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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, 1997
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: 724-274-2156
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
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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 13, 1998, the aggregate market value
of shares of the Registrant's Common Stock held by non-affiliates (excluding for
purposes of this calculation only, 751,355 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 $107,473,112.
As of March 13, 1998, the Registrant had outstanding 5,853,936 of its Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of Form 10-K into which
Document Document is incorporated
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Portions of the Annual Report to Shareholders
for the year ended December 31, 1997 II and IV
Portions of the Proxy Statement to be distributed
in connection with the 1998 Annual
Meeting of Shareholders III
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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 1997 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 (724) 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(R)") 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 proprietary design integrated circuits
("PDICs"). The PDICs are the design and property of the DLC system manufacturer
from which they are purchased. The Company maintains license agreements with and
pays royalties to
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Lucent Technologies, Fujitsu Network Transmission Systems, Inc., NEC American,
Inc. and Reliance Comm/Tec Corporation. In general, the current terms for
expiration of these agreements range at various times between August 1998 and an
indefinite duration, with renewal provisions (unless earlier terminated) for
periods of between one and five years. In addition, certain of these agreements
can be terminated prior to renewal. The Company incurred $1,075,800, $1,893,000
and $2,014,000, respectively in 1995, 1996 and 1997 as royalties under the
license agreements, which royalties are calculated either based on a percentage
of the list price of MCU products or a fixed amount per unit 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.
In addition, the Company maintains license agreements which do not contain
royalty provisions with Advanced Fibre Communications, DSC Technologies
Corporation, Northern Telecom Inc., UTSTARCOM, Inc., and most recently entered
into license agreements with Next Level Communications and SAT Division Reseaux
et Telecommunications (a French Corporation) for which products are still in the
early phase of development. The expiration dates of these agreements range at
various times between July 1998 and November 2004, with renewal provisions
(unless earlier terminated) for periods of one or more years. Future license
agreements entered into by the Company may contain terms comparable to, or
materially different than, the terms of existing agreements as competitive and
other conditions warrant. The loss of PDICs license agreements or the inability
of the Company to maintain an adequate supply of PDICs could have a material
adverse effect on the Company's business. Other MCU technology is also used with
home and business alarm systems. As with home service line testing, home alarm
systems must be monitored from the alarm company's headquarters along a hybrid
copper and fiber-optic line. The Company's alarm-related MCU products are used
to facilitate the transport of analog alarm signals from subscriber homes to
alarm company monitoring stations across the hybrid telephone network. These
units plug into equipment at both central office and remote locations. MCU
products accounted for more than 93%, 93% and 94% of the Company's sales in
1995, 1996 and 1997, respectively. In addition, the Company has recently entered
into a license agreement with C-Cor Electronics, Inc. (a cable television
systems developer) in which the Company will develop and subsequently provide
its status monitoring transponder technology that will be incorporated into
C-Cor's cable network management system.
Product and Technology Development. The Company's product
development personnel are organized into teams, each of which is effectively
dedicated to a specific product line(s) or technology. Each product team also
implements the Company's ongoing "value engineering" programs 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 1995, 1996 and 1997, research and
development expenses were approximately $2,637,000, $3,921,000 and $5,945,000,
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 TollgradeSM" is a service mark of the Company and
"Lighthouse(TM)", "Digitest(TM)" and "Telaccord(TM)" are trademarks for which
registration has been applied. The Company has obtained three patents on the MCU
products with expiration dates ranging from 2010 to the year 2014. In addition,
the Company has five U.S. provisional and two international patent cooperation
treaty ("PCT") patent applications pending. The Company will seek additional
patents from time to time related to its research and development activities.
The Company protects its trademarks, patents, inventions, trade secrets, and
other proprietary rights by contract, trademark, copyright and patent
registration, and internal security.
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Customers. The Company's primary customers are the five regional
Bell operating companies ("RBOCs"), which are Ameritech Corporation, Bell
Atlantic Corporation, BellSouth Corporation, SBC Communications Inc., and US
WEST Inc., as well as major independent telephone companies such as Sprint and
Southern New England Telephone Company. Historically, almost all of the
Company's sales have been made to the RBOCs (86% in 1997). Bell Atlantic
Corporation and BellSouth Corporation accounted for 30% and 24%, respectively,
of the Company's total sales in 1997. 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. During 1997, the Company received ISO 9001 registration from British
Standards Institution, Inc. ISO 9000 is a harmonized set of standards that
define quality assurance management. Written by the International Organization
for Standardization ("ISO"), it is recognized throughout the United States,
Canada, the European Union and Japan. To be registered, the Company developed
and maintains internal documentation and processes to support the production of
quality products to ensure customer satisfaction.
For a portion of 1997 and prior years, the Company utilized one key
independent subcontractor to perform a majority of the circuit board assembly
and in-circuit testing work on its products. The Company also utilized other
subassembly contractors on a more limited basis. During the third quarter, 1997,
the key subcontractor notified the Company that its services would be phased
out, at the latest, during early 1998. The Company is in the process of phasing
out the use of that subcontractor, and is now utilizing two other subassembly
subcontractors that had been utilized by the Company on a more limited basis in
the past. The loss of the subcontractors could cause delays in the Company's
ability to meet production obligations and could have a material adverse effect
on the Company's results of operations. In addition, shortages of raw material
to, or production capacity constraints at, the Company's subcontractors could
negatively affect the Company's ability to meet its production obligations and
result in increased prices for affected parts. Any such reduction may result in
delays in shipments of the Company's products or increases in the price of
components, either of which could have a material adverse impact on the Company.
The Company currently procures all of its components from outside
suppliers. Generally, the Company uses industry standard components for its
products. Application specific integrated circuits ("ASICs") are a key component
to the manufacturing process and are custom made to the Company's
specifications. Although the Company has generally been able to obtain ASICs on
a timely basis, a delay in the delivery of these components could have a
material adverse impact on the Company.
Backlog. The Company's backlog at December 31, 1997 was
approximately $1.6 million, as compared to approximately $0.9 million at
December 31, 1996. The increase was due largely to the receipt of certain orders
under Original Equipment Manufacturer ("OEM") arrangements scheduled for
shipment in the first quarter of 1998 and beyond. 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
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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, 1997 the Company had 205 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, 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 67,000 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 1997, there were no matters submitted
to a vote of security holders through solicitation of proxies or otherwise.
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EXECUTIVE OFFICERS OF THE COMPANY
Information relating to the executive officers of the Company as of January 31,
1998 is set forth below:
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 57.
Christian L. Allison Chief Executive Officer since September
1995; Treasurer from May 1992 until April
1997; 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 37.
Sara M. Antol Chief Counsel and Secretary since April
1996; prior thereto, employed by the law
firm of Babst, Calland, Clements and Zomnir
P.C.; Age 36.
Robert L. Cornelia Executive Vice President, Operations since
May 1996; Vice President, Manufacturing
from October 1993 until May 1996; prior
thereto, Production Manager; Age 35.
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 35.
Herman Flaminio Executive Vice President, Marketing
Services, Planning and Technical Support
since July 1997; Senior Vice President,
Marketing and Strategic Products from
October 1993 to June 1997; prior thereto,
Director of Marketing, Technical Support
and Planning; brother of Rocco L. Flaminio,
Vice Chairman, Chief Technology Officer and
a Director; Age 58.
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 73.
Mark C. Frey Senior Vice President, Engineering since
1993; prior thereto, Vice President,
Engineering; Age 44.
Joseph P. 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 61.
Frederick J. Kiko Senior Vice President, Design Engineering
since 1988; Age 54.
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Samuel C. Knoch Chief Financial Officer since August 1996;
Treasurer since April 1997; 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 42.
Geoffrey W. Lea Vice President, Sales N.A./L.A. since July
1997;Vice President, Marketing & Special
Assignment Sales Administration from August
1996 to June 1997; 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 39.
Gregory M. 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 44.
Joseph G. O'Brien Senior Vice President, Organizational
Development since October 1997; Director of
Employee Development from April 1997 until
October 1997; Coordinator, Elderberry
Junction, Goodwill Industries (a charitable
organization) from May 1995 until April
1997; Director of Public Relations of
Goodwill Industries from June 1994 until
May 1995; prior thereto, Roman Catholic
Priest, Diocese of Greensburg,
Pennsylvania; Age 38.
Timothy D. O'Brien Director of Communications since August
1997; Vice President of Ketchum Public
Relations ( a public relations firm) from
November 1995 until August 1997; prior
thereto, Account Supervisor at Ketchum; Age
37.
Mark B. Peterson Executive Vice President, Sales since
October 1997; prior thereto, Testing
Application Group product manager (MLT and
Switched Access Remote Test Systems (SARTS)
product lines) of Lucent Technologies (a
manufacturer of communication systems,
software and products and formerly AT&T
Bell Laboratories) from October 1995 until
October 1997; prior thereto, various other
management level positions at Lucent in
systems engineering, hardware design,
system test and product manaagement; Age
37.
Matthew J. Rosgone Vice President, Purchasing since July 1996;
Director of Purchasing from July 1995 until
July 1996; prior thereto, Buyer; Age 29.
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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 26 of the Company's 1997 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, 1997, is set forth
under the caption "Selected Consolidated Financial Data" on page 6 of the
Company's 1997 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 7 through 11 of the
Company's 1997 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 13 through 25
of the Company's 1997 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.
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 1998 Annual Meeting of Shareholders
and is incorporated herein by reference.
