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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC
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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 September 30, 2000
[ ] 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)
412-820-1400
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes ___X___ No _______
As of October 28, 2000, there were 13,296,249 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 34 pages. The exhibit index is on page 21.
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TOLLGRADE COMMUNICATIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2000
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE NO.
------------------------------ --------
<S> <C> <C>
ITEM 1 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2000 AND DECEMBER 31, 1999 .....3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE-MONTH AND NINE
MONTH PERIODS ENDED SEPTEMBER 30, 2000 AND SEPTEMBER 25, 1999..............................4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE-MONTH PERIODS
ENDED SEPTEMBER 30, 2000 AND SEPTEMBER 25, 1999 ...........................................5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.......................................6
REVIEW REPORT OF INDEPENDENT ACCOUNTANTS..................................................10
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION................................................................................ 11
PART II. OTHER INFORMATION
---------------------------
ITEM 1 LEGAL PROCEEDINGS.........................................................................21
ITEM 2 CHANGES IN SECURITIES.....................................................................21
ITEM 3 DEFAULTS UPON SENIOR SECURITIES...........................................................21
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......................................21
ITEM 5 OTHER INFORMATION.........................................................................21
ITEM 6 EXHIBITS AND REPORTS FILED ON FORM 8-K....................................................21
SIGNATURE...............................................................................................22
EXHIBIT INDEX...........................................................................................23
</TABLE>
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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)
SEPTEMBER
30, 2000 DECEMBER 31, 1999
=========================================================================================================================
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 33,245,797 $ 15,555,810
Short-term investments 20,772,837 13,516,676
Accounts receivable:
Trade 14,096,405 10,865,244
Other 673,123 335,155
Inventories 26,130,850 17,335,747
Prepaid expenses and deposits 465,662 461,934
1
Deferred and refundable tax assets 13,820,231 575,25
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TOTAL CURRENT ASSETS 109,204,905 58,645,817
Long-term investments 4,533,000 2,850,000
Property and equipment, net 5,935,753 4,337,115
Deferred tax assets 516,702 367,626
Patents and other assets 47,254 1,396
=========================================================================================================================
TOTAL ASSETS $ 120,237,614 $ 66,201,954
=========================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,256,719 $ 911,769
Accrued expenses 1,314,833 1,222,866
Accrued salaries and wages 2,817,227 2,209,473
Royalties payable 745,979 793,689
Income taxes payable 605,395 2,443,609
Deferred income 100,000 1,106,483
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TOTAL CURRENT LIABILITIES 8,840,153 8,687,889
Deferred tax liabilities 9,950 9,950
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TOTAL LIABILITIES 8,850,103 8,697,839
Shareholders' equity:
Common stock, $.20 par value; authorized shares,
50,000,000; issued shares, 13,258,031 and 12,102,280,
respectively 2,651,606 2,420,456
Additional paid-in capital 62,806,780 28,828,568
Treasury stock, at cost, 386,800 shares, respectively (3,164,975) (3,164,975)
Retained earnings 49,094,100 29,420,066
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TOTAL SHAREHOLDERS' EQUITY 111,387,511 57,504,115
=========================================================================================================================
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 120,237,614 $ 66,201,954
=========================================================================================================================
</TABLE>
The accompanying notes are an integral part of the condensed
consolidated financial statements.
