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EX-32 - EX-32 - TOLLGRADE COMMUNICATIONS INC \PA\ | l39090exv32.htm |
EX-23.1 - EX-23.1 - TOLLGRADE COMMUNICATIONS INC \PA\ | l39090exv23w1.htm |
EX-31.2 - EX-31.2 - TOLLGRADE COMMUNICATIONS INC \PA\ | l39090exv31w2.htm |
EX-10.12 - EX-10.12 - TOLLGRADE COMMUNICATIONS INC \PA\ | l39090exv10w12.htm |
EX-10.10 - EX-10.10 - TOLLGRADE COMMUNICATIONS INC \PA\ | l39090exv10w10.htm |
EX-10.37 - EX-10.37 - TOLLGRADE COMMUNICATIONS INC \PA\ | l39090exv10w37.htm |
EX-10.38 - EX-10.38 - TOLLGRADE COMMUNICATIONS INC \PA\ | l39090exv10w38.htm |
EX-31.1 - EX-31.1 - TOLLGRADE COMMUNICATIONS INC \PA\ | l39090exv31w1.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
þ | Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the fiscal year ended December 31, 2009
Commission file number 000-27312
TOLLGRADE COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA (State or other jurisdiction of incorporation or organization) |
25-1537134 (I.R.S. Employer Identification No.) |
|
493 Nixon Road, Cheswick, Pennsylvania (Address of principal executive offices) |
15024 (Zip Code) |
Registrants telephone number, including area code: 412-820-1400
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.20 per share | The NASDAQ Stock Market LLC | |
(Title of Class) | (Exchange on which registered) |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. Yes o No þ
Indicate by a check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§
229.405 of this chapter) is not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K. Yes o No þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
The aggregate market value of the voting and non-voting Common Stock of the registrant held by
non-affiliates of the registrant, calculated based on the closing price as of June 26, 2009 on the
NASDAQ Global Select Market, was approximately $73 million.
As of February 28, 2010, the registrant had outstanding 12,637,431 shares of its Common Stock.
Table of Contents
DOCUMENTS INCORPORATED BY REFERENCE
Part of Form 10-K into which | ||||
Document | Document is incorporated | |||
Portions of the Proxy Statement to be
distributed in connection with the 2010
Annual Meeting of Shareholders |
III |
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EX-32 |
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Table of Contents
PART I
CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995.
The statements contained in this Annual Report on Form 10-K of Tollgrade Communications, Inc.
(Tollgrade, the Company, us, or we), including, but not limited to the statements contained
in Item 1, Business, and Item 7, Managements Discussion and Analysis of Financial Condition and
Results of Operations, along with statements contained in other reports that we have filed with
the Securities and Exchange Commission (the SEC), external documents and oral presentations,
which are not historical facts are considered to be forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. These statements, which may be expressed in a variety of ways,
including the use of forward-looking terminology such as believe, expect, intend, may,
will, should, could, potential, continue, estimate, plan, or anticipate, or the
negatives thereof, other variations thereon or compatible terminology, relate to, among other
things, the effect of the current economic recession on our customers and our ability to reposition
the Company with a greater focus on our service assurance testing offerings to the
telecommunications market, the effect of unfavorable exchange rate fluctuations, possible delays in
or the inability to extend, complete, negotiate and execute purchase, service and maintenance
agreements with new or existing customers, changes in exchange rates of foreign currencies in which
we transact business relative to the U.S. dollar; the ability of the Company to realize the
benefits of its strategic revenue and cost initiatives due to unforeseen delays, changes in its
markets or other factors, and the risk that these initiatives will not promote revenue growth or
restore profitability in the timeframe anticipated by the Company, new product initiatives will
not realize revenues or be market accepted such as Stratum, our new test management operating
support system, and our LightHouse products targeted at the electric utility market, the ability
to complete sales, project delays or cancellations, political instability, inability to obtain
proper acceptances or other unforeseen obstacles or delays, projected cash flows which are used in
the valuation of intangible assets, our ability to utilize current deferred and refundable tax
assets, service opportunities offered to customers, the potential loss of certain customers, the
timing of orders from customers, including the timing of international sales, the effect of
consolidations in the markets to which Tollgrade sells, the effects of the economic slowdown in the
telecommunications industry specifically and the U.S. market and the jurisdictions
where we generally transact business, the possibility of future provisions for slow moving
inventory, the effect on earnings and cash flows or changes in interest rates, and changes in
technology that have impacted our customers product needs and spending. We do not undertake any
obligation to publicly update any forward-looking statements.
These forward-looking statements, and any forward-looking statements contained in other public
disclosures of the Company which make reference to the cautionary factors contained in this Form
10-K, are based on assumptions that involve risks and uncertainties and are subject to change based
on the considerations described below. We discuss many of these risks and uncertainties in greater
detail in Item 1A of this Annual Report on Form 10-K under the heading Risk Factors. These and
other risks and uncertainties may cause our actual results, performance or achievements to differ
materially from anticipated future results, performance or achievements expressed or implied by
such forward-looking statements.
The following discussion should be read in conjunction with our Managements Discussion and
Analysis of Financial Condition and Results of Operations, and our financial statements and
related notes contained in this Annual Report on Form 10-K.
Item 1. | Business. |
Tollgrade designs, engineers, markets and supports test system and status monitoring hardware and
software products for the telecommunications industry in the United States and international
markets. Our products enable telecommunications service providers to remotely diagnose problems in
Digital Subscriber Lines (DSL) and Plain Old Telephone Service (POTS) lines in Public Switched
Telephone Network (PSTN), and broadband and Internet Protocol (IP) networks. By coupling our
hardware and software offerings together, we provide proactive, centralized test solutions for our
customers.
Our primary product offerings include the DigiTest® and LDU measurement
hardware and LoopCare and 4TEL® centralized test software. These products enable local
exchange carriers to conduct a full range of measurement and fault diagnosis for efficient dispatch
of field staff to maintain and repair POTS and/or DSL services, along with the ability to
pre-qualify and provide broadband DSL services offerings. We also sell and support proprietary test
access products, such as the MCU®, which extends line test capabilities to remote sites
that are connected by fiber from the central office.
Our services and managed services business includes software maintenance and support for our
operating systems, along with hardware maintenance for our test probes, and our professional
services, which are designed to ensure that all of the components of our customers test systems
operate properly. In addition, in 2009, we expanded our service capabilities to include managed
services, offering those services to both our traditional telecommunications service provider
customers and our telecommunications network
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Table of Contents
equipment provider customers. In April 2009, we secured a managed services project with Ericsson,
Inc. (Ericsson), a large global network equipment provider, to provide customer support and
engineering services. We also provide managed services capabilities as part of a number of our
software maintenance contracts to our telecommunications customers.
Since 2001, we have made several acquisitions allowing us to consolidate our positions in the
telecommunications line test markets. These acquisitions included the LoopCare product line from
Lucent Technologies, Inc. in 2001, our N(x)Test product line and other assets associated with the
Line Test Business of Emerson Network Power Energy Systems, North
America, Inc. in 2006, and the assets of the
Broadband Test Division (BTD) of Teradyne, Inc., including the 4TEL, Celerity® and LDU
products in 2007. Most recently, in April 2009, we acquired certain assets from Ericsson in
connection with entering into our managed services agreement. Through these acquisitions, we
significantly expanded our product and service offerings along with our customer base, particularly
our international customer base through the Teradyne and Emerson product line acquisitions.
During 2009, we sold our cable product line (now shown as discontinued operations), consistent with
our focus on our core telecommunications markets and customers and our refocused growth strategy.
We were incorporated in Pennsylvania in 1986, and began operations in 1988. Our principal offices
are located at 493 Nixon Road, Cheswick, Pennsylvania 15024 and our telephone number is (412)
820-1400.
We make available free of charge on our Internet website (www.tollgrade.com) our annual reports on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended, as soon as reasonably practicable after we electronically file such material
with, or otherwise furnish it to, the SEC.
You may read and copy any materials that we file with the SEC at the SECs Public Reference Room at
100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that
contains our reports, proxy, information statements and other information that we file with the SEC
(www.sec.gov). Copies of our filings are available free of charge to any shareholder of
record upon written request to the Secretary, Tollgrade Communications, Inc., 493 Nixon Road,
Cheswick, Pennsylvania 15024.
Products
and Services
Telecommunications Test and Measurement Products
Our proprietary telecommunications test and measurement products, which include our Systems Test
and MCU products, enable telephone companies to qualify and troubleshoot broadband DSL and IP
services and remotely diagnose problems in POTS lines. Most DSL lines today provide broadband
Internet access for residential and business customers, fed from a central or remote office Digital
Subscriber Line Access Multiplexer (DSLAM) or Multi-Service Access Node (MSAN). Our systems can be
used to qualify loops for DSL service as well as ongoing maintenance and repair of the access
lines. As telecommunications service providers move to all IP networks and services (voice, video
and data), we have introduced products over time to enable IP services testing. At the end of
2009, we introduced additional products to test and monitor voice over IP (VoIP), video over IP
(IPTV), and mobile voice services through third party original equipment manufacturer (OEM)
agreements.
An important aspect of efficiently maintaining a telecommunications network is the ability to
remotely test, diagnose and locate any service-affecting problems within that network. Our Systems
Test Products are made up of a centralized test operating system integrated into the customers
repair handling database systems, and test hardware located at telephone companies central and
remote offices. These systems enable a full range of fault diagnostics in the access network, the
portion of the telephone network that connects end users to the central office or remote cabinet.
In addition, line test systems provide the capability to remotely qualify, deploy and maintain DSL
services which are carried over copper lines. These test systems reduce the time needed to
identify and resolve problems, eliminating or reducing the costs of dispatching a technician to the
problem site.
Most line test systems, however, were designed only for use over copper lines; as a result,
traditional test systems could not access local loops in which fiber optic technology had been
introduced. Our MCU product line, which is used primarily by large domestic carriers, solved this
problem by extending line test capabilities from the central office to the fiber-fed remote Digital
Loop Carrier (DLC) lines by mimicking a digital bypass pair, which is essentially a telephone
circuit that connects central test and measurement devices to the copper circuits close to the
customer.
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Table of Contents
Systems Test Products
Our Systems Test Products include the DigiTest product family, which includes our LoopCare software
and DigiTest ICE, DigiTest EDGE® and DigiTest HUB hardware. Our Test Products perform physical
and logical measurements to verify the connection performance of lines and circuits and reports
those measurements to our LoopCare operating support systems (OSS). LoopCare, in turn, analyzes
that measurement data and creates an easy-to-understand fault description. At the same time,
LoopCare can automatically dispatch a technician to a work center in order to fix the problem.
LoopCare and the DigiTest hardware are also used to pre-qualify, verify installation, and remotely
isolate troubles for various DSL services, including testing the logical layers to verify modem
synchronization in to the DSLAM or out to the customer. The DigiTest product family can also
serve as a replacement for aging Loop Test System (LTS) equipment deployed in current domestic
networks.
DigiTest ICE, our latest IP Service Assurance Test Probe, is aimed at testing Triple Play voice,
video and data services over emerging fiber to the curb or cabinet broadband access networks.
Because these remote sites have a lower line count, they require cost optimized test probes and
greater IP test capabilities to fulfill the requirements of triple play testing. DigiTest ICE
provides both metallic and multi-layered testing to help service providers install and maintain
triple play services. With DigiTest ICE, the customer will be able to quickly isolate VoIP, IPTV
and high speed Internet access issues, verify their network performance, and synch with broadband
equipment to validate connectivity and throughput. Coupled with our centralized software
platforms, DigiTest ICE provides a comprehensive broadband test and dispatch solution.
Our Systems Test Products also include 4TEL and Celerity software products working with LDU
hardware test probes. These products perform similar line test functions and test measurements as
our other Systems Test Products, but have been optimized for operation in the international
markets, and have extensive deployment in Europe, covering over 100 million access lines. The 4TEL
and LDU products have also been deployed on a more targeted basis in North America, as well as in
international markets outside of Europe.
During 2009, we began to reposition ourselves with a greater focus on our service assurance product
offerings. We are building upon the strength of our Systems Test Products, which are at the center
of our service assurance offerings, but with a greater emphasis on expanding our service assurance
software solutions. Our Systems Test Product software offerings include LoopCare, 4TEL, Celerity,
and LTSC OSS. Each of our OSS has an established installed base of customers. In September 2009,
we introduced our new test management OSS, Stratum. Stratums initial features are based on both
existing customer requests for enhanced features and our view of the trends in the marketplace. We
plan to leverage our incumbent position with our installed base of customers and extend testing
coverage to next generation network architectures with Stratum. Stratum includes several new
software test and probe capabilities that we believe will enhance the benefits of our solutions for
existing and new customers. Based on International Telecommunication Union (ITU) standards,
Stratum has software to drive metallic tests on embedded subscriber line interface circuits (SLIC)
in remote DSLAMS for next generation networks. Stratum incorporates interfaces to capture
management information base (MIB) status and alarms from deployed access network elements from
multiple network equipment vendors, and provides backwards compatibility with our LoopCare and 4TEL
systems. Stratum aggregates the data from the different sources and provides an integrated
analysis of the data in fault location, including a more accurate identification and dispatch
recommendation than the individual results alone.
We have OEM software licensing and technology licensing agreements in place for offerings in our
telecommunications product portfolio. More recently, we signed an OEM agreement with Mariner
Partners, Inc. in December 2009 to customize a version of their xVu IPTV quality of experience
product line which will be incorporated into Stratum.
In October 2009, we signed an agreement with Accanto Systems, SRL to provide mobile and VoIP
protocol analyzers under the Tollgrade brand name. The agreement
enables us to sell the Accanto protocol analyzer probes, and OSS
platforms with exclusivity in certain territories.
The protocol probes monitor signaling protocols and network traffic, allowing rapid resolution of
difficult network and equipment problems.
We purchased a card for our DigiTest EDGE product and an access device for the DigiTest product
line through OEM agreements. We are also a party to a number of third party software license
agreements that allow us to incorporate third party software products and features into our
LoopCare, 4TEL and Celerity software. We have licensing arrangements with Aware, Inc. for certain
technology related to our DigiTest products. We have also entered into a license agreement with
Green Hills Software, Inc. for certain technology related to our DigiTest ICE product.
We market and sell our Systems Test Products primarily through our direct sales force as well as
through certain reseller and distributor agreements. Sales of the DigiTest Product line (including
related software sales) accounted for approximately 31%, 37% and 46% of our total revenues for the
years ended December 31, 2009, 2008 and 2007, respectively.
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Table of Contents
MCU
Our MCU products plug into DLC systems, the large network transmission systems used by telephone
companies to link the copper and fiber-optic portions of the local loop. MCU products allow our
customers to extend their line testing capabilities to all of their POTS lines served by a DLC
system regardless of whether the system is fed by a copper or fiber optic link. DLC systems, which
are located at telephone companies central offices and at remote sites within local user areas,
effectively multiplex the services of a single fiber-optic line into multiple copper lines. In
many instances, several DLC systems are located at a single remote site to create multiple local
loops that serve several thousand different end-user homes and businesses. Generally, for every
DLC remote site, customers will deploy at least two MCU line-testing products.
We market and sell our MCU products directly to customers as well as through certain OEM
agreements. We have certain royalty-based license agreements in place to enable us to maintain
capability with specific DLC systems. We paid royalties under these agreements in the amounts of
$0.2 million, $0.4 million and $0.6 million during the years ended December 31, 2009, 2008 and
2007, respectively.
Sales of MCU products and related hardware accounted for approximately 13%, 18% and 24% of our
revenue for the years ended December 31, 2009, 2008 and 2007, respectively.
Services
and Managed Services
Our service offerings include three primary areas, including software maintenance and support for
our OSS offerings and hardware maintenance for the test probes, professional services, and managed
services. Our software and hardware support services are designed to ensure that all of the
components of our customers test systems operate properly. The primary customers for our software
and hardware support services are the large domestic and international service providers. We also
offer professional services, such as installation, commissioning, and training to these same
customers. Most of our support services are provided through yearly or multi-year service
agreements, and can cover both software and hardware maintenance for our products.
Including software maintenance and support, services revenue accounted for approximately 56%, 45%
and 30% of our total revenues for the years ended December 31, 2009, 2008 and 2007, respectively.
Historically, our services business was comprised of the more traditional POTS-based testability
services, and the revenue stream was largely project-based and as such, difficult to predict.
During the last few years, our services business has moved toward more contract-based software
maintenance services, the revenue from which is more predictable. We expect our service business
to continue to comprise a large percentage of our revenue in the future.
On April 15, 2009, we entered into a multi-year managed services agreement with Ericsson, pursuant
to which we will provide customer support and engineering services. We entered into this four year
agreement as part of our continued strategic focus to grow our services business. In 2009,
revenues from this contract were approximately $5.1 million or approximately 11% of our total
revenues. Managed services are an area of potential growth for us. We are focused on expanding
our managed services business with both our telecommunications customers as well as larger network
equipment and managed service providers.
Electric Utility Monitoring Products
In 2008, we launched a new product development effort, our LightHouse product line, which is
designed to provide power grid monitoring capabilities to the electric utility market. Research
and investment, which began in 2007 and continued into 2009, enabled the general availability of
the first release of the product line during the first quarter of 2009. The test system solution
currently consists of line mounted sensors, aggregators, and centralized software providing an end
to end solution for power providers to efficiently monitor their overhead distribution circuits in
real time. The system is designed to improve the overall efficiency of energy delivery, improve
customer satisfaction and improve the financial performance of the electric power utilities.
The market for power grid monitoring has been slower to evolve than we originally projected and to
date, our efforts in the monitoring segment of the market have not produced the results we
anticipated. As a result, we reviewed the strategic alternatives for our LightHouse product
activities in late 2009 and early 2010. After this review, we determined that the best course of
action was to continue our efforts and focus on an expanded trial we have with a major US utility
company.
Operating Segment
We have determined that our business has one operating segment, test assurance. All product and
service sales relate to the business of testing infrastructure and networks for the
telecommunications industry. Our products have similar production processes, and are sold through
comparable distribution channels and means to similar types and classes of customers already in, or
entering into, the
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telecommunications businesses. Operating results are regularly reviewed by our chief operating
decision maker regarding decisions about the allocation of resources and to assess performance.
Research and Development
Our research and development activities are focused on improving our existing telecommunications
product lines, investing in growth opportunities in the Telecommunications Service Assurance
market, and leveraging our technology strengths in test and measurement into the utility industry.
We have made improvements to certain of our existing line test product lines, including enhanced
measurement techniques that deliver more accurate service repair dispatches for our customers.
Additionally, we have augmented these product lines with customer-specified features, enhancing the
usability, scalability, security, and resiliency of our current product lines. We enhanced the
functionality of our products to be able to interface with third party equipment, thereby enabling
migration with the evolving next generation networks. We continue to stay current with the latest
standards for Broadband Forum and ITU standard bodies.
Our Service Assurance product activities provide our customers an expanded reach of test
technologies, utilizing our existing line test technology and augmenting the network analysis with
next generation test technologies. This provides our customers more comprehensive results and
analysis with which to resolve trouble points in the network. In addition, we continue to enhance
our portfolio of test technologies working with semiconductor companies and equipment providers in
order implement the emerging ITU Glt standards.
Leveraging our traditional strength in system test and our core competency in complex measurements
and analytics, we have entered the utility Smart Grid market with a focus on measurements and
faults in the distribution network. Our research and development activities in this market to date
have focused on emerging standards, interoperability with complementary communication systems, and
refining customer market requirements.
As of December 31, 2009, we had an engineering staff of 55 employees, representing 33% of our total
employee workforce. As of December 31, 2008 and 2007, we had an engineering support staff of 62
and 80 employees which comprised 32% and 39% of our total workforce, respectively. Our engineering
staff is primarily located in three locations, Cheswick, Pennsylvania; Piscataway, New Jersey; and
Bracknell, United Kingdom. During the years ended December 31, 2009, 2008, and 2007, research and
development expenses charged to operations were $9.4 million, $10.8 million and $11.0 million,
respectively. In addition, because some of our contractual agreements require us to provide
engineering development or repair services to our customers, a portion of our total engineering
costs has been allocated to cost of sales. The amount allocated to cost of sales for the years
ended December 31, 2009, 2008, and 2007 are $1.5 million, $1.4 million and $1.1 million
respectively. In 2010, we expect that we will continue to invest in organic growth opportunities
to help support our customers ongoing needs and to help them solve their business problems.
Sales and Marketing
In our telecommunications business, our primary sales and marketing strategy is a direct approach
to tier one and tier two service provider customers. We utilize our direct sales, marketing and
service resources in North America and Europe to develop sales opportunities with our current
customer base, as well as new customers. In territories outside North America and Europe, our
primary route to market is through a network of value added reseller partners and distributors who
provide in-country capabilities to complement our capabilities. We have sales and service offices
in Cheswick, Pennsylvania and Piscataway, New Jersey in the United States and Bracknell, United
Kingdom; Antwerp, Belgium and Wuppertal, Germany in Europe.
As of
December 31, 2009, we had a sales and marketing staff of 27 employees. As of December 31,
2008 and 2007, we had a marketing and sales staff of 28 and 32
people, representing 16% and 16% of
our total workforce, respectively.
Competition
The market for telecommunications testing equipment is highly competitive. Primary competitive
factors in our market include price, product features, performance, reliability, service and
support, breadth of product line, technical documentation, prompt delivery and availability of
alternative technologies.
The competitors for our traditional POTS telecommunications products and our broadband technologies
and applications solution offerings include JDS Uniphase, EXFO Electro-Optical Engineering Inc.,
Spirent Communications PLC, Huawei Technologies Co., Ltd., Fluke Networks and Nortel.
Historically, we have positioned ourselves against competitors offerings by leveraging our
patented technologies, partnering with network equipment providers, and investing in next
generation research and development. We also
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leverage our incumbent position with existing customers and core competencies to test broadband
next generation networks to position ourselves against our competitors on the basis of lower
deployment costs and long-term operational cost efficiencies.
We also face competition as a growing number of network equipment providers offer testing
technology embedded into their products. Where testing was once only available in the form of
multi-chip, circuit board-based designs like those found in our remote test system hardware
products, integrated testing technology is now available in low-cost chipsets embedded into the
products of these network equipment providers. Referred to as SELT and DELT (Single Ended Line
Test and Double Ended Line Test), the testing technology available in this form has limited
functionality and only provides partial views of faults in the network. A new SLIC chipset is
expected to be offered by the network equipment providers in 2010 and 2011 to provide MELT
(Metallic Line Test) that will provide a subset of our test capabilities available in our remote
test system products. In response to the industry and competitive trends, our Stratum platform
includes software drivers for the MELT tests. We will continue to face competition and downward
pricing pressure as a result of the availability of these less expensive, less robust alternatives
possibly resulting in decreased sales of our system products to certain of our customers.
Another area of competition is from software solution providers and the internal Information
Technology (IT) departments of our own carrier customers. In the past, we offered solutions
consisting of hardware probes, coupled with a centralized software platform that analyzed the data
pulled from the probes and determined the appropriate dispatch statement or issue identification
statement. As the capabilities of new infrastructure equipment increases, test and monitoring
software platforms are increasingly taking advantage of the available data from the infrastructure
equipment. The new software platforms offer customers a lower upfront cost, but offer less robust
capabilities as compared to solutions built with hardware and software combinations. Several
network equipment providers (Alcatel-Lucent, Huawei, AdTran) have included test software platforms
as part of the element management systems. At the same time, many of our larger customers have
captive development capabilities in their own IT organizations. These IT teams can develop
software systems that compete with our offerings. Because of our intimate knowledge of many
carrier customers, we believe we have a strategic advantage over these internal groups based on our
industry knowledge and the efficiency of our development resources in comparison to internal
customer resources.
As with the telecommunications products, the extension of our IP service assurance and mobile and
VoIP products to address IP and mobile test applications expands our list of traditional
competitors to now include Empirix Inc., JDS Uniphase, Tektronix Canada Inc., EXFO (as successor to
Brix Networks, Inc.), Agilent Technologies Inc, and IneoQuest.
Our Customers
Our customers include the top telecommunications providers and numerous independent
telecommunications and broadband providers around the world. Our primary customers for our
telecommunications products and services are large domestic and European telecommunications service
providers. We track our telecommunications sales by two large groups, the first of which includes
AT&T, Verizon, and Qwest (referred to herein as the large domestic carriers), and the second of
which includes certain large international telephone service providers in Europe, namely British
Telecom, Royal KPN N.V., Belgacom S.A., Deutsche Telecom AG (T-Com) and Telefonica O2 Czech
Republic, a.s. (collectively referred to herein as the European Telcos).
For the year ended December 31, 2009, sales to the large domestic carriers accounted for
approximately 39% of our total revenue, compared to approximately 39% and 42% of our total revenue
for the same 2008 and 2007 period, respectively. We had 2009 sales to our largest customer, AT&T,
which was comprised of approximately 23% of our total revenue for 2009, compared to 27% and 31% for
the same 2008 and 2007 periods, respectively. For the year ended December 31, 2009, sales to the
European Telcos accounted for approximately 19% of our total revenue, compared to approximately 27%
and 15% of our total revenue for the same 2008 and 2007 period, respectively.
In addition, in April 2009, we entered into a multi-year managed services agreement with Ericsson
to provide customer support and engineering services. We entered into this agreement as part of
our continued strategic focus to grow our services business. In 2009, revenues from this contract
were approximately $5.1 million or 11% of our total revenue.
Because of our continued dependency on certain large domestic and international carriers, as well
as on Ericsson, the potential loss of one or more of these customers, or the reduction of orders
for our products by one or more of these customers, could materially and adversely affect our
results.
Manufacturing and Quality Control
Throughout 2009, we began to outsource our in-house manufacturing and production capabilities to
Express Manufacturing Inc. (Express Manufacturing), a global provider of subcontracting services.
Express Manufacturing fulfills our manufacturing requirements in Santa Ana, California including
the direct shipment of products to our end customers. Express Manufacturing has an
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additional offshore site at which our requirements may also be fulfilled. We believe that the
outsourcing of our manufacturing enables us to conserve our working capital, adjust better to
fluctuations in demand and ensure a more timely delivery to our customers.
We are ISO 9001:2008 registered with the British Standards Institution, Inc. ISO 9000 is a
harmonized set of standards that define quality assurance management. Written by the International
Organization for Standardization (ISO), ISO 9000 is recognized throughout the United States,
Canada, the European Union and Japan. We continue to develop and maintain internal documentation
and processes to support the production of quality products to ensure customer satisfaction and
have been ISO compliant since 1996.
Proprietary Rights
We have registered trademarks in the names Tollgrade®, MCU®,
DigiTest®, EDGE®, Telaccord®, MITS®,
Clearview®, MICRO-BANK®, the names and logos for 4TEL®,
Celerity® and NETFLARE®. We have common law trademarks in the names
LoopCare, MLT, ICE, Clear, the Clear logo, Early Warning, ReportCard, CircuitView, Network
Assurance Simplified, Minutes Mean Millions,
N(x)Test, N(x)DSL, LTSC, and HyFi, and in the
LightHouse name and logo (as applicable to our new power grid monitoring products), and our corporate logo.
Team TollgradeSM is a common law service mark of the Company.
We have three United States patents on MCU products with expiration dates ranging from 2010 to
2014. We have forty-nine patents in the United States, eight patents in Belgium, eleven patents in
Canada, eight patents in Europe, four patents in France, eight patents in Germany, eight patents in
the Netherlands, eight patents in the United Kingdom and three patents in Canada on other
telecommunications technology with expiration dates ranging from 2014 to 2026. In addition, we
have seven United States, five European, one German, one United Kingdom and two international,
patent applications pending on our products, some of which relate to our new Stratum and LightHouse
products.
We will apply for additional patents from time to time related to our research and development
activities. We protect our trademarks, patents, inventions, trade secrets, and other proprietary
rights by contract, trademark, copyright and patent registration, and internal security.
Although we believe that these patents, when aggregated, are an important element of our business,
we do not believe that our business, as a whole, is materially dependent on any one patent.
Backlog
Our order backlog for firm customer purchase orders and signed software maintenance contracts was
$15.6 million at December 31, 2009, compared to backlog of $16.3 million at December 31, 2008. The
backlog at December 31, 2009 and December 31, 2008 includes approximately $8.4 million and $12.1
million, respectively, related to software maintenance contracts. In 2010, we expect to realize
revenues related to the entire backlog at December 31, 2009.
In our reported backlog, we have adopted a policy to include a maximum of twelve months revenue
from multi-year software maintenance agreements. Software maintenance revenue is deemed to be
earned and recognized as income on a straight-line basis over the terms of the underlying
agreements.
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. Although these fluctuations
could impact short-term results, they are not necessarily indicative of long-term trends in sales
of our products.