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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 1998 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
1998 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 1998 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 12
through 26 of the Company's 1997 Annual Report to Shareholders, which are
incorporated herein by reference:
Statement of Management's Responsibility for Financial Reporting, dated
January 27, 1998
Report of Independent Accountants, dated January 27, 1998
Consolidated Balance Sheets at December 31, 1996 and 1997
Consolidated Statements of Operations for the three years ended
December 31, 1997
Consolidated Statements of Shareholders' Equity for the three years
ended December 31, 1997
Consolidated Statements of Cash Flows for the three years ended
December 31, 1997
Notes to Consolidated Financial Statements
Statements of Operations Data by Quarter
(a)(2) The following financial statement schedule is included herewith on page
15 and made a part hereof:
Schedule II (Valuation and Qualifying Accounts)
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(a)(3) The following exhibits are included herewith and made a part hereof:
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Exhibit
Number Description
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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.
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").
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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 as
Exhibit 10.15 of Form 10-K for the year ended December 31, 1996 ("the 1996 Form 10-K").
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, Samuel Knoch, Goeffrey
Lea, Gregory Nulty and Matthew Rosgone, 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* Form of Non-employee Stock Option Agreement entered into December 13, 1996 and December
30, 1997 between the Company and Lawrence Arduini, filed as Exhibit 10.19 of the 1996 Form 10-
K.
10.20* Amendment to Employment Agreements, dated as of December 13, 1996, between the Company and
R. Craig Allison and Christian L. Allison, filed as Exhibit 10.20 of the 1996 Form 10-K.
10.21* Amendment to Employment Agreements, dated as of December 13, 1997, between the Company and
R. Craig Allison and Christian L. Allison, filed herewith.
10.22* Change of Control Agreement, entered into July 17, 1997 between the Company and Timothy
O'Brien, together with a schedule listing substantially a similar agreement with Joseph O'Brien
incorporated by reference to Exhibit 10.1 of the Report on Form 10-Q of the Company filed on
November 10, 1997.
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10.23 Amendment, dated February 21, 1997, to Technical Information Agreement relating to Metallic
Channel Units Types A and B, dated February 1, 1993, between American Telephone and Telegraph
Company ("AT&T") (licensor) and the Company (licensee) incorporated by reference to Exhibit
10.3 of the Report on Form 10-Q of the Company filed on November 10, 1997.
10.24* Change of Control Agreement, entered into October 15, 1997 between the Company and Mark B.
Peterson, filed herewith.
10.25* Form of Non-employee Director Stock Option Agreement with respect to the Company's 1995
Long-Term Incentive Compensation Plan, filed herewith.
11.1 Statement re: Computation of Per Share Earnings, filed herewith.
13.1 Company's 1997 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, 1997.
None
12
<PAGE> 13
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized as of March 23, 1998.
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 23, 1998.
<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,
- ------------------------------------------------- (Principal Executive Officer)
Christian L. Allison
/s/JAMES J. BARNES Director
- -------------------------------------------------
James J. Barnes
/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 and Treasurer
- ------------------------------------------------- (Principal Financial Officer)
Samuel C. Knoch
/s/BRADLEY N. DINGER Controller
- ------------------------------------------------- (Principal Accounting Officer)
Bradley N. Dinger
</TABLE>
13
<PAGE> 14
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 13 of the 1997 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 27, 1998
14
<PAGE> 15
SCHEDULE II
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 1995, 1996 and 1997
(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, 1995 $ 60 $ 60 $ -- $-- $120
Year ended December 31, 1996 120 95 -- -- 215
Year ended December 31, 1997 215 -- -- (36) 179
Allowance for doubtful accounts:
Year ended December 31, 1995 $ -- $ -- $ -- $-- $ --
Year ended December 31, 1996 -- -- -- -- --
Year ended December 31, 1997 -- 50 -- -- 50
</TABLE>
15
<PAGE> 16
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. *
10.1 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. *
</TABLE>
16
<PAGE> 17
<TABLE>
<S> <C> <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. *
10.7 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. *
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>
17
<PAGE> 18
<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 as
Exhibit 10.15 of Form 10-K for the year ended December 31, 1996
("the 1996 Form 10-K"). *
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, Samuel Knoch, Goeffrey Lea,
Gregory Nulty and Matthew Rosgone, 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 Form of Non-employee Stock Option Agreement entered into
December 13, 1996 and December 30, 1997 between the Company
and Lawrence Arduini, filed as Exhibit 10.19 of the 1996 Form 10-K. *
10.20 Amendment to Employment Agreements, dated as of
December 13, 1996, between the Company and R. Craig Allison
and Christian L. Allison, filed as Exhibit 10.20 of the 1996 Form 10-K. *
10.21 Amendment to Employment Agreements, dated as of December 13,
1997, between the Company and R. Craig Allison and Christian
L. Allison, filed herewith.
10.22 Change of Control Agreement, entered into July 17, 1997
between the Company and Timothy O'Brien, together with a
schedule listing substantially a similar agreement with
Joseph O'Brien incorporated by reference to Exhibit 10.1 of
the Report on Form 10-Q of the Company filed on November 10, 1997. *
10.23 Amendment, dated February 21, 1997, to Technical Information Agreement
</TABLE>
18
<PAGE> 19
<TABLE>
<S> <C> <C>
relating to Metallic Channel Units Types A and B, dated
February 1, 1993, between American Telephone and Telegraph
Company ("AT&T") (licensor) and the Company (licensee) incorporated
by reference to Exhibit 10.3 of the Report on Form 10-Q of the Company
filed on November 10, 1997. *
10.24 Change of Control Agreement, entered into October 15, 1997 between the
Company and Mark B. Peterson, filed herewith.
10.25 Form of Non-employee Director Stock Option Agreement with
respect to the Company's Long-Term Incentive Compensation
Plan, filed herewith.
11.1 Statement re: Computation of Per Share Earnings, filed herewith.
13.1 Company's 1997 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>
- ----------
* Incorporated by reference.
19
<PAGE> 1
Exhibit 10.21
AMENDMENT
THIS AMENDMENT, dated as of January 10, 1998 (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 and amended effective January 14, 1997 governing
the employment of the Executive and 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
$193,000 per annum, effective as of the anniversary date of the
Agreement.
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 & Secretary
---------------------------
/s/ R. CRAIG ALLISON
----------------------------------
R. Craig Allison
20
<PAGE> 2
AMENDMENT
THIS AMENDMENT, dated as of January 8, 1998 (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 entered into an Agreement effective dated
the 13th day of December, 1995 and amended effective January 14, 1997 governing
the employment of the Executive and 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
$193,000 per annum, effective as of the anniversary date of the
Agreement.
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 & Secretary
----------------------------
/s/ CHRISTIAN L. ALLISON
-----------------------------------
Christian L. Allison
21
<PAGE> 1
Exhibit 10.24
AGREEMENT
This Agreement, made as of the 30th day of December, 1997 by and between
TOLLGRADE COMMUNICATIONS, INC., a Pennsylvania corporation (the "Corporation")
and Mark B. Peterson, an individual residing in the Commonwealth of Pennsylvania
and an employee of the Corporation (the "Executive").
WITNESSETH:
WHEREAS, the Board of Directors of the Corporation has determined that it is in
the best interests of the Corporation to enter into this Agreement with the
Executive to provide for compensation of the Executive upon termination of
employment under certain circumstances relating to a change in control of the
Corporation; and
WHEREAS, the Executive desires to obtain such benefits in the event the
Executive's employment is terminated under the circumstances provided herein.
NOW, THEREFORE, in consideration of the covenants and premises contained herein,
and intending to be legally bound hereby, the parties hereto agree as follows:
1. DEFINITION OF TERMS. The following terms when used in this Agreement shall
have the meaning hereafter set forth:
"ANNUAL SALARY ADJUSTMENT PERCENTAGE" shall mean the mean average percentage
increase in base salary for all elected officers of the Corporation during the
two full calendar years immediately preceding the time to which such percentage
is being applied; provided however, that if after a Change-in-Control, as
hereinafter defined, there should be a significant change in the number of
elected officers of the Corporation or in the manner in which they are
compensated, then the foregoing definition shall be changed by substituting for
the phrase "elected officers of the Corporation" the phrase "persons then
performing the functions formerly performed by the elected officers of the
Corporation."
"CAUSE FOR TERMINATION" shall mean:
(a) the deliberate and intentional failure by the Executive to devote
substantially his entire business time and best efforts to the performance of
his duties (other than any such failure resulting from the Executive's
incapacity due to physical or mental illness or disability) after a demand for
substantial performance is delivered to the Executive by the Board of Directors
which specifically identifies the manner in which the Board of Directors
believes that the Executive has not substantially performed his duties,
22
<PAGE> 2
or
(b) wilfully engaging by the Executive in conduct which constitutes a fraud
against the Corporation or a material breach of this Agreement,
or
(c) the Executive's conviction of any crime which constitutes a felony.
For purposes of this definition, no act, or failure to act, on the Executive's
part shall be considered "deliberate and intentional" or "willfully" unless
done, or omitted to be done, by the Executive not in good faith and without
reasonable belief that his action or omission was in the best interests of the
Corporation.
