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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, 1998
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
--- ---
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 12, 1999, the aggregate market value
of shares of the Registrant's Common Stock held by non-affiliates (excluding for
purposes of this calculation only, 369,664 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 $87,963,024.
As of March 12, 1999, the Registrant had outstanding 5,932,543 shares 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, 1998 II and IV
Portions of the Proxy Statement to be distributed
in connection with the 1999 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 1998 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 relate 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 test access and
test extension products for the telecommunications and cable television
industries. The Company's telecommunication proprietary products enable
telephone companies to use their existing line test systems to remotely diagnose
problems in "plain old telephone service" ("POTS") lines containing both copper
and fiber optics. POTS lines comprise the vast majority of lines in service
today throughout the world. In addition to traditional voice service, POTS
includes lines for popular devices such as computer modems and fax machines.
POTS excludes the more complex lines, such as data communications service lines,
commonly referred to as "special services."
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
Lucent (formerly part of AT&T), that are used by telephone companies to link the
copper and fiber-optic portions of the local loop. DLC systems are located at
the telephone company central offices and at remote sites within a local user
area, and effectively multiplex the services of the copper lines into a single
fiber-optic line. In many instances, several DLC systems are located at a single
remote site to serve several thousand different end-user homes and offices.
Generally, for every DLC remote site, 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
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the DLC system manufacturer from which they are purchased. The Company maintains
license agreements with and pays royalties to Lucent Technologies, Fujitsu
Network Transmission Systems, Inc., NEC American, Inc. and Reliance Comm/Tec
Corporation. In general, the current terms for expiration of these agreements
range at various times between August 1999 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 $1,893,000, $2,014,000 and $2,069,000 respectively
in 1996, 1997 and 1998 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., Next Level Communications and SAGEM SA (a French
corporation). The expiration dates of these agreements range at various times
between May 1999 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%, 94% and 90% of the Company's sales in 1996, 1997
and 1998, respectively.
The Company's cable products consist of a complete cable status
monitoring system that provides a comprehensive testing solution for the
Broadband Hybrid Fiber Coax distribution system. The status monitoring system
consists of a host for user interface, control and configuration; a headend
controller for managing network communications; and transponders that are
strategically located within the cable network to gather status reports from
power supplies, line amplifiers and fiber-optic nodes. The Company has entered
into a license agreement with C-Cor Electronics, Inc. (a cable television
systems developer) in which the Company provides its status monitoring
transponder technology that is incorporated into C-Cor's cable network
management system. In 1998, the Company, under certain other business
arrangements, also shipped cable products to ANTEC and General Instrument.
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 1996, 1997 and 1998, research and development expenses were approximately
$3,921,000, $5,945,000 and $6,880,000, respectively.
Proprietary Rights. The names "Tollgrade(R)", "MCU(R)" and
"Micro-Bank(R)", and the Company's corporate logo are registered trademarks of
the Company. "Team Tollgrade(SM)" is a service mark of the Company. The Company
has also applied for trademark registration for "Lighthouse(TM)", "Digitest(TM)"
and "Telaccord(TM)". 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 two U.S. provisional, two United States, one Canada and three
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 telecommunication 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. Historically, almost all of the Company's sales have
been made to the RBOCs (79% in 1998). Bell Atlantic Corporation and BellSouth
Corporation accounted for 29% and 25%, respectively, of the Company's total
sales in 1998. The Company's primary cable product customers are Original
Equipment Manufacturers ("OEM") cable equipment manufacturers such as C-Cor
Electronics, Inc., ANTEC and General Instruments. Sales of the Company's cable
products in 1998 were less than [2%] of total revenues. The Company's
relationships with its customers are material to the Company's business, and the
loss of any such relationship could have a material adverse effect on the
Company's business.
Manufacturing. The Company's manufacturing operations consist primarily
of quality control, functional testing, final assembly, burn-in and shipping.
The Company is ISO 9001 registered from the British Standards Institution, Inc.
ISO 9000 is a harmonized set of standards that define quality assurance
management. Written by the International Organization for Standardization
("ISO"), it is recognized throughout the United States, Canada, the European
Union and Japan. To be registered, the Company develops and maintains internal
documentation and processes to support the production of quality products to
ensure customer satisfaction.
The Company utilizes two key independent subcontractors to perform a
majority of the circuit board assembly and in-circuit testing work on its
products. The Company also utilizes other subassembly contractors on a more
limited basis. The loss of the subcontractors could cause delays in the
Company's ability to meet production obligations and could have a material
adverse effect on the Company's results of operations. In addition, shortages of
raw material to, or production capacity constraints at, the Company's
subcontractors could negatively affect the Company's ability to meet its
production obligations and result in increased prices for affected parts. Any
such reduction may result in delays in shipments of the Company's products or
increases in the price of components, either of which could have a material
adverse impact on the Company.
The Company currently procures all of its components from outside
suppliers. Generally, the Company uses industry standard components for its
products. Application specific integrated circuits ("ASICs") are a key component
to the manufacturing process and are custom made to the Company's
specifications. Although the Company has generally been able to obtain ASICs on
a timely basis, a delay in the delivery of these components could have a
material adverse impact on the Company.
Backlog. The Company's backlog at December 31, 1998 was approximately
$0.6 million, as compared to approximately $1.6 million at December 31, 1997. At
December 31, 1998, the composition of the backlog related primarily to one
customer order, while backlog at December 31, 1997 consisted of several customer
orders. 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. 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 telecommunications reform legislation has lifted the
restrictions which previously prevented the RBOCs from manufacturing
telecommunications equipment. Pursuant to this legislative
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reform, the RBOCs, which are the Company's largest customers, may become
competitors of the Company in the markets served by the Company.
For the Company's line-testing MCU devices, the primary competitive
products are the remote monitoring units made by Teradyne, Inc. and the Harris
Dracon division of Harris Corporation. In addition, the Wiltron Company, Inc.
offers the Wiltron LoopMATE(R), a modular remote test head, which competes with
the Company's POTS testing capabilities. 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 the Tau-Tron division of General Signal Corporation, which
provides special services test systems, could also expand into POTS line
testing. The alarm-related MCU product's primary competitor is the Turbo 2000
unit made by ANTEC Corporation. For the Company's cable products, the primary
competitors for status monitoring are Cheetah Technologies and AM
Communications, Inc.
Employees. At December 31, 1998, the Company had 230 full-time
employees, all in the United States. None of the Company's employees are
represented by a collective bargaining agreement.
Government Regulation. The telecommunications industry is subject to
regulation in the United States and other countries. Federal and state
regulatory agencies, including the FCC and various state public utility
commissions and public service commissions, regulate most of the Company's
domestic customers. While such regulation does not typically affect the Company
directly, the effects of such regulations on the Company's customers may, in
turn, adversely impact the Company's business and operating results.
Governmental authorities also have promulgated regulations which, among other
things, set installation and equipment standards for private telecommunications
systems and require that all newly installed hardware be registered and meet
certain government standards.
ITEM 2. PROPERTIES.
The Company's headquarters and principal administrative, engineering
and assembly facilities are located in Cheswick, Pennsylvania and occupy
approximately 104,400 square feet. The Company occupies its current facilities
under a lease that expires in December, 2001 with an option to renew the term of
the lease for one additional period of three years. 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 1998, 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,
1999 is set forth below:
Christian L. Allison Chairman of the Board, since April 1998; Chief
Executive Officer since September 1995; Treasurer from
May 1992 until April 1997; President since October
1993; prior thereto, Chief Operating Officer; Director
since 1992; Age 38.
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 37.
Robert L. Cornelia Executive Vice President, Operations since May 1996;
prior thereto; Vice President, Manufacturing; Age 36.
Bradley N. Dinger Controller since September 1996; prior thereto,
Assistant Controller of AMSCO International, Inc.
(manufacturer of health care equipment); Age 36.
Herman Flaminio Executive Vice President, Marketing Services, Planning
and Technical Support since July 1997; prior thereto,
Senior Vice President, Marketing and Strategic
Products; brother of Rocco L. Flaminio, Vice Chairman,
Chief Technology Officer and a Director; Age 59.
Rocco L. Flaminio Vice Chairman and Chief Technology Officer since
October 1993; Director since December 1995; brother of
Herman Flaminio, Executive Vice President; Age 74.
Mark C. Frey Senior Vice President, Engineering since 1993; Age 45.
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; prior thereto,
Director of Internal Audit at AMSCO; Age 43.
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 39.
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 38.
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
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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 management; Age 38.
Matthew J. Rosgone Senior Vice President, Purchasing/Manufacturing since
July 1998; Vice President, Purchasing from July 1996
until July 1998; Director of Purchasing from July 1995
until July 1996; prior thereto, Buyer; Age 30.
Roger A. Smith Senior Vice President, Test Systems since July 1998;
Engineering Manager from June 1997 until July 1998;
Senior Software Engineer from June 1996 until June
1997; prior thereto, Senior Software Development
Engineer of Caldon Inc., (a manufacturer of ultrasonic
flow meters for nuclear power industry); Age 38.
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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 27 of the Company's 1998 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, 1998, is set forth
under the caption "Selected Consolidated Financial Data" on page 7 of the
Company's 1998 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 13 of the
Company's 1998 Annual Report to Shareholders and is incorporated herein by
reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company's consolidated financial statements, together with the
report thereon of PricewaterhouseCoopers LLP, are set forth on pages 15 through
26 of the Company's 1998 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 1999 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 1999 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
1999 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 1999 Annual
Meeting of Shareholders and is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) The following financial statements and supplementary data are
incorporated in Item 8 of Part II of this Form 10-K by reference to pages 14
through 27 of the Company's 1998 Annual Report to Shareholders, which are
incorporated herein by reference:
Statement of Management's Responsibility for Financial Reporting, dated
January 25, 1999
Report of Independent Accountants, dated January 25, 1999
Consolidated Balance Sheets at December 31, 1997 and 1998
Consolidated Statements of Operations for each of the three years in
the period ended December 31, 1998
Consolidated Statements of Shareholders' Equity for the three years
ended December 31, 1998
Consolidated Statements of Cash Flows for the three years ended
December 31, 1998
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:
Exhibit
Number Description
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3.1 Amended and Restated Articles of Incorporation of the Company, as
amended through May 6, 1998 (conformed copy), filed herewith.
3.1a Statement with Respect to Shares dated July 23, 1996 (conformed copy),
filed herewith.
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 A to the
Company's 1997 Proxy Statement 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 to the Annual
Report of Tollgrade Communications, Inc. on Form
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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 to 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 to 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 to 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, Herman
Flaminio, Rocco Flaminio, Mark Frey, Samuel Knoch, and Matthew Rosgone,
filed as Exhibit 10.1 to 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 to 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 to 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 to 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 to 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 as Exhibit 10.21 to the Annual Report of the Company on Form 10-K
for the year ended December 31, 1997 (the "1997 Form 10-K").
10.22* 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 to 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 to 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 as Exhibit 10.24 to the 1997 Form
10-K.
10.25* Form of Non-employee Director Stock Option Agreement with respect to
the Company's 1995 Long-Term Incentive Compensation Plan, filed as
Exhibit 10.25 to the 1997 Form 10-K.
10.26* Change of Control Agreement, entered into July 17, 1997 between the
Company and Roger A. Smith, filed herewith.
10.27* 1998 Employee Incentive Compensation Plan, filed herewith.
10.28* Amendment to Employment Agreement, dated as of December 30, 1998,
between the Company and Christian L. Allison, filed herewith.
13.1 Company's 1998 Annual Report to Shareholders, filed herewith.
21.1 List of subsidiaries of the Company, filed as Exhibit 21.1 to the S-1
and incorporated herein by reference thereto.
23.1 Consent of PricewaterhouseCoopers LLP, filed herewith.
27 Financial Data Schedule
* 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, 1998.
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 24, 1999.
TOLLGRADE COMMUNICATIONS, INC.
By /s/ Christian L. Allison
---------------------------------------
Christian L. Allison
Chairman, President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the Company and in the capacities indicated as of March 24, 1999.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/Christian L. Allison Director, Chairman, President and Chief
- -------------------------------------- Executive Officer,
Christian L. Allison (Principal Executive Officer)
/s/James J. Barnes Director
- --------------------------------------
James J. Barnes
/s/Daniel P. Barry Director
- --------------------------------------
Daniel P. Barry
/s/David S. Egan Director
- --------------------------------------
David S. Egan
/s/Rocco L. Flaminio Director, Vice Chairman
- -------------------------------------- and Chief Technology Officer
Rocco L. Flaminio
/s/Richard H. Heibel, M.D. Director
- --------------------------------------
Richard H. Heibel, M.D.
/s/Robert W. Kampmeinert Director
- --------------------------------------
Robert W. Kampmeinert
/s/Samuel C. Knoch Chief Financial Officer and Treasurer
- -------------------------------------- (Principal Financial Officer)
Samuel C. Knoch
/s/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 15 of the 1998 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/ PRICEWATERHOUSECOOPERS LLP
Pittsburgh, Pennsylvania
January 25, 1999
14
<PAGE> 15
SCHEDULE II
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 1996, 1997 and 1998
(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, 1996 $120 $ 95 $ -- $ -- $215
Year ended December 31, 1997 215 -- -- (36) 179
Year ended December 31, 1998 179 88 -- -- 267
Allowance for doubtful accounts:
Year ended December 31, 1996 $ -- $ -- $ -- $ -- $ --
Year ended December 31, 1997 -- 50 -- -- 50
Year ended December 31, 1998 50 50 -- -- 100
Warranty reserve:
Year ended December 31, 1996 $ 45 $155 $ -- $ -- $200
Year ended December 31, 1997 200 100 -- -- 300
Year ended December 31, 1998 300 135 -- -- 435
</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, as
amended through May 6, 1998 (conformed copy), filed herewith.
3.1a Statement with Respect to Shares dated July 23, 1996 (conformed copy),
filed herewith.
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 A to the
Company's 1997 Proxy statement 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>
<CAPTION>
<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 to 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 to the 1995
Form 10-K. *
</TABLE>
17
<PAGE> 18
<TABLE>
<CAPTION>
<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 to 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 to 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, Herman
Flaminio, Rocco Flaminio, Mark Frey, Samuel Knoch, and Matthew Rosgone,
filed as Exhibit 10.1 to the Report 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 to 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 to 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 to 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 as Exhibit 10.21 to the Annual Report of the Company on Form 10-K
for the year ended December 31, 1997 (the "1997 Form 10-K"). *
10.22 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 to the Report on Form 10-Q of the Company
filed on November 10, 1997. *
</TABLE>
18
<PAGE> 19
<TABLE>
<CAPTION>
<S> <C> <C>
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 to 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 as Exhibit 10.24 to the 1997 Form
10-K. *
10.25 Form of Non-employee Director Stock Option Agreement with respect to
the Company's Long-Term Incentive Compensation Plan, filed as Exhibit
10.25 to the 1997 Form 10-K. *
10.26 Change of Control Agreement, entered into July 17, 1997 between the
Company and Roger A. Smith, filed herewith.
10.27 1998 Employee Incentive Compensation Plan, filed herewith.
10.28 Amendment to Employment Agreement, dated as of December 30, 1998,
between the Company and Christian L. Allison, filed herewith.
13.1 Company's 1998 Annual Report to Shareholders, filed herewith.
21.1 List of subsidiaries of the Company, filed as Exhibit 21.1 to the S-1
and incorporated herein by reference thereto. *
23.1 Consent of PricewaterhouseCoopers LLP, filed herewith.
27 Financial Data Schedule
</TABLE>
- ----------------
* Incorporated by reference.
19
<PAGE> 1
[CONFORMED COPY] Exhibit 3.1
AMENDED AND RESTATED
ARTICLES OF INCORPORATION
OF
TOLLGRADE COMMUNICATIONS, INC.
1. Name. The name of the Corporation is Tollgrade Communications, Inc.
2. Address of Registered Office. The address of the Corporation's
registered office in the Commonwealth of Pennsylvania is 493 Nixon Road,
Cheswick, Allegheny County, PA 15024.
