<PAGE> 1
--------------------------------------
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 July 1, 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 July 31, 2000, there were 13,238,198 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 21 pages. The exhibit index is on page 20.
TOLLGRADE COMMUNICATIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JULY 1, 2000
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 JULY 1, 2000 AND DECEMBER 31, 1999 ............3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE-MONTH AND SIX MONTH
PERIODS ENDED JULY 1, 2000 AND JUNE 26, 1999...............................................4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX-MONTH PERIODS ENDED
JULY 1, 2000 AND JUNE 26, 1999 ............................................................5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.......................................6
REVIEW REPORT OF INDEPENDENT ACCOUNTANTS...................................................9
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION................................................................................ 10
PART II. OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS.........................................................................18
ITEM 2 CHANGES IN SECURITIES.....................................................................18
ITEM 3 DEFAULTS UPON SENIOR SECURITIES...........................................................18
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......................................18
ITEM 5 OTHER INFORMATION.........................................................................18
ITEM 6 EXHIBITS AND REPORTS FILED ON FORM 8-K....................................................18
SIGNATURE...............................................................................................19
EXHIBIT INDEX...........................................................................................20
</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) DECEMBER 31,
JULY 1, 2000 1999
======================================================================================================================
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $20,773,332 $15,555,810
Short term investments 24,666,179 13,516,676
Accounts receivable:
Trade 12,499,628 10,865,244
Other 682,900 335,155
Inventories 21,635,260 17,335,747
Prepaid expenses and deposits 369,957 461,934
Deferred and refundable tax assets 6,040,628 575,251
----------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 86,667,884 58,645,817
Long term investments 3,225,000 2,850,000
Property and equipment, net 5,707,918 4,337,115
Deferred tax assets 367,626 367,626
Patents and other assets 53,009 1,396
======================================================================================================================
TOTAL ASSETS $96,021,437 $66,201,954
======================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,507,651 $ 911,769
Accrued expenses 963,684 1,222,866
Accrued salaries and wages 1,725,894 2,209,473
Royalties payable 1,265,889 793,689
Income taxes payable 688,601 2,443,609
Deferred income 105,000 1,106,483
----------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 6,256,719 8,687,889
Deferred tax liabilities 9,950 9,950
----------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 6,266,669 8,697,839
Shareholders' equity:
Common stock, $.20 par value; authorized shares,
50,000,000; issued shares, 13,030,561 and 12,102,280, respectively 2,606,112 2,420,456
Additional paid-in capital 48,515,072 28,828,568
Treasury stock, at cost, 386,800 shares, respectively (3,164,975) (3,164,975)
Retained earnings 41,798,559 29,420,066
----------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 89,754,768 57,504,115
======================================================================================================================
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $96,021,437 $66,201,954
======================================================================================================================
</TABLE>
The accompanying notes are an integral part of the condensed
consolidated financial statements
3
<PAGE> 4
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
==============================================================================================================================
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 1, 2000 JUNE 26, 1999 JULY 1, 2000 JUNE 26, 1999
==============================================================================================================================
<S> <C> <C> <C> <C>
REVENUES $29,666,710 $14,269,719 $52,084,245 $25,390,064
COST OF PRODUCT SALES 11,413,382 5,902,774 19,785,042 10,654,718
------------------------------------------------------------------------------------------------------------------------------
GROSS PROFIT 18,253,328 8,366,945 32,299,203 14,735,346
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OPERATING EXPENSES:
Selling and marketing 3,027,461 1,767,547 5,411,144 3,165,988
General and administrative 1,495,334 964,933 2,873,057 2,013,369
Research and development 3,098,095 2,157,980 5,688,763 4,033,658
------------------------------------------------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 7,620,890 4,890,460 13,972,964 9,213,015
------------------------------------------------------------------------------------------------------------------------------
INCOME FROM OPERATIONS 10,632,438 3,476,485 18,326,239 5,522,331
Interest and other income, net 545,441 236,549 1,015,254 507,763
------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 11,177,879 3,713,034 19,341,493 6,030,094
Provision for income taxes 4,024,000 1,339,855 6,963,000 2,170,855
==============================================================================================================================
NET INCOME $ 7,153,879 $ 2,373,179 $12,378,493 $ 3,859,239
==============================================================================================================================
EARNINGS PER SHARE INFORMATION:
Weighted average shares of common stock and equivalents:
Basic 12,562,822 11,537,850 12,392,619 11,556,466
Diluted 13,318,461 11,611,886 13,217,634 11,683,552
------------------------------------------------------------------------------------------------------------------------------
Net income per common and common equivalent shares:
Basic $ .57 $ .21 $1.00 $ .33
Diluted $ .54 $ .20 $ .94 $ .33
==============================================================================================================================
</TABLE>
The accompanying notes are an integral part of the condensed
consolidated financial statements.
