TOLLGRADE COMMUNICATIONS INC \PA\, 10-K, 1997-03-19

TOLLGRADE COMMUNICATIONS INC \PA\
10-K, 1997-03-19
TELEPHONE INTERCONNECT SYSTEMS

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<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
COMMISSION FILE NUMBER 0-27312

TOLLGRADE COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)

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

493 NIXON ROAD, CHESWICK, PENNSYLVANIA 15024
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: 412-274-2156

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK, PAR VALUE $.20 PER SHARE
(Title of Class)

Indicate by a check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registration was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
--- ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K.
---

The Registrant estimates that as of March 7, 1997, the aggregate market value
of shares of the Registrant's Common Stock held by non-affiliates (excluding
for purposes of this calculation only, 968,540 shares of Common Stock held of
record or beneficially by the executive officers and directors of the
Registrant as a group) of the Registrant was $106,209,805.

As of March 7, 1997, the Registrant had outstanding 5,662,896 of its
Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

<TABLE>
<CAPTION>
Parts of Form 10-K into which
Document Document is incorporated
- -------- -----------------------------
<S> <C>
Portions of the Annual Report to Shareholders
for the year ended December 31, 1996 II and IV

Portions of the Proxy Statement to be distributed
in connection with the 1997 Annual
Meeting of Shareholders III
</TABLE>

<PAGE> 2

PART I

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

The statements contained in this Annual Report on Form 10-K, specifically those
contained in Item 1 "Business" and Item 7 "Management's Discussion and Analysis
of Financial Condition and Results of Operation," and statements incorporated by
reference into this Form 10-K from the 1996 Annual Report to Shareholders, along
with statements in other reports filed with the Securities and Exchange
Commission, external documents and oral presentations, which are not historical
are "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. These forward-looking statements represent Tollgrade
Communications, Inc.'s (the "Company") present expectations or beliefs
concerning future events. The Company cautions that such statements are
qualified by important factors that could cause actual results to differ
materially from those in the forward-looking statements. Results actually
achieved may differ materially from expected results included in these
statements. Those factors which specifically related to the Company's business
include the following: rapid technological change along with the need to
continually develop new products; dependence on a single product line;
competition; dependence on key employees; management of Company's growth;
dependence on certain customers; dependence on certain suppliers; proprietary
rights and risks of third party claims of infringement; and government
regulation.

ITEM 1. BUSINESS.

The Company was incorporated in Pennsylvania in 1986 and began
operations in 1988. Its principal offices are located at 493 Nixon Road,
Cheswick, Pennsylvania 15024 and its telephone number is (412) 274-2156.

The Company designs, engineers, markets and supports proprietary
products which enable telephone companies to use their existing line test
systems to remotely diagnose problems in "plain old telephone service" ("POTS")
lines containing both copper and fiber optics. POTS lines comprise the vast
majority of lines in service today throughout the world. In addition to
traditional voice service, POTS includes lines for popular devices such as
computer modems and fax machines. POTS excludes the more complex lines, such as
data communications service lines, commonly referred to as "special services."

POTS line test systems, located at telephone companies' central
offices, diagnose problems in the "local loop", which is the portion of the
telephone network which connects end users to a telephone company's central
office, and is comprised primarily of copper wireline. The ability to remotely
test reduces the time needed to identify and resolve problems and eliminates or
reduces the cost of dispatching a technician to the problem site. Most POTS
line test systems were designed for use over copper wireline only, so that the
introduction of fiber-optic technology into the local loop renders it
inaccessible to these test systems. The Company's metallic channel unit ("MCU")
products solve this problem by extending test-system access through the
fiber-optic portion into the copper portion of the local loop.

Products. The Company's MCU products plug into the digital loop
carrier ("DLC") systems that are large systems manufactured by equipment
vendors such as AT&T, that are used by telephone companies to link the copper
and fiber-optic portions of the local loop. DLC systems are located at the
telephone company central offices and at remote sites within a local user area,
and effectively multiplex the services of the copper lines into a single
fiber-optic line. In many instances, several DLC systems are located at a
single remote site to serve several thousand different end-user homes and
offices. Generally, for every DLC remote site, two MCU line testing products
are deployed. To ensure compatibility with these DLC systems, the Company pays
royalties pursuant to license agreements for the use of

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proprietary design integrated circuits ("PIDCs"). The PIDCs are the design and
property of the DLC system manufacturer from which they are purchased. The
Company maintains license agreements with Advanced Fibre Communications, Lucent
Technologies, DSC Technologies Corporation, Fujitsu Network Transmission
Systems, Inc., NEC American, Inc., Northern Telecom Inc. and Reliance Comm/Tec
Corporation. In general, the current terms of these agreements expire at various
times between July 1997 and November 2004, with renewal provisions (unless
either party desires to terminate) for periods of between one and five years.
The Company paid $254,300, $1,075,800 and $1,779,700, respectively in 1994, 1995
and 1996 as royalties under the license agreements, which royalties are
calculated based on a percentage of the list price of MCU products which
incorporate the technology licensed under each such agreement. Certain of the
license agreements require the Company to maintain the confidentiality of the
licensor's proprietary information and/or the terms and conditions of the
agreement itself. Future license agreements entered into by the Company may
contain terms comparable to, or materially different than, the terms of existing
agreements as competitive and other conditions warrant. The loss of PDICs
license agreements or the inability of the Company to maintain an adequate
supply of PDICs could have a material adverse effect on the Company's business.
Other MCU technology is also used with home and business alarm systems. As with
home service line testing, home alarm systems must be monitored from the alarm
company's headquarters along a hybrid copper and fiber-optic line. The Company's
alarm-related MCU products are used to facilitate the transport of analog alarm
signals from subscriber homes to alarm company monitoring stations across the
hybrid telephone network. These units plug into equipment at both central office
and remote locations. MCU products accounted for more than 90%, 93% and 93% of
the Company's sales in 1994, 1995 and 1996, respectively.

Product and Technology Development. The Company's product
development personnel are organized into teams, each of which is effectively
dedicated to a specific product line or lines. Each product team also
implements the Company's ongoing "value engineering" programs which are
designed to replace the Company's products with successive generations having
additional features and/or lower costs. The Company continuously monitors
developing technologies and introduces products as defined standards and
markets emerge. In addition, the Company continues to investigate the
development of new applications for its MCU technology and other technologies
to service the telecommunications industry. During 1994, 1995 and 1996,
research and development expenses were approximately $1,585,000, $2,637,000 and
$3,921,000, respectively.

Proprietary Rights. The names "Tollgrade(R)", "MCU(R)" and
"Micro-Bank(R)", and the Company's corporate logo are registered trademarks of
the Company. "Team Tollgrade(SM)" is a service mark of the Company. The Company
has obtained three patents on the MCU products with expiration dates ranging
from 2010 to the year 2014 and has two provisional patent applications pending.
The Company will seek additional patents from time to time related to its
research and development activities. The Company protects its trademarks,
patents, inventions, trade secrets, and other proprietary rights by contract,
trademark, copyright and patent registration, and internal security.

Customers. The Company's primary customers are the seven regional
Bell operating companies ("RBOCs"), which are Ameritech Corporation, Bell
Atlantic Corporation, BellSouth Corporation, NYNEX Corporation, Pacific Telesis
Group, SBC Communications Inc., and US WEST Inc., as well as major independent
telephone companies such as GTE Corporation, Sprint and The Southern New
England Telephone Company. Historically, almost all of the Company's sales have
been made to the RBOCs (86% in 1996). BellSouth Corporation, NYNEX Corporation,
Bell Atlantic Corporation and US WEST Inc. accounted for 30%, 27%, 8% and 8%,
respectively, of the Company's total sales in 1996. The Company's relationships
with its customers are material to the Company's business, and the loss of any
such relationship could have a material adverse effect on the Company's
business.

Manufacturing. The Company's manufacturing operations consist
primarily of quality control, functional testing, final assembly, burn-in and
shipping. The Company uses independent third-party contract assembly and test
companies on primarily a consignment basis for circuit board

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<PAGE> 4

assembly and in-circuit testing for all of its products. In particular, one
third-party contract assembler is utilized by the Company for a significant
portion of its circuit board assembly and in-circuit testing requirements. The
loss of this particular subcontractor could cause delays in the Company's
ability to meet production obligations and could have a material adverse effect
on the Company's results of operations. In addition, shortages of raw material
to, or production capacity constraints at, the Company's subcontractors could
negatively affect the Company's ability to meet its production obligations and
result in increased prices for affected parts. Any such reduction may result in
delays in shipments of the Company's products or increases in the price of
components, either of which could have a material adverse impact on the Company.

The Company currently procures all of its components from outside
suppliers. Generally, the Company uses industry standard components for its
products. Application specific integrated circuits ("ASICs") are a key
component to the manufacturing process and are custom made to the Company's
specifications. Currently the Company obtains all of its ASICs from National
Semiconductor Corp. Although the Company has generally been able to obtain
ASICs on a timely basis, a delay in the delivery of these components could have
a material adverse impact on the Company.

Backlog. The Company's backlog at December 31, 1996 was
approximately $0.9 million, as compared to approximately $2.1 million at
December 31, 1995. The decrease was due largely to a $1.3 million order
relating to a one-time project for a major customer that was included in the
December 31, 1995 backlog and was subsequently shipped in the first quarter of
1996. The Company includes in backlog all firm purchase orders for products
regardless of their ship date. Because of the quick turnaround that the
customers expect on their orders, which is sometimes one to two weeks, and
because of the possibility of customer changes in delivery schedules or
cancellation of orders, the Company's backlog as of any particular date may not
be indicative of actual revenues expected for any future period.

Competitive Conditions. The deciding competitive factors in the
Company's market include price, product features, performance, reliability,
service and support, breadth of product line, technical documentation and
prompt delivery. The Company believes that it competes favorably on all of
these factors, and certain of its products have proprietary or patented
features. The Company also attempts to enter into development agreements for
its MCU products with the manufacturers of DLC and other complex systems, which
serves to ensure compatibility for its products. Competition would increase if
new companies enter the Company's product markets or existing competitors
expand their product lines. For instance, the recently enacted
telecommunications reform legislation has lifted the restrictions which
previously prevented the RBOCs from manufacturing telecommunications equipment.
Pursuant to this legislative reform, the RBOCs, which are the Company's largest
customers, may become competitors of the Company in the markets served by the
Company.

For the Company's line-testing MCU devices, the primary
competitive products are the remote monitoring units made by Teradyne, Inc. and
the Harris Dracon division of Harris Corporation. The Company's MCU is simpler
and less costly to install and permits the full complement of centralized
testing to be performed as quickly and accurately as with copper by-pass
wiring. The Company believes that Wiltron Company, Inc. and the Tau-Tron
division of General Signal Corporation, providers of special services test
systems, could expand into POTS line testing. The alarm-related MCU product's
primary competitor is the Turbo 2000 unit made by Antec Corporation.

Employees. At December 31, 1996 the Company had 184 full-time
employees, all in the United States. None of the Company's employees is
represented by a collective bargaining agreement.

Government Regulation. The telecommunications industry is subject
to regulation in the United States and other countries. Federal and state
regulatory agencies, including the FCC and various state public utility
commissions and public service commissions, regulate most of the Company's
domestic customers. While such regulation does not typically affect the Company
directly, the effects of such regulations on the Company's customers may, in
turn,

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adversely impact the Company's business and operating results. Governmental
authorities also have promulgated regulations which, among other things, set
installation and equipment standards for private telecommunications systems and
require that all newly installed hardware be registered and meet certain
government standards.

ITEM 2. PROPERTIES.

The Company's headquarters and principal administrative,
engineering and assembly facilities are located in Cheswick, Pennsylvania and
occupy approximately 58,000 square feet. The Company occupies its current
facilities under a lease that expires in December, 1998 with successive options
to renew through 2010. The Company believes that its current facilities are
adequate to support its present level of operations and there is ample room to
support continued sales growth for the foreseeable future.

ITEM 3. LEGAL PROCEEDINGS.

There are currently no outstanding or pending material legal
proceedings with respect to the Company or its business.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

During the fourth quarter of 1996, there were no matters submitted
to a vote of security holders through solicitation of proxies or otherwise.

EXECUTIVE OFFICERS OF THE COMPANY
---------------------------------

Information relating to the executive officers of the Company as of January 31,
1997 is set forth below:

<TABLE>
<S> <C>
R. Craig Allison Chairman of the Board since April 1990;
also Chief Executive Officer from April
1990 until September 1995; Director since
1986; father of Christian L. Allison, Chief
Executive Officer; Age 56.

Christian L. Allison Chief Executive Officer since September
1995; Treasurer since May 1992; President
from October 1993 until September 1995;
prior thereto, Chief Operating Officer;
Director since 1992; son of R. Craig
Allison, Chairman of the Board; Age 36.

Sara M. Antol Chief Counsel and Secretary since April
1996; prior thereto, employed by the law
firm of Babst, Calland, Clements and
Zomnir; Age 35.

John Benedict Assistant Director of Engineering since
November 1995; Design Engineer from July
1992 until November 1995; prior thereto,
employed as a test engineer by Modicon Inc.
(manufacturer of industrial automation
systems); Age 35.

Robert Cornelia Executive Vice President, Operations since
May 1996; Vice President, Manufacturing
from October 1993 until May 1996; prior
thereto, Production Manager; Age 34.
</TABLE>

5
<PAGE> 6

<TABLE>
<S> <C>
Ruth Dilts Director of Communications since May 1994;
prior thereto, Art Director at DDF&M Inc.
(advertising, marketing and public
relations firm); Age 36.

Bradley N. Dinger Controller since September 1996; prior
thereto Assistant Controller of AMSCO
International, Inc. (manufacturer of health
care equipment) from May 1993 until
September 1996; prior thereto, Corporate
Accounting Manager of AMSCO; Age 34.

Herman Flaminio Senior Vice President, Marketing and
Strategic Products since October 1993;
Director of Marketing, Technical Support
and Planning from January 1992 until
October 1993; prior thereto, Manager of
Long-Range Planning and Director of
Marketing, Technical Support and Planning;
brother of Rocco L. Flaminio, Vice
Chairman, Chief Technology Officer and a
Director; Age 57.