3
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
For the For the
Three Nine
Months Ended Months Ended
Sept. 30, 2000 Sept. 25, 1999 Sept. 30, 2000 Sept. 25, 1999
===========================================================================================================================
<S> <C> <C> <C> <C>
REVENUES $29,787,819 $13,402,653 $81,872,064 $38,792,717
COST OF PRODUCT SALES 10,840,558 6,039,595 30,625,600 16,694,313
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GROSS PROFIT 18,947,261 7,363,058 51,246,464 22,098,404
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OPERATING EXPENSES:
Selling and marketing 3,439,953 1,560,692 8,851,097 4,726,680
General and administrative 1,591,603 980,508 4,464,660 2,993,877
Research and development 3,178,081 2,125,826 8,866,844 6,159,484
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TOTAL OPERATING EXPENSES 8,209,637 4,667,026 22,182,601 13,880,041
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INCOME FROM OPERATIONS 10,737,624 2,696,032 29,063,863 8,218,363
Interest and other income, net 661,917 334,301 1,677,171 842,064
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INCOME BEFORE INCOME TAXES 11,399,541 3,030,333 30,741,034 9,060,427
Provision for income taxes 4,104,000 1,092,000 11,067,000 3,262,855
===========================================================================================================================
NET INCOME $7,295,541 $1,938,333 $19,674,034 $5,797,572
===========================================================================================================================
Earnings per share information:
Weighted average shares of common stock and
equivalents:
Basic 12,821,132 11,547,610 12,536,510 11,553,492
Diluted 13,460,481 12,016,604 13,314,988 11,786,080
---------------------------------------------------------------------------------------------------------------------------
Net income per common share:
Basic $.57 $.17 $1.57 $.50
Diluted $.54 $.16 $1.48 $.49
===========================================================================================================================
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
Sept. 30, 2000 Sept. 25, 1999
======================================================================================================================
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $19,674,034 $5,797,572
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 1,331,410 920,097
Deferred income taxes (114,785) (253,545)
Changes in assets and liabilities:
Increase in accounts receivable-trade (3,231,161) (1,521,422)
Increase in accounts receivable-other (337,968) (12,393)
Increase in inventories (8,795,103) (4,740,301)
(Increase) decrease in prepaid expenses and other assets (49,586) 124,222
Increase in accounts payable 2,344,950 718,440
(Decrease) increase in accrued expenses and deferred income (914,516) 801,218
Increase in accrued salaries and wages 607,754 132,369
Decrease in royalties payable (47,710) (219,905)
(Decrease) increase in income taxes payable (1,838,214) 151,863
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Net cash provided by operating activities 8,629,105 1,898,215
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CASH FLOWS FROM INVESTING ACTIVITIES:
Redemption/maturity of investments 14,427,752 9,353,489
Purchase of investments (23,366,913) (9,299,831)
Capital expenditures (2,930,048) (1,259,712)
Purchase of treasury stock -- (1,375,688)
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Net cash used in investing activities (11,869,209) (2,581,742)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options, including related tax
benefits 20,930,091 677,857
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Net cash provided by financing activities 20,930,091 677,857
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Net increase (decrease)in cash and cash equivalents 17,689,987 (5,670)
Cash and cash equivalents at beginning of period 15,555,810 8,311,353
---------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $33,245,797 $8,305,683
======================================================================================================================
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 accounting principles generally accepted in the United States of
America for the interim financial information and Article 10 of Regulation S-X.
The condensed consolidated financial statements as of and for the three-month
and nine-month periods ended September 30, 2000 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, 1999. Accordingly, the accompanying condensed consolidated financial
statements do not include all of the information and footnotes required by
accounting principles generally accepted in the United States of America for
complete financial statements, although the Company believes that the
disclosures are adequate to make the information presented not misleading. In
the opinion of 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 and nine-month periods ended
September 30, 2000 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2000.
2. INVENTORIES
At September 30, 2000 and December 31, 1999, inventories consisted of the
following:
<TABLE>
<CAPTION>
(Unaudited)
September 30, December 31,
2000 1999
---- ----
<S> <C> <C>
Raw materials . . . . . . . . . . . . . . . $10,560,352 $ 8,173,299
Work in progress . . . . . . . . . . . . . 12,572,315 7,410,203
Finished goods . . . . . . . . . . . . . . 2,998,183 1,752,245
----------- -----------
$26,130,850 $17,335,747
=========== ===========
</TABLE>
3. SHORT-TERM AND LONG-TERM INVESTMENTS
Short-term investments at September 30, 2000 and December 31, 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 comprised of individual
municipal bonds with a maturity of more than one year but less than eighteen
months and are stated
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at cost, which approximated market value. The primary investment purpose is to
provide a reserve for future business purposes, including possible acquisitions
and capital expenditures and to meet working capital requirements. Realized
gains and losses are computed using the specific identification method.