"CHANGE-IN-CONTROL" shall mean the determination (which may be made effective as
of a particular date specified by the Board of Directors of the Corporation) by
the Board of Directors of the Corporation, made by a majority vote that a change
in control has occurred, or is about to occur. Such a change shall not include,
however, a restructuring, reorganization, merger, or other change in
capitalization in which the Persons who own an interest in the Corporation on
the date hereof (the "Current Owners")(or any individual or entity which
receives from a Current Owner an interest in the Corporation through will or the
laws of descent and distribution) maintain more than a sixty-five percent (65%)
interest in the resultant entity. Regardless of the Board's vote or whether or
not the Board votes, a Change-in-Control will be deemed to have occurred as of
the first day any one (1) or more of the following subparagraphs shall have been
satisfied:
(a) Any Person (other than the Person in control of the Corporation as of the
date of this Agreement, or other than a trustee or other fiduciary holding
securities under an employee benefit plan of the Corporation, or a corporation
owned directly or indirectly by the stockholders of the Corporation in
substantially the same proportions as their ownership of stock of the
Corporation), becomes the beneficial owner, directly or indirectly, of
securities of the Corporation representing more than thirty five percent (35%)
of the combined voting power of the Corporation's then outstanding securities;
or
(b) The stockholders of the Corporation approve:
(i) A plan of complete liquidation of the Corporation;
(ii) An agreement for the sale or disposition of all or substantially all of the
Corporation's assets; or
(iii) A merger, consolidation, or reorganization of the Corporation with or
involving any other corporation, other than a merger, consolidation, or
reorganization that would result in the voting securities of the Corporation
outstanding immediately prior thereto continuing to represent (either by
remaining outstanding or by being converted into voting securities of the
surviving entity) at least sixty-five percent (65%) of the combined voting power
of the voting securities of the Corporation (or such
23
<PAGE> 3
surviving entity) outstanding immediately after such merger, consolidation, or
reorganization.
However, in no event shall a Change in Control be deemed to have occurred, with
respect to the Executive, if the Executive is part of a purchasing group which
consummates the Change-in-Control transaction. The Executive shall be deemed
"part of the purchasing group" for purposes of the preceding sentence if the
Executive is an equity participant or has agreed to become an equity participant
in the purchasing company or group (except for (i) passive ownership of less
than five percent (5%) of the voting securities of the purchasing company; or
(ii) ownership of equity participation in the purchasing company or group which
is otherwise deemed not to be significant, as determined prior to the
Change-in-Control by a majority of the non-employee continuing Directors of the
Board of Directors of the Corporation).
"DATE OF TERMINATION" shall mean:
(a) if the Executive's employment is terminated for Disability, the date that a
Notice of Termination is given to the Executive;
(b) if the Executive terminates due to his death or Retirement, the date of
death or Retirement, respectively;
(c) if the Executive decides to terminate employment upon Good Reason for
Termination, the date following such decision specified by the Corporation after
it has been notified of the Executive's decision to terminate employment; or
(d) if the Executive's employment is terminated for any other reason, the date
on which such termination becomes effective pursuant to a Notice of Termination.
"DISABILITY" shall mean such incapacity due to physical or mental illness or
injury as causes the Executive to be unable to perform his duties with the
Corporation during 180 consecutive days.
"GOOD REASON FOR TERMINATION" shall mean the occurrence of:
(a) without the Executive's express written consent, the assignment to the
Executive of any duties materially and substantially inconsistent with his
positions, duties, responsibilities and status with the Corporation immediately
prior to a Change-in-Control, or a material change in his reporting
responsibilities, titles or offices as in effect immediately prior to a
Change-in-Control, or any removal of the Executive from or any failure to
re-elect the Executive to any of such positions, except in connection with the
termination of the Executive's employment due to Cause for Termination,
Disability or Retirement (as hereinafter defined) or as a result of the
Executive's death;
(b) (i) a reduction by the Corporation prior to a Change-in-Control in the
Executive's base salary unless such reduction is the result of the Board of
Directors of the Corporation determining that the Executive has not adequately
discharged his duties;
24
<PAGE> 4
(ii) a reduction by the Corporation after a Change-in-Control in the Executive's
base salary as in effect immediately prior to any Change-in-Control or a failure
by the Corporation after a Change-in-Control to increase the Executive's base
salary by the Annual Salary Adjustment Percentage;
(c) a failure by the Corporation to continue to provide incentive compensation
comparable to that provided by the Corporation immediately prior to any
Change-in-Control;
(d) a failure by the Corporation after a Change-in-Control to continue in effect
any benefit or compensation plan, stock option plan, pension plan, life
insurance plan, health and accident plan or disability plan in which the
Executive is participating immediately prior thereto (provided, however, that
there shall not be deemed to be any such failure if the Corporation substitutes
for the discontinued plan, a plan providing the Executive with substantially
similar benefits) or the taking of any action by the Corporation which would
adversely affect the Executive's participation in or materially reduce the
Executive's benefits under any of such plans or deprive the Executive of any
material fringe benefit enjoyed by the Executive immediately prior to a
Change-in-Control (provided, however, that any act or failure to act by the
Corporation that is on a plan-wide basis, i.e., it similarly affects all
employees of the Corporation or all employees eligible to participate in any
such plan, as the case may be, shall not constitute Good Reason for
Termination);
(e) the failure of the Corporation to obtain the assumption of this Agreement by
any successor as contemplated in SECTION 10(c) hereof;
(f) any purported termination of the employment of the Executive by the
Corporation which is not (i) due to the Executive's Disability, Retirement (as
hereinafter defined) or Cause for Termination, or (ii) effected as a Notice of
Termination, as defined herein; or
(g) the Corporation's requiring the Executive to be based anywhere other than
the Corporation's executive offices at which the Executive has his principal
office immediately prior to a Change-in-Control or executive offices located
within 50 miles of the location of the Corporation's executive offices
immediately prior to a Change-in-Control, except for required travel on the
Corporation's business to an extent substantially consistent with the
Executive's present business travel obligations.
"NOTICE OF TERMINATION" shall mean a written statement which sets forth the
specific reason for termination and, if such is claimed to be a Cause for
Termination or Good Reason for Termination, in reasonable detail the facts and
circumstances which indicate that such is Cause for Termination or Good Reason
for Termination.
"OPTIONS" shall mean any stock options issued pursuant to any present or future
stock option plan of the Corporation.
"PERSON" shall have the meaning ascribed to such term in Section 3(a)(9) of the
Securities Exchange Act of 1934, as in effect on the date hereof and used in
Sections 13(d) and 14(d) thereof, including a "group" as defined in Section
13(d) thereof.
25
<PAGE> 5
"RETIREMENT" shall mean the termination of the Executive's employment after age
65 or in accordance with any mandatory retirement arrangement with respect to an
earlier age agreed to by the Executive.
"STOCK APPRECIATION RIGHT" shall mean any stock appreciation rights issued
pursuant to any stock option plan of the Corporation or any future stock
appreciation rights plan.
2. TERMS OF EMPLOYMENT. The Executive acknowledges that this Agreement does not
constitute an employment contract and that the Executive's employment
relationship with the Corporation is at-will and not for any particular period.
Rather, this Agreement is only intended to set forth certain liquidated damages
to be paid in the event of termination of the Executive upon the terms and
conditions specified herein.
3.TERM OF AGREEMENT. The initial term of this Agreement shall be for a period of
four (4) years. Upon expiration of the initial term, the Company shall, in its
sole discretion, determine whether this Agreement shall be renewed upon such
terms it deems advisable.
4. PAYMENTS FOLLOWING TERMINATION OF EMPLOYMENT UPON A CHANGE-IN-CONTROL.
(a) If the Executive's employment with the Corporation shall be terminated:
(i) due to the Executive's death,
(ii) by the Executive other than the Executive's having terminated for Good
Reason for Termination following a Change-in-Control, or
(iii) by the Corporation due to Cause for Termination or for Disability or
Retirement, then the Corporation shall have no obligations to the Executive
other than to pay the Executive any unpaid portion of base salary due until the
Date of Termination and any other sums due in accordance with the then various
policies, practices and benefit plans of the Corporation.
(b) If the Executive's employment with the Corporation shall have terminated
during the period commencing six months prior to the date of a Change-in-Control
and ending on the third anniversary of a Change-in-Control other than in the
circumstances described in subsection (a) above, then the Corporation shall pay
on or before the fifth day following the Date of Termination (or if the Date of
Termination preceded the date of the Change-in-Control, on or before the fifth
day following the date of the Change-in-Control), to the Executive the following
sums:
(i) in cash any unpaid portion of the Executive's full base salary for the
period from the last period for which the Executive was paid to the
Date of Termination, or the date of the Change-in-Control,
as the case may be; and
(ii) an amount in cash as liquidated damages for lost future renumeration equal
to the product obtained by multiplying
26
<PAGE> 6
(A) the lesser of
(1) two, or
(2) a number equal to the number of calendar months remaining from the Date of
Termination to the date on which the Executive is 65 years of age (or, if
earlier, the age agreed to by the Executive pursuant to any prior arrangement)
divided by twelve, or
(3) a number equal to the greater of (i) one (1.0) and (ii) thirty six (36) less
the number of completed months commencing after the date of the
Change-in-Control during which the Executive was employed by the Corporation and
did not have Good Reason for Termination times (iii) one-twelfth (1/12)
times
(B) the sum of
(1) the greater of
(i) the Executive's annual base salary for the year in effect on the Date of
Termination (provided that in the case of Termination for Good Reason by the
Executive the date immediately preceding the date of the earliest event which
gave rise to the Termination for Good Reason by the Executive shall be used
instead of the Date of Termination)
or
(ii) the Executive's annual base salary for the year in effect on the date of
the Change-in-Control;
plus
(2) the greater of
(i) the average annual cash award received by the Executive as incentive
compensation or bonus for one calendar year immediately preceding the Date of
Termination (provided that in the case of Termination for Good Reason by the
Executive the date immediately preceding the date of the event which gave rise
to the Termination for Good Reason by the Executive shall be used instead of the
Date of Termination)
or
(ii) the average annual cash award received by the Executive as incentive
compensation or bonus for one calendar year immediately preceding the date of
the Change-in-Control.