4
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
July 1, 2000 June 26, 1999
=======================================================================================================================
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 12,378,493 $ 3,859,239
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization 846,460 541,794
Changes in assets and liabilities:
Increase in accounts receivable-trade (1,634,384) (4,140,812)
(Increase) decrease in accounts receivable-other (347,745) 98,872
Increase in inventories (4,299,513) (1,674,160)
Decrease in prepaid expenses and other assets 40,364 7,194
Increase in accounts payable 595,882 495,925
Decrease in accrued expenses and deferred income (1,260,665) (457,419)
Increase in royalties payable 472,200 233,027
(Decrease) increase in accrued salaries and wages (483,579) 43,764
(Decrease) increase in income taxes payable (3,052,958) 228,103
-----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 3,254,555 (764,473)
-----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Redemption/maturity of investments 4,624,648 5,689,303
Purchase of investments (16,149,151) (1,960,877)
Capital expenditures (2,217,263) (750,324)
Purchase of treasury stock -- (1,375,688)
-----------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by investing activities (13,741,766) 1,602,414
-----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options including related tax 15,704,733 517,200
benefits
-----------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 15,704,733 517,200
---------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 5,217,522 1,355,141
Cash and cash equivalents at beginning of period 15,555,810 8,311,353
-----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 20,773,332 $9,666,494
=======================================================================================================================
</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
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 and six-month
periods ended July 1, 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 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 and six- month periods ended July
1, 2000 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2000.
2. INVENTORIES
At July 1, 2000 and December 31, 1999, inventories consisted of the following:
<TABLE>
<CAPTION>
(Unaudited)
July 1, December 31,
2000 1999
----------- -----------
<S> <C> <C>
Raw materials ..................................... $ 9,697,971 $ 8,173,299
Work in progress................................... 10,133,908 7,410,203
Finished goods..................................... 1,803,381 1,752,245
----------- -----------
$21,635,260 $17,335,747
=========== ===========
</TABLE>
3. SHORT-TERM AND LONG-TERM INVESTMENTS
Short-term investments at July 1, 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 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 Six Months Six Months
Ended Ended Ended Ended
July 1, 2000 June 26, 1999 July 1, 2000 June 26, 1999
=======================================================================================================================
<S> <C> <C> <C> <C>
Net income............................... $ 7,153,879 $ 2,373,179 $12,378,493 $ 3,859,239
=========== =========== =========== ===========
Common and common equivalent shares:
Weighted average number of
common shares outstanding
during the period.................. 12,562,822 11,537,850 12,392,619 11,556,466
Common shares issuable upon
exercise of outstanding
stock options
Diluted................... 755,639 74,036 825,015 127,086
----------- ----------- ----------- -----------
Common and common equivalent
shares outstanding during
the period
Diluted................... 13,318,461 11,611,886 13,217,634 11,683,552
=========== =========== =========== ===========
Earnings per share data
Net income per common and common
equivalent shares
Basic..................... $0.57 $0.21 $1.00 $0.33
Diluted................... $0.54 $0.20 $0.94 $0.33
</TABLE>
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5. DEFERRED AND REFUNDABLE TAX ASSETS
The Company's current deferred and refundable tax assets as of July 1, 2000
includes a tax benefit of $5,465,377 for compensation expense 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 six 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.
8
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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 July 1, 2000, and the
related condensed consolidated statements of operations for each of the three-
month and six- month periods ended July 1, 2000 and June 26, 1999 and the
condensed consolidated statement of cash flows for the six- month periods ended
July 1, 2000 and June 26, 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 generally accepted accounting principles.
We previously audited, in accordance with auditing standards generally accepted
in the United States, 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
July 11, 2000
9
<PAGE> 10
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: rapid technological change
along with the need to continually develop new products and gain customer
acceptance and approval; the Company's dependence on a relatively narrow range
of products; 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 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 67% of the
Company's revenue for the second quarter ended July 1, 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 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
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<PAGE> 11
("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 23% of the Company's revenue for the second 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 8% of the Company's revenue for the second quarter of 2000.
Through the second 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 customers digital loop carrier ("DLC") testability levels,
the customers 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 second 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 second quarter ended July 1, 2000, approximately 55% of the Company's
total revenue was generated from sales to these four RBOCs, the two largest of
which comprised approximately 36% 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 are now the subject of ongoing negotiations. Such contracts cover the
majority of Verizons union employees associated with the former Bell Atlantic.