3. Capital Stock. (a) Generally. The authorized capital stock of the
Corporation shall be: 25,000,000 shares of Common Stock, par value of $.20 per
share, and 10,000,000 shares of Preferred Stock, par value of $1.00 per share.
(b) Preferred Stock. The Board of Directors is authorized, at any time
or from time to time, to divide any or all of the shares of Preferred Stock into
one or more series, and in the resolution or resolutions establishing the series
to fix and determine the number of shares and the designation of such series, so
as to distinguish it from the shares of all other series and classes, and to fix
and determine the voting rights, preferences, limitations, qualifications,
privileges, options, conversion rights, restrictions and other special or
relative rights of the Preferred Stock or of such series, to the fullest extent
now or hereafter permitted by the laws of the Commonwealth of Pennsylvania
including, but not limited to, the variations between different series in the
following respects: (i) the distinctive designation of such series and the
number of shares which shall constitute such series, which number may be
increased or decreased (but not below the number of shares thereof then
outstanding) from time to time by the Board of Directors; (ii) the annual
dividend rate for such series, and the date or dates from which dividends shall
commence to accrue; (iii) the price or prices at which, and the terms and
conditions on which, the shares of such series may be made redeemable; (iv) the
purchase or sinking fund provisions, if any, for the purchase of redemption of
shares of such series; (v) the preferential amount or amounts payable upon
shares of such series in the event of liquidation, dissolution, or winding up of
the Corporation; (vi) the voting rights, if any, of shares of such series; (vii)
the terms and conditions, if any, upon which shares of such series may be
converted and the class or classes or series of shares of the Corporation or
other securities into which such shares may be converted; (viii) the relative
seniority, priority or junior rank of such series as to dividends or assets with
respect to any other classes or series of stock then or thereafter to be issued;
and (ix) such other terms, qualifications, privileges, limitations, options,
restrictions, and special or relative rights and preferences, if any, of shares
of such series as the Board of Directors may, at the time of such resolution or
resolutions, lawfully fix or determine
1
<PAGE> 2
under the laws of the Commonwealth of Pennsylvania. Unless otherwise provided in
a resolution or resolutions establishing any particular series of Preferred
Stock, the aggregate number of authorized shares of Preferred Stock may be
increased by an amendment to the Articles approved solely by the holders of the
Common Stock. The Common Stock shall be subject to the prior rights and
preferences, if any, of any series of Preferred Stock outstanding according to
the terms of such series.
(c) No Cumulative Voting. Shareholders shall not be entitled to
cumulative voting rights in the election of directors.
2
<PAGE> 1
[CONFORMED COPY] Exhibit 3.1a
STATEMENT WITH RESPECT TO SHARES
of
SERIES A JUNIOR PARTICIPATING PREFERRED STOCK
of
TOLLGRADE COMMUNICATIONS, INC.
(Pursuant to Section 1522 (c) of the Pennsylvania Business
Corporation Law of 1998)
- -------------------------------------------------------------------------------
In compliance with the requirements of Section 1522(c) of Pennsylvania
Business Corporation Law of 1988 (the "BCL"), Tollgrade Communications, Inc., a
corporation organized and existing under the BCL (the "Corporation"), hereby
certifies that:
1. The name of the Corporation is Tollgrade Communications, Inc.
2. The resolution ("Resolution") duly adopted by the Board of Directors
of the Corporation establishing and designating a series of the Corporation's
Preferred Stock, par value $1.00 per share, and fixing and determining the
relative rights and preferences thereof is as follows:
RESOLVED, that pursuant to the authority granted to and vested in the
Board of Directors of this Corporation (hereinafter called the "Board of
Directors" or the "Board") in accordance with the provisions of the Amended and
Restated Articles of Incorporation, the Board of Directors hereby creates a
series of Preferred Stock, par value $1.00 per share (the "Preferred Stock"), of
the Corporation and hereby states the designation and number of shares, and
fixes the relative rights, preferences, and limitations thereof as follows:
Series A Junior Participating Preferred Stock:
Section 1. Designation and Amount. The shares of such series shall be
designated as "Series A Junior Participating Preferred Stock" (the "Series A
Preferred Stock"), and the number of shares constituting the Series A Preferred
Stock shall be 100,000. Such number of shares may be increased or decreased by
resolution of the Board of Directors; provided, that no decrease shall reduce
the number of shares of Series A Preferred Stock to a number less than the
number of shares then outstanding plus the number of shares reserved for
issuance upon the exercise of outstanding options, rights or warrants or upon
the conversion of any outstanding securities issued by the Corporation
convertible into Series A Preferred Stock.
1
<PAGE> 2
Section 2. Dividends and Distributions.
(A) Subject to the rights of the holders of any shares of any series of
Preferred Stock (or any similar stock) ranking prior and superior to the Series
A Preferred Stock with respect to dividends, the holders of shares of Series A
Preferred Stock, in preference to the holders of Common Stock, par value $0.20
per share (the "Common Stock"), of the Corporation, and of any other junior
stock, shall be entitled to receive, when, as and if declared by the Board of
Directors out of funds legally available for the purpose, quarterly dividends
payable in cash on the first day of March, June, September and December in each
year (each such date being referred to herein as a "Quarterly Dividend Payment
Date"), commencing on the first Quarterly Dividend Payment Date after the first
issuance of a share or fraction of a share of Series A Preferred Stock, in an
amount per share (rounded to the nearest cent) equal to the greater of (a) $1 or
(b) subject to the provision for adjustment hereinafter set forth, 100 times the
aggregate per share amount of all cash dividends, and 100 times the aggregate
per share amount (payable in kind) of all non-cash dividends or other
distributions, other than a dividend payable in shares of Common Stock or a
subdivision of the outstanding shares of Common Stock (by reclassification or
otherwise), declared on the Common Stock since the immediately preceding
Quarterly Dividend Payment Date or, with respect to the first Quarterly Dividend
Payment Date, since the first issuance of any share or fraction of a share of
Series A Preferred Stock. In the event the Corporation shall at any time declare
or pay any dividend on the Common Stock payable in shares of Common Stock, or
effect a subdivision or combination or consolidation of the outstanding shares
of Common Stock (by reclassification or otherwise than by payment of a dividend
in shares of Common Stock) into a greater or lesser number of shares of Common
Stock, then in each such case the amount to which holders of shares of Series A
Preferred Stock were entitled immediately prior to such event under clause (b)
of the preceding sentence shall be adjusted by multiplying such amount by a
fraction, the numerator of which is the number of shares of Common Stock
outstanding immediately after such event and the denominator of which is the
number of shares of Common Stock that were outstanding immediately prior to such
event.
(B) The Corporation shall declare a dividend or distribution on the
Series A Preferred Stock as provided in subsection (A) of this Section
immediately after it declares a dividend or distribution on the Common Stock
(other than a dividend payable in shares of Common Stock); provided that, in the
event no dividend or distribution shall have been declared on the Common Stock
during the period between any Quarterly Dividend Payment Date and the next
subsequent Quarterly Dividend Payment Date, a dividend of $1 per share on the
Series A Preferred Stock shall nevertheless be payable on such subsequent
Quarterly Dividend Payment Date.
(C) Dividends shall begin to accrue and be cumulative on outstanding
shares of Series A Preferred Stock from the Quarterly Dividend Payment Date next
preceding the date of issue of such shares, unless the date of issue of such
2
<PAGE> 3
shares is prior to the record date for the first Quarterly Dividend Payment
Date, in which case dividends on such shares shall begin to accrue from the date
of issue of such shares, or unless the date of issue is a Quarterly Dividend
Payment Date or is a date after the record date for the determination of holders
of shares of Series A Preferred Stock entitled to receive a quarterly dividend
and before such Quarterly Dividend Payment Date, in either of which events such
dividends shall begin to accrue and be cumulative from such Quarterly Dividend
Payment Date. Accrued by unpaid dividends shall not bear interest. Dividends
paid on the shares of Series A Preferred Stock in an amount less than the total
amount of such dividends at the time accrued and payable on such shares shall be
allocated pro rata on a share-by-share basis among all such shares at the time
outstanding. The Board of Directors may fix a record date for the determination
of holders of shares of Series A Preferred Stock entitled to receive payment of
a dividend or distribution declared thereon, which record date shall be not more
than 60 days prior to the date fixed for the payment thereof.
Section 3. Voting Rights. The holders of shares of Series A Preferred
Stock shall have the following voting rights:
(A) Subject to the provision for adjustment hereinafter set forth, each
share of Series A Preferred Stock shall entitle the holder thereof to 100 votes
on all matters submitted to a vote of the shareholders of the Corporation. In
the event the Corporation shall at any time declare or pay any dividend on the
Common Stock payable in shares of Common Stock, or effect a subdivision or
combination or consolidation of the outstanding shares of Common Stock (by
reclassification or otherwise than by payment of a dividend in shares of Common
Stock) into a greater or lesser number of shares of Common Stock, then in each
such case the number of votes per share to which holders of shares of Series A
Preferred Stock were entitled immediately prior to such event shall be adjusted
by multiplying such number by a fraction, the numerator of which is the number
of shares of Common Stock that were outstanding immediately prior to such event
and the denominator of which is the number of shares of Common Stock that were
outstanding immediately prior to such event.
(B) Except as otherwise provided herein, in any other Statement With
Respect to Shares creating a series of Preferred Stock or any similar stock, or
by law, the holders of shares of Series A Preferred Stock and the holders of
shares of Common Stock and any other capital stock of the Corporation having
general voting rights shall vote together as one class on all matters submitted
to a vote of shareholders of the Corporation.
3
<PAGE> 4
(C) Except as set forth herein, or as otherwise provided by law,
holders of Series A Preferred Stock shall have no special voting rights and
their consent shall not be required (except to the extent they are entitled to
vote with holders of Common Stock as set forth herein) for taking any corporate
action.
Section 4. Certain Restrictions.
(A) Whenever quarterly dividends or other dividends or distributions
payable on the Series A Preferred Stock as provided in Section 2 are in arrears,
thereafter and until all accrued and unpaid dividends and distributions, whether
or not declared, on shares of Series A Preferred Stock outstanding shall have
been paid in full, the Corporation shall not:
(i) declare or pay dividends, or make any other distributions,
on any shares of stock ranking junior (either as to dividends or upon
liquidation, dissolution or winding up) to the Series A Preferred
Stock;
(ii) declare or pay dividends, or make any other
distributions, on any shares of stock ranking on a parity (either as to
dividends or upon liquidation, dissolution or winding up) with the
Series A Preferred Stock, except dividends paid ratably on the Series A
Preferred Stock and all such parity stock on which dividends are
payable or in arrears in proportion to the total amounts to which the
holders of all such shares are then entitled;
(iii) redeem or purchase or otherwise acquire for
consideration shares of any stock ranking junior (either as to
dividends or upon liquidation, dissolution or winding up) to the Series
A Preferred Stock, provided that the Corporation may at any time
redeem, purchase or otherwise acquire shares of any such junior stock
in exchange for shares of any stock of the Corporation ranking junior
(either as to dividends or upon dissolution, liquidation or winding up)
to the Series A Preferred Stock; or
(iv) redeem or purchase or otherwise acquire for consideration
any shares of Series A Preferred Stock, or any shares of stock ranking
on a parity with the Series A Preferred Stock, except in accordance
with a purchase offer made in writing or by publication (as determined
by the Board of Directors) to all holders of such shares upon such
terms as the Board of Directors, after consideration of the respective
annual dividend rates and other relative rights and preferences of the
respective series and classes, shall determine in good faith will
result in fair and equitable treatment among the respective series or
classes.
4
<PAGE> 5
(B) The Corporation shall not permit any subsidiary of the Corporation
to purchase or otherwise acquire for consideration any shares of stock of the
Corporation to purchase or otherwise acquire for consideration any shares of
stock of the Corporation unless the Corporation could, under subsection (A) of
this Section 4, purchase or otherwise acquire such shares at such time and in
such manner.
Section 5. Reacquired Shares. Any shares of Series A Preferred Stock
purchased or otherwise acquired by the Corporation in any manner whatsoever
shall be retired and cancelled promptly after the acquisition thereof. All such
shares shall upon their cancellation become authorized but unissued shares of
Preferred Stock and may be reissued as part of the same or a new series of
Preferred Stock subject to the conditions and restrictions on issuance set forth
herein, in the Amended and Restated Articles of Incorporation, or in any other
Statement With Respect to Shares creating a series of Preferred Stock or any
similar stock or as otherwise required by law.
Section 6. Liquidation, Dissolution or Winding Up. Upon any
liquidation, dissolution or winding up of the Corporation, no distribution shall
be made (1) to the holders of shares of stock ranking junior (either as to
dividends or upon liquidation, dissolution or winding up) to the Series A
Preferred Stock unless, prior thereto, the holders of shares of Series A
Preferred Stock shall have received $100 per share, plus an amount equal to
accrued and unpaid dividends and distributions thereon, whether or not declared,
to the date of such payment, provided that the holders of shares of Series A
Preferred Stock shall be entitled to receive an aggregate amount per share,
subject to the provision for adjustment hereinafter set forth, equal to 100
times the aggregate amount to be distributed per share to holders of shares of
Common Stock, or (2) to the holders of shares of stock ranking on a parity
(either as to dividends or upon liquidation, dissolution or winding up) with the
Series A Preferred Stock, except distributions made ratably on the Series A
Preferred Stock and all such parity stock in proportion to the total amounts to
which the holders of all such shares are entitled upon such liquidation,
dissolution or winding up. In the event the Corporation shall at any time
declare or pay any dividend on the Common Stock payable in shares of Common
Stock, or effect a subdivision or combination or consolidation of the
outstanding shares of Common Stock (by reclassification or otherwise than by
payment of a dividend in shares of Common Stock) into a greater or lesser number
of shares of Common Stock, then in each such case the aggregate amount to which
holders of shares of Series A Preferred Stock were entitled immediately prior to
such event under the proviso in clause (1) of the preceding sentence shall be
adjusted by multiplying such amount by a fraction the numerator of which is the
number of shares of Common Stock outstanding immediately after such event and
the denominator of which is the number of shares of Common Stock that were
outstanding immediately prior to such event.
Section 7. Consolidation, Merger, etc. In case the Corporation shall
enter into any consolidation, merger, combination or other transaction in which
the shares of Common combination or other transaction in which the shares of
Common Stock are exchanged for or changed into other stock or securities, cash
and/or any other property, then in any such case each share of Series A
5
<PAGE> 6
Preferred Stock shall at the same time be similarly exchanged or changed into an
amount per share, subject to the provision for adjustment hereinafter set forth,
equal to 100 times the aggregate amount of stock, securities, cash and/or any
other property (payable in kind), as the case may be, into which or for which
each share of Common Stock is changed or exchanged. In the event the Corporation
shall at any time declare or pay any dividend on the Common Stock payable in
shares of Common Stock, or effect a subdivision or combination or consolidation
of the outstanding shares of Common Stock (by reclassification or otherwise than
by payment of a dividend in shares of Common Stock) into a greater or lesser
number of shares of Common Stock, then in each such case the amount set forth in
the preceding sentence with respect to the exchange or change of shares of
Series A Preferred Stock shall be adjusted by multiplying much [sic] amount by a
fraction, the numerator of which is the number of shares of Common Stock
outstanding immediately after such event and the denominator of which is the
number of shares of Common Stock that were outstanding immediately prior to such
event.
Section 8. No Redemption. The shares of Series A Preferred Stock shall
not be redeemable.
Section 9. Rank. Except as otherwise set forth in the Amended and
Restated Articles of Incorporation or in the Statement With Respect to Shares
creating another series of Preferred Stock or any other class or series of
stock, the Series A Preferred Stock shall rank, with respect to the payment of
dividends and the distribution of assets, junior to all other series of the
Corporation's Preferred Stock and to any other class or series of stock other
than the Common Stock, whether now existing or hereafter created.
