capital and capital expenditure requirements, including funding for expansion of operations, through net cash flows provided by operating activities. Our principal source of liquidity is our operating cash flows. There are no material restrictions on the ability to transfer and remit funds among our international affiliated companies.

The Company had working capital of $75.6 million at March 28, 2009, an increase of $0.1 million from $75.5 million of working capital as of December 31, 2008. As of March 28, 2009, we had approximately $60.0 million in cash, cash equivalent and short term investments, which are available for corporate purposes, including acquisitions and other general working capital requirements.

Net cash used in operating activities for the three months ended March 28, 2009 was $0.3 million compared to net cash used of $3.2 million for the same period in the prior year. The change in net cash related to operating activities is largely attributable to less cash usage as a result of cost saving initiatives as well as changes in working capital.

Cash used in investing activities was $1.9 million for the three months ended March 29, 2008 compared to cash provided by investing activities of $1.8 million for the three months ended March 28, 2009. The cash provided is related to the redemption of short-term investments.

The Company is party with a bank to a three-year $25.0 million Unsecured Revolving Credit Facility (the “Facility”), which includes a $2.0 million letter of credit sub-facility, expiring on December 19, 2009. In accordance with the terms of the Facility, the proceeds must be used for general corporate purposes, working capital needs, and in connection with certain acquisitions, as defined. The Facility contains certain standard covenants with which the Company must comply, including a minimum fixed charge coverage ratio, a minimum defined level of tangible net worth and a restriction on the amount of capital expenditures that can be made on an annual basis, among others. Our borrowings are limited by the calculation of our maximum leverage ratio, which is calculated on a quarterly basis. Interest is payable on any revolving credit amounts utilized under the Facility at prime, or the prevailing Euro rate plus 0.75% to 1.5% depending on the ratio of consolidated total indebtedness of the Borrower and its subsidiaries to consolidated EBITDA. Letter of credit fees are payable on letters of credit outstanding quarterly at the rate of 0.75% to 1.5% depending on the ratio of consolidated total indebtedness of the Borrower and its subsidiaries to consolidated EBITDA, and annually at the rate of 1/8% beginning with letter of credit issuance. Commitment fees are payable quarterly at the rate of 0.25% per annum on the average unused commitment. As of March 28, 2009 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.

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

KEY RATIOS

The Company’s days sales outstanding (DSO) in accounts receivable trade, based on the past twelve months rolling revenue, was 86 and 88 days as of March 28, 2009 and March 29, 2008, respectively. The Company’s inventory turnover ratio was 2.3 and 3.1 turns at March 28, 2009 and March 29, 2008, respectively.

COMMITMENTS AND CONTRACTUAL OBLIGATIONS

The Company leases office space and equipment under agreements which are accounted for as operating leases. The office lease for our Cheswick, Pennsylvania facility expires on June 30, 2009. The lease for our Piscataway, New Jersey location expires on April 30, 2012. As a result of the Broadband Test Division acquisition, we have leases in Bracknell, United Kingdom; Kontich, Belgium; and Wuppertal, Germany, which expire on December 24, 2012, April 1, 2012, and January 31, 2010, respectively. The Company is also involved in various month-to-month leases for research and development and office equipment at all five locations. In addition, one of the office leases include provisions for possible adjustments in annual future rental commitments relating to excess taxes, excess maintenance costs that may occur and increases in rent based on the consumer price index and based on increases in our annual lease commitments; however, none of these commitments are material.

Included in the commitment schedule below are certain pension obligations. As a result of our acquisition of the Broadband Test Division, we assumed a defined benefit pension plan for three employees based in our German location. The German pension obligation assumed as of August 1, 2007, which is an unfunded obligation of the Company in accordance with regulations in Germany, was approximately $0.7 million. The acquired net pension obligations for the Belgian and Netherlands plans, the majority of which are supported by insurance programs, were less than $0.1 million each. Net periodic pension expense for these plans recorded from the date of the acquisition through March 28, 2009 was insignificant. The total pension obligation as of March 28, 2009 was approximately $0.9 million. The increase in pension obligation from December 31, 2008 through March 28, 2009 primarily relates to increases in the Company’s benefit obligation.