These employees have entered into a formal work stoppage against Verizon. The
Company provides Verizon with certain of its MCU products, as well as its
professional service offerings that improve their DLC testability levels within
certain of their regions. Verizon represented slightly less than 10% of the
Company's total
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revenues during the first six months of 2000. The Company believes the effect of
a short-term work stoppage on its operations will not be significant. However,
should the labor dispute persist on a longer term basis the Company's operations
may be unfavorably impacted, but the extent is not determinable at this time. 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 year
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 10% for the second quarter ended July 1, 2000. The
Company expects its research and development expenses to continue at significant
levels.
12
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RESULTS OF OPERATIONS - SECOND QUARTER
REVENUES
Revenues for the second quarter of 2000 of $29,666,710 were $15,396,991, or
107.9%, higher than the revenues of $14,269,719 reported for the second quarter
of 1999. The increase in revenues for the second 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 that company's continued effort to improve testability in
their multi-state region, as well as to the CLEC markets and those sold on an
Original Equipment Manufacturer (OEM) basis. The current quarter also included
increased shipments of the Company's next generation DigiTest system products
primarily to Sprint under the Company's purchase agreement with Sprint North
Supply, as well as to Nortel Networks for deployment into the CLEC markets,
including TriVergent Communications and ATI. Current quarter sales include
approximately $3,600,000 of revenue related to orders shipped prior to April 1,
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. In addition, the current quarter 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.
Additionally, the current quarter also 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 second quarter of 2000 was $18,253,328 compared to
$8,366,945 for the second quarter of 1999, representing an increase of
$9,886,383, or 118.2%. Gross profit as a percentage of revenues increased to
61.5% in the second quarter of 2000, compared to 58.6% 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.
SELLING AND MARKETING EXPENSE
Selling and marketing expense for the second quarter of 2000 was $3,027,461
compared to $1,767,547 for the second quarter of 1999. This increase of
$1,259,914, or 71.3%, 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 to 10.2% in the second quarter of 2000 from 12.4% in the second
quarter of 1999.
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GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense for the second quarter of 2000 was
$1,495,334, an increase of $530,401, or 55.0%, from the $964,933 recorded in the
second 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
5.0% in the second quarter of 2000 from 6.8% in the second quarter of 1999.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense in the second quarter of 2000 was $3,098,095,
an increase of $940,115, or 43.6%, over the $2,157,980 recorded in the second
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 10.4% in
the second quarter of 2000 from 15.1% in the second quarter of 1999.
INTEREST AND OTHER INCOME
Interest and other income consists primarily of interest income. For the second
quarter of 2000, interest and other income was $545,441 compared to $236,549 for
the second quarter of 1999, representing an increase of $308,892, or 130.6%.
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 second quarter of 2000 was $4,024,000, an
increase of $2,684,145, or 200.3%, from the $1,339,855 for the second quarter of
1999. The effective income tax rate for the second quarter of 2000 was
approximately 36.0% of pretax income, which is comparable to the effective tax
rate for the second quarter of 1999.
NET INCOME AND EARNINGS PER SHARE
As a result of the above factors, net income for the second quarter of 2000 was
$7,153,879, an increase of $4,780,700, or 201.4%, from the $2,373,179 recorded
in the second quarter of 1999. Basic and diluted earnings per common share of
$.57 and $.54, respectively, for the second quarter of 2000 increased by $.36
and $.34, or 171.4% and 170.0%, from the $.21 and $.20, respectively, earned in
the second quarter of 1999. Basic and diluted weighted average common and common
equivalent shares outstanding were 12,562,822 and 13,318,461, respectively, in
the second quarter of 2000 compared to 11,537,850 and 11,611,886, respectively,
in the second quarter of 1999. The increase in the weighted average equivalent
shares resulted from an increase in the average share price between periods. As
a percentage of revenues, net income for the second quarter of 2000 increased to
24.1% compared to the 16.6% for the second quarter of 1999.
14
<PAGE> 15
RESULTS OF OPERATIONS - YEAR TO DATE
REVENUES
For the first six months of 2000, revenues were $52,084,245 compared to
$25,390,064 for the first six months of 1999, representing an increase of
$26,694,181, or 105.1%. The increase in revenues for the first six 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), US West and Bell South. In addition, sales to the CLEC markets
increased as well as those sold on an Original Equipment Manufacturer (OEM)
basis. The first six months also includes increased shipments of the Company's
next generation DigiTest system products primarily to Sprint under the Company's
purchase agreement with Sprint North Supply, as well as to Nortel Networks for
deployment into the CLEC markets, including TriVergent Communications and ATI.
The first six 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 six 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 six months of 2000 was $32,299,203, which represents
an increase of $17,563,857, or 119.2%, from the $14,735,346 in the same period
last year. As a percentage of revenues, gross profit increased to 62.0% in the
first six months of 2000 compared to 58.0% 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.