5.OUTPLACEMENT SERVICES. If the Executive's employment with the Corporation
should terminate under circumstances as to entitle the Executive to receive
payment hereunder, the Corporation shall reimburse
27
<PAGE> 7
the Executive for any reasonable fees or other costs incurred by the Executive
during the two (2) years following the Date of Termination in retaining
executive placement agencies, up to a maximum dollar amount not to exceed
fifteen percent (15%) of the Executive's base salary at the time of such
termination. Such reimbursement shall be made within five (5) days following the
Executive's presentment of bills or other evidence of the costs incurred with
executive placement agencies.
6.TAX IMPLICATIONS. If any payment due to the Executive pursuant to this
Agreement result in a tax being imposed on the Executive pursuant to Section
4999 of the Internal Revenue Code of 1954, as amended, or any successor
provision ("Section 4999"), then the Corporation shall, at the Executive's
option, either (i) reduce the total payments payable to the Executive to the
maximum amount payable without incurring the Section 4999 tax, or (ii) pay to
the Executive the total amount payable, with the understanding that Section 4999
tax will be due on that total amount.
7.BENEFITS. If the Executive's employment with the Corporation should terminate
under circumstances as to entitle the Executive to receive payment hereunder,
the Executive shall also be deemed, for purposes of medical insurance, pension
and other benefits of the Corporation, to have remained in the continuous
employment of the Corporation for the two (2) year period following the Date of
Termination and shall be entitled to all of the medical insurance, pension or
other benefits provided by the Corporation as if the Executive had so remained
in the employment of the Corporation. If, for any reason, whether by law or
provisions of the Corporation's employee medical insurance, pension or other
benefit plans, or otherwise any benefits which the Executive would be entitled
to under this SECTION 6 cannot be paid pursuant to such employee benefit plans,
then the Corporation contractually agrees to pay the Executive the difference
between the benefits which the Executive would have received in accordance with
this Section if the relevant employee medical insurance, pension or other
benefit plan could have paid such benefit and the amount of benefits, if any,
actually paid by such employee medical insurance, pension or other benefit plan.
The Corporation shall not be required to fund its obligation to pay the
foregoing difference.
8.OTHER EMPLOYMENT. In the event of termination under the circumstances
contemplated in SECTION 4(b) hereunder, the Executive shall have no duty to seek
any other employment after termination of his employment with the Corporation
and the Corporation hereby waives and agrees not to raise or use any defense
based upon the position that the Executive had a duty to mitigate or reduce the
amounts due him hereunder by seeking other employment whether suitable or
unsuitable and should the Executive obtain other employment, then the only
effect of such on the obligations of the Corporation shall be that the
Corporation shall be entitled to credit against any payments that would
otherwise be made pursuant to SECTION 7 hereof, any comparable payments to which
the executive is entitled under the employee benefit plans maintained by the
Executive's other employer or employers in connection with services to such
employer or employers after termination of this employment with the Corporation.
9.STOCK APPRECIATION RIGHTS AND OPTIONS. If the Executive's employment should
terminate under circumstances as to entitle the Executive to receive payment
hereunder, then with respect to any standing Stock Appreciation Rights and/or
Options which did not immediately become exercisable upon the occurrence of a
Change-in-Control, such Stock Appreciation Right or Option shall be
automatically
28
<PAGE> 8
vested and remain outstanding in accordance with its terms and be exercisable
thereafter until the stated expiration date of such Stock Appreciation Right or
Option.
10.MISCELLANEOUS.
(a)This Agreement shall be construed under the laws of the Commonwealth of
Pennsylvania.
(b)This Agreement constitutes the entire understanding of the parties hereto
with respect to the subject matter hereof and may only be amended or modified by
written agreement signed by the parties hereto.
(c)The Corporation will require any successor (whether direct or indirect, by
purchase, merger, consolidation or otherwise) to all or substantially all of the
business and/or assets of the Corporation, by agreement in form and substance
satisfactory to the Executive, to expressly assume and agree to perform this
Agreement in the same manner required of the Corporation and to perform it as if
no such succession had taken place. As used in this Agreement, "Corporation"
shall mean the Corporation as hereinbefore defined and any successor to its
business and/or assets as aforesaid which executes and delivers the agreement
provided for in this subsection (c) or which otherwise becomes bound by all of
the terms and provisions of this Agreement by operation of law.
(d)This Agreement shall inure to the benefit of and be enforceable by the
Executive and the Corporation and their respective legal representatives,
executors, administrators, successors, heirs, distributees, devisees and
legatees. If the Executive should die while any amounts would still be payable
to him hereunder if he had continued to live, all such amounts, unless otherwise
provided herein, shall be paid in accordance with the terms of this Agreement to
his devisee, legatee or other designee or, if there be no such designee, to his
estate.
(e)Any notice or other communication provided for in this Agreement shall be in
writing and, unless otherwise expressly stated herein, shall be deemed to have
been duly given if mailed by United States registered mail, return receipt
requested, postage prepaid, addressed in the case of the Executive to his office
at the Corporation with a copy to his residence and in the case of the
Corporation to its principal executive offices, attention to the Chief Executive
Officer.
(f)No provision of this Agreement may be modified, waived or discharged unless
such waiver, modification or discharge is agreed to in writing signed by the
Executive and approved by resolution of the Board of Directors of the
Corporation. No waiver by either party hereto at any time of any breach by the
other party hereto of, or compliance with, any condition or provision of this
Agreement to be performed by such other party shall be deemed a waiver of
similar or dissimilar provisions or conditions at the same or at any prior or
subsequent time. No agreements or representations, oral or otherwise, express or
implied, with respect to the subject matter hereof have been made by either
party which are not set forth expressly in this Agreement.
(g)The invalidity or unenforceability of any provisions of this Agreement shall
not affect the validity or unenforceability of any other provision of this
Agreement, which shall remain in full force and effect. If any provision hereof
shall be deemed invalid or unenforceable, either in whole or in part, this
29
<PAGE> 9
Agreement shall be deemed amended to delete or modify, as necessary, the
offending provision and to alter the bounds thereof in order to render it valid
and enforceable.
(h)This Agreement may be executed in one or more counterparts, each of which
shall be deemed to be an original but all of which taken together will
constitute one and the same instrument.
(i)If litigation should be brought to enforce, interpret or challenge any
provision contained herein, the prevailing party shall be entitled to its
reasonable attorney's fees and disbursements and other costs incurred in such
litigation and, if a money judgment be rendered in favor of the Executive, to
interest on any such money judgment obtained calculated at the prime rate of
interest in effect from time to time at Mellon Bank, N.A., from the date that
the payment should have been made or damages incurred under this Agreement.
IN WITNESS WHEREOF, this Agreement has been executed on the date first above
written.
ATTEST: TOLLGRADE COMMUNICATIONS, INC.
/s/ SARA M. ANTOL By: /s/ CHRISTIAN L. ALLISON
- ------------------ ------------------------
WITNESS:
/s/ SARA M. ANTOL /s/ MARK B. PETERSON
- ------------------ ------------------------
Mark B. Peterson
30
<PAGE> 1
Exhibit 10.25
TOLLGRADE COMMUNICATIONS, INC.
1995 LONG-TERM INCENTIVE COMPENSATION PLAN
NON-EMPLOYEE DIRECTOR
NONSTATUTORY STOCK OPTION AGREEMENT
THIS AGREEMENT is made and entered into this _____ day of _______, 199__, by and
between TOLLGRADE COMMUNICATIONS, INC., a Pennsylvania corporation (the
"Company") and ____________________, 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
_________________ (the "Date of Grant") of an option (the "Option") to purchase,
from time to time in accordance with the terms hereof ___________ (________)
shares of common stock of the Company, par value $.20 per share (the "Common
Stock") at an option price of $____________ per share, under and subject to the
terms and conditions of the Company's 1995 Long-Term Incentive Compensation
Plan, as amended (the "Plan") and this Agreement. The Plan is incorporated
herein by reference and made a part hereof as though set forth in full herein.
Terms which are capitalized herein but which are not defined herein have the
same meaning as in the Plan unless the context otherwise requires.
The Option confirmed hereby is a nonstatutory stock option as that term is
defined in Section 2.20 of the Plan. The Option will expire at the close of
business on ____________________.
2.Acceptance of Grant of Option.The Holder accepts the grant of the Option
confirmed hereby, acknowledges having received a copy of the Plan and agrees to
be bound by the terms and provisions of the Plan, as the Plan may be amended
from time to time; provided, however, that no alteration, amendment, revocation
or termination of the Plan shall, without the written consent of the Holder,
adversely affect the rights of the Holder with respect to the Option.
3.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.
4.Procedure for Exercise of Option. The Option may be exercised only by (a)
execution and delivery by the
31
<PAGE> 2
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.