Minimum annual future commitments as of March 28, 2009 are (in thousands):

Payments due by period


	Total		2009		2010		2011		2012		2013		Thereafter

Operating Lease Obligations	$	1,800	$	512	$	507	$	474	$	307	$	—	$	—

Purchase Obligations		73		69		4		—		—		—		—

FIN 48 Obligations		541		—		541		—		—		—		—

Pension Obligations		883		19		—		—		—		—		864

Total	$	3,297	$	600	$	1,052	$	474	$	307	$	—	$	864

The lease expense for the three month period ended March 28, 2009 was $0.2 million. The lease expense for the three month period ended March 29, 2008 was $0.3 million.

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.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our current investment policy limits our 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. We believe that our risk is minimized 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. We hold our investment securities to maturity and believe that earnings and cash flows are not materially affected by changes in interest rates, due to the nature and short-term investment horizon for which these securities are invested.

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 March 28, 2009 that have materially affected or are reasonably likely to materially affect these controls.

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 other factors discussed herein and in other past reports, including but not limited to prior year Form 10-K and quarterly Form 10-Q reports filed with the SEC. Our business and results of operations could be materially affected by any of the following risks. The factors discussed herein are not 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.

Our Services business is subject to a trend of reduced capital spending for our products by our major customers and possible delays in, or the inability to complete, negotiation and execution of purchase and service agreements with new or existing customers could significantly impact business results and possibly result in impairment charges in the future.

Our Services business, which includes software maintenance as well as professional services, is sensitive to the decline in our large carrier 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 materially adverse 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 to substantiate the value of our long term service contracts. For example, the three major customer contracts that expired on December 31, 2008 have resulted in extended negotiations that have forced the Company to demonstrate to these customers the value provided by our products and services. One of these contracts was extended during the first quarter of 2009 for a three year term, but the other two are still in the process of negotiation as of the date of this report. We believe that our services and our software systems provide significant value to our customers, however, each time a contract is scheduled for renewal, we must show our customers the value of the entire system and the costs saved by maintaining and even extending the system capabilities. To date, we have been able to renegotiate most of the major contracts (other than the two still subject to negotiation as described above) and substantially maintain existing pricing and terms through these efforts, however, if we are not successful in the future, such failure would potentially have significant adverse effects on our business. Accordingly, our ability to maintain historical levels from traditional sources or increase levels of Services revenues cannot be assured, and in fact, such levels may decrease. Also, if the negotiations for the two major customer contracts that expired on December 31, 2008 and whose renewals have yet to be finalized are not successful, the agreements may not be renewed at all or may be renewed on terms that are not as favorable to the Company as the former arrangements. In either event, the revenue and profitability of our Services offerings could be materially adversely affected, which could result in an impairment charge to the corresponding intangible assets on our balance sheet in future periods.

Our future growth depends to a large extent upon our ability to reposition the Company with a greater focus on our service assurance testing offerings to the telecom market.

As a result of the strategic review of our business in 2008, we determined that the Company should reposition itself with a greater focus on its service assurance offerings to the telecom market, and our software testing solutions in particular. Specifically, our goal is to develop an integrated software platform to serve multiple applications and products specifically for the telecommunications industry in the IP service assurance market which we believe will grow rapidly in the foreseeable future. To implement our strategy and exploit this opportunity, we will need to create new software products and enter into strategic partnerships so that we can maximize the potential of our incumbent position with customers and our long term relationships.

There can be no assurance that we will be able to reposition the Company in the manner described above or that, if we are successful, the repositioning will result in the benefits and opportunities that we expect. The development of new software solutions is an uncertain and potentially expensive process and requires that we accurately anticipate technological and market trends so that we can

deliver products in a timely manner. We may not be successful in completing the development of the new platform or, if we do so, we may not be able to commercialize the product in a timely manner or achieve market acceptance. 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. In addition, because it is customary in our industry to sell perpetual enterprise licenses that cover a customer’s entire operations, it can be difficult to assess at the time of sale the appropriate price that we should charge for a particular license. If we fail to set appropriate prices for our software licenses, our profitability could be adversely affected.