Employees
As of December 31, 2009, we had 167 full-time employees, 141 of whom were located in the United
States and 26 of whom were located in Europe. As of December 31,
2008 and 2007, we had 179 and 205
full time employees, of which 150 and 178 where located in the United States and 29 and 27 were
located in Europe, respectively. As of February 28, 2010, we had 162 employees of which 136 were
located in the United States and 26 were located in Europe. None of our employees are represented
by a collective bargaining agreement, and we believe that our relations with our employees are
good.
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Executive Officers of the Company
The executive officers of the Company as of February 28, 2010 and their biographical information
are set forth below.
Joseph A. Ferrara
|
Chief Executive Officer, President and Board Member of Tollgrade since November 2007; serving as Chairman of the Board of Directors since May 2009; Senior Vice President, Sales and Marketing of Tollgrade from August 2007 until November 2007; prior thereto General Manager Data Networks Division of Ericsson from January 2006 until July 2007 following Ericssons acquisition of Marconi Corporation plcs (Marconi) product divisions; Chief Executive Officer of Marconis North American operations from June 2005 until January 2006; Vice President of Business Operations of Marconis Data Networks Division from February until June 2005 and July 2000 until April 2004; and Vice President of Marketing of Marconis Data Networks Division from April 2004 until February 2005. Age 43. | |
Michael D. Bornak
|
Chief Financial Officer of the Company since November 2009; served as the Companys interim Chief Financial Officer from September 2009 to November 2009; prior thereto served as Chief Financial Officer of Solar Power Industries, Inc. from June 2008 until July 2009; Chief Financial Officer for MHF Logistical Solutions, Inc. from February 2005 to June 2008; Vice President of Finance and Chief Financial Officer of Portec Rail Products, Inc. from January 1998 to February 2005. Mr. Bornak is also a Certified Public Accountant. Age 47. | |
David L. Blakeney
|
Vice President, Research and Development of the Company since October 2008; prior thereto consultant to the Company in the same capacity from March 2008 until October 2008; Vice President, Engineering, for Altrix Logic from December 2006 until October 2008; prior thereto, Vice President of Engineering for the Data Networks Division of Ericsson from April 1999 to October 2006. Age 48. | |
Jennifer M. Reinke
|
General Counsel of the Company since November 2009 and Secretary of the Company since December 2009; Assistant General Counsel of the Company from February 2009 to November 2009; Corporate Attorney for the Company from March 2003 to February 2009; served as the Companys Assistant Secretary from March 2003 to December 2009; prior thereto, Associate Attorney with Reed Smith LLP, from August 1998 to March 2003. Age 37. | |
Robert H. King
|
Vice President, Global Sales and Marketing of the Company since February 2009; Executive Director, Business Development of the Company from December 2008 until February 2009; prior thereto President and General Manager of the Broadband Products Group at Sunrise Telecom Incorporated (Sunrise) from April 2006 until June 2008; Vice President, Sales at Sunrise from January 2000 until April 2006. Age 48. | |
Joseph G. OBrien
|
Vice President, Human Resources of the Company since October 1997; Director of Employee Development of the Company from April 1997 until October 1997; prior thereto, Coordinator, Elderberry Junction, Goodwill Industries, a charitable organization, from May 1995 until April 1997. Age 50. | |
Kenneth J. Shebek
|
Vice President, Operations of the Company since October 2008; prior thereto, Vice President of Supply and Logistics for the Data Networks Division of Ericsson from January, 2006 until October 2008; Vice President of Supply Chain for Marconi and its Vice President of North American Operations from January 2003 to December 2005. Age 47. |
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Item 1A. | Risk Factors |
We wish to caution each reader of this Form 10-K to consider the following factors and other
factors discussed herein and in other past reports, including but not limited to prior year Form
10-K and quarterly Form 10-Q reports filed with the SEC. Our business and results of operations
could be materially affected by any of the following risks. The factors discussed herein are not
exhaustive. Therefore, the factors contained herein should be read together with other reports and
documents that we file with the SEC from time to time, which may supplement, modify, supersede or
update the factors listed in this document.
Revenue from product sales may be subject to further declines due to the mature nature of many of
our product lines and from customers transitioning their access network service assurance
solutions.
Our legacy products are primarily oriented towards POTS lines. As many customers implement next
generation network improvements, such as fiber to the premises (FTTP), our continuing ability to
sell our legacy technology or to maintain historic pricing levels for these products will likely be
adversely affected. In particular, sales of our MCU products, which have historically represented
a meaningful portion of our product sales, are declining. MCU sales largely depend upon the rate
of deployment of new, and the retrofitting of existing, DLC systems in the United States.
Installation and replacement of DLC systems are, in turn, driven by a number of factors, including
the availability of capital resources and the demand for new or better POTS. Next generation
network improvements such as FTTP do not require the use of our MCU products as does the present
hybrid POTS network. If our major customers fail to continue to build out their DSL networks and
other projects requiring DLC deployments, or if we otherwise satisfy the domestic
telecommunications markets demand for MCUs, our MCU sales will continue to decline and our future
results would be materially and adversely affected.
Certain of our larger customers are in the process of upgrading their access networks, as well as,
their service assurance solutions for these networks. This has and may continue to adversely
impact revenues from our testing products. Further, these customers may decide not to adopt our
technologies for their service assurance needs, which would have a significant adverse affect on
revenues for those products.
Our product sales have experienced continual declines over the past five years, with sales from
continuing operations of $19.9 million for 2009, $27.0 million in 2008 and $36.1 million for 2007.
Our MCU product line, which historically has represented a larger portion of our sales, has
declined by 36% and 29% as a percentage of continuing operation product sales, over the 2009 and
2008 periods, respectively. In addition, we also have experienced year over year declines in our
DigiTest, LoopCare and LDU product lines. If we are unable to continue to derive sales of these
products to our existing customers due to their lower demand, capital constraints and a move
towards other technologies, this could have a materially adverse impact on our future financial
results.
Our ability to maintain or increase revenues will be dependent on our ability to expand our
customer base, increase unit sales volumes of our existing products and to successfully, develop,
introduce and sell new products.
Our service business may be negatively affected by a trend of reduced capital spending and by
delays in our ability, or by our inability, to secure and extend long-term maintenance contracts
with our existing or new customers, and by customer initiatives to consolidate services purchases
with a single supplier.
Our Services business, which includes software maintenance and professional services, as well as
our managed services offerings, is sensitive to the decline in our large carrier customers capital
investment in their traditional voice services. This decline may lead to a decreasing demand for
our professional services. In addition, if we are unsuccessful in renewing our software maintenance
agreements, or if we experience delays in the extension or renewal of certain of the more
significant software maintenance agreements, our revenues may be negatively affected. In
particular, in December 2009, we were advised that Verizon, a major customer for our LoopCare
post-warranty software maintenance services, would not renew its contract for those services after
the expiration of that contract on December 31, 2009, and would instead seek to purchase
post-warranty maintenance services for our LoopCare products through a larger supplier, requiring
us to negotiate a new contract with that supplier. In addition, another significant maintenance
contract that was scheduled for expiration on December 31, 2009 was extended through March 2010
pending negotiation of that contract renewal. If the negotiations for these or any other
significant maintenance contract that becomes subject to renewal are not successful, the agreements
may not be reached at all or may be reached on terms that are not as favorable to us as the former
or extended arrangements, and as a result our revenues may be adversely affected. In addition, to
the extent more of our customers seek to consolidate services purchases through a large vendor, and
in so doing seek to purchase maintenance for our software products through a third-party vendor, we
will likely experience significant downward pricing pressure for these services.
We are also experiencing intense pricing pressure from many of our other larger software
maintenance customers, as they continue to attempt to reduce their own internal costs to
substantiate the value of our long term service contracts. We believe that our services and our
software systems provide significant value to our customers; however, each time a contract is
scheduled for renewal, we must
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show our customers the value of the entire system and the costs saved by maintaining and even
extending the system capabilities. To date, apart from the customer noted above, we have been able
to renegotiate or have had contract extensions to most of our major contracts as they become
subject to renewal. We have, however, had to reduce our pricing in some instances. Accordingly,
our ability to maintain historical levels from traditional sources or increase levels of Services
revenues cannot be assured, and in fact, such levels may decrease.
The expiration of the Verizon contract in December 2009, as well as the pricing pressure on many of
our other services contracts and our increasing difficulty in securing extensions on major customer
contracts, triggered our evaluation of the carrying value and the remaining useful lives of our
intangible asset associated with our LoopCare post-warranty software maintenance agreements. Based
on this evaluation, we recorded a significant impairment charge of $27.0 million in the fourth
quarter of 2009, and reduced the remaining finite useful life of this asset from approximately
forty six years to fifteen years. Further declines in our post-warranty maintenance services may
result in future impairment charges as well as having a materially adverse impact on our financial
results and cash flow.
Our future growth depends to a large extent upon our success in developing and selling new products
and service offerings. We have focused our growth efforts and are managing our investments. If we
are unable to drive sales of new products and services to counter the expected declines in our
legacy product lines, this could have a materially adverse impact on our future financial
results.
We are actively selling and developing new product and service offerings. Our long term growth is
dependent upon the success of these products and additional new products to be developed in the
future. In the telecommunications market, our new products include hardware solutions, including
enhanced LDU and DigiTest ICE offerings, a new software platform, Stratum, our managed services
offering, and OEM product offerings. In the power utility market, we offer a new solution
consisting of hardware sensors, aggregation nodes, and a centralized software platform. We
continue to believe that there is a significant market opportunity for these products. However,
there can be no assurance that these product offerings will be commercially successful in the near
term or at all.
We continue to pursue product development initiatives to supplement our new offerings described
above. There can be no assurance that we will be successful in marketing and selling our new
product and services offerings or that the new offerings will result in the benefits and
opportunities that we expect. The development of new solutions is an uncertain and potentially
expensive process and requires that we accurately anticipate technological and market trends so
that we can deliver products in a timely manner. We may not be successful in delivering the
required product features to achieve success, or if we do so, we may not be able to commercialize
the product in a timely manner or achieve market acceptance. If we fail to set appropriate prices
for our products, our profitability could be adversely affected.
In addition, the potential market growth rate may not be as significant as we expect or could
develop in unforeseen directions. For example, the commercial availability of competing products
may affect the extent or timing of market acceptance of our solutions. Furthermore, we may not be
successful in forming the strategic alliances contemplated by our new strategy. We may not identify
the right partners or our partners could fail to perform their obligations and the commercial
relationship may fail to develop as expected. As a result of these and other factors, we may not
be able to implement our strategy and our ability to exploit our incumbent position in the manner
contemplated by our strategic planning and we would be materially and adversely affected.
Our restructuring efforts and cost reduction plans may be ineffective or may limit our ability to
compete.
During 2009, we restructured our business operations through three different restructuring
initiatives. During the first quarter of 2009, we announced a restructuring initiative, which
included the realignment of existing resources to new projects, reductions in our field services
and sales staffing, as well as other reduction activities, and on July 6, 2009, we announced a
restructuring initiative which included reductions in our production staffing. In October of 2009,
we eliminated twenty-eight positions across all levels of the organization. Previously, during
2008, we implemented a series of initiatives designed to increase efficiency and reduce costs and
to focus our core business on our test and measurement expertise. These initiatives included
reductions of staff, alignment of investments and a completion of the integration plans from prior
acquisitions. Although we have experienced some cost savings from these restructuring and cost
reduction programs and initiatives and we believe that these actions will continue to reduce costs,
they may not be sufficient to achieve the required operational efficiencies that will enable us to
respond more quickly to changes in the market or result in the improvements in our business that we
anticipate or be sufficient to offset a decline in our revenue. In such event, we may be forced to
take additional cost-reducing initiatives, which may negatively impact quarterly earnings and
profitability as we account for severance and other related costs. In addition, there is the risk
that such measures could have long-term effects on our business by reducing our pool of talent,
decreasing or slowing improvements in our products, making it more difficult for us to respond to
customers, limiting our ability to increase production quickly if and when the demand for our
products increases and limiting our ability to hire and retain key personnel. These circumstances
could cause our earnings to be lower than they otherwise might be.
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Failure to achieve the maximum revenues under our managed services contract could have an adverse
effect on our revenues and results of operations.
During the second quarter of 2009, we entered into a multi-year, managed services contract with
Ericsson, a leading global network equipment provider, pursuant to which we provide customer
support and engineering services capabilities. In connection with the agreement, we hired
twenty-one employees. The inability to successfully integrate and/or retain the hired employees
and to integrate the tools and resources acquired as part of the agreement into our services
business would have an adverse impact on our ability to realize the potential revenue opportunities
under the agreement. In addition, under the terms of the managed services contract, we may not
achieve the full revenue potential of the contract in the event that (i) we fail to meet certain
specified service level requirements in the contract, and subsequently, service level credits
reducing payments to us are applied, (ii) the network equipment provider terminates the contract
for our failure to perform in accordance with its terms; and (iii) fees payable to us are reduced
due to revenues from the network equipment providers customer agreements declining more rapidly
than anticipated. Additionally, our overall profitability may be negatively impacted in the event
we are required to incur unanticipated expenses to satisfy obligations assumed under the managed
services agreement.
A continuing downturn in the global economy may adversely affect our revenues, results of
operations and financial condition.
Demand for our products and services are increasingly dependent upon the rate of growth in the
global economy. If current economic conditions continue, customer demand for our products and
services could be even more adversely affected than experienced to date, which in turn could
adversely affect our revenues, results of operations and financial condition. Many factors could
continue to adversely affect regional or global economic growth. Some of these factors include:
| Poor availability of credit, | ||
| Continued recession in the United States economy and other countries that we serve, | ||
| Fluctuation in the value of the U.S. dollar relative to foreign currencies in jurisdictions where we transact business, | ||
| Significant act of terrorism which disrupts global trade or consumer confidence, | ||
| Geopolitical tensions including war and civil unrest, and | ||
| Reduced levels of economic activity or disruption of domestic or international transportation. |
The recent challenging economic conditions also may impair the ability of our customers to pay for
products and services they have purchased or otherwise constrict our customers spending on our
products and services. As a result, revenues may decline and reserves for doubtful accounts and
write-offs of accounts receivable may increase. We had to take such action in the third quarter of
2009 as we wrote off a significant receivable from an international customer that we have been
unable to collect, and have been forced to bring court action in a foreign jurisdiction in an
attempt to enforce payment. Although we believe that the merits of the claim are in our favor,
there can be no assurance of success in any litigation, and we may incur additional expenses in
connection with the litigation and other collection efforts that we would be unable to recover. In
addition, certain of our contracts are paid, in part or whole, in foreign currencies. A decrease
in the exchange rate of the U.S. dollar relative to these currencies could further reduce our
revenues, and such impact could be material.
We maintain an investment portfolio, consisting of cash, cash equivalents and investments in
individual municipal bonds, and corporate and government bonds. These investments are subject to
general credit, liquidity, market, and interest rate risks. If the global credit market continues
to deteriorate, our investment portfolio may be impacted and potentially creating an
other-than-temporary decline in fair value, which would result in an impairment charge adversely
impacting our financial results.
We are dependent upon our ability to attract, retain and motivate our key personnel.
Our success depends on our ability to attract, retain and motivate our key management personnel,
including the Companys CEO, CFO, senior management team members, and key engineers, necessary to
implement our business plan and to grow our business. Despite the adverse economic conditions of
the past several years, competition for certain specific technical and management skill sets is
intense. If we are unable to identify and hire the personnel that we need to succeed, or if one or
more of our key employees were to cease to be associated with the Company, our future results could
be adversely affected. Furthermore, since 2007 we have experienced a number of changes in our
senior management positions, both as part of the restructuring initiatives and otherwise. Although
we believe we have taken appropriate measures to address the impact of these changes, such changes
could impact our business, and/or negatively affect operating results.
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We depend upon a few major customers for a majority of our revenues, and the loss of any of these
customers, or the substantial reduction in the products or services that they purchase from us,
would significantly reduce our revenues and net income.
We currently depend upon a few major customers for a significant portion of our revenues and we
expect to continue to derive a significant portion of our revenues from a limited number of
customers in the future. The loss of any of these customers or a substantial reduction in the
products or services that they purchase from us or our inability to renew services agreements with
customers and to do so upon terms at least as favorable to our current agreements would
significantly reduce our revenues and net income. Furthermore, diversions in the capital spending
of certain of these customers to new network elements have and could continue to lead to their
reduced demand for our products, which could in turn have a material adverse affect on our business
and results of operation. The capital spending of our large domestic carrier customers, as well as
many of our other customers and potential customers, are dictated by a number of factors, most of
which are beyond our control, including:
| Conditions of the telecommunications market and the weakening economy in general; | ||
| Subscriber line loss and related reduced demand for wireline telecommunications services; | ||
| Changes or shifts in the technology utilized in the networks; | ||
| Labor disputes between our customers and their collective bargaining units; | ||
| Failure of our customers to meet established purchase forecasts and growth projections; | ||
| Competition among the large domestic carriers, competitive exchange carriers and wireless telecommunications and cable providers; and | ||
| Reorganizations, including management changes, at one or more of our customers or potential customers. |
If the financial condition of one or more of our major customers should deteriorate, or if they
have difficulty acquiring investment capital or reduce their capital expenditures due to any of
these or other factors, a substantial decrease in our revenues would likely result.
Our operating results may vary from quarter to quarter, causing our stock price to fluctuate.
Our operating results have in the past been subject to quarter to quarter fluctuations, and we
expect that these fluctuations may continue in future periods. Demand for our products is driven by
many factors, including the availability of funding for our products in customers capital budgets.
Some of our customers place large orders near the end of a quarter or fiscal year, in part to spend
remaining available capital budget funds. Seasonal fluctuations in customer demand for our products
driven by budgetary and other reasons can create corresponding fluctuations in period-to-period
revenues, and we therefore cannot assure you that our results in one period are necessarily
indicative of our revenues in any future period. In addition, the number and timing of large
individual sales and the ability to obtain acceptances of those sales, where applicable, has been
difficult for us to predict, and large individual sales have, in some cases, occurred in quarters
subsequent to those we anticipated, or have not occurred at all. The loss or deferral of one or
more significant sales in a quarter could harm our operating results. It is possible that in some
quarters our operating results will be below the expectations of investors. In such events, or in
the event adverse conditions prevail, the market price of our common stock may decline
significantly.
We have completed, and may pursue additional acquisitions, which could result in the disruption of
our current business, difficulties related to the integration of acquired businesses, and
substantial expenditures.
We have completed, and we may pursue additional acquisitions of companies, product lines and
technologies as part of our strategic efforts to realign our resources around growth opportunities
in current, adjacent and new markets, to enhance our existing products, to introduce new products
and to fulfill changing customer requirements. The consideration for any such acquisition may be
cash or stock, or a combination thereof, and the payment of such consideration may result in a
reduction in our cash balance and/or the issuance of additional shares which may dilute the
interest of our existing shareholders. Acquisitions involve numerous risks, including the
disruption of our business, exposure to assumed or unknown liabilities of the acquired target, and
the failure to integrate successfully the operations and products of acquired businesses.
International acquisitions provide specific challenges due to the unique topology of international
telecommunications networks, as well as requirements of doing business in particular countries.
Further, our ability to sell certain products internationally depends upon our ability to maintain
certain key manufacturing relationships and we may not be able to continue those relationships.
Goodwill and acquired intangible assets arising from acquisitions may result in significant
impairment charges against our operating results in one or more future periods. Furthermore, we may
never achieve the anticipated results or benefits of an acquisition, such as increased market share
or the successful development and sales of a new product. The effects of any of these risks could
materially harm our business and reduce our future results of operations and cause our stock price
to decline.
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The failure of acquired assets to meet expectations, or a decline in our fair value determined by
market prices of our stock, could indicate impairment of our intangible assets and result in
impairment charges.
Accounting guidance for the impairment or disposal of long-lived assets addresses financial
accounting and reporting for the impairment or disposal of long-lived assets and requires that
these assets be measured for impairment whenever events or changes in circumstances indicate that
its carrying amount may not be recoverable. During 2009, 2008 and 2007, based on our assessment
that triggering events had occurred, we performed the required recoverability tests and determined
that certain long-lived assets were impaired. The occurrence of further triggering events could
result in additional impairments.
The sale of our products is dependent upon our ability to satisfy the proprietary requirements of
our customers.
We depend upon a relatively narrow range of products for the majority of our revenue. Our success
in marketing our products is dependent upon their continued acceptance by our customers. In some
cases, our customers require that our products meet their own proprietary requirements. If we are
unable to satisfy such requirements, or forecast and adapt to changes in such requirements, our
business could be materially harmed. In addition, we have recently introduced new products,
including the DigiTest ICE and the first version of the LightHouse products in 2008, and our
Stratum software platform in 2009. As of the end of 2009, we had very limited sales of our
LightHouse product line and our trial with a major utility is still ongoing and is expected to
continue into mid-2010. We have not yet seen the customer acceptance of our Stratum platform that
we had expected. In addition, there can be no assurance that our trial with a major utility will
be successful or, even if successful, will result in the orders for our Lighthouse product line
that we anticipate. The rate of acceptance of these new products could be further delayed by, or
may not be achieved at all as a result of, among other factors, extended testing or acceptance
periods or requests for custom or modified engineering of such products to conform to customer
requirements.
The sale of our products is dependent on our ability to respond to rapid technological change and
may be adversely affected by the development, and acceptance by our customers, of new technologies
which may compete with or reduce the demand for our products.
Changes in network architecture experienced by our customers in the telephony market have and may
continue to negatively affect our ability to sell products in these markets. Although we are
addressing these changes with modifications to our existing products, if customers do not accept
this new product technology, our revenues could be adversely affected. Further, we are
experiencing competition from the internal Information Technology (IT) departments of our own
carrier customers. In the past, we offered solutions consisting of hardware probes, coupled with a
centralized software platform that analyzed the data pulled from the probes and determined the
appropriate dispatch statement or issue identification statement. As the capabilities of new
infrastructure equipment increases, test and monitoring software platforms are increasingly taking
advantage of the available data from the infrastructure equipment. At the same time, many of our
larger customers have captive development capabilities in their own IT organizations. These IT
teams can develop competing software systems to our offerings, which could adversely affect our
ability to sell our products to those customers, which could negatively impact overall revenues
from such products.
Furthermore, the development of new technologies which compete with or reduce the demand for our
products, and the adoption of such technologies by our customers, could adversely affect sales of
our products. For example, as our products generally serve the wireline marketplace, to the extent
wireline customers migrate to wireless technologies, there may be reduced demand for our products.
In addition, we face new competition as testing functions that were once only available with
purpose-built test systems are now available as integrated components of network elements. To the
extent our customers adopt such new technology in place of our telecommunications products, the
sales of our telecommunications products may be adversely affected. Such competition may also
increase pricing pressure for our telecommunications products and adversely affect the revenues
from such products.
We depend on a single contract manufacturer to produce more than 80% of our hardware customer
product requirements. Changes to this relationship may result in delays or disruptions that could
harm our business.
We depend on one independent contract manufacturer to manufacture, test and ship our products. We
rely on purchase orders with our contract manufacturer to fulfill our product demands. Our
contract manufacturer is not obligated to supply products to us for any specific period, quantity
or price. It is time consuming and costly to qualify and implement a contract manufacturer
relationship. Therefore, if our contract manufacturer suffers an interruption in its business, or
experiences delays, disruptions or quality control problems in its manufacturing operations, or we
have to change or add additional contract manufacturers, our ability to ship products to our
customers would be delayed and our business, operating results and financial condition would be
adversely affected.
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We depend on single source component parts for certain product designs, and our reliance on third
parties to manufacture certain aspects of our products involves risks, including delays in product
shipments and reduced control over product quality.
Generally, our products use industry standard components. In addition, some parts, such as ASICS,
are custom-made to our specifications. While there are multiple sources for most of the component
parts of our products, some components are sourced from single sources or from a limited number of
outside suppliers. We typically do not have a written agreement with any of these component
manufacturers to guarantee the supply of the key components used in our products, and we do not
require our contract manufacturer to have written agreements with these component manufacturers. We
regularly monitor the supply of the component parts and the availability of alternative sources. We
provide forecasts to our contract manufacturer so that it can source the key components in advance
of their anticipated use, with the objective of maintaining an adequate supply for use in the
manufacture of our products. Our reliance upon third party contractors involve several risks,
including reduced control over manufacturing costs, delivery times, reliability and quality of
components. If we were to encounter a shortage of key manufacturing components from limited
sources of supply, or experience manufacturing delays caused by reduced manufacturing capacity,
inability of our contract manufacturers to procure raw materials, the loss of key assembly
subcontractors, or other factors, we could experience lost revenues, increased costs, delays in,
cancellations or rescheduling of orders or shipments, any of which would materially harm our
business.
If we fail to accurately predict our manufacturing requirements, we could incur additional costs or
experience manufacturing delays that could harm our business.
We provide demand forecasts to our contract manufacturer. If we overestimate our requirements, our
contract manufacturer may assess charges or we may have liabilities for excess inventory, each of
which could negatively affect our gross margins. Conversely, because lead times for required
materials and components vary significantly and depend on factors such as the specific supplier,
contract terms and the demand for each component at a given time, if we underestimate our
requirements, our contract manufacturer may have inadequate materials and components required to
produce our products, which could interrupt manufacturing of our products and result in delays in
shipments and deferral or loss of revenues.
Our future sales in international markets are subject to numerous risks and uncertainties.
Our business is becoming more dependent upon international markets. Our future sales in
international markets are subject to numerous risks and uncertainties, including local economic and
labor conditions, political instability including terrorism and other acts of war or hostility,
unexpected changes in the regulatory environment, trade protection measures, tax laws, our ability
to market current or develop new products suitable for international markets, difficulties with
deployments and acceptances of products, obtaining and maintaining successful distribution and
resale channels, changes in tariffs and foreign currency exchange rates, and longer payment cycles.
These specific risks, or an overall reduction in the demand for or the sales of our products in
international markets, could adversely affect future results.
We face intense competition, which could result in our losing market share or experiencing a
decline in our gross margins.
The markets for some of our products are very competitive. Some of our competitors have greater
technological, financial, manufacturing, sales and marketing, and personnel resources than we have.
As a result, these competitors may have an advantage in responding more rapidly or effectively to
changes in industry standards or technologies. We are facing competition with our IP-based testing
solutions, and many competitive technologies, encompassing both hardware and software, are
available in these markets. Moreover, better financed competitors may be better able to withstand
the pricing pressures that increased competition may bring. If our introduction of improved
products or services is not timely or well received, or if our competitors reduce their prices for
products that are comparable to ours, demand for our products and services could be adversely
affected. Competition from certain network element providers offering chip-based testing
functionality may also intensify the pricing pressure for our telecommunications products and
adversely affect future revenues from such products. We also face increasing pressure from certain
of our large domestic carrier customers on software maintenance agreements, as they continue to
divert spending from legacy networks to next generation network elements.
We may also compete directly with our customers. Generally, we sell our products either directly or
indirectly through OEM channels and other means to end-user telecommunications service providers.
It is possible that our customers, as the result of bankruptcy or other rationales for dismantling
network equipment, could attempt to resell our products. The successful development of such a
secondary market for our products by a third party could negatively affect demand for our products,
reducing our future revenues.
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Our future results are dependent on our ability to establish, maintain and expand our distribution
channels and our existing third-party distributors.
We market and sell certain of our products, including our DigiTest and LDU products, through
domestic and international OEM relationships. Our future results are dependent on our ability to
establish, maintain and expand third party relationships with OEM as well as other marketing and
sales distribution channels. If, however, the third parties with whom we have entered into such OEM
and other arrangements should fail to meet their contractual obligations, cease doing, or reduce
the amount of their business with us or otherwise fail to meet their own performance objectives,
customer demand for our products could be adversely affected, which would have an adverse effect on
our revenues.
The sales cycle for our system products is long, and the delay or failure to complete one or more
large transactions in a quarter could cause our operating results to fall below our expectations.
The sales cycle for our system products is highly customer specific and can vary from a few weeks
to many months. The system requirements of customers is highly dependent on many factors, including
but not limited to their projections of business growth, capital budgets and anticipated cost
savings from implementation of the system. Our delay or failure to complete one or more large
transactions in a quarter could harm our operating results. Our systems involve significant capital
commitments by customers. Potential customers generally commit significant resources to an
evaluation of available enterprise software and system testing solutions and require us to expend
substantial time, effort and money educating them about the value of our solutions. System sales
often require an extensive sales effort throughout a customers organization because decisions to
acquire software licenses and associated system hardware involve the evaluation of the products by
a significant number of customer personnel in various functional and geographic areas, each often
having specific and conflicting requirements. A variety of factors, including actions by
competitors and other factors over which we have little or no control, may cause potential
customers to favor a particular supplier or to delay or forego a purchase.