Rocco L. Flaminio Vice Chairman and Chief Technology Officer
since October 1993; prior thereto,
President; Director since December 1995;
brother of Herman Flaminio, Senior Vice
President; Age 72.

Mark C. Frey Senior Vice President, Engineering since
1993; Vice President, Engineering from 1992
until 1993; prior thereto employed by Pulse
Communications, Inc. (a DLC system vendor
and subsidiary of Hubbel, Inc.) as
Director, PSC 6000 Development (a
proprietary DLC system); Age 43.

Joseph Giannetti Vice President, Human Resources, Safety and
Security since June 1995; Director of
Safety and Environmental on a part-time
basis from June 1993 until June 1995; prior
thereto, worked on a contract basis for
Pittsburgh Applied Research Corporation (a
contractor in research and development
services); Age 60.

Frederick J. Kiko Senior Vice President, Design Engineering;
Age 53.

Samuel C. Knoch Chief Financial Officer since August 1996;
Controller of AMSCO International, Inc.
(manufacturer of health care equipment)
from October 1994 until August 1996;
Director of Internal Audit at AMSCO from
June 1993 until October 1994; prior
thereto, employed by the accounting firm of
Arthur Andersen & Co.; Age 41.

Geoffrey Lea Vice President, Marketing & Special
Assignment Sales Administration since
August 1996; Vice President, Sales from
September 1995 until August 1996; Vice
President, Marketing from January 1995
until September 1995; prior thereto,
Regional Sales Manager for ADC
Telecommunications Inc.(a manufacturer of
telecommunications equipment); Age 38.

Gregory Nulty Vice President, Marketing since December
1994; prior thereto, Senior Product Manager
for Pulse Communications, Inc. ( a DLC
system vendor and subsidiary of Hubbel,
Inc.); Age 43.
</TABLE>

<PAGE> 7

<TABLE>
<S> <C>
Matthew Rosgone Vice President, Purchasing since July 1996;
Director of Purchasing from July 1995 until
July 1996; prior thereto, a Buyer; Age 28.

Kristee Williams Director of Quality Assurance since July
1995; prior thereto, Quality Assurance
Manager for American Meter Co. (a
manufacturer of flow correctors for the
natural gas industry); Age 48.
</TABLE>

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS.

Information relating to the market for the Company's Common Stock and
other matters related to the holders thereof is set forth under the caption
"Common Stock Market Prices" on page 29 of the Company's 1996 Annual Report to
Shareholders and is incorporated herein by reference.

ITEM 6. SELECTED FINANCIAL DATA.

A summary of selected financial data for the Company, including each
of the last five fiscal years in the period ended December 31, 1996, is set
forth under the caption "Selected Consolidated Financial Data" on page 8 of the
Company's 1996 Annual Report to Shareholders and is incorporated herein by
reference.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

A discussion of the Company's financial condition and results of
operations is set forth under the caption "Management's Discussion and Analysis
of Financial Condition and Results of Operations" on pages 9 through 13 of the
Company's 1996 Annual Report to Shareholders and is incorporated herein by
reference.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The Company's consolidated financial statements, together with the
report thereon of Coopers & Lybrand L.L.P., are set forth on pages 15 through
28 of the Company's 1996 Annual Report to Shareholders and are incorporated
herein by reference. Such financial statements and supplementary data are
listed in Item 14(a) (1), "Exhibits, Financial Statement Schedules, and Reports
on Form 8-K."

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

None.

<PAGE> 8

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

In addition to the information reported in Part I of this Form 10-K,
under the caption "Executive Officers of the Company", the information required
by this item appears beneath the captions "Election of Directors" and
"Executive Compensation -- Section 16(a) Beneficial Ownership Reporting
Compliance" in the Company's definitive proxy statement for its 1997 Annual
Meeting of Shareholders and is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION.

Information relating to executive compensation is set forth beneath
the caption "Executive Compensation" in the Company's definitive proxy
statement for its 1997 Annual Meeting of Shareholders and is incorporated
herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

Information relating to the security ownership of beneficial owners of
5% or more of the Common Stock and of the executive officers and directors of
the Company is set forth under the caption "Stock Ownership of Management and
Certain Beneficial Owners" in the Company's definitive proxy statement for its
1997 Annual Meeting of Shareholders and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

Information relating to certain relationships and related transactions
is set forth beneath the caption "Certain Relationships and Related
Transactions" in the Company's definitive proxy statement for its 1997 Annual
Meeting of Shareholders and is incorporated herein by reference.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

(a)(1) The following financial statements and supplementary data are
incorporated in Item 8 of Part II of this Form 10-K by reference to pages 14
through 29 of the Company's 1996 Annual Report to Shareholders, which are
incorporated herein by reference:

Statement of Management's Responsibility for Financial Reporting,
dated January 29, 1997
Report of Independent Accountants, dated January 29, 1997
Consolidated Balance Sheets at December 31, 1995 and 1996
Consolidated Statements of Operations for the three years ended
December 31, 1996
Consolidated Statements of Shareholders' Equity for the three years
ended December 31, 1996
Consolidated Statements of Cash Flows for the three years ended
December 31, 1996
Notes to Consolidated Financial Statements
Statements of Operations Data by Quarter

<PAGE> 9

(a)(2) The following financial statement schedule is included herewith on page
14 and made a part hereof:

Schedule II (Valuation and Qualifying Accounts)

(a)(3) The following exhibits are included herewith and made a part hereof:

<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C>
3.1 Amended and Restated Articles of Incorporation of the
Company, filed as Exhibit 3.1 to the Company's Registration
Statement on Form S-1 (Reg. No. 33-98322) (as amended, the
"S-1") and incorporated herein by reference thereto.

3.2 Bylaws of the Company, filed as Exhibit 3.2 to the S-1 and
incorporated herein by reference thereto.

4.1 Rights Agreement, dated as of July 23, 1996 between the
Company and Chase Mellon Shareholder Services, L.L.C., filed
as Exhibit 1 to the Company's Registration Statement on Form
8-A and incorporated herein by reference thereto.

10.1 Common Stock Purchase Agreement dated November 7, 1994,
between the Company and the investors listed on Schedule A
thereto (attachments and exhibits omitted), filed as Exhibit
10.1 to the S-1 and incorporated herein by reference
thereto.

10.2 Credit Agreement, dated as of July 1, 1995, by and between
the Company and Creditanstalt Corporate Finance, Inc.
(schedules and exhibits omitted), filed as Exhibit 10.2 to
the S-1 and incorporated herein by reference thereto.

10.3* 1995 Long-Term Incentive Compensation Plan, filed as
Exhibit 10.3 to the S-1 and incorporated herein by reference
thereto.

10.4 License Agreement, dated August 24, 1993 between Fujitsu
Network Transmission Systems, Inc. and the Company, filed as
Exhibit 10.4 to the S-1 and incorporated herein by reference
thereto.

10.5 License Agreement, dated September 26, 1994 between NEC
America, Inc. and the Company, filed as Exhibit 10.5 to the
S-1 and incorporated herein by reference thereto.

10.6 Interface License Agreement, dated March 22, 1995 between
Northern Telecom Inc. and the Company, filed as Exhibit 10.7
to the S-1 and incorporated herein by reference thereto.

10.7 Technical Information Agreement, dated February 1, 1993
between American Telephone and Telegraph Company and the
Company, filed as Exhibit 10.8 to the S-1 and incorporated
herein by reference thereto.

10.8 Technology License Agreement, dated November 16, 1994
between DSC Technologies Corporation and the Company, filed
as Exhibit 10.12 to the S-1 and incorporated herein by
reference thereto.
</TABLE>

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<TABLE>
<S> <C>
10.9 License Agreement, dated August 24, 1993 between Reliance
Comm/Tec Corporation and the Company, filed as Exhibit 10.13
to the S-1 and incorporated herein by reference thereto.

10.10* Employment Agreement, dated as of December 13, 1995, between
the Company and R. Craig Allison, filed as Exhibit 10.10 of
the Annual Report of Tollgrade Communications, Inc. on Form
10-K for the year ended December 31, 1995 (the "1995 Form
10-K").

10.11* Employment Agreement, dated as of December 13, 1995, between
the Company and Christian L. Allison, filed as Exhibit
10.11 of the 1995 Form 10-K.

10.12* Stock Option Agreement entered into January 1, 1994 between
the Company and Frederick Kiko, together with a schedule
listing substantially identical agreements with Christian L.
Allison and Rocco L. Flaminio, filed as Exhibit 10.12 of the
1995 Form 10-K.

10.13* Stock Option Agreement entered into July 7, 1994 between the
Company and R. Craig Allison, together with a schedule
listing substantially identical agreements with Gordon P.
Anderson, John H. Guelcher, Richard H. Heibel and Joseph T.
Messina, filed as Exhibit 10.13 of the 1995 Form 10-K.

10.14* Stock Option Agreement entered into December 14, 1995
between the Company and R. Craig Allison, together with a
schedule listing substantially identical agreements with
Gordon P. Anderson, Jeffrey Blake, John H. Guelcher, Richard
H. Heibel, Joseph T. Messina and Douglas T. Halliday, filed
as Exhibit 10.14 of the 1995 Form 10-K.

10.15* Form of Stock Option Agreement dated December 14, 1995 and
December 29, 1995 for Non-Statutory Stock Options granted
under the 1995 Long-Term Incentive Compensation Plan, filed
herewith.

10.16* Change in Control Agreement, entered into May 30, 1996
between the Company and Sara M. Antol, together with a
schedule listing substantially identical agreements with
Robert Cornelia, Ruth Dilts, Herman Flaminio, Rocco
Flaminio, Mark Frey, Joseph Giannetti, Fred Kiko, Samuel
Knoch, Goeffrey Lea, Gregory Nulty, Matthew Rosgone and
Kristee Williams, filed as Exhibit 10.1 of the Report on
Form 10-Q of the Company filed on August 13, 1996.

10.17* Change in Control Agreement, entered into September 9, 1996
between the Company and Bradley N. Dinger, filed as Exhibit
10.1 of the Report on Form 10-Q of the Company filed on
November 12, 1996.

10.18* Form of Stock Option Agreement for Non-Statutory Stock
Options granted under the 1995 Long-Term Incentive
Compensation Plan, filed as Exhibit 10.2 of the Report on
Form 10-Q of the Company filed on November 12, 1996.

10.19* Non-employee Stock Option Agreement entered into December
13, 1996 between the Company and Lawrence Arduini, together
with a schedule listing substantially identical agreements
with Daniel Barry, Dr. Thomas Dugan, Robert Kampmeinert and
Dr. Richard Heibel, filed herewith.

10.20* Amendment to Employment Agreements, dated as of December 13,
1996, between the Company and R. Craig Allison and Christian
L. Allison, filed herewith.
</TABLE>

<PAGE> 11
<TABLE>
<S> <C>
11.1 Statement re: Computation of Per Share Earnings, filed
herewith.

13.1 Company's 1996 Annual Report to Shareholders, filed herewith.

21.1 List of subsidiaries of the Company, filed as Exhibit 21.1
to the S-1 and incorporated herein by reference thereto.

23.1 Consent of Coopers & Lybrand L.L.P., filed herewith.

27 Financial Data Schedule
</TABLE>

* Management contract or compensatory plan, contract or arrangement required
to be filed by item 601(b)(10)(iii) of Regulation S-K.

The Company agrees to furnish to the Commission upon request copies
of all instruments not listed above which define the rights of holders of
long-term debt of the Company.

Copies of the exhibits filed as part of this Form 10-K are available
at a cost of $.20 per page to any shareholder of record upon written request to
the Secretary, Tollgrade Communications, Inc., 493 Nixon Road, Cheswick,
Pennsylvania 15024.

(b) Reports on Form 8-K filed during the quarter ended December 31, 1996.

None

<PAGE> 12

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, Company has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized as of March 19, 1997.

TOLLGRADE COMMUNICATIONS, INC.

By /s/ Christian L. Allison
----------------------------
Christian L. Allison
Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the Company and in the capacities indicated as of March 19, 1997.

<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/ R. Craig Allison Chairman of the Board
- ------------------------------------------
R. Craig Allison

/s/ Christian L. Allison Director, Chief Executive Officer,
- ------------------------------------------ Treasurer (Principal Executive Officer)
Christian L. Allison

/s/ Lawrence A. Arduini Director
- ------------------------------------------
Lawrence A. Arduini

/s/ Daniel P. Barry Director
- ------------------------------------------
Daniel P. Barry

/s/ Rocco L. Flaminio Director, Vice Chairman
- ------------------------------------------ and Chief Technology Officer
Rocco L. Flaminio

/s/ Richard H. Heibel, M.D. Director
- ------------------------------------------
Richard H. Heibel, M.D.

/s/ Robert W. Kampmeinert Director
- ------------------------------------------
Robert W. Kampmeinert

/s/ Samuel C. Knoch Chief Financial Officer
- ------------------------------------------ (Principal Financial Officer)
Samuel C. Knoch

/s/ Bradley N. Dinger Controller
- ------------------------------------------ (Principal Accounting Officer)
Bradley N. Dinger
</TABLE>

<PAGE> 13

Report of Independent Accountants

To the Board of Directors
Tollgrade Communications, Inc.:

Our report on the consolidated financial statements of Tollgrade
Communications, Inc. and subsidiaries has been incorporated by reference in
this Form 10-K from page 15 of the 1996 Annual Report to Shareholders of
Tollgrade Communications, Inc. and subsidiaries. In connection with our audits
of such financial statements, we have also audited the related financial
statement schedule listed in the index on page 9 of this Form 10-K.

In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presently fairly, in all material respects, the information required to be
included therein.

/s/ COOPERS & LYBRAND L.L.P.