In addition, the potential market growth rate may not be as significant as we expect or could develop in unforeseen directions. For example, the commercial availability of competing products may affect the extent or timing of market acceptance of our solutions. Furthermore, we may not be successful in forming the strategic alliances contemplated by our new strategy. We may not identify the right partners or our partners could fail to perform their obligations and the partnership may fail to develop as expected. As a result of these and other factors, we may not be able to implement our strategy and our ability to exploit our incumbent position in the manner contemplated by our strategic repositioning would be materially and adversely affected.

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

During 2008, we implemented a series of initiatives designed to increase efficiency and reduce costs and to focus our core business on our test and measurement expertise. These initiatives included reductions of staff, alignment of investments and a completion of the integration plans from recent acquisitions, including Emerson and Broadband Test Division. Although we have experienced some cost savings from these initiatives and we believe that these actions will continue to reduce costs, they may not be sufficient to achieve the required operational efficiencies that will enable us to respond more quickly to changes in the market or result in the improvements in our business that we anticipate or be sufficient to offset a decline in our revenue. In such event, we may be forced to take additional cost-reducing initiatives, which may negatively impact quarterly earnings and profitability as we account for severance and other related costs. In addition, there is the risk that such 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.

A continuing downturn in the global economy may adversely affect our revenues, results of operations and financial condition.

Demand for our products and services is increasingly dependent upon the rate of growth in the global economy. If current economic conditions continue, customer demand for our products and services could be even more adversely affected than experienced to date, which in turn could adversely affect our revenues, results of operations and financial condition. Many factors could continue to adversely affect regional or global economic growth. Some of these factors include:

	•		poor availability of credit,

	•		continued recession in the United States economy and other countries that we serve,

	•		fluctuation in the value of the U.S. dollar relative to foreign currencies in jurisdictions where we transact business,

	•		significant act of terrorism which disrupts global trade or consumer confidence,

	•		geopolitical tensions including war and civil unrest, and

	•		reduced levels of economic activity or disruption of domestic or international transportation.

The recent challenging economic conditions also may impair the ability of our customers to pay for products and services they have purchased or otherwise constrict our customers’ spending on our products and services. As a result, revenues may decline and reserves for doubtful accounts and write-offs of accounts receivable may increase. In addition, certain of our contracts are paid or make payments in foreign currencies, and continued decrease in the exchange rate of the U.S. dollar relative to these currencies could further reduce our revenues, and such impact could be material.

We maintain an investment portfolio, consisting of cash, cash equivalents and investments in individual municipal bonds, and corporate and government bonds. These investments are subject to general credit, liquidity, market, and interest rate risks. If the global credit market continues to deteriorate, our investment portfolio may be impacted and we could determine that some of our investments have experienced an other-than-temporary decline in fair value, requiring an impairment charge which could adversely impact our financial results.

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 our key management personnel, including the Company’s CEO, CFO, senior management team members, and key engineers, 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. Furthermore, since 2007 we have experienced a number of changes in our senior management positions, both as part of the restructuring initiatives and otherwise, including a new CEO during 2007 and a new CFO during 2008. Although we believe we have taken appropriate measures to address the impact of these changes, there is the risk that such changes could impact our business, which could negatively affect operating results.

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 or services that they purchase from us, would significantly reduce our revenues and net income.

We currently depend upon a few major customers for a significant portion of our revenues and we expect to continue to derive a significant portion of our revenues from a limited number of customers in the future. The loss of any of these customers or a substantial reduction in the products or services that they purchase from us or our inability to renew services agreements with customers and to do so upon terms at least as favorable to the Company as current agreements would significantly reduce our

revenues and net income. Furthermore, diversions in the capital spending of certain of these customers to new network elements have and could continue to 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 spending of our large domestic carrier customers, as well as many of our other customers and potential customers, are dictated by a number of factors, most of which are beyond our control, including:

	•		the conditions of the communications market and the weakening 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 of our customers to meet established purchase forecasts and growth projections;

	•		competition among the large domestic carriers, 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 condition of one or more of our major customers should deteriorate, or if they have difficulty acquiring investment capital or reduce their capital expenditures 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 for our products in customers’ capital budgets. Some of our customers 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 and the ability to obtain acceptances of those sales, where applicable, 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 investors. In such events, or in the event adverse conditions prevail, the market price of our common stock may decline significantly.