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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 Nine Months Nine Months
Ended Ended Ended Ended
Sept. 30, 2000 Sept. 25, 1999 Sept. 30, 2000 Sept. 25, 1999
===============================================================================================================================
<S> <C> <C> <C> <C>
Net income $ 7,295,541 $ 1,938,333 $19,674,034 $ 5,797,572
=========== =========== =========== ===========
Common and common equivalent shares:
Weighted average number of
common shares outstanding
during the period 12,821,132 11,547,610 12,536,510 11,553,492
Common shares issuable upon exercise
of outstanding stock options
Diluted 639,349 468,994 778,478 232,588
----------- ----------- ----------- -----------
Common and common equivalent shares
outstanding during the period
Diluted 13,460,481 12,016,604 13,314,988 11,786,080
=========== =========== =========== ===========
Earnings per share data:
Net income per common and common
equivalent shares
Basic $ 0.57 $ 0.17 $ 1.57 $ 0.50
Diluted $ 0.54 $ 0.16 $ 1.48 $ 0.49
</TABLE>
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5. DEFERRED AND REFUNDABLE TAX ASSETS
The Company's current deferred and refundable tax assets as of September 30,
2000 includes a tax benefit of $13,279,271 resulting from the exercising of
certain nonstatutory stock options by various directors, officers and other
employees under the Company's various stock option programs during the first
nine months of 2000. The Company is entitled to a tax deduction in the current
tax year ending December 31, 2000 equal to the difference between the fair
market value of the shares received by the option holders upon exercise and the
exercise price of the nonstatutory stock options. It is anticipated that these
deductions will be utilized over the next twelve-month period either through
elimination of income taxes payable or refund of prior taxes paid.
This tax benefit is accounted for as a non-cash item in the Condensed
Consolidated Statements of Cash Flow.
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<PAGE> 10
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 its subsidiaries as of September 30, 2000,
and the related condensed consolidated statements of operations for each of the
three-month and nine-month periods ended September 30, 2000 and September 25,
1999 and the condensed consolidated statement of cash flows for the nine-month
periods ended September 30, 2000 and September 25, 1999. 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 interim financial statements
for them to be in conformity with accounting principles generally accepted in
the United States of America.
We previously audited, in accordance with auditing standards generally accepted
in the United States of America, the consolidated balance sheet of Tollgrade
Communications, Inc. and subsidiaries as of December 31, 1999 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 24,
2000, except for Note 2, which is as of March 20, 2000, 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, 1999, 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
October 10, 2000
10
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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 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 statements as
to management's beliefs, strategies, plans, expectations or opinions in
connection with Company performance, 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: customers' ability to meet
established purchase forecasts and their own growth projections; the ability of
certain customers to maintain financial strength and access to capital; the
ability for sales and marketing partners to meet their own performance
objectives and provide vendor financing to certain local exchange carriers;
rapid technological change along with the need to continually develop new
products and gain customer acceptance and approval; the Company's focus on a
relatively narrow range of products; competition; the Company's dependence on
key employees and the ability to continue to recruit appropriate personnel;
difficulties in managing the Company's growth; the Company's dependence upon
certain customers and certain suppliers and contract manufacturers; 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 system, test access and status
monitoring products for the telecommunications and cable television industries.
The Company's telecommunications proprietary test access 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 71% of the
Company's revenue for the third quarter ended September 30, 2000 and will
continue to account for a majority of the Company's revenues for the foreseeable
future.
The Company's DigiTest(R) centralized network test system platform focuses on
helping local exchange carriers conduct the full range of fault diagnosis, along
with the ability to qualify, deploy and maintain next generation services that
include Digital Subscriber Line ("DSL") service and
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Integrated Services Digital Network ("ISDN") service. The Company's DigiTest
system is designed to provide complete hardware testing for POTS and local loop
prequalification for DSL services. The system currently consists of three
integrated pieces of hardware - the Digital Measurement Node ("DMN"), the
Digital Measurement Unit ("DMU"), and the Digital Wideband Unit ("DWU"). When
used in an integrated fashion, the DigiTest system will permit local exchange
carriers to perform a complete array of central office testing including POTS,
DSL line prequalification, bridged tap detection, data rate prediction, and
in-service wideband testing. Sales of the DigiTest product line accounted for
approximately 15% of the Company's revenue for the third quarter of 2000.