Pittsburgh, Pennsylvania
January 29, 1997

<PAGE> 14
SCHEDULE II

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES

VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 1994, 1995 and 1996
(In thousands)

<TABLE>
<CAPTION>
Col. A Col. B Col. C Col. D Col. E
- ------ ------ ------ ------ ------
Additions
Balance at ---------------------------
Beginning Charged to Charged to Balance at
of Year Expense Other Accounts Deductions End of Year
------- ------- -------------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Inventory Reserve:
Year ended December 31, 1994 $ 50 $107 $ -- $(97) $60
Year ended December 31, 1995 60 60 -- -- 120
Year ended December 31, 1995 120 95 -- -- 215

Deferred Tax Asset Valuation:
Year ended December 31, 1994 $1,060 $ -- $ -- $(1,060) $ --
Year ended December 31, 1995 -- -- -- -- --
Year ended December 31, 1996 -- -- -- -- --
</TABLE>

<PAGE> 15

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

<TABLE>
<CAPTION>
Exhibit
Number Description
- ------ -----------
<S> <C> <C>
3.1 Amended and Restated Articles of Incorporation of
the Company, filed as Exhibit 3.1 to the
Company's Registration Statement on Form
S-1 (Reg. No. 33-98322) (as amended, the "S-1")
and incorporated herein by reference thereto. *

3.2 Bylaws of the Company, filed as Exhibit 3.2 to
the S-1 and incorporated herein by reference
thereto. *

4.1 Rights Agreement dated as of July 23, 1996 between the
Company and Chase Mellon Shareholder Services, L.L.C., filed
as Exhibit 1 to the Company's Registration Statement on Form 8-A
and incorporated herein by reference thereto. *

10.3 1995 Long-Term Incentive Compensation Plan, filed
as Exhibit 10.3 to the S-1 and incorporated herein
by reference thereto. *

10.4 License Agreement, dated August 24, 1993 between
Fujitsu Network Transmission Systems, Inc. and
the Company, filed as Exhibit 10.4 to the S-1
and incorporated herein by reference thereto. *

10.5 License Agreement, dated September 26, 1994 between
NEC America, Inc. and the Company, filed as
Exhibit 10.5 to the S-1 and incorporated herein by
reference thereto. *
</TABLE>

<PAGE> 16

<TABLE>
<S> <C>
10.6 Interface License Agreement, dated March 22, 1995
between Northern Telecom Inc. and the Company,
filed as Exhibit 10.7 to the S-1 and incorporated
herein by reference thereto. *

10.8 Technology License Agreement, dated November 16, 1994
between DSC Technologies Corporation and the Company, filed
as Exhibit 10.12 to the S-1 and incorporated herein by reference thereto. *

10.9 License Agreement, dated August 24, 1993 between Reliance
Comm/Tec Corporation and the Company, filed as Exhibit 10.13
to the S-1 and incorporated herein by reference thereto. *

10.10 Employment Agreement, dated as of December 13, 1995, between
the Company and R. Craig Allison, filed as Exhibit 10.10 of
the Annual Report of Tollgrade Communications, Inc.
on Form 10-K for the year ended December 31, 1995
(the "1995 Form 10-K"). *

10.11 Employment Agreement, dated as of December 13, 1995,
between the Company and Christian L. Allison, filed as
Exhibit 10.11 of the 1995 Form 10-K. *

10.12 Stock Option Agreement entered into January 1, 1994 between
the Company and Frederick Kiko, together with a schedule
listing substantially identical agreements with Christian L.
Allison and Rocco L. Flaminio, filed as Exhibit 10.12 of the
1995 Form 10-K. *

10.13 Stock Option Agreement entered into July 7, 1994
between the Company and R. Craig Allison, together
with a schedule listing substantially identical
agreements with Gordon P. Anderson, John H. Guelcher,
Richard H. Heibel and Joseph T. Messina, filed
as Exhibit 10.13 of the 1995 Form 10-K. *
</TABLE>

<PAGE> 17
<TABLE>
<S> <C> <C>
10.14 Stock Option Agreement entered into December 14, 1995
between the Company and R. Craig Allison, together
with a schedule listing substantially identical
agreements with Gordon P. Anderson, Jeffrey Blake,
John H. Guelcher, Richard H. Heibel, Joseph T.
Messina and Douglas T. Halliday, filed as
Exhibit 10.14 of the 1995 Form 10-K. *

10.15 Form of Stock Option Agreement dated December 14, 1995
and December 29, 1995 for Non-Statutory Stock Options granted
under the 1995 Long-Term Incentive Compensation Plan, filed herewith.

10.16 Change in Control Agreement, entered into May 30, 1996
between the Company and Sara M. Antol, together with a
schedule listing substantially identical agreements with Robert Cornelia,
Ruth Dilts, Herman Flaminio, Rocco Flaminio, Mark Frey,
Joseph Giannetti, Fred Kiko, Samuel Knoch, Goeffrey Lea,
Gregory Nulty, Matthew Rosgone and Kristee Williams,
filed as Exhibit 10.1 of the Report on Form 10-Q of the
Company filed on August 13, 1996. *

10.17 Change in Control Agreement, entered into September 9, 1996
between the Company and Bradley N. Dinger, filed as
Exhibit 10.1 of the Report on Form 10-Q of the Company
filed on November 12, 1996. *

10.18 Form of Stock Option Agreement for Non-Statutory Stock Options
granted under the 1995 Long-Term Incentive Compensation Plan,
filed as Exhibit 10.2 of the Report on Form 10-Q of the Company
filed on November 12, 1996. *

10.19 Non-employee Stock Option Agreement entered into
December 13, 1996 between the Company and Lawrence Arduini,
together with a schedule listing substantially identical agreements
with Daniel Barry, Dr. Thomas Dugan, Robert Kampmeinert and
Dr. Richard Heibel, filed herewith.

10.20 Amendment to Employment Agreements, dated as of
December 13, 1996, between the Company and R. Craig Allison
and Christian L. Allison, filed herewith.

11.1 Statement re: Computation of Per Share Earnings, filed herewith.

13.1 Company's 1996 Annual Report to Shareholders, filed herewith.
</TABLE>

<PAGE> 18

<TABLE>
<S> <C> <C>
21.1 List of subsidiaries of the Company, filed as
Exhibit 21.1 to the S-1 and incorporated herein
by reference thereto. *

23.1 Consent of Coopers & Lybrand L.L.P., filed herewith.

27 Financial Data Schedule
</TABLE>

- --------------
* Incorporated by reference.

<PAGE> 1

Exhibit 10.15

STOCK OPTION AGREEMENT

THIS AGREEMENT is made and entered into this day of ,1995
by and between TOLLGRADE COMMUNICATIONS, INC., a Pennsylvania corporation (the
"Company") and (the "Holder").

WHEREAS, the Company desires to issue, and the Holder desires to receive,
Options to purchase shares of the common stock of the Company, pursuant to the
terms described herein.

NOW, THEREFORE, in consideration of the terms and conditions contained herein
and intending to be legally bound hereby, the parties agree as follows:

1. Grant of Option. The Company hereby grants to Holder the right, privilege
and option to purchase at any time prior to up to shares of fully paid
and nonassessable no par value common stock of the Company, at a purchase price
of per share (the "Option"), upon written request by the Holder at the
office of the Transfer Agent for the Company, or if there be none, at the
principal office of the Company at 493 Nixon Road, Cheswick, Pennsylvania
15025 and upon payment of the purchase price appropriate thereto.

2. Investment Purpose. The Holder represents to the Company that such Holder
is acquiring this Option and any securities which may be acquired pursuant to
this Option for investment and not with a view to or for sale in connection
with any distribution thereof. Such Holder represents that he will not sell or
transfer any securities acquired pursuant to this Option in violation of the
Securities Act of 1933, as amended (the "Act"), or the rules and regulations
promulgated thereunder. Without limiting the scope of the foregoing
representation and warranty, the Holder agrees that he will not sell or
transfer any such securities unless either (I) a Registration Statement under
the Act shall be in effect with respect to such

<PAGE> 2

securities and the Holder shall comply with the provisions of the Act in
connection with the sale of such securities or (ii) the Holder has, prior to any
transfer or attempt to transfer such securities, obtained an opinion of counsel
to the Company to the effect that in the opinion of such counsel, such transfer
may be effected without registration of such securities under the Act.

3. Legend. The Holder of this Option agrees that the Company may place a
legend reflecting the provision of the foregoing paragraph on each certificate
evidencing any securities delivered to the Holder pursuant to this Option and
the Company may refuse to transfer on its books any such securities which the
Holder may attempt to transfer otherwise then in compliance herewith.

4. Recapitalization. (a) Subject to any required action by the stockholders,
the number of shares of common stock of the Company covered by this Option, and
the price per share thereof, shall be proportionately adjusted for any increase
or decrease in the number of issued shares of common stock of the Company
resulting from the subdivision of consolidation of shares or the payment of
stock dividend (but only on the common stock of the Company covered by this
Option) or any other increase or decrease in the number of such shares affected
without receipt of consideration by the Company. Subject to any required action
by the stockholders, if the Company shall be the surviving company in any
merger or consolidation, this Option shall pertain to and apply to the
securities to which a holder of the number of shares of common stock of the
Company subject to the Option would have been entitled. A dissolution or
liquidation of the Company or a merger or consolidation in which the Company is
not the surviving company shall cause this Option to terminate, provided that
the Holder shall, in such event, have the right immediately prior to such
dissolution or liquidation or merger or consolidation in which the Company is
not the surviving company, to exercise his Option in whole or in part.

(b) Except as hereinbefore expressly provided, the Holder shall have no rights
by reason of any subdivision or consolidation of shares of stock of any class
or the payment of any stock dividend or other increase or decrease in the
number of shares of stock of any class or by reason of any dissolution,
liquidation, merger or consolidation or spin-off of assets or stock of another
company, and any issue by the Company of shares of stock of any class, or
securities convertible into shares of stock of any class, shall not affect, and
no

<PAGE> 3

adjustment by reason thereof shall be made with respect to, the number or
price of shares of common stock subject to the Option.

5. Fractional Shares. No fractional shares of common stock will be issued in
connection with any subscription hereunder, but in lieu of such fractional
shares, the Company shall make a cash payment thereof upon the basis of the
Option price then in effect.

6. Non-Transferability. This Option is nontransferable except pursuant to
the laws of succession and descent.

7. Reservation of Shares. The Company covenants that during the period this
Option is exercisable, the Company will reserve from its authorized and
unissued common stock a sufficient number of shares to provide for the issuance
of common stock upon the exercise of this Option.

8. Indemnification. The Holder indemnifies and holds harmless the Company
against any and all loss, damages, liability or expense, including costs and
reasonable attorneys' fees to which they may be put or which they may incur by
reason of or in connection with any misrepresentation made by the Holder, any
breach of any of his warranties, or his failure to fulfill any of his covenants
or agreements set forth herein. The Option and the representations and
warranties contained herein shall be binding upon the heirs, legal
representatives and successors of the undersigned.

9. Exercise of Option. This Option may be exercised by the Holder, in
whole or in part, by the surrender of this Option at the principal office of
the Company. Upon partial exercise hereof, a new Option or Options containing
the same provisions as this Option shall be issued by the Company to Holder for
the number of shares of common stock with respect to which this Option shall
not have been exercised.

<PAGE> 4

HOLDER TOLLGRADE COMMUNICATIONS, INC.

By:
- ------------------------- -----------------------------

ATTEST:

By:
-----------------------------

<PAGE> 1

Exhibit 10.19

TOLLGRADE COMMUNICATIONS, INC.

STOCK OPTION AGREEMENT

THIS AGREEMENT is made and entered into this 27th day of December,
1996, by and between TOLLGRADE COMMUNICATIONS, INC., a Pennsylvania corporation
(the "Company") and LAWRENCE A. ARDUINI, an individual (the "Holder").

WHEREAS, the Company desires to issue, and the Holder desires to
receive, an option to purchase shares of the common stock of the Company,
pursuant to the terms described herein.

NOW, THEREFORE, in consideration of the terms and conditions contained
herein and intending to be legally bound hereby, the parties agree as follows:

1. Grant of Option. The Company hereby confirms the grant to the
Holder on December 13, 1996 (the "Date of Grant") of an option (the "Option")
to purchase, in accordance with the terms hereof, up to Five Thousand (5,000)
shares of common stock of the Company, par value $.20 per share (the "Common
Stock") at an option price of $25.75 per share. The Option will expire at the
close of business on December 13, 2006.

2. Acceptance of Grant of Option. The Holder accepts the grant of the
Option confirmed hereby and agrees to be bound by the terms and conditions of
this Agreement.

<PAGE> 2

3. Investment Purpose. The Holder represents to the Company that such
Holder is acquiring this Option and any securities which may be acquired
pursuant to this Option for investment and not with a view to or for sale in
connection with any distribution thereof. Such Holder represents that he or she
will not sell or transfer any securities acquired pursuant to the Option in
violation of the Securities Act of 1933, as amended (the "Act"), or the rules
and regulations promulgated thereunder. Without limiting the scope of the
foregoing representation and warranty, the Holder agrees that he or she will
not sell or transfer any such securities unless either (a) a registration
statement under the Act shall be in effect with respect to such securities and
the Holder shall comply with the provisions of the Act in connection with the
sale of such securities; or (b) the Holder has, prior to any transfer or
attempt to transfer such securities, obtained an opinion of counsel
satisfactory to the Company, stating that such transfer may be effected without
registration of such securities under the Act.

4. Legend. The Holder of this Option agrees that the Company may place
a legend reflecting the provisions of Section 3 on each certificate evidencing
any securities delivered to the Holder pursuant to this Option and the Company
may refuse to transfer on its books any such securities in which the Holder may
attempt to transfer otherwise than in compliance herewith.

5. Recapitalization.

(a) Subject to any required action by the stockholders, the number of
shares of common stock of the Company covered by this Option, and the price per
share thereof, shall be proportionately adjusted for any increase or decrease
in the number of issued shares of common stock of the Company resulting from
the subdivision of consolidation of shares or the payment of stock dividend
(but only on the common stock of the Company covered by this Option) or any
other increase or decrease in the number of such shares affected without
receipt of consideration by the Company. Subject to any required action by the
stockholders, if the Company shall be the surviving company in any merger or
consolidation, this Option shall pertain to and apply to the securities to
which a holder of the number of shares of common stock of the Company subject
to the Option would have been entitled. A dissolution or liquidation of the
Company or a merger or consolidation

<PAGE> 3

in which the Company is not the surviving company shall cause this Option to
terminate, provided that the Holder shall, in such event, have the right
immediately prior to such dissolution or liquidation or merger or consolidation
in which the Company is not the surviving company, to exercise his Option in
whole or in part.