We may experience reduced product sales caused by customers transitioning their access network service assurance solutions.

Certain of our larger customers are in the process of upgrading their access networks, and continue transitioning and upgrading their service assurance solutions for these networks. This has and may continue to adversely impact revenues from our testing products. Further, these customers may decide

not to adopt our technologies for their service assurance needs, which would have a significant adverse affect on revenues for those products.

We have completed, and may pursue additional acquisitions, which could result in the disruption of our current business, difficulties related to the integration of acquired businesses, and substantial expenditures.

We have completed, and we may pursue additional acquisitions of companies, product lines and technologies as part of our strategic efforts to realign our resources around growth opportunities in current, adjacent and new markets, to enhance our existing products, to introduce new products and to fulfill changing customer requirements. The consideration for any such acquisition may be cash or stock, or a combination of such forms of consideration, and the payment of such consideration may result in a reduction in our cash balance and/or the issuance of additional shares which may dilute the interest of our existing shareholders. 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. International acquisitions provide specific challenges 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 depends upon our ability to maintain certain key manufacturing relationships and we may not be able to continue those relationships. 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 and cause our stock price to decline.

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

Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) addresses financial accounting and reporting for the impairment or disposal of long-lived assets and requires that these assets be measured for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. During 2008 and 2007, based on our assessment that triggering events had occurred, we performed the required recoverability tests of SFAS 144 and determined that certain long-lived assets were impaired. The occurrence of further triggering events could result in additional impairments.

The sale of our products is dependent upon our ability to satisfy the proprietary requirements of our customers.

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. In addition, we introduced new products during 2008, including the DigiTest ICE

and the first version of the LightHouse products. The rate of acceptance of these new products could be delayed by, or fail to achieve, among other factors, extended testing or acceptance periods or requests for custom or modified engineering of such products to conform to customer requirements.

The sale of our products is dependent on our ability to respond to rapid technological change, including evolving industry-wide standards, and may be adversely affected by the development, and acceptance by our customers, of new technologies which may compete with or reduce the demand for our products.

Rapid technological change, including evolving industry standards, could render our products obsolete. Sales of our legacy cable products are declining, and demand for these products may further decline or be eliminated, as the market for these products transitions to industry-wide standards, such as the HMS and DOCSIS cable standards. 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 our products, develop new products or 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, our overall revenues and profitability will be adversely affected.

In addition, changes in network architecture experienced by our customers in the telephony market have and may continue to negatively affect our ability to sell products in these markets. Although we are addressing these changes with modifications to our existing products, if customers do not accept this new product technology, our revenues could be adversely affected. Further, we are experiencing competition from the internal Information Technology (“IT”) departments of our own carrier customers. In the past, we offered solutions consisting of hardware probes, coupled with a centralized software platform that analyzed the data pulled from the probes and determined the appropriate dispatch statement or issue identification statement. As the capabilities of new infrastructure equipment increases, test and monitoring software platforms are increasingly taking advantage of the available data from the infrastructure equipment. At the same time, many of our larger customers have captive development capabilities in their own IT organizations. These IT teams can develop competing software systems to our offerings, which could adversely affect our ability to sell our products to those customers, which could negatively impact overall revenues from such products.

Furthermore, the development of new technologies which compete with or reduce the demand for our products, and the adoption of such technologies by our customers, could adversely affect sales of our products. For example, as our products generally serve the wireline marketplace, to the extent wireline customers migrate to wireless technologies, there may be reduced demand for our products. In addition, we face new competition as testing functions that were once only available with purpose-built test systems are now available as integrated components of network elements. To the extent our customers adopt such new technology in place of our telecommunications products, the sales of our telecommunications products may be adversely affected. Such competition may also increase pricing pressure for our telecommunications products and adversely affect the revenues from such products.