SELLING AND MARKETING EXPENSE
For the first six months of 2000, selling and marketing expense totaled
$5,411,144 compared to $3,165,988 for the first six months of 1999, representing
an increase of $2,245,156 or 70.9%. The 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 six months of 2000 include increased spending
on advertising, promotion and related marketing activities. As a percentage of
revenue, selling and marketing expense decreased from 10.4% in the first six
months of 2000 from 12.5% for the same period in 1999.
15
<PAGE> 16
GENERAL AND ADMINISTRATIVE EXPENSE
For the first six months of 2000, general and administrative expense totaled
$2,873,057 compared to $2,013,369 for the first six months of 1999, representing
an increase of $859,688, or 42.7%. 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 six months of 2000 from 7.9% for the same period
of 1999.
RESEARCH AND DEVELOPMENT EXPENSE
For the first six months of 2000, research and development expense totaled
$5,688,763 compared to $4,033,658 for the first six months of 1999, representing
an increase of $1,655,105, or 41.0%. This increase is primarily associated with
additional personnel to support product development 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 10.9% in the first six months of 2000 from
15.9% for the same period of 1999.
INTEREST AND OTHER INCOME
For the first six months of 2000, interest and other income was $1,015,254
compared to $507,763 for the first six months of 1999, representing an increase
of $507,491, or 99.9%. This increase is primarily attributable to an increase in
funds available for investments during the first six months of 2000.
PROVISION FOR INCOME TAXES
The provision for income taxes for the first six months of 2000 was $6,963,000,
which was an increase of $4,792,145, or 220.7%, from $2,170,855 for the first
six months of 1999. The effective income tax rate for the first six 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 half of 2000 was
$12,378,493, an increase of $8,519,254, or 220.7%, from the $3,859,239 recorded
in the first six months of 1999. Basic and diluted earnings per common share of
$1.00 and $.94, respectively, for the first half of 2000 increased by $.67 and
$.61, or 203.0% and 184.8%, from the $.33 earned in the first half of 1999.
Basic and diluted weighted average common and common equivalent shares
outstanding were 12,392,619 and 13,217,634, respectively, in the first half of
2000 compared to 11,556,466 and 11,683,552, respectively, in the first half of
1999. As a percentage of revenues, net income for the first half of 2000
increased to 23.8% compared to the 15.2% in the first half of 1999.
LIQUIDITY AND CAPITAL RESOURCES
At July 1, 2000, the Company had working capital of $80,411,165, which
represented an increase of $30,453,237, or 61.0%, 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
16
<PAGE> 17
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 $4,299,513 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 July 1,
2000, the Company had a backlog of $11,591,177 compared to $12,115,608 at
December 31, 1999 and $7,431,562 at June 26, 1999. The majority of the backlog
is expected to be recognized as revenue in the third quarter of 2000. 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.
17
<PAGE> 18
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
On May 4, 2000, the Company held its annual shareholders meeting. At
the meeting, James J. Barnes and Rocco L. Flaminio were elected to the Board of
Directors for a three-year term expiring at the annual meeting of shareholders
in 2003. The terms of Directors Richard H. Heibel and Robert W. Kampmeinert also
continued after the meeting and will expire at the annual meeting of
shareholders in 2001. The terms of Directors Christian L. Allison, Daniel P.
Barry, and David S. Egan also continued after the meeting and will expire at the
annual meeting of shareholders in 2002. In addition, the Company's Articles of
Incorporation were amended to increase the number of shares of Common Stock
authorized for issuance by the Company to fifty million. Also, the shareholders
ratified the appointment of PricewaterhouseCoopers LLP as the Company's
independent auditors for fiscal year 2000. The results of the voting were as
follows:
<TABLE>
<CAPTION>
Total
Votes Cast For Against Withheld Abstained
---------- --- ------- -------- ---------
<S> <C> <C> <C> <C> <C>
Election of Directors:
James J. Barnes 5,489,976 5,253,658 -- 236,318 --
Rocco L. Flaminio 5,489,976 5,268,553 -- 221,423 --
Amendment of Articles of Incorporation 5,489,976 5,212,302 257,639 -- 20,035
Ratification of Appointment of
PricewaterhouseCoopers LLP 5,489,976 5,453,560 32,724 -- 3,692
</TABLE>
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
18
<PAGE> 19
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: August 11, 2000 /s/ CHRISTIAN L. ALLISON
------------------------------------------------
CHRISTIAN L. ALLISON
CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER
Dated: August 11, 2000 /s/ SAMUEL C. KNOCH
------------------------------------------------
SAMUEL C. KNOCH
CHIEF FINANCIAL OFFICER AND TREASURER
Dated: August 11, 2000 /s/ BRADLEY N. DINGER
------------------------------------------------
BRADLEY N. DINGER
CONTROLLER
19
<PAGE> 20
EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
Exhibit
Number Description
------ -----------
15 Letter re unaudited interim financial information
27 Financial Data Schedule
20