(b) Except as hereinbefore expressly provided, the Holder shall have
no rights by reason of any subdivision or consolidation of shares of stock of
any class or the payment of any stock dividend or other increase or decrease in
the number of shares of stock of any class or by reason of any dissolution,
liquidation, merger or consolidation or spin-off of assets or stock of another
company, and any issue by the Company of shares of stock of any class, or
securities convertible into shares of stock of any class, shall not affect, and
no adjustment by reason thereof shall be made with respect to, the number or
price of shares of common stock subject to the Option.

6. Non-Transferability. This Option shall not be transferrable
otherwise than by Will or the laws of descent or distribution, and the Option
shall be exercisable during the lifetime of the Holder only by the Holder.

7. Procedure for Exercise of Option. The Option may be exercised only
by (a) execution and delivery by the Holder to the Company of an exercise form
or forms prescribed by the Committee; and (b) surrender of this Agreement at
the principal office of the Company. Each exercise form must set forth the
number of shares of Common Stock for which the Option is exercised and must be
dated and signed by the person exercising the Option. Upon partial exercise
hereof, a new Agreement containing the same provisions as this Agreement shall
be issued by the Company to the Holder for the number of shares of Common Stock
with respect to which this Option shall not have been exercised.

Subject to the last paragraph of this Section 7, the exercise is not
effective until the Company receives payment of the full option price for the
number of shares of Common Stock for which the Option is exercised. The Option
Price shall be paid to the Company in full.

<PAGE> 4

If any person other than the Holder exercises the Option, the exercise
material must include proof satisfactory to the Company of the right of such
person to exercise the Option, and the signature on all certificates or stock
powers must be guaranteed by a commercial bank or trust company or by a firm
having membership in the New York Stock Exchange, Inc., the American Stock
Exchange, Inc., or the National Association of Securities Dealers, Inc.

The date of exercise of the Option is the date on which the exercise
form or forms, proof of right to exercise (if required) and payment of the
Option Price are received by the Company.

8. Issuance of Certificates. Subject to Section 7 above and this
Section 8, the Company will issue a certificate or certificates representing
the number of shares of Common Stock for which the Option is exercised as soon
as practicable after the date of exercise. Unless otherwise directed, the
certificate(s) will be registered in the name of the person exercising the
Option and delivered to such person.

9. Withholding of Taxes. The Holder will be advised by the Company as
to the amount of any federal income, employment or excise taxes required to be
withheld by the Company on any compensation income resulting from the exercise
of the Option, and the Holder will pay such taxes directly to the Company upon
request. State, local or foreign income or employment taxes may also be required
to be withheld by the Company and the Holder will also be required to pay such
taxes directly to the Company upon request. If the Holder does not pay any taxes
required to be withheld directly to the Company within ten (10) days after any
such request, the Company may withhold such taxes from any other compensation to
which the Holder is entitled from the Company. The Holder will hold the Company
harmless in acting to satisfy its withholding obligations in this manner if it
becomes necessary to do so.

10. Indemnification. The Holder indemnifies and holds harmless the
Company from and against any and all loss, damages, liability or expense,
including costs and reasonable attorneys' fees, to which the Company may be put
or may incur by reason of or in connection with any misrepresentation made by
the Holder, any breach of the Holder's warranties, or the Holder's failure to
fulfill any of his or her covenants or

<PAGE> 5

agreements set forth herein.

11. Binding Effect. This Agreement shall be binding upon the successors
and assigns of the Company and upon the legal representatives, heirs and
legatees of the Holder.

12. Entire Agreement. This Agreement constitutes the entire agreement
between the parties and supersedes all prior agreements and understandings, oral
or written, between the parties with respect to the subject matter of this
Agreement.

13. Amendment. This Agreement may be amended only a written instrument
signed by the Company and the Holder.

14. Governing Law. This Agreement shall be governed by and construed
and enforced in accordance with the laws of the Commonwealth of Pennsylvania.

<PAGE> 6

IN WITNESS WHEREOF, the Company and the Holder have executed this
Agreement as of the date first written above.

TOLLGRADE COMMUNICATIONS, INC.

By: /s/ Sara M. Antol
----------------------------------

Title: Chief Counsel and Secretary
-------------------------------

WITNESS:

/s/ Lawrence A. Arduini
- -------------------------- ----------------------------------
LAWRENCE A. ARDUINI

<PAGE> 7

Schedule to Exhibit 10.19

Non-employee Stock Option Agreements entered into December 13, 1996 between the
Company and each of Daniel P. Barry, Dr. Thomas Dugan, Robert Kampmeinert and
Dr. Richard Heibel, which were substantially identical to that filed as Exhibit
10.19, differing only in number of shares underlying the option granted.

<PAGE> 1

Exhibit 10.20

AMENDMENT

THIS AMENDMENT, dated as of January 14, 1997 (herein called the "Amendment"),
is entered into by and between TOLLGRADE COMMUNICATIONS, INC. (herein referred
to "Tollgrade") and R. CRAIG ALLISON (herein referred to as the "Executive").

AMENDMENT TO AGREEMENT

WHEREAS, Tollgrade and the Executive entered into an Agreement effective dated
the 13th day of December, 1995 governing certain benefits to be received by the
Executive in the event his employment is terminated (herein referred to as the
"Agreement"); and

WHEREAS, Tollgrade and the Executive desire to amend the Agreement upon the
terms and conditions stated in this Amendment.

NOW, THEREFORE, in consideration of the promises and the faithful
performance of the mutual covenants herein contained, and intending to be
legally bound hereby, Tollgrade and the Executive agree as follows:

1. Capitalized terms used herein and not otherwise defined in this
Amendment shall have the meaning assigned to them in the Agreement.

2. The Agreement shall be amended such that the Executive's base salary,
as specified in Section 2(b) of the Agreement, shall be increased to
$180,000 per annum, effective as of the anniversary date of the
Agreement.

<PAGE> 2

3. Except as modified by this Amendment, the provisions of the Agreement
will remain in full force and effect.

IN WITNESS WHEREOF, the parties have executed this Amendment as of the
date first above written.

TOLLGRADE COMMUNICATIONS, INC.

By: /s/ Sara M. Antol
---------------------------------
Title: Chief Counsel and Secretary
------------------------------

/s/ R. Craig Allison
---------------------------------
R. Craig Allison

<PAGE> 3

AMENDMENT

THIS AMENDMENT, dated as of January 14, 1997 (herein called the "Amendment"),
is entered into by and between TOLLGRADE COMMUNICATIONS, INC. (herein referred
to "Tollgrade") and CHRISTIAN L. ALLISON (herein referred to as the
"Executive").

AMENDMENT TO AGREEMENT

WHEREAS, Tollgrade and the Executive desire to amend the Agreement upon the
terms and conditions stated in this Amendment.

1. Capitalized terms used herein and not otherwise defined in this
Amendment shall have the meaning assigned to them in the Agreement.

3. Except as modified by this Amendment, the provisions of the Agreement
will remain in full force and effect.

<PAGE> 4

IN WITNESS WHEREOF, the parties have executed this Amendment as of the
date first above written.

TOLLGRADE COMMUNICATIONS, INC.

By: /s/ Sara M. Antol
---------------------------------
Title: Chief Counsel and Secretary
------------------------------

/s/ Christian L. Allison
---------------------------------
Christian L. Allison

<PAGE> 1
Exhibit 11.1

Tollgrade Communications, Inc. and Subsidiaries

Calculation of Earnings Per Share

For the Years Ended December 31, 1994, 1995, and 1996

<TABLE>
<CAPTION>
December 31,
-----------------------------------------------
1994 1995 1996
<S> <C> <C> <C>
Net income. . . . . . . . . . . . . . . . . . . . . . . $2,144,593 $2,521,827 $5,596,623

Accretion of fair market value of
redeemable warrants . . . . . . . . . . . . . . . 833,715 -- --
---------- ---------- ----------

Net income applicable to common stock . . . . . . . . . $1,310,878 $2,521,827 $5,596,623
========== ========== ==========

Common and common equivalent shares:
Weighted average number of common
shares outstanding during the period . . . . . 2,674,215 4,227,648 5,500,884
Common shares issuable upon
conversion of convertible
preferred stock
Primary . . . . . . . . . . . . . . . . . . 951,721 -- --
Fully diluted . . . . . . . . . . . . . . . 951,721 -- --
Common shares issuable upon
conversion of redeemable warrants
Primary . . . . . . . . . . . . . . . . . . 438,798 -- --
Fully diluted . . . . . . . . . . . . . . . 438,798 -- --
Common shares issuable upon exercise
of outstanding stock options
Primary . . . . . . . . . . . . . . . . . . 93,809 276,064 438,778
Fully diluted . . . . . . . . . . . . . . . 192,565 333,992 503,469
-------- ------- -------
Common and common equivalent
shares outstanding during the period
Primary . . . . . . . . . . . . . . . . . . 4,158,543 4,503,712 5,939,662
---------- --------- ----------
Fully diluted . . . . . . . . . . . . . . . 4,257,299 4,561,640 6,004,353
---------- --------- ----------

Earnings per share data:
Net income per common and common
equivalent shares
Primary . . . . . . . . . . . . . . . . . . $ .32 $ .56 $ .94
Fully diluted . . . . . . . . . . . . . . . $ .31 $ .55 $ .93
</TABLE>

<PAGE> 1

Exhibit 13.1

SELECTED CONSOLIDATED FINANCIAL DATA
- --------------------------------------------------------------------------------

The selected consolidated financial data of the Company as of December 31,
1992, 1993, 1994, 1995 and 1996 is derived from audited consolidated financial
statements of the Company.

<TABLE>
<CAPTION>
(In thousands, except per share data)
YEAR ENDED DECEMBER 31,
1992 1993 1994 1995 1996
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenues(1) $ 5,319 $10,089 $14,722 $22,310 $37,490
Cost of product sales 3,144 5,860 8,168 11,329 18,322
...........................................................................................................................
Gross profit 2,175 4,229 6,554 10,981 19,168

Operating expenses:
Selling and marketing 591 1,409 1,903 2,953 4,767
General and administrative 607 1,079 1,268 1,471 2,552
Research and development 540 769 1,585 2,637 3,921
...........................................................................................................................
Total operating expenses 1,738 3,257 4,756 7,061 11,240
- ---------------------------------------------------------------------------------------------------------------------------
Income from operations 437 972 1,798 3,920 7,928
Other income (expense) (305) (295) (270) 20 845
...........................................................................................................................
Income before income taxes 132 677 1,528 3,940 8,773
Provision (benefit) for income taxes 18 76 (617) 1,418 3,176
- ---------------------------------------------------------------------------------------------------------------------------
Net income $ 114 $ 601 $ 2,145 $ 2,522 $ 5,597
- ---------------------------------------------------------------------------------------------------------------------------
Net income applicable to common stock(2) $ 114 $ 432 $ 1,311 $ 2,522 $ 5,597
- ---------------------------------------------------------------------------------------------------------------------------
Fully diluted earnings per share $ .04 $ .12 $ .31 $ .55 $ .93
- ---------------------------------------------------------------------------------------------------------------------------
Weighted average shares of
common stock and equivalents 3,581 3,770 4,257 4,562 6,004
</TABLE>

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
1992 1993 1994 1995 1996
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit) $(1,344) $ 896 $ 3,195 $21,159 $27,232
Total assets 2,741 3,590 7,151 25,728 34,626
Long-term debt, less current portion 292 1,800 1,400 -- --
Shareholders' equity (deficit) (1,778) (911) 1,387 22,609 30,006

1992 1993 1994 1995 1996
- -------------------------------------------------------------------------------------------------------------------------------
OTHER DATA:
Number of employees at year end (3) 54 71 96 126 184
Average revenue per employee $ 98 $ 142 $ 153 $ 177 $ 204
</TABLE>

(1) Includes license and royalty fees of $450 and $75, respectively, for 1992
and 1993.
(2) Net of accretion for redeemable warrants, all of which were redeemed in
February 1995.
(3) Data not derived from Company's audited financial statements.

8
<PAGE> 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE "SELECTED
CONSOLIDATED FINANCIAL DATA" AND THE CONSOLIDATED FINANCIAL STATEMENTS AND
NOTES THERETO APPEARING ELSEWHERE IN THIS ANNUAL REPORT TO SHAREHOLDERS.

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

The statements contained in this Annual Report to Shareholders, specifically
including those contained in the following Management's Discussion and Analysis
of Results of Operations and Financial Condition, which are not historical are
"forwardlooking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. These forward-looking statements represent the Company's present
expectations or beliefs concerning future events. The Company cautions that such
statements are qualified by important factors that could cause actual results to
differ materially from those in the forward looking statements. Results actually
achieved may differ materially from expected results included in these
statements. Reference is made to a discussion of the important risk factors
detailed from time to time in the Company's SEC reports, including the report on
Form 10-K for the year ended December 31, 1996, a copy of which may be obtained
from the Company upon written request and without charge (except for the
exhibits thereto).

OVERVIEW

Tollgrade Communications, Inc. (the "Company"), was organized in 1986 and began
operations in 1988. The Company designs, engineers, markets and supports
proprietary products which enable local telephone companies to use their
existing line test systems to remotely diagnose problems in Plain Old Telephone
Service ("POTS") lines containing both copper and fiber optics. The Company's
MCU product line, which includes POTS line testing as well as alarm-related
products, represented more than 93% of the Company's revenue for the year ended
December 31, 1996 and will continue to account for a majority of Tollgrade's
revenues for the foreseeable future.

The Company's revenues include product sales as well as license and
royalty fees paid to the Company for the use of its proprietary technology.
With the exception of 1992, when the Company received $450,000 in licensing
revenue, these fees have not been significant. The Company's product sales are
primarily to the seven Regional Bell Operating Companies ("RBOCs"), as well as
major independent telephone companies such as GTE Corporation and Sprint. For
the year ended December 31, 1996, 86% of revenue was from the seven RBOCs, the
two largest of which comprised 57% of revenues. The Company's operating results
have fluctuated and may continue to fluctuate as a result of various factors,
including the timing of orders from and shipments to the RBOCs.

Although international sales to date have not been significant, the
Company believes the international markets offer opportunities. The Company
intends to focus additional sales, marketing and development resources on
increasing its international presence; however, there can be no assurance that
these efforts will be successful or that the Company will achieve significant
international sales.