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

We depend upon a limited number of third party contract manufacturers to manufacture certain elements of our products, and transitioned to two new contract manufacturers for our cable products in 2008. Furthermore, the components of our hardware products are procured from a limited number of outside suppliers. Although our products generally use industry standard products, some parts, such as ASICs, are custom-made to our specifications. Our reliance upon such third party contractors involve several risks, including reduced control over manufacturing costs, delivery times, reliability and quality of components. 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, inability of our contract manufacturers to procure raw materials, the loss of key assembly subcontractors, difficulties associated with the transition to our new contract manufacturers 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.

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

As a result of our acquisition of BTD and domestic market conditions, our business is becoming more dependent upon international markets. 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, changes in tariffs and foreign currency exchange rates, and longer payment cycles. 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.

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 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 intense in the cable markets, due to the introduction of the DOCSIS standard, which allows customers to purchase system components from multiple vendors. We are also facing competition with our IP-based testing solutions, and many competitive technologies, encompassing both hardware and software, are available in these markets. 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 telecommunications products and adversely affect future revenues from such products. We also face increasing pressure from certain of our large domestic carrier

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 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.

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 acquired Broadband Test Division 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 fail to meet their contractual obligations, cease doing, or reduce the amount of their 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.

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 for our system products is highly customer specific and can vary from a few weeks to many months. The system 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 the system. Our delay or failure to complete one or more large transactions in a quarter could harm our operating results. Our systems involve significant capital commitments by customers. Potential customers generally commit significant resources to an evaluation of available enterprise software and system testing solutions and require us to expend substantial time, effort and money educating them about the value of our solutions. System sales often require an extensive sales effort throughout a customer’s organization because decisions to acquire software licenses and associated system hardware involve the evaluation of the products 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 our MCU products may continue to account for a meaningful percentage of our revenues for the foreseeable future. However, these sales are declining and our three patents for our MCU products will expire between 2010 and 2014. MCU sales largely depend upon the rate of deployment of new, and the retrofitting of existing, 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 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. Further, the loss of patent protection for these products might allow competition within this market segment, which, if successful, could cause our revenues from this product line to be materially adversely affected.

The continued adoption of industry-wide standards in both the telecommunications and cable markets could have a material adverse effect on our profitability.

We are actively engaged in research to improve and expand our product offerings, including research and development to reduce product costs while providing enhancements; however, with the rise of industry-wide standards, among other factors, a number of our products have faced increased pricing pressure, driving lower margins. If sales of our network assurance and testing solutions and cable status monitoring products do not increase, decrease rapidly, 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.

The presence of available open source software could adversely affect our ability to maximize revenue from software products.

An emerging risk to our software development efforts is the presence of available open source software, which can allow our competitors and/or our customers to piece together a non-proprietary software solution relatively quickly. To the extent they are successful in developing software that meets their feature and benefit needs, revenue from our proprietary software could be adversely affected. Further, to the extent we incorporate open source into our software products, our ability to maximize revenue from our software products could be adversely impacted.

If our development efforts with respect to our LightHouse system fail to result in products which meet our customers’ needs, or if our customers fail to accept our new products, our revenues will be adversely affected.

We have recently introduced the first version of our LightHouse centralized remote monitoring system for the electric utility industry. The successful development, introduction and commercial success of this new technology will depend on a number of factors, including our ability to meet customer requirements, the existence of competitive products in the market, our timely and efficient completion of product design and implementation of manufacturing and manufacturing processes, our ability to meet product cost targets generating acceptable margins, timely remediation of product performance issues, if any, identified during testing, product performance at customer locations, differentiation of our product from our competitors’ products, and management of customer expectations concerning product capabilities and life cycles.

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 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 which will regulate their conduct in their respective markets. Changes in the 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, and our products could infringe upon the intellectual property rights of others, resulting in claims against us the results of which could be costly.

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 may 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.

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.

The success of some of our products is dependent on our ability to maintain licenses to technology from the manufacturers of systems with which our products must be compatible.

Some of our products require that we license technology from 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.

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.

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, 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.

We may incur significant liabilities if we fail to comply with environmental regulations.