Many of our products must comply with significant governmental and industry-based regulations,
certifications, standards and protocols, some of which evolve as new technologies are deployed.
Compliance with such regulations, certifications, standards and protocols may prove costly and
time-consuming for us, and we cannot provide assurance that its products will continue to meet
these standards in the future. In addition, regulatory compliance may present barriers to entry in
particular markets or reduce the profitability of our product offerings. Such regulations,
certifications, standards and protocols may also adversely affect the industries in which we
compete, limit the number of potential customers for our products and services or otherwise have a
material adverse effect on its business, financial condition and results of operations. Failure to
comply, or delays in compliance, with such regulations, standards and protocols or delays in
receipt of such certifications could delay the introduction of new products or cause our existing
products to become obsolete.
The continued adoption of industry-wide standards in the telecommunications market could have a
material adverse effect on our profitability.
We are actively engaged in research to improve and expand our product offerings, including research
and development to reduce product costs while providing enhancements; however, with the rise of
industry-wide standards, among other factors, a number of our products have faced increased pricing
pressure, driving lower margins. If sales of our network assurance and testing solutions do not
increase, decrease rapidly, or are not accepted in the marketplace, or if our research and
development activities do not produce marketable products that are both competitive and accepted by
our customers, our overall revenues and profitability will be adversely affected.
The presence of available open source software could adversely affect our ability to maximize
revenue from software products.
An emerging risk to our software development efforts is the presence of available open source
software, which can allow our competitors and/or our customers to piece together a non-proprietary
software solution relatively quickly. To the extent they are successful in developing software
that meets their feature and benefit needs, revenue from our proprietary software could be
adversely affected. Further, to the extent we incorporate open source into our software products,
our ability to maximize revenue from our software products could be adversely impacted.
Our customers are subject to an evolving governmental regulatory environment that could
significantly reduce the demand for our products or increase our costs of doing business.
Our domestic customers have historically been subject to a number of governmental regulations, many
of which have been repealed or amended as a result of the passage of The Telecommunications Act of
1996. Deregulatory efforts have affected and likely will continue to affect our customers in
several ways, including the introduction of competitive forces into the local telephone markets and
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the imposition (or removal) of controls on the pricing of services. These and other regulatory
changes may limit the scope of our customers deployments of future services and budgets for
capital expenditures, which could significantly reduce the demand for our products.
Moreover, as the FCC adopts new and amends existing regulations, and as the courts analyze the
FCCs authority to do so, our customers cannot accurately predict the rules which will regulate
their conduct in their respective markets. Changes in the telecommunications regulatory environment
could, among other results, increase our costs of doing business, require our customers to share
assets with competitors or prevent the Company or our customers from engaging in business
activities they may wish to conduct, which could adversely affect our future results.
Similarly, our international customers are subject to a number of governmental regulations.
Regulatory changes affect our customers in several ways, including the introduction of competitive
forces, controls (or removal of controls), and new rules and limits. These and other regulatory
changes may limit our customers, their service offerings, of spending, which could significantly
reduce the demand for our products.
Our limited ability to protect our proprietary information and technology may adversely affect our
ability to compete, and our products could infringe upon the intellectual property rights of
others, resulting in claims against us the results of which could be costly.
Many of our products consist entirely or partly of proprietary technology owned by us. Although we
seek to protect our technology through a combination of copyrights, trade secret laws, contractual
obligations and patents, these protections may not be sufficient to prevent the wrongful
appropriation of our intellectual property, nor will they prevent our competitors from
independently developing technologies that are substantially equivalent or superior to our
proprietary technology. In addition, the laws of some foreign countries do not protect our
proprietary rights to the same extent as the laws of the United States. In order to defend our
proprietary rights in the technology utilized in our products from third party infringement, we may
be required to institute legal proceedings. If we are unable to successfully assert and defend our
proprietary rights in the technology utilized in our products, our future results could be
adversely affected.
Although we attempt to avoid infringing known proprietary rights of third parties in our product
development efforts, we may become subject to legal proceedings and claims for alleged infringement
from time to time in the ordinary course of business. Any claims relating to the infringement of
third-party proprietary rights, even if not meritorious, could result in costly litigation, divert
managements attention and resources, require us to reengineer or cease sales of our products or
require us to enter into royalty or license agreements which are not advantageous to us. In
addition, parties making claims may be able to obtain an injunction, which could prevent us from
selling our products in the United States or abroad.
In addition, the loss of patent protection for any of our products might allow competition, which,
if successful, could cause our revenues from affected products to be materially adversely affected.
In particular, our three patents for our MCU products will expire between 2010 and 2014.
The success of some of our products is dependent on our ability to maintain licenses to technology
from the manufacturers of systems with which our products must be compatible.
Some of our products require that we license technology from manufacturers of systems with which
our products must be compatible. The success of our proprietary MCU products, in particular, rely
upon our ability to acquire and maintain licensing arrangements with the various manufacturers of
DLC systems for the Proprietary Design Integrated Circuits (PDICs) unique to each. Although most
of our PDIC licensing agreements have perpetual renewal terms, all of them can be terminated by
either party. If we are unable to obtain the PDICs necessary for our MCU products to be compatible
with a particular DLC system, we may be unable to satisfy the needs of our customers. Furthermore,
future PDIC license agreements may contain terms comparable to, or materially different than, the
terms of existing agreements, as dictated by competitive or other conditions. The loss of these
PDIC license agreements, or our inability to maintain an adequate supply of PDICs on acceptable
terms, could have a material adverse effect on our business.
If we are unable to satisfy our customers specific product quality, certification or network
requirements, our business could be disrupted and our financial condition could be harmed.
Our customers demand that our products meet stringent quality, performance and reliability
standards. We have, from time to time, experienced problems in satisfying such standards. Defects
or failures have in the past, and may in the future occur relating to our product quality,
performance and reliability. From time to time, our customers also require us to implement specific
changes to our products to allow these products to operate within their specific network
configurations. If we are unable to remedy these failures or
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defects or if we cannot affect such required product modifications, we could experience lost
revenues, increased costs, including inventory write-offs, warranty expense and costs associated
with customer support, delays in or cancellations or rescheduling of orders or shipments and
product returns or discounts, any of which would harm our business.
If our accounting controls and procedures are circumvented or otherwise fail to achieve their
intended purposes, our business could be seriously harmed.
We evaluate our disclosure controls and procedures as of the end of each fiscal quarter, and are
annually reviewing and evaluating our internal controls over financial reporting in order to comply
with SEC rules relating to internal control over financial reporting adopted pursuant to the
Sarbanes-Oxley Act of 2002. Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or procedures may
deteriorate.
If we ship products that contain defects, the market acceptance of our products and our reputation
will be harmed and our customers could seek to recover their damages from us.
Our products, are complex, and despite extensive testing, may contain defects or undetected errors
or failures that may become apparent only after our products have been shipped to our customers and
installed in their network or after product features or new versions are released. Any such defect,
error or failure could result in failure of market acceptance of our products or damage to our
reputation or relations with our customers, resulting in substantial costs for us and for our
customers as well as the cancellation of orders, warranty costs and product returns. In addition,
any defects, errors, misuse of our products or other potential problems within or out of our
control that may arise from the use of our products could result in financial or other damages to
our customers. Our customers could seek to have us pay for these losses. Although we maintain
product liability insurance, it may not be adequate.
Compliance with environmental regulations could be costly, and noncompliance could have a material
adverse effect on our results of operations, expenses and financial condition.
Failure to comply with environmental regulations in the jurisdictions in which we do business could
result in penalties and damage to our reputation. In effect in the European Union are the
directive on the Restriction of the Use of Certain Hazardous Substances in Electrical and
Electronic Equipment (the RoHS Directive) and the directive on Waste Electrical and Electronic
Equipment (the WEEE Directive). Both the RoHS Directive and the WEEE Directive impact the form
and manner in which electronic equipment is imported, sold and handled in the European Union.
Other jurisdictions, such as China, have followed the European Unions lead in enacting legislation
with respect to hazardous substances and waste removal. Although we have concluded that our test
and measurement products fall outside the scope of the RoHS Directive, we have voluntarily
undertaken to cause our next generation products to comply with its requirements. Ensuring
compliance with the RoHS Directive, the WEEE Directive and similar legislation in other
jurisdictions, and integrating compliance activities with our suppliers and customers could result
in additional costs and disruption to operations and logistics and thus, could have a negative
impact on our business, operations and financial condition. In addition, based on our conclusion
that our test and measurement products do not fall within the scope of these Directives, we have
determined not to take these compliance measures with respect to certain of our older, legacy
products. Should our conclusions with respect to the applicability of the RoHS Directive to these
products be challenged and fail to prevail, we may be subject to monetary and non-monetary
penalties, and could suffer harm to our reputation or further decline in the sales of our legacy
products.
We are subject to governmental export and import controls that could subject us to liability or
impair our ability to compete in international markets.
Our products are subject to United States import and export controls. Changes in our products or
changes in export and import regulations may create delays in the introduction of our products in
international markets, prevent our customers with international operations from deploying our
products throughout their networks or, in some cases, prevent the export or import of our products
to certain countries altogether. Any change in export or import laws and regulations, shifts in
approach to the enforcement or scope of existing laws and regulations, or change in the countries,
persons or technologies targeted by such regulations, could result in decreased use of our products
by, or in our decreased ability to import, export or sell our products to existing or potential
customers with international operations. Any limitation on our ability to import, export or sell
our products would likely adversely affect our business, operating results and financial condition.
Consolidations in, or a continued slowdown in, the telecommunications industry could harm our
business.
We have derived a substantial amount of our revenues from sales of products and related services to
the telecommunications industry. In recent quarters, capital spending in the telecommunications
industry has decreased and may continue to decrease in the future as a result of the challenging
general economic conditions prevailing in domestic and international markets. In particular, large
carrier
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customers have been adversely affected by subscriber line losses as well as by competition from
cable and wireless carriers and other carriers entering the local telephone service market. Certain
emerging carriers also continue to be hampered by financial instability caused in large part by a
lack of access to capital. In the event of continued or further significant decreases in capital
spending of the telecommunications industry, our business would be adversely affected. Furthermore,
as a result of industry consolidation, there may be fewer potential customers requiring our
software in the future. Larger, consolidated telecommunications companies may also use their
purchasing power to create pressure on the prices and the margins we could realize. We cannot be
certain that consolidations in, or a slowdown in the growth of, the telecommunication industry will
not harm our business.
Our expenses are relatively fixed in the short term, and we may be unable to adjust spending to
compensate for unexpected revenue shortfalls.
We base our expense levels in part on forecasts of future orders and sales, which are extremely
difficult to predict. A substantial portion of our operating expenses is related to personnel
expense, facilities and public company costs. The level of spending for such expenses cannot be
adjusted quickly and is, therefore, relatively fixed in the short term. Accordingly, our operating
results will be harmed if revenues fall below our expectations in a particular quarter.
We rely on software that we license from third-party developers to perform key functions in our
products.
We rely on software that we license from third parties, including software that is integrated with
internally developed software and used in our products to perform key functions. We could lose the
right to use this software or it could be made available to us only on commercially unreasonable
terms. Although we believe that, in most cases, alternative software is available from other
third-party suppliers or internal developments, the loss of or inability to maintain any of these
software licenses or the inability of the third parties to enhance in a timely and cost-effective
manner their products in response to changing customer needs, industry standards or technological
developments could delay or reduce our product shipments until equivalent software could be
developed internally or identified, licensed and integrated, which would harm our business.
Our common stock price may be extremely volatile.
Our common stock price has been and is likely to continue to be highly volatile. The market price
may vary in response to many factors, some of which are outside our control, including:
| General market and economic conditions; | ||
| Changes in the telecommunications industry; | ||
| Actual or anticipated variations in operating results; | ||
| Announcements of technological innovations, new products or new services by us or by our competitors or customers; | ||
| Lack of research coverage by sell-side market analysts; | ||
| Announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures, capital commitments or other strategic announcements; | ||
| Announcements by our customers regarding end market conditions and the status of existing and future infrastructure network deployments; | ||
| Additions or departures of key personnel; and | ||
| Future equity or debt offerings or our announcements of these offerings. |
In addition, in recent years, the stock market in general, and The NASDAQ Global Select Market and
the securities of technology companies in particular, have experienced extreme price and volume
fluctuations. These fluctuations have often been unrelated or disproportionate to the operating
performance of individual companies. These broad market fluctuations have in the past and may in
the future materially and adversely affect our stock price, regardless of our operating results. In
the past, following periods of volatility in the market price of a companys securities, securities
class action litigation has often been initiated against such company. Such litigation could result
in substantial costs and a diversion of our managements attention and resources that could harm
our business regardless of the outcome of such litigation.
We may be subject from time to time to legal proceedings, and any adverse determinations in these
proceedings could materially harm our business.
We may from time to time be involved in various lawsuits and legal proceedings, which arise in the
ordinary course of business. Litigation matters are inherently unpredictable, and we cannot predict
the outcome of any such matters. If we ultimately lose or settle a case, we may be liable for
monetary damages and other costs of litigation. Even if we are entirely successful in a lawsuit, we
may incur significant legal expenses and our management may expend significant time in the defense.
An adverse resolution of a lawsuit or legal proceeding could negatively impact our financial
position and results of operations.
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Item 1B. | Unresolved Staff Comments. |
None.
Item 2. | Properties. |
Our headquarters and principal administrative, engineering, manufacturing, warehouse and
maintenance operations are located in Cheswick, Pennsylvania. We occupy an 111,600 square foot
facility, which is under a lease that has been extended to March 2011, with the possibility to
extend to March 2012. We had acquired certain land parcels that surround this facility for
possible expansion that we began to sell during 2007; however, we completed the sale of the
remaining parcels during 2008.
We are also a party to a lease agreement for 11,429 square feet of space in Piscataway, New Jersey,
which lease commenced on March 1, 2007 and expires April 30, 2012. The Piscataway facility provides
workspace for the administrative, engineering and services personnel.
We lease office space in three locations in Europe, the largest of which is in Bracknell, United
Kingdom. At that location, we lease 7,500 square feet of space, primarily for engineers who
support our European customer base and customer support personnel. This lease expires on December
24, 2012. We also lease 3,240 square feet of space in Kontich, Belgium, under a lease agreement
with an initial term that ends on April 1, 2012, which is used primarily by customer support and
administrative personnel; however, we expect to terminate this lease in early 2010 and are
currently working with the landlord to exit this facility. Lastly, we lease 2,422 square feet of
space in Wuppertal, Germany, under a lease which expires on January 31, 2011. This facility is
used primarily by sales and customer support personnel.
Item 3. | Legal Proceedings. |
There are currently no outstanding or pending material legal proceedings to which the Company or
any of its subsidiaries is a party or of which any of their property is the subject.
Item 4. | Reserved. |
PART II
Item 5. Market for the Registrants Common Stock, Related Stockholder Matters and Issuer
Purchases of Equity Securities.
Our common stock is traded on the NASDAQ Global Select Market under the symbol TLGD. The
following table sets forth, by quarter, the high and low sales prices for our common stock for the
years ended December 31, 2009 and December 31, 2008.
2009 | 2008 | |||||||||||||||
High | Low | High | Low | |||||||||||||
First Quarter |
$ | 7.14 | $ | 4.73 | $ | 8.13 | $ | 5.08 | ||||||||
Second Quarter |
$ | 5.95 | $ | 5.04 | $ | 6.07 | $ | 4.24 | ||||||||
Third Quarter |
$ | 6.93 | $ | 4.98 | $ | 7.00 | $ | 4.25 | ||||||||
Fourth Quarter |
$ | 6.83 | $ | 5.49 | $ | 5.56 | $ | 3.00 |
On February 28, 2010, there were 157 holders of record and 12,637,431 million shares outstanding of
the Companys common stock.
We have never paid any dividends on our common stock and do not expect to pay dividends in the
foreseeable future.
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Table of Contents
During the quarter ended December 31, 2009, the Company repurchased the following shares of its
common stock:
(d) Maximum Number | ||||||||||||||||
(or Approximate | ||||||||||||||||
(c) Total number of | Dollar Value) of | |||||||||||||||
shares purchased as part | Shares that May Yet | |||||||||||||||
(a) Total Number of | (b) Average Price Paid | of publicly announced | Be Purchased Under | |||||||||||||
Period | Shares Purchased (1) | per Share | plans or programs | the Plans or Programs | ||||||||||||
November 2009 |
45,850 | $ | 6.07 | 45,850 | $ | 12,519,000 | ||||||||||
December 2009 |
33,193 | $ | 6.01 | 33,193 | $ | 12,318,000 |
(1) | On October 28, 2008, the Board of Directors approved a share repurchase program, pursuant to which the Company could repurchase common stock with an aggregate share value of up to $15 million with no expiration date. Such purchases could be made through open market transactions and privately negotiated transactions at the Companys discretion, subject to market conditions and other factors. The repurchase program does not obligate the Company to acquire any particular amount of common stock and, at the Boards discretion, may be suspended, discontinued or modified at any time. As of December 31, 2009 and 2008, the Company had acquired 79,043 and 496,918 shares pursuant to this program at a total cost of approximately $0.5 million and $2.2 million, respectively. The shares that were repurchased are being held for later resale or to be utilized under certain employee benefit programs and are not considered cancelled or retired shares. |
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Table of Contents
STOCK PERFORMANCE GRAPH
Set forth below is a performance graph comparing the cumulative total returns (assuming
reinvestment of dividends) for the five fiscal years ended December 31, 2009 of $100 invested on
December 31, 2004 in Tollgrades common stock, the Standard & Poors 500 Composite Index and the
NASDAQ Telecomm (IXUT).
The performance graph shall not be deemed filed for purposes of Section 18 of the Securities
Exchange Act of 1934, as amended (the Exchange Act) or otherwise subject to the liabilities under
that Section and shall not be deemed to be incorporated by reference into any of our other filings
under the Securities Act of 1933, as amended or the Exchange Act.
December | December | December | December | December | December | |||||||||||||||||||
31, | 31, | 31, | 31, | 31, | 31, | |||||||||||||||||||
2004 | 2005 | 2006 | 2007 | 2008 | 2009 | |||||||||||||||||||
Tollgrade |
100 | 89 | 86 | 66 | 39 | 50 | ||||||||||||||||||
NASDAQ Telecomm (IXUT) |
100 | 93 | 119 | 129 | 74 | 109 | ||||||||||||||||||
S&P 500 |
100 | 103 | 117 | 121 | 75 | 92 |
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Item 6. | Selected Financial Data. |
The following selected consolidated financial data of the Company has been derived from our audited
consolidated financial statements. The following selected consolidated financial data may not be
representative of our future financial performance and should be read in conjunction with the
consolidated financial statements, the notes to the consolidated financial statements, and
Managements Discussion and Analysis of Financial Condition and Results of Operations, which are
included elsewhere in this report.
(IN THOUSANDS, EXCEPT PER SHARE DATA AND NUMBER OF EMPLOYEES)
FOR THE YEARS ENDED DECEMBER 31: | 2009 | 2008 | 2007 | 2006 | 2005 | |||||||||||||||
Revenues: |
||||||||||||||||||||
Products |
$ | 19,936 | $ | 26,997 | $ | 36,143 | $ | 35,270 | $ | 35,608 | ||||||||||
Services |
25,005 | 22,055 | 15,689 | 11,736 | 11,860 | |||||||||||||||
Total revenue |
44,941 | 49,052 | 51,832 | 47,006 | 47,468 | |||||||||||||||
Cost of sales: |
||||||||||||||||||||
Products |
11,812 | 14,181 | 15,874 | 14,653 | 14,130 | |||||||||||||||
Services |
7,143 | 6,146 | 4,103 | 3,473 | 2,707 | |||||||||||||||
Amortization of intangible assets |
2,576 | 3,085 | 2,199 | 2,597 | 2,225 | |||||||||||||||
Inventory write-down |
3,070 | 759 | | 4,101 | 424 | |||||||||||||||
Impairment of long-lived assets |
27,151 | 201 | 1,090 | | | |||||||||||||||
Severance |
778 | | | | | |||||||||||||||
Total cost of sales |
52,530 | 24,372 | 23,266 | 24,824 | 19,486 | |||||||||||||||
Gross margin |
(7,589 | ) | 24,680 | 28,566 | 22,182 | 27,982 | ||||||||||||||
Operating expenses: |
||||||||||||||||||||
Selling and marketing |
6,809 | 6,835 | 7,807 | 7,794 | 6,650 | |||||||||||||||
General and administrative |
12,141 | 9,455 | 9,702 | 7,702 | 7,224 | |||||||||||||||
Research and development |
9,411 | 10,789 | 10,987 | 9,088 | 8,830 | |||||||||||||||
Restructuring/severance |
1,180 | 827 | 922 | 566 | 775 | |||||||||||||||
Impairment of long-lived assets and
goodwill |
293 | | 20,036 | | | |||||||||||||||
Total operating expenses |
29,834 | 27,906 | 49,454 | 25,150 | 23,479 | |||||||||||||||
(Loss) income from operations |
(37,423 | ) | (3,226 | ) | (20,888 | ) | (2,968 | ) | 4,503 | |||||||||||
Other income, net |
567 | 1,337 | 2,770 | 2,741 | 1,359 | |||||||||||||||
(Loss) income before income taxes |
(36,856 | ) | (1,889 | ) | (18,118 | ) | (227 | ) | 5,862 | |||||||||||
(Benefit) provision for income taxes |
(874 | ) | 1,137 | 1,220 | (1,213 | ) | 1,301 | |||||||||||||
(Loss) income from continuing operations |
(35,982 | ) | (3,026 | ) | (19,338 | ) | 986 | 4,561 | ||||||||||||
(Loss) from discontinued operations |
(223 | ) | (4,089 | ) | (6,815 | ) | (2,820 | ) | (1,043 | ) | ||||||||||
Net (Loss) income |
$ | (36,205 | ) | $ | (7,115 | ) | $ | (26,153 | ) | $ | (1,834 | ) | $ | 3,518 | ||||||
Weighted average shares
of common stock equivalents: |
||||||||||||||||||||
Basic |
12,683 | 13,102 | 13,219 | 13,239 | 13,168 | |||||||||||||||
Diluted |
12,683 | 13,102 | 13,219 | 13,239 | 13,217 | |||||||||||||||
EARNINGS PER SHARE INFORMATION: |
||||||||||||||||||||
Net (loss) income per common share: |
||||||||||||||||||||
Basic |
$ | (2.85 | ) | $ | (0.54 | ) | $ | (1.98 | ) | $ | (0.14 | ) | $ | 0.27 | ||||||
Diluted |
$ | (2.85 | ) | $ | (0.54 | ) | $ | (1.98 | ) | $ | (0.14 | ) | $ | 0.27 | ||||||
EARNINGS PER SHARE INFORMATION: |
||||||||||||||||||||
Net (loss) income per common share
from continuing operations: |
||||||||||||||||||||
Basic |
$ | (2.83 | ) | $ | (0.23 | ) | $ | (1.46 | ) | $ | 0.07 | $ | 0.35 | |||||||
Diluted |
$ | (2.83 | ) | $ | (0.23 | ) | $ | (1.46 | ) | $ | 0.07 | $ | 0.35 | |||||||
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FOR THE YEARS ENDED DECEMBER 31: | 2009 | 2008 | 2007 | 2006 | 2005 | |||||||||||||||
EARNINGS PER SHARE INFORMATION: |
||||||||||||||||||||
Net (loss) income per common share
from discontinued operations: |
||||||||||||||||||||
Basic |
$ | (0.02 | ) | $ | (0.31 | ) | $ | (0.52 | ) | $ | (0.21 | ) | $ | (0.08 | ) | |||||
Diluted |
$ | (0.02 | ) | $ | (0.31 | ) | $ | (0.52 | ) | $ | (0.21 | ) | $ | (0.08 | ) | |||||
2009 | 2008 | 2007 | 2006 | 2005 | ||||||||||||||||
BALANCE SHEET DATA: |
||||||||||||||||||||
Working capital |
$ | 69,195 | $ | 75,475 | $ | 77,080 | $ | 83,186 | $ | 80,806 | ||||||||||
Total assets |
87,687 | 124,347 | 140,143 | 162,352 | 163,329 | |||||||||||||||
Pension obligation |
983 | 889 | 908 | | | |||||||||||||||
Shareholders equity |
77,743 | 112,454 | 123,000 | 149,444 | 150,261 | |||||||||||||||
2009 | 2008 | 2007 | 2006 | 2005 | ||||||||||||||||
OTHER DATA: (unaudited) |
||||||||||||||||||||
Number of full-time
employees at year-end |
167 | 179 | 205 | 161 | 177 |
Item 7. Item 7. Managements Discussion and Analysis (MD&A) of Financial Condition and Results
of Operations.
The following discussion should be read in conjunction with the other sections of this annual
report on Form 10-K, including Item 1: Business, Item 6: Selected Financial Data and Item 8:
Financial Statements. Unless otherwise specified, any reference to a year is to a year ended
December 31. Additionally, when used in this Form 10-K, unless the context requires otherwise, the
terms we, our, us and the Company refer to Tollgrade Communications, Inc. and its
subsidiaries. Certain statements contained in this MD&A and elsewhere in this report 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 that involve risks and
uncertainties. These statements relate to future events or our future financial performance. In
some cases, forward-looking statements can be identified by terminology such as believe,
expect, intend, may, will, should, could, potential, continue, estimate, plan,
or anticipate, or the negatives thereof, other variations thereon or compatible terminology.
These statements involve a number of risks and uncertainties. Actual events or results may differ
materially from any forward-looking statement as a result of various factors, including those
described in Item 1A above under Risk Factors.
Cable Product Line
On May 27, 2009, we completed the sale of our cable product line for consideration of approximately
$3.4 million, subject to adjustment for certain items pursuant to the terms of the sale agreement.
The cable product line no longer supported our refocused growth strategy and this divesture allows
us to continue to focus on our core telecommunications markets and customers. Unless otherwise
indicated, references to revenues and earnings throughout this MD&A and elsewhere in this Form 10-K
refer to revenues and earnings from continuing operations and do not include revenue and earnings
from the discontinued cable product line. Similarly, discussion of other matters in our
Consolidated Financial Statements refers to continuing operations unless otherwise indicated. The
results from this divested product line are reported in discontinued operations. This divestiture
eliminated an unprofitable product line and is expected to result in significant improvements to
our future statements of operations and cash flows as we focus on our core markets and customers.
Overview
Tollgrade Communications, Inc. is a leading provider of centralized test and measurement systems
and service offerings to the telecommunications market. Our products enable service providers to
remotely diagnose and proactively address problems in their networks. Our services and managed
services include offerings that complement our product solutions as well as provide customer
support and engineering services.
Industry and Market Trends
Our traditional product lines and the markets in which we compete faced continued pressure
throughout 2009. This pressure came through a variety of sources, including shifting customer
spending and the economic slowdown, which has impacted capital expense spending and competitive market
conditions.
Our traditional customer base continues to minimize spending on legacy areas of their networks.
This trend has resulted in reduced demand for a number of our copper-based products throughout
2009. Since the end of 2008, the general economic environment has challenged many companies,
including our customers. Service provider spending continues to be focused on next generation
networks and services, with VoIP, IPTV, and mobile data at the forefront. Spending in test and
measurement is equally focused in
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these areas with reduced spending on legacy networks. In the downturn, our customers, the service
providers, have delayed capital expense decisions while they wait for the economy to recover and
their own businesses to stabilize. Competitively, our solutions have historically consisted of
hardware and software combinations. Over the past years, competitors have introduced low-cost
hardware solutions, software-only solutions, as well as integrated test capabilities within
infrastructure products. We have also seen consolidation in the test and measurement market with
the Ixia purchase of Catapult Communications and JDS Uniphase Corporations announced purchase of
the telecommunications test and measurement division of Agilent Technologies, Inc. These
transactions increase the competitive pressure in the market as they
sell a broader portfolio of products.
There is also a trend in the telecommunications market to outsource functions to companies that
specialize in different areas to attain cost reductions and, in some cases, improve service. Our
customers have approached this in two ways. First, a small number have outsourced their entire
network operations to large managed services providers. Second, certain of the larger service
providers are beginning to consolidate vendor relationships to a select group of vendors and feed
smaller suppliers through the larger vendor relationships. This trend affected us in December 2009
when Verizon, a major customer, decided not to renew its direct contract with us for post-warranty
maintenance service, but instead, consolidated several vendor relationships through a single large
global network equipment manufacturer. In addition, we have certain other customers that now
purchase their maintenance through contracts with larger, third-party suppliers. This practice can
create additional pricing pressure as the intermediary vendor looks to make a profit by managing
the complexity for the service provider.
