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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC
-------------------------------
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended March 27, 1999
[ ] Transition Report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from _____________ to ____________
Commission file number 0-27312
TOLLGRADE COMMUNICATIONS, INC.
(Exact Name of Registrant as Specified in its Charter)
PENNSYLVANIA 25-1537134
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification Number)
493 NIXON RD.
CHESWICK, PA 15024
(Address of Principal Executive Offices, including zip code)
724-274-2156
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
As of April 15, 1999, there were 5,959,564 shares of the Registrant's
Common Stock, $0.20 par value per share, and no shares of the Registrant's
Preferred Stock, $1.00 par value per share, outstanding.
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This report consists of a total of 18 pages. The exhibit index is at page 17.
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TOLLGRADE COMMUNICATIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 27, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE NO.
<S> <C>
ITEM 1 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF MARCH 27, 1999 AND
DECEMBER 31,1998 ..........................................................................3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE-MONTH PERIODS
ENDED MARCH 27, 1999 AND MARCH 28, 1998....................................................4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE-MONTH PERIODS
ENDED MARCH 27, 1999 AND MARCH 28, 1998 ...................................................5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.......................................6
REPORT OF INDEPENDENT ACCOUNTANTS..........................................................8
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION..................................................................................9
PART II. OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS.........................................................................15
ITEM 2 CHANGES IN SECURITIES.....................................................................15
ITEM 3 DEFAULTS UPON SENIOR SECURITIES...........................................................15
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......................................15
ITEM 5 OTHER INFORMATION.........................................................................15
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K..........................................................15
SIGNATURE...............................................................................................16
EXHIBIT INDEX...........................................................................................17
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(UNAUDITED) DECEMBER 31,
MARCH 27, 1999 1998
===========================================================================================================
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 8,201,373 $ 8,311,353
Short term investments 13,227,968 14,249,164
Accounts receivable:
Trade 9,555,924 7,888,060
Other 343,567 300,680
Inventories 14,435,323 13,201,771
Prepaid expenses and deposits 367,933 352,413
Deferred tax assets 354,891 354,891
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TOTAL CURRENT ASSETS 46,486,979 44,658,332
Long term investments 650,000 1,553,000
Property and equipment, net 3,438,806 3,314,522
Deferred tax assets 334,474 334,474
Patents and other assets 3,534 4,247
===========================================================================================================
TOTAL ASSETS $50,913,793 $49,864,575
===========================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,289,282 $ 687,079
Accrued expenses 935,811 1,128,421
Accrued salaries and wages 343,764 801,908
Royalties payable 590,839 712,971
Income taxes payable 1,292,720 788,479
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TOTAL CURRENT LIABILITIES 4,452,416 4,118,858
Deferred income -- 40,000
Deferred tax liabilities 9,950 9,950
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TOTAL LIABILITIES 4,462,366 4,168,808
Shareholders' equity:
Common stock, $.20 par value; authorized shares,
25,000,000; issued shares 5,934,564 and
5,920,464, respectively 1,186,913 1,184,093
Additional paid-in capital 27,712,152 27,503,772
Treasury stock, at cost, 165,500 and 109,100 shares,
respectively (2,730,887) (1,789,287)
Retained earnings 20,283,249 18,797,189
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TOTAL SHAREHOLDERS' EQUITY 46,451,427 45,695,767
===========================================================================================================
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $50,913,793 $49,864,575
===========================================================================================================
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
3
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
FOR THE
THREE MONTHS ENDED
MARCH 27, 1999 MARCH 28, 1998
===============================================================================================
<S> <C> <C>
REVENUES $11,120,345 $10,763,840
COST OF PRODUCT SALES 4,751,944 4,355,312
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GROSS PROFIT 6,368,401 6,408,528
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OPERATING EXPENSES:
Selling and marketing 1,398,441 1,621,884
General and administrative 1,048,436 1,089,707