Failure to comply with environmental regulations in the jurisdictions in which we do business could result in penalties and damage to our reputation. In effect in the European Union are the directive on the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (the “RoHS Directive”) and the directive on Waste Electrical and Electronic Equipment (the “WEEE Directive”). Both the RoHS Directive and the WEEE Directive impact the form and manner in which electronic equipment is imported, sold and handled in the European Union. Other jurisdictions, such as China, have followed the European Union’s lead in enacting legislation with respect to hazardous substances and waste removal. Although we have concluded that our test and measurement products fall outside the scope of the RoHS Directive, we have voluntarily undertaken to cause our next generation products to comply with its requirements. Ensuring compliance with the RoHS Directive, the WEEE Directive and similar legislation in other jurisdictions, and integrating compliance activities with our suppliers and customers could result in additional costs and disruption to operations and logistics and thus, could have a negative impact on our business, operations and financial condition. In addition, based on our conclusion that our test and measurement products do not fall within the scope of these Directives, we have determined not to take these compliance measures with respect to certain of our older, legacy products. Should our conclusions with respect to the applicability of the RoHS

Directive to these products be challenged and fail to prevail, we may be subject to monetary and non-monetary penalties, and could suffer harm to our reputation.

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. Trends indicate that capital spending in the telecommunications 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, large carrier customers have been adversely affected by subscriber line losses 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.

We rely on software that we license from third-party developers to perform key functions in our products.

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 could lose the right to use this software or it could be made available to us only on commercially unreasonable terms. Although we believe that, in most cases, alternative software 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 delay or reduce our product shipments 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 telephony offerings, an increase in the percentage of our sales of cable-related products relative to our traditional products will result in lower profit margins. Furthermore, 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. As a result of these factors, our revenues have been and are likely to continue to be adversely affected. Although we have developed DOCSIS-based hardware and we believe that our relationships with our OEM partners 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 there is greater competition, we will need to sell greater volumes of our products to maintain our profitability.

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;

	•		The fact that we no longer receive research coverage by sell-side market analysts;

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

	•		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 Global Select 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 regardless of the outcome of such litigation.

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.

We may have difficulty securing new financing upon the same or substantially similar terms.

The Company is party with a bank to a three-year $25.0 million Unsecured Revolving Credit Facility (the “Facility”), which includes a $2.0 million letter of credit sub-facility, expiring on December 19, 2009. 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 in 2009. However, our needs may change in the future. Because the global capital and credit markets have been severely constrained, we may not be able to obtain replacement financing or, even if we are able to obtain replacement financing, such financing may not be upon the same or substantially similar terms or may contain more onerous debt covenants that may be difficult for the Company to achieve. Inability to obtain replacement financing in these circumstances could have a material adverse effect on our future financial condition and results of operations.

Our business may be interrupted and adversely affected if we are unable to extend the lease for our corporate headquarters or to secure and prepare new office space for our corporate headquarters prior to our lease expiration.

The Company’s lease for its office space in Cheswick, Pennsylvania expires on June 30, 2009. The Company is currently negotiating an extension of its lease for a nine month period (which may be shortened to six months, at the landlord’s election); however, there is no guarantee that a final agreement with our existing landlord to extend our Cheswick lease will be reached nor that we will be able to hold over at our Cheswick location if we are not successful in extending our lease or in locating, securing and preparing new office space on or before
June 30, 2009.

If the Company is unable to extend its lease beyond its expiration or to enter into a definitive agreement for new office space as soon as possible, the Company may have to enter into a lease for new office space on terms which may be substantially less favorable than the terms of the Company’s existing lease. In addition, even if the Company does enter into a definitive agreement for the lease of new office space prior to the expiration of its current lease, the Company may need to expend substantial amounts of time and money in order to prepare the office space to meet the Company’s business needs and requirements, which could result in significant expenses to the Company and may delay our ability to relocate to the new location beyond the expiration of our lease. The Company could incur substantial additional fees and expenses in order to locate, secure and prepare new office space in a timely manner, including additional rent, construction and capital improvement costs associated with the Company’s technical and other facility requirements, which could adversely affect our future results.

Furthermore, if the Company is unable to locate, secure and prepare new office space on or before the expiration of its current lease and/or move out of its existing office space before such time, the Company may incur penalties from its existing landlord, additional expenses and fees associated with temporary office and storage space and related moving costs. All of the foregoing could result in

substantial costs to the Company and could result in material interruption to the Company’s business and operations.