Our Responses to These Industry Trends
In response to these conditions and trends, we have taken decisive action to reinforce our position
with our customers while also exploring new markets for growth. We have focused on
improving our already strong customer relationships while aggressively containing costs. We
continue to provide excellent customer support and enhanced capabilities to our customers and are
focused on retaining and extending our software support and maintenance contracts. While the
service providers actively manage their own capital expense budgets, we have reduced our cost
structure to ensure that the impacts to our financial results are minimized. We continue to focus
on managing and growing our cash and short term investment balance to enable future investment
options.
We have also redirected our spending activities toward new growth initiatives versus maintenance
efforts. Some of these growth areas include new hardware, software and services offerings for the
telecommunications service assurance market. Our new offerings recently launched and under
development include a software platform, Stratum, that can be sold stand-alone or as part of a
service assurance system solution, hardware products that integrate into our service assurance
solutions, and OEM products that will be sold and supported under the Tollgrade brand name.
In the power utility market, we see a convergence of thought toward a smart network architecture
that can help limit the negative impacts of expanding power production while offering additional
control and capabilities to customers and utilities to manage their networks, homes and businesses.
This smart grid architecture is rapidly evolving through the efforts of forward-looking
utilities coupled with companies offering innovative new products to enable the utility
infrastructure revolution that seems to be required. More than $3.4 billion of stimulus funding
was awarded by the U.S. Department of Energy to more than 100 recipients for investment in Smart
Grid projects with over $8.1 billion of public and private investment projected. Our focus in this
market is on our current customer trial activity with a large US power utility.
Lastly, we have created a new area of opportunity through our managed services contract with
Ericsson. We now have the expertise to provide a new suite of managed services not only to our
service provider customers, but also to additional network equipment manufacturers, thus expanding
our target market. We believe this new platform will provide new growth opportunities and enable us
to effectively respond to our customers trend in an area that builds upon our expertise and
experience in test and measurement.
In the short term, we are leveraging strategic OEM relationships. Our OEM arrangements allow us to
expand our system solutions into adjacent market segments with the Tollgrade name, while reducing
our investment and time to market. In 2009, we entered into an OEM arrangement with Mariner
Partners, Inc., whereby we will market and sell a customized version of their xVU offering, a
real-time quality of experience test solution for IPTV services, which will be integrated into our
Stratum platform. We also signed an OEM agreement with Accanto Systems, whereby we will be able to
market and sell their suite of products under our brand name on an
exclusive basis in certain territories.
For 2010, our primary focus has turned to strengthening our business and delivering improved
results. In building our plan for 2010, we had three guiding principles:
| First and foremost, ensure profitability; | ||
| Second, minimize resources and spending on legacy products to allow for focused investments; and | ||
| Third, align the business around growth initiatives and focus our resources on near term opportunities. |
Our near term growth opportunities include the new customer projects, managed services, LightHouse,
Stratum and software application projects, our OEM offerings and exploring strategic acquisitions.
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Results of Operations for the Year Ended December 31, 2009 Compared to the Year Ended December 31,
2008
Revenue
2009 | 2008 | Change | % | |||||||||||||
System Test Products |
$ | 14,118 | $ | 18,061 | $ | (3,943 | ) | -22 | % | |||||||
MCU |
5,694 | 8,936 | (3,242 | ) | -36 | % | ||||||||||
Other |
124 | | 124 | 100 | % | |||||||||||
Total Products |
19,936 | 26,997 | (7,061 | ) | -26 | % | ||||||||||
Services |
25,005 | 22,055 | 2,950 | 13 | % | |||||||||||
Total Revenues |
$ | 44,941 | $ | 49,052 | $ | (4,111 | ) | -8 | % |
Our total revenues for the year ended December 31, 2009 were $44.9 million, a decrease of $4.1
million, or 8%, compared to our total revenues of $49.1 million for the year ended December 31,
2008. For the full year 2009, our total product revenues amounted to $19.9 million compared to
$27.0 million for the same 2008 period, a decrease of $7.1 million or 26%. However, our full year
2009 service revenues increased to $25.0 million, a $3.0 million or a 13% increase over the same
prior period.
The decline in our 2009 product line revenue of $7.1 million is primarily due to a decline in most
of our legacy test product lines and our MCU products. Our Systems Test products include the
product families of DigiTest, LDU and N(x)Test and associated software applications and license
fees. Revenues for System Test products in 2009, were $14.1 million, a decrease of approximately
$3.9 million, or 22% from the same prior year period. Our Systems Test product line revenues
decreased in 2009 primarily as a result of the conclusion of certain international projects
involving DigiTest products in 2008. The Systems Test product line revenue accounted for 31% of
2009 total revenues compared to 37% of 2008 total revenues. In addition, sales of our MCU product
line in 2009 were $5.7 million, compared to $8.9 million in the previous year, which represents a
decrease of approximately $3.2 million, or 36%. Although our MCU product line still provided a
meaningful contribution to revenue in 2009, this is a very mature product line whose future sales
are hard to predict due to the large domestic carriers limiting capital spending in their
traditional POTS networks, and the evolution of the transmission network toward end-to-end fiber.
Our MCU product line accounted for approximately 13% of our 2009 total revenues compared to 18% of
our 2008 total revenues. Lastly, our other revenue for 2009 is comprised of approximately $0.1
million in revenue from OEM and LightHouse sales as we had no sales in either of these product
lines in 2008. Our product revenues accounted for 44% of our total revenues for 2009 compared to
55% of our total revenues for 2008.
Our
services revenue consists primarily of software maintenance for 4TEL
and Celerity LTSC, and
LoopCare, project management fees, repair work and managed services. In 2009, our full year
service revenue was approximately $25.0 million compared to $22.1 million in the same 2008 period.
The increase in 2009 is primarily due to our new managed services contract with Ericsson that
closed in April of 2009 and added $5.1 million of new revenues which was offset by lower service
revenues related to Loopcare. Services revenues accounted for approximately 56% of our total
revenues for 2009 compared to 45% of 2008 total revenues.
Gross Margin
Our 2009 gross margin was a negative $(7.6) million compared to $24.7 million for the same 2008
period, a decrease of approximately $32.3 million. Our 2009 gross margin decrease of $32.3 million
is primarily related to longlived asset impairments of $27.2 million, which included the fourth
quarter write-down of our LoopCare intangible asset that amount to approximately $27.0 million, a
third quarter 2009 inventory write-down of approximately $3.1 million that primarily related to
slow-moving and obsolete legacy product inventory, and severance costs that amounted to
approximately $0.8 million.
Selling and Marketing Expenses
2009 | 2008 | Change | % | |||||||||||||
Employee Costs |
$ | 4,780 | $ | 4,583 | $ | 197 | 4 | % | ||||||||
Travel Expenses |
694 | 799 | (105 | ) | -13 | % | ||||||||||
Professional Fees |
419 | 677 | (258 | ) | -38 | % | ||||||||||
Other |
916 | 776 | 140 | 18 | % | |||||||||||
Total |
$ | 6,809 | $ | 6,835 | (26 | ) | 0 | % |
Our selling and marketing expenses consist primarily of employee costs, which include
salaries, benefits and commission expenses, consulting fees and travel expenses of direct sales and
marketing personnel and other expenses which individually are not material. Our selling and
marketing expenses of $6.8 million for 2009 and 2008 were flat year over year. The increase in
employee costs in
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2009 is primarily due to the addition of sales and business development employees in the fourth
quarter of 2009 to bolster our sales efforts in certain markets and in recently announced product
offerings. The 2009 decrease in travel costs and professional fees of approximately $0.1 million
and $0.3 million is primarily related to our overall cost reduction efforts that occurred
throughout 2009.
General and Administrative Expenses
2009 | 2008 | Change | % | |||||||||||||
Employee Costs |
$ | 3,922 | $ | 3,912 | $ | 10 | 0 | % | ||||||||
Professional Fees |
3,880 | 3,132 | 748 | 24 | % | |||||||||||
Bad Debt |
1,121 | | 1,121 | 100 | % | |||||||||||
Stock Compensation |
855 | 299 | 556 | 186 | % | |||||||||||
Other |
2,363 | 2,112 | 251 | 12 | % | |||||||||||
Total |
$ | 12,141 | $ | 9,455 | 2,686 | 28 | % |
Our general and administrative expenses consist primarily of employee costs, professional services,
bad debt expenses, stock compensation expenses and other expenses which individually are not
material. For the full year ended December 31, 2009, our general and administrative expenses were
$12.1 million, or a $2.7 million increase over the same 2008 period. The $2.7 million increase is
primarily attributable to a $1.1 million bad debt expense recorded in the third quarter of 2009
related to one of our large international contracts whose collectability was deemed to be
uncertain, additional legal expenses and professional service fees of approximately $0.7 million in
connection with the contested election of directors and fees related to potential acquisition
candidates that were not pursued beyond the due diligence stage, and $0.6 million in additional
stock compensation expenses due primarily to restricted stock awards granted our non-employee
directors in the fourth quarter of 2009 pursuant to the non-employee director compensation program
adopted by the Board in October 2009. These non-employee director awards offset substantial
reductions in director cash compensation and meeting fees going forward.
Research and Development Expenses
2009 | 2008 | Change | % | |||||||||||||
Employee Costs |
$ | 7,977 | $ | 8,435 | $ | (458 | ) | -5 | % | |||||||
Professional Services |
722 | 1,205 | (483 | ) | -40 | % | ||||||||||
Depreciation |
622 | 865 | (243 | ) | -28 | % | ||||||||||
Other |
90 | 284 | (194 | ) | -68 | % | ||||||||||
Total |
$ | 9,411 | $ | 10,789 | (1,378 | ) | -13 | % |
Our research and development expenses consist primarily of employee costs, professional service
expenses, depreciation expense and other costs associated with the development of new product
initiatives, such as our LightHouse and Stratum initiatives, along with maintaining and upgrading
our current product lines which individually are not material. Our research and development
expenses for the full year ended December 31, 2009 were $9.4 million, or a $1.4 million decrease,
over the same 2008 period. The decrease in our research and development expenses for 2009 is
primarily related to reductions in the work force, reduced consulting and professional fees and
lower depreciation expenses due to reduced capital spending.
Severance Expense
Severance expense primarily consists of wages, benefits and outplacement costs at a time when an
employee is terminated. In 2009, we had three instances where we reduced and re-aligned our work
force to reduce costs and to further streamline and improve our business. During the third quarter
of 2009, we developed a plan to significantly reduce and restructure our workforce across all
levels of the organization in an effort to reduce costs and to better align our human resources to
match ongoing revenue streams. The total severance associated with this action was $1.4 million of
which $0.5 million was recorded to cost of sales while $0.9 million was recorded as an operating
expense. In addition, in the third quarter of 2009, we also incurred a $0.2 million charge related
to the departure of our former chief financial officer. During the first and second quarters of
2009, we implemented certain initiatives aimed at increasing efficiency and decreasing costs, which
included reductions in our professional services, operations and marketing staff. Severance
expense associated with these actions was $0.3 million. Cash payments related to the
aforementioned actions were $1.5 million in 2009. As of December 31, 2009, we had $0.4 million
accrued on our balance sheet related to this action, which was paid in early 2010.
During the first quarter of 2008, we reduced our engineering and senior management staff, made
changes to our field service and sales staffing, and realigned existing resources to new projects.
The severance costs associated with this program amounted to approximately $0.4 million. In
addition, we incurred severance costs in the fourth quarter related to the separation of two senior
executives and one other executive that amounted to approximately $0.4 million. All cash payments
related to this action have been paid in 2008 and no further expense is expected.
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Long-Lived Asset Impairments
We perform impairment reviews on our long-lived assets upon a change in business conditions or upon
the occurrence of a triggering event. In mid-December 2009, we learned that Verizon, a major
customer of our LoopCare post-warranty software maintenance services, would not renew its direct
contract with us for those services following the contracts expiration date on December 31, 2009,
but would instead consolidate its purchase of maintenance services (including LoopCare and 4TEL
post-warranty services) through a single large supplier. We are currently in discussions with the
supplier for the continuing provision of the LoopCare post-warranty maintenance services to
Verizon. However, based on this triggering event we evaluated the carrying value of the
intangible asset related to our LoopCare post-warranty intangible asset using an undiscounted cash
flow model, and determined the asset to be impaired. We then performed a valuation on this asset
to determine its fair value. Through this valuation process, we determined that the fair value of
this asset approximated $2.3 million compared to its current carrying value of $29.3 million and,
as such, took an impairment charge of approximately $27.0 million in the fourth quarter of 2009.
In addition, through this valuation process, we determined that a fifteen year life, instead of
life of approximately forty-six years, on this asset is more indicative of current market and
technological conditions, as well as the anticipated future ability to extend existing maintenance
agreements. Earlier in the year, we also recorded a $0.4 million charge for impairments in various
other long-lived assets.
In 2008 we determined that certain long-lived assets, primarily related to assets acquired as part
of our Emerson acquisition, were impaired and an impairment loss of $0.2 million was recorded to
reflect these assets at their fair market value.
Other Income, (net)
Other income, which consists primarily of interest income, was $0.6 million for 2009, compared to
$1.3 million for 2008. The $0.7 million decrease in other income is due primarily to lower
interest yields on our investment balances due to the overall decline in economic market
conditions.
(Benefit)/Provisions for Income Taxes
For the year ended December 31, 2009, we recorded a total income tax benefit of approximately $0.9
million. The primary reason for this income tax benefit was the $1.1 million benefit associated
with the impairment of our LoopCare intangible asset, whereby we reduced a deferred tax liability
on our balance sheet. This benefit was offset by income tax expenses primarily related to foreign
income tax obligations generated by profitable operations in certain foreign jurisdictions. This
compares to the same 2008 period whereby we recorded $1.1 million of income tax expenses primarily
related to foreign tax obligations generated by our profitable foreign jurisdictions, as well as
adjustments to reserves for uncertain tax positions in all jurisdictions. Additionally, we
continued to record a valuation allowance against U.S. federal, certain foreign and certain state
net operating losses incurred in 2009 as the tax benefit was deemed more than likely not to be
realizable in future periods.
Loss from Continuing Operations and Loss Per Share from Continuing Operations:
For the year ended December 31, 2009, our net loss from continuing operations was approximately
$36.0 million compared to a net loss of $3.0 million from continuing operations for the year ended
December 31, 2008 for the reasons stated above. Our basic and diluted loss from continuing
operations per common share was $(2.83) for 2009 versus a loss of $(0.23) for 2008. Diluted
weighted average shares of common stock and equivalents outstanding were 12.7 million and
13.1 million in 2009 and 2008, respectively.
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Results of Operations for the Year Ended December 31, 2008 Compared to the Year Ended December 31,
2007
Revenue
2008 | 2007 | Change | % | |||||||||||||
System Test Products |
$ | 18,061 | $ | 23,480 | $ | (5,419 | ) | -23 | % | |||||||
MCU |
8,936 | 12,663 | (3,727 | ) | -29 | % | ||||||||||
Total Products |
26,997 | 36,143 | (9,146 | ) | -25 | % | ||||||||||
Services |
22,055 | 15,689 | 6,366 | 41 | % | |||||||||||
Total Revenue |
$ | 49,052 | $ | 51,832 | $ | (2,780 | ) | -5 | % |
Our total
revenues for the year ended December 31, 2008 were $49.1 million, a decrease of
$2.8 million, or 5%, compared to our total revenues of $51.8 million for the year ended
December 31, 2007. For the full year 2008, our total product revenues amounted to $27.0 million
compared to $36.1 million for the same 2007 period, a decrease of $9.1 million or 25%; however, our
full year 2008 service revenue increased by $6.3 million to $22.1 million from $15.7 million in the
same 2007 period.
The decline in our 2008 product line revenues of $9.1 million is primarily due to the decrease in
our legacy test product lines as well as our MCU product lines. Our Systems Test product revenues
for 2008, which include the product families of DigiTest, LDU and N(x)Test and associated software
applications and license fees, were $18.1 million, a decrease of approximately $5.4 million, or 23%
from the prior year. Our Systems Test product line revenue decreased in 2008 primarily as a result
of significant revenue from certain international projects involving DigiTest products at the end of 2007.
This decline was offset, in part, by increased sales of LDU products and software applications in
both international and domestic markets and our first domestic sale of the DigiTest ICE product in
2008. The Systems Test product line revenue accounted for 37% of 2008 revenue compared to 46% of
2007 revenue. During 2008, we continued to experience lower sales to independent carriers than
those experienced in 2007 due to changes in network deployment architecture. Sales of our MCU
product line in 2008 were $8.9 million, compared to $12.7 million in the previous year, which
represents a decrease of approximately $3.8 million, or 29%. While the MCU is a mature product, it
continued to provide meaningful contribution to revenue in 2008. The decline in MCU revenue was
primarily due to the non-recurrence of a large project in one of our major domestic carriers, as
well as lower capital spending by our customers in traditional POTS networks. The MCU product line
accounted for approximately 18% of 2008 revenue compared to 24% of our 2007 revenue.
Our services revenue consists of installation oversight and product management services provided to
customers and fees from software maintenance agreements. Services revenue was approximately
$22.1 million in 2008 compared to $15.7 million in 2007. The increase in 2008 is largely due to the
inclusion of a full years revenue contribution from contracts acquired from the 2007 BTD
acquisition. Services revenue accounted for approximately 45% of 2008 revenue, compared to 30% of
2007 revenue.
Gross Margin
Our 2008 gross margin for 2008 was $24.7 million compared to $28.6 million for 2007, a decrease of
approximately $3.9 million, or 14%, from the previous year. Gross profit as a percentage of
revenue decreased to 50% for 2008 from 55% for 2007. The decrease in gross profit was due
primarily to the approximate 5% decline in revenue and a change in the product sales mix.
Additionally, gross profit for 2008 included charges related to impairments of certain intangible
assets as well as inventory obsolescence charges associated with our move to two new contract
manufacturers from a former contract manufacturer. Both of these charges totaled approximately
$1.0 million.
Selling and Marketing Expenses
2008 | 2007 | Change | % | |||||||||||||
Employee Costs |
$ | 4,583 | $ | 4,887 | $ | (304 | ) | -6 | % | |||||||
Travel Expenses |
799 | 936 | (137 | ) | -15 | % | ||||||||||
Professional Fees |
677 | 1,019 | (342 | ) | -34 | % | ||||||||||
Other |
776 | 965 | (189 | ) | -20 | % | ||||||||||
Total |
$ | 6,835 | $ | 7,807 | (972 | ) | -12 | % |
Our selling and marketing expenses consist primarily of employee costs, which include salaries,
benefits, and commission expenses, travel expenses of direct sales and marketing personnel, and
professional fees and other expenses which individually are not material. Our overall, selling and
marketing expenses for 2008 were $6.8 million, or 14% of revenue, compared to $7.8 million, or 15%
of revenue for 2007. The decrease in selling and marketing expenses is primarily due to reductions
in the work force which occurred in
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early 2008 and declines in travel related expenses, consulting fees and stock compensation
expenses, which is included in other expenses.
General and Administrative Expenses
2008 | 2007 | Change | % | |||||||||||||
Employee Costs |
$ | 3,912 | $ | 3,901 | $ | 11 | 0 | % | ||||||||
Professional Fees |
3,132 | 2,367 | 765 | 32 | % | |||||||||||
Stock Compensation |
299 | 494 | (195 | ) | -39 | % | ||||||||||
Other |
2,112 | 2,940 | (828 | ) | -28 | % | ||||||||||
Total |
$ | 9,455 | $ | 9,702 | (247 | ) | -3 | % |
Our general and administrative expenses consist primarily of employee costs, which include salaries
and benefits for finance, administrative and general management personnel, professional fees which
consist primarily of accounting, legal and insurance expenses, stock compensation expenses and
other expenses which individually are not material. For the year ended December 31, 2008, our
general and administrative expenses for 2008 were $9.5 million, or approximately 19% of total
revenue compared to $9.7 million, or 19% of total revenue for 2007. The decrease of $0.2 million in
our 2008 general and administrative expenses is primarily attributable to the reversal of stock
compensation expense in 2008 related to forfeiture of performance-based restricted shares that were
granted to certain members of management in 2007 partially offset by the increase in professional
fees of $0.8 million.
Research and Development Expenses
2008 | 2007 | Change | % | |||||||||||||
Employee Costs |
$ | 8,435 | $ | 8,430 | $ | 5 | 0 | % | ||||||||
Professional Services |
1,205 | 1,277 | (72 | ) | -6 | % | ||||||||||
Depreciation |
865 | 830 | 35 | 4 | % | |||||||||||
Other |
284 | 450 | (166 | ) | -37 | % | ||||||||||
Total |
$ | 10,789 | $ | 10,987 | (198 | ) | -2 | % |
Our research and development expenses consist primarily of employee costs, professional services,
depreciation expense and other costs associated with the development of new product initiatives,
such as our LightHouse product line along with maintaining and upgrading our existing product
lines, which individually are not material. Our research and development expenses were comparable
for 2008 and 2007 as our expenses in this area were $10.8 million and $11.0 million, respectively.
Severance Expense
During 2008, we reduced our engineering and senior management staff, made changes to our field
service and sales staffing, and realigned existing resources to new projects. The severance costs
associated with this program amounted to approximately $0.8 million. All cash payments related to
this action have been paid in 2008 and no further expense is expected.
During the fourth quarter of 2007, our former chief executive officer and president and two other
senior executives terminated employment with us. The costs associated with these separations
amounted to approximately $0.8 million. An additional cost of $0.1 million was recorded for
employee severance costs in relation to other restructuring activity. All cash payments related to
this action have been paid in 2007 and no further expense is expected.
Long-Lived Asset Impairments
Due to a decline in the trading price of our shares during the fourth quarter of 2007 along with
lower projected revenues for 2008, we reviewed our goodwill carrying balance at the end of 2007 and
found the entire remaining carrying balance to be impaired and thus recorded a non-cash charge of
approximately $20.0 million in the fourth quarter of 2007. In addition, certain other indefinite
lived assets were reviewed and also found to be impaired, thus we incurred additional an impairment
charge of approximately $1.1 million in the fourth quarter of 2007.
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Other Income, (net)
Other income, which consists primarily of interest income, was $1.3 million for 2008 as compared to
$2.8 million for 2007. The $1.5 million decrease in other incomes is primarily a result of lower
interest yields on our investment balances due to the overall decline in economic conditions in
2008.
Provisions for Income Taxes
For the years ended December 31, 2008 and 2007, our income taxes provision was approximately
$1.1 million and $1.2 million, respectively. During 2008 and 2007, the provision for income taxes
was primarily related to foreign income tax obligations generated by profitable operations in
certain of our foreign jurisdictions, as well as adjustments to reserves for uncertain tax
positions in all jurisdictions. Additionally, we continued to record a valuation allowance against
U.S. federal, certain foreign and certain state net operating losses incurred in 2008 and 2007 as
the tax benefit was deemed more likely than not to be unrealizable in future periods.
Loss from Continuing Operations and Loss Per Share from Continuing Operations
For the year ended December 31, 2008, our loss from continuing operations was approximately $3.0
million compared to a net loss of $19.3 million from continuing operations the year ended December
31, 2007 for the reasons stated above. Our basic and diluted loss from continuing operations per
common share was $(0.23) for 2008 versus a loss of $(1.46) for 2007. Diluted weighted average
shares of common stock and equivalents outstanding were 13.1 million and 13.2 million in 2008 and
2007, respectively.
Liquidity and Capital Resources
We have historically met our working capital and capital spending requirements, including the
funding for expansion of operations, product developments and acquisitions, through net cash flows
provided by operating activities. Our principle source of liquidity is our operating cash flows
and cash on our balance sheet. Our cash, cash equivalents and short-term investments are
unrestricted and available for corporate purposes, including acquisitions, research and development
and other general working capital requirements. In addition, there are no material restrictions on
our ability to transfer and remit funds among our international affiliated companies. Our cash and
cash equivalents and short-term investments increased to $66.0 million at December 31, 2009 from
$60.4 million at December 31, 2008. The increase in cash and cash equivalents and short term
investments from December 31, 2008 is largely attributable to positive cash flow from operations
and proceeds received from the divesture of our cable product line which were offset by capital
expenditures and the repurchase of our common shares under our Board-approved stock repurchase
plan. We believe we have sufficient cash balances to meet our cash flow requirements and growth
objectives over the next twelve months.
Excluding discontinued operations, we had working capital of $69.2 million as of December 31, 2009,
a decrease of $3.1 million, or 4%, from the $72.3 million of working capital as of December 31,
2008. Overall, we generated cash from operating activities of $3.7 million in 2009 compared to $4.6
million in 2008. The $0.9 million decrease in cash flow from operating activates is primarily
attributable to the overall reduction in net working capital. In 2008, we generated cash from
operating activities of $4.6 million compared to $10.4 million in 2007. The decrease in cash flow
is attributable to payments in 2008 related to certain inventory components, warranty items and
royalty obligations that had grown in 2007.
Excluding discontinued operations, cash provided by investing activities in 2009 was approximately
$4.5 million and included approximately $3.2 million in proceeds and note repayments received from
the divestiture of our cable product line, redemptions of short term investments in the amount of
$2.4 million offset by $0.3 million in acquired assets along with capital expenditures of $0.8
million. This compares to the same 2008 period in which we had cash used for investing activities
of approximately $2.0 million, whereby we purchased net short-term investments of $1.8 million and
incurred capital expenditures of approximately $0.5 million. Capital expenditures, including
capitalized software, were $0.8 million, $0.5 million and $2.3 million in the years ended December
31, 2009, 2008 and 2007, respectively. Planned capital expenditures for 2010 are in the range of
$0.7 million to $1.2 million.
We were party to a three-year $25.0 million unsecured revolving credit facility, which expired in
December 2009. We believe that our cash balances are sufficient to meet our obligations in the
near future and, on that basis, decided not to renew the credit facility when it expired.
The decline in global economic conditions that began in 2008 had an adverse effect on the
performance due to lower yields on our investment portfolio. Interest income for the year ended
December 31, 2009 was $0.3 million compared to $1.5 million and $2.8 million for the years ended
December 31, 2008 and 2007, respectively.
On October 28, 2008, our Board of Directors approved a share repurchase program, pursuant to which
the Company could repurchase common stock with an aggregate share value of up to $15 million with
no expiration date. Such purchases could be made through
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open market transactions and privately negotiated transactions at the discretion of executive
management, subject to market conditions and other factors. The repurchase program does not
obligate us to acquire any particular amount of common stock and, at the Boards discretion, may be
suspended, discontinued or modified at any time. During the fourth quarter of the years ended
December 31, 2009 and 2008, we have acquired 79,043 and 496,918 shares pursuant to this program at
a total cost of $0.5 million and $2.2 million, respectively.
The impact of inflation on both the Companys financial position and the results of operations have
been minimal and did not adversely affect our 2009, 2008 and 2007 results nor is it expected to
adversely affect our 2010 results.
Off-Balance Sheet Arrangements
As a matter of policy, we do not engage in transactions or arrangements with unconsolidated or
other special purpose entities.
Commitments and Contractual Obligations
We lease office space and equipment under agreements which are accounted for as operating leases.
The office lease for our Cheswick, Pennsylvania facility was extended on September 14, 2009 until
March 31, 2011. The lease for our Piscataway, New Jersey office expires on April 30, 2012. We
also have office leases in Bracknell, United Kingdom; Kontich, Belgium; and Wuppertal, Germany,
which expire on December 24, 2012, April 1, 2012, and January 31, 2011, respectively. In the
fourth quarter of 2009, we notified the landlord of our Kontich, Belgium office that we planned on
terminating our lease in early 2010 in accordance with the provisions of the lease agreement. We
are also involved in various month-to-month leases for research and development and office
equipment at all three European locations. In addition, all three of the European office leases
include provisions for possible adjustments in annual future rental commitments relating to excess
taxes, excess maintenance costs that may occur and increases in rent based on the consumer price
index and based on increases in our annual lease commitments. None of these commitments are
material.
Included in the commitment schedule below are certain purchase obligations primarily arising from
non-cancelable, non-returnable agreements with materials vendors. Additionally, we have
arrangements with certain manufacturing subcontractors under which we are contingently obligated to
purchase $0.1 million of raw material parts in the event they would not be consumed by the
manufacturing process in the normal course of business. This liability has been recorded in the
consolidated balance sheet as we have a legal obligation to purchase this inventory as of December
31, 2009. The recording of this obligation in the financial statements did not result in a charge
to the Consolidated Statements of Operations as we fully expect to utilize this inventory during
the normal course of business.