The Company's LIGHTHOUSE(R) cable products consist of a complete cable status
monitoring system that provides a broad testing solution for the Broadband
Hybrid Fiber Coax distribution system. The status monitoring system includes 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. Sales of the LIGHTHOUSE product line accounted
for approximately 12% of the Company's revenue for the third quarter of 2000.
Through the third quarter of 2000, the Company continued to build upon and
extend its Professional Services offering to customers. The cornerstone of the
Company's Professional Services offering is the Testability Improvement
Initiatives. These services may offer the customer the opportunity to make
dramatic improvements in testability levels, while training their own staffs in
targeted geographic regions over a defined period of time. By making
improvements in the customer's digital loop carrier ("DLC") testability levels,
the customer's internal repair technicians can make use of automated systems to
diagnose and repair subscriber loop problems thereby automatically eliminating
the need for the involvement of several highly trained people to test and
diagnose line problems. The Professional Services business levels continued to
increase in the third quarter of 2000 but are not yet considered material to the
Company's revenue.
The Company's telecommunication product sales are primarily to the four Regional
Bell Operating Companies ("RBOCs") as well as major independent telephone
companies and to certain digital loop carrier ("DLC") equipment manufacturers.
For the third quarter ended September 30, 2000, approximately 64% of the
Company's total revenue was generated from sales to these four RBOCs, the two
largest of which comprised approximately 49% of revenues. The Company markets
and sells 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.
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. Certain contracts concerning Verizon
Communications ("Verizon") (formerly Bell Atlantic) organized employees expired
on August 6, 2000, and were subject to negotiation during the third quarter.
Such contracts cover the majority of
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Verizon's union employees associated with the former Bell Atlantic. These
employees entered into a formal work stoppage against Verizon in the third
quarter and subsequently reached a formal agreement during the quarter. The
Company believes the effect of the short-term work stoppage on its operations
was not significant. In addition, the markets for the Company's new products,
specifically DigiTest and LIGHTHOUSE, are highly competitive, beyond the
competition historically seen in the Company's MCU markets. Due to the rapidly
evolving market in which these products compete, additional competitors with
significant market presence and financial resources could further intensify the
competition for these products.
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 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. Also, recent efforts in
the cable status monitoring industry to standardize transponders among status
monitoring systems could cause pricing pressure as well as affect deployment
within certain customers of the Company's cable products. These standards, if
adopted by the standards setting body, are expected to become final in the
fourth quarter of 2000 and may affect the Company's revenues from such products
in subsequent periods. 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 that certain international markets may offer opportunities. However,
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. In addition, certain competitive
elements also are found internationally which do not exist in the Company's
domestic markets. These factors, when combined, have made entrance into these
international markets very difficult. From time to time, the Company has
utilized the professional services of various marketing consultants to assist in
defining the Company's international market opportunities. With the assistance
of these consultants and through direct marketing efforts by the Company, it has
been determined that its present MCU technology offers limited opportunities in
certain international markets for competitive and other technological reasons.
These markets include China (other than through an existing OEM relationship),
Europe and the Pac Rim countries. There can be no assurance that any continued
efforts by the Company 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 11% for the third quarter ended
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September 30, 2000. The Company expects its research and development expenses to
continue at significant levels.