Item 6. EXHIBITS

(a) Exhibits:

The following exhibits are being filed with this report:


Exhibit
Number		Description
10.1		Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Sara M. Antol (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on March 19, 2009).

10.2		10.2 Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Gary W. Bogatay, Jr. (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on March 19, 2009).

10.3		Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Joe O’Brien (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on March 19, 2009).

10.4		Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Robert King (incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the SEC on March 19, 2009).

10.5		Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Grant Cushny (incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed with the SEC on March 19, 2009).

10.6		Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and David L. Blakeney (incorporated by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K filed with the SEC on March 19, 2009).

10.7		Severance and Retention Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Kenneth J. Shebek (incorporated by reference to Exhibit 10.7 to the Company’s Current Report on Form 8-K filed with the SEC on March 19, 2009).

10.8		Purchase and Sale Agreement, dated May 1, 2009, by and among the Company, Tollgrade Communications, Inc. (Delaware corporation) and Cheetah Technologies, L.P. (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on May 5, 2009).

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.

™ICE is a trademark of Tollgrade Communications, Inc.

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

™LTSC is a trademark of Tollgrade Communications, Inc.

®Tollgrade is a registered 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.

®4TEL is a trademark of Tollgrade Communications, Inc.

®Celerity is a 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.

EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)


Exhibit
Number		Description
10.1		Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Sara M. Antol (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on March 19, 2009).

10.2		10.2 Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Gary W. Bogatay, Jr. (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on March 19, 2009).

10.3		Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Joe O’Brien (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on March 19, 2009).

10.4		Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Robert King (incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the SEC on March 19, 2009).

10.5		Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Grant Cushny (incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed with the SEC on March 19, 2009).

10.6		Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and David L. Blakeney (incorporated by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K filed with the SEC on March 19, 2009).

10.7		Severance and Retention Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Kenneth J. Shebek (incorporated by reference to Exhibit 10.7 to the Company’s Current Report on Form 8-K filed with the SEC on March 19, 2009).

10.8		Purchase and Sale Agreement, dated May 1, 2009, by and among the Company, Tollgrade Communications, Inc. (Delaware corporation) and Cheetah Technologies, L.P. (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on May 5, 2009).

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.


	PAGE NO.
PART I. FINANCIAL INFORMATION
Item 1 Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of March 28, 2009 and December 31, 2008 (Unaudited)		4
Condensed Consolidated Statements of Operations for the three month periods ended March 28, 2009 and March 29, 2008 (Unaudited)		5
Condensed Consolidated Statements of Cash Flows for the three month periods ended March 28, 2009 and March 29, 2008 (Unaudited)		6
Condensed Consolidated Statements of Changes in Shareholders’ Equity for the three month period ended March 28, 2009 (Unaudited)		7
Notes to Condensed Consolidated Financial Statements (Unaudited)		8
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations		19
Item 3 Quantitative and Qualitative Disclosures about Market Risk		31
Item 4 Controls and Procedures		31
PART II. OTHER INFORMATION
Item 1A Risk Factors		31
Item 6 Exhibits		47
SIGNATURES		49
EXHIBIT INDEX		50
EX-31.1
EX-31.2
EX-32


	Tollgrade Communications, Inc. (Registrant)
Dated: May 7, 2009
	/s/ Joseph A. Ferrara
	Joseph A. Ferrara
	Chief Executive Officer and President


Dated: May 7, 2009
	/s/ Gary W. Bogatay, Jr.
	Gary W. Bogatay, Jr.
	Chief Financial Officer and Treasurer

	(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

	(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.

	(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

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:


/s/ Joseph A. Ferrara Name: Joseph A. Ferrara
Title: Chief Executive Officer and President


/s/ Gary W. Bogatay, Jr. Name: Gary W. Bogatay, Jr.
Title: Chief Financial Officer and Treasurer


/s/ Joseph A. Ferrara Name: Joseph A. Ferrara
Title: Chief Executive Officer and President

/s/ Gary W. Bogatay , Jr. Name: Gary W. Bogatay, Jr.
Title: Chief Financial Officer and Treasurer