Minimum annual future commitments as of December 31, 2009 are (in thousands):
Payments due by period
More than 5 | ||||||||||||||||||||
Total | Less than 1 year | 1-3 years | 3-5 years | years | ||||||||||||||||
Operating Lease
Obligations |
$ | 2,023 | $ | 968 | $ | 1,005 | $ | 50 | $ | | ||||||||||
Purchase Obligations |
295 | 183 | 62 | 50 | | |||||||||||||||
Uncertain Tax
Obligations |
738 | | 738 | | | |||||||||||||||
Pension Obligations |
1,003 | 20 | | | 983 | |||||||||||||||
Total |
$ | 4,059 | $ | 1,171 | $ | 1,805 | $ | 100 | $ | 983 | ||||||||||
Our lease expense was $1.0 million in 2009, $1.2 million in 2008 and $1.3 million in 2007.
In addition, we are, from time to time, party to various legal claims and disputes, either asserted
or unasserted, which arise in the ordinary course of business. While the final resolution of these
matters cannot be predicted with certainty, we do not believe that the outcome of any of these
claims will have a material adverse effect on the Companys consolidated financial position, or
annual results of operations or cash flow.
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Critical Accounting Policies
Our financial statements are prepared in conformity with accounting principles generally accepted
in the United States of America. The application of certain of these accounting principles is more
critical than others in gaining an understanding of the basis upon which our financial statements
have been prepared. We consider the following accounting policies to involve critical accounting
estimates.
Revenue Recognition
We market and sell test system hardware and related software to the telecommunications industry.
We follow the revenue recognition accounting guidance for recognizing hardware and software sales.
This guidance requires, among other things, that revenue should be recognized only when title has
transferred and risk of loss has passed to a customer with the capability to pay, and that there
are no significant remaining obligations related to the sale. The bulk of our hardware sales are
made to the former large domestic carriers and European telecommunication and other large
customers. Delivery terms of hardware sales are predominantly FOB origin. Revenue is recognized
for these customers upon shipment against a valid purchase order. Where title and risk of loss do
not pass to the customer until the product reaches the customers delivery site, revenue is
deferred unless we can objectively determine delivery occurred before the end of the applicable
reporting period. We reduce collection risk by requiring letters of credit or other payment
guarantees for significant sales to new customers, certain international customers and customers in
weak financial condition.
For perpetual software license fee and maintenance revenue, we follow the accounting guidance for
software revenue recognition, which requires that software license fee revenue be recorded only
when evidence of a sales arrangement exists, the software has been delivered, and a customer with
the capacity to pay has accepted the software, leaving no significant obligations on our part to
perform. We require a customer purchase order or other written agreement to document the terms of
a software order and written, unqualified acceptance from the customer prior to revenue
recognition. In certain limited cases, however, agreements provide for automatic customer
acceptance after the passage of time from a pre-determined event and we have relied on these
provisions for an indication of the timing of revenue recognition. In certain cases for orders of
custom software, or orders that require significant software customization, we employ contract
accounting using the percentage-of-completion method, whereby revenue is recognized based on costs
incurred to date compared to total estimated contract cost in accordance with the accounting
guidance for construction-type and certain production-type contracts. The revenue for orders with
multiple deliverables such as hardware, software and/or installation or other services may be
separated into stand-alone fair values if not already documented in the purchase order or agreement
and where list prices or other objective evidence of fair value exists to support such allocation,
in accordance with the accounting for revenue arrangements with multiple deliverables. Revenue
will not be recognized for any single element until all elements considered essential to the
functionality of the delivered elements under the contract are delivered and accepted.
The recognition of revenue requires certain judgment by management. If any undelivered elements,
which can include hardware, software or services, are essential to the functionality of the system
as defined in the contract, revenue will not be recorded until all of the items considered
essential are delivered as one unit of accounting. Although infrequent, in some situations
contingencies will be noted by the customer on the written acceptance. In these situations,
management will use judgment to determine the importance of such contingencies for recognizing
revenue related to the sale. Our general practice is to defer revenue recognition unless these
contingencies are inconsequential.
Our software customers usually enter into separate agreements for software maintenance upon
expiration of the stated software warranty period. Maintenance agreements include software
upgrades and bug fixes as they become available; however, newly developed features must be
purchased separately. Post-warranty maintenance for new features is either included under the
current maintenance agreement without additional charge, and is considered in the maintenance
agreement fees, or is separately charged upon expiration of the warranty. Depending upon the
timing of the new feature purchase and the length of the maintenance agreement, we must evaluate
whether or not a portion of a perpetual right to use fee should be treated as post-contract support
to be deferred and recognized over the remaining life of the maintenance agreement.
Software maintenance revenue is recognized on a straight-line basis over the period the respective
arrangements are in effect. Revenue recognition, especially for software products, involves
critical judgments and decisions that can result in material effects to reported net income.
Intangible Assets and Goodwill
At December 31, 2009, we had net intangible assets of $7.1 million resulting from the acquisitions
of the LoopCare product line in September 2001, the test business of Emerson in February 2006 and
the Broadband Test Division of Teradyne, Inc. in August 2007. In connection with these
acquisitions, we utilized the accounting guidance associated with business combinations, and
goodwill and other intangible assets. This guidance requires that the purchase method of
accounting be used for all business combinations and that goodwill, as well as any indefinite-lived
intangible assets, not be amortized for financial reporting purposes. Finite-lived intangible
assets are amortized on a straight-line basis or an accelerated method, whichever better reflects
the pattern in which the economic benefits of the asset are consumed or otherwise used.
Software-related intangible assets are amortized based on the greater of the
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amount computed using the ratio that current gross revenues bear to the total of current and
anticipated future gross revenues for that product or the straight-line method over the remaining
estimated economic life.
We review our finite-lived intangible assets or fixed assets and their related useful lives
whenever events or changes in circumstances indicate that the carrying amounts may not be
recoverable, including: a change in the competitive landscape; any internal decisions to pursue new
or different technology strategies; a loss of a significant customer; or a significant change in
the market place including changes in the prices paid for our products or changes in the size of
the market for our products. An impairment results if the carrying value of the asset exceeds the
sum of the future undiscounted cash flows expected to result from the use and disposition of the
asset or the period of economic benefit has changed. If impairment were indicated, the amount of
the impairment would be determined by comparing the carrying value of the asset group to the fair
value of the asset group. Fair value is generally determined by calculating the present value of
the estimated future cash flows using an appropriate discount rate. The projection of the future
cash flows and the selection of a discount rate require significant management judgment. The key
assumptions that management must estimate include sales volume, prices, inflation, product costs,
capital expenditures and sales and marketing costs. For developed technology, we also must
estimate the likelihood of both pursuing a particular strategy and the level of expected market
adoption.
In 2009, we had a significant impairment to one of our intangible assets related to the LoopCare
product line that was acquired from Lucent in 2001. At the time of the acquisition, the intangible
asset was valued at $32 million, with an indefinite life. In 2005, we determined that facts and
circumstances which had supported the assignment of an indefinite life to this asset had changed,
and we then determined the intangible asset to have a finite useful life of fifty years. In the
fourth quarter 2009, facts and circumstances relating to the Companys LoopCare post-warranty
maintenance service agreements again led us to evaluate the life assigned to this
intangible asset, as well as its valuation. Specifically, in mid-December of 2009, we learned that
Verizon, a major customer of our LoopCare post warranty software maintenance services, was not
going to renew its direct contract with Tollgrade that was due to expire on December 31, 2009.
Verizon consolidated several vendor relationships through a single large global network equipment
manufacturer, including both our LoopCare and 4TEL maintenance contracts. The loss of the direct
contract with Verizon was a triggering event for us to evaluate the fair market value of the
LoopCare intangible asset. Through our overall evaluation process, which included a valuation, we
determined that not only the useful life estimate, but the value of the asset itself, was no longer
supported. We ultimately determined that the LoopCare intangible asset had a fair value of $2.3
million coupled with a remaining life of fifteen years, versus its remaining carrying value of
$29.3 million dollars and a forty-six year remaining life. We feel this current fair value and
useful life is more indicative of current market and technological conditions and the life of the
existing maintenance agreements.
In 2008 we determined that certain long-lived assets, primarily related to assets acquired as part
of our Emerson acquisition, were impaired and an impairment loss of $0.2 million was recorded to
reflect these assets at their fair market value.
Due to a decline in the trading price of our shares during the fourth quarter of 2007 along with
lower projected revenues for 2008, we reviewed our goodwill carrying balance at the end of 2007 and
found the entire remaining carrying balance to be impaired and thus recorded a non-cash charge of
approximately $20 million in the fourth quarter of 2007. In addition, certain other indefinite
lived assets were reviewed and also found to be impaired, thus we incurred additional an impairment
charge of approximately $1.1 million in the fourth quarter of 2007.
Inventory Valuation
We utilize a standard cost system that approximates first-in, first-out costing of our products.
Standards are monitored regularly and changes are made on individual parts if warranted; otherwise
standard costs, which include material, labor and overhead, are updated annually, generally in the
fourth quarter. Excess capacity is not included in the standard cost of inventory. This standard
cost update was performed in 2009 and 2008; however, as we transitioned virtually 100% of our
in-house manufacturing to a third party sub-contractor as of December 31, 2009, our inventory cost
in 2010 will be primarily valued at the purchase price that we will pay the contractor to
manufacture our products. We evaluate our inventories on a monthly basis for slow moving, excess
and obsolete stock on hand. The carrying value of such inventory that is determined not to be
realizable is reduced, in whole or in part, by a charge to cost of sales and reduction of the
inventory value in the financial statements. The evaluation process relies in large part on a
review of inventory items that have not been sold, purchased or used in production within a
one-year period. Management also reviews, where appropriate, inventory products that do not meet
this threshold but which may be unrealizable due to discontinuance of products, evolving
technologies, loss of certain customers or other known factors. As a result of this
comprehensive review process, an adjustment to the reserve for slow moving and obsolete inventory
is normally made monthly. Inventory identified as obsolete is also discarded from time to time
when circumstances warrant. As part of our review process, in 2009 and 2008, we wrote-down
approximately $3.1 million and $0.8 million, respectively, primarily related to slow moving and
obsolete inventory.
Inventory valuation is considered a critical accounting estimate since it relies in large part on
management judgments as to future events and differing judgments could materially affect reported
net income.
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Allowance for Doubtful Accounts
The allowance for doubtful accounts is based on our assessment of the collectability of customer
accounts. We regularly review the allowance by considering factors such as historical experience,
credit quality, age of the accounts receivable balances, and current economic conditions that may
affect a customers ability to pay. We recorded a $1.1 million bad debt reserve in the third
quarter of 2009 related to one of our large international contracts whose collectability was deemed
to be uncertain.
If a major customers creditworthiness deteriorates, or if actual defaults are higher than our
historical experience, or if other circumstances arise, our estimates of the recoverability of
amounts due to us could be overstated, and an additional allowance could be required, which could
have a negative impact on our earnings and cash flow.
Income Taxes
We follow the accounting guidance for income taxes, in reporting the effects of income taxes in our
consolidated financial statements. Deferred tax assets and liabilities are determined based on the
temporary differences between the financial statement carrying amounts and the tax basis of
assets and liabilities using enacted tax rates in effect in the years in which the differences are
expected to reverse. We evaluate all remaining deferred tax assets based on our current outlook,
and, as of December 31, 2009, all U.S. and certain foreign net operating losses and net deferred
tax assets have been eliminated through the recording of a valuation allowance. We recognize
interest and penalties related to uncertain tax positions in income tax expense. On January 1,
2007, we adopted accounting for uncertainty in income taxes. The adoption of this interpretation
required no material cumulative effect adjustment to be recorded.
Warranty
We record estimated warranty costs on the accrual basis of accounting. These warranty reserves are
recorded by applying the five year historical returns percentage to the current level of product
shipments within the agreed-upon warranty period. The costs associated with servicing these
warranties are updated at least annually.
Pension Benefits
We sponsor defined benefit pension plans for three employees based in Germany, one employee based
in Belgium and two employees based in Netherlands in addition to three former employees that were
part of our Belgium plan. Accounting for the cost of these plans requires the estimation of the
cost of the benefits to be provided well into the future and attributing that cost over the
expected work life of employees participating in these plans. This estimation requires our
judgment about the discount rate used to determine these obligations, rate of future compensation
increases, withdrawal and mortality rates and participant retirement age. Differences between our
estimates and actual results may significantly affect the cost of our obligations under these
plans.
In the valuation of this pension benefit liability, management utilizes various assumptions. We
determine our discount rate based on an investment grade bond yield curve with a duration that
approximates the benefit payment timing of each plan. This rate can fluctuate based on changes in
investment grade bond yields.
Future compensation rates, withdrawal rates and participant retirement age are determined based on
historical information. These assumptions are not expected to significantly change. Mortality
rates are determined based on a review of published mortality tables.
Stock-Based Compensation
We recognize stock-based compensation expense for all stock options and restricted stock awards
over the period from the date of grant to the date when the award is no longer contingent on the
employee providing additional service (substantive vesting period). We utilize the Black-Scholes
valuation method to establish fair value of all awards. The Black-Scholes valuation method
requires that we make certain assumptions regarding estimated forfeiture rates, expected holding
period and stock price volatility.
Foreign Currency Translation
Assets and liabilities of our international operations are translated into U.S. dollars using
month-end or year-end exchange rates, while revenues and expenses are translated at average
exchange rates throughout the year. The resulting net translation adjustments are recorded as a
component of accumulated other comprehensive income (loss). The local currency is the functional
currency for all of our locations.
These areas involving critical accounting estimates are periodically reviewed and discussed with
the Audit Committee of our Board of Directors.
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Recent Accounting Pronouncements
For reference purposes, we list recent accounting pronouncements in Item 8, Financial Statements
and Supplementary Data, that may have a material impact on our business.
Item 7A. | Quantitative and Qualitative Disclosures About Market Risk. |
Our current investment policy limits our investments in financial instruments to cash and cash
equivalents, individual municipal bonds and corporate and government bonds. The use of financial
derivatives and preferred and common stocks is strictly prohibited. We believe that our risk is
minimized through proper diversification along with the requirements that the securities must be of
investment grade with an average rating of A or better by Standard & Poors. We hold our
investment securities to maturity and believe that earnings and cash flows are not materially
affected by changes in interest rates, due to the nature and short-term investment horizon for
which these securities are invested.
In addition, we are exposed to foreign currency translation fluctuations with our international
operations. We do not have any foreign exchange derivative contracts to hedge against foreign
currency exposures. Therefore, we are exposed to the related effects when the foreign currency
exchange rates fluctuate. If the U.S. dollar strengthens against the Euro and/or the British pound
sterling and or the Czech Republics Koruna, the translation rate for these foreign currencies will
decrease, which will have a negative impact on our operating income. Foreign currency translation
fluctuations have no impact on cash flows as long as we continue to reinvest any profits back into
the respective foreign operations.
Item 8. | Financial Statements and Supplementary Data. |
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Tollgrade Communications, Inc.
In our opinion, the accompanying consolidated balance sheets and the related consolidated
statements of operations, changes in shareholders equity and of cash flows present fairly, in all
material respects, the financial position of Tollgrade Communications, Inc. at December 31, 2009
and 2008, and the results of their operations and their cash flows for each of the three years in
the period ended December 31, 2009 in conformity with accounting principles generally accepted in
the United States of America. In addition, in our opinion, the financial statement schedule listed
in the accompanying index presents fairly, in all material respects, the information set forth
therein when read in conjunction with the related consolidated financial statements.
Also in our opinion, the Company maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2009, based on criteria established in Internal
Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). The Companys management is responsible for these financial statements and
financial statement schedule, for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial reporting, included
in Managements Report on Internal Control over Financial Reporting under Item 9A. Our
responsibility is to express opinions on these financial statements, on the financial statement
schedule, and on the Companys internal control over financial reporting based on our integrated
audits. We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of material
misstatement and whether effective internal control over financial reporting was maintained in all
material respects. Our audits of the financial statements included examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and evaluating the overall
financial statement presentation. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting, assessing the risk that a
material weakness exists, and testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk. Our audits also included performing such other
procedures as we considered necessary in the circumstances. We believe that our audits provide a
reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A
companys internal control over financial reporting includes those policies and procedures that (i)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of management and directors of the company;
and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the companys assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
March 10, 2010
Pittsburgh, Pennsylvania
March 10, 2010
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Tollgrade Communications, Inc. and Subsidiaries
Consolidated Balance Sheets
In thousands (except par value)
Consolidated Balance Sheets
In thousands (except par value)
December 31, 2009 | December 31, 2008 | |||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 66,046 | $ | 57,976 | ||||
Short-term investments |
3 | 2,419 | ||||||
Accounts receivable: |
||||||||
Trade, net of allowance for doubtful accounts at $1,496 in 2009 and $222 in 2008 |
6,998 | 9,392 | ||||||
Other |
1,007 | 632 | ||||||
Inventories |
2,119 | 7,865 | ||||||
Prepaid expenses and deposits |
759 | 1,200 | ||||||
Deferred and refundable income taxes |
196 | 453 | ||||||
Current assets related to discontinued operations |
| 4,261 | ||||||
Total current assets |
77,128 | 84,198 | ||||||
Property and equipment, net |
3,101 | 2,661 | ||||||
Intangibles |
7,110 | 36,678 | ||||||
Deferred tax assets |
119 | 81 | ||||||
Other assets |
229 | 262 | ||||||
Noncurrent assets related to discontinued operations |
| 467 | ||||||
Total assets |
$ | 87,687 | $ | 124,347 | ||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 927 | $ | 1,227 | ||||
Accrued warranty |
504 | 926 | ||||||
Accrued expenses |
2,319 | 1,511 | ||||||
Accrued salaries and wages |
1,190 | 354 | ||||||
Accrued royalties payable |
137 | 288 | ||||||
Income taxes payable |
393 | 268 | ||||||
Deferred revenue |
2,463 | 3,024 | ||||||
Current liabilities related to discontinued operations |
| 1,125 | ||||||
Total current liabilities |
7,933 | 8,723 | ||||||
Pension obligation |
983 | 889 | ||||||
Deferred tax liabilities |
290 | 1,792 | ||||||
Other tax liabilities |
738 | 489 | ||||||
Total liabilities |
9,944 | 11,893 | ||||||
Commitments and contingencies |
||||||||
Shareholders equity: |
||||||||
Common stock, $0.20 par value 50,000 authorized shares,
issued shares, 13,788 in 2009 and 13,733 in 2008 |
2,746 | 2,744 | ||||||
Additional paid-in capital |
75,244 | 73,923 | ||||||
Treasury stock, at cost, 1,151 shares in 2009 and 1,072 shares in 2008 |
(8,563 | ) | (8,081 | ) | ||||
Retained earnings |
9,543 | 45,748 | ||||||
Accumulated other comprehensive loss |
(1,227 | ) | (1,880 | ) | ||||
Total shareholders equity |
77,743 | 112,454 | ||||||
Total liabilities and shareholders equity |
$ | 87,687 | $ | 124,347 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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Tollgrade Communications, Inc. and Subsidiaries
Consolidated Statements of Operations
In thousands (except per share data)
Consolidated Statements of Operations
In thousands (except per share data)
Years Ended December 31, | ||||||||||||
2009 | 2008 | 2007 | ||||||||||
Revenues: |
||||||||||||
Products |
$ | 19,936 | $ | 26,997 | $ | 36,143 | ||||||
Services |
25,005 | 22,055 | 15,689 | |||||||||
Total revenues |
44,941 | 49,052 | 51,832 | |||||||||
Cost of sales: |
||||||||||||
Products |
11,812 | 14,181 | 15,874 | |||||||||
Services |
7,143 | 6,146 | 4,103 | |||||||||
Amortization |
2,576 | 3,085 | 2,199 | |||||||||
Inventory write-down |
3,070 | 759 | | |||||||||
Impairment of long-lived assets |
27,151 | 201 | 1,090 | |||||||||
Severance |
778 | | | |||||||||
Total cost of sales |
52,530 | 24,372 | 23,266 | |||||||||
Gross margin |
(7,589 | ) | 24,680 | 28,566 | ||||||||
Operating expenses: |
||||||||||||
Selling and marketing |
6,809 | 6,835 | 7,807 | |||||||||
General and administrative |
12,141 | 9,455 | 9,702 | |||||||||
Research and development |
9,411 | 10,789 | 10,987 | |||||||||
Severance expense |
1,180 | 827 | 922 | |||||||||
Impairment of long-lived assets |
293 | | 20,036 | |||||||||
Total operating expense |
29,834 | 27,906 | 49,454 | |||||||||
Loss from operations |
(37,423 | ) | (3,226 | ) | (20,888 | ) | ||||||
Other income |
567 | 1,337 | 2,770 | |||||||||
Loss before income taxes |
(36,856 | ) | (1,889 | ) | (18,118 | ) | ||||||
(Benefit) provision for income taxes |
(874 | ) | 1,137 | 1,220 | ||||||||
Loss from continuing operations |
(35,982 | ) | (3,026 | ) | (19,338 | ) | ||||||
Loss from discontinued operations |
(223 | ) | (4,089 | ) | (6,815 | ) | ||||||
Net loss |
$ | (36,205 | ) | $ | (7,115 | ) | $ | (26,153 | ) | |||
PER SHARE INFORMATION: |
||||||||||||
Weighted average shares of common stock and equivalents: |
||||||||||||
Basic |
12,683 | 13,102 | 13,219 | |||||||||
Diluted |
12,683 | 13,102 | 13,219 | |||||||||
Net loss per common share: |
||||||||||||
Basic |
$ | (2.85 | ) | $ | (0.54 | ) | $ | (1.98 | ) | |||
Diluted |
$ | (2.85 | ) | $ | (0.54 | ) | $ | (1.98 | ) | |||
Net loss per common share from continuing operations: |
||||||||||||
Basic |
$ | (2.83 | ) | $ | (0.23 | ) | $ | (1.46 | ) | |||
Diluted |
$ | (2.83 | ) | $ | (0.23 | ) | $ | (1.46 | ) | |||
Net loss per common share from discontinued operations: |
||||||||||||
Basic |
$ | (0.02 | ) | $ | (0.31 | ) | $ | (0.52 | ) | |||
Diluted |
$ | (0.02 | ) | $ | (0.31 | ) | $ | (0.52 | ) |
The accompanying notes are an integral part of the consolidated financial statements.
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Tollgrade Communications, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders Equity
In thousands
Consolidated Statements of Changes in Shareholders Equity
In thousands
Accumulated | ||||||||||||||||||||||||||||||||||||
Other | Other | |||||||||||||||||||||||||||||||||||
Common Stock | Additional | Treasury Stock | Retained | Comprehensive | Comprehensive | |||||||||||||||||||||||||||||||
Shares | Amount | Paid-In | Shares | Amount | Earnings | Loss | Total | Loss | ||||||||||||||||||||||||||||
Balance at December 31, 2006 |
13,709 | $ | 2,742 | $ | 72,477 | 462 | $ | (4,791 | ) | $ | 79,016 | $ | | $ | 149,444 | |||||||||||||||||||||
Exercise of Common Stock Options |
10 | 2 | 87 | 89 | ||||||||||||||||||||||||||||||||
Tax Benefit
from exercise of stock options |
10 | 10 | ||||||||||||||||||||||||||||||||||
Purchase of Treasury Stock |
113 | (1,109 | ) | (1,109 | ) | |||||||||||||||||||||||||||||||
Compensation expense for options and
restricted stock, net |
12 | 815 | 815 | |||||||||||||||||||||||||||||||||
Actuarial gain, net of tax |
32 | 32 | $ | 32 | ||||||||||||||||||||||||||||||||
Foreign currency translation |
(128 | ) | (128 | ) | (128 | ) | ||||||||||||||||||||||||||||||
Net Loss |
(26,153 | ) | (26,153 | ) | (26,153 | ) | ||||||||||||||||||||||||||||||
Comprehensive Loss |
| $ | (26,249 | ) | ||||||||||||||||||||||||||||||||
Balance at December 31, 2007 |
13,731 | 2,744 | 73,389 | 575 | (5,900 | ) | 52,863 | (96 | ) | 123,000 | ||||||||||||||||||||||||||
Purchase of Treasury Stock |
497 | (2,181 | ) | (2,181 | ) | |||||||||||||||||||||||||||||||
Compensation expense for options and
restricted stock, net |
2 | 534 | 534 | |||||||||||||||||||||||||||||||||
Actuarial gain, net of tax |
87 | 87 | $ | 87 | ||||||||||||||||||||||||||||||||
Foreign currency translation |
(1,871 | ) | (1,871 | ) | (1,871 | ) | ||||||||||||||||||||||||||||||
Net Loss |
(7,115 | ) | (7,115 | ) | (7,115 | ) | ||||||||||||||||||||||||||||||
Comprehensive Loss |
$ | (8,899 | ) | |||||||||||||||||||||||||||||||||
Balance at December 31, 2008 |
13,733 | 2,744 | 73,923 | 1,072 | (8,081 | ) | 45,748 | (1,880 | ) | 112,454 | ||||||||||||||||||||||||||
Exercise of Common Stock Options |
10 | 2 | 52 | 54 | ||||||||||||||||||||||||||||||||
Purchase of Treasury Stock |
79 | (482 | ) | (482 | ) | |||||||||||||||||||||||||||||||
Compensation expense for options and
restricted stock, net |
45 | 1,269 | 1,269 | |||||||||||||||||||||||||||||||||
Actuarial loss net of tax |
(13 | ) | (13 | ) | $ | (13 | ) | |||||||||||||||||||||||||||||
Foreign currency translation |
666 | 666 | 666 | |||||||||||||||||||||||||||||||||
Net Loss |
(36,205 | ) | (36,205 | ) | (36,205 | ) | ||||||||||||||||||||||||||||||
Comprehensive Loss |
$ | (35,552 | ) | |||||||||||||||||||||||||||||||||
Balance at December 31, 2009 |
13,788 | $ | 2,746 | $ | 75,244 | 1,151 | $ | (8,563 | ) | $ | 9,543 | $ | (1,227 | ) | $ | 77,743 | ||||||||||||||||||||
The accompanying notes are an integral part of the consolidated financial statements.
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Tollgrade Communications, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
Consolidated Statements of Cash Flows
(In thousands)
Years Ended December 31, | ||||||||||||
2009 | 2008 | 2007 | ||||||||||
Cash flows from operating activities: |
||||||||||||
Net loss |
$ | (36,205 | ) | $ | (7,115 | ) | $ | (26,153 | ) | |||
Adjustments to reconcile net loss to net cash provided by operating activities: |
||||||||||||
Loss from discontinued operations |
223 | 4,089 | 6,815 | |||||||||
Depreciation and amortization |
3,761 | 4,559 | 3,588 | |||||||||
Impairment of long-lived assets |
27,444 | 201 | 21,126 | |||||||||
Valuation allowance |
| 123 | 9,922 | |||||||||
Compensation expense related to stock plans |
1,236 | 468 | 727 | |||||||||
Gain on disposed assets |
(42 | ) | | | ||||||||
Deferred income taxes |
(1,030 | ) | 182 | (9,435 | ) | |||||||
Excess tax benefits from share based compensation |
| | (10 | ) | ||||||||
Write-down of inventory |
3,070 | 759 | | |||||||||
Provision for losses on inventories |
231 | 969 | 875 | |||||||||
Provision for allowance for doubtful accounts |
1,119 | 100 | 86 | |||||||||
Changes in assets and liabilities, net of acquisitions: |
||||||||||||
Accounts receivable trade |
2,362 | 3,782 | 2,998 | |||||||||
Accounts receivable other |
786 | 1,215 | (37 | ) | ||||||||
Inventories |
2,445 | 348 | (1,750 | ) | ||||||||
Refundable income taxes |
| | 897 | |||||||||
Prepaid expenses and deposits |
284 | (375 | ) | (224 | ) | |||||||
Accounts payable |
(1,276 | ) | (3,431 | ) | 1,656 | |||||||
Accrued warranty |
(434 | ) | (218 | ) | (125 | ) | ||||||
Accrued expenses, deferred revenue and salaries and wages |
(310 | ) | (417 | ) | (1,640 | ) | ||||||
Accrued royalties payable |
(152 | ) | (383 | ) | 488 | |||||||
Income taxes payable |
114 | (287 | ) | 557 | ||||||||
Net cash provided by discontinued operations: |
57 | 38 | 31 | |||||||||
Net cash provided by operating activities: |
3,683 | 4,607 | 10,392 | |||||||||
Cash flows from investing activities: |
||||||||||||
Proceeds from sale of assets |
3,074 | 265 | 892 | |||||||||
Proceeds from note receivable |
112 | | | |||||||||
Purchase of Ericsson test business |
(300 | ) | | | ||||||||
Purchase of BTD from Teradyne |
| | (11,855 | ) | ||||||||
Purchase of investments |
| (4,266 | ) | (12,194 | ) | |||||||
Redemption/maturity of investments |
2,416 | 2,479 | 16,885 | |||||||||
Capital expenditures, including capitalized software |
(762 | ) | (469 | ) | (2,293 | ) | ||||||
Net cash used in investing activities of discontinued operations: |
(57 | ) | (38 | ) | (31 | ) | ||||||
Net cash provided by (used in) investing activities: |
4,483 | (2,029 | ) | (8,596 | ) | |||||||
Cash flows from financing activities: |
||||||||||||
Repurchase of treasury shares |
(482 | ) | (2,181 | ) | (1,109 | ) | ||||||
Proceeds from the exercise of stock options |
54 | | 89 | |||||||||
Excess tax benefit from share based compensation |
| | 10 | |||||||||
Net cash used in financing activities: |
(428 | ) | (2,181 | ) | (1,010 | ) | ||||||
Net increase in cash and cash equivalents |
7,738 | 397 | 786 | |||||||||
Effect of exchange rate change on cash and cash equivalents |
332 | (643 | ) | 58 | ||||||||
Cash and cash equivalents at beginning of year |
57,976 | 58,222 | 57,378 | |||||||||
Cash and cash equivalents at end of year |
$ | 66,046 | $ | 57,976 | $ | 58,222 | ||||||
Supplemental disclosure of cash flow information: |
||||||||||||
Cash paid during the year for income taxes |
$ | 7 | $ | 14 | $ | 3 |
The accompanying notes are an integral part of the consolidated financial statements.