14
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RESULTS OF OPERATIONS - THIRD QUARTER
REVENUES
Revenues for the third quarter of 2000 of $29,787,819 were $16,385,166, or
122.3%, higher than the revenues of $13,402,653 reported for the third quarter
of 1999. The increase in revenues for the third quarter of 2000 was primarily
attributable to an increase in unit volume sales of core MCU line testing
products to SBC Communications, Inc. (including Ameritech, Pacific Bell and
SNET) associated with its Project Pronto, a broadband initiative, and its
continued effort to improve testability in their multi-state region, as well as
significantly increased sales to Verizon (formerly Bell Atlantic). The current
quarter also included increased shipments of the Company's next generation
DigiTest system products primarily to Lucent for deployment into the CLEC
(Competitive Local Exchange Carrier) markets, including Choice One
Communications, as well as direct sales to Sprint and SBC Telecom, Inc. (a CLEC
subsidiary of SBC Communications, Inc.). In addition, the current quarter
includes increased sales of the Company's LIGHTHOUSE Cable Status Monitoring
System to RCN Corporation. Additionally, the current quarter included increased
billings related to the Company's Professional Service business. 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 third quarter of 2000 was $18,947,261 compared to
$7,363,058 for the third quarter of 1999, representing an increase of
$11,584,203, or 157.3%. Gross profit as a percentage of revenues increased to
63.6% in the third quarter of 2000, compared to 54.9% in the same quarter last
year. 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 a favorable sales mix and associated manufacturing efficiencies
related to increased production levels. The Company's gross margin continue to
be highly sensitive to the mix of products shipped. Revenues from the Company's
DigiTest test platform, which is being marketed aggressively on both a direct
and OEM sale basis, in what is becoming an extremely competitive environment,
are expected to become a larger portion of the Company's total revenues in 2001.
To the extent that such increased DigiTest revenues are attributable either to
O.E.M. sales or to product deployment into applications downstream from the
central office, the Company believes that actual overall margins may decline
slightly from their current levels.
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SELLING AND MARKETING EXPENSE
Selling and marketing expense for the third quarter of 2000 was $3,439,953
compared to $1,560,692 for the third quarter of 1999. This increase of
$1,879,261, or 120.4%, is primarily due to an increase in the number of sales
and marketing personnel to support new product introductions and enhance
customer support, as well as an increase in commissions associated with the
increased sales level during the current quarter. In addition, the current
quarter includes increased spending on advertising, promotion and related
marketing activities. As a percentage of revenues, selling and marketing
expenses decreased slightly to 11.5% in the third quarter of 2000 from 11.6% in
the third quarter of 1999.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense for the third quarter of 2000 was $1,591,603,
an increase of $611,095, or 62.3%, from the $980,508 recorded in the third
quarter of 1999. The increase in general and administrative expense primarily
reflects increases in certain performance-based compensation reserves associated
with the Company's management incentive compensation program, certain
professional service fees, as well as various recruiting-related expenditures.
As a percentage of revenues, general and administrative expenses decreased to
5.3% in the third quarter of 2000 from 7.3% in the third quarter of 1999.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense in the third quarter of 2000 was $3,178,081, an
increase of $1,052,255, or 49.5%, over the $2,125,826 recorded in the third
quarter of 1999. The increase is primarily associated with additional personnel
and related development costs associated with developing new products and new
technologies and enhancing features of existing products. The new personnel were
hired for positions in design engineering, hardware and software development,
engineering support, and test engineering. In addition, research and development
expenses reflect an increase in certain performance-based compensation reserves
associated with the Company's management incentive compensation program. As a
percentage of revenues, research and development expense decreased to 10.7% in
the third quarter of 2000 from 15.9% in the third quarter of 1999.
INTEREST AND OTHER INCOME
Interest and other income consists primarily of interest income. For the third
quarter of 2000, interest and other income was $661,917 compared to $334,301 for
the third quarter of 1999, representing an increase of $327,616, or 98%. This
increase is primarily a result of additional funds available for investment
purposes during the current period.
PROVISION FOR INCOME TAXES
The provision for income taxes for the third quarter of 2000 was $4,104,000, an
increase of $3,012,000, or 275.8%, from the $1,092,000 for the third quarter of
1999. The effective income tax rate for the third quarter of 2000 was
approximately 36.0% of pretax income, which is comparable to the effective tax
rate for the third quarter of 1999.
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NET INCOME AND EARNINGS PER SHARE
As a result of the above factors, net income for the third quarter of 2000 was
$7,295,541, an increase of $5,357,208, or 276.4%, from the $1,938,333 recorded
in the third quarter of 1999. Basic and diluted earnings per common share of
$.57 and $.54, respectively, for the third quarter of 2000 increased by $.40 and
$.38, or 235.3% and 237.5%, from the $.17 and $.16, respectively, earned in the
third quarter of 1999. Basic and diluted weighted average common and common
equivalent shares outstanding were 12,821,132 and 13,460,481, respectively, in
the third quarter of 2000 compared to 11,547,610 and 12,016,604, respectively,
in the third quarter of 1999. The increase in the weighted average equivalent
shares resulted primarily from an increase in the average share price between
periods. As a percentage of revenues, net income for the third quarter of 2000
increased to 24.5% compared to the 14.5% for the third quarter of 1999.