Research and development 1,875,678 1,628,002
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Total operating expenses 4,322,555 4,339,593
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INCOME FROM OPERATIONS 2,045,846 2,068,935
Interest and other income, net 271,214 188,625
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INCOME BEFORE INCOME TAXES 2,317,060 2,257,560
Provision for income taxes 831,000 813,000
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NET INCOME $ 1,486,060 $ 1,444,560
===============================================================================================
EARNINGS PER SHARE INFORMATION:
Weighted average shares of common stock and equivalents:
Basic 5,787,819 5,777,666
Diluted 5,879,702 5,956,313
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Net income per common and common equivalent shares:
Basic $.26 $.25
Diluted $.25 $.24
===============================================================================================
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
4
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
FOR THE
THREE MONTHS ENDED
MARCH 27, 1999 MARCH 28, 1998
========================================================================================================================
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,486,060 $ 1,444,560
Adjustments to reconcile net income to net cash (used in) provided
by operating activities:
Depreciation and amortization 268,445 295,282
Compensation expense for restricted stock -- 13,475
Changes in assets and liabilities:
(Increase) decrease in accounts receivable-trade (1,667,864) 880,042
(Increase) decrease in accounts receivable-other (42,887) 236,454
Increase in inventories (1,233,552) (975,214)
Increase in prepaid expenses and deposits (15,520) (713,272)
Increase in accounts payable 602,203 825,665
(Decrease) increase in accrued expenses, deferred income, and
royalties payable (354,742) 139,341
Decrease in accrued salaries and wages (458,144) (1,009,846)
Increase (decrease) in income taxes payable 504,241 (252,390)
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Net cash (used in) provided by operating activities (911,760) 884,097
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CASH FLOWS FROM INVESTING ACTIVITIES:
Redemption/maturity of investments 2,200,383 3,493,387
Purchase of investments (276,187) (2,986,826)
Capital expenditures (392,016) (679,978)
Purchase of treasury stock (941,600) (237,423)
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Net cash provided by (used in) investing activities 590,580 (410,840)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options including related tax benefits 211,200 1,197,346
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Net cash provided by financing activities 211,200 1,197,346
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Net (decrease) increase in cash and cash equivalents (109,980) 1,670,603
Cash and cash equivalents at beginning of period 8,311,353 3,183,944
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Cash and cash equivalents at end of period $ 8,201,373 $ 4,854,547
========================================================================================================================
</TABLE>
The accompanying notes are an integral part of the
condensed consolidated financial statements.
5
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements included
herein have been prepared by Tollgrade Communications, Inc. (the "Company") in
accordance with generally accepted accounting principles for the interim
financial information and Article 10 of Regulation S-X. The condensed
consolidated financial statements as of and for the three-month period ended
March 27, 1999 should be read in conjunction with the Company's consolidated
financial statements (and notes thereto) included in the Company's Annual Report
on Form 10-K for the year ended December 31, 1998. Accordingly, the accompanying
condensed consolidated financial statements do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements, although the Company believes that the
disclosures are adequate to make the information presented not misleading. In
the opinion of the Company's management, all adjustments considered necessary
for a fair presentation of the accompanying condensed consolidated financial
statements have been included, and all adjustments are of a normal and recurring
nature. Operating results for the three-month period ended March 27,1999 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999.
2. INVENTORY
At March 27, 1999 and December 31, 1998, inventory consisted of the following:
<TABLE>
<CAPTION>
(Unaudited)
March 27, December 31,
1999 1998
----------- -----------
<S> <C> <C>
Raw materials ....................................... $6,233,238 $6,135,743
Work in progress .................................... 5,557,057 4,725,776
Finished goods ...................................... 2,645,028 2,340,252
----------- -----------
$14,435,323 $13,201,771
=========== ===========
</TABLE>
3. INVESTMENTS
Short-term investments at March 27, 1999 consisted of 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.
6
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4. INCOME PER COMMON SHARE
Net income per share is calculated by dividing net income by the weighted
average number of common shares plus incremental common stock equivalent shares
(shares issuable upon exercise of stock options). Incremental common stock
equivalent shares are calculated for each measurement period based on the
treasury stock method, which uses the monthly average market price per share.