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1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION, BUSINESS AND BASIS OF PRESENTATION
Tollgrade Communications, Inc. and subsidiaries design, engineer, market and support centralized
test and measurement systems and service offerings to the telecommunications and power utility
markets in the United States and in certain international markets.
We reported our quarterly results for the first three interim periods of 2009 based on fiscal
quarters ending March 28, 2009, June 27, 2009 and September 26, 2009 and for the fourth interim
period ended December 31, 2009. We reported our quarterly results for the first three interim
periods of 2008 based on fiscal quarters ending March 29, 2008, June 28, 2008 and September 27,
2008 and for the fourth interim period ended on December 31, 2008.
In 2010, we will report our quarterly results for the first three interim periods based on the
periods ending March 31, 2010, June 30, 2010 and September 30, 2010. For consistency in reporting,
the 2009 fiscal quarterly periods will be changed, which may result in a change in the total
assets, liabilities, equity, revenues and expenses and net loss from those amounts which were
previously reported.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles
in the United States of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date
of the financial statements and the reported amounts of income and expense during the reporting
period. The actual results of the Company could differ from those estimates.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated.
CASH AND CASH EQUIVALENTS
We consider highly liquid investments with a maturity of less than three months at the date of
purchase to be cash equivalents. Substantially all of the Companys cash and cash equivalents are
maintained at one financial institution. No collateral or security is provided on these deposits,
other than $250,000 of deposits which is insured by the Federal Deposit Insurance Corporation.
INVESTMENTS
Short-term investments at December 31, 2009 and 2008 primarily consisted of individual municipal
bonds stated at cost, which approximated market value. These securities have maturities of more
than three months and less than one year from the date of purchase and/or contain a callable
provision in which the bonds can be called within one year from date of purchase. The primary
investment purpose is to provide a return on investment of funds held for future business purposes,
including acquisitions and capital expenditures. Realized gains and losses are computed using the
specific identification method. These debt securities are classified as held to maturity, and are
recorded at amortized cost, which approximates market value.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is based on our assessment of the collectability of customer
accounts. We regularly review the allowance by considering factors such as historical experience,
credit quality, age of the accounts receivable balances, and current economic conditions that may
affect a customers ability to pay.
INVENTORIES
Inventories are stated at the lower of cost or market, on a first-in, first-out basis. Excess
capacity is not included in the standard cost of inventory. We evaluate our inventories on a
periodic basis for slow moving, customer consumption rates on our legacy product lines, end of life
products due to technology changes, excess quantities and obsolete stock on hand. The carrying
value of such inventory that is determined not to be realizable is reduced, in whole or in part, by
a charge to cost of sales. The evaluation process relies in large part on a review of inventory
items that have not been sold, purchased or used in production within a one-year period.
Management also reviews, where appropriate, inventory products that do not meet this threshold but
which may be unrealizable due to discontinuance of products, evolving technologies, loss of certain
customers or other known factors.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is provided on a straight-line basis over
the estimated useful lives of the respective assets. Leasehold improvements are amortized over the
relative lease term or the estimated useful life, whichever is shorter. The cost of renewals and
betterments that extend the lives or productive capacities of properties and equipment is
capitalized. Expenditures for normal repairs and maintenance are charged to operations as incurred.
The cost of property and equipment retired or otherwise disposed of and the related accumulated
depreciation or amortization are removed from the accounts, and any resulting gain or loss is
reflected in current operations.
VALUATION OF LONG-LIVED ASSETS
We assess potential impairments to our long-lived assets when there is evidence that events or
changes in circumstances indicate that the carrying amount of an asset may not be recovered. An
impairment loss is recognized when the carrying amount of the long-lived asset is not recoverable
and exceeds its fair value. The carrying amount of a long-lived asset is not recoverable if it
exceeds the sum of
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the undiscounted cash flows expected to result from the use and eventual disposition of the asset.
Any required impairment loss is measured as the amount by which the carrying amount of a long-lived
asset exceeds its fair value and is recorded as a reduction in the carrying value of the related
asset and a charge to operating results.
PRODUCT WARRANTY
We record estimated warranty costs on the accrual basis of accounting. These warranty reserves are
recorded by applying the five year historical returns percentage to the current level of product
shipments within the agreed-upon warranty period. The costs associated with servicing these
warranties are updated at least annually.
REVENUE RECOGNITION
We market and sell test system hardware and related software to the telecommunications industry.
We follow the revenue recognition accounting guidance for recognizing hardware and software sales.
This guidance requires, among other things, that revenue should be recognized only when title has
transferred and risk of loss has passed to a customer with the capability to pay, and that there
are no significant remaining obligations related to the sale. The bulk of our hardware sales are
made to the former large domestic carriers and European telecommunication companies and other large
customers. Delivery terms of hardware sales are predominantly FOB origin. Revenue is recognized
for these customers upon shipment against a valid purchase order. Where title and risk of loss do
not pass to the customer until the product reaches the customers delivery site, revenue is
deferred unless we can objectively determine delivery occurred before the end of the applicable
reporting period. We reduce collection risk by requiring letters of credit or other payment
guarantees for significant sales to new customers, certain international customers and customers in
weak financial condition.
For perpetual software license fee and maintenance revenue, we follow the accounting guidance for
software revenue recognition, which requires that software license fee revenue be recorded only
when evidence of a sales arrangement exists, the software has been delivered, and a customer with
the capacity to pay has accepted the software, leaving no significant obligations on our part to
perform. We require a customer purchase order or other written agreement to document the terms of
a software order and written, unqualified acceptance from the customer prior to revenue
recognition. In certain limited cases, however, agreements provide for automatic customer
acceptance after the passage of time from a pre-determined event and we have relied on these
provisions for an indication of the timing of revenue recognition. In certain cases for orders of
custom software, or orders that require significant software customization, we employ contract
accounting using the percentage-of-completion method, whereby revenue is recognized based on costs
incurred to date compared to total estimated contract cost in accordance with the accounting
guidance for construction-type and certain production-type contracts. The revenue for orders with
multiple deliverables such as hardware, software and/or installation or other services may be
separated into stand-alone fair values if not already documented in the purchase order or agreement
and where list prices or other objective evidence of fair value exists to support such allocation,
in accordance with the accounting for revenue arrangements with multiple deliverables. Revenue
will not be recognized for any single element until all elements considered essential to the
functionality of the delivered elements under the contract are delivered and accepted.
The recognition of revenue requires certain judgment by management. If any undelivered elements,
which can include hardware, software or services, are essential to the functionality of the system
as defined in the contract, revenue will not be recorded until all of the items considered
essential are delivered as one unit of accounting. Although infrequent, in some situations
contingencies will be noted by the customer on the written acceptance. In these situations,
management will use judgment to determine the importance of such contingencies for recognizing
revenue related to the sale. Our general practice is to defer revenue recognition unless these
contingencies are inconsequential.
Our software customers usually enter into separate agreements for software maintenance upon
expiration of the stated software warranty period. Maintenance agreements include software
upgrades and bug fixes as they become available; however, newly developed features must be
purchased separately. Post-warranty maintenance for new features is either included under the
current maintenance agreement without additional charge, and is considered in the maintenance
agreement fees, or is separately charged upon expiration of the warranty. Depending upon the
timing of the new feature purchase and the length of the maintenance agreement, we must evaluate
whether or not a portion of a perpetual right to use fee should be treated as post-contract support
to be deferred and recognized over the remaining life of the maintenance agreement.
Software maintenance revenue is recognized on a straight-line basis over the period the respective
arrangements are in effect. Revenue recognition, especially for software products, involves
critical judgments and decisions that can result in material effects to reported net income.
COST OF SALES
Cost of sales includes the charges associated with the manufacturing of our products. These costs
consist primarily of material cost, outside manufacturing costs, salaries and wages, depreciation
and amortization expenses, rent expense, inventory write-downs, obsolescence, and slow-moving
reserves as well as warranty costs, and production overhead. As of December 31, 2009, almost all
in-house production has been outsourced to a third party sub-contractor.
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SHIPPING AND HANDLING COSTS
Costs incurred for shipping and handling are included in the cost of equipment and service.
Amounts billed to a customer for shipping and handling are reported as revenue.
INTANGIBLE ASSETS
Accounting guidance for goodwill and other intangible assets, requires that indefinite-lived
intangible assets and goodwill be tested for impairment on an annual basis or more frequently if
events or changes in circumstances indicate that the carrying value of such assets may not be
recoverable. If the carrying amount exceeds its fair value, an impairment charge is recognized in
the amount by which the carrying value exceeds fair value. With respect to goodwill in 2007, we
determined that we had one reporting unit and performed our annual impairment test as of December
31, 2007. At December 31, 2007, we based step one of our goodwill impairment testing on a
comparison of fair value, which we estimated based on our market capitalization and an estimated
control premium, to the Companys book value. Our analysis work in step two indicated a 100%
impairment of goodwill in 2007 as a result of a decline in our share price in the fourth quarter of
2007. Historically, indefinite lived intangible assets were valued using the relief from royalty
method with no residual value. Regarding indefinite lived intangible assets, during 2007 our
annual impairment tests indicated partial impairment and the results of our review of useful lives,
based on current events and circumstances, required the assignment of definite lives to these
assets. Refer to Note 4 for further discussion of these impairment charges. During 2009 and 2008,
we had no goodwill or indefinite-lived intangible assets.
The values assigned to finite-lived assets were determined using an undiscounted cash flow model
and no residual value. Furthermore, the accounting guidance requires purchased intangible assets
with a finite life to be amortized over their useful lives using a methodology which reflects the
pattern in which the economic benefit of the assets is consumed. Amortization of these assets is
generally straight-line. All amortization of intangible assets is recorded in cost of sales.
Finite-lived intangibles and their related useful lives are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of the asset may not be recoverable
or the period of economic benefit has changed. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of the related asset or group of assets to
estimated undiscounted future cash flows expected to be generated by the asset or group of assets.
If the carrying amount of an asset exceeds its fair value, which is generally estimated based on
future cash flows, an impairment charge is recognized by the amount by which the carrying amount of
an asset exceeds the fair value of the asset. If the estimate of an intangible assets remaining
useful life would be changed, the remaining carrying amount of the intangible asset would be
amortized prospectively over the revised remaining useful life.
At the end of 2009, we had a triggering event which required us to review the recoverability of
the intangible asset associated with our Loopcare post-warranty software maintenance agreements.
Through our evaluation process, we determined that the fair value of this asset approximated $2.3
million compared to its then remaining carrying value of $29.3 million and as such, took an
impairment charge of approximately $27.0 million in the fourth quarter of 2009. The premise of the
valuation is based on the highest and best use of the asset by market participants.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs, which consist primarily of employee costs, are charged to
operations as incurred; however, certain research and development costs that apply to specific
customer application/support work or repair and maintenance work are captured and allocated back to
cost of sales. As of December 31, 2009, 2008, and 2007, research and development costs that were
allocated back to cost of sales amounted to $1.5 million, $1.4 million and $1.1 million,
respectively.
CAPITALIZED SOFTWARE COSTS
In accordance with accounting guidance for costs of computer software to be sold, leased or
otherwise marketed, any costs incurred to establish the technological feasibility of software to be
sold or otherwise marketed are expensed as research and development costs. Costs incurred
subsequent to the establishment of technological feasibility, and prior to the general availability
of the product to the public are capitalized. Software related intangible assets are amortized
based on the greater of the amount computed using the ratio that current gross revenues bear to the
total of current and anticipated future gross revenues for that product or the straight-line method
over the remaining estimated economic life. We define technological feasibility as coding and
testing in accordance with detailed program designs. Such costs are generally amortized over five
years.
INCOME TAXES
In accordance with accounting guidance for income taxes, deferred tax liabilities and assets are
determined based on the temporary differences between the financial statement carrying amounts
and the tax basis of assets and liabilities using enacted tax rates in effect in the years in which
the differences are expected to reverse. Valuation allowances are established when necessary to
reduce deferred tax assets to the amount expected to be realized.
Effective January 1, 2007, we adopted accounting for uncertainty in income taxes, which clarifies
the accounting for uncertainties in income taxes recognized on an enterprises financial
statements. There was no material cumulative effect as a result of this adoption.
We recognize windfall tax benefits associated with the exercise of stock options directly to
stockholders equity only when realized. A windfall tax benefit occurs when the actual tax benefit
realized upon an employees disposition of a share-based award exceeds the recorded deferred tax
asset, if any, associated with the award that was recorded.
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SEGMENT INFORMATION
We follow the accounting guidance for disclosures about segments of an enterprise and related
information. This statement establishes standards for reporting information about operating
segments, products and services, geographic areas and major customers in annual and interim
financial statements. We manage and operate our business as one operating segment. Operating
results are regularly reviewed by our chief operating decision maker regarding decisions about the
allocation of resources and to assess performance.
RECLASSIFICATIONS
Certain reclassifications for discontinued operations have been made to prior year amounts to
conform to the current year presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
Fair Value Measurements: In February 2008, accounting guidance was issued on fair value
measurements. The accounting guidance delayed the effective date for the application of recently
adopted accounting for fair value measurements to nonfinancial assets and nonfinancial liabilities
that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis
until fiscal years beginning after November 15, 2008. Management has determined that the adoption
of these changes did have a material impact on the Consolidated
Financial Statements. See footnote 4 for impact and disclosures
related to fair values measurement to nonfinancial assets.
Factors
used to Determine Useful Life of Intangible Assets: In April 2008, the FASB issued a
staff position that amends the factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible asset. The objective of
this staff position is to improve the consistency between the useful life of a recognized
intangible asset and the period of expected cash flows used to measure the fair value of the asset.
This staff position applies to all intangible assets, whether acquired in a business combination or
otherwise, and is to be applied prospectively to intangible assets acquired on or after January 1,
2009. The adoption of this staff position did not have a material effect on our consolidated
financial statements.
Disclosure for Pension and other Postretirement Plan Assets: In December 2008, the FASB issued
a staff position that provides guidance on an employers disclosures about defined benefit pension
or other postretirement plan assets, including investment policies and strategies, major categories
of plan assets, inputs and valuation techniques used to measure the fair value of plan assets, and
significant concentrations of risk within plan assets. This staff position is effective on December
31, 2009. The adoption of this staff position did not have a material effect on our consolidated
financial statements. See note 8 for disclosures related to pension plan assets..
Fair Value Disclosures in Interim and Annual Reports: In April 2009, new accounting guidance
was issued to enhance disclosures of the fair value of financial instruments for both interim and
annual periods. The Company adopted the new accounting guidance as of June 30, 2009.
Subsequent Events Disclosure: In May 2009, the FASB issued a statement that establishes
general standards of accounting for and disclosures of events that occur after the balance sheet
date but before financial statements are issued or are available to be issued. Specifically, the
statement sets forth the period after the balance sheet date during which management of a reporting
entity should evaluate events or transactions that may occur for potential recognition or
disclosure in the financial statements, the circumstances under which an entity should recognize
events or transactions occurring after the balance sheet date in its financial statements, and the
disclosures that an entity should make about events or transactions that occurred after the balance
sheet date. Our adoption of the new statement on June 30, 2009 had no impact on the financial
statements as management already followed a similar approach prior to the adoption of this
standard.
References of Accounting Standards: In June 2009, Accounting Standards Codification
TM was issued and replaces the previously issued authoritative accounting guidance. The
new accounting guidance identifies the source of authoritative accounting principles recognized by
the Financial Accounting Standards Board to be applied by nongovernmental entities in the
preparation of financial statements in conformity with generally accepted accounting principles.
The Company adopted the new accounting guidance as of September 30, 2009.
Revenue Recognition for Multiple-Deliverable Arrangements: In October 2009, new accounting
guidance was issued for revenue arrangements with multiple deliverables that are outside the scope
of the software revenue recognition guidance. Under the new accounting guidance, when vendor
specific objective evidence or third party evidence for deliverables in an arrangement cannot be
determined, a best estimate of the selling price is required to separate deliverables and allocate
arrangement consideration using the relative selling price method. The new guidance includes new
disclosure requirements on how the application of the relative selling price method affects the
timing and amount of revenue recognition. This guidance is effective prospectively for revenue
arrangements entered into or materially modified in fiscal years beginning on or after June 15,
2010. The company is still evaluating the impact of adopting the new
guidance. The impact on the Companys financial position, results of operations and cash flows will
depend on the types of future arrangements.
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Revenue Recognition for Certain Arrangements that Include Software Elements: In October 2009,
new accounting guidance was issued for revenue arrangements that include both tangible products and
software elements. This new accounting guidance affects companies that sell or lease tangible
products in an arrangement that contains software that is more than incidental to the tangible
product as a whole. Additionally, clarification is given regarding what guidance should be used in
allocation and measuring revenue. This guidance is effective prospectively for revenue arrangements
entered into or materially modified in fiscal years beginning on or after June 15, 2010. The
company is still evaluating the impact of adopting this new guidance. The impact on the Companys
financial position, results of operations and cash flows will depend on the types of future
arrangements.
2. ACCOUNTING FOR STOCK-BASED COMPENSATION
We have one active equity compensation plan. Our 2006 Long-Term Incentive Compensation Plan (the
2006 Plan) was adopted by our Board of Directors in March 2006 and was approved by our
shareholders in May 2006. The 2006 Plan originally authorized up to 1,300,000 shares for issuance
under the Plan, and was amended during 2009 to increase the shares authorized for issuance under
the 2006 Plan to 2,800,000 shares. This amendment was adopted by our Board of Directors in May
2009 and approved by our shareholders in August 2009. Awards under the 2006 Plan may be granted to
directors, officers and employees in the form of stock options, restricted shares, stock
appreciation rights, performance shares or performance units.
The 2006 Plan was intended to replace our 1995 Long-Term Incentive Compensation Plan (the 1995
Plan) and 1998 Employee Incentive Compensation Plan (the 1998 Plan), the terms of which provided
that no further awards could be granted under these plans beyond October 15, 2005 and January 29,
2008, respectively.
Options granted under our equity compensation plans prior to 2007 generally vested over a two-year
period with one-third vesting upon grant. Beginning in 2007, options were granted which generally
vest over a three-year period, with one-third vesting at the end of each year during such period.
Options granted under our equity compensation plans expire ten years from the date of grant.
As of
December 31, 2009 and December 31, 2008, there were
1,577,557 and 459,039 shares authorized
but not granted under the 2006 Plan, respectively. During 2009 and 2008, the Company granted from
the 2006 Plan 615,500 and 684,400 options to 39 and 135 employees, respectively. There were no
options granted by the Company from the 1998 Plan in 2009 and 2008.
During 2009 and 2008, the Board of Directors approved the issuance of 45,037 and 11,540 restricted
shares under the 2006 Plan, respectively. The 45,037 restricted shares granted during 2009 were
issued to eight non-employee members of our Board of Directors. In 2008, 2,463 restricted shares
were issued to one non-employee member of the Board of Directors and 9,077 restricted shares were
issued to certain employees. The restricted share awards granted during 2008 and 2009 to
non-employee directors were subject to a one-year period of restriction, and provide each director
the right to receive the shares one year following the date of grant, regardless of whether the
director is still serving on the Board of Directors, unless the director is removed from the Board
for cause during the period of restriction. During the one year restriction period, directors can
vote but are not permitted to trade restricted shares.
Certain of the shares subject to the restricted share awards granted during 2008 to employees were
subject to performance-based restrictions, and the remaining shares were subject to time-based
restrictions. Of the 9,077 restricted shares awarded during 2008, 6,049 have been forfeited
subject to the terms of such awards, either due to termination of employment during the period of
restriction or because we did not achieve the required performance targets.
Stock-Based Compensation Expense
Stock based compensation is based on the fair value of share-based payment awards on the date of
grant using the black-scholes option pricing model and the following weighted average assumptions
for the options granted during the years ended December 31, 2009, 2008 and 2007:
Year Ended | Stock Options Year Ended |
Year Ended | ||||||||||
December 31, 2009 | December 31, 2008 | December 31, 2007 | ||||||||||
| | | | | |||||||||||
Weighted average grant date fair values
|
$ | 2.60 | $ | 2.68 | $ | 3.69 | ||||||
Expected life (in years)
|
5.0 | 5.0 | 5.0 | |||||||||
Risk free interest rate
|
1.9 | % | 2.8 | % | 3.6 | % | ||||||
Expected Volatility
|
53.8 | % | 48.1 | % | 48.6 | % |
Expected volatility is based on historical stock price over the estimated holding period. The
estimated holding period is primarily based on historical experience. The expected life of options
granted is based on historical stock option exercise data. The risk free rate is based upon the
treasury note applicable for that specific holding period.
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Transactions involving stock options under our various plans and otherwise are summarized below:
Weighted Average | ||||||||||||
Number of Shares | Range of Exercise Price | Exercise Price | ||||||||||
Outstanding, December 31, 2006 |
1,358,385 | $ | 7.28 - 159.19 | $ | 30.24 | |||||||
Granted |
160,000 | 7.78 - 9.84 | 7.91 | |||||||||
Exercised (A) |
(10,500 | ) | 7.56 - 9.49 | 8.49 | ||||||||
Cancelled/Forfeited/Expired |
(67,323 | ) | 8.49 - 159.19 | 43.74 | ||||||||
Outstanding, December 31, 2007 |
1,440,562 | 7.28 - 159.19 | 27.28 | |||||||||
Granted |
684,400 | 3.27 - 6.57 | 5.97 | |||||||||
Exercised (A) |
| | | |||||||||
Cancelled/Forfeited/Expired |
(519,472 | ) | 6.57 - 55.90 | 12.16 | ||||||||
Outstanding, December 31, 2008 |
1,605,490 | 3.27 - 159.19 | 23.08 | |||||||||
Granted |
615,500 | 5.17 - 5.86 | 5.47 | |||||||||
Exercised (A) |
(10,000 | ) | 5.87 - 6.48 | 6.11 | ||||||||
Cancelled/Forfeited/Expired |
(526,195 | ) | 3.27 - 159.19 | 19.10 | ||||||||
Outstanding, December 31, 2009 |
1,684,795 | $ | 3.27 - 159.19 | $ | 27.29 | |||||||
Number of Shares | ||||||||
Options exercisable at: |
||||||||
December 31, 2007 |
1,280,563 | $ | 29.70 | |||||
December 31, 2008 |
937,757 | $ | 35.14 | |||||
December 31, 2009 |
957,353 | $ | 27.29 |
(A) | The intrinsic value associated with exercised options which represent the difference between the strike price and the market value of Tollgrade stock at the time of exercise was less than $0.1 million in 2009, 2008 and 2007, respectively. |
The following table summarized the status of stock options, outstanding and exercisable, at
December 31, 2009:
Stock Options Outstanding | Stock Options Exercisable | |||||||||||||||||||||||||||
Number | ||||||||||||||||||||||||||||
Outstanding | Weighted | Weighted | Number | Weighted | ||||||||||||||||||||||||
as of | Average | Average | Aggregate | Exercisable as | Average | Aggregate | ||||||||||||||||||||||
Range of Exercise | December 31, | Remaining | Exercise | Intrinsic | of December | Exercise | Intrinsic | |||||||||||||||||||||
Prices | 2009 | Contractual Life | Price ($) | Value ($) | 31, 2009 | Price ($) | Value (B) ($) | |||||||||||||||||||||
$3.27 - 5.32 |
151,500 | 9.14 | $ | 4.28 | $ | 527,285 | 61,001 | $ | 4.41 | $ | 131,306 | |||||||||||||||||
5.38 - 5.38 |
311,500 | 9.07 | 5.38 | 20,000 | 5.38 | |||||||||||||||||||||||
5.74 - 6.03 |
148,000 | 9.91 | 5.96 | 35,000 | 5.74 | |||||||||||||||||||||||
6.57 - 6.57 |
357,947 | 6.95 | 6.57 | 175,504 | 6.57 | |||||||||||||||||||||||
7.78 - 8.49 |
248,332 | 6.68 | 8.06 | 198,332 | 8.13 | |||||||||||||||||||||||
9.49 - 28.40 |
251,316 | 2.38 | 19.27 | 251,316 | 19.27 | |||||||||||||||||||||||
28.70 - 55.90 |
110,950 | 1.11 | 46.37 | 110,950 | 46.37 | |||||||||||||||||||||||
103.59 - 103.59 |
5,000 | 0.75 | 103.59 | 5,000 | 103.59 | |||||||||||||||||||||||
117.34 - 117.34 |
88,000 | 0.52 | 117.34 | 88,000 | 117.34 | |||||||||||||||||||||||
159.19 - 159.19 |
12,250 | 0.49 | 159.19 | 12,250 | 159.19 | |||||||||||||||||||||||
Total $3.27-159.19 |
1,684,795 | 6.29 | $ | 18.01 | $ | 527,285 | 957,353 | $ | 27.29 | $ | 131,306 | |||||||||||||||||
(B) | The aggregate intrinsic value in the preceding table represents the difference between the strike price and the market value of Tollgrade stock which was $6.04 and $6.33 on December 31, 2009 and December 31, 2008, respectively. The total number of exercisable shares in-the-money was 116,001 and zero shares on December 31, 2009 and December 31, 2008, respectively. |
Weighted Average | ||||||||||||||||
Weighted Average | Remaining | Aggregate Intrinsic | ||||||||||||||
No. of Shares | Exercise Price | Contractual Term | Value (1) | |||||||||||||
Vested |
957,353 | $ | 27.29 | 4.32 | $ | 131,306 | ||||||||||
Expected to Vest |
727,442 | $ | 5.50 | 9.09 | $ | 395,979 | ||||||||||
Total |
1,684,795 | $ | 18.01 | 6.29 | $ | 527,285 | ||||||||||
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(1) | The aggregate intrinsic value in the preceding table represents the difference between the exercise price and the value of Tollgrade stock, which was $6.04 and $6.33 on December 31, 2009 and December 31, 2008, respectively. |
Unrecognized compensation cost related to stock options and restricted shares
granted under our equity incentive plans which is expected to be incurred
through 2012 was $1.5 million on December 31, 2009. The unrecognized compensation cost is expected to be recognized over a
weighted average period of three years. During 2009, we recorded cash received from the exercise of stock options of $0.1 million.
During 2008, there were no stock option exercises. During 2007, we recorded cash received from the exercise of stock options of $0.1
million and related tax benefit of less than $0.1 million.
The shares that were repurchased are being held for later resale or to be utilized
under certain employee benefit programs and are not considered cancelled or retired shares.
3. ACQUISITIONS AND DISCONTINUED OPERATIONS
On April 15, 2009, we entered into a multi-year managed services agreement with
a leading global network equipment provider, pursuant to which we provide customer support and engineering
service capabilities. We entered into this agreement as part of our continued strategic
focus to grow our managed services business. In connection with the agreement, we paid $0.3 million for certain assets and hired 22 of their employees. The acquisition was recorded under the purchase method of accounting in accordance with generally accepted accounting pronouncements. Accordingly, the results of operations of the acquired assets are included in our consolidated financial
statements for the period ended December 31, 2009.
On May 27, 2009, we completed the sale of our cable product line to private
equity buyers in Pittsburgh, Pennsylvania, and recorded a gain of less than $0.1 million.
This divesture allowed us to continue our business focus on our core telecommunications markets
and customers, as the cable product line no longer supported our refocused growth strategies.