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RESULTS OF OPERATIONS - YEAR TO DATE
REVENUES
For the first nine months of 2000, revenues were $81,872,064 compared to
$38,792,717 for the first nine months of 1999, representing an increase of
$43,079,347, or 111.1%. The increase in revenues for the first nine months of
2000 was primarily attributable to an increase in unit volume sales of core MCU
line testing products to SBC Communications, Inc. (including Ameritech, Pacific
Bell and SNET), Verizon (formerly Bell Atlantic), Bell South and Qwest (formerly
US West). The first nine months also includes increased shipments of the
Company's next generation DigiTest system products to Sprint and SBC Telecom,
Inc., as well as to Nortel Networks and Lucent for deployment into the CLEC
markets, including TriVergent Communications, ATI and Choice One Communications.
The first nine months of 2000 sales include approximately $1,400,000 of revenue
related to orders shipped prior to January 1, 2000 and an additional $2,200,000
shipped during the first quarter of 2000 which were pending receipt of final
third party certifications and customer acceptance. All such certifications and
customer acceptance notifications were received in the second quarter of 2000.
Additionally, the first nine months includes increased sales of the Company's
LIGHTHOUSE Cable Status Monitoring System to RCN Corporation and AT&T Broadband
and Internet Services (AT&T BIS), as well as to ANTEC, an Original Equipment
Manufacturer of cable network products. Also, sales included increased billings
related to the Company's Professional Service business. 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 nine months of 2000 was $51,246,464, which represents
an increase of $29,148,060, or 131.9%, from the $22,098,404 in the same period
last year. As a percentage of revenues, gross profit increased to 62.6% in the
first nine months of 2000 compared to 57.0% in the same period for 1999. The
overall increase in gross profit resulted primarily from increased sales levels,
while improvements in gross margin as a percentage of sales were a result of a
favorable sales mix and associated manufacturing efficiencies related to
increased production levels. The Company's gross margin continue to be highly
sensitive to the mix of products shipped. Revenues from the Company's DigiTest
test platform, which is being marketed aggressively on both a direct and OEM
sale basis, in what is becoming an extremely competitive environment, are
expected to become a larger portion of the Company's total revenues in 2001. To
the extent that such increased DigiTest revenues are attributable either to
O.E.M. sales or to product deployment into applications downstream from the
central office, the Company believes that actual overall margins may decline
slightly from their current levels.
SELLING AND MARKETING EXPENSE
For the first nine months of 2000, selling and marketing expense totaled
$8,851,097 compared to $4,726,680 for the first nine months of 1999,
representing an increase of $4,124,417 or 87.3%. The
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<PAGE> 19
increase is primarily due to an increase in the number of sales and marketing
personnel to support new product introductions and enhance customer support, as
well as an increase in commissions associated with the increased sales level. In
addition, selling and marketing expenses for the first nine months of 2000
include increased spending on advertising, promotion and related marketing
activities. As a percentage of revenue, selling and marketing expense decreased
to 10.8% in the first nine months of 2000 from 12.2% for the same period in
1999.
GENERAL AND ADMINISTRATIVE EXPENSE
For the first nine months of 2000, general and administrative expense totaled
$4,464,660 compared to $2,993,877 for the first nine months of 1999,
representing an increase of $1,470,873, or 49.1%. The increase in general and
administrative expense reflects an increase in certain performance-based
compensation reserves associated with the Company's management incentive
compensation program, certain professional service fees, as well as various
employee recruiting-related expenditures. As a percentage of revenue, general
and administrative expense decreased to 5.5% in the first nine months of 2000
from 7.7% for the same period of 1999.