Tollgrade believes that continued growth will depend on its ability to
design and engineer new products and therefore spends a significant amount on
research and development. Research and development expenses as a percent of
revenues were approximately 11% for the year ended December 31, 1996. The
Company expects its research and development expenses to continue at
significant levels.

In 1996, the Eighth Circuit Court of Appeals imposed a partial stay of
the Federal Communications Commission's Interconnection Order in Iowa Utilities
Board, et. al v. FCC (consolidated cases beginning at No. 96-3321). The stay
postponed the pricing standards of the Interconnection Order on the basis of
arguments the FCC exceeded its authority in setting pricing levels, which
authority should reside with state commissions. The FCC's Interconnection Order
would have imposed mandates on the pricing methods of local exchange carriers
under the Telecommunications Act of 1996. To date, these legal proceedings have
not yet been finally determined, and it remains uncertain how the ultimate
outcome will affect the Company's future results of operations.

9
<PAGE> 3
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
- --------------------------------------------------------------------------------

REVENUES

Revenues for the year ended December 31, 1996 were $37.5 million, and were
$15.2 million, or 68.0%, higher than revenues of $22.3 million for the year
ended December 31, 1995. Revenues for both periods consisted almost entirely of
product sales. Royalty and license fees were not material for either period.
The increase in revenues is primarily associated with the increase in unit
volume sales of the MCU product line as a result of increased market
penetration and customer acceptance. The increase includes revenues of $5.6
million from eight new products introduced in 1996. Overall, increased product
demand is at least partly attributable to technology licensing agreements
and/or joint venture relationships with certain major Digital Loop Carrier
("DLC") vendors, as well as continued expansion of a marketing program to train
customers in advanced line test system trouble-shooting. In addition, revenues
in the first quarter of 1996 included $1.3 million associated with the
completion of a one-time project for a major customer. This project was not
related to the Company's core MCU line testing product line.

GROSS PROFIT

Gross profit for 1996 was $19.2 million compared to $11.0 million for 1995,
representing an increase of $8.2 million, or 74.6%. Gross profit as a
percentage of revenues increased to 51.1% for 1996 compared to 49.2% for 1995.
The overall increase in gross profit margin resulted primarily from the
increased sales levels, while improvements in gross margin as a percentage of
sales were a result of increased sales of certain higher-margin products within
the MCU product line as well as reduced unit costs from suppliers and
manufacturing efficiencies. The Company's ability to sustain current gross
margin levels will depend on its success in gaining further cost reductions as
well as experiencing a similar mix of products sold.

SELLING AND MARKETING EXPENSE

Selling and marketing expenses consist primarily of personnel costs as well as
commissions and travel expenses of direct sales and marketing personnel, and
costs associated with marketing programs. Selling and marketing expense for
1996 was $4.8 million, or 12.7% of revenues, compared to $3.0 million, or 13.2%
of revenues for 1995. This increase of $1.8 million, or 61.4%, reflects
additional salaries and benefits associated with increased staffing levels to
support expanding product lines and increased consulting and travel expenses
associated with the planned expansion into international markets.

The Company expects selling and marketing expenses to rise commensurate
with increased revenues and selling efforts. The Company is continuing its
efforts to expand its business by marketing new products, developing additional
customer training programs and expanding its international presence.

GENERAL AND ADMINISTRATIVE EXPENSE

General and administrative expenses consist primarily of personnel costs for
finance, administrative and general management personnel as well as accounting
and legal expenses. General and administrative expense for 1996 was $2.6
million, or 6.8%, of revenues, compared to $1.5 million, or 6.6%, of revenues
for 1995. This increase of $1.1 million, or 73.5%, is primarily attributable to
additional salaries and benefits associated with increased staffing levels to
support the expanded business operations, as well as additional costs
associated with being a public company.

RESEARCH AND DEVELOPMENT EXPENSE

Research and development expenses consist primarily of personnel costs and
costs associated with the development of new products. Research and development
expense for 1996 was $3.9 million, an increase of $1.3 million, or 48.7%,
compared to $2.6 million for 1995. The increase was principally due to costs
associated with additional personnel to support new product introductions. As a
percentage of revenues, research and development expense was 10.5% for 1996
compared to 11.8% for 1995. The Company expenses all research and development
costs as they are incurred.

OTHER INCOME AND EXPENSE

Other income, which consists primarily of interest income, was $845,000 for
1996 compared to $20,000 for 1995. The increase in other income was primarily
attributable to increased interest income, which resulted from the investment
of the initial public offering proceeds for the entire year of 1996 versus only
a portion of 1995.

PROVISION FOR INCOME TAXES

The Company's effective tax rate for 1996 was 36.2% of income before income
taxes, which was comparable to the 36.0% rate in 1995.

10
<PAGE> 4
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
- --------------------------------------------------------------------------------

REVENUES

Revenues for the year ended December 31, 1995 were $22.3 million, and were $7.6
million, or 51.5%, higher than revenues of $14.7 million for the year ended
December 31, 1994. Revenues for both periods consisted almost entirely of
product sales. Royalty and license fees were not material for either period.
The increase in revenues is primarily due to continued sales volume increases
in the line-testing MCU product line to existing customers. This sales volume
increase primarily resulted from new product approvals by customers and the
introduction of a new marketing program to train customers in advanced line
test system trouble-shooting. The Company also generated $1.3 million of
revenues from the shipments of four new line testing products.

GROSS PROFIT

Gross profit increased to $11.0 million for 1995 compared to $6.6 million for
1994, a $4.4 million, or 67.6% increase. Gross profit as a percentage of
revenues increased to 49.2% for 1995 compared to 44.5% for 1994. The increase
in gross profit margin primarily resulted from the increase in sales and
increased sales of certain higher-margin products within the MCU product line,
as well as reduced unit costs from suppliers and manufacturing efficiencies.
The Company may experience variations in the gross profit margin due to timing
differences of cost reductions or changes in the mix of products sold.

SELLING AND MARKETING EXPENSE

Selling and marketing expenses consist primarily of personnel costs as
well as commissions and travel expenses of direct sales and marketing
personnel, and costs associated with marketing programs. Selling and
marketing expense for 1995 was $3.0 million, or 13.2% of revenues,
compared to $1.9 million, or 12.9% of revenues for 1994. This increase
of $1.1 million, or 55.2%, was primarily the result of hiring additional
marketing and support personnel and increased promotion costs for
domestic and international business development. The Company expects
selling and marketing expense to rise with increased revenues and
selling efforts. As part of the Company's continuing efforts to expand
its business, it plans on marketing new products, developing customer
training programs and expanding its international presence.

GENERAL AND ADMINISTRATIVE EXPENSE

General and administrative expenses consist primarily of personnel costs for
finance, administrative and general management personnel as well as accounting
and legal expenses. General and administrative expense for 1995 was $1.5
million, or 6.6%, of revenues, compared to $1.3 million, or 8.6%, of revenues
for 1994. This was an increase of $0.2 million, or 16.0%. The increase was due
to increased hiring of personnel in finance and systems administration. The
general and administrative expense as a percentage of revenue decreased as a
result of increased revenue levels.

RESEARCH AND DEVELOPMENT EXPENSE

Research and development expenses consist primarily of personnel costs and
costs associated with the development of new products. Research and development
expense for 1995 was $2.6 million, an increase of $1.0 million, or 66.3%,
compared to $1.6 million for 1994. Research and development expense as a
percentage of revenues was 11.8% for 1995 compared to 10.8% for 1994. The
increase was principally due to increased personnel costs as a result of
continuing expansion of the engineering department for new product development
activities along with increased purchases of engineering materials. The Company
expenses all research and development costs as they are incurred.

OTHER INCOME AND EXPENSE

Other income and expense consists primarily of interest income and interest
expense. Other income was $20,000 for 1995 compared to other expense of
$270,000 for 1994. The decrease in other expense was caused by lower interest
expense resulting from the elimination of outstanding debt and the investment
of the net proceeds of $15.8 million from the Company's initial public offering
in December, 1995.

PROVISION (BENEFIT) FOR INCOME TAXES

The Company's effective tax rate for 1995 was 36.0% of income before income
taxes. For 1994, the Company recorded a tax benefit equal to 40.4% of income
before income taxes. The tax benefit resulted from the reversal of the $1.1
million valuation allowance established in 1993 and the reinstatement of $1.5
million in state net operating losses ("NOL"s) by the Pennsylvania legislature,
which had previously suspended their use.

11
<PAGE> 5
LIQUIDITY AND CAPITAL RESOURCES
- --------------------------------------------------------------------------------

The Company had working capital of $27.2 million as of December 31, 1996
compared to working capital of $21.2 million as of December 31, 1995. The
increase in working capital can be attributed to operating cash flow (income
from operations before depreciation and amortization) exceeding the
requirements for purchases of property and equipment. Cash provided by
operations was $2.0 million and $0.4 million for 1996 and 1995, respectively.
Increased net income was the primary source of cash provided by operations for
1996 and 1995, offset by increased investments in accounts receivable and
inventories due to increased product sales. Inventories increased 42.3% during
the period due to the investment required to support increased sales of
existing products, introduce new products and to maintain sufficient inventory
stocking levels. As of December 31, 1996, the Company had $16.9 million of cash
and cash equivalents and short-term investments which were available for
acquisitions and other corporate requirements.

Capital expenditures were $2.0 million for 1996 and were primarily
related to test fixtures and development systems, computer and office equipment
for increased staff, as well as leasehold improvements made to the Company's
facilities. Capital expenditures were $1,040,000 and $541,000 for 1995 and
1994, respectively, and were primarily related to office equipment, test
fixtures and development systems, tooling and leasehold improvements. The
Company presently has no material capital expenditure commitments. Planned
capital expenditures for 1997 are anticipated to total approximately $1.2
million. These planned capital projects include test fixtures and development
systems, computer and office equipment and leasehold improvements to the
Company's facilities.

On July 1, 1995 the Company entered into a Credit Agreement with the
U.S. branch of Creditanstalt-Bankverein (the "Bank"), a banking corporation of
the Republic of Austria, replacing an earlier agreement between the Company and
the Bank. Under the Credit Agreement, the Company may borrow up to an amount
equal to 90% of the amount of eligible accounts receivable plus the lesser of
$750,000 and 40% of the amount of eligible inventory, and accrue interest at
.5% above the higher of the Bank's prime rate or the federal funds rate plus
.5%. Loans may not in any event exceed $2.5 million. The Credit Agreement is
collateralized by substantially all of the Company's assets, including accounts
receivable and inventory. The Credit Agreement contains a variety of
restrictive covenants, including prohibitions on the incurrence of additional
indebtedness for borrowed money, dividends and stock repurchases. The Credit
Agreement also requires the Company to be in compliance with certain financial
ratios and other financial requirements. At December 31, 1996, there was $2.5
million available under the Credit Agreement and there were no outstanding
borrowings under the Credit Agreement. The agreement expires on June 30, 1997,
however the Company believes its financial position will enable it to negotiate
any further credit agreements on comparable or more favorable terms.

On July 23, 1996, the Board of Directors of the Company declared a
distribution of one preferred stock purchase right for each outstanding share
of the Company's common stock. The rights will be exercisable only if a person
or group acquires or announces a tender or exchange offer for 20% or more of
the Company's common stock. In such an event, each right will entitle
shareholders to buy one-hundredth of a share of a new series of preferred stock
at an exercise price of $115.00. Each one-hundredth of a share of the new
preferred stock has terms designed to make it the economic and voting
equivalent of one share of common stock.

If after a person or group acquires 20% or more of the outstanding
common stock the Company is acquired in a merger or other business transaction,
each right will entitle its holder to purchase, at the right's exercise price,
a number of the acquiring company's

12
<PAGE> 6
common shares having a market value at that time of twice the exercise price.

The Board of Directors is entitled to redeem the rights for one cent per
right at any time before a 20% position has been acquired. The Board of
Directors is also authorized to reduce the 20% thresholds referred to above to
not less than 10%.

The rights are not being distributed in response to any specific effort
to acquire control of the Company, nor is the Company aware of any such effort.
The distribution of the rights will not affect the Company's reported earnings
and is not taxable to shareholders or to the Company. Shareholders will not
receive any documents evidencing their rights unless and until the rights
become exercisable. Until that time, the rights will not trade separately from
the common stock. The rights will expire on August 15, 2006.

The impact of inflation on both the Company's financial position and the
results of operations has been minimal and is not expected to adversely affect
1997 results. The Company's financial position continues to remain strong,
enabling it to meet cash requirements for operations and capital expansion
programs.

BACKLOG
- -------------------------------------------------------------------------------

The Company's backlog consists of firm customer purchase orders for the
Company's various products. At December 31, 1996 the Company had backlog of
$0.9 million, a $1.2 million decrease from the December 31, 1995 backlog of
$2.1 million. The decrease was due largely to a $1.3 million order relating to
a one-time project for a major customer that was included in the December 31,
1995 backlog and was subsequently shipped in the first quarter of 1996. This
one-time project was a contributing factor to the revenue increase in 1996.

13
<PAGE> 7

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
STATEMENT OF MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING
- --------------------------------------------------------------------------------

The accompanying consolidated financial statements of Tollgrade Communications,
Inc. and Subsidiaries have been prepared by management, who are responsible for
their integrity and objectivity. The statements have been prepared in
conformity with generally accepted accounting principles and include amounts
based on management's best estimates and judgements. Financial information
elsewhere in this Annual Report is consistent with that in the financial
statements.

Management has established and maintains a system of internal control
designed to provide reasonable assurance that assets are safeguarded and that
the financial records reflect the authorized transactions of the Company. The
system of internal control includes widely communicated statements of policies
and business practices that are designed to require all employees to maintain
high ethical standards in the conduct of Company affairs. The internal controls
are augmented by organizational arrangements that provide for appropriate
delegation of authority and division of responsibility.

The financial statements have been audited by Coopers & Lybrand
L.L.P., Independent Public Accountants. As part of their audit of the Company's
1996 financial statements, Coopers & Lybrand L.L.P. considered the Company's
system of internal control to the extent they deemed necessary to determine the
nature, timing and extent of their audit tests. The Independent Public
Accountants' Report follows.