The assets and liabilities, results of operations and cash flows of the cable product line have been
classified as discontinued operations in the consolidated financial
statements for all periods
presented through the date of sale. Cash flows for cable have been segregated in the consolidated
statement of cash flows as separate line items within operating and investing activities.
We determined that the operations and cash flows of
the cable product line have been eliminated from our ongoing
operations as a result of the disposal transaction and that we will not have any
significant continuing involvement in the buyers operations.
The following table details selected financial information for the cable
product line included within discontinued operations:
Twelve Months Ended | ||||||||||||
December 31, | December 31, | December 31, | ||||||||||
2009 | 2008 | 2007 | ||||||||||
Revenues: |
||||||||||||
Products |
$ | 2,376 | $ | 6,377 | $ | 12,750 | ||||||
Services |
723 | 1,795 | 1,978 | |||||||||
$ | 3,099 | $ | 8,172 | $ | 14,728 | |||||||
Loss from discontinued operations |
||||||||||||
Loss from discontinued operations, before tax |
$ | (223 | ) | $ | (4,089 | ) | $ | (6,815 | ) | |||
Income tax expense |
| | | |||||||||
Loss from discontinued operations, net of tax |
$ | (223 | ) | $ | (4,089 | ) | $ | (6,815 | ) |
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The major classes of assets and liabilities related to discontinued operations are as follows:
December 31, 2008 | ||||
ASSETS |
||||
Accounts receivable trade, net of allowance for doubtful
accounts |
$ | 1,168 | ||
Accounts receivable other |
36 | |||
Inventories |
2,808 | |||
Prepaid expenses |
249 | |||
Property and equipment, net |
292 | |||
Intangibles and capitalized software, net |
174 | |||
Assets related to discontinued operations |
4,727 | |||
LIABILITIES |
||||
Accounts payable |
38 | |||
Accrued warranty |
663 | |||
Accrued expenses |
153 | |||
Accrued royalties |
11 | |||
Deferred revenue |
259 | |||
Liabilities related to discontinued operations |
$ | 1,124 | ||
The following condensed pro forma results of operations reflect the pro forma combination of the
Company and the acquired BTD business as if the combination occurred as of the beginning of 2007.
Revenues for the periods prior to the Companys ownership were based on historical information
provided by Teradyne, Inc. The pro forma financial information is presented for comparative
purposes only and is not necessarily indicative of the operating results that actually would have
been incurred had the BTD acquisition consummated on January 1, 2007. In addition, these results
are not intended to be projections of future results.
(In Thousands, Except Per Share | ||||
Data) | ||||
Unaudited Pro Forma | ||||
Year Ended | ||||
December 31, 2007 | ||||
Revenues |
$ | 62,986 | ||
Loss from operations |
$ | (20,817 | ) | |
Net loss |
$ | (26,082 | ) | |
Pro forma basic and diluted loss per share |
$ | (1.97 | ) | |
Actual basis and diluted loss per share |
$ | (1.98 | ) | |
4. INTANGIBLES
We perform impairment reviews of our long-lived assets upon a change in business conditions or upon
the occurrence of a triggering event. In mid-December 2009, a major customer notified us that they
would not be renewing their LoopCare post-warranty software maintenance service agreement with us
following the contracts expiration date on December 31, 2009, but would instead consolidate their
purchase of maintenance services (including LoopCare and 4TEL post-warranty services) through a
single large supplier. Based on this triggering event and following the appropriate accounting
guidance, we evaluated the carrying value of the intangible asset related to our LoopCare
post-warranty intangible asset using an undiscounted cash flow model, Step 1 impairment review, and
found the asset to be impaired. We then performed a valuation of this asset to help determine its
fair value. Through this valuation process, we determined that the fair value of this asset
approximated $2.3 million compared to its current carrying value of $29.3 million and, as such,
took an impairment charge of approximately $27.0 million in the fourth quarter of 2009. The fair
value measurement would be considered a Level 3 measurement as the valuation performed to determine
the fair value utilized an income approach, specifically, an excess earnings approach. The
Companys significant inputs used in determining the fair value included the Companys forecasted
revenues, direct costs, deprecation and the associated contributory asset charges. The Company
used a present value factor of 14% and an estimated 15 year period of forecasted revenues and costs
based on the estimated useful life of the intangible asset. The assumptions used were based on a
market participants view. In addition, through this valuation process, we
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determined that a fifteen year life, instead of a remaining forty six year life, for this asset is
more indicative of current market and technological conditions, as well as the anticipated future
ability to extend existing maintenance agreements.
In 2008 we determined that certain long-lived assets, primarily related to assets acquired as part
of our Emerson acquisition, were impaired and an impairment loss of $0.2 million was recorded to
reflect these assets at their fair market value.
Due to the decline in the value of our shares during the fourth quarter of 2007, we performed an
impairment review of our goodwill at its measurement date of December 31, 2007. Since we are a
single segment reporting unit, we based our step one goodwill impairment test on a comparison of
the estimated fair value of the Company to our net book value. Fair value is considered to be our
market capitalization plus an estimated control premium. Based on our work in determining the
implicit value of goodwill, we concluded that our goodwill was entirely impaired and consequently
recorded a non-cash charge in the fourth quarter of 2007 of approximately $20.0 million.
The following information is provided regarding our intangible assets (in thousands):
Useful | December 31, 2009 | |||||||||||||||||||
Life | Accumulated | |||||||||||||||||||
(Years) | Gross | Amortization | Impairments | Net | ||||||||||||||||
Amortizing Intangible Assets: |
||||||||||||||||||||
Post Warranty Service
Agreements |
6-15 | $ | 37,779 | 5,438 | $ | 26,960 | $ | 5,381 | ||||||||||||
Technology |
2-10 | 14,000 | 12,488 | 191 | 1,321 | |||||||||||||||
Customer Relationships |
5-15 | 927 | 613 | | 314 | |||||||||||||||
Trade names and other |
0.5-10 | 537 | 443 | | 94 | |||||||||||||||
Total Intangible Assets |
$ | 53,243 | $ | 18,982 | $ | 27,151 | $ | 7,110 | ||||||||||||
Useful | December 31, 2008 | |||||||||||||||||||
Life | Accumulated | |||||||||||||||||||
(Years) | Gross | Amortization | Impairments | Net | ||||||||||||||||
Amortizing Intangible Assets: |
||||||||||||||||||||
Post Warranty Service Agreements |
6-50 | $ | 37,563 | $ | 3,752 | $ | | $ | 33,811 | |||||||||||
Technology |
2-10 | 13,987 | 11,700 | 30 | 2,257 | |||||||||||||||
Customer Relationships |
5-15 | 904 | 334 | 112 | 458 | |||||||||||||||
Trade names and other |
0.5-10 | 534 | 322 | 59 | 152 | |||||||||||||||
Total Intangible Assets |
$ | 52,988 | $ | 16,108 | $ | 201 | $ | 36,678 | ||||||||||||
Amortization expense was $2.6 million, $3.1 million, and $2.2 million for the years ended December
31, 2009, 2008, and 2007, respectively.
Differences between reported amortization expense and the change in reported accumulated
amortization may vary because of foreign currency translation differences between balance sheet and
income statement.
Due to the significant intangible asset impairment charge incurred during the fourth quarter of
2009 related to our LoopCare post-warranty maintenance services described above, we currently
estimate an annual reduction of amortization expense of approximate $0.5 million as a result of
this impairment. Amortization expense is expected to be approximately $1.6, $1.2, $0.7, $0.6, and
$0.5 million for each of the years ended December 31, 2010, 2011, 2012, 2013 and 2014,
respectively.
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5. INVENTORIES
Inventories consisted of the following (in thousands):
December 31, 2009 | December 31, 2008 | |||||||
Raw materials |
$ | 3,584 | $ | 4,621 | ||||
Work in process |
830 | 3,142 | ||||||
Finished goods |
2,352 | 1,782 | ||||||
6,766 | 9,545 | |||||||
Reserves for slow moving and obsolete inventory |
(4,647 | ) | (1,680 | ) | ||||
$ | 2,119 | $ | 7,865 | |||||
Throughout 2009, we began a program to out-source our in-house production capabilities to third
party vendors. As of December 31, 2009, this program is virtually complete. During the third quarter
of 2009, we implemented a program to evaluate certain legacy products based on anticipated future
consumption and technological end-of-life cycle. As a result of this evaluation, we wrote-off $3.1
million for slow moving and obsolete inventory in the third quarter of 2009. As part of our
overall 2008 restructuring program, we took a $0.8 million charge in the first quarter of 2008 for
inventory associated with products that were no longer part of our strategic focus.
6. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following (in thousands):
Years | December 31, 2009 | December 31, 2008 | ||||||||||
Test equipment and tooling |
3-5 | $ | 10,747 | $ | 10,215 | |||||||
Office equipment and fixtures |
5-7 | 10,187 | 9,453 | |||||||||
Leasehold improvements |
1-6 | 2,777 | 2,723 | |||||||||
Gross Property and Equipment |
23,711 | 22,391 | ||||||||||
Less accumulated depreciation and amortization |
(20,610 | ) | (19,730 | ) | ||||||||
Net Property and Equipment |
$ | 3,101 | $ | 2,661 | ||||||||
Depreciation expense was $1.2 million in 2009, $1.4 million in 2008, and $1.4
million in 2007.
7. PRODUCT WARRANTY
Activity in the warranty accrual is as follows (in thousands):
December 31, 2009 | December 31, 2008 | |||||||
Balance at the beginning of the year |
$ | 926 | $ | 1,148 | ||||
Accruals for warranties issued during the year |
894 | 1,682 | ||||||
Settlements during the year |
(1,316 | ) | (1,904 | ) | ||||
Balance at the end of the year |
$ | 504 | $ | 926 | ||||
8. PENSIONS
We sponsor contributory or noncontributory defined benefit plans for six active European employees
and three other pensioners that have left our employment. Benefits under these plans are based upon
years of service and final average pensionable earnings, or a minimum benefit based upon years of
service, whichever is greater.
As part of a 2007 acquisition, we assumed three defined benefit pension plans: one which related to
two employees based in the Netherlands, one which related to four employees based in Belgium and
one which related to three employees based in Germany. The Netherlands and Belgian plan assets are
invested in insurance vehicles, the assets of which are contained within the general investment
fund of the plans insurance contract provider and are considered Level 2 assets. These assets are
recorded at the net realizable value
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based upon cash surrender value of the policies. Since our German plan has no plan assets as of
December 31, 2009, we would be responsible for the $0.9 million underfunded position of this plan
by utilizing cash from our general operating bank accounts.
We use a December 31 measurement date for our pension plans and may have an interim measurement
date if significant events occur. Below are details related to pension benefits.
Pension | Pension | |||||||
Benefits | Benefits | |||||||
(in thousands) | 2009 | 2008 | ||||||
Change in projected benefit obligation: |
||||||||
Projected benefit obligation at January 1, |
$ | 1,257 | $ | 1,260 | ||||
Curtailments |
(70 | ) | | |||||
Service cost |
80 | 83 | ||||||
Interest cost |
76 | 65 | ||||||
Plan participants contributions |
5 | 5 | ||||||
Actuarial loss(gains) |
35 | (96 | ) | |||||
Effect of foreign currency |
41 | (60 | ) | |||||
Projected benefit obligation at December 31, |
$ | 1,424 | $ | 1,257 | ||||
2009 | 2008 | |||||||
Change in fair value of plan assets: |
||||||||
Fair value of plan assets at January 1, |
$ | 368 | $ | 352 | ||||
Employer contributions |
24 | 23 | ||||||
Plan participants contributions |
5 | 5 | ||||||
Actual return on plan assets (net of cost) |
32 | 5 | ||||||
Effect of foreign currency |
12 | (17 | ) | |||||
Fair value of plan assets at December 31, |
$ | 441 | $ | 368 | ||||
Unfunded status of plans at December 31, |
$ | 983 | $ | 889 | ||||
2009 | 2008 | |||||||
Amounts recognized in accumulated other comprehensive
income: |
||||||||
Prior service cost |
| | ||||||
Actuarial gains |
$ | 106 | $ | 87 | ||||
Total |
$ | 106 | $ | 87 | ||||
At December 31, 2009 and 2008, the following amounts were recognized in the consolidated balance
sheet:
Pension | Pension | |||||||
Benefits | Benefits | |||||||
(in thousands) | 2009 | 2008 | ||||||
Noncurrent assets |
$ | | $ | | ||||
Noncurrent liabilities |
983 | 889 | ||||||
Net amount recognized at December 31, |
$ | 983 | $ | 889 | ||||
Other changes in plan assets and benefit obligations recognized in 2009 other comprehensive
income/loss:
Curtailments (gain)/loss |
$ | (6 | ) | |
Current year actuarial (gain)/loss |
17 | |||
Amortization of actuarial gain/(loss) |
5 | |||
Foreign currency exchange rate change |
(3 | ) | ||
Total recognized in other comprehensive income |
$ | 13 |
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The accumulated benefit obligation for all defined benefit pension plans at December 31, 2009 and
2008 was as follows:
Pension | Pension | |||||||
Benefits | Benefits | |||||||
(in thousands) | 2009 | 2008 | ||||||
Projected benefit obligation in excess of plan assets: |
||||||||
Projected benefit obligation |
$ | 1,424 | $ | 1,257 | ||||
Fair value of plan assets |
$ | 441 | $ | 368 | ||||
Accumulated benefit obligation in excess of plan assets: |
||||||||
Accumulated benefit obligation |
$ | 1,126 | $ | 933 | ||||
Fair value of plan assets |
$ | 441 | $ | 368 |
Following are the details of the net periodic benefit costs related to the pension plans:
Pension | Pension | |||||||
Benefits | Benefits | |||||||
(in thousands) | 2009 | 2008 | ||||||
Components of net periodic benefit cost: |
||||||||
Service cost |
$ | 80 | $ | 83 | ||||
Interest cost |
76 | 65 | ||||||
Actuarial (gain) |
(4 | ) | | |||||
Curtailment (gain) |
(65 | ) | | |||||
Expected return on plan assets |
(15 | ) | (15 | ) | ||||
Net periodic benefit cost |
$ | 72 | $ | 133 | ||||
Employer contributions in 2010 are expected to be less than $20,000. The amount of accumulated
other comprehensive income expected to be recognized in net periodic pension cost during 2010
related to prior service cost and actuarial gains is insignificant.
(in thousands) | ||||
Expected benefit payments: |
||||
2010 2014 |
| |||
2015 2019 |
$ | 310 |
Assumptions used to determine the benefit obligation at December 31, 2009 and 2008 and net periodic
benefit cost for the years ended December 31, 2009 and 2008 are detailed below:
2009 | 2008 | |||||||
Weighted-average assumptions used to determine the
benefit obligation |
||||||||
Discount rate |
5.75 | % | 6.00 | % | ||||
Rate of compensation increase |
3.00 | % | 3.00 | % |
2009 | 2008 | |||||||
Weighted-average assumptions used to determine the net
benefit costs |
||||||||
Discount rate |
6.00 | % | 5.37 | % | ||||
Rate of compensation increase |
3.00 | % | 3.00 | % | ||||
Expected annual return on plan assets |
3.80 | % | 4.00 | % |
The company is currently using a 3.8% assumed rate of return on plan assets. This rate was
determined based upon Euro zone government and corporate bond yields of 10 year and 30 year
maturities.
9. LICENSE AND ROYALTY FEES
We have entered into several technology license agreements with certain major Digital Loop Carrier
vendors and major Operation Support System equipment manufacturers under which we have been granted
access to the licensors patent technology and the right to manufacture and sell the patent
technology in our product line. We are obligated to pay royalty fees, as defined, through the
terms of these license agreements. Under these agreements, license and royalty fees are due only
upon purchase of the technology or shipment of units; there are no contingent payment provisions in
any of these arrangements. The terms of these agreements automatically renew (unless earlier
terminated) for periods ranging from one to five years, except for one, which has a perpetual term.
Royalty fees of $0.4 million, $0.5 million and $0.9 million were incurred in 2009, 2008 and 2007,
respectively, and are included in cost of product sales in the accompanying consolidated statements
of operations.
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10. INCOME TAXES
The (benefit) provision for income taxes consisted of the following (in thousands):
2009 | 2008 | 2007 | ||||||||||
Current: |
||||||||||||
Federal |
$ | (202 | ) | $ | (16 | ) | $ | (19 | ) | |||
Foreign |
482 | 777 | 742 | |||||||||
State |
15 | 7 | 10 | |||||||||
295 | 768 | 733 | ||||||||||
Deferred: |
||||||||||||
Federal |
(1,105 | ) | | 648 | ||||||||
Foreign |
(32 | ) | 369 | (180 | ) | |||||||
State |
(32 | ) | | 19 | ||||||||
(1,169 | ) | 369 | 487 | |||||||||
$ | (874 | ) | $ | 1,137 | $ | 1,220 | ||||||
The federal current income tax benefit recorded for 2009 primarily relates to a refund of the 2008
NOL carryback to tax year 2003. Additionally, the 2009 and 2008 benefit is a result of adjustments
to reserves for uncertain tax positions to reflect current requirements under the accounting
guidance for income tax uncertainties. The federal and state deferred tax benefit recorded for
2009 is attributable to the write down of the LoopCare software maintenance intangible asset for
book purposes. The write down reduces book basis below tax basis. The foreign current tax
expense primarily relates to income tax obligations generated by profitable operations in foreign
jurisdictions. The foreign deferred tax benefit recorded in 2009 and 2008 relates primarily to
temporary differences arising as a result of life differentials between book and tax on intangible
and fixed assets. State current tax expense in 2009 and 2008 is primarily attributable to taxes
generated in a state which levies obligations based on margin.
Reconciliation of the federal statutory rate to the effective tax rates are as follows:
Years Ended December 31, | ||||||||||||
2009 | 2008 | 2007 | ||||||||||
Federal statutory tax rate |
(34 | %) | (34 | %) | (34 | %) | ||||||
Foreign income taxes |
| (1 | %) | | ||||||||
Valuation allowance |
35 | % | 49 | % | 38 | % | ||||||
Tax contingency reserve |
1 | % | 5 | % | 1 | % | ||||||
Intangible write down |
(3 | %) | | | ||||||||
Other |
(1 | %) | | | ||||||||
Effective tax rate |
(2 | %) | 19 | % | 5 | % | ||||||
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The components of and changes in the deferred tax assets and liabilities recorded in the
accompanying balance sheets at December 31, 2009 and 2008 were as follows (in thousands):
December 31, | December 31, | |||||||
2009 | 2008 | |||||||
Deferred Tax Assets: |
||||||||
Excess of tax basis over book basis for: |
||||||||
Property and equipment |
$ | 295 | $ | 328 | ||||
Goodwill and intangible assets |
10,233 | 9,331 | ||||||
Inventory |
691 | 634 | ||||||
Reserves recorded for: |
||||||||
Warranty |
44 | 602 | ||||||
Inventory |
1,649 | 819 | ||||||
Allowance for doubtful accounts |
524 | 132 | ||||||
Severance |
138 | 34 | ||||||
Federal net operating loss carryforward |
9,737 | 3,660 | ||||||
State net operating loss carryforward |
4,152 | 3,409 | ||||||
Stock based compensation |
774 | 595 | ||||||
Unrealized foreign exchange |
453 | | ||||||
Pension benefit |
42 | 39 | ||||||
Other |
31 | 31 | ||||||
Gross deferred tax assets |
$ | 28,763 | $ | 19,614 | ||||
Valuation allowance |
(28,567 | ) | (15,848 | ) | ||||
Deferred tax assets |
196 | 3,766 | ||||||
Deferred Tax Liabilities: |
||||||||
Excess of book basis over tax basis for: |
||||||||
Intangible assets |
$ | (78 | ) | $ | (4,984 | ) | ||
Property and equipment |
(154 | ) | (14 | ) | ||||
Other |
(117 | ) | (90 | ) | ||||
Total deferred tax liabilities |
(349 | ) | (5,088 | ) | ||||
Net deferred tax liabilities |
$ | (153 | ) | $ | (1,322 | ) | ||
Reconciliation to the consolidated
balance sheet: |
||||||||
Deferred tax assets current: |
$ | 18 | $ | 389 | ||||
Deferred tax assets noncurrent: |
119 | 81 | ||||||
Deferred tax liabilities noncurrent: |
(290 | ) | (1,792 | ) | ||||
Net deferred tax liabilities |
$ | (153 | ) | $ | (1,322 | ) | ||
The valuation allowance increased by $12.7 million in 2009, $3.2 million in 2008 and $9.9
million in 2007. Increases in the valuation allowance were related primarily to reserving for
deferred tax assets net of deferred tax liabilities which would reverse in future periods and
federal, certain foreign and state net operating losses considered more likely than not to be not
realizable in future periods.
At December 31, 2009, we had gross federal, state and foreign net operating loss carryforwards of
$26.4 million, $47.4 million, and $2.1 million, respectively. We also had an AMT tax credit
carryforward of $0.1 million. These tax net operating loss and tax credit carryforwards expire at
various dates through 2030 if not utilized. Loss carryforward limitations could possibly result in
expiring or reduced utilization of a portion of all of these carryforwards.
We are subject to periodic audits of our various tax returns by government agencies which could
result in possible tax liabilities. Although the outcome of these matters cannot currently be
determined, we do not believe that amounts, if any, which may be required to be paid by reason of
such audits will have a material adverse effect on our financial statements.
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Unrecognized Tax Benefits Tabular Reconciliation (in thousands)
2009 | 2008 | 2007 | ||||||||||
Beginning balance January 1, |
$ | 489 | $ | 272 | $ | 96 | ||||||
Additional uncertain tax positions |
285 | 244 | 201 | |||||||||
Reductions due to expirations of statute of limitations |
(36 | ) | (27 | ) | (25 | ) | ||||||
Ending balance December 31, |
$ | 738 | $ | 489 | $ | 272 | ||||||
We include interest and penalties related to uncertain tax positions in income tax expense. At
December 31, 2009, 2008 and 2007, our accrual for interest and penalties related to uncertain tax
positions was insignificant.
We are no longer subject to examination by various U.S. taxing authorities for years before 2006.
The company was not subject to foreign jurisdictions prior to 2007.
At this time, we do not expect unrecognized tax benefits to significantly change within the next
twelve months. The total amount of the companys unrecognized tax benefits at December 31, 2009 is
$0.7 million, of which $0.7 million would impact the companys effective tax rate, if recognized.
At December 31, 2009, we intend to permanently reinvest accumulated earnings in foreign
subsidiaries. As a result, deferred taxes have not been provided on foreign earnings at December
31, 2009. If our intention changes and such amounts are expected to be repatriated, deferred taxes
will be provided.
11. COMMITMENTS AND CONTINGENCIES
We lease office space and equipment under agreements which are accounted for as operating leases.
The office lease for our Cheswick, Pennsylvania facility was extended on September 14, 2009 until
March 31, 2011. The lease for our Piscataway, New Jersey office expires on April 30, 2012. We
also have office leases in Bracknell, United Kingdom; Kontich, Belgium; and Wuppertal, Germany,
which expire on December 24, 2012, April 1, 2012, and January 31, 2011 respectively. In the fourth
quarter of 2009, we notified the landlord of our Kontich, Belgium office that we planned on
terminating our lease in early 2010 in accordance with the provisions of the lease agreement. We
are also involved in various month-to-month leases for research and development and office
equipment at all three European locations. In addition, all three of the European office leases
include provisions for possible adjustments in annual future rental commitments relating to excess
taxes, excess maintenance costs that may occur and increases in rent based on the consumer price
index and based on increases in our annual lease commitments, none of these commitments are
material.
Future minimum lease payment under operating leases having initial or remaining non-cancellable
lease terms in excess of one year are as follows (in thousands):
At December 31, 2009 | ||||
2010 |
$ | 968 | ||
2011 |
645 | |||
2012 |
360 | |||
2013 |
25 | |||
2014 |
25 | |||
Thereafter |
| |||
$ | 2,023 | |||
Our lease expense was $1.0 million in 2009, $1.2 million in 2008 and $1.3 million in 2007.
Additionally, we have arrangements with certain manufacturing subcontractors under which we are
contingently obligated to purchase $0.1 million of raw material parts in the event they would not
be consumed by the manufacturing process in the normal course of business. This liability has been
recorded in the consolidated balance sheet as we have a legal obligation to purchase this inventory
as of December 31, 2009. The recording of this obligation in the financial statements did not
result in a charge to the Consolidated Statements of Operations. We fully expect to utilize this
inventory during the normal course of business and have not recorded any reserve related to this
specific item.
In addition, we are, from time to time, party to various legal claims and disputes, either asserted
or unasserted, which arise in the ordinary course of business. While the final resolution of these
matters cannot be predicted with certainty, we do not believe that the outcome of any of these
claims will have a material adverse effect on our consolidated financial position, or annual
results of operations or cash flow.
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12. MAJOR CUSTOMERS, REVENUE CONCENTRATION AND DEPENDENCE ON CERTAIN SUPPLIERS
The following table represents our total sales by major product lines as well as the % of their
sales on total revenue.
December 31 , | December 31 , | December 31, | ||||||||||||||||||||||
2009 | 2008 | 2007 | ||||||||||||||||||||||
MCU |
$ | 5.7 | 13 | % | $ | 8.9 | 18 | % | $ | 12.7 | 24 | % | ||||||||||||
Test Products |
14.2 | 32 | % | 18.1 | 37 | % | 23.6 | 46 | % | |||||||||||||||
Other |
0.1 | 0 | % | 0.0 | 0 | % | 0.0 | 0 | % | |||||||||||||||
Services |
24.9 | 55 | % | 22.1 | 45 | % | 15.5 | 30 | % | |||||||||||||||
Total |
$ | 44.9 | 100 | % | $ | 49.1 | 100 | % | $ | 51.8 | 100 | % | ||||||||||||
As of December 31, 2009, we had approximately $5.4 million of accounts receivable with five
customers, each of which individually exceeded 10% of our December 31, 2009 receivable balances.
As of December 31, 2008, the Company had approximately $4.5 million of accounts receivable with
three customers, each of which individually exceeded 10% of our December 31, 2008 receivable
balances.
The following table represents sales to our customers that individually exceeded 10% of our net
sales:
December 31 , | December 31 , | December 31, | ||||||||||||||||||||||
2009 | 2008 | 2007 | ||||||||||||||||||||||
Company A |
$ | 10,262 | 23 | % | $ | 13,436 | 27 | % | $ | 16,283 | 31 | % | ||||||||||||
Company B |
5,254 | 12 | % | | 0 | % | | 0 | % | |||||||||||||||
Company C |
4,534 | 10 | % | 3,796 | 8 | % | 2,695 | 5 | % | |||||||||||||||
Company D |
4,523 | 10 | % | 4,554 | 9 | % | 3,384 | 7 | % | |||||||||||||||
Company E |
3,118 | 7 | % | 7,448 | 15 | % | 3,954 | 8 | % | |||||||||||||||
Company F |
| 0 | % | 1,435 | 3 | % | 7,054 | 14 | % | |||||||||||||||
Total |
$ | 27,691 | $ | 30,669 | $ | 33,370 |
Our sales are primarily in three geographic areas: the Americas (including the United
States); Europe, the Middle East and Africa (EMEA); and Asia. The following table represents
sales to our customers based on these geographic locations:
December 31 , 2009 | December 31 , 2008 | December 31 , 2007 | ||||||||||
Region : |
||||||||||||
Asia |
$ | 1,079 | $ | 828 | $ | 2,041 | ||||||
Americas |
3,408 | 2,390 | 3,240 | |||||||||
EMEA |
12,479 | 18,029 | 17,863 | |||||||||
Total International |
16,966 | 21,247 | 23,144 | |||||||||
Total Domestic |
27,975 | 27,805 | 28,688 | |||||||||
Total Revenue |
$ | 44,941 | $ | 49,052 | $ | 51,832 | ||||||
In 2009 and 2008, we utilized two key contract manufactures to perform a majority of the
circuit board assembly and in-circuit testing work on our telecommunication products. We paid each
of these two contract manufacturers $2.6 million and $0.3 million in 2009 and $3.4 million and $0.4
million in 2008, respectively.