Section 10. Amendment. The Amended and Restated Articles of
Incorporation of the Corporation shall not be amended in any manner which would
materially alter or change the powers, preferences or special rights of the
Series A Preferred Stock so as to affect them adversely without the affirmative
vote of a majority of the votes cast at a meeting of shareholders by the holders
of Series A Preferred Stock, voting together as a single class.
3. (i) The aggregate number of shares of the Series A Preferred Stock
established and designated by the Resolution is 100,000; (ii) the number of
shares of stock which the Corporation has previously established and designated
pursuant to Section 1522 of the BCL or any corresponding provision of prior law
is hereby reduced to zero; and (iii) the aggregate number of shares authorized
under the Amended and Restated Articles of Incorporation of the Corporation is
35,000,000, of which 10,000,000 shares are Preferred Stock, par value $1.00 per
share, issuable in one or more series, and 25,000,000 shares are Common Stock,
par value $0.20 per share.
4. The Resolution was duly adopted at a meeting of the Board of
Directors of the Corporation duly called and held on July 23, 1996, at which
meeting a quorum was present and acted throughout.
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IN WITNESS WHEREOF, this Statement with Respect to Shares is executed
on behalf of the Corporation by its Chief Executive Officer and attested by its
Secretary this 23rd day of July, 1996.
/s/ Christian L. Allison
---------------------------------------------
Christian L. Allison, Chief Executive Officer
Attest:
/s/ Sara M. Antol
- ------------------------------
Sara M. Antol, Secretary
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Exhibit 10.26
AGREEMENT
This Agreement, made as of the 17th day of July, 1997 by and between
TOLLGRADE COMMUNICATIONS, INC., a Pennsylvania corporation (the "Corporation")
and ROGER A. SMITH, 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,
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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
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involving any other corporation, other than a merger,
consolidation, or reorganization that would result in
the voting securities of the Corporation outstanding
immediately prior thereto continuing to represent
(either by remaining outstanding or by being
converted into voting securities of the surviving
entity) at least sixty-five percent (65%) of the
combined voting power of the voting securities of the
Corporation (or such surviving entity) outstanding
immediately after such merger, consolidation, or
reorganization.
However, in no event shall a Change in Control be deemed to have
occurred, with respect to the Executive, if the Executive is part of a
purchasing group which consummates the Change-in-Control transaction.
The Executive shall be deemed "part of the purchasing group" for
purposes of the preceding sentence if the Executive is an equity
participant or has agreed to become an equity participant in the
purchasing company or group (except for (i) passive ownership of less
than five percent (5%) of the voting securities of the purchasing
company; or (ii) ownership of equity participation in the purchasing
company or group which is otherwise deemed not to be significant, as
determined prior to the Change-in-Control by a majority of the
non-employee continuing Directors of the Board of Directors of the
Corporation).
"DATE OF TERMINATION" shall mean:
(a) if the Executive's employment is terminated for Disability,
the date that a Notice of Termination is given to the
Executive;
(b) if the Executive terminates due to his death or Retirement,
the date of death or Retirement, respectively;
(c) if the Executive decides to terminate employment upon Good
Reason for Termination, the date following such decision
specified by the Corporation after it has been notified of the
Executive's decision to terminate employment; or
(d) if the Executive's employment is terminated for any other
reason, the date on which such termination becomes effective
pursuant to a Notice of Termination.
"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-
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Control, or a material change in his reporting
responsibilities, titles or offices as in effect immediately
prior to a Change-in-Control, or any removal of the Executive
from or any failure to re-elect the Executive to any of such
positions, except in connection with the termination of the
Executive's employment due to Cause for Termination,
Disability or Retirement (as hereinafter defined) or as a
result of the Executive's death;
(b) (i) a reduction by the Corporation prior to a
Change-in-Control in the Executive's base salary unless such
reduction is the result of the Board of Directors of the
Corporation determining that the Executive has not adequately
discharged his duties;
(ii) a reduction by the Corporation after a Change-in-Control
in the Executive's base salary as in effect immediately prior
to any Change-in-Control or a failure by the Corporation after
a Change-in-Control to increase the Executive's base salary by
the Annual Salary Adjustment Percentage;
(c) a failure by the Corporation to continue to provide incentive
compensation comparable to that provided by the Corporation
immediately prior to any Change-in-Control;
(d) a failure by the Corporation after a Change-in-Control to
continue in effect any benefit or compensation plan, stock
option plan, pension plan, life insurance plan, health and
accident plan or disability plan in which the Executive is
participating immediately prior thereto (provided, however,
that there shall not be deemed to be any such failure if the
Corporation substitutes for the discontinued plan, a plan
providing the Executive with substantially similar benefits)
or the taking of any action by the Corporation which would
adversely affect the Executive's participation in or
materially reduce the Executive's benefits under any of such
plans or deprive the Executive of any material fringe benefit
enjoyed by the Executive immediately prior to a
Change-in-Control (provided, however, that any act or failure
to act by the Corporation that is on a plan-wide basis, i.e.,
it similarly affects all employees of the Corporation or all
employees eligible to participate in any such plan, as the
case may be, shall not constitute Good Reason for
Termination);
(e) the failure of the Corporation to obtain the assumption of
this Agreement by any successor as contemplated in SECTION
10(c) hereof;
(f) any purported termination of the employment of the Executive
by the Corporation which is not (i) due to the Executive's
Disability, Retirement (as hereinafter defined) or Cause for
Termination, or (ii) effected as a Notice of Termination, as
defined herein; or
(g) the Corporation's requiring the Executive to be based anywhere
other than the
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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.
"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
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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
(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
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(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 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
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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
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Option shall be automatically vested and remain outstanding in accordance with
its terms and be exercisable thereafter until the stated expiration date of such
Stock Appreciation Right or Option.
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.
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(f) No provision of this Agreement may be modified, waived or
discharged unless such waiver, modification or discharge is
agreed to in writing signed by the Executive and approved by
resolution of the Board of Directors of the Corporation. No
waiver by either party hereto at any time of any breach by the
other party hereto of, or compliance with, any condition or
provision of this Agreement to be performed by such other
party shall be deemed a waiver of similar or dissimilar
provisions or conditions at the same or at any prior or
subsequent time. No agreements or representations, oral or
otherwise, express or implied, with respect to the subject
matter hereof have been made by either party which are not set
forth expressly in this Agreement.
(g) The invalidity or unenforceability of any provisions of this
Agreement shall not affect the validity or unenforceability of
any other provision of this Agreement, which shall remain in
full force and effect. If any provision hereof shall be deemed
invalid or unenforceable, either in whole or in part, this
Agreement shall be deemed amended to delete or modify, as
necessary, the offending provision and to alter the bounds
thereof in order to render it valid and enforceable.
(h) This Agreement may be executed in one or more counterparts,
each of which shall be deemed to be an original but all of
which taken together will constitute one and the same
instrument.
(i) If litigation should be brought to enforce, interpret or
challenge any provision contained herein, the prevailing party
shall be entitled to its reasonable attorney's fees and
disbursements and other costs incurred in such litigation and,
if a money judgment be rendered in favor of the Executive, to
interest on any such money judgment obtained calculated at the
prime rate of interest in effect from time to time at Mellon
Bank, N.A., from the date that the payment should have been
made or damages incurred under this Agreement.
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/ Jayne F. Smith /s/ Roger A. Smith
- --------------------------- -------------------------------
10
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Exhibit 10.27
Tollgrade Communications, Inc.
1998 Employee Incentive Compensation Plan
ARTICLE 1. ESTABLISHMENT, OBJECTIVES AND DURATION.
1.1 ESTABLISHMENT OF THE PLAN. Tollgrade Communications, Inc., a
Pennsylvania corporation (hereinafter referred to as the "Company"),
hereby establishes an incentive compensation plan for all employees
excluding officers and directors of the Company, to be known as the
"Tollgrade Communications, Inc. 1998 Employee Incentive Compensation
Plan" (hereinafter referred to as the "Plan"), as set forth in this
document. The Plan permits the grant of Nonqualified Stock Options,
Stock Appreciation Rights, Restricted Stock, Performance Shares and
Performance Units. The Plan shall be effective as of January 29, 1998
(the "Effective Date") and shall remain in effect as provided in
SECTION 1.3 hereof.
1.2 OBJECTIVES OF THE PLAN. The objectives of the Plan are to optimize the
profitability and growth of the Company through incentives which are
consistent with the Company's goals and which link the personal
interests of Employees to those of the Company's stockholders; to
provide Employees with an incentive for excellence in individual
performance; and to promote teamwork among Employees. The Plan is
further intended to provide flexibility to the Company in its ability
to motivate, attract, and retain the services of Employees who make
significant contributions to the Company's success and allow Employees
to share in the success of the Company.
1.3 DURATION OF THE PLAN. The Plan was adopted by the Board of Directors on
January 29, 1998, and shall commence on the Effective Date, as
described in SECTION 1.1 hereof, and shall remain in effect, subject to
the right of the Board of Directors to amend or terminate the Plan at
any time pursuant to ARTICLE 14 hereof, until all Shares subject to it
shall have been purchased or acquired according to the Plan's
provisions. However, in no event shall an Award be granted under the
Plan on or after January 29, 2008.
ARTICLE 2. DEFINITIONS
Whenever used in the Plan, the following terms shall have the meanings set forth
below, and when the meaning is intended, the initial letter of the word shall be
capitalized:
2.1 "AWARD" means, individually or collectively, a grant under this Plan of
Nonqualified Stock Options, Stock Appreciation Rights, Restricted
Stock, Performance Shares or Performance Units.
2.2 "AWARD AGREEMENT" means an agreement entered into by the Company and
each Employee setting forth the terms and provisions applicable to
Awards granted under this Plan.
2.3 "BENEFICIAL OWNER" OR "BENEFICIAL OWNERSHIP" shall have the meaning
ascribed to such term in Rule 13d-3 of the General Rules and
Regulations under the Exchange Act.
2.4 "BOARD" OR "BOARD OF DIRECTORS" means the Board of Directors of the
Company.
2.5 "CHANGE IN CONTROL" of the Company shall be deemed to have occurred (as
of a particular day, as specified by the Board) if the Board, by a
majority vote, agrees that a Change in Control has occurred, or is
about to occur. Such a change shall not include, however, a
restructuring, reorganization, merger or other change in capitalization
in which the Persons who own an interest in the Company on the
Effective Date (the "Current Owners") (or any individual or entity
which received from a Current Owner an interest in the Company through
will or the laws of descent and distribution) maintain more than a
fifty percent (50%) interest in the resultant entity.
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Regardless of the Board's vote, a Change in Control will be deemed to
have occurred as of the first day any one (1) or more of the following
paragraphs shall have been satisfied:
(a) Any Person (other than the Person in control of the Company as
of the Effective Date of the Plan, or other than a trustee or
other fiduciary holding securities under an employee benefit
plan of the Company, or a corporation owned directly or
indirectly by the stockholders of the Company in substantially
the same proportions as their ownership of stock in the
Company), becomes the Beneficial Owner, directly or
indirectly, of securities of the Company representing more
than fifty percent (50%) of the combined voting power of the
Company"s then outstanding securities; or
(b) The stockholders of the Company approve:
(i) A plan of complete liquidation of the Company; or
(ii) An agreement for the sale or disposition of all or
substantially all of the Company"s assets (other than
one in which the stockholders of the Company, as
determined immediately prior to such transaction,
hold, directly or indirectly, as determined
immediately following such transaction, a majority of
the voting power of each surviving, resulting or
acquiring corporation which, immediately following
such transaction, holds more than 10% of the
consolidated assets of the Company immediately prior
to the transaction); or
(iii) A merger, consolidation, or reorganization of the
Company with or involving any other corporation,
other than a merger, consolidation, or reorganization
that would result in the voting securities of the
Company outstanding immediately prior thereto
continuing to represent (either by remaining
outstanding or by being converted into voting
securities of the surviving entity) at least fifty
percent (50%) of the combined voting power of the
voting securities of the Company (or such surviving
entity) outstanding immediately after such merger,
consolidation or reorganization.
However, in no event shall a Change in Control be deemed to have
occurred, with respect to a Employee, if that Employee is part of a
purchasing group which consummates the Change in Control transaction.
The Employee shall be deemed "part of a purchasing group" for purposes
of the preceding sentence if the Employee is an equity participant or
has agreed to become an equity participant in the purchasing company or
group (except for (i) passive ownership of less than five percent (5%)
of the voting equity securities of the purchasing company; or (ii)
ownership of equity participation in the purchasing company or group
which is otherwise deemed not to be significant, as determined prior to
the Change in Control by a majority of the nonemployee continuing
Directors).
2.6 "CODE" means the Internal Revenue Code of 1986, as amended from time to
time.
2.7 "COMMITTEE" means the Compensation Committee of the Board, as specified
in ARTICLE 3 herein, or such other Committee appointed by the Board to
administer the Plan with respect to grants of Awards.
2.8 "COMPANY" means Tollgrade Communications, Inc., a Pennsylvania
corporation, any successor thereto as provided in ARTICLE 17 herein.
2.9 "DIRECTOR" means any individual who is a member of the Board of
Directors of the Company.
2.10 "EFFECTIVE DATE" shall have the meaning ascribed to such term in
SECTION 1.1 hereof.
2.11 "EMPLOYEE" means any full-time active employee of the Company who is
not an Officer, as defined in SECTION 2.17 hereof. Directors shall not
be considered employees under the Plan.
2.12 "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended
from time to time, or any successor act thereto.
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2.13 "FAIR MARKET VALUE" shall be the mean between the following prices, as
applicable, for the date as of which fair market value is to be
determined as quoted in The Wall Street Journal (or in such other
reliable publication as the Committee, in its discretion, may determine
to rely upon): (i) if the Common Stock is listed on the New York Stock
Exchange, the highest and lowest sales prices per share of the Common
Stock as quoted in the NYSE Composite Transactions listing for such
date, (ii) if the Common Stock is not listed on such exchange, the
highest and lowest sales prices per share of Common Stock for such date
on (or on any composite index including) the principal united States
securities exchange registered under the 1934 Act on which the Common
Stock is listed or (iii) if the Common Stock is not listed on such
exchange, the highest and lowest sales prices per share of the Common
Stock for such date on the National Association of Securities Dealers
Automated Quotations System or any successor system then in use
("NASDAQ"). If there are no such sale price quotations for the date as
of which fair market value is to be determined but there are such sale
price quotations within a reasonable period both before and after such
date, then fair market value shall be determined by taking a weighted
average of the means between the highest and lowest sales prices per
share of the Common Stock as so quoted on the nearest date before and
the nearest date after the date as of which fair market value is to be
determined. The average should be weighted inversely by the respective
number of trading days between the selling dates and the date as of
which fair market value is to be determined. If there are no such sale
prices quotations on or within a reasonable period both before and
after the date as of which fair market value is to be determined, then
fair market value of the Common Stock shall be the mean between the
bona fide bid and asked prices per share of Common Stock as so quoted
for such date on NASDAQ, or if none, the weighted average of the means
between such bona fide bid and asked prices on the nearest trading date
before and the nearest trading date after the date as of which fair
market value is to be determined, if both such dates are within a
reasonable period. The average is to be determined in the manner
described above in this SECTION 2.13. If the fair market value of the
Common Stock cannot be determined on any basis previously set forth in
this SECTION 2.13 for the date as of which fair market value is to be
determined, the Committee shall in good faith determine the fair market
value of the Common Stock on such date. Fair market value shall be
determined without regard to any restriction other than a restriction
which, by its terms, will never lapse.
2.14 "FREESTANDING SAR" means an SAR that is granted independently of any
Options, as described in ARTICLE 7 herein.
2.15 "INSIDER" shall mean an individual who, immediately prior to the grant
of any Award, owns stock possessing more than ten percent (10%) of the
total combined voting power of all classes of stock for the Company.
For purposes of this SECTION 2.15, an individual (i) shall be
considered as owning not only Shares of Stock owned individually but
also all Shares of stock that are at the time owned, directly or
indirectly, by or for the spouse, ancestors, lineal descendants and
bothers and sisters (whether by whole or half blood) of such individual
and (ii) shall be considered as owning proportionately any Shares
owned, directly or indirectly, by or for any corporation, partnership,
estate or trust in which such individual is a stockholder, partner or
beneficiary.
2.16 "NONQUALIFIED STOCK OPTION" OR "NQSO" means an option to purchase
Shares granted under ARTICLE 6 herein and which is not intended to meet
the requirements of Code Section 422.
2.17 "OFFICER" means any person serving as an officer on behalf of the
Company, as defined in the Company"s bylaws and by requirements of
Pennsylvania corporate law, and by the requirements of the rules of the
National Association of Securities Dealers, Inc.
2.18 "OPTION" means a Nonqualified Stock Option, as described in ARTICLE 6
herein.
2.19 "OPTION PRICE" means the price at which a Share may be purchased by a
Employee pursuant to an Option.
2.20 "PERFORMANCE-BASED EXCEPTION" means the performance-based exception
from the tax deductibility limitations of Code Section 162(m).
2.21 "PERFORMANCE SHARE" means an Award granted to an Employee, as described
in ARTICLE 9 herein.
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2.22 "PERFORMANCE UNIT" means an award granted to an Employee, as described
in ARTICLE 9 herein.
2.23 "PERIOD OF RESTRICTION" means the period during which the transfer of
Shares of Restricted Stock is limited in some way (based upon the
passage of time, the achievement of performance goals, or upon the
occurrence of other events as determined by the Committee, at its
discretion), and the Shares are subject to a substantial risk of
forfeiture, as provided in ARTICLE 8 herein.
2.24 "PERSON" shall have the meaning ascribed to such term in Section
3(a)(9) of the Exchange Act and used in Sections 13(d) and 14(d)
thereof, including a "group" as defined in Section 13(d) thereof.
2.25 "RESTRICTED STOCK" means an award granted to an Employee pursuant to
ARTICLE 8 herein.
2.26 "RETIREMENT" shall mean any voluntary termination of employment by an
Employee following the attainment of age 65.
2.27 "SHARES" means the shares of Common Stock of the Company.
2.28 "STOCK APPRECIATION RIGHT" OR "SAR" means an Award, granted alone or in
connection with a related Option, designated as an SAR, pursuant to the
terms of ARTICLE 7 herein.
2.29 "TANDEM SAR" means an SAR that is granted in connection with a related
Option pursuant to ARTICLE 7 herein, the exercise of which shall
require forfeiture of the right to purchase a Share under the related
Option (and when a Share is purchased under the Option, the Tandem SAR
shall similarly be canceled).
ARTICLE 3. ADMINISTRATION
3.1 THE COMMITTEE. Except as set forth in SECTION 3.5 below, the Plan shall
be administered by the Compensation Committee of the Board, or by any
other Committee appointed by the Board consisting of not less than two
(2) Directors who (i) are "non-employee" directors and otherwise meet
the "disinterested administration" rules of Rule 16b-3 under the
Exchange Act and (ii) are "outside directors" under Section
162(m)(4)(C) of the Code, or any successor provision. The members of
the Committee shall be appointed from time to time by, and shall serve
at the discretion of, the Board of Directors.
3.2 AUTHORITY OF THE COMMITTEE. Except as set forth in SECTION 3.4 below,
except as limited by law or by the Articles of Incorporation or Bylaws
of the Company, and subject to the provisions herein, the Committee
shall have full power to grant Options (with or without SARs) and to
award Restricted Stock, Performance Shares and Performance Units as
described herein and to determine the Employees to whom any such award
shall be made and the number of Shares to be covered thereby; determine
the sizes and types of Awards; determine terms and conditions of Awards
in a manner consistent with the Plan; construe and interpret the Plan
and any agreement or instrument entered into under the Plan as they
apply to Employees; and (subject to the provisions of ARTICLE 14
herein) amend the terms and conditions of any outstanding Award to the
extent such terms and conditions are within the discretion of the
Committee as provided in the Plan. Further, the Committee shall make
all other determinations which may be necessary or advisable for the
administration of the Plan, as the Plan applies to Employees. As
permitted by law the Committee may delegate its authority as identified
herein.
3.3 DECISIONS BINDING. All determinations and decisions made by the
Committee pursuant to the provisions of the Plan and all related orders
and resolutions of the Board shall be final, conclusive and binding on
all persons, including the Company, its stockholders, Employees, and
their estates and beneficiaries.
3.4 NON-COMPETITION. If a grantee of an Option, Restricted Stock,
Performance Units or Performance Shares (i) engages in the operation or
management of a business (whether as owner, partner, officer, director,
employee or otherwise and whether during or after employment) which is
in competition with the Company, (ii) induces or attempts to induce any
customer, supplier, licensee or other individual, corporation or other
business organization having a
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business relationship with the Company to cease doing business with the
Company or any in any way interferes with the relationship between any
such customer, supplier, licensee or other person and the Company or
(iii) solicits any employee of the Company to leave the employment
thereof or in any way interferes with the relationship of such employee
with the Company, the Committee, in its discretion, may immediately
terminate all outstanding Options held by the grantee, declare
forfeited all Restricted Stock held by the grantee as to which the
restrictions have not yet lapsed and/or immediately cancel any award of
Performance Units or Performance Shares. Whether a grantee has engaged
in any of the activities referred to in the preceding sentence which
would cause the outstanding Options to be terminated, and/or the
Restricted Stock to be forfeited and/or any award of Performance Units
or Performance Shares to be canceled shall be determined, in its
discretion, by the Committee, and any such determination by the
Committee shall be final and binding.
ARTICLE 4. SHARES SUBJECT TO THE PLAN
4.1 NUMBER OF SHARES AVAILABLE FOR GRANTS. Subject to adjustment as
provided in SECTION 4.3 herein, the number of Shares hereby reserved
for issuance to Employees under the Plan shall be 100,000; provided
that, of that total, the maximum number of Shares of Restricted Stock
granted pursuant to ARTICLE 8 herein, shall be 50,000.
4.2 LAPSED AWARDS. If any Award granted under this Plan is canceled,
terminates, expires or lapses for any reason (with the exception of
termination of a Tandem SAR upon exercise of the related Option, or the
termination of a related Option upon exercise of the corresponding
Tandem SAR), any Shares subject to such Award shall again be available
for the grant of an Award under the Plan.
4.3 ADJUSTMENTS IN AUTHORIZED SHARES. In the event of any change in
corporate capitalization, such as a stock split, or a corporate
transaction, such as any merger, consolidation, separation, including a
spin-off, or other distribution of stock or property of the Company,
any reorganization (whether or nor such reorganization comes within the
definition of such term in Code Section 368) or any partial or complete
liquidation of the Company, such adjustment shall be made in the number
and class of Shares which may be delivered under SECTION 4.1 and in the
number and class of and/or price of Shares subject to outstanding
Awards granted under the Plan, and in the number and class of and/or
price of Shares subject to outstanding Awards granted under the Plan,
as may be determined to be appropriate and equitable by the Committee,
in its sole discretion, to prevent dilution or enlargement of rights;
provided, however, that the number of Shares subject to any Award shall
always be a whole number.
ARTICLE 5. ELIGIBILITY AND PARTICIPATION
5.1 ELIGIBILITY. Persons eligible to participate in this Plan shall include
all Employees of the Company, excluding Officers and Directors.
5.2 ACTUAL PARTICIPATION. Subject to the provisions of the Plan, the
Committee may, from time to time, select from all eligible Employees
those to whom Awards shall be granted and shall determine the nature
and amount of each Award.
ARTICLE 6. STOCK OPTIONS
6.1 GRANT OF OPTIONS. Subject to the terms and provisions of the Plan, the
Committee may grant Nonqualified Stock Options in such number, and upon
such terms, and at any time and from time to time as shall be
determined by the Committee.
6.2 AWARD AGREEMENT. Each Option shall be evidenced by an Award Agreement
that shall specify the Option Price, the duration of the Option, the
number of Shares to which the Option pertains, and such other
provisions as the Committee shall determine.
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6.3 OPTION PRICE. The Option Price at which each Option may be exercised
shall be no less than one hundred percent (100%) of the fair market
value per share of the Common Stock covered by the Option on the date
of grant. For purposes of this SECTION 6.3, the fair market value of
the Common Stock shall be as determined in SECTION 2.14.
6.4 DURATION OF OPTIONS. Each Option granted to an Employee shall expire at
such time as the Committee shall determine at the time of grant;
provided, however, that no Option shall be exercisable after the
expiration of ten years from the date of grant.
6.5 EXERCISE OF OPTIONS. Options granted under this Article 6 shall be
exercisable at such times and be subject to such restrictions and
conditions as the Committee shall in each instance approve, which need
not be the same for each grant or for each Employee.
6.6 PAYMENT. Options granted under this Article 6 shall be exercised by the
delivery of a written notice of exercise to the Company, setting forth
the number of Shares with respect to which the Option is to be
exercised, accompanied by full payment for the Shares.
The Option Price upon exercise of the Option shall be payable to the
Company in full either: (a) in cash in United States Dollars (including
check, bank draft or money order), or (b) by tendering previously
acquired Shares having an aggregate Fair Market Value at the time of
exercise equal to the total Option Price, or (c) by a combination of
(a) and (b).
The Company will also cooperate with any person exercising an Option
who participates in a cashless exercise program of a broker or other
agent under which all or part of the Shares received upon exercise of
the Option are sold through the broker or other agent or under which
the broker or other agent makes a loan to such person. Notwithstanding
the foregoing, unless the Committee, in its discretion, shall otherwise
determine at the time of grant the exercise of the Option shall not be
deemed to occur and no Shares of Common Stock will be issued by the
Company upon exercise of the Option until the Company has received
payment of the Option Price in full.
6.7 RESTRICTIONS ON SHARE TRANSFERABILITY. The Committee may impose
restrictions on any Shares acquired pursuant to the exercise of an
Option granted under this ARTICLE 6 as it may deem advisable,
including, without limitation, restrictions under applicable Federal
securities laws, under the requirements of any stock exchange or market
upon which such Shares are then listed and/or traded, and under any
blue sky or other state securities laws applicable to such Shares.
6.8 TERMINATION OF EMPLOYMENT. Unless the Committee, in its discretion,
shall otherwise determine:
(i) If the employment of an Employee who is not disabled within the
meaning of Section 422(c)(6) of the Code (a "Disabled Grantee") is
voluntarily terminated with the consent of the Company or an Employee
retires under any retirement plan of the Company, any Option held by
such Employee shall be exercisable by the Employee (but only to the
extent exercisable by the Employee immediately prior to the termination
of employment) at any time prior to the expiration date of such Option
or within one year after the date of termination, whichever is the
shorter period;
(ii) If the employment of an Employee who is a Disabled Grantee is
voluntarily terminated with the consent of the Company, any outstanding
Option held by such Employee shall be exercisable by the Employee in
full (whether or not so exercisable by the Employee immediately prior
to the termination of employment) at any time prior to the expiration
date of such Option or within one year after the date of termination of
employment, whichever is the shorter period;
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(iii) Following the death of an Employee during employment, any
outstanding Option held by the Employee at the time of death shall be
exercisable in full (whether or not so exercisable by the Employee
immediately prior to the death of the Employee) by the person entitled
to do so under the Will of the Employee, or, if the Employee shall fail
to make testamentary disposition of the stock option or shall die
intestate, by the legal representative of the Employee at any time
prior to the expiration date of such stock option or within one year
after the date of death of the Employee, whichever is the shorter
period;
(iv) Following the death of an Employee after termination of employment
during the period when an Option is exercisable, the Option shall be
exercisable by such person entitled to do so under the Will of the
Employee by such legal representative (but only to the extent
exercisable by the Employee immediately prior to the termination of
employment) at any time prior to the expiration date of such Option or
within one year after the date of death, whichever is the shorter
period;
(v) Unless the exercise period of a stock option following termination
of employment has been extended as provided in SECTION 13.1, if the
employment of an Employee terminates for any reason other than
voluntary termination with the consent of the Company, retirement under
any retirement plan of the Company or death, all outstanding Options
held by the Employee at the time of such termination of employment
shall automatically terminate.
Whether termination of employment is a voluntary termination with the
consent of the Company shall be determined, in its discretion, by the
Committee and any such determination by the Committee shall be final
and binding.
6.9 NONTRANSFERABILITY OF OPTIONS. No Option granted under the Plan may be
sold, transferred, pledged, assigned, or otherwise alienated or
hypothecated, other than by Will or if the Employee dies intestate by
the laws of descent and distribution of the state of domicile of the
Employee at the time of death. Further, all Options granted to an
Employee under the Plan shall be exercisable during his or her lifetime
only by the Employee.
ARTICLE 7. STOCK APPRECIATION RIGHTS
7.1 GRANT OF SARS. Subject to the terms and conditions of the Plan, SARs
may be granted to Employees at any time and from time to time as shall
be determined by the Committee. The Committee may grant Freestanding
SARs, Tandem SARs, or any combination of these forms of SARs. The
Committee shall have complete discretion in determining the number of
SARs granted to each Employee (subject to ARTICLE 4 herein) and,
consistent with the provisions of the Plan, in determining the terms
and conditions pertaining to such SARs. The grant price of a
Freestanding SAR shall equal the Fair Market Value of a Share on the
date of grant of the SAR. The grant price of Tandem SARs shall equal
the Option Price of the related Option, as provided in SECTION 6.3.
7.2 EXERCISE OF TANDEM SARS. Tandem SARs may be exercised for all or part
of the Shares subject to the related Option upon the surrender of the
right to exercise the equivalent portion of the related Option. A
Tandem SAR may be exercised only with respect to the Shares for which
its related Option is then exercisable.
7.3 EXERCISE OF FREESTANDING SARS. Freestanding SARs may be exercised upon
whatever terms the Committee, in its sole discretion, imposes upon
them.
7.4 SAR AGREEMENT. Each SAR grant shall be evidenced by an Award Agreement
that shall specify the grant price, the term of the SAR, and such other
provisions as the Committee shall determine.
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7.5 TERM OF SARs. The term of an SAR granted under the Plan shall be
determined by the Committee, in its sole discretion; provided however,
that such term shall not exceed ten (10) years.
7.6 PAYMENT OF SAR AMOUNT. Upon exercise of an SAR, an Employee shall be
entitled to receive payment from the Company in an amount determined by
multiplying:
(a) the difference between the Fair Market Value of a Share on the date
of exercise over the grant price; by
(b) the number of Shares with respect to which the SAR is granted.
At the discretion of the Committee, the payment upon SAR exercise may
be in cash, in Shares of equivalent value, or in some combination
thereof.
7.7 RULE 16b-3 REQUIREMENTS. Notwithstanding any other provision of the
Plan, the Committee may impose such conditions on the exercise of an
SAR as may be required to satisfy the requirements of Section 16 of the
Exchange Act (or any successor rule).
7.8 TERMINATION OF EMPLOYMENT. Each SAR Award Agreement shall set forth the
extent to which the Employee shall have the right to exercise the SAR
following termination of the Employee's employment with the Company
and/or its Subsidiaries. Such provisions shall be determined in the
sole discretion of the Committee, shall be included in the Award
Agreement entered into with Employees, need not be uniform among all
SARs issued pursuant to the Plan, and may reflect distinctions based on
the reasons for termination of such employment.
7.9 NONTRANSFERABILITY OF SARs. No SAR granted under the Plan may be sold,
transferred, pledged, assigned, or otherwise alienated or hypothecated,
other than by will or, if the grantee dies intestate, by the laws of
descent and distribution of the state of domicile of the grantee at the
time of death. Further, all SARs granted to an Employee under the Plan
shall be exercisable during his or her lifetime only by such Employee.
ARTICLE 8. RESTRICTED STOCK
8.1 GRANT OF RESTRICTED STOCK. Subject to the terms and provisions of the
Plan, the Committee, at any time and from time to time, may grant
Shares of Restricted Stock to Employees in such amounts as the
Committee shall determine.
8.2 RESTRICTED STOCK AGREEMENT. Each Restricted Stock grant shall be
evidenced by a Restricted Stock Award Agreement that shall specify the
Period(s) of Restriction, the number of Shares of Restricted Stock
granted, and such other provisions as the Committee shall determine.
8.3 TRANSFERABILITY. Except as provided in this ARTICLE 8, the Shares of
Restricted Stock granted herein may not be sold, transferred, pledged,
assigned or otherwise alienated or hypothecated until the end of the
applicable Period of Restriction established by the Committee and
specified in the Restricted Stock Award Agreement, or upon earlier
satisfaction of any other conditions, as specified by the Committee in
its sole discretion and set forth in the Restricted Stock Award
Agreement. All rights with respect to the Restricted Stock granted to
an Employee under the Plan shall be available during his or her
lifetime only to such Employee.
8.4 OTHER RESTRICTIONS. Subject to ARTICLE 10 herein, the Committee shall
impose such other conditions and/or restrictions on any Shares of
Restricted Stock granted pursuant to the Plan as it may deem
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advisable including, without limitation, a requirement that Employees
pay a stipulated purchase price for each Share of Restricted Stock,
restrictions based upon the achievement of specific performance goals
(Company-wide, divisional, and/or individual), time-based restrictions
on vesting following the attainment of the performance goals, and/or
restrictions under applicable Federal or state securities laws. The
Company shall retain the certificates representing Shares of Restricted
Stock in the Company's possession until such time as all conditions
and/or restrictions applicable to such Shares have been satisfied.
Except as otherwise provided in this ARTICLE 8, Shares of Restricted
Stock covered by each Restricted Stock grant made under the Plan shall
become freely transferable by the Employee after the last day of the
applicable Period of Restriction.
8.5 VOTING RIGHTS. During the Period of Restriction, Employees holding
Shares of Restricted Stock granted hereunder may exercise full voting
rights with respect to those Shares.
8.6 DIVIDENDS AND OTHER DISTRIBUTIONS. During the Period of Restriction,
Employees holding Shares of Restricted Stock granted hereunder may be
credited with regular cash dividends paid with respect to the
underlying Shares while they are so held. The Committee may apply any
restrictions to the dividends that the Committee deems appropriate. In
the event that any dividend constitutes a "derivative security" or an
"equity security" pursuant to Rule 16(a) under the Exchange Act, such
dividend shall be subject to a vesting period equal to the remaining
vesting period of the Shares of Restricted Stock with respect to which
the dividend is paid.
8.7 TERMINATION OF EMPLOYMENT. Each Restricted Stock Award Agreement shall
set forth the extent to which the Employee shall have the right to
receive unvested Restricted Shares following termination of the
Employee's employment with the Company. Such provisions shall be
determined in the sole discretion of the Committee, shall be included
in the Award Agreement entered into with each Employee, need not be
uniform among all Shares of Restricted Stock issued pursuant to the
Plan, and may reflect distinctions based upon the reasons for
termination of such employment.
ARTICLE 9. PERFORMANCE UNITS AND PERFORMANCE SHARES
9.1 GRANT OF PERFORMANCE UNITS/SHARES. Subject to the terms of the Plan,
Performance Units and/or Performance Shares may be granted to Employees
in such amounts and upon such terms, and at any time and from time to
time, as shall be determined by the Committee.
9.2 VALUE OF PERFORMANCE UNITS/SHARES. Each Performance Unit shall have an
initial value that is established by the Committee at the time of
grant. Each Performance Share shall have an initial value equal to the
Fair Market Value of a Share on the date of grant. The Committee shall
set performance goals in its discretion which, depending upon the
extent to which they are met, will determine the number and/or value of
Performance Units/Shares that will be paid out to the Employee. For
purposes of this ARTICLE 9, the time period during which the
performance goals must be met shall be called a "Performance Period."
9.3 EARNING OF PERFORMANCE UNITS/SHARES. Subject to the terms of this Plan,
after the applicable Performance Period has ended, the holder of
Performance Units/Shares shall be entitled to receive payout on the
number and value of Performance Units/Shares earned by the Employee
over the Performance Period, to be determined as a function of the
extent to which the corresponding performance goals have been achieved.
9.4 FORM AND TIMING OF PERFORMANCE UNITS/SHARES. Payment of earned
Performance Units/Shares shall be made in a single lump sum within
seventy-five (75) calendar days following the close of the applicable
Performance Period. Subject to the terms of this Plan, the Committee,
in its sole discretion, may pay
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earned Performance Units/Shares in the form of cash or Shares (or a
combination thereof) which have an aggregate Fair Market Value equal to
the value of the earned Performance Units/Shares at the close of the
applicable Performance Period. Such Shares may be granted subject to
any restrictions deemed appropriate by the Committee.
At the discretion of the Committee, Employees may be entitled to
receive any dividends declared with respect to Shares which have been
earned in connection with grants of Performance Units and/or
Performance Shares which have been earned, but not yet distributed to
Employees (such dividends shall be subject to the same accrual,
forfeiture, and payout restrictions as apply to dividends earned with
respect to Shares of Restricted Stock, as set forth in SECTION 8.6
herein). In addition, Employees may, at the discretion of the
Committee, be entitled to exercise their voting rights with respect to
such Shares.
9.5 TERMINATION OF EMPLOYMENT DUE TO DEATH, DISABILITY OR RETIREMENT.
Unless otherwise determined by the Committee and set forth in the
Employee's Award Agreement, in the event the employment of an Employee
is terminated by reason of death, disability or Retirement during a
Performance Period, the Employee shall receive a payout of the
Performance Units/Shares which is prorated, as specified by the
Committee in its discretion. Payment of earned Performance Units/Shares
shall be made at a time specified by the Committee in its sole
discretion and set forth in the Employee's Award Agreement.
9.6 TERMINATION OF EMPLOYMENT FOR OTHER REASONS. In the event that an
Employee's employment terminates for any reason other than those
reasons set forth in SECTION 9.5 herein, all Performance Units/Shares
shall be forfeited by the Employee to the Company unless determined
otherwise by the Committee, as set forth in the Employee's Award
Agreement.
9.7 NONTRANSFERABILITY. Performance Units/Shares may not be sold,
transferred, pledged, assigned or otherwise alienated or hypothecated,
other than by will or if the grantee dies intestate by the laws of
descent and distribution of the state of domicile of the grantee at the
time of death. Further, an Employee's rights under the Plan shall be
exercisable during the Employee's lifetime only by the Employee or the
Employee's legal representative.
ARTICLE 10. BENEFICIARY DESIGNATION
Each Employee under the Plan may, from time to time, name any beneficiary or
beneficiaries (who may be named contingently or successively) to whom any
benefit under the Plan is to be paid in case of his or her death before he or
she receives any or all of such benefit. Each such designation shall revoke all
prior designations by the same Employee, shall be in a form prescribed by the
Company, and will be effective only when filed by the Employee in writing with
the Company during the Employee's lifetime. In the absence of any such
designation, benefits remaining unpaid at the Employee's death shall be paid to
the Employee's estate.
ARTICLE 11. DEFERRALS
The Committee may permit or require an Employee to defer such Employee's receipt
of the payment of cash or the delivery of Shares that would otherwise be due to
such Employee by virtue of the exercise of an Option or SAR, the lapse or waiver
of restrictions with respect to Restricted Stock, or the satisfaction of any
requirements or goals with respect to Performance Units/Shares. If any such
deferral election is required or permitted, the Committee shall, in its sole
discretion, establish rules and procedures for such payment deferrals.
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ARTICLE 12. RIGHTS OF EMPLOYEES
12.1 EMPLOYMENT. Nothing in the Plan shall interfere with or limit in any
way the right of the Company to terminate any Employee's employment at
any time, nor confer upon any Employee any right to continue in the
employ of the Company.
12.2 PARTICIPATION. No Employee shall be entitled to have the right to be
selected to receive an Award under this Plan, or having been so
selected, to be selected to receive a future Award.
ARTICLE 13. CHANGE IN CONTROL
13.1 TREATMENT OF OUTSTANDING AWARDS. Upon the occurrence of a Change in
Control, unless otherwise specifically prohibited under applicable
laws, or by the rules and regulations of any governing governmental
agencies or national securities exchanges:
(a) Any and all Options and SARs granted hereunder shall become
immediately exercisable, and shall remain exercisable throughout their
entire term;
(b) Any restriction periods and restrictions imposed on Restricted
Shares shall lapse;
(c) The target payout opportunities attainable under all outstanding
Awards of Restricted Stock, Performance Units and Performance Shares
shall be deemed to have been fully earned for the entire Performance
Period(s) as of the effective date of the Change in Control. The
vesting of all Awards denominated in Shares shall be accelerated as of
the effective date of the Change in Control, and there shall be paid
out in cash to Employees within thirty (30) days following the
effective date of the Change in Control an amount equal to one hundred
percent (100%) of all targeted cash payout opportunities associated
with outstanding cash-based Awards; and
(d) Subject to ARTICLE 14 herein, the Committee shall have the
authority to make any modifications to the Awards as determined by the
Committee to be appropriate before the effective date of the Change in
Control.
13.2 ACCELERATION OF AWARD VESTING. Notwithstanding any provision of this
Plan or any Award Agreement provision to the contrary, the Committee,
in its sole and exclusive discretion, shall have the power at any time
to accelerate the vesting of any Award granted under the Plan to any
Employee, including without limitation acceleration to such a date that
would result in said Awards becoming immediately vested.
13.3 TERMINATION, AMENDMENT AND MODIFICATIONS OF CHANGE IN CONTROL
PROVISIONS. Notwithstanding any other provision of this Plan or any
Award Agreement provision, the provisions of this ARTICLE 13 may not be
terminated, amended or modified on or after the date of a Change in
Control to affect adversely any Award theretofore granted under the
plan without the prior written consent of the Employee with respect to
said Employee's outstanding Awards; provided, however, the Board of
Directors, upon recommendation of the committee, may terminate, amend,
or modify this ARTICLE 13 at any time and from time to time prior to
the date of a Change in Control.
ARTICLE 14. AMENDMENT, MODIFICATION AND TERMINATION
14.1 ADMENDMENT, MODIFICATION AND TERMINATION. The Board may at any time and
from time to time, alter, amend, suspend, or terminate the Plan in
whole or in part.
14.2 ADJUSTMENT OF AWARDS UPON THE OCCURRENCE OF CERTAIN UNUSUAL OR
NONRECURRING EVENTS. The Committee may make adjustments in the terms
and conditions of, and the criteria included in, Awards in recognition
of unusual or nonrecurring events (including, without limitation, the
events described in SECTION 4.3 hereof) affecting the Company or the
financial statements of the Company or of changes in
11
<PAGE> 12
applicable laws, regulations, or accounting principles, whenever the
Committee determined that such adjustments are appropriate in order to
prevent dilution or enlargement of the benefits or potential benefits
intended to be made available under the Plan; provided that no such
adjustment shall be authorized to the extent that such authority would
be inconsistent with the Plan's meeting the requirements of Section
162(m) of the Code, as from time to time amended.
14.3 AWARDS PREVIOUSLY GRANTED. No termination, amendment, or modification
of the Plan shall adversely affect in any material way any Award
previously granted under the Plan, without the written consent of the
Employee holding such Award.
14.4 COMPLIANCE WITH CODE 162(m). At all times when Code Section 162(m) is
applicable, all Awards granted under this Plan shall comply with the
requirements of Code Section 162(m); provided, however, that in the
event the Committee determines that such compliance is not desired with
respect to any Award or Awards available for grant under the Plan, then
compliance with Code Section 162(m) will not be required. In addition,
in the event that any changes are made to Code Section 162(m) to permit
greater flexibility with respect to any Award or Awards available under
the Plan, the Committee may, subject to this ARTICLE 14, make any
adjustments it deems appropriate.
ARTICLE 15. WITHHOLDING
15.1 TAX WITHHOLDING. The Company shall have the power and the right to
deduct or withhold, or require any Employee to remit to the Company, an
amount sufficient to satisfy Federal, state and local taxes, domestic
or foreign, required by law or regulation to be withheld with respect
to any taxable event arising as a result of this Plan.
15.2 SHARE WITHHOLDING. With respect to withholding required upon the
exercise of Options or SARs, upon the lapse of restrictions on
Restricted Stock, or upon any other taxable event arising as a result
of Awards granted hereunder, Employees may elect, subject to the
approval of the Committee, to satisfy the withholding requirement, in
whole or in part, by having the Company withhold Shares having a Fair
Market Value on the date the tax is to be determined equal to the
minimum statutory total tax which could be imposed on the action. All
such elections shall be irrevocable, made in writing, signed by the
Employee, and shall be subject to any restrictions or limitations that
the Committee, in its sole discretion, may determine.
ARTICLE 16. INDEMNIFICATION
Each person who is or shall have been a member of the Committee, or of the
Board, shall be indemnified and held harmless by the Company against and from
any loss, cost, liability or expense that may be imposed upn or reasonably
incurred by him or her in connection with or resulting from any claim, action,
suit or proceeding to which he or she may be a party or in which he or she may
be involved by reason of any action taken or failure to act under the Plan and
against and from any and all amounts paid by him or her in settlement thereof,
with the Company's approval, or paid by him or her in satisfaction of any
judgment in any such action, suit or proceeding against him or her, provided he
or she shall give the Company an opportunity at its own expense, to handle and
defend the same before he or she undertakes to handle and defend it on his or
her own behalf. The foregoing right of indemnification shall not be exclusive of
any other right of indemnification to which such persons may be entitled under
the Company's Articles of Incorporation or Bylaws, as a matter of law, or
otherwise, or any power that the Company may have to indemnify them or hold them
harmless.
12
<PAGE> 13
ARTICLE 17. SUCCESSOR
All obligations of the Company under the Plan with respect to Awards granted
hereunder shall be binding upon any successor to the Company, whether the
existence of such successor is the result of a direct or indirect purchase,
merger, consolidation, or otherwise, of all or substantially all of the business
and/or assets of the Company.
ARTICLE 18. LEGAL CONSTRUCTION
18.1 GENDER AND NUMBER. Except where otherwise indicated by the context, any
masculine term used herein shall also include the feminine; the plural
shall include the singular and the singular shall include the plural.
18.2 SEVERABILITY. In the event any provision of the Plan shall be held
illegal or invalid for any reason, the illegality or invalidity shall
not affect the remaining parts of the Plan, and the Plan shall be
construed and enforced as if the illegal or invalid provision had not
been included.
18.3 REQUIREMENTS OF LAW. The granting of Awards and the issuance of Shares
under the Plan shall be subject to all applicable laws, rules, and
regulations, and to such approvals by governmental agencies or national
securities exchanges as may be required.
18.4 SECURITIES LAW COMPLIANCE. With respect to (i) any person who is
required to file reports pursuant to the rules promulgated under
Section 16 of the Exchange Act and (ii) insiders, transactions under
this Plan are intended to comply with all applicable conditions of Rule
16b-3 or its successors under the Exchange Act. To the extent any
provision of the Plan or action by the Committee fails to so comply, it
will be deemed null and void to the extent permitted by law and deemed
advisable by the Committee.
18.5 GOVERNING LAW. To the extent not preempted by Federal law, the Plan and
all agreements hereunder, shall be construed in accordance with and
governed by the laws of the Commonwealth of Pennsylvania.
13
<PAGE> 1
Exhibit 10.28
AMENDMENT
THIS AMENDMENT, dated as of December 30, 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 and January 8, 1998 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
$200,000 per annum, plus the cost of the Executive's annual long term
disability premium, 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
1
<PAGE> 1
Exhibit 13.1
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data of the Company as of December 31, 1994,
1995, 1996, 1997, 1998 and for the years then ended is derived from audited
consolidated financial statements of the Company.
<TABLE>
<CAPTION>
(In thousands, except per share data)
Years Ended December 31,
1994 1995 1996 1997 1998
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenues(1) $ 14,722 $ 22,310 $ 37,490 $ 45,421 $ 46,277
Cost of product sales 8,168 11,329 18,322 20,104 19,620
...............................................................................................................