Subject to the last paragraph of this Section 4, 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 in the manner specified in Section 6.6 of the
Plan. To the extent the Holder pays the Option Price in whole or in part by
shares of already-owned Common Stock, as permitted by the Plan, the Company
shall advise any person exercising the Option in such manner as to the amount of
any cash required to be paid to the Company for any shares representing a
fraction of a share, and such person will be required to pay any such cash
directly to the Company before any distribution of certificates representing
shares of Common Stock will be made. The person exercising the Option should
execute the form of assignment on the back of the certificate or should deliver
an executed Assignment Separate from Certificate with respect to each stock
certificate delivered in payment of the Option Price.
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. For purposes of determining the date of exercise
where payment of the Option Price is made in shares of already-owned Common
Stock, any cash required to be paid to the Company with respect to a fraction of
a share shall not be taken into account when determining whether payment of the
Option Price has been made.
5.Issuance of Certificates.Subject to Section 4 above and this Section 5, 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. If the Option Price is paid in whole or in part with shares of
already-owned Common Stock, the Company will issue at the same time and return
to the person exercising the Option a certificate representing the number of any
excess shares included in any certificate or certificates delivered to the
Company at the time of exercise.
The obligation of the Company to issue shares on exercise of an option is
subject to the effectiveness of a Registration Statement under the Securities
Act of 1933, as amended, with respect to such shares, if deemed necessary or
appropriate by counsel to the Company. The Company is not obligated to file such
a Registration Statement. If at the time of exercise of the Option, no such
Registration Statement is in effect, the issuance of shares on exercise of the
Option may also be made subject to restrictions on the transfer of the shares,
including the placing of an appropriate legend on the certificates restricting
the transfer thereof, and to such other restrictions as the Committee, on the
advice of counsel, may deem necessary or appropriate to prevent a violation of
applicable securities laws.
32
<PAGE> 3
6.Withholding of Taxes.The Holder will be advised by the Company as 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.
7.Interpretation of Plan and Agreement.This Agreement is an award agreement
referred to in Section 6.2 of the Plan. If there is any conflict between the
Plan and this Agreement, the provisions of the Plan shall control. However,
there may be provisions in this Agreement not contained in the Plan, which
provisions shall nonetheless be effective. In addition, to the extent that
provisions of the Plan are expressly modified for purposes of this Agreement
pursuant to authorization in the Plan, the provisions of this Agreement shall
control. Any dispute or disagreement which shall arise under or in any way
relate to the construction or interpretation of the Plan or this Agreement shall
be resolved by the Committee, and the decision of the Committee shall be final,
binding and conclusive for all purposes.
8.Effect of Agreement on Rights of Company and Holder.This Agreement does not
confer any rights on the Holder to continue as a Director.
9.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 agreements set forth herein.
10.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.
11.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.
12.Amendment.This Agreement may be amended only a written instrument signed by
the Company and the Holder.
13.Governing Law.This Agreement shall be governed by and construed and enforced
in accordance with the laws of the Commonwealth of Pennsylvania.
33
<PAGE> 4
IN WITNESS WHEREOF, the Company and the Holder have executed this Agreement as
of the date first written above.
TOLLGRADE COMMUNICATIONS, INC.
By:_________________________
Title: _____________________
WITNESS: HOLDER:
____________________________ ___________________________
34
<PAGE> 1
Exhibit 11.1
Tollgrade Communications, Inc. and Subsidiaries
Calculation of Earnings Per Share
For the Years Ended December 31, 1995, 1996, and 1997
<TABLE>
<CAPTION>
December 31,
------------------------------------------------
1995 1996 1997
<S> <C> <C> <C>
Net income. . . . . . . . . . . . . . . . . . . . . . . . . $2,521,827 $5,596,623 $6,883,148
========== ========== ==========
Common and common equivalent shares:
Weighted average number of common
shares outstanding during the period . . . . . . . 4,227,648 5,500,884 5,686,182
Common shares issuable upon exercise
of outstanding stock options
Diluted . . . . . . . . . . . . . . . . . . . . . . 276,064 438,778 275,358
-------- ------- -------
Common and common equivalent
shares outstanding during the period
Diluted . . . . . . . . . . . . . . . . . . . . . . 4,503,712 5,939,662 5,961,540
---------- --------- ----------
Earnings per share data:
Net income per common and common
equivalent shares
Basic . . . . . . . . . . . . . . . . . . . . . . . $ .60 $ 1.02 $ 1.21
Diluted . . . . . . . . . . . . . . . . . . . . . . $ .56 $ .94 $ 1.15
</TABLE>
35
<PAGE> 1
Exhibit 13.1
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data of the Company as of December 31, 1993,
1994, 1995, 1996 and 1997 is derived from audited consolidated financial
statements of the Company.
<TABLE>
<CAPTION>
(In thousands, except per share data)
Year Ended December 31,
1993 1994 1995 1996 1997
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenues(1) $ 10,089 $ 14,722 $22,310 $37,490 $45,421
Cost of product sales 5,860 8,168 11,329 18,322 20,104
- ------------------------------------------------------------------------------------------------------------------------------------
Gross profit 4,229 6,554 10,981 19,168 25,317
Operating expenses:
Selling and marketing 1,409 1,903 2,953 4,767 5,446
General and administrative 1,079 1,268 1,471 2,552 3,768
Research and development 769 1,585 2,637 3,921 5,945
- ------------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 3,257 4,756 7,061 11,240 15,159
- ------------------------------------------------------------------------------------------------------------------------------------
Income from operations 972 1,798 3,920 7,928 10,158
Other income (expense), net (295) (270) 20 845 899
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 677 1,528 3,940 8,773 11,057
Provision (benefit) for income taxes 76 (617) 1,418 3,176 4,174
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 601 $ 2,145 $ 2,522 $ 5,597 $ 6,883
- ------------------------------------------------------------------------------------------------------------------------------------
Net income applicable to common stock (2) $ 432 $ 1,311 $ 2,522 $ 5,597 $ 6,883
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings per share:
Basic $ .25 $ .49 $ .60 $ 1.02 $ 1.21
Diluted .12 .32 .56 .94 1.15
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted average shares of common stock and equivalents:
Basic 1,707 2,674 4,228 5,501 5,686
Diluted 3,465 4,159 4,504 5,940 5,962
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
As of December 31,
1993 1994 1995 1996 1997
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital $ 896 $3,195 $21,159 $27,232 $34,570
Total assets 3,590 7,151 25,728 34,626 43,713
Long-term debt, less current portion 1,800 1,400 -- -- --
Shareholders' equity (deficit) (911) 1,387 22,609 30,006 38,101
1993 1994 1995 1996 1997
- ------------------------------------------------------------------------------------------------------------------------------------
OTHER DATA: (3)
Number of employees at year end 71 96 126 184 205
Average revenue per employee $ 142 $ 153 $ 177 $ 204 $ 222
</TABLE>
(1) Includes royalty and license fees of $75 and $250 for 1993 and 1997,
respectively.
(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.
6
<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
"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 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, 1997, 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
metallic channel unit ("MCU") product line, which includes POTS line testing as
well as alarm-related products, represented more than 94% of the Company's
revenue for the year ended December 31, 1997 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. The Company's
product sales are primarily to the five Regional Bell Operating Companies
("RBOCs"), as well as major independent telephone companies such as Sprint. For
the year ended December 31, 1997, 86% of revenue was from the five RBOCs, the
two largest of which comprised 54% 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 13% for the year ended December 31, 1997. The Company expects its
research and development expenses to continue at significant levels.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES
Revenues for the year ended December 31, 1997 were $45.4 million, and were $7.9
million, or 21.2%, higher than revenues of $37.5 million for the year ended
December 31, 1996. Revenues for both periods consisted almost entirely of
product sales. 1997
7
<PAGE> 3
revenues included $250,000 of royalty and license fees while similar fees for
1996 were immaterial. 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
$0.7 million from six new products introduced in 1997. 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. Periodic
fluctuations in customer orders and backlog result from a variety of factors,
including but not limited to the timing of significant orders and shipments, and
are not necessarily indicative of long-term trends in sales of the Company's
products. Management believes that during fiscal year 1998 there is a
possibility that one of the Company's major customers will have satisfied a
substantial portion of its requirements for certain of the Company's important
product lines. Management is focusing on the development of new product lines to
attempt to meet the other requirements of this and other customers.
GROSS PROFIT
Gross profit for 1997 was $25.3 million compared to $19.2 million for 1996,
representing an increase of $6.1 million, or 32.1%. Gross profit as a percentage
of revenues increased to 55.7% for 1997 compared to 51.1% for 1996. 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 volumes and increased 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 and maintaining current pricing levels.
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 1997
was $5.4 million, or 12.0% of revenues, compared to $4.8 million, or 12.7% of
revenues for 1996. This increase of $0.6 million, or 14.2%, 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 1997 was $3.8
million, or 8.3%, of revenues, compared to $2.6 million, or 6.8%, of revenues
for 1996. This increase of $1.2 million, or 47.6%, is primarily attributable to
additional salaries and benefits associated with increased staffing levels to
support the expanded business operations and increased travel and business
development activities.
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 1997 was $5.9 million, an increase of $2.0 million, or 51.6%,
compared to $3.9 million for 1996. 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 13.1% for 1997
compared to 10.5% for 1996. 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 $0.9 million for
1997 compared to $0.8 million for 1996. The increase in other income was
primarily attributable to increased interest income, which resulted from the
increased levels of investable funds.
PROVISION FOR INCOME TAXES
The Company's effective tax rate for 1997 was 37.7% of income before income
taxes, compared to the 36.2% rate in 1996. The slight increase reflects
increases in state taxes offset by benefits from higher levels of tax-exempt
interest and increased credits for research and development.