13. SHORT-TERM INVESTMENTS
The estimated fair values of our financial instruments are as follows (in thousands):
December 31, 2009 | December 31, 2008 | |||||||||||||||
Carrying Amount | Fair Value | Carrying Amount | Fair Value | |||||||||||||
Financial assets: |
||||||||||||||||
Cash and cash equivalents |
$ | 66,046 | $ | 66,046 | $ | 57,976 | $ | 57,976 | ||||||||
Short-term investments |
$ | 3 | $ | 3 | $ | 2,419 | $ | 2,419 |
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14. PER SHARE INFORMATION
Basic earnings per common share are computed by dividing net income by the weighted-average number
of common shares outstanding during the reporting period. Diluted earnings per common share is
computed by dividing net income by the combination of dilutive common share equivalents, comprised
of shares issuable under our share-based compensation plans and the weighted-average number of
common shares outstanding during the reporting period. Dilutive common share equivalents include
the dilutive effect of in-the-money shares, which are calculated based on the average share price
for each period using the treasury stock method. Under the treasury stock method, the exercise
price of a share, the amount of compensation cost, if any, for future service that we have not yet
recognized, and the amount of estimated tax benefits that would be recorded in additional paid-in
capital, if any, when the share is exercised are assumed to be used to repurchase shares in the
current period. When we are in a loss position, we do not include any stock options outstanding
with an exercise price below the average market price, as their effect would be considered
anti-dilutive.
As of December 31, 2009, 2008 and 2007, 1,682,327, 1,840,760 and 821,310 of equivalent shares,
respectively, were anti-dilutive. Basic earnings per share are calculated on the actual number of
weighted average common shares outstanding for the period, while diluted earnings per share must
include the effect of any dilutive securities
Earnings per share are as follows (in thousands except per share information):
December 31, 2009 | December 31, 2008 | December 31, 2007 | ||||||||||
Net loss |
$ | (36,205 | ) | $ | (7,115 | ) | $ | (26,153 | ) | |||
Weighted average common shares outstanding |
12,683 | 13,102 | 13,219 | |||||||||
Effect of dilutive securities stock options |
| | | |||||||||
12,683 | 13,102 | 13,219 | ||||||||||
Loss per common share: |
||||||||||||
Basic |
$ | (2.85 | ) | $ | (0.54 | ) | $ | (1.98 | ) | |||
Diluted |
$ | (2.85 | ) | $ | (0.54 | ) | $ | (1.98 | ) | |||
Loss per common share from continuing
operations: |
||||||||||||
Basic |
$ | (2.83 | ) | $ | (0.23 | ) | $ | (1.46 | ) | |||
Diluted |
$ | (2.83 | ) | $ | (0.23 | ) | $ | (1.46 | ) | |||
Loss per common share from
discontinued operations: |
||||||||||||
Basic |
$ | (0.02 | ) | $ | (0.31 | ) | $ | (0.52 | ) | |||
Diluted |
$ | (0.02 | ) | $ | (0.31 | ) | $ | (0.52 | ) | |||
15. EMPLOYEE DEFINED CONTRIBUTION PLANS
We offer our employees a 401(k) benefit plan. Eligible employees, as defined in the plan, may
contribute up to 20% of eligible compensation, not to exceed the statutory limit. We do not make
matching contributions to the plan. We also offer a group personnel pension plan to employees of
our United Kingdom subsidiary. Eligible employees, as defined in the plan, may contribute up to
100% of eligible compensation, not to exceed the statutory limit. For this plan, we make matching
contributions of up to 6% of eligible compensation. Our expense related to the Plan totaled less
than $0.1 million for each of the years ended December 31, 2009 and 2008, respectively.
16. SEVERANCE EXPENSE
Over the past several years, we have had various restructuring programs that have resulted in
reductions in force, have severed relations with certain executives and had a resignation of our
president and chief executive officer and as such, have recorded some significant severance and
separation costs. A summary of these actions are as follows:
During the third quarter of 2009, we developed a plan to significantly reduce and restructure our
workforce across all levels of the organization in an effort to reduce costs to better align our
human resources to match ongoing revenue streams. The total severance costs associated with this
action was approximately $1.4 million, of which $0.5 million was recorded to cost of sales while
$0.9 million was recorded to operating expenses. During the first and second quarter of 2009, we
implemented certain initiatives aimed at increasing efficiency and decreasing cost which included
reductions in our professional services, operations and marketing staff. Severance expense
associated with these actions was $0.3 million. In addition, we also incurred a third quarter 2009
charge of $0.2
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million related to the departure of our former chief financial officer. Cash payments related to
the aforementioned actions were $1.5 million in 2009. Our related severance accrual as of December
31, 2009 was $0.4 million, which has been paid in early 2010.
During the first quarter of 2008, we implemented a restructuring program whereby we reduced our
engineering and senior management staff, made changes to our field service and sales staffing, and
realigned existing resources to new projects. The severance costs associated with this program
amounted to approximately $0.4 million. In addition, we incurred severance costs in the fourth
quarter related to the separation of three executives that amounted to approximately $0.4 million.
All cash payments related to this action have been paid in 2008 and no further expense is expected.
During the fourth quarter of 2007, our former chief executive officer and president resigned and
the employment of two other executives was terminated. The costs associated with these separations
amounted to approximately $0.8 million. An additional cost of
$0.1 million was recorded for employee severance costs in
relation to other restructuring activity. All cash payments related to this action have been paid in
2007 and no further expense is expected.
17. QUARTERLY FINANCIAL DATA (Unaudited)
The following tables present unaudited quarterly operating results for each of our last eight
fiscal quarters. This information has been prepared by us on a basis consistent with our audited
financial statements and includes all adjustments (consisting only of normal recurring adjustments)
that we consider necessary for a fair statement of the data. Such quarterly results are not
necessarily indicative of the future results of operations.
March 28, | June 27, | September 26, | December 31, | |||||||||||||
2009 | 2009 | 2009 | 2009 | |||||||||||||
Revenue |
$ | 10,317 | $ | 10,643 | $ | 11,326 | $ | 12,655 | ||||||||
Gross profit |
5,284 | 5,197 | 2,230 | (20,300 | ) | |||||||||||
Net (loss) |
$ | (1,223 | ) | $ | (1,509 | ) | $ | (7,082 | ) | $ | (26,391 | ) | ||||
(Loss) Per Share Information |
||||||||||||||||
Weighted average shares |
||||||||||||||||
Basic |
12,679 | 12,681 | 12,682 | 12,690 | ||||||||||||
Diluted |
12,679 | 12,681 | 12,682 | 12,690 | ||||||||||||
Basic |
$ | (0.09 | ) | $ | (0.12 | ) | $ | (0.56 | ) | $ | (2.08 | ) | ||||
Diluted |
$ | (0.09 | ) | $ | (0.12 | ) | $ | (0.56 | ) | $ | (2.08 | ) | ||||
March 29, | June 28, | September 29, | December 31, | |||||||||||||
2008 | 2008 | 2008 | 2008 | |||||||||||||
Revenue |
$ | 11,189 | $ | 12,114 | $ | 12,898 | $ | 12,851 | ||||||||
Gross profit |
4,795 | 6,323 | 7,096 | 6,466 | ||||||||||||
Net (loss) income |
$ | (6,504 | ) | $ | (255 | ) | $ | 918 | $ | (1,274 | ) | |||||
(Loss) Earnings Per Share Information |
||||||||||||||||
Weighted average shares |
||||||||||||||||
Basic |
13,158 | 13,158 | 13,173 | 12,908 | ||||||||||||
Diluted |
13,158 | 13,158 | 13,173 | 12,908 | ||||||||||||
Basic |
$ | (0.49 | ) | $ | (0.02 | ) | $ | 0.07 | $ | (0.10 | ) | |||||
Diluted |
$ | (0.49 | ) | $ | (0.02 | ) | $ | 0.07 | $ | (0.10 | ) | |||||
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SCHEDULE II
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 2009, 2008 and 2007
(In thousands)
For the Years Ended December 31, 2009, 2008 and 2007
(In thousands)
Col. A | Col. B | Col C. | Col. D | Col. E | ||||||||||||||||
Balance at | Additions | Balance at | ||||||||||||||||||
Beginning | Charged to | Charged to | End | |||||||||||||||||
of Year | Expense | Other Accounts | Deductions | of Year | ||||||||||||||||
Allowance for doubtful
accounts: |
||||||||||||||||||||
Year ended December 31, 2009 |
$ | 222 | 1,274 | | | $ | 1,496 | |||||||||||||
Year ended December 31, 2008 |
$ | 309 | 100 | | (187 | ) | $ | 222 | ||||||||||||
Year ended December 31, 2007 |
$ | 355 | 86 | | (132 | ) | $ | 309 | ||||||||||||
Inventory reserve: |
||||||||||||||||||||
Year ended December 31, 2009 |
$ | 1,680 | 2,967 | | | $ | 4,647 | |||||||||||||
Year ended December 31, 2008 |
$ | 1,306 | 953 | | (579 | ) | $ | 1,680 | ||||||||||||
Year ended December 31, 2007 |
$ | 1,247 | 277 | | (218 | ) | $ | 1,306 | ||||||||||||
Warranty reserve: |
||||||||||||||||||||
Year ended December 31, 2009 |
$ | 926 | 894 | | (1,316 | ) | $ | 504 | ||||||||||||
Year ended December 31, 2008 |
$ | 1,148 | 1,682 | | (1,904 | ) | $ | 926 | ||||||||||||
Year ended December 31, 2007 |
$ | 1,273 | 1,588 | | (1,713 | ) | $ | 1,148 | ||||||||||||
Valuation allowance on net
deferred tax assets: |
||||||||||||||||||||
Year ended December 31, 2009 |
$ | 15,848 | | 12,719 | | $ | 28,567 | |||||||||||||
Year ended December 31, 2008 |
$ | 12,655 | 123 | 3,070 | | $ | 15,848 | |||||||||||||
Year ended December 31, 2007 |
$ | 2,733 | 9,922 | | | $ | 12,655 |
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
As of December 31, 2009, we have carried out an evaluation, under the supervision of, and with the
participation of, our management, including our principal executive officer and principal financial
officer, of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15
under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, the principal
executive officer and principal financial officer concluded that our disclosure controls and
procedures (as defined in Rules 13a-15(e) under the Securities Exchange Act of 1934) were effective
to ensure that information required to be disclosed by the Company in the reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported within the time
periods specified by the SECs rules and forms, and that such information is accumulated and
communicated to our management, including our principal executive officer and principal financial
officer, as appropriate, to allow timely decisions regarding required financial disclosure.
Managements Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over
financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control
over financial reporting is a process designed by, or under the supervision of our principal
executive and principal financial officers, and effected by our board of directors, management and
other personnel, to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A companys internal control over financial reporting includes
those policies and procedures that (i) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
Our management assessed the effectiveness of our internal control over financial reporting as of
December 31, 2009. In making this assessment, our management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control-Integrated Framework. Our management has concluded that, as of December 31, 2009, our
internal control over financial reporting was effective.
The effectiveness of the Companys internal control over financial reporting as of December 31,
2009, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting
firm, as stated in their report which appears herein.
Evaluation of Changes in Internal Controls over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rule
13a-15(f) under the Securities Exchange Act of 1934) during the quarter ended December 31, 2009
that have materially affected, or are reasonably likely to materially affect our internal control
over financial reporting.
Item 9B. Other Information.
None.
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Table of Contents
PART III
Item 10. Directors, Executive Officers and Corporate Governance.
Information related to our executive officers is included in Item I of this Form 10-K under the
caption Executive Officers of the Company. Information related to the directors will be included
under the caption Election of Directors in the Companys definitive Proxy Statement to be filed
with the Securities and Exchange Commission relating to our 2010 Annual Meeting of Shareholders
(the 2010 Proxy Statement), which information is incorporated herein by reference. Information
regarding compliance with Section 16(a) of the Securities Exchange Act of 1934 will be included
under the caption Section 16(a) Beneficial Ownership Reporting Compliance in the 2010 Proxy
Statement, which information is incorporated herein by reference. Information relating to the
Companys Audit Committee and the Audit Committee Financial Expert will be included under the
caption/sub caption The Board of Directors and its Committees Committees of the Board of
Directors in the section Audit Committee in the 2010 Proxy Statement, which section is
incorporated herein by reference.
We have adopted a Code of Ethics applicable to our chief executive officer, chief financial
officer, controller, and other individuals performing similar functions. A copy of the Companys
Code of Ethics is available on our website at www.tollgrade.com.
Item 11. Executive Compensation.
Information relating to executive compensation will be included under the captions Director
Compensation, Compensation of Executive Officers, Employment Agreements, Separation of
Employment and Change-in-Control Agreements, Compensation Committee Interlocks and Insider
Participation, and Compensation Committee Report and sub-captions thereof in the 2010 Proxy
Statement, which information is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.
Information relating to the security ownership of beneficial owners of 5% or more of the Companys
Common Stock and of our executive officers and directors of the Company will be included under the
caption Stock Ownership of Certain Beneficial Owners and Management in the 2010 Proxy Statement,
which information is incorporated herein by reference.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information about the Companys Common Stock that may be issued upon
the exercise of options outstanding under its equity compensation plans and the number of
securities remaining available for future issuance under its equity compensation plans as of
December 31, 2009.
No. of securities remaining | ||||||||||||
available for future issuance | ||||||||||||
under equity compensation plans | ||||||||||||
No. of securities to be | Weighted average exercise | (excluding securities to be issued | ||||||||||
issued upon exercise of | price of outstanding | upon exercise of outstanding | ||||||||||
outstanding options | options | options) | ||||||||||
Equity compensation
plans approved by
security holders |
||||||||||||
1995 Long-Term
Incentive
Compensation Plan
(1) |
430,732 | $ | 45.36 | | ||||||||
2006 Long-Term
Incentive
Compensation Plan |
1,128,947 | $ | 6.04 | 1,577,557 | ||||||||
Equity compensation
plans not approved
by security holders |
||||||||||||
1998 Employee
Incentive
Compensation Plan
(1) |
125,116 | $ | 31.81 | | ||||||||
Total: |
1,684,795 | 1,577,557 |
(1) | No further grants may be made under these plans. |
See Note 2 to the consolidated financial statements for additional information regarding the
Companys equity compensation plans.
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Table of Contents
Item 13. Certain Relationships and Related Transactions and Director Independence.
Information relating to this Item will be included under the caption Certain Relationships and
Related Transactions in the 2010 Proxy Statement, which information is incorporated herein by
reference. Information relating to this Item will also be included under the caption The Board of
Directors and Its Committees in the 2010 Proxy Statement, which information is incorporated herein
by reference.
Item 14. Principal Accountant Fees and Services.
Information relating to this Item will be included under the caption Ratification of Independent
Registered Public Accounting Firm in the 2010 Proxy Statement, which information is incorporated
herein by reference.
PART IV
Item 15. Exhibits and Financial Statement Schedules.
(a) | The following documents have been filed as part of this report or, where noted, incorporated by reference: |
(1) | Financial Statements The financial statements of the Company are listed in the Index to Consolidated Financial Statements on Page 46. |
||
(2) | Financial Statement Schedule The financial statement schedule filed in response to Item 8 and Item 15(d) of Form 10-K, Schedule II (Valuation and Qualifying Accounts), is listed in the Index to Consolidated Financial Statements on Page 46. |
||
(3) | The following exhibits are included herewith and made a part hereof: |
Exhibit | ||
Number | Description | |
3.1
|
Amended and Restated Articles of Incorporation of the Company (the Articles) as amended through May 6, 1998 (conformed copy), incorporated herein by reference to Exhibit 3.1 to the Annual Report of Tollgrade Communications, Inc. (the Company) on Form 10-K, filed with the Securities and Exchange Commission (the SEC) on March 24, 1999 (the 1998 Form 10-K). | |
3.1a
|
Statement with Respect to Shares dated July 23, 1996 (conformed copy), incorporated herein by reference to Exhibit 3.1a to the 1998 Form 10-K. | |
3.1b
|
Amendment to Articles incorporated herein by reference, filed on the Companys Current Report on Form 8-K filed with the SEC on May 21, 2007. | |
3.2
|
Amended and Restated Bylaws of the Company filed as Exhibit 3.2 to the Companys Current Report on Form 8-K filed with the SEC on May 21, 2007. | |
10.1*
|
1995 Long-Term Incentive Compensation Plan, amended and restated as of January 24, 2002, incorporated herein by reference to Exhibit B to the 2002 Proxy Statement of the Company, filed with the SEC on March 22, 2002. | |
10.2*
|
Form of Stock Option Agreement dated December 14, 1995 and December 29, 1995 for Non-Statutory Stock Options granted under the 1995 Long-Term Incentive Compensation Plan, incorporated herein by reference to Exhibit 10.15 to the Companys Form 10-K, filed with the SEC on March 19, 1997 (the 1996 Form 10-K). | |
10.3*
|
Form of Stock Option Agreement for Non-Statutory Stock Options granted under the 1995 Long-Term Incentive Compensation Plan, incorporated herein by reference to Exhibit 10.2 to the Companys Form 10-Q, filed with the SEC on November 12, 1996. | |
10.4*
|
Form of Non-employee Director Stock Option Agreement with respect to the Companys 1995 Long-Term Incentive Compensation Plan, incorporated herein by reference to Exhibit 10.25 to the Companys Form 10-K filed with the SEC on March 25, 1998 (the 1997 Form 10-K). | |
10.5*
|
1998 Employee Incentive Compensation Plan, amended and restated as of January 24, 2002, incorporated herein by reference to Exhibit 10.25 to the Companys Form 10-K, filed with the SEC on March 22, 2002 (the 2001 Form 10-K). | |
10.6
|
Lease and License for Alterations dated October 18, 2007 among Tollgrade UK Limited, Tollgrade Communications, Inc., Bedell Corporate Trustees Limited and Atrium Trustees (as Trustees of the Park One Unit Trust), filed as Exhibit 10.2 to the Companys Form 10-Q filed with the SEC on November 8, 2007. | |
10.7
|
Agreement dated November 27, 2006 by and between Knightsbridge Realty L.L.C. and Tollgrade Communications, Inc., filed as Exhibit 10.1 to the Companys Current Report on Form 8-K filed with the SEC on November 30, 2006. |
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Table of Contents
Exhibit | ||
Number | Description | |
10.8
|
Lease Agreement, dated as of August 31, 2005, between Regional Industrial Development Corporation of Southwestern Pennsylvania and the Company, incorporated herein by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K filed with the SEC on September 7, 2005. | |
10.9
|
Amendment of Lease, dated May 22, 2009, between the Regional Industrial Development Corporation of Southwestern Pennsylvania and Tollgrade Communications, Inc., filed as Exhibit 10.3 to the Quarterly Report on Form 10-Q filed with the SEC on August 6, 2009. | |
10.10___
|
Amendment of Lease, dated September 14, 2009, between the Regional Industrial Development Corporation of Southwestern Pennsylvania and Tollgrade Communications, Inc., filed herewith. | |
10.11*
|
Management Incentive Compensation Plan, as amended, filed as Exhibit 10.1 to the Companys Form 10-Q filed with the SEC on April 27, 2007. | |
10.12*
|
Tollgrade Communications, Inc. 2006 Long-Term Incentive Compensation Plan as amended and restated as of August 5, 2009, filed herewith. | |
10.13*
|
Form of Stock Option Agreement for Non-Statutory Stock Options granted under the 2006 Long-Term Incentive Compensation Plan, filed as Exhibit 10.1 to the Companys Form 10-Q filed with the SEC on October 27, 2006. | |
10.14*
|
Form of Employee Restricted Share Agreement for restricted share grants pursuant to the 2006 Long-Term Incentive Compensation Plan, filed as Exhibit 10.37 to the Companys Form 10-K filed with the SEC on March 17, 2008 (the 2007 Form 10-K). | |
10.15*
|
Form of Director Restricted Share Agreement for restricted share grants pursuant to the 2006 Long-Term Incentive Compensation Plan, filed as Exhibit 10.38 to the 2007 Form 10-K. | |
10.16*
|
Amendment dated December 13, 2007 to the Management Incentive Compensation Plan, filed as Exhibit 10.39 to the 2007 Form 10-K. | |
10.17*
|
Amendment dated December 13, 2007 to the 1995 Long-Term Incentive Compensation Plan, filed as Exhibit 10.40 to the 2007 Form 10-K. | |
10.18*
|
Amendment dated December 13, 2007 to the 1998 Long-Term Incentive Compensation Plan, filed as Exhibit 10.41 to the 2007 Form 10-K. | |
10.19*
|
Severance Policy, filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on January 31, 2008. | |
10.20*
|
Employment Agreement, dated April 10, 2008 between the Company and Joseph A. Ferrara, filed as Exhibit 10.1 to the Current Report on Form 8-K/A filed with the SEC on April 16, 2008. | |
10.21*
|
Severance and Retention Agreement dated October 14, 2008 between the Company and Kenneth J. Shebek, filed as Exhibit 10.3 to the Current Report on Form 8-K filed with the SEC on October 22, 2008. | |
10.22*
|
Severance Agreement dated October 14, 2008 between the Company and David L. Blakeney, filed as Exhibit 10.2 to the Current Report on Form 8-K filed with the SEC on October 22, 2008. | |
10.23*
|
Severance Agreement dated October 14, 2008 between the Company and Gary W. Bogatay, Jr., filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on October 22, 2008. | |
10.24*
|
Agreement dated November 21, 2008 between the Company and Samuel C. Knoch, filed as Exhibit 10.1 to the Current Report on Form 8-K/A filed with the SEC on November 26, 2008. | |
10.25*
|
Agreement dated November 28, 2008 between the Company and Matthew J. Rosgone, filed as Exhibit 10.1 to the Current Report on Form 8-K/A filed with the SEC on December 3, 2008. | |
10.26*
|
Summary of Compensatory Arrangement with Robert H. King, as described in the Current Report on Form 8-K filed with the SEC on February 20, 2009. | |
10.27*
|
Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Sara M. Antol, filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on March 19, 2009 (the March 19, 2009 8-K). | |
10.28*
|
Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Gary W. Bogatay, Jr. filed as Exhibit 10.2 to the March 19, 2009 8-K. | |
10.29*
|
Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Joe OBrien, filed as Exhibit 10.3 to the March 19, 2009 8-K. | |
10.30*
|
Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Robert King, filed as Exhibit 10.4 to the March 19, 2009 8-K. | |
10.31*
|
Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Grant Cushny, filed as Exhibit 10.5 to the March 19, 2009 8-K. | |
10.32*
|
Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and David L. Blakeney, filed as Exhibit 10.6 to the March 19, 2009 8-K. |
- 66 -
Table of Contents
Exhibit | ||
Number | Description | |
10.33*
|
Severance and Retention Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Kenneth J. Shebek, filed as Exhibit 10.7 to the March 19, 2009 8-K. | |
10.34
|
Asset Purchase Agreement by and among Tollgrade Communications, Inc. (PA), Tollgrade Communications, Inc. (DE) and Cheetah Technologies, L.P., dated May 1, 2009, filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on May 5, 2009. | |
10.35*
|
Agreement dated September 17, 2009 by and between Tollgrade Communications, Inc. and Gary W. Bogatay, Jr., filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on September 22, 2009. | |
10.36*
|
Summary of compensation program for non-employee directors, filed as Exhibit 10.3 to the Quarterly Report on Form 10-Q filed with the SEC on November 3, 2010. | |
10.37*
|
Separation and Release Agreement dated November 5, 2009 between Tollgrade Communications, Inc. and Sara M. Antol, filed herewith. | |
10.38*
|
Severance Agreement dated November 19, 2009 between Tollgrade Communications, Inc. and Jennifer M. Reinke, filed herewith. | |
10.39*
|
Severance Agreement dated November 24, 2009 between Tollgrade Communications, Inc. and Michael D. Bornak, filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on November 30, 2009. | |
21.1
|
List of subsidiaries of the Company, filed as Exhibit 21.1 to the 2007 Form 10-K. | |
23.1
|
Consent of PricewaterhouseCoopers LLP, filed herewith. | |
31.1
|
Certification of Chief Executive Officer, filed herewith. | |
31.2
|
Certification of Chief Financial Officer, filed herewith. | |
32
|
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 350, filed herewith. |
* | Management contract or compensatory plan, contract or arrangement required to be filed by Item 601(b)(10)(iii) of Regulation S-K. |
Copies of the exhibits filed as part of this Form 10-K are available free of charge to any
shareholder of record upon written request to the Secretary, Tollgrade Communications, Inc., 493
Nixon Road, Cheswick, Pennsylvania 15024.
LoopCare is a trademark of Tollgrade Communications, Inc.
Stratum is a trademark of Tollgrade Communications, Inc.
HUB is a trademark of Tollgrade Communications, Inc.
ICE is a trademark of Tollgrade Communications, Inc.
LightHouse is a trademark of Tollgrade Communications, Inc.
N(x)Test is a trademark of Tollgrade Communications, Inc.
LTSC is a trademark of Tollgrade Communications, Inc.
®Tollgrade is a registered trademark of Tollgrade Communications, Inc.
®DigiTest is a registered trademark of Tollgrade Communications, Inc.
®EDGE is a registered trademark of Tollgrade Communications, Inc.
®MCU is a registered trademark of Tollgrade Communications, Inc.
®4TEL is a registered trademark of Tollgrade Communications, Inc.
®Celerity is a registered trademark of Tollgrade Communications, Inc.
All other trademarks are the property of their respective owners.
Stratum is a trademark of Tollgrade Communications, Inc.
HUB is a trademark of Tollgrade Communications, Inc.
ICE is a trademark of Tollgrade Communications, Inc.
LightHouse is a trademark of Tollgrade Communications, Inc.
N(x)Test is a trademark of Tollgrade Communications, Inc.
LTSC is a trademark of Tollgrade Communications, Inc.
®Tollgrade is a registered trademark of Tollgrade Communications, Inc.
®DigiTest is a registered trademark of Tollgrade Communications, Inc.
®EDGE is a registered trademark of Tollgrade Communications, Inc.
®MCU is a registered trademark of Tollgrade Communications, Inc.
®4TEL is a registered trademark of Tollgrade Communications, Inc.
®Celerity is a registered trademark of Tollgrade Communications, Inc.
All other trademarks are the property of their respective owners.
- 67 -
Table of Contents
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized as of March 10, 2010.
TOLLGRADE COMMUNICATIONS, INC. |
||||
By | /s/ Joseph A. Ferrara | |||
Joseph A. Ferrara | ||||
Chief Executive Officer and President | ||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the Company and in the capacities indicated as of March
10, 2010.
Signature | Title | |
/s/ Joseph A. Ferrara
|
Chairman, Chief Executive Officer and President (Principal Executive Officer) | |
/s/
Scott C. Chandler
|
Director | |
/s/
Richard H. Heibel
|
Director | |
/s/ Charles E. Hoffman
|
Director | |
/s/ Robert W. Kampmeinert
|
Director | |
/s/ Edward H. Kennedy
|
Director | |
/s/ Edward B. Meyercord
|
Director | |
/s/
Jeffrey M. Solomon
|
Director | |
/s/ Michael D. Bornak
|
Chief Financial Officer and Treasurer (Principal Financial Officer) | |
/s/ Mark C. Lang
|
Corporate Controller (Principal Accounting Officer) |
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Table of Contents
EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
(Pursuant to Item 601 of Regulation S-K)
Exhibit | ||
Number | Description | |
3.1
|
Amended and Restated Articles of Incorporation of the Company (the Articles) as amended through May 6, 1998 (conformed copy), incorporated herein by reference to Exhibit 3.1 to the Annual Report of Tollgrade Communications, Inc. (the Company) on Form 10-K, filed with the Securities and Exchange Commission (the SEC) on March 24, 1999 (the 1998 Form 10-K). | |
3.1a
|
Statement with Respect to Shares dated July 23, 1996 (conformed copy), incorporated herein by reference to Exhibit 3.1a to the 1998 Form 10-K. | |
3.1b
|
Amendment to Articles incorporated herein by reference, filed on the Companys Current Report on Form 8-K filed with the SEC on May 21, 2007. | |
3.2
|
Amended and Restated Bylaws of the Company filed as Exhibit 3.2 to the Companys Current Report on Form 8-K filed with the SEC on May 21, 2007. | |
10.1
|
1995 Long-Term Incentive Compensation Plan, amended and restated as of January 24, 2002, incorporated herein by reference to Exhibit B to the 2002 Proxy Statement of the Company, filed with the SEC on March 22, 2002. | |
10.2
|
Form of Stock Option Agreement dated December 14, 1995 and December 29, 1995 for Non-Statutory Stock Options granted under the 1995 Long-Term Incentive Compensation Plan, incorporated herein by reference to Exhibit 10.15 to the Companys Form 10-K, filed with the SEC on March 19, 1997 (the 1996 Form 10-K). | |
10.3
|
Form of Stock Option Agreement for Non-Statutory Stock Options granted under the 1995 Long-Term Incentive Compensation Plan, incorporated herein by reference to Exhibit 10.2 to the Companys Form 10-Q, filed with the SEC on November 12, 1996. | |
10.4
|
Form of Non-employee Director Stock Option Agreement with respect to the Companys 1995 Long-Term Incentive Compensation Plan, incorporated herein by reference to Exhibit