Gross profit 6,554 10,981 19,168 25,317 26,657
Operating expenses:
Selling and marketing 1,903 2,953 4,767 5,446 5,704
General and administrative 1,268 1,471 2,552 3,768 4,128
Research and development 1,585 2,637 3,921 5,945 6,880
...............................................................................................................
Total operating expenses 4,756 7,061 11,240 15,159 16,712
Income from operations 1,798 3,920 7,928 10,158 9,945
Other income (expense), net (270) 20 845 899 1,062
...............................................................................................................
Income before income taxes 1,528 3,940 8,773 11,057 11,007
Provision (benefit) for income taxes (617) 1,418 3,176 4,174 4,040
- ---------------------------------------------------------------------------------------------------------------
Net income $ 2,145 $ 2,522 $ 5,597 $ 6,883 $ 6,967
Net income applicable
to common stock (2) $ 1,311 $ 2,522 $ 5,597 $ 6,883 $ 6,967
- ---------------------------------------------------------------------------------------------------------------
Earnings per share: (3)
Basic $ .49 $ .60 $ 1.02 $ 1.21 $ 1.19
Diluted .32 .56 .94 1.15 1.17
- ---------------------------------------------------------------------------------------------------------------
Weighted average shares of common stock
and equivalents:
Basic 2,674 4,228 5,501 5,686 5,841
Diluted 4,159 4,504 5,940 5,962 5,967
- ---------------------------------------------------------------------------------------------------------------
<CAPTION>
As of December 31,
1994 1995 1996 1997 1998
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital $ 3,195 $ 21,159 $ 27,232 $ 34,570 $ 40,539
Total assets 7,151 25,728 34,626 43,713 49,865
Long-term debt, less current portion 1,400 -- -- -- --
Shareholders' equity 1,387 22,609 30,006 38,101 45,696
- ---------------------------------------------------------------------------------------------------------------
<CAPTION>
1994 1995 1996 1997 1998
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
OTHER DATA: (4)
Number of employees at year end 96 126 184 205 230
Average revenue per employee $ 153 $ 177 $ 204 $ 222 $ 201
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes license fees of $250 and $150 for 1997 and 1998, respectively.
(2) Net of accretion for redeemable warrants, all of which were redeemed in
February 1995.
(3) 1998 includes $.04 per share related to the after-tax effect of net key man
life insurance proceeds associated with the death of the Company's former
Chairman R. Craig Allison.
(4) Data not derived from Company's audited financial statements.
6
<PAGE> 2
Management's Discussion and Analysis of Results of Operations and Financial
Condition
The following discussion should be read in conjunction with the "Selected
Consolidated Financial Statements" and notes thereto appearing elsewhere in this
Annual Report to Shareholders.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995.
The statements contained in this Annual Report to Shareholders, specifically
those contained in the following Management's Discussion and Analysis of Results
of Operations and Financial Condition which are not historical, are
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. These forward-looking statements represent Tollgrade Communications,
Inc.'s (the "Company") present expectations or beliefs concerning future events.
The Company cautions that such statements must be qualified by important factors
that could cause actual earnings and other results to differ materially from
those achieved in the past or those expected by the Company. These include rapid
technological change, along with the need to continually develop new products;
the Company's dependence on a single product line; competition; the Company's
dependence on key employees; difficulties in managing the Company's growth; the
Company's dependence upon a small number of large customers and certain
suppliers; the Company's dependence upon proprietary rights; risks of
third-party claims of infringement; and government regulation.
OVERVIEW
The Company was organized in 1986 and began operations in 1988. The Company
designs, engineers, markets and supports test access and test extension products
for the telecommunications and cable television industries. The Company's
telecommunication proprietary products enable telephone companies to use their
existing line test systems to remotely diagnose problems in Plain Old Telephone
Service (POTS) lines containing both copper and fiber optics. The Company's MCU
product line, which includes POTS line testing as well as alarm-related
products, represented approximately 90% of the Company's revenue for the year
ended December 31, 1998 and will continue to account for a majority of the
Company's revenues for the foreseeable future. The Company's cable products
consist of a complete cable status monitoring system that provides a
comprehensive testing solution for the Broadband Hybrid Fiber Coax distribution
system. The status monitoring system consists of a host for user interface,
control and configuration; a headend controller for managing network
communications; and transponders that are strategically located within the cable
network to gather status reports from power supplies, line amplifiers and
fiber-optic nodes.
The Company's telecommunication product sales are primarily to the five
Regional Bell Operating Companies (RBOCs) as well as major independent telephone
companies such as Sprint and to certain digital loop carrier (DLC) equipment
manufacturers. For the year ended December 31, 1998, approximately 79% of the
Company's total revenue was generated from sales to these five RBOCs, the two
largest of which comprised approximately 54% of revenues. The Company intends to
market and sell its cable products directly, as well as through various Original
Equipment Manufacturer (OEM) arrangements with cable network equipment
manufacturers. The Company presently has one OEM arrangement under contract and
works on less formal arrangements with several other OEM partners. Sales for the
Company's cable products for the year ended December 31, 1998 were not material.
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.
7
<PAGE> 3
This timing is particularly sensitive to various business factors within each of
the RBOCs, including the RBOCs relationships with their various organized labor
groups. During the third quarter of 1998, the Company's financial results were
impacted by the effect of certain labor disputes at Bell Atlantic, USWest and
Southern New England Telephone. These work stoppages, along with other factors,
disrupted ongoing and established network expansion and maintenance programs and
exacerbated seasonally lower sales. Certain contracts concerning the RBOCs
organized employees were renegotiated during the third quarter of 1998. Refer to
discussions on 1998 revenues for further comments.
The Company believes that recent changes within the telecommunication
marketplace, including industry consolidation, as well as the Company's ability
to successfully penetrate certain new markets, have resulted in some discounting
and more favorable terms granted to certain customers of the Company. In
addition, the Company has recently experienced certain customer demands to
consolidate product purchases which have translated into large bulk orders.
Although the Company will continue to strive to meet the demands of its
customers, which include delivery of quality products at an acceptable price and
on acceptable terms, there are no assurances that the Company will be successful
in negotiating acceptable terms and conditions pertaining to these large orders.
Additionally, recent consolidations and potential future consolidations among
the RBOCs, and their ability to consolidate their inventory and product
procurement systems could cause fluctuations or delays in the Company's order
patterns. The Company cannot predict such future events or business conditions,
and the Company's results may be adversely affected by these industry trends in
the primary markets its serves.
Although international sales to date have not been significant, the Company
believes the international markets offer opportunities. The international
telephony markets differ from those found domestically due to the different
types and configurations of equipment used by those international communication
companies to provide services. Certain competitive elements also are found
internationally which do not exist in the Company's domestic markets. The
Company has, up to the present time, utilized the professional services of
various marketing consultants to define the Company's international market
opportunities. Markets that are the subject of continuing review are those
markets in China, Europe and several countries in the Pacific Rim area. During
the fourth quarter of 1998, the Company streamlined the structure responsible
for its international efforts. The changes resulted in a more cost-effective
structure that is now focused at the customer level. There continues to be a
high level of interest expressed by certain potential customers in the
international markets; however, there can be no assurance that these efforts
will be successful or that the Company will achieve significant international
sales.
The Company 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 14.9% for the year ended December 31, 1998. The
Company expects its research and development expenses to continue at significant
levels.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUES
Revenues for the year ended December 31, 1998 were $46.3 million and were $0.9
million, or 1.9%, higher than the revenues of $45.4 million for the year ended
December 31, 1997. Revenues for both periods consisted almost entirely of
product sales. Revenues for 1998 and 1997 include approximately $0.5 million and
$0.9 million, respectively, for non-recurring engineering fees, royalty and
license fees. The increase in revenues is primarily associated with new product
revenues. During 1998, the Company generated revenues of approximately $2.2
million associated with new product introductions, including the Company's
LIGHTHOUSE cable products, while same product sales between periods decreased
$1.3 million, or 3.0%. This decrease occurred primarily in the second half of
1998, and the Company believes it was caused by several factors, including
certain labor disputes at Bell Atlantic, USWest and Southern New England
Telephone during the third quarter of 1998, higher than expected inventories at
Ameritech, as well as slower than expected deployment of MCU products within
certain regions of Bell Atlantic. Bell Atlantic's testability improvement
initiatives migrated to more complex embedded DLC
8
<PAGE> 4
architectures that require the provisioning of additional equipment and
increased installation time. The Company is working to implement strategies
designed to return product usage to historical levels for certain customers
through comprehensive technical training and other testability improvement
initiatives. The effectiveness of these programs from a timing point of view are
highly dependent upon a number of factors outside of the Company's control,
including the Company's customers' willingness to dedicate the appropriate
levels of resources to see such initiatives through to their successful
conclusion. Therefore, there can be no assurances as to the ultimate
effectiveness of these programs in returning product deployment to historical
levels. Periodic fluctuations in customer orders and backlog result from a
variety of factors, including but not limited to the timing of significant
orders and shipments, and are not necessarily indicative of long-term trends in
sales of the Company's products. Management believes that there is a continuing
possibility that the requirements for certain important MCU products which are
utilized in legacy DLC systems may be satisfied in the near future, especially
within one major customer. In order to reduce associated risks, the Company is
focusing on the development of new product lines to attempt to meet the other
requirements of this and other customers.
GROSS PROFIT
Gross profit for 1998 was $26.7 million compared to $25.3 million for 1997,
representing an increase of $1.4 million, or 5.3%. Gross profit as a percentage
of revenues increased to 57.6% for 1998 compared to 55.7% for 1997. The overall
increase in gross profit resulted primarily from the increased sales levels,
while improvements in gross margin as a percentage of sales were a result of
increased sales volumes and increased manufacturing efficiencies. The Company's
continuing gross margin levels will depend on its success in holding pricing,
gaining further cost reductions, as well as the mix of products sold including
the effect of the Company's cable products which carry lower gross margins than
earned historically on the Company's telecommunication products.
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 1998
was $5.7 million, or 12.3% of revenues, compared to $5.4 million, or 12.0% of
revenues for 1997. This increase of $0.3 million, or 4.7%, is primarily
associated with additional personnel to support expanding product lines and
increased consulting and travel expenses associated with international market
development. 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 and the
development of comprehensive technical training and other testability
improvement initiatives.
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 1998 was $4.1
million, or 8.9% of revenues, compared to $3.8 million, or 8.3% of revenues for
1997. This increase of $0.3 million, or 9.5%, is primarily attributable to
increased expenditures for legal and professional fees associated with business
development activities as well as personnel recruiting costs.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expenses consist primarily of personnel costs and costs
associated with the development of new products and technologies. Research and
development expense for 1998 was $6.9 million, or 14.9% of revenues, compared to
$5.9 million, or 13.1% of revenues for 1997. This increase of $1.0 million, or
15.7%, was principally due to costs associated with new product development and
the addition of personnel to support these new product development activities.
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 $1.1 million for
1998 compared to $0.9 million for 1997. The increase of $0.2 million, or 18.2%,
includes approximately $0.2 million of net key man life insurance proceeds
associated with the death of the Company's former Chairman R. Craig Allison.
Additionally, 1998 other income and expense included
9
<PAGE> 5
interest expense of approximately $0.1 million related to settlements of issues
with certain prior years' tax returns.
PROVISION FOR INCOME TAXES
The Company's effective tax rate for 1998 was 36.7% of income before income
taxes, compared to the 37.7% rate in 1997. The decrease in the effective income
tax rate primarily reflects the permanent effect of an increase in non-taxable
interest income on the Company's short- and long-term investments related to
individual municipal bonds.
NET INCOME AND EARNINGS PER SHARE
For the year ended December 31, 1998, net income was $7.0 million compared to
$6.9 million for the year ended December 31, 1997, representing an increase of
$0.1 million, or 1.2%. Diluted earnings per common share of $1.17 for 1998
increased by 1.7%, or $.02, from the $1.15 earned in 1997. Fiscal year 1998
includes approximately $0.2 million, or $.04 per share, related to the after-tax
effect of net key man life insurance as previously discussed above. Excluding
the effect of net key man life insurance proceeds, net income decreased $0.1
million, or 2.1% while diluted earnings per share for 1998 decreased 1.7% to
$1.13 per share. Diluted weighted average shares of common stock and equivalents
outstanding were 5,966,551 in 1998 compared to 5,961,540 in 1997. As a
percentage of revenues, net income for 1998 decreased to 15.1% from 15.2% in
1997.
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 revenues included $250,000 of royalty and license fees,
while similar fees for 1996 were immaterial. The increase in revenues was
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 included revenues of $0.7 million from six new products introduced in
1997. Overall, increased product demand was 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. 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 believed that during fiscal year 1998, there was a
possibility that one of the Company's major customers would satisfy a
substantial portion of its requirements for certain of the Company's important
product lines. Management focused on the development of new product lines to
attempt to meet the other requirements of this and other customers. Refer to
discussions on 1998 revenues for further comments
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 has depended 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%, reflected 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's selling and
marketing expenses have risen commensurate with increased revenues and selling
efforts. The Company is continuing its efforts to expand its business
10
<PAGE> 6
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%, was 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 reflected
increases in state taxes offset by benefits from higher levels of tax-exempt
interest and increased credits for research and development.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $40.5 million as of December 31, 1998
compared to the working capital of $34.6 million as of December 31, 1997. The
increase of $5.9 million, or 17.3%, can be attributed to operating cash flow
(income from operations before depreciation and amortization) and proceeds from
the exercise of stock options exceeding requirements for purchases of property
and equipment and funding of the Company's stock buyback program. Significant
components of the Company's change in working capital include an increase in
cash and cash equivalents, which include the effect of cash received as a result
of stock option exercises and net collections, an increase in inventories due to
the investment required to introduce new products and to maintain sufficient
inventory stocking levels. Most significantly offsetting these increases was a
decrease in short-term investments of $1.4 million; the majority of such funds
were invested in long-term investments and, as such, are still available for
general corporate use upon maturity. These investments reflect the Company's
strategy to migrate to individual municipal bonds with a maturity of more than
one year and less than eighteen months and was undertaken to maximize investment
income levels. As of December 31, 1998, the Company had $24.1 million of cash
and cash equivalents, short-term and long-term investments which are available
for acquisitions and other corporate requirements.
The Company made capital expenditures of $1.7 million in 1998 and were
primarily related to an upgrade of the MIS infrastructure, production test
equipment and fixtures, as well as leasehold improvements made to the Company's
facilities. Capital expenditures were $1.2 million and $2.0 million for 1997 and
1996, 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 1999 are anticipated to total approximately $2.4
million. These planned capital projects include test fixtures and development
systems, computer and office equipment and leasehold improvements to the
Company's facilities.
As of May 31, 1998, the Company terminated its $2,500,000 bank line of
credit. The Company believes that, based upon its current financial position,
the line of credit is not necessary to be continued at the present time.
On April 22, 1997, the Company's Board of Directors authorized a program to
purchase up to 200,000 shares of its common stock over the
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<PAGE> 7
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, 1998, the Company had
purchased 106,900 shares of common stock under this program. Subsequent to
December 31, 1998 and through March 1, 1999, the Company purchased an additional
27,900 shares of 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
1998 results. The Company's financial position enables it to meet cash
requirements for operations and capital expansion programs.
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 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.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 issue exists because many computer systems and applications use
two-digit rather than four-digit date fields to designate an applicable year. As
a result, the systems and applications may not properly recognize the year 2000
or process data which include it, potentially causing data miscalculations or
inaccuracies or operational malfunctions or failures.
The Company has established a Year 2000 committee to transition the
Company's business applications, computing infrastructure and communication
systems into the next millennium. The objectives of the Year 2000 committee are
to ensure all internal computer systems function correctly in the Year 2000,
ensure data exchanged with external organizations conforms to Year 2000
standards and ensure all products sold by the Company conform to Year 2000
standards. The Company has developed an inventory of all Company business
systems and corresponding software applications and is currently in the process
of assessing the business priority of each system. Each system will be
classified by mission criticality and a determination will be made to either
replace or remediate the system, depending upon its importance. In addition, the
Year 2000 project will include a review of the Year 2000 compliance efforts of
the Company's key suppliers and other principal business partners and, as
appropriate, the development of joint business support and continuity plans
12
<PAGE> 8
for Year 2000 issues. While this initiative is broad in scope, it has been
structured to identify and prioritize efforts for mission-critical systems,
products and key business partners.
The inventory and assessment phases have been substantially completed as of
December 31, 1998. The Company has established a Year 2000 test center to
certify all business applications and processes utilized throughout the Company.
To date, more than 300 internal software applications or systems have been
identified for testing. Initial results indicate less than 20% of these
applications do not meet Year 2000 standards and, more importantly, less than 5%
are business-critical. During the remainder of 1999, the Year 2000 committee
will focus attention to remediation and testing of internal business systems and
contingency planning.
The Company's products with time-of-day (TOD) clocks in their design have
been tested for successful Year 2000 operation. Products that do not have TOD
clocks have no potential Year 2000 operational issues and, therefore, have not
been tested. The Company believes that it will have no material exposure to
contingencies related to the Year 2000 issue for the products it has sold.
In order to ensure Year 2000 compliance among the Company's key suppliers
and business partners, the Year 2000 committee developed surveys that were
provided to the suppliers in addition to verifying compliance efforts via the
suppliers' and business partners' Web sites for Year 2000 compliance-related
information. The Company is currently examining where and how outside suppliers
and business partners impact the business and apply the same mission-critical
standard to suppliers and business partners that applies to the Company's own
internal systems.
Under the Company's current Year 2000 plan, the target date of June 30,
1999 has been established for completion of remediation, testing and
implementation. The Company's ability to meet that target date is dependent upon
the timely provision of necessary upgrades and modifications by the Company's
suppliers and customers. 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.
The Company currently estimates the expenses associated with the
anticipated Year 2000 efforts to be approximately $0.1 million through 1999,
with an additional $0.3 million for capital improvement costs to support this
project. The costs expensed to date have been immaterial. The timing of the
Company's expenses may vary and is not necessarily indicative of readiness
efforts or progress to date. The Company anticipates that a portion of the Year
2000 expenses will not be incremental costs, but rather will represent the
redeployment of existing Information Technology (IT) resources.
As part of the Year 2000 initiative, the Company is evaluating scenarios
that may occur as a result of the century change and is in the process of
developing contingency and business plans that address potential Year
2000-related occurrences. These plans are expected to assess the potential for
business disruption and to provide operational back-up, recovery and restoration
alternatives.
The above information is based on the Company's current best estimates.
Given the complexity of the Year 2000 issues and risks, actual results may vary
materially from those anticipated and discussed above. Specific factors that
might cause such differences include, among others, the availability and cost of
personnel trained in this area, the ability to locate and correct all affected
computer systems, applications and products and the timing and success of
remedial efforts of the Company's third party suppliers and business partners.
BACKLOG
The Company's backlog consists of firm customer purchase orders for the
Company's various products. As of December 31, 1998, the Company had a backlog
of $0.6 million, a $1.0 million decrease from the December 31, 1997 backlog of
$1.6 million. At December 31, 1998, the composition of the backlog related
primarily to one customer order, while backlog at December 31, 1997 consisted of
several customer orders. 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.
13
<PAGE> 9
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 PricewaterhouseCoopers LLP,
Independent Accountants. As part of their audit of the Company's 1998 financial
statements, PricewaterhouseCoopers LLP considered the Company's system of
internal control to the extent they deemed necessary to determine the nature,
timing and extent of their audit tests. The Independent 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
Chairman, President and
Chief Executive Officer
/s/ Samuel C. Knoch
--------------------------
Samuel C. Knoch
Chief Financial Officer and Treasurer
January 25, 1999
14
<PAGE> 10
REPORT OF INDEPENDENT ACCOUNTANTS
January 25, 1999
To the Board of Directors and Shareholders of Tollgrade Communications, Inc. and
Subsidiaries:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of changes in shareholders' equity and of
cash flows present fairly, in all material respects, the consolidated financial
position of Tollgrade Communications, Inc. and subsidiaries at December 31, 1998
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, 1998, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
-------------------------------
PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
January 25, 1999
15
<PAGE> 11
TOLLGRADE COMMUNICATIONS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS December 31, 1997 DECEMBER 31, 1998
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 3,183,944 $ 8,311,353
Short-term investments 15,666,626 14,249,164
Accounts receivable:
Trade 7,884,683 7,888,060
Other 517,090 300,680
Inventories 12,101,114 13,201,771
Prepaid expenses and deposits 409,252 352,413
Deferred tax assets 213,216 354,891
.................................................................................................................
Total current assets 39,975,925 44,658,332
Long-term investments 600,000 1,553,000
Property and equipment, net 3,001,824 3,314,522
Deferred tax assets 126,895 334,474
Patents and other assets 8,568 4,247
.................................................................................................................
Total assets $ 43,713,212 $ 49,864,575
- -----------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
- -----------------------------------------------------------------------------------------------------------------
Current liabilities:
Accounts payable $ 959,185 $ 687,079
Accrued expenses 1,091,990 1,128,421
Accrued salaries and wages 1,529,525 801,908
Royalties payable 878,780 712,971
Income taxes payable 946,233 788,479
.................................................................................................................
Total current liabilities 5,405,713 4,118,858
Deferred income -- 40,000
Deferred tax liabilities 206,116 9,950
.................................................................................................................
Total liabilities 5,611,829 4,168,808
Commitments
Shareholders' equity:
Preferred stock, $1.00 par value; authorized shares,
10,000,000; issued shares, -0- in 1997 and 1998, respectively -- --
Common stock, $.20 par value; authorized shares, 25,000,000;
issued shares, 5,727,350 in 1997 and 5,920,464 in 1998 1,145,470 1,184,093
Additional paid-in capital 25,232,315 27,503,772
Treasury stock, at cost, 3,200 shares in 1997
and 109,100 shares in 1998 (70,355) (1,789,287)
Unearned compensation (35,934) --
Retained earnings 11,829,887 18,797,189
.................................................................................................................
Total shareholders' equity 38,101,383 45,695,767
.................................................................................................................
Total liabilities and shareholders' equity $ 43,713,212 $ 49,864,575
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
16
<PAGE> 12
TOLLGRADE COMMUNICATIONS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
1996 1997 1998
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $ 37,489,949 $ 45,421,135 $ 46,277,409
Cost of product sales 18,321,677 20,104,202 19,620,226
...............................................................................................................
Gross profit 19,168,272 25,316,933 26,657,183
Operating expenses:
Selling and marketing 4,767,339 5,446,102 5,704,323
General and administrative 2,551,959 3,767,925 4,127,580
Research and development 3,921,091 5,944,819 6,880,015
...............................................................................................................
Total operating expenses 11,240,389 15,158,846 16,711,918
...............................................................................................................
Income from operations 7,927,883 10,158,087 9,945,265
Other income (expense):
Interest expense (3,076) (3,271) (107,694)
Interest and other income 848,569 901,981 1,169,531
...............................................................................................................
Total other income (expense) 845,493 898,710 1,061,837
Income before income taxes 8,773,376 11,056,797 11,007,102
Provision for income taxes 3,176,753 4,173,649 4,039,800
...............................................................................................................
Net income $ 5,596,623 $ 6,883,148 $ 6,967,302
- ---------------------------------------------------------------------------------------------------------------
EARNINGS PER SHARE INFORMATION:
- ---------------------------------------------------------------------------------------------------------------
Weighted average shares of common stock and equivalents:
Basic 5,500,884 5,686,182 5,841,347
Diluted 5,939,662 5,961,540 5,966,551
...............................................................................................................
Net income per common share: (1)
Basic $ 1.02 $ 1.21 $ 1.19
Diluted .94 1.15 1.17
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
(1) 1998 includes $.04 per share related to the after-tax effect of net key man
life insurance proceeds associated with the death of the Company's former
Chairman R. Craig Allison.
The accompanying notes are an integral part of the consolidated financial
statements.
17
<PAGE> 13
TOLLGRADE COMMUNICATIONS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Additional
Preferred Stock Common Stock Paid-in Treasury
Shares Amount Shares Amount Capital Stock
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
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 (49,775)
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 (49,775)
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 -- -- -- -- -- (20,580)
Net income -- -- -- -- -- --
.............................................................................................
Balance at
December 31, 1997 -- -- 5,727,350 1,145,470 25,232,315 (70,355)
EXERCISE OF COMMON
STOCK OPTIONS -- -- 193,814 38,763 1,114,876 --
RESTRICTED STOCK -
COMPENSATION
CHARGED TO
EXPENSE, NET -- -- -- -- -- --
SHARES FORFEITED -- -- (700) (140) (6,860) --
TAX BENEFIT FROM
EXERCISE OF
STOCK OPTIONS -- -- -- -- 1,163,441 --
PURCHASE OF
TREASURY STOCK -- -- -- -- -- (1,718,932)
NET INCOME -- -- -- -- -- --
.............................................................................................
BALANCE AT
DECEMBER 31, 1998 -- $ -- 5,920,464 $1,184,093 $27,503,772 $(1,789,287)
- ---------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Retained
Earnings
Unearned (Accumulated
Compensation Deficit) Total
- -----------------------------------------------------------------------
<S> <C> <C> <C>
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 -- -- 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 (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)
Net income -- 6,883,148 6,883,148
.......................................................................
Balance at
December 31, 1997 (35,934) 11,829,887 38,101,383
EXERCISE OF COMMON
STOCK OPTIONS -- -- 1,153,639
RESTRICTED STOCK -
COMPENSATION
CHARGED TO EXPENSE,
NET 28,934 -- 28,934
SHARES FORFEITED 7,000 -- --
TAX BENEFIT FROM
EXERCISE OF
STOCK OPTIONS -- -- 1,163,441
PURCHASE OF
TREASURY STOCK -- -- (1,718,932)
NET INCOME -- 6,967,302 6,967,302
.......................................................................
BALANCE AT
DECEMBER 31, 1998 $ -- $18,797,189 $45,695,767
- -----------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
18
<PAGE> 14
TOLLGRADE COMMUNICATIONS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
1996 1997 1998
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 5,596,623 $ 6,883,148 $ 6,967,302
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 688,323 1,005,744 1,387,598
Deferred income taxes (77,990) 26,495 (545,420)
Provision for losses on inventory 95,000 -- 88,000
Provision for allowance for doubtful accounts -- 50,000 50,000
Compensation expense for restricted stock 52,356 52,344 28,934
Changes in assets and liabilities:
Increase in accounts receivable-trade (2,582,356) (2,781,094) (53,377)
(Increase) decrease in accounts receivable-other (192,716) (212,656) 216,410
Increase in inventories (2,643,352) (3,531,296) (1,188,657)
(Increase) decrease in prepaid expenses and deposits (398,302) 140,501 56,839
Decrease in accounts payable (275,517) (732,743) (272,106)
Increase (decrease) in accrued expenses, salaries
and wages, royalty payable and deferred income 1,679,404 911,508 (816,995)
Increase (decrease) in income taxes payable 86,089 775,344 (157,754)
..............................................................................................................
Net cash provided by operating activities 2,027,562 2,587,295 5,760,774
..............................................................................................................
Cash flows from investing activities:
Purchase of investments (20,690,542) (19,567,255) (17,380,104)
Redemption/maturity of investments 8,347,950 15,643,221 17,844,566
Capital expenditures (1,993,541) (1,230,910) (1,695,975)
Patent expenditures (4,760) -- --
Purchase of treasury stock -- (20,580) (1,718,932)
..............................................................................................................
Net cash used in investing activities (14,340,893) (5,175,524) (2,950,445)
..............................................................................................................
Cash flows from financing activities:
Proceeds from the exercise of stock options
including related tax benefits 1,803,106 1,180,900 2,317,080
Issuance costs related to the initial public offering (55,889) -- --
..............................................................................................................
Net cash provided by financing activities 1,747,217 1,180,900 2,317,080
..............................................................................................................
Net increase (decrease) in cash and cash equivalents (10,566,114) (1,407,329) 5,127,409
Cash and cash equivalents at beginning of year 15,157,387 4,591,273 3,183,944
..............................................................................................................
Cash and cash equivalents at end of year $ 4,591,273 $ 3,183,944 $ 8,311,353
- --------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ 3,076 $ 3,271 $ 107,694
Cash paid during the year for income taxes 2,013,981 2,420,460 3,596,079
- --------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
19
<PAGE> 15
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 test access and test extension products for the telecommunications and
cable television industries. The Company's telecommunications proprietary
products enable telephone companies to use their existing line test systems to
remotely diagnose problems in Plain Old Telephone Service (POTS) lines
containing both copper and fiber optics. The Company's cable products consist of
a complete cable status monitoring system that provides a comprehensive testing
solution for the Broadband Hybrid Fiber Coax distribution system. The status
monitoring system consists of a host for user interface, control and
configuration; a headend controller for managing network communications; and
transponders that are strategically located within the cable network to gather
status reports from power supplies, line amplifiers and fiber-optic nodes. The
Company was organized in 1986 and began operations in 1988.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of income and expense during the reporting period. Actual
results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany
transactions have been eliminated.
CASH AND CASH EQUIVALENTS
The Company considers highly liquid investments with a maturity of three months
or less when purchased to be cash equivalents. Substantially all of the
Company's cash and cash equivalents are maintained at one financial institution.
No collateral or security is provided on these deposits, other than $100,000 of
deposits per financial institution insured by the Federal Deposit Insurance
Corporation.
INVESTMENTS
Short-term investments at December 31, 1997 and 1998 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. Long-term investments are individual municipal bonds
with a maturity of more than one year but less than eighteen months. The primary
investment purposes are to provide a reserve for future business purposes,
including possible acquisitions, capital expenditures and to meet working
capital requirements.
The Company classifies its investment in all debt securities as "held to
maturity" in accordance with Statement of Financial Accounting Standards (SFAS)
No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
INVENTORIES
Inventories are stated at the lower of cost or market, with cost determined on
the first-in, first-out method. The Company provides appropriate reserves for
any inventory deemed slow moving or obsolete.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. 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.
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.
20
<PAGE> 16
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.
RECLASSIFICATIONS
Certain reclassifications have been made to the Company's 1997 financial
statements to agree with current year classifications.
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>
Years Ended December 31,
1996 1997 1998
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Income $ 5,596,623 $ 6,883,148 $ 6,967,302
- ---------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding 5,500,884 5,686,182 5,841,347
...............................................................................................................
Effect of dilutive securities - stock options 438,778 275,358 125,204
...............................................................................................................
5,939,662 5,961,540 5,966,551
- ---------------------------------------------------------------------------------------------------------------
Earnings per share:
Basic $ 1.02 $ 1.21 $ 1.19
- ---------------------------------------------------------------------------------------------------------------
Diluted $ .94 $ 1.15 $ 1.17
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
2. INVENTORIES
Inventories consisted of the following:
<TABLE>
<CAPTION>
December 31, 1997 DECEMBER 31, 1998
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Raw materials $ 5,738,576 $ 6,135,743
Work in process 5,070,113 4,725,776
Finished goods 1,292,425 2,340,252
.................................................................................................................
$ 12,101,114 $ 13,201,771
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31, 1997 DECEMBER 31, 1998
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Test equipment and tooling $ 2,409,088 $ 3,289,767
Office equipment and fixtures 2,143,567 2,728,443
Leasehold improvements 921,049 1,127,904
.................................................................................................................
5,473,704 7,146,114
Less accumulated depreciation and amortization 2,471,880 3,831,592
.................................................................................................................
$ 3,001,824 $ 3,314,522
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
21
<PAGE> 17
4. SHAREHOLDERS' EQUITY
COMMON STOCK
The Company has 25,000,000 authorized shares which have a par value of $.20 per
share. As of December 31, 1997 and 1998, there are 5,727,350 and 5,920,464
issued shares, respectively.
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, 1998, the Company had purchased 106,900 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. 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 1997 and 1998.
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 date
of $10.00, as determined by the Board of Directors.
Compensation expense was $52,356, $52,344 and $28,934 in 1996, 1997 and
1998, respectively. In 1996, 1997 and 1998, 2,440, 350 and 700 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 $9,487, $18,408 and $7,000 was reversed in 1996, 1997
and 1998, respectively. At December 31, 1998, all shares of restricted common
stock granted had vested.
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, as defined. The options generally vest ratably over a
two-year period, with one-third vested upon grant. The Company's option programs
cover all employees and are used to attract and retain qualified personnel in
all positions.
On 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 Company's Board of Directors adopted the 1998 Employee Incentive
Compensation Plan on January 29, 1998 and further amended such plan on April 10,
1998. All full-time active employees of the Company, excluding officers and
directors, are eligible to participate in the plan. The aggregate number of
shares of the Company's common stock which may be issued under the plan is
600,000 shares, subject to proportionate adjustment in the event of stock splits
and similar events. The shares authorized but not granted under these plans at
December 31, 1997 and 1998 were as follows:
<TABLE>
<CAPTION>
Shares Authorized But Not Granted
December 31, 1997 DECEMBER 31, 1998
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
1995 Long-Term Incentive Compensation Plan 357,973 64,073
1998 Employee Incentive Compensation Plan -- 389,333
......................................................................................................
Total 357,973 453,406
- ------------------------------------------------------------------------------------------------------
</TABLE>
22
<PAGE> 18
Certain employees and directors of the Company were granted stock options
under the 1995 Long-Term Incentive Compensation Plan and the 1998 Employee
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 1996, 1997 and
1998 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>
Years Ended December 31,
1996 1997 1998
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income As reported $ 5,596,623 $ 6,883,148 $ 6,967,302
Pro forma $ 4,687,153 $ 5,805,709 $ 5,159,610
............................................................................................................
Diluted earnings per share As reported $ .94 $ 1.15 $ 1.17
Pro forma $ .79 $ .97 $ .86
- ------------------------------------------------------------------------------------------------------------
</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 1996, 1997 and 1998: expected volatility of 46.5% in 1996, 40.4%
in 1997 and 50.8% in 1998; a risk-free interest rate of 5.64% in 1996, 6.10% in
1997 and 4.82% in 1998; 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 1996, 1997 and 1998, is
$10.71, $8.54 and $7.68, respectively.
Transactions involving stock options under the Company's various stock
option plans and otherwise are summarized below:
<TABLE>
<CAPTION>
Weighted Average
Number of Shares Range of Option Price Exercise Price
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
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
Granted 540,000 14.5625 - 27.125 17.19
Exercised (193,714) 17.00 - 27.125 5.95
Cancelled (40,533) 12.00 - 27.125 20.66
- -----------------------------------------------------------------------------------------------------------
OUTSTANDING, DECEMBER 31, 1998 1,059,220 $ 12.00 - $27.125 $ 18.16
- -----------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Weighted Average
Options exercisable at: Number of Shares Exercise Price
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
December 31, 1996 542,369 $ 10.33
December 31, 1997 615,289 14.17
DECEMBER 31, 1998 711,015 18.40
- -----------------------------------------------------------------------------------------------------------
</TABLE>
23
<PAGE> 19
The following table summarizes the status of the stock options, outstanding
and exercisable, at December 31, 1998:
<TABLE>
<CAPTION>
Stock Options
Stock Options Outstanding Exercisable
- -----------------------------------------------------------------------------------------------------------------
Weighted Average Weighted Weighted
Range of Exercise Remaining Average Average
Prices Shares Contractual Life Exercise Price Shares Exercise Price
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$12.0000 - $15.0000 312,597 7.78 $13.19 279,264 $13.03
.................................................................................................................
$15.1250 - $19.6250 390,704 9.62 16.84 128,229 16.77
.................................................................................................................
$20.6250 - $25.7500 333,252 8.34 23.76 296,519 23.96
.................................................................................................................
$27.1250 - $27.1250 22,667 9.54 27.13 7,003 27.13
.................................................................................................................
Total 1,059,220 8.67 $18.16 711,015 $18.40
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
Subsequent to December 31, 1998, the Board of Directors granted an
additional 157,000 options to employees of the Company pursuant to the 1998
Employee Incentive Compensation Plan.
SERIES A JUNIOR PARTICIPATING PREFERRED STOCK PURCHASE RIGHTS
In order to protect shareholder value in the event of an unsolicited offer to
acquire the Company, on July 23, 1996, the Board of Directors of the Company
declared a dividend of one preferred stock purchase right for each outstanding
share of the Company's common stock. The dividend was payable on August 15, 1996
to shareholders of record as of that date. The aforementioned rights are
exercisable only if a person or group acquires or announces an offer to acquire
20% or more of the Company's common stock. In such an event, each right will
entitle shareholders to buy one-hundredth of a share of a new series of
preferred stock at an exercise price of $115.00. Each one-hundredth of a share
of the new preferred stock has terms designed to make it the economic and voting
equivalent of one share of common stock.
If a person or group acquires 20% or more of the Company's outstanding
common stock, each right not owned by the person or group will entitle its
holder to purchase at the right's exercise price a number of shares of the
Company's common stock (or, at the option of the Company, the new preferred
stock) having a market value of twice the exercise price. Further, at any time
after a person or group acquires 20% or more (but less than 50%) of the
outstanding common stock, the Board of Directors may at its option, exchange
part or all of the rights (other than rights held by the acquiring person or
group) for shares of the Company's common or preferred stock on a one-for-one
basis. Each right further provides that if the Company is acquired in a merger
or other business transaction, each right will entitle its holder to purchase,
at the right's exercise price, a number of the acquiring company's common shares
having a market value at that time of twice the exercise price.
The Board of Directors is entitled to redeem the rights for one cent per
right at any time before a 20% position has been acquired. The Board of
Directors is also authorized to reduce the 20% thresholds referred to above to
not less than 10%.
5. 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 $1,893,000, $2,014,000 and $1,903,701 were incurred
in 1996, 1997 and 1998, respectively, and are included in cost of product sales
in the accompanying consolidated statements of operations.
24
<PAGE> 20
6. INCOME TAXES
The provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
Years Ended December 31,
1996 1997 1998
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $ 2,938,491 $ 3,726,200 $ 4,030,841
State 316,252 421,000 554,379
...............................................................................................................
3,254,743 4,147,200 4,585,220
- ---------------------------------------------------------------------------------------------------------------
Deferred:
Federal (111,056) (28,160) (475,494)
State 33,066 54,609 (69,926)
...............................................................................................................
(77,990) 26,449 (545,420)
...............................................................................................................
$ 3,176,753 $ 4,173,649 $ 4,039,800
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
Reconciliations of the federal statutory rate to the effective tax rates
are as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
1996 1997 1998
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal statutory tax rate 34% 34% 34%
Research and development tax credit (1) (2) (1)
State income taxes 2 3 3
Other 1 3 1
...............................................................................................................
Effective tax rate 36% 38% 37%
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
The components of and changes in the deferred tax assets and liabilities
recorded in the accompanying balance sheets at December 31, 1997 and 1998 were
as follows:
<TABLE>
<CAPTION>
Deferred Deferred
December 31, Expense December 31, Expense DECEMBER 31,
1996 (Credit) 1997 (Credit) 1998
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
DEFERRED TAX ASSETS:
Excess of tax basis over book basis for:
Property and equipment $ -- $ -- $ -- $ (149,797) $149,797
Inventory 57,470 (16,328) 73,798 (130,980) 204,778
Reserves recorded for:
Warranty 78,000 (39,000) 117,000 (52,650) 169,650
Obsolescence 83,850 14,040 69,810 (34,320) 104,130
Allowance for doubtful accounts -- (19,500) 19,500 (19,500) 39,000
Net operating loss carryforward - State 58,750 58,750 -- -- --
Other 50,829 (9,174) 60,003 37,993 22,010
...................................................... ......... ........
Total deferred tax assets 328,899 340,111 689,365
- ------------------------------------------------------ --------- --------
DEFERRED TAX LIABILITIES:
Excess of book basis over tax basis for:
Property and equipment (111,777) 84,389 (196,166) (196,166) --
Other (56,678) (46,728) (9,950) -- (9,950)
...................................................... ......... ........
Total deferred tax liabilities (168,455) (206,116) (9,950)
- ------------------------------------------------------ --------- --------
- -----------------------------------------------------------------------------------------------------------------
Net deferred taxes $ 160,444 $ 26,449 $ 133,995 $ (545,420) $679,415
Reconciliation to the consolidated balance
sheets:
Current portion of deferred tax assets 171,776 213,216 354,891
Current portion of deferred
tax liabilities (168,455) (206,116) (9,950)
.................................................................................................................
Long-term deferred taxes, net $ 157,123 $ 126,895 $334,474
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
The Company had a state tax operating loss carryforward at December 31, 1996 of
approximately $500,000 which was utilized in 1997.
25
<PAGE> 21
7. LEASE COMMITMENTS
The Company leases office space and equipment under agreements which are
accounted for as operating leases. The office lease expires December 31, 2001
and may be extended up to an additional 3 years. The equipment lease expires in
September 2003. 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 $4,827, $4,727 and $1,619 in 1998, 1997 and 1996,
respectively.
<TABLE>
<S> <C>
Minimum annual future rental commitments under noncancelable leases
as of December 31 are:
1999................................................................ $ 579,917
2000................................................................ 595,577
2001................................................................ 616,457
2002................................................................ 31,817
2003................................................................ 23,863
</TABLE>
The rent expense for all lease commitments was approximately $335,000,
$354,000 and $425,714 in 1996, 1997 and 1998, respectively.
8. MAJOR CUSTOMERS, REVENUE CONCENTRATION AND DEPENDENCE ON CERTAIN SUPPLIERS
The Company sells primarily 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 90% of the Company's net product sales for
1998. 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 86%, 86% and 79% of the Company's
net product sales for fiscal years 1996, 1997 and 1998, respectively. During
fiscal years 1996, 1997 and 1998, sales to two RBOCs individually exceeded 10%
of consolidated revenues and, on a combined basis, comprised 60%, 54% and 54%,
respectively, of the Company's net product sales. At December 31, 1997 and 1998,
accounts receivable-trade included in the consolidated balance sheets related to
these two RBOCs was approximately $3,819,000 and $3,639,000, respectively. Due
to the Company's present dependency on the RBOCs, the loss of one or more of the
RBOCs as a customer, or the reduction of orders for the Company's products by
the RBOCs, could materially and adversely affect the Company.
The Company utilizes two key independent subcontractors to perform a
majority of the circuit board assembly and in-circuit testing work on its
products. The Company also utilizes other subassembly contractors on a more
limited basis. The loss of the subcontractors could cause delays in the
Company's ability to meet production obligations and could have 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.
9. 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 or not to exceed the regulatory imposed limit, as defined. The
Company does not make any matching contributions to the plan.
26
<PAGE> 22
STATEMENTS OF OPERATIONS DATA BY QUARTER
The following table presents unaudited quarterly operating results for each of
the Company's last eight fiscal quarters. This information has been prepared by
the Company on a basis consistent with the Company's audited financial
statements and includes all adjustments (consisting only of normal recurring
adjustments) that the Company considers necessary for a fair presentation of the
data. Such quarterly results are not necessarily indicative of the future
results of operations.
<TABLE>
<CAPTION>
(In thousands, except per share data)
Quarter Ended (Unaudited)
March 31, June 30, Sept. 30, Dec. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1997 1997 1997 1997 1998 1998 1998 1998
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues $ 8,619 $ 12,115 $ 11,363 $ 13,324 $ 10,764 $ 14,025 $ 10,120 $ 11,368
Cost of product sales 3,789 5,454 5,226 5,635 4,355 5,920 4,511 4,834
..................................................................................................................
Gross profit 4,830 6,661 6,137 7,689 6,409 8,105 5,609 6,534
Operating expenses:
Selling and marketing 1,046 1,334 1,287 1,779 1,622 1,499 1,227 1,356
General and administrative 831 914 948 1,075 1,090 1,263 1,133 642
Research and development 1,241 1,425 1,517 1,762 1,628 1,542 1,587 2,123
..................................................................................................................
Total operating expenses 3,118 3,673 3,752 4,616 4,340 4,304 3,947 4,121
..................................................................................................................
Income from operations 1,712 2,988 2,385 3,073 2,069 3,801 1,662 2,413
Other income, net 177 239 221 261 189 417 103 353
..................................................................................................................
Income before income taxes 1,889 3,227 2,606 3,334 2,258 4,218 1,765 2,766
Provision for income taxes 710 1,194 999 1,270 813 1,575 655 997
..................................................................................................................
Net income $ 1,179 $ 2,033 $ 1,607 $ 2,064 $ 1,445 $ 2,643 $ 1,110 $ 1,769
- ------------------------------------------------------------------------------------------------------------------
Net income per common share (1)
Basic $ .21 $ .36 $ .28 $ .36 $ .25 $ .45 $ .19 $ .30
Diluted $ .20 $ .34 $ .27 $ .35 $ .24 $ .44 $ .18 $ .30
Weighted average shares of
common stock and equivalents:
Basic 5,632 5,677 5,709 5,725 5,778 5,855 5,893 5,839
Diluted 5,976 5,942 5,955 5,975 5,956 6,008 6,048 5,890
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Second quarter 1998 includes $.04 per share related to the after-tax effect
of net key man life insurance proceeds associated with the death of the
Company's former Chairman R. Craig Allison.
COMMON STOCK MARKET PRICES
The Company's Common Stock has been included for quotation on the Nasdaq
National Market System under the Nasdaq symbol "TLGD" since the Company's
initial public offering in December 1995. The following table sets forth, for
the periods indicated, the high and low sales prices for the Common Stock on
such market:
<TABLE>
<CAPTION>
High Low
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
1997:
First Quarter $ 31-3/4 $ 17
Second Quarter 24-1/4 16-3/4
Third Quarter 24 20
Fourth Quarter 26-1/2 20-1/2
1998:
FIRST QUARTER $ 23-3/4 $ 18-1/4
SECOND QUARTER 26-1/2 20-1/2
THIRD QUARTER 27-3/4 19-3/4
FOURTH QUARTER 21 11
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
At March 1, 1999, the Company had 352 holders of record of its Common Stock
and 5,922,543 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.
27
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements of
Tollgrade Communications, Inc. and Subsidiaries on Form S-8 (Registration No.
333-4290 and Registration No. 333-52907) of our report dated January 25, 1999,
on our audits of the consolidated financial statements and financial statement
schedule of Tollgrade Communications Inc. and subsidiaries as of December 31,
1998 and 1997, and for each of the three years in the period ended December 31,
1998, which report is incorporated by reference or included in this Form 10-K.
/s/ PRICEWATERHOUSECOOPERS LLP
Pittsburgh, Pennsylvania
March 25, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0001002531
<NAME> TOLLGRADE COMMUNICATIONS, INC.
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 8,311,353
<SECURITIES> 14,249,164
<RECEIVABLES> 8,288,740
<ALLOWANCES> 100,000
<INVENTORY> 13,201,771
<CURRENT-ASSETS> 44,658,332
<PP&E> 7,146,114
<DEPRECIATION> 3,831,592
<TOTAL-ASSETS> 49,864,575
<CURRENT-LIABILITIES> 4,118,858
<BONDS> 0
0
0
<COMMON> 1,184,093
<OTHER-SE> 44,511,674
<TOTAL-LIABILITY-AND-EQUITY> 49,864,575
<SALES> 45,767,409
<TOTAL-REVENUES> 510,000
<CGS> 19,620,226
<TOTAL-COSTS> 19,620,226
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 50,000
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 11,007,102
<INCOME-TAX> 4,039,800
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,967,302
<EPS-PRIMARY> 1.19
<EPS-DILUTED> 1.17
</TABLE>