8
<PAGE> 4
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 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.
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.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $34.6 million as of December 31, 1997
compared to working capital of $27.2 million as of December 31, 1996. 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 oper-
9
<PAGE> 5
ations was $2.6 million and $2.0 million for 1997 and 1996, respectively. Net
income was the primary source of cash provided by operations for 1997 and 1996,
offset by increased levels in accounts receivable and inventories due to
increased product sales. Inventories increased 41.2% 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, 1997, the Company had $19.5 million of cash and cash
equivalents, short-term and long-term investments which are available for
acquisitions and other corporate requirements.
Capital expenditures were $1.2 million for 1997 and were primarily related to
prototype tooling, 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 $2.0 million and $1.0 million
for 1996 and 1995, 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 1998 are anticipated to total approximately $2.0
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. Borrowings 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, 1997, 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, 1998, 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 dividend 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 a person or group acquires 20% or more of the Company's outstanding common
stock, each right not owned by the person or group will entitle its holder to
purchase at the right's exercise price a number of shares of the Company's
common stock (or, at the option of the Company, the new preferred stock) having
a market value of twice the exercise price. Further, at any time after a person
or group acquires 20% or more (but less than 50%) of the outstanding common
stock, the Board of Directors may at its option, exchange part or all of the
rights (other than rights held by the acquiring person or group) for shares of
the Company's common or preferred stock on a one-for-one basis.
If after a person or group acquires 20% or more of the outstanding common stock,
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%.
The rights were not distributed in response to any specific effort to acquire
control of the Company, nor is the Company presently aware of any such effort.
The distribution of the rights will not affect the
10
<PAGE> 6
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.
On April 22, 1997 the Company's Board of Directors authorized a program to
repurchase up to 200,000 shares of its common stock over the next two years. The
shares will be utilized to provide stock under certain employee benefit
programs. The number of shares that the Company intends to purchase and the time
of such purchases will be determined by the Company, at its discretion. The
Company plans to use existing cash and short-term investments to finance the
repurchases. To date, the Company has purchased 12,800 shares of the Company's
common stock under this program.
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 enables it to meet cash requirements
for operations and capital expansion programs.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruption of operations, including among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
The Company is currently assessing whether its existing computer systems will
properly utilize dates beyond December 31, 1999. If modifications are required
for its existing systems and the modifications are not completed on a timely
basis, the Year 2000 Issue could have a material impact on the operations of the
Company. The Company believes that it has no exposure to contingencies related
to the Year 2000 Issue for the products it has sold.
The Company plans to engage in formal communication with all of its significant
suppliers and large customers to determine the extent to which the Company is
vulnerable to those third parties' failure to remediate their own Year 2000
Issue. There can be no guarantee that the systems of other companies on which
the Company's systems rely will be timely converted, or that a failure to
convert by another company, or a conversion that is incompatible with the
Company's systems, would not have a material adverse effect on the Company.
Presently, the Company does not have an estimate for the costs of the project
and the date on which the Company plans to complete the Year 2000 modifications,
if any. However, based upon the Company's initial assessment, the Company
believes that the costs of the project will not be material.
ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income," which
establishes standards for reporting and displaying comprehensive income and its
components in a full set of general-purpose financial statements. This
Statement, which is effective for financial statements for fiscal years
beginning after December 15, 1997, requires that all items that are required to
be recognized under accounting standards as components of comprehensive income
be reported in a financial statement that is displayed with the same prominence
as other financial statements. Additionally, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information," which establishes
standards for the way that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports. This Statement, which is effective for financial statements
for fiscal years beginning after December 15, 1997, also establishes standards
for related disclosures about products and services, geographic areas and major
customers. Management is currently evaluating the implication of these
statements from both an operations and financial reporting perspective.
BACKLOG
The Company's backlog consists of firm customer purchase orders for the
Company's various products. At December 31, 1997 the Company had backlog of $1.6
million, a $0.7 million increase from the December 31, 1996 backlog of $0.9
million. The increase was due largely to the receipt of certain orders under
Original Equipment Manufacturer ("OEM") arrangements scheduled for shipment in
the first quarter of 1998 and beyond.
11
<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 1997
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 and Treasurer
January 27, 1998
12
<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, 1996 and 1997, and the
related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. 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, 1996 and
1997, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 1997 in conformity with
generally accepted accounting principles.
/s/ COOPERS & LYBRAND L.L.P.
----------------------------
COOPERS & LYBRAND L.L.P.
Pittsburgh, Pennsylvania
January 27, 1998
13
<PAGE> 9
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS December 31, 1996 December 31, 1997
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 4,591,273 $ 3,183,944
Short-term investments 12,342,592 15,666,626
Accounts receivable:
Trade 5,153,589 7,884,683
Other 304,434 517,090
Inventories 8,569,818 12,101,114
Prepaid expenses and deposits 549,753 409,252
Deferred tax asset 171,776 213,216
- --------------------------------------------------------------------------------------------------------------
Total current assets 31,683,235 39,975,925
Long-term investments -- 600,000
Property and equipment, net 2,769,657 3,001,824
Deferred tax asset 157,169 126,895
Patents and other assets 15,569 8,568
- --------------------------------------------------------------------------------------------------------------
Total assets $34,625,630 $43,713,212
- --------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------------------------------------
Current liabilities:
- --------------------------------------------------------------------------------------------------------------
Accounts payable $ 1,691,928 $ 959,185
Accrued expenses 1,077,151 1,091,990
Accrued salaries and wages 769,855 1,529,525
Royalty payable 741,781 878,780
Income taxes payable 170,889 946,233
- --------------------------------------------------------------------------------------------------------------
Total current liabilities 4,451,604 5,405,713
Deferred tax liability 168,455 206,116
- --------------------------------------------------------------------------------------------------------------
Total liabilities 4,620,059 5,611,829
Commitments
Shareholders' equity:
Preferred stock, $1.00 par value; authorized shares,
10,000,000 issued shares, -0- in 1996 and 1997, respectively -- --
Common stock, $.20 par value; authorized shares, 7,000,000;
issued shares, 5,620,417 in 1996 and 5,727,350 in 1997 1,124,083 1,145,470
Additional paid-in capital 24,091,210 25,232,315
Treasury stock, at cost, 2,200 shares in 1996 and 3,200 in 1997 (49,775) (70,355)
Unearned compensation (106,686) (35,934)
Retained earnings 4,946,739 11,829,887
- --------------------------------------------------------------------------------------------------------------
Total shareholders' equity 30,005,571 38,101,383
- --------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $34,625,630 $43,713,212
- --------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
14
<PAGE> 10
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
1995 1996 1997
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $ 22,309,629 $ 37,489,949 $ 45,421,135
Cost of product sales 11,328,660 18,321,677 20,104,202
Gross profit 10,980,969 19,168,272 25,316,933
- --------------------------------------------------------------------------------------------------------------------------------
Operating expenses:
Selling and marketing 2,953,223 4,767,339 5,446,102
General and administrative 1,471,222 2,551,959 3,767,925
Research and development 2,636,770 3,921,091 5,944,819
- --------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 7,061,215 11,240,389 15,158,846
- --------------------------------------------------------------------------------------------------------------------------------
Income from operations 3,919,754 7,927,883 10,158,087
Other income (expense):
Interest expense (58,583) (3,076) (3,271)
Interest and other income 78,656 848,569 901,981
- --------------------------------------------------------------------------------------------------------------------------------
20,073 845,493 898,710
- --------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 3,939,827 8,773,376 11,056,797
Provision for income taxes 1,418,000 3,176,753 4,173,649
- --------------------------------------------------------------------------------------------------------------------------------
Net income $ 2,521,827 $ 5,596,623 $ 6,883,148
- --------------------------------------------------------------------------------------------------------------------------------
EARNINGS PER SHARE INFORMATION:
Weighted average shares of common stock and equivalents:
Basic 4,227,648 5,500,884 5,686,182
Diluted 4,503,712 5,939,662 5,961,540
- --------------------------------------------------------------------------------------------------------------------------------
Net income per common share:
Basic $ .60 $ 1.02 $ 1.21
Diluted .56 .94 1.15
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
15
<PAGE> 11
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Additional
Preferred Stock Common Stock Paid-in
Shares Amount Shares Amount Capital
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1994 958,721 $958,721 2,591,427 $ 518,286 $ 3,834,386
Receipt of stock subscriptions -- -- -- -- --
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
EXERCISE OF COMMON STOCK OPTIONS -- -- 107,283 21,457 456,759
RESTRICTED STOCK - COMPENSATION
CHARGED TO EXPENSE, NET -- -- -- -- --
SHARES FORFEITED -- -- (350) (70) (18,338)
TAX BENEFIT FROM EXERCISE OF
STOCK OPTIONS -- -- -- -- 702,684
PURCHASE OF TREASURY STOCK -- -- -- -- --
NET INCOME -- -- -- -- --
BALANCE AT DECEMBER 31, 1997 -- $ -- 5,727,350 $1,145,470 $25,232,315
- --------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Retained
Earnings