The calculation of net income per common and common equivalent shares follows:
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 27, 1999 MARCH 28, 1998
================================================================================================================
<S> <C> <C>
Net income .......................................................... $1,486,060 $1,444,560
Common and common equivalent shares:
Weighted average number of common shares outstanding
during the period ......................................... 5,787,819 5,777,666
Common shares issuable upon exercise
of outstanding stock options
Diluted .............................................. 91,883 178,647
---------- ----------
Common and common equivalent shares outstanding
during the period
Diluted .............................................. 5,879,702 5,956,313
========== ==========
Earnings per share data
Net income per common and common equivalent shares
Basic ................................................ $0.26 $0.25
Diluted .............................................. $0.25 $0.24
</TABLE>
7
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REVIEW REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Tollgrade Communications, Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of
Tollgrade Communications, Inc. and subsidiaries as of March 27, 1999, and the
related condensed consolidated statements of operations and condensed
consolidated statements of cash flows for the three-months then ended. These
financial statements are the responsibility of the company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated financial statements for them
to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Tollgrade Communications, Inc. and
subsidiaries as of December 31, 1998 and the related consolidated statements of
operations, shareholders' equity and cash flows for the year then ended (not
presented herein); and in our report dated January 25, 1999, we expressed an
unqualified opinion on those consolidated financial statements. In our opinion,
the information set forth in the accompanying condensed consolidated balance
sheet as of December 31, 1998, is fairly stated in all material respects in
relation to the consolidated balance sheet from which it has been derived.
/s/ PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
April 12, 1999
8
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
The following discussion should be read in conjunction with the Condensed
Consolidated Financial Statements and notes thereto appearing elsewhere in this
report.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995.
The statements contained in 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 statements as to management's beliefs, strategies, plans,
expectations or opinions in connection with Company performance, which are based
on a number of assumptions concerning future conditions that may ultimately
prove to be inaccurate. 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(R) product line, which includes POTS line testing as well as alarm-related
productS, represented approximately 88% of the Company's revenue for the first
quarter ended March 27, 1999 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 quarter ended March 27, 1999, approximately 80% of the
Company's total revenue was generated from sales to these five RBOCs, the two
largest of which comprised approximately 42% 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 such OEM arrangement under contract
and works under less formal arrangements with several other OEM partners. Sales
for the Company's cable products for the first quarter of 1999 were not
material.
9
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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. This timing is particularly sensitive to various business factors
within each of the RBOCs including the RBOCs relationships with their various
organized labor groups.
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 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 may 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 until the fourth quarter of 1998, 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.
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 16.9% for the first quarter ended March 27, 1999.
The Company expects its research and development expenses to continue at
significant levels.
10
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RESULTS OF OPERATIONS - FIRST QUARTER
REVENUES
Revenues for the first quarter of 1999 of $11,120,345 were $356,505, or 3.3%,
higher than the revenues of $10,763,840 reported for the first quarter of 1998.
The increase in revenues for the first quarter was primarily attributable to an
increase in unit volume sales of core MCU(R) line testing products to BellSouth,
SBC Communications which includes the former Southern New England Telephone, as
well as increase in sales to Ameritech and USWest. Additionally, sales to
Competitive Local Exchange Carriers improved with increased shipments to
Allegiance Telecom, NextLink and US Xchange. The current quarter sales increase
was offset somewhat by decreased shipment levels to Bell Atlantic, which the
Company believes can be attributed to lingering inventory and product deployment
issues. The Company is continuing to implement strategies designed to bring this
customer back to its historical product usage levels, including product
installation training and support. 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.
GROSS PROFIT
Gross profit for the first quarter of 1999 was $6,368,401 compared to $6,408,528
for the first quarter of 1998, representing a decrease of $40,127, or 0.6%.