RESEARCH AND DEVELOPMENT EXPENSE
For the first nine months of 2000, research and development expense totaled
$8,866,844 compared to $6,159,484 for the first nine months of 1999,
representing an increase of $2,707,360, or 44.0%. This increase is primarily
associated with additional personnel to support new product development,
increased expenditures on prototypes, and an increase in certain
performance-based compensation reserves associated with the Company's management
incentive compensation program. As a percentage of revenue, research and
development expense decreased to 10.8% in the first nine months of 2000 from
15.9% for the same period of 1999.
INTEREST AND OTHER INCOME
For the first nine months of 2000, interest and other income was $1,677,171
compared to $842,064 for the first nine months of 1999, representing an increase
of $835,107, or 99.2%. This increase is primarily attributable to an increase in
funds available for investments during the first nine months of 2000.
PROVISION FOR INCOME TAXES
The provision for income taxes for the first nine months of 2000 was
$11,067,000, which was an increase of $7,804,145, or 239.2%, from $3,262,855 for
the first nine months of 1999. The effective income tax rate for the first nine
months of 2000 was 36.0% of income before taxes, which was consistent with the
rate in the prior year period.
NET INCOME AND EARNINGS PER SHARE
As a result of the above factors, net income for the first nine months of 2000
was $19,674,034, an increase of $13,876,462, or 239.3% , from the $5,797,572
recorded in the first nine months of 1999. Basic and diluted earnings per common
share of $1.57 and $1.48, respectively, for the first nine months of 2000
increased by $1.07 and $.99, or 214.0% and 202.0%, from the $.50 and $.49,
respectively, earned in the first nine months of 1999. Basic and diluted
weighted average common and common equivalent shares outstanding were 12,536,510
and 13,314,988, respectively, in the first nine months of 2000 compared to
11,553,492 and 11,786,080, respectively, in the first nine
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<PAGE> 20
months of 1999. The increase in the weighted average equivalent shares resulted
primarily from an increase in the average share price between periods. As a
percentage of revenues, net income for the first nine months of 2000 increased
to 24.0% compared to the 14.9% in the first nine months of 1999.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2000, the Company had working capital of $100,364,752, which
represented an increase of $50,406,824, or 100.9%, from the $49,957,928 of
working capital as of December 31, 1999. 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
including related tax benefits exceeding requirements for purchases of property
and equipment. Significant components of the Company's change in working capital
include an increase in inventories of $8,795,103 associated primarily with
increases in raw materials and work-in-process to support the new product
introductions of the Company's DigiTest and LIGHTHOUSE cable status monitoring
system as well as an increase in MCU related inventory to support certain
project related customer programs. 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.
BACKLOG
The Company's backlog consists of firm customer purchase orders. As of September
30, 2000, the Company had a backlog of $14,412,165 compared to $12,115,608 at
December 31, 1999 and $7,765,957 at September 25, 1999. The backlog includes a
$2,610,000 order for Tollgrade's Broadcast Program Channel destined for use at
the Salt Lake City Winter Olympic Games. The Company plans to ship this order
during the next six months. 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.
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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
------ -----------
10.30 Change in Control Agreement, entered into
August 10, 2000 between the company and
Stephen M. Garda, together with a schedule
listing a substantially identical agreement
entered into October 20, 2000 with William
Anderson.
15 Letter re unaudited interim financial information
27 Financial Data Schedule
21
<PAGE> 22
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: November 13, 2000 /S/ CHRISTIAN L. ALLISON
---------------------------------------
CHRISTIAN L. ALLISON
CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE
OFFICER
Dated: November 13, 2000 /S/ SAMUEL C. KNOCH
---------------------------------------
SAMUEL C. KNOCH
CHIEF FINANCIAL OFFICER AND TREASURER
Dated: November 13, 2000 /S/ BRADLEY N. DINGER
---------------------------------------
BRADLEY N. DINGER
CONTROLLER
22
<PAGE> 23
EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
Exhibit
Number Description
------ -----------
10.30 Change in Control Agreement, entered into
August 10, 2000 between the company and
Stephen M. Garda, together with a schedule
listing a substantially identical agreement
entered into October 20, 2000 with William
Anderson.
15 Letter re unaudited interim financial information
27 Financial Data Schedule
23