Subscriptions Treasury Unearned (Accumulated
Receivable Stock Compensation Deficit) Total
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1994 $(681,830) $(28,200) $(42,873) $( 3,171,711) $ 1,386,779
Receipt of stock subscriptions 681,830 -- -- -- 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
EXERCISE OF COMMON STOCK OPTIONS -- -- -- -- 478,216
RESTRICTED STOCK - COMPENSATION
CHARGED TO EXPENSE, NET -- -- 52,344 -- 52,344
SHARES FORFEITED -- -- 18,408 -- --
TAX BENEFIT FROM EXERCISE OF
STOCK OPTIONS -- -- -- -- 702,684
PURCHASE OF TREASURY STOCK -- (20,580) -- -- (20,580)
NET INCOME -- -- -- 6,883,148 6,883,148
BALANCE AT DECEMBER 31, 1997 $ -- $(70,355) ($35,934) $ 11,829,887 $38,101,383
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
16
<PAGE> 12
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
1995 1996 1997
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2,521,827 $ 5,596,623 $ 6,883,148
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 342,310 688,323 1,005,744
Deferred income taxes 692,000 (77,990) 26,495
Provision for losses on inventory 60,000 95,000 --
Compensation expense for restricted stock 63,939 52,356 52,344
Changes in assets and liabilities:
Increase in accounts receivable-trade (892,290) (2,582,356) (2,731,094)
Decrease (increase) in accounts receivable-other 29,222 (192,716) (212,656)
Increase in inventories (3,250,474) (2,643,352) (3,531,296)
(Increase) decrease in prepaid expenses and deposits (109,982) (398,302) 140,501
Increase (decrease) in accounts payable 457,809 (275,517) (732,743)
Increase in accrued expenses and royalty payable 389,048 1,679,404 911,508
Increase in income taxes payable 66,194 86,089 775,344
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 369,603 2,027,562 2,587,295
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchase of short-term investments -- (20,690,542) (19,567,255)
Redemption/maturity of short-term investments 74,219 8,347,950 15,643,221
Capital expenditures (1,040,062) (1,993,541) (1,230,910)
Patent expenditures (3,405) (4,760) --
Purchase of treasury stock -- -- (20,580)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (969,248) (14,340,893) (5,175,524)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net Repayments under line of credit (865,719) -- --
Payments on long-term debt (1,800,000) -- --
Purchase of stock warrants (1,253,708) -- --
Proceeds from issuance of common stock, net of
issuance costs 2,146,922 -- --
Proceeds from the exercise of stock options
including related tax benefits -- 1,803,106 1,180,900
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 15,017,019 1,747,217 1,180,900
- ------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 14,417,374 (10,566,114) (1,407,329)
Cash and cash equivalents at beginning of year 740,013 15,157,387 4,591,273
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 15,157,387 $ 4,591,273 $ 3,183,944
- ------------------------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ 79,101 $ 3,076 $ 3,271
Cash paid during the year for income taxes 658,765 2,013,981 2,420,460
Noncash financing and operating activities:
Issuance of restricted common stock at no cost 189,595 -- --
Tax benefit from vesting of restricted stock 29,200 -- --
Conversion of preferred stock to common stock 951,721 -- --
Conversion of preferred stock to common stock in treasury 7,000 -- --
Issuance costs for initial public offering in
accounts payable 328,816 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
17
<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.
INVESTMENTS:
Short-term investments at December 31, 1996 and 1997 consist of a treasury note
and/or individual municipal bonds stated at cost, which approximated market
value. These securities 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. Long-term investments are
individual municipal bonds with a maturity of more than one year but less than
eighteen months.
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 all 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.
PATENTS:
The costs of patents are being amortized on a straight-line method over a period
of five years.
18
<PAGE> 14
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 SFAS No. 109, "Accounting for Income
Taxes" (SFAS 109). Under SFAS 109, deferred tax liabilities and assets are
determined based on the "temporary differences" between the financial statement
carrying amounts and the tax basis of assets and liabilities using enacted tax
rates in effect in the years in which the differences are expected to reverse.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized.
PER SHARE INFORMATION:
Net income per share has been computed in accordance with the provisions of SFAS
No. 128, "Earnings Per Share" for all periods presented. The statement requires
companies with complex capital structures to report earnings per share on a
basic and diluted basis, as defined. Basic earnings per share are calculated on
the actual number of weighted average common shares outstanding for the period,
while diluted earnings per share must include the effect of any dilutive
securities. All prior periods have been restated in accordance with SFAS No.
128. A reconciliation of earnings per share is as follows:
<TABLE>
<CAPTION>
December 31,
1995 1996 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Income $ 2,521,827 $ 5,596,623 $ 6,883,148
- ---------------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding 4,227,648 5,500,884 5,686,182
- ---------------------------------------------------------------------------------------------------------------------------
Effect of dilutive securities - stock options 276,064 438,778 275,358
- ---------------------------------------------------------------------------------------------------------------------------
4,503,712 5,939,662 5,961,540
- ---------------------------------------------------------------------------------------------------------------------------
Earnings per share:
Basic $ .60 $ 1.02 $ 1.21
- ---------------------------------------------------------------------------------------------------------------------------
Diluted $ .56 $ .94 $ 1.15
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
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 1995
through the date of the initial public offering (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.
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 were retroactively restated to reflect the seven-for-ten reverse stock
split.
19
<PAGE> 15
4. INVENTORIES:
Inventories consisted of the following:
<TABLE>
<CAPTION>
December 31, 1996 DECEMBER 31, 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Raw materials $ 3,816,242 $ 5,738,576
Work in process 3,808,842 5,070,113
Finished goods 944,734 1,292,425
- ---------------------------------------------------------------------------------------------------------------------------
$ 8,569,818 $ 12,101,114
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
5. PROPERTY AND EQUIPMENT:
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31, 1996 DECEMBER 31, 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Test equipment and tooling $ 1,715,227 $ 2,409,088
Office equipment and fixtures 1,672,929 2,143,567
Leasehold improvements 854,637 921,049
- ---------------------------------------------------------------------------------------------------------------------------
4,242,793 5,473,704
Less accumulated depreciation and amortization 1,473,136 2,471,880
- ---------------------------------------------------------------------------------------------------------------------------
$ 2,769,657 $ 3,001,824
- ---------------------------------------------------------------------------------------------------------------------------
</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 adopted this standard in 1996 and the standard did not impact the
financial position and results of operations of the Company in 1996 or 1997.
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.
During April 1995, the Company repaid the entire balance outstanding of $865,719
on the line of credit. In addition, 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).
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 has been extended to June 30,
1998. 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, 1997, there were no outstanding borrowings under the credit
agreement.
7. SHAREHOLDERS' EQUITY:
PREFERRED STOCK:
The non-voting 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.
20
<PAGE> 16
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, 1996 and 1997, there are 5,620,417 and 5,727,350
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.
STOCK REPURCHASE PROGRAM:
On April 22, 1997, the Company's Board of Directors authorized a program to
repurchase up to 200,000 shares of its common stock over the next two years. The
shares will be utilized to provide stock under certain employee benefit
programs. The number of shares that the Company intends to purchase and the time
of such purchases will be determined by the Company, at its discretion. The
Company plans to use existing cash and short-term investments to finance the
purchases. As of December 31, 1997, the Company had purchased 1,000 shares of
the Company's common stock under this program.
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 1995, 18,960 shares of restricted stock under
the Plan were issued. Additionally, prior to 1995, the Company had granted a
total of 193,134 shares of restricted common stock to certain key employees, of
which 22,403 were granted under the provisions of the Plan. Effective upon
approval by the Company's Board of Directors of the 1995 Long-Term Incentive
Compensation Plan, the Plan was terminated. No shares of restricted stock were
granted under the 1995 Long-Term Incentive Compensation Plan in 1996 and 1997.
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 $63,939, $52,356 and $52,344 in 1995, 1996 and 1997,
respectively. In 1995, 1996 and 1997, -0-, 2,440 and 350 shares of restricted
stock, respectively, were forfeited due to the termination of certain employees.
Accordingly, the compensation expense recorded for these shares in prior periods
amounting to $-0-, $9,487 and $18,408 was reversed in 1995, 1996 and 1997,
respectively. At December 31, 1997, 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 August 1998.
STOCK COMPENSATION PLANS:
Under the Company's stock compensation 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.
21
<PAGE> 17
On April 22, 1997, the shareholders of the Company approved an amendment of the
1995 Long-Term Incentive Compensation Plan to increase the number of shares
authorized for issuance under the plan by 375,000 and to allow for inclusion of
non-employee directors under the plan. The shares authorized but not granted
under the Company's stock option plans were 126,168 at December 31, 1996 and
357,973 at December 31, 1997.
Prior to and during 1995, 1996 and 1997, certain employees of the Company were
granted stock options under the 1995 Long-Term Incentive Compensation Plan and
various other agreements. The Company has adopted the disclosure-only provisions
of SFAS No. 123 "Accounting for Stock-based Compensation," but applies
Accounting Principles Board Opinion No. 25 and related interpretations in
accounting for its plans. If the Company had elected to recognize compensation
cost for these stock options based on the fair value at the grant dates for
awards granted under those plans in 1995, 1996 and 1997 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 December 31, 1996 DECEMBER 31, 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income As reported $ 2,521,827 $ 5,596,623 $ 6,883,148
Pro forma $ 2,113,201 $ 4,687,153 $ 5,805,709
- ---------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share As reported $ .56 $ .94 $ 1.15
Pro forma $ .47 $ .79 $ .97
</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, 1996 and 1997: expected volatility of 40.4%; a risk free
interest rate of 5.44% in 1995, 5.64% in 1996 and 6.10% in 1997; 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, 1996 and 1997 is $5.40, $10.71 and $8.54, respectively.
Transactions involving stock options under the Company's various stock option
plans and otherwise are summarized below:
<TABLE>
<CAPTION>
Number of Shares Range of Option Price Weighted Average Exercise Price
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
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
Granted 135,750 17.50 - 25.13 21.50
Exercised (107,283) .957 - 17.50 4.42
Cancelled (5,055) 12.00 - 15.00 13.81
- ---------------------------------------------------------------------------------------------------------------------------
OUTSTANDING, DECEMBER 31, 1997 753,467 $ .957 - $ 25.75 $ 15.84
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Options exercisable at: Number of Shares Weighted Average Exercise Price
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
December 31, 1995 578,694 $ 5.61
December 31, 1996 542,369 10.33
DECEMBER 31, 1997 615,289 14.17
</TABLE>
22
<PAGE> 18
The following table summarizes the status of the stock options, outstanding and
exercisable at December 31, 1997:
<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>
$.957 89,000 1 year $ .957 89,000 $ .957
- ---------------------------------------------------------------------------------------------------------------------------
$2.14 30,100 1 year $ 2.14 30,100 $ 2.14
- ---------------------------------------------------------------------------------------------------------------------------
$12.00 to $17.50 302,617 8 years $ 12.76 298,949 $ 12.70
- ---------------------------------------------------------------------------------------------------------------------------
$21.00 to $25.75 331,750 9.3 years $ 23.89 197,240 $ 24.20
- ---------------------------------------------------------------------------------------------------------------------------
Total 753,467 $ 15.84 615,289 $ 14.17
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
Subsequent to December 31, 1997, the Board of Directors granted an additional
86,000 options to officers of the Company pursuant to the 1995 Long-Term
Incentive Compensation Plan, as well as an additional 81,000 options to
non-officers of the Company pursuant to a separate plan established by the Board
of Directors on January 29, 1998.
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.
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.
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
23
<PAGE> 19
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 $1,075,800, $1,893,000 and $2,014,000 were incurred
in 1995, 1996 and 1997, respectively, and are included in cost of product sales
in the accompanying consolidated statements of operations.
9. INCOME TAXES:
The provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
December 31,
1995 1996 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $ 641,400 $ 2,938,491 $ 3,726,200
State 84,600 316,252 421,000
- ---------------------------------------------------------------------------------------------------------------------------
726,000 3,254,743 4,147,200
- ---------------------------------------------------------------------------------------------------------------------------
Deferred:
Federal 640,000 (111,056) (28,160)
State 52,000 33,066 54,609
- ---------------------------------------------------------------------------------------------------------------------------
692,000 (77,990) 26,449
- ---------------------------------------------------------------------------------------------------------------------------
$ 1,418,000 $ 3,176,753 $ 4,173,649
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
Reconciliations of the federal statutory rate to the effective tax rates are as
follows:
<TABLE>
<CAPTION>
December 31,
1995 1996 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal statutory tax rate 34% 34% 34%
Research and development tax credit (3) (1) (2)
State income taxes 5 2 3
Other ---- 1 3
- ---------------------------------------------------------------------------------------------------------------------------
Effective tax rate 36% 36% 38%
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
The components of net deferred tax assets and liabilities were as follows:
<TABLE>
<CAPTION>
December 31,
1996 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
State net operating loss carryforwards $ 58,750 $ ----
Other, net 101,740 133,995
- ---------------------------------------------------------------------------------------------------------------------------
Total net deferred tax assets $ 160,490 $ 133,995
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
The Company had a state tax operating loss carryforward at December 31, 1996 of
approximately $500,000 which was utilized in 1997.
24
<PAGE> 20
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
May 2002. 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 $4,727 and $1,619 in 1997 and 1996, respectively,
and no additional rental payments in 1995.
<TABLE>
<CAPTION>
Minimum annual future rental commitments under noncancelable leases as of
December 31 are:
<S> <C>
1998.........................................................$397,985
1999...........................................................26,578
2000...........................................................26,578
2001...........................................................26,578
2002............................................................8,859
The rent expense for all lease commitments was approximately $273,000,
$335,000 and $354,000 in 1995, 1996 and 1997, 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 five Regional Bell Operating Companies (RBOCs)
as well as major independent telephone companies such as Sprint. Sales are
primarily from the Company's metallic channel unit ("MCU") product line. The MCU
product line accounted for more than 94% of the Company's net product sales for
1997. 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 95%, 86% and 86% of the Company's
net product sales for fiscal years 1995, 1996 and 1997, respectively. During
fiscal years 1995, 1996 and 1997, sales to two RBOCs comprised 65%, 60% and 54%,
respectively, of the Company's net product sales. At December 31, 1996 and 1997,
accounts receivable-trade included in the consolidated balance sheets related to
these two RBOCs was approximately $3,034,000 and $3,819,000, 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.
For a portion of 1997 and prior years, the Company utilized one key independent
subcontractor to perform a majority of the circuit board assembly and in-circuit
testing work on its products. The Company also utilized other subassembly
contractors on a more limited basis. During the third quarter, 1997, the key
subassembly subcontractor notified the Company that, due to a change in its
business strategy, only customers that provide certain volume levels of business
would be sought or retained. As a result of this evaluation, the key subassembly
subcontractor notified the Company that its services would be phased out, at the
latest, during early 1998. The Company is in the process of phasing out the use
of the subcontractor, and is now utilizing two other subassembly subcontractors
that had been utilized by the Company on a more limited basis in the past. 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 or a reduction in the capacity for any
reason of the Company's key subassembly contractors could cause a delay in
manufacturing and a possible loss of sales, which would affect operating results
adversely.
12. EMPLOYEE BENEFIT PLANS:
The Company 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.
25
<PAGE> 21
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,
1996 1996 1996 1996 1997 1997 1997 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues $6,849 $10,182 $10,080 $10,379 $8,619 $12,115 $11,363 $13,324
Cost of product sales 3,463 4,971 5,000 4,888 3,789 5,454 5,226 5,635
- ---------------------------------------------------------------------------------------------------------------------------
Gross profit 3,386 5,211 5,080 5,491 4,830 6,661 6,137 7,689
Operating expenses:
Selling and marketing 892 1,259 1,234 1,382 1,046 1,334 1,287 1,779
General and administrative 480 596 672 804 831 914 948 1,075
Research and development 713 878 1,044 1,286 1,241 1,425 1,517 1,762
- ---------------------------------------------------------------------------------------------------------------------------
Total operating expenses 2,085 2,733 2,950 3,472 3,118 3,673 3,752 4,616
- ---------------------------------------------------------------------------------------------------------------------------
Income from operations 1,301 2,478 2,130 2,019 1,712 2,988 2,385 3,073
Other income, net 204 184 90 367 177 239 221 261
- ---------------------------------------------------------------------------------------------------------------------------
Income before income taxes 1,505 2,662 2,220 2,386 1,889 3,227 2,606 3,334
Provision for income taxes 548 1,050 824 754 710 1,194 999 1,270
- ---------------------------------------------------------------------------------------------------------------------------
Net income $ 957 $ 1,612 $ 1,396 $ 1,632 $1,179 $2,033 $ 1,607 $ 2,064
- ---------------------------------------------------------------------------------------------------------------------------
Net income per common share
Basic $ .18 $ .30 $ .25 $ .29 $ .21 $ .36 $ .28 $ .36
Diluted $ .16 $ .27 $ .23 $ .27 $ .20 $ .34 $ .27 $ .35
Weighted average shares
of common stock and equivalents:
Basic 5,444 5,446 5,504 5,612 5,632 5,677 5,709 5,725
Diluted 5,858 5,942 5,940 5,978 5,976 5,942 5,955 5,975
</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>
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
1997:
FIRST QUARTER $30-3/4 $18-1/4
SECOND QUARTER 24 17
THIRD QUARTER 23-1/2 20
FOURTH QUARTER 26-3/8 20-1/2
</TABLE>
At March 3, 1998, the Company had 410 holders of record of its Common Stock and
5,837,766 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).
26
<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 27, 1998, on our audits of the
consolidated financial statements and financial statement schedule of Tollgrade
Communications Inc. and Subsidiaries as of December 31, 1997 and 1996, and for
each of the three years in the period ended December 31, 1997, which report is
incorporated by reference or included in this Form 10-K.
/s/ COOPERS & LYBRAND L.L.P.
Pittsburgh, Pennsylvania
March 18, 1998
37
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1997.
</LEGEND>
<CIK> 0001002531
<NAME> TOLLGRADE COMMUNICATIONS, INC.
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 3,183,944
<SECURITIES> 15,666,626
<RECEIVABLES> 8,451,773
<ALLOWANCES> 50,000
<INVENTORY> 12,101,114
<CURRENT-ASSETS> 39,975,925
<PP&E> 5,473,704
<DEPRECIATION> 2,471,880
<TOTAL-ASSETS> 43,713,212
<CURRENT-LIABILITIES> 5,405,713
<BONDS> 0
0
0
<COMMON> 1,145,470
<OTHER-SE> 36,955,913
<TOTAL-LIABILITY-AND-EQUITY> 43,713,212
<SALES> 44,546,135
<TOTAL-REVENUES> 45,421,135
<CGS> 20,104,202
<TOTAL-COSTS> 20,104,202
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 50,000
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 11,056,797
<INCOME-TAX> 4,173,649
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,883,148
<EPS-PRIMARY> 1.21
<EPS-DILUTED> 1.15
</TABLE>