Gross profit as a percentage of revenues decreased to 57.3% in the first quarter
of 1999, compared to 59.5% in the same quarter last year. The decrease in gross
profit margin as a percentage of revenues was primarily due to increased
manufacturing costs associated with the initial production of certain of the
Company's new products.
SELLING AND MARKETING EXPENSE
Selling and marketing expense for the first quarter of 1999 was $1,398,441
compared to $1,621,884 for the first quarter of 1998. This decrease of $223,443,
or 13.8%, is primarily attributable to a reduction in sales commissions between
periods, as well as a recent reorganization of the Company's international
market development activities. At year-end 1998 and through the first quarter of
1999, 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. As a percentage of revenues, selling and
marketing expenses decreased to 12.6% in the first quarter of 1999 from 15.1% in
the first quarter of 1998.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense for the first quarter of 1999 was $1,048,436,
a decrease of $41,271, or 3.8%, from the $1,089,707 recorded in the first
quarter of 1998. The decrease in general and administrative expense primarily
reflects decreases in salary and related expenditures as well as a reduction in
consulting expenses between periods. As a percentage of revenues, general and
administrative expenses decreased to 9.4% in the first quarter of 1999 from
10.1% in the first quarter of 1998.
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RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense in the first quarter of 1999 was $1,875,678, an
increase of $247,676, or 15.2%, over the $1,628,002 recorded in the first
quarter of 1998. The increase is primarily associated with additional personnel
and related development costs to support new product introductions. The new
personnel were hired for positions in design engineering, hardware and software
development, engineering support, and test engineering. Their efforts are
associated with the development of future products, support for newer products,
and feature enhancements for existing products. As a percentage of revenues,
research and development expense increased to 16.9% in the first quarter of 1999
from 15.1% in the first quarter of 1998.
INTEREST AND OTHER INCOME
Interest and other income consists primarily of interest income. For the first
quarter of 1999, interest and other income was $271,214 compared to $188,625 for
the first quarter of 1998, representing an increase of $82,589, or 43.8%. This
increase is primarily a result of an increase in funds available for investment
between periods.
PROVISION FOR INCOME TAXES
The provision for income taxes for the first quarter of 1999 was $831,000, an
increase of $18,000, or 2.2%, from $813,000 for the first quarter of 1998. This
was largely due to higher pre-tax earnings. In addition, the effective income
tax rate decreased to approximately 35.9% in the first quarter of 1999, compared
to approximately 36.0% in the first quarter of 1998. The decrease in the
effective tax rate between periods reflects certain refinements for the
estimated effective tax rate for fiscal year 1999.
NET INCOME AND EARNINGS PER SHARE
As a result of the above factors, net income for the first quarter of 1999 was
$1,486,060, an increase of $41,500, or 2.9%, from the $1,444,560 recorded in the
first quarter of 1998. Basic and diluted earnings per common share of $.26 and
$.25, respectively, for the first quarter of 1999 increased by $.01or 4.0% and
4.2%, from the $.25 and $.24, respectively, earned in the first quarter of 1998.
Basic and diluted weighted average common and common equivalent shares
outstanding were 5,787,819 and 5,879,702, respectively, in the first quarter of
1999 compared to 5,777,666 and 5,956,313, respectively, in the first quarter of
1998. As a percentage of revenues, net income for the first quarter of 1999
remained unchanged between periods at 13.4%.
LIQUIDITY AND CAPITAL RESOURCES
At March 27, 1999, the Company had working capital of $42,034,563, which
represented an increase of $1,495,089, or 3.7%, from the $40,539,474 of working
capital as of December 31, 1998. The increase in working capital can be
attributed primarily 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 inventories associated with
increases in raw materials and work-in-process for new product introductions as
well as an increase in accounts receivable-trade which reflects the shipment of
certain large bulk purchases towards the end of the first quarter of 1999.
Management believes that operating cash flow and cash reserves are adequate to
finance currently planned capital expenditures and to meet the overall liquidity
needs of the Company.