The Board of Directors pursues its responsibility for the Company's
financial reporting through its Audit Committee, which is composed entirely of
outside directors. The Audit Committee has met periodically with the
Independent Public Accountants and management. The Independent Public
Accountants had direct access to the Audit Committee, with and without the
presence of management representatives, to discuss the results of their audit
work and their comments on the adequacy of internal accounting controls and the
quality of financial reporting.

/s/ CHRISTIAN L. ALLISON
--------------------------
Christian L. Allison
Chief Executive Officer

/s/ SAMUEL C. KNOCH
--------------------------
Samuel C. Knoch
Chief Financial Officer

January 29, 1997

14
<PAGE> 8
REPORT OF INDEPENDENT ACCOUNTANTS
- -------------------------------------------------------------------------------

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

We have audited the accompanying consolidated balance sheets of
Tollgrade Communications, Inc. and subsidiaries as of December 31, 1995 and
1996, and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the consolidated financial
position of Tollgrade Communications, Inc. and subsidiaries as of December 31,
1995 and 1996, and the consolidated results of their operations and their cash
flows for each of the three years in the period ended December 31, 1996 in
conformity with generally accepted accounting principles.

/s/ COOPERS & LYBRAND L.L.P.
- -----------------------------
Pittsburgh, Pennsylvania
January 29, 1997

15
<PAGE> 9
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
ASSETS DECEMBER 31, 1995 DECEMBER 31, 1996
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
CURRENT ASSETS:

Cash and cash equivalents $ 15,157,387 $ 4,591,273
Short-term investments -- 12,342,592
Accounts receivable:

Trade 2,571,233 5,153,589
Other 59,887 304,434
Inventories 6,021,466 8,569,818
Prepaid expenses and deposits 151,451 549,753
Deferred tax asset 159,500 171,776
...........................................................................................................................

TOTAL CURRENT ASSETS 24,120,924 31,683,235
Property and equipment, net 1,457,677 2,769,657
Deferred tax asset 80,100 157,169
Patents and other assets 69,402 15,569
...........................................................................................................................

TOTAL ASSETS $ 25,728,103 $ 34,625,630
- ---------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
- ---------------------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES:

Accounts payable $ 1,967,445 $ 1,691,928
Accrued expenses 161,264 1,077,151
Accrued salaries and wages 186,683 769,855
Royalty payable 561,436 741,781
Income taxes payable 84,800 170,889
...........................................................................................................................

TOTAL CURRENT LIABILITIES 2,961,628 4,451,604
Deferred tax liability 157,100 168,455
...........................................................................................................................

TOTAL LIABILITIES 3,118,728 4,620,059
Commitments
Shareholders' equity:
Convertible preferred stock, $1.00 par value; authorized shares,
10,000,000 issued shares, - 0- in 1995 and 1996, respectively -- --
Common stock, $.20 par value; authorized shares, 7,000,000;
issued shares, 5,443,830 in 1995 and 5,620,417 in 1996 1,088,766 1,124,083
Additional paid-in capital 22,339,022 24,091,210
Treasury stock, at cost,- 0- shares in 1995 and 2,200 in 1996 -- (49,775)
Unearned compensation (168,529) (106,686)
Retained earnings (accumulated deficit) (649,884) 4,946,739
...........................................................................................................................

TOTAL SHAREHOLDERS' EQUITY 22,609,375 30,005,571
...........................................................................................................................

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 25,728,103 $ 34,625,630
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>

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

16
<PAGE> 10
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,
1994 1995 1996
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
REVENUES $ 14,722,559 $ 22,309,629 $ 37,489,949
COST OF PRODUCT SALES 8,168,784 11,328,660 18,321,677
..................................................................................................................
GROSS PROFIT 6,553,775 10,980,969 19,168,272
..................................................................................................................
OPERATING EXPENSES:
Selling and marketing 1,902,695 2,953,223 4,767,339
General and administrative 1,268,293 1,471,222 2,551,959
Research and development 1,585,322 2,636,770 3,921,091
..................................................................................................................
Total operating expenses 4,756,310 7,061,215 11,240,389
..................................................................................................................
Income from operations 1,797,465 3,919,754 7,927,883
OTHER INCOME (EXPENSE):
Interest expense (273,183) (58,583) (3,076)
Interest and other income 3,311 78,656 848,569
..................................................................................................................
(269,872) 20,073 845,493
..................................................................................................................
INCOME BEFORE INCOME TAXES 1,527,593 3,939,827 8,773,376
PROVISION (BENEFIT) FOR INCOME TAXES (617,000) 1,418,000 3,176,753
..................................................................................................................
Net income $ 2,144,593 $ 2,521,827 $ 5,596,623
- ------------------------------------------------------------------------------------------------------------------

EARNINGS PER SHARE INFORMATION:
Weighted average shares of common stock
and equivalents 4,257,299 4,561,640 6,004,353
..................................................................................................................
Fully diluted net income per common and
common equivalent shares $ .31 $ .55 $ .93
- ------------------------------------------------------------------------------------------------------------------
COMPONENTS OF INCOME APPLICABLE TO COMMON STOCK:
Net income $ 2,144,593 $ 2,521,827 $ 5,596,623
Accretion of fair market value of
redeemable warrants (833,715) -- --
..................................................................................................................
Net income applicable to common stock $ 1,310,878 $ 2,521,827 $ 5,596,623
- ------------------------------------------------------------------------------------------------------------------
</TABLE>

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

17
<PAGE> 11
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
ADDITIONAL
PREFERRED STOCK COMMON STOCK PAID-IN SUBSCRIPTIONS
SHARES AMOUNT SHARES AMOUNT CAPITAL RECEIVABLE
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993 1,326,659 $ 1,326,659 1,748,009 $ 349,602 $ 2,768,757 $ --

Exercise of common stock options -- -- 326,518 65,303 855,528 (552,264)

Issuance of common stock through
rights offering, net of offering
costs -- -- 140,944 28,189 642,343 (129,566)

Conversion of preferred stock to
common stock (367,938) (367,938) 367,938 73,588 294,350 --

Restricted stock:
Issuance of common stock -- -- 8,403 1,681 40,337 --

Compensation charged to expense,
net -- -- -- -- -- --

Shares forfeited -- -- (385) (77) (1,474) --

Tax benefit from vesting of restricted
stock and exercise of stock options -- -- -- -- 100,000 --

Accretion of fair market value of
redeemable warrants -- -- -- -- (833,715) --

Issuance costs for private placement
offering in 1995 -- -- -- -- (31,740) --

Net income -- -- -- -- -- --
...................................................................................................................................

Balance at December 31, 1994 958,721 958,721 2,591,427 518,286 3,834,386 (681,830)

Receipt of stock subscriptions -- -- -- -- -- 681,830

Issuance of common stock through
private placement offering,
net of offering costs -- -- 463,337 92,667 2,054,255 --

Conversion of preferred stock
to common stock (958,721) (958,721) 958,721 191,744 766,977 --

Restricted stock:

Issuance of common stock -- -- 18,960 3,792 185,803 --

Compensation charged to expense,
net -- -- -- -- -- --

Tax benefit from vesting of
restricted stock -- -- -- -- 29,200 --

Cancellation of treasury stock -- -- (74,200) (14,840) (13,360) --

Issuance of common stock
through initial public offering,
net of offering costs -- -- 1,485,585 297,117 15,481,761 --

Net income -- $ -- -- -- -- --
...................................................................................................................................

Balance at December 31, 1995 -- -- 5,443,830 1,088,766 22,339,022 --

ISSUANCE COSTS FOR INITIAL
PUBLIC OFFERING IN 1995 -- -- -- -- (55,889) --

EXERCISE OF COMMON STOCK OPTIONS -- -- 179,027 35,805 439,005 --

RESTRICTED STOCK - COMPENSATION
CHARGED TO EXPENSE, NET -- -- -- -- -- --

SHARES FORFEITED -- -- (2,440) (488) (8,999) --

TAX BENEFIT FROM EXERCISE OF
STOCK OPTIONS -- -- -- -- 1,378,071 --

NET INCOME -- -- -- -- -- --
...................................................................................................................................

BALANCE AT DECEMBER 31, 1996 -- $ -- 5,620,417 $ 1,124,083 $24,091,210 --
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
- ---------------------------------------------------------------------------------------------------------
RETAINED
EARNINGS
TREASURY UNEARNED (ACCUMULATED
STOCK COMPENSATION DEFICIT) TOTAL
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1993 $(28,200) $ (11,456) $(5,316,304) $ (910,942)
Exercise of common stock options -- -- -- 368,567
Issuance of common stock through
rights offering, net of offering
costs -- -- -- 540,966
Conversion of preferred stock to
common stock -- -- -- --
Restricted stock:
Issuance of common stock -- (42,018) -- --
Compensation charged to expense,
net -- 9,050 -- 9,050
Shares forfeited -- 1,551 -- --
Tax benefit from vesting of restricted
stock and exercise of stock options -- -- -- 100,000
Accretion of fair market value of
redeemable warrants -- -- -- (833,715)
Issuance costs for private placement
offering in 1995 -- -- -- (31,740)
Net income -- -- 2,144,593 2,144,593
.........................................................................................................

Balance at December 31, 1994 (28,200) (42,873) (3,171,711) 1,386,779

Receipt of stock subscriptions -- -- -- 681,830
Issuance of common stock through
private placement offering,
net of offering costs -- -- -- 2,146,922
Conversion of preferred stock
to common stock -- -- -- --
Restricted stock:
Issuance of common stock -- (189,595) -- --
Compensation charged to expense,
net -- 63,939 -- 63,939
Tax benefit from vesting of
restricted stock -- -- -- 29,200
Cancellation of treasury stock 28,200 -- -- --
Issuance of common stock
through initial public offering,
net of offering costs -- -- -- 15,778,878
Net income -- -- 2,521,827 2,521,827

.........................................................................................................

Balance at December 31, 1995 -- (168,529) (649,884) 22,609,375

ISSUANCE COSTS FOR INITIAL
PUBLIC OFFERING IN 1995 -- -- -- (55,889)
EXERCISE OF COMMON STOCK OPTIONS (49,775) -- -- 425,035
RESTRICTED STOCK - COMPENSATION

CHARGED TO EXPENSE, NET -- 52,356 -- 52,356
SHARES FORFEITED -- 9,487 -- --
TAX BENEFIT FROM EXERCISE OF
STOCK OPTIONS -- -- -- 1,378,071
NET INCOME -- -- 5,596,623 5,596,623
.........................................................................................................

BALANCE AT DECEMBER 31, 1996 $(49,775) $(106,686) $ 4,946,739 $30,005,571
- ---------------------------------------------------------------------------------------------------------
</TABLE>

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

18
<PAGE> 12
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
1994 1995 1996
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,144,593 $ 2,521,827 $ 5,596,623
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 187,438 342,310 688,323
Deferred income taxes (712,000) 692,000 (77,990)
Provision for losses on inventory 107,530 60,000 95,000
Compensation expense for restricted stock 9,050 63,939 52,356
Amortization of debt discount for redeemable warrants 13,225 -- --
Loss on sale of property and equipment 5,319 -- --
Changes in assets and liabilities:
Increase in accounts receivable-trade (335,183) (892,290) (2,582,356)
(Increase) decrease in accounts receivable-other (45,451) 29,222 (192,716)
Increase in inventories (1,233,457) (3,250,474) (2,643,352)
Increase in prepaid expenses and deposits (11,098) (109,982) (398,302)
(Decrease) increase in accounts payable 169,720 457,809 (275,517)
Increase in accrued expenses and royalty payable 225,917 389,048 1,679,404
Increase in income taxes payable 16,998 66,194 86,089
.............................................................................................................................
Net cash provided by operating activities 542,601 369,603 2,027,562
- -----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of short-term investments (74,219) -- (20,690,542)
Redemption/maturity of short-term investments -- 74,219 8,347,950
Capital expenditures (540,605) (1,040,062) (1,993,541)
Patent expenditures (13,052) (3,405) (4,760)
Other (51,831) -- --
.............................................................................................................................
Net cash used in investing activities (679,707) (969,248) (14,340,893)
- -----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) under line of credit 275,000 (865,719) --
Payments on long-term debt (200,000) (1,800,000) --
Payment of convertible subordinated debentures (40,000) -- --
Purchase of stock warrants -- (1,253,708) --
Proceeds from issuance of common stock, net of issuance costs 788,205 2,146,922 --
Proceeds from the exercise of stock options including
related tax benefits -- -- 1,803,106
Proceeds from initial public offering, net of issuance costs -- 16,107,694 (55,889)
Receipt of stock subscriptions -- 681,830 --
.............................................................................................................................
Net cash provided by financing activities 823,205 15,017,019 1,747,217
.............................................................................................................................
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 686,099 14,417,374 (10,566,114)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 53,914 740,013 15,157,387
.............................................................................................................................
Cash and cash equivalents at end of year $ 740,013 $15,157,387 $ 4,591,273
- -----------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 249,703 $ 79,101 $ 3,076
Cash paid during the year for income taxes 61,748 658,765 2,013,981
Noncash financing and operating activities:
Issuance of restricted common stock at no cost 42,018 189,595 --
Tax benefit from vesting of restricted stock 100,000 29,200 --
Conversion of preferred stock to common stock 367,938 951,721 --
Conversion of preferred stock to common stock in
treasury -- 7,000 --
Subscriptions receivable for issuance of
common stock 681,830 -- --
Issuance costs for initial public offering in
accounts payable -- 328,816 --
Conversion of officer compensation, net of taxes to
common stock 89,588 -- --
Accretion in value of redeemable warrants 833,715 -- --
</TABLE>

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

19
<PAGE> 13
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

ORGANIZATION AND BASIS OF PRESENTATION:

Tollgrade Communications, Inc. (the "Company") designs, engineers, markets and
supports its proprietary electronic equipment for use by telephone companies to
use their existing line test systems to remotely diagnose problems in Plain Old
Telephone Service ("POTS") lines containing both copper and fiber optics. The
Company was organized in 1986 and began operations in 1988.

USE OF ESTIMATES:

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of income and expense during the reporting period. Actual
results could differ from those estimates.

PRINCIPLES OF CONSOLIDATION:

The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany
transactions have been eliminated.

CASH AND CASH EQUIVALENTS:

The Company considers highly liquid investments with a maturity of three months
or less when purchased to be cash equivalents. Substantially all of the
Company's cash and cash equivalents is maintained at one financial institution.
No collateral or security is provided on these deposits, other than $100,000 of
deposits per financial institution insured by the Federal Deposit Insurance
Corporation.

SHORT-TERM INVESTMENTS:

The short-term investments at December 31, 1996 consisted of individual
municipal bonds stated at cost, which approximated market value. The municipal
bonds have a maturity of one year or less at date of purchase and/or contain a
callable provision in which the bonds can be called within one year from date
of purchase. The primary investment purpose is to provide a reserve for future
business purposes, including possible acquisitions, capital expenditures and to
meet working capital requirements. In May 1993, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards (SFAS) No.
115, "Accounting for Certain Investments in Debt and Equity Securities." The
Company adopted the new accounting and disclosure rules for this standard in
the first quarter of 1996. The Company classifies its investment in debt
securities as "held-to-maturity."

INVENTORIES:

Inventories are stated at the lower of cost or market, with cost determined on
the first-in, first-out method. The Company provides appropriate reserves for
any inventory deemed slow moving or obsolete.

PROPERTY AND EQUIPMENT:

Property and equipment is stated at cost. Property and equipment is depreciated
on a straight-line method over their estimated useful lives ranging from 3 to 7
years. Leasehold improvements are amortized over the related lease period or
the estimated useful life, whichever is shorter.

The cost of renewals and betterments that extend the lives or productive
capacities of properties is capitalized. Expenditures for normal repairs and
maintenance are charged to operations as incurred. The cost of property and
equipment retired or otherwise disposed of and the related accumulated
depreciation or amortization are removed from the accounts and any resulting
gain or loss is reflected in current operations.

20
<PAGE> 14
PATENTS:

The costs of patents and patent applications are being amortized on a
straight-line method over a period of five years.

PRODUCT WARRANTY:

The Company records estimated warranty costs on the accrual basis of
accounting. These reserves are based on applying historical returns and cost
experience to the current level of product shipments.

REVENUE RECOGNITION:

Revenue from product sales is recognized at the time of shipment. Revenue for
license and royalty fees is recognized when earned.

RESEARCH AND DEVELOPMENT COSTS:

Research and development costs are charged to operations in the year incurred.

INCOME TAXES:

The Company follows the provisions of Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" (SFAS 109). Under SFAS 109,
deferred tax liabilities and assets are determined based on the "temporary
differences" between the financial statement carrying amounts and the tax basis
of assets and liabilities using enacted tax rates in effect in the years in
which the differences are expected to reverse. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized.

RECLASSIFICATIONS:

Certain reclassifications have been made to the Company's 1995 and 1994
financial statements to agree with current year classifications.

PER SHARE INFORMATION:

Net income per share is computed using the weighted average number of common
shares and common share equivalents outstanding during the periods presented.
Common share equivalents result from outstanding options and warrants to
purchase common stock and convertible preferred stock. Pursuant to the
requirements of the Securities and Exchange Commission, common, restricted and
convertible preferred shares issued by the Company during the twelve months
immediately preceding the initial public offering (See Note 2) plus the number
of shares issuable upon exercise of stock options and warrants granted during
this period, have been included in the calculation of the shares used in
computing net income per share as if they were outstanding for all periods
presented (using the treasury stock method and the public offering price in
calculating equivalent shares).

2. INITIAL PUBLIC OFFERING:

On December 14, 1995, the Company completed an initial public offering of
common stock, receiving net proceeds (after deduction of underwriting discounts
and other offering costs of $2,048,142) of $15,778,878 from the sale of
1,485,585 shares of common stock at the initial public offering price of $12
per share. The Company expects to use the net proceeds to provide working
capital for general corporate purposes, including the introduction and
development of new products.

3. STOCK SPLIT:

On October 16, 1995, the Board of Directors approved a seven-for-ten reverse
split of its common stock which was ratified on November 12, 1995 by the
shareholders. All references in the accompanying consolidated financial
statements to the number of shares of common stock and convertible preferred
stock have been retroactively restated to reflect a seven-for-ten reverse stock
split.

21
<PAGE> 15
4. INVENTORIES:

Inventories consisted of the following:

<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1996
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Raw materials $ 2,577,638 $ 3,816,242
Work in process 1,730,364 3,808,842
Finished goods 1,713,464 944,734
............................................................................................................

$ 6,021,466 $ 8,569,818
- ------------------------------------------------------------------------------------------------------------
</TABLE>

5. PROPERTY AND EQUIPMENT:

Property and equipment consisted of the following:

<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1996
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Test equipment and tooling $ 1,023,052 $ 1,715,227
Office equipment and fixtures 786,287 1,672,929
Leasehold improvements 439,913 854,637
............................................................................................................

2,249,252 4,242,793
Less accumulated depreciation and amortization 791,575 1,473,136
............................................................................................................

$ 1,457,677 $ 2,769,657
- ------------------------------------------------------------------------------------------------------------
</TABLE>

In March 1995, the Financial Accounting Standards Board issued SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of." This statement requires review and measurement methods to
calculate impairment of long-lived assets whenever events or circumstances
indicate that the carrying amount of an asset may not be recoverable. The
Company has adopted this standard in 1996 and the new standard did not impact
the financial position and results of operations of the Company.

6. DEBT:

FINANCING AGREEMENT:

During 1994, the Company maintained a financing agreement with the U.S. branch
of Creditanstalt-Bankverein, a banking corporation of the Republic of Austria.
At December 31, 1994, the financing agreement, as amended on July 8, 1994,
provided for a revolving line of credit up to $1,000,000 and for a $2,000,000
term loan. Balances outstanding as of December 31, 1994 were $865,719 under the
line of credit and $2,000,000 under the term loan.

The line of credit was due upon demand with interest payable at the bank's
prime rate (8.5% at December 31, 1994) plus 1%. The line of credit had a
weighted average interest rate during 1994 of 8.6%. Borrowings under the line
were limited to 90% of eligible accounts receivable. The agreement contained a
commitment fee of 1/2 of 1% per annum on the average unused borrowing capacity.
During April 1995, the Company repaid the entire balance outstanding of
$865,719 on the line of credit.

The $2,000,000 term loan was payable in semi-annual installments of $200,000 on
November 30 and May 31 of each year with a balloon payment of $1,000,000 due
May 31, 1997. Interest was payable monthly at the bank's prime rate (8.5% at
December 31, 1994) plus 2%. The term loan had a weighted average interest rate
during 1994 of 9.2%. Required principal payments under the term loan were
$400,000 in both 1995 and 1996 and $1,000,000 in 1997. On February 9, 1995, the
Company used the proceeds from a private placement and rights offerings to
repay the balance outstanding on the term loan of $1,800,000 (refer to Note 7).

22
<PAGE> 16

On July 1, 1995, the Company entered into a new credit agreement with the U.S.
Branch of Creditanstalt-Bankverein providing for maximum borrowing of
$2,500,000 under a revolving line of credit. This agreement expires on June 30,
1997. Borrowings under the line are limited to 90% of eligible accounts
receivable plus the lesser of $750,000 and 40% of eligible inventory and accrue
interest at .5% above the higher of the bank's prime rate or the federal funds
rate plus .5%. The financing agreement is collateralized by substantially all
of the Company's assets, including accounts receivable and inventory, and
contains certain financial covenants including the prohibition on the
incurrence of additional indebtedness for borrowed money and the payment of
dividends. At December 31, 1996, there were no outstanding borrowings under the
credit agreement.

7. SHAREHOLDERS' EQUITY:

CONVERTIBLE PREFERRED STOCK:

The non-voting convertible preferred stock, issued prior to 1994, was
redeemable at the option of the Company, at a price equal to the issuance
price, plus 13% of the issuance price for each year the shares are outstanding,
limited to 165% of the issuance price. The preferred stock had a liquidation
value equal to the issuance price reduced by the amount of preferred stock
dividends paid. In addition, the preferred stock was convertible into shares of
common stock at any time, on a one-for-one basis.

In 1994, 367,938 shares of preferred stock were converted to common stock.
During 1995, the remaining shares of preferred stock were converted into
958,721 shares of common stock.

COMMON STOCK:

The Company has 7,000,000 authorized shares which have a par value of $ .20 per
share. As of December 31, 1995 and 1996, there are 5,443,830 and 5,620,417
issued shares, respectively.

RIGHTS OFFERING:

On September 19, 1994, the Company offered for sale to every common or
preferred shareholder non-transferable rights to subscribe to one share of
common stock at a purchase price of $5 per share for every four shares of
common or preferred stock held on that date. During September 1994, the Company
sold 140,944 shares of common stock under the rights offering for an aggregate
price of $704,720. As of December 31, 1994, the rights offering was closed.
Subscriptions receivable related to this offering totaled $129,566 at December
31, 1994, which were collected in 1995. The proceeds from the offering were
reduced by $34,188 for costs incurred in connection with the offering.

PRIVATE PLACEMENT OFFERING:

During January and February 1995, the Company sold 463,337 shares of common
stock at an issue price of $5 per share in a private placement offering for an
aggregate price of $2,316,685. These proceeds were reduced by $201,503 for
costs incurred in connection with the offering, of which $31,740 was incurred
in 1994.

RESTRICTED STOCK:

In May 1989, the Company adopted the Tollgrade Communications, Inc. Restricted
Stock Employee Incentive Plan (the "Plan"), which provides for the granting of
restricted common stock to key employees. A maximum of 140,000 shares were
issuable under the Plan. During 1994, 1995 and 1996, 8,403, 18,960 and -0-
shares, respectively, of restricted stock under the Plan were issued.
Additionally, prior to 1994, the Company had granted a total of 184,731 shares
of restricted common stock to certain key employees, of which 14,000 were
granted under the provisions of this Plan.

All shares of restricted stock were issued at no cost. Generally, the
recipients of the restricted stock are required to continue in the employment
of the Company for three to five years after the date of issuance for ownership
to vest. The unearned compensation related to the restricted stock is being
charged to expense over the vesting period using the market value at the
issuance dates, ranging from $.571 to $10.00, as determined by the board of
directors. Compensation expense was $9,050, $63,939 and $52,356 in 1994, 1995
and 1996, respectively. In 1994, 1995 and 1996, 385, -0- and 2,440, shares of
restricted stock, respectively, were forfeited due to the termination of
certain employees.

23
<PAGE> 17

Accordingly, the compensation expense recorded for these shares in prior
periods amounting to $1,551, $-0- and $9,487 was reversed in 1994, 1995
and 1996, respectively. At December 31, 1996, all shares of restricted
common stock granted had vested with the exception of the 18,960 shares
granted under the Plan in 1995, which vest in December 1998.

Stock Compensation Plans:

Under the Company's stock option plans, officers and other employees may be
granted options to purchase shares of the Company's common stock. The option
price on all outstanding options is equal to the fair market value of the stock
at the date of the grant.

The shares authorized but not granted under the Company's stock option plans
were 302,168 at December 31, 1995 and 126,168 at December 31, 1996.

Prior to and during 1995 and 1996, certain employees of the Company were
granted stock awards under the Long-term Incentive Compensation Plan, the
Restricted Stock Employee Incentive Plan and various other agreements. Such
awards consisted of stock options and restricted stock awards. The Company has
adopted the disclosure-only provisions of the Financial Accounting Standards
Board ("SFAS") No. 123 "Accounting for Stock-based Compensation," but applies
Accounting Principles Board Opinion No. 25 and related interpretations in
accounting for its plans. If the Company had elected to recognize compensation
cost for these stock awards based on the fair value at the grant dates for
awards granted under those plans in 1995 and 1996, consistent with the method
prescribed by SFAS No. 123, net income and earnings per share would have been
changed to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995 YEAR ENDED DECEMBER 31, 1996
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income As reported $ 2,521,827 $ 5,596,623
Pro forma $ 2,497,780 $ 5,266,133
.........................................................................................................................
Fully diluted earnings per share As reported $ .55 $ .93
Pro forma $ .55 $ .88
</TABLE>

The fair value of the stock options used to compute pro forma net income and
earnings per share disclosures is the estimated present value at grant date
using the Black-Scholes option-pricing model with the following weighted
average assumptions for 1995 and 1996: expected volatility of 46.5%; a risk
free interest rate of 5.44% in 1995 and 5.64% in 1996; and an expected holding
period of 4 years. The weighted average fair value of stock options, calculated
using the Black-Scholes option-pricing model, granted during the year ended
1995 and 1996 is $5.40 and $10.71, respectively.

Transactions involving stock options are summarized below:

<TABLE>
<CAPTION>
NUMBER OF SHARES RANGE OF OPTION PRICE WEIGHTED AVERAGE EXERCISE PRICE
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Outstanding, December 31, 1993 625,628 $ .957 - $4.29 $ 3.06
Granted 271,600 .957 - 5.50 2.20
Exercised (326,518) .957 - 4.29 2.82
Cancelled (89,110) 4.29 4.29

- ---------------------------------------------------------------------------------------------------------------------------
Outstanding, December 31, 1994 481,600 .957 - 5.50 2.52
Granted 333,982 12.00 - 15.00 12.65
Exercised -- -- --
Cancelled (105,000) 4.41 4.41

- ---------------------------------------------------------------------------------------------------------------------------
Outstanding, December 31, 1995 710,582 .957 - 15.00 7.00
Granted 201,500 21.75 - 25.75 25.33
Exercised (179,027) 1.43 - 15.00 2.67
Cancelled (3,000) 12.00 12.00

- ---------------------------------------------------------------------------------------------------------------------------
OUTSTANDING, DECEMBER 31, 1996 730,055 $.957 - $25.75 $ 13.10
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>

24
<PAGE> 18

Options exercisable at:

<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
NUMBER OF SHARES WEIGHTED AVERAGE EXERCISE PRICE
<S> <C> <C>
December 31, 1994 481,600 $ 2.52
December 31, 1995 578,694 5.61
December 31, 1996 542,369 10.33
</TABLE>

The following table summarizes the status of the stock options, outstanding and
exercisable at December 31, 1996:

<TABLE>
<CAPTION>
STOCK OPTIONS OUTSTANDING STOCK OPTIONS EXERCISABLE
- -----------------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE
RANGE OF EXERCISE REMAINING WEIGHTED AVERAGE WEIGHTED AVERAGE
PRICES SHARES CONTRACTUAL LIFE EXERCISE PRICE SHARES EXERCISE PRICE
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$.975 105,000 2 years $ .957 105,000 $ .957
.............................................................................................................................
$2.14 to $5.50 97,300 2.1 years $ 2.38 97,300 $ 2.38
.............................................................................................................................
$12.00 to $15.00 326,255 9 years $ 12.65 262,941 $ 12.54
.............................................................................................................................
$21.75 to $25.75 201,500 9.9 years $ 25.33 77,128 $ 25.58
.............................................................................................................................
Total 730,055 $ 13.10 542,369 $ 10.33
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>

REDEEMABLE WARRANTS:

In association with the bank financing agreement (refer to Note 6), the Company
issued to the bank over a four year period, at no cost, warrants to purchase
shares of common stock in the amount of 438,798 shares. The warrants were
exercisable by the bank up to six years from the termination date of the
financing agreement. The $250,738 value assigned to the warrants was recorded
as a discount on the related debt. For the year ended December 31, 1994,
$13,225 of the discount was amortized and recorded as interest expense.

The warrants contained an anti-dilutive provision if additional shares of stock
(other than through a stock split) were issued for a consideration per share
less than market value. In addition, the warrants granted the bank, at its sole
option, the right to require the Company to repurchase all or any portion of
the warrants on or after April 30, 1994. The repurchase price was the fair
market value of the common stock purchasable with the warrants, as defined in
the financing agreement.

On July 8, 1994, the Company entered into an agreement with the bank under
which the repurchase provisions of the warrants were eliminated and a stock
redemption agreement was established. Under the stock redemption agreement, the
consideration to be paid per share would be the market value of the shares on
the day of the offer.

In December 1994, the bank offered to sell all of its warrants to the Company
at $2.86 per warrant through February 15, 1995. On February 9, 1995, the
Company repurchased all of the warrants from the bank at the price of $2.86 per
warrant for an aggregate purchase price of $1,253,708. As a result of such
repurchase, the stock redemption agreement was terminated.

SERIES A JUNIOR PARTICIPATING PREFERRED STOCK PURCHASE RIGHTS:

In order to protect shareholder value in the event of an unsolicited offer to
acquire the Company, on July 23, 1996, the Board of Directors of the Company
declared a dividend of one preferred stock purchase right for each outstanding
share of the Company's common stock. The dividend was payable on August 15,
1996 to shareholders of record as of that date. The aforementioned rights are
exercisable only if a person or group acquires or announces an offer to acquire
20% or more of the Company's common stock. In such an event, each right will
entitle shareholders to buy one-hundredth of a share of a new series of
preferred stock at an exercise price of $115.00. Each one-hundredth of a share
of the new preferred stock has terms designed to make it the economic and
voting equivalent of one share of common stock.

25
<PAGE> 19

If a person or group acquires 20% or more of the Company's outstanding common
stock, each right not owned by the person or group will entitle its holder to
purchase at the right's exercise price a number of shares of the Company's
common stock (or, at the option of the Company, the new preferred stock) having
a market value of twice the exercise price. Further, at any time after a person
or group acquires 20% or more (but less than 50%) of the outstanding common
stock, the Board of Directors may at its option, exchange part or all of the
rights (other than rights held by the acquiring person or group) for shares of
the Company's common or preferred stock for a one-for-one basis. Each right
further provides that if the Company is acquired in a merger or other business
transaction, each right will entitle its holder to purchase, at the right's
exercise price, a number of the acquiring company's common shares having a
market value at that time of twice the exercise price.

The Board of Directors is entitled to redeem the rights for one cent per right
at any time before a 20% position has been acquired. The Board of Directors is
also authorized to reduce the 20% thresholds referred to above to not less than
10%.

8. LICENSE AND ROYALTY FEES:

The Company has entered into several technology license agreements with certain
major Digital Loop Carrier ("DLC") vendors under which the Company has been
granted access to the licensor's patent technology and the right to manufacture
and sell the patent technology in the Company's product line. The Company is
obligated to pay royalty fees, as defined, through the terms of these license
agreements. Royalty fees of $254,300, $1,075,800 and $1,779,700 were paid in
1994, 1995 and 1996, respectively, and are included in cost of product sales in
the accompanying consolidated statements of operations.

9. INCOME TAXES:

The provision (benefit) for income taxes consisted of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
1994 1995 1996
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $ 45,000 $ 641,400 $ 2,938,491
State 50,000 84,600 316,252
...........................................................................................................................
95,000 726,000 3,254,743
- ---------------------------------------------------------------------------------------------------------------------------
Deferred:

Federal 514,000 640,000 (111,056)
State (166,000) 52,000 33,066
Valuation allowance reversal (1,060,000) -- --
...........................................................................................................................
(712,000) 692,000 (77,990)
...........................................................................................................................
$ (617,000) $ 1,418,000 $ 3,176,753
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>

Reconciliations of the federal statutory to the effective tax rates are as
follows:

<TABLE>
<CAPTION>
DECEMBER 31,
1994 1995 1996
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal statutory tax rate 34% 34% 34%
Research and development tax credit -- (3) (1)
Reversal of valuation allowance (69) -- --
State income taxes 2 5 2
Reinstatement of state NOLs (7) -- --
Other -- -- 1
.......................................................................................................................
Effective tax rate (40)% 36% 36%
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>

26
<PAGE> 20

The components of net deferred tax assets and liabilities were as follows:

<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1996
<S> <C> <C>
State net operating loss carryforwards $ 108,700 $ 58,750
Other, net (26,200) 101,740
...........................................................................................................................
Total net deferred tax assets $ 82,500 $ 160,490
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>

The Company had a state tax operating loss carryforward at December 31, 1996 of
approximately $500,000 which will expire in 1997. The valuation allowance of
$1,060,000 established against the net deferred tax assets at December 31, 1993
was reversed in the fourth quarter of 1994 because management determined that
it is more likely than not that all of the deferred tax asset will be realized.

10. LEASE COMMITMENTS:

The Company leases office space and equipment under agreements which are
accounted for as operating leases. The office lease expires December 31, 1998
and may be extended up to an additional 12 years. The equipment lease expires
in September 2000. The Company is also involved in various month-to-month
leases for research and development equipment. In addition, the office lease
includes provisions for possible adjustments in annual future rental
commitments relating to excess taxes and excess maintenance costs that may
occur. The Company made additional rental payments of $1,619 in 1996 and no
additional rental payments in 1994 and 1995.

<TABLE>
<S> <C>
Minimum annual future rental commitments under noncancellable leases
as of December 31 are:
1997 . . . . . . . . . . . . . . . . . . . . . . . . . . $332,900
1998 . . . . . . . . . . . . . . . . . . . . . . . . . . 332,900
1999 . . . . . . . . . . . . . . . . . . . . . . . . . . 15,300
2000 . . . . . . . . . . . . . . . . . . . . . . . . . . 13,500
2001 . . . . . . . . . . . . . . . . . . . . . . . . . . 0
The rent expense for all lease commitments was approximately $107,000,
$273,000 and $335,000 in 1994, 1995, and 1996, respectively.
</TABLE>

11. MAJOR CUSTOMERS, REVENUE CONCENTRATION AND DEPENDENCE ON CERTAIN
SUPPLIERS:

The Company sells precision electronic equipment to companies in the
telecommunications industry primarily in the United States. Sales are
concentrated primarily with the seven Regional Bell Operating Companies (RBOCs)
as well as major independent telephone companies such as GTE Corporation and
Sprint. Sales are primarily from the Company's MCU product line. The MCU
product line accounted for more than 93% of the Company's net product sales for
fiscal year 1996. The Company expects that revenues from MCU products will
continue to account for a majority of the Company's revenues for the
foreseeable future. Sales to the RBOCs accounted for approximately 96%, 95%
and 86% of the Company's net product sales for fiscal years 1994, 1995 and
1996, respectively. During fiscal years 1994, 1995 and 1996, sales to four
RBOCs comprised 78%, 72% and 73%, respectively, of the Company's net product
sales. At December 31, 1995 and 1996, accounts receivable-trade included in the
consolidated balance sheets related to these four RBOCs was approximately
$1,363,000 and $3,253,000, respectively. Due to the Company's present
dependency on the RBOCs, the loss of one or more of the RBOCs as a customer, or
the reduction of orders for the Company's products by the RBOCs, could
materially and adversely affect the Company.

The Company currently purchases all of its application specific integrated
circuits, an important component of its products, from one supplier as well as
utilizes one key subcontractor to perform a majority of its subassembly work.
In addition, proprietary design integrated circuits, which are a key component
of certain products, are the design and property of the manufacturer from which
they are purchased. The license agreements under which the proprietary design
integrated circuits are supplied can be terminated on relatively short notice.
The loss of such license agreements, a reduction in the supply of the
application specific integrated circuits or a reduction in the capacity for any
reason of the Company's key subassembly contractor could cause a delay in
manufacturing and a possible loss of sales, which would affect operating
results adversely.

27
<PAGE> 21
12. EMPLOYEE BENEFIT PLANS: The Company has adopted a 401(k)
benefit plan effective March 1, 1996. Eligible employees, as defined in the
plan, may contribute up to 20% of eligible compensation, as defined. The
Company does not make any matching contributions to the plan.

28
<PAGE> 22
- ------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS DATA BY QUARTER:
- ------------------------------------------------------------------------------

The following table presents unaudited quarterly operating results for each of
the Company's last eight fiscal quarters. This information has been prepared by
the Company on a basis consistent with the Company's audited financial
statements and includes all adjustments (consisting only of normal recurring
adjustments) that the Company considers necessary for a fair presentation of
the data. Such quarterly results are not necessarily indicative of the future
results of operations.

<TABLE>
<CAPTION>
(In thousands, except per share data)

QUARTER ENDED
(UNAUDITED)

MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1995 1995 1995 1995 1996 1996 1996 1996
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues $ 5,796 $ 5,542 $ 5,307 $ 5,665 $ 6,849 $ 10,182 $ 10,080 $ 10,379
Cost of product sales 3,112 2,711 2,743 2,763 3,463 4,971 5,000 4,888
...............................................................................................................................
Gross profit 2,684 2,831 2,564 2,902 3,386 5,211 5,080 5,491

Operating expenses:
Selling and marketing 621 711 782 839 892 1,259 1,234 1,382
General and administrative 330 381 351 409 480 596 672 804
Research and development 524 604 686 823 713 878 1,044 1,286
...............................................................................................................................
Total operating expenses 1,475 1,696 1,819 2,071 2,085 2,733 2,950 3,472
...............................................................................................................................
Income from operations 1,209 1,135 745 831 1,301 2,478 2,130 2,019
Other income (expense) (37) 19 12 26 204 184 90 367
...............................................................................................................................
Income before income taxes 1,172 1,154 757 857 1,505 2,662 2,220 2,386
Provision for income taxes 422 415 273 308 548 1,050 824 754
...............................................................................................................................
Net income $ 750 $ 739 $ 484 $ 549 $ 957 $ 1,612 $ 1,396 $ 1,632
- -------------------------------------------------------------------------------------------------------------------------------
Net income per common and
common equivalent shares $ .17 $ .16 $ .11 $ .12 $ .16 $ .27 $ .23 $ .27
- -------------------------------------------------------------------------------------------------------------------------------
Weighted average shares of common stock
and equivalents 4,541 4,548 4,469 4,561 5,858 5,942 5,943 6,015
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>

- ------------------------------------------------------------------------------
COMMON STOCK MARKET PRICES
- ------------------------------------------------------------------------------

The Company's Common Stock has been included for quotation on the Nasdaq
National Market System under the Nasdaq symbol "TLGD" since the Company's
initial public offering in December 1995. The following table sets forth, for
the periods indicated, the high and low closing sale prices for the Common
Stock on such market:

<TABLE>
<CAPTION>
HIGH LOW
- --------------------------------------------------------------------
<S> <C> <C>
1995:
Fourth Quarter (since December 14, 1995) $15-1/4 $14-1/4
....................................................................
1996:
FIRST QUARTER $18-1/4 $14-1/2
SECOND QUARTER 27 17-7/8
THIRD QUARTER 24-1/2 20-3/4
FOURTH QUARTER 31 22-1/2
</TABLE>

At March 7, 1997, the Company had 475 holders of record of its Common Stock and
5,662,896 shares outstanding.

The Company has never paid any dividends on its common stock and does not
expect to pay cash dividends in the foreseeable future. In addition, the
Company is prohibited from paying dividends under the terms of a credit
agreement with Creditanstalt Corporate Finance.

(See Note 6 in the accompanying consolidated financial statements).

<PAGE> 1

Exhibit 23.1

CONSENT OF INDEPENDENT ACCOUNTANTS

We consent to the incorporation by reference in the registration statement of
Tollgrade Communications, Inc. and Subsidiaries on Form S-8 (Registration No.
333- 4290) of our report dated January 29, 1997, on our audits of the
consolidated financial statements and financial statement schedule of Tollgrade
Communications Inc. and Subsidiaries as of December 31, 1996 and 1995, and for
each of the three years in the period ended December 31, 1996, which report is
incorporated by reference or included in this Form 10-K.

/s/ COOPERS & LYBRAND L.L.P.

Pittsburgh, Pennsylvania
March 19, 1997

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-K
FOR THE PERIOD ENDED DECEMBER 31, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0001002531
<NAME> TOLLGRADE COMMUNICATIONS, INC.

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 4,591,273
<SECURITIES> 12,342,592
<RECEIVABLES> 5,458,023
<ALLOWANCES> 0
<INVENTORY> 8,569,818
<CURRENT-ASSETS> 31,683,235
<PP&E> 4,242,793
<DEPRECIATION> 1,473,136
<TOTAL-ASSETS> 34,625,630
<CURRENT-LIABILITIES> 4,451,604
<BONDS> 0
0
0
<COMMON> 1,124,083
<OTHER-SE> 28,881,488
<TOTAL-LIABILITY-AND-EQUITY> 34,625,630
<SALES> 37,489,949
<TOTAL-REVENUES> 37,489,949
<CGS> 18,321,677
<TOTAL-COSTS> 18,321,677
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 8,773,376
<INCOME-TAX> 3,176,753
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,596,623
<EPS-PRIMARY> .94
<EPS-DILUTED> .93

</TABLE>