12
<PAGE> 13
The Company made capital expenditures of $392,016 in the first three months of
1999 which were primarily related to test equipment and fixtures for new product
introductions, as well as leasehold improvements made to the Company's
facilities. The Company presently has no material capital expenditure
commitments.
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 a two-year period. The
program intended that the shares would be utilized to provide stock under
certain employee benefit programs. As of March 27, 1999, the Company had
purchased 163,300 shares of common stock under this program. Subsequent to March
27, 1999 and through April 22, 1999 the Company purchased an additional 27,900
shares of common stock under this program. The Company has used existing cash
and short-term investments to finance these purchases.
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 has assessed the business priority of each system.
Each system was classified by mission criticality and a determination was 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 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 an internal 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 supplier
and business partners Web site 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.
13
<PAGE> 14
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 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 March 27, 1999, the Company had a backlog of
$1,096,206 compared to $570,155 at December 31, 1998 and $3,481,359 at March 28,
1998. The increase in backlog from December 31, 1998 occurred due to customer
orders exceeding product shipments during the period. 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.
14
<PAGE> 15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
The following exhibits are being filed with this report:
Exhibit
Number Description
------- -----------
15 Letter re unaudited interim financial information
27 Financial Data Schedule
(b) Reports on Form 8-K:
The Company did not file any Current Report on Form 8-K during the
quarter ended March 27, 1999.
15
<PAGE> 16
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
TOLLGRADE COMMUNICATIONS, INC.
(REGISTRANT)
Dated: May 5, 1999 /s/ Christian L. Allison
----------------------------------------------
Christian L. Allison
Chairman, President and Chief Executive Officer
Dated: May 5, 1999 /s/ Samuel C. Knoch
-----------------------------------------------
Samuel C. Knoch
Chief Financial Officer and Treasurer
Dated: May 5, 1999 /s/ Bradley N. Dinger
-----------------------------------------------
Bradley N. Dinger
Controller
16
<PAGE> 17
EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
Exhibit
Number Description
------- -----------
15 Letter re unaudited interim financial information
27 Financial Data Schedule
17
<PAGE> 1
EXHIBIT 15
May 5, 1999
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
RE: Tollgrade Communications, Inc. and subsidiaries
1). Form S-8 (Registration No. 333-4290) 1995 Long-Term Incentive
Compensation Plan and Individual Stock Options Granted to Certain Directors and
Employees Prior to the Adoption of the Plan
2). Form S-8 (Registration No. 333-52907) 1998 Employee Incentive
Compensation Plan
Ladies and gentlemen:
We are aware that our report dated April 12, 1999 on our review of interim
financial information of Tollgrade Communications, Inc. and subsidiaries for the
three-month period ended March 27,1999 and included within the Company's
quarterly report on Form 10-Q for the quarter then ended is incorporated by
reference in the registration statement referred to above. Pursuant to Rule
436(c)under the Securities Act of 1933, this report should not be considered a
part of the registration statement prepared or certified by us within the
meaning of Sections 7 and 11 of that Act.
Very truly yours,
/s/ PricewaterhouseCoopers LLP
18
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
FOR THE PERIOD ENDED MARCH 27, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0001002531
<NAME> TOLLGRADE COMMUNICATIONS, INC.
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-27-1999
<CASH> 8,201,373
<SECURITIES> 13,227,968
<RECEIVABLES> 9,755,810
<ALLOWANCES> 199,886
<INVENTORY> 14,435,323
<CURRENT-ASSETS> 46,486,979
<PP&E> 7,534,844
<DEPRECIATION> 4,096,038
<TOTAL-ASSETS> 50,913,793
<CURRENT-LIABILITIES> 4,452,416
<BONDS> 0
0
0
<COMMON> 1,186,913
<OTHER-SE> 45,264,514
<TOTAL-LIABILITY-AND-EQUITY> 50,913,793
<SALES> 11,120,345
<TOTAL-REVENUES> 11,120,345
<CGS> 4,751,944
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<OTHER-EXPENSES> 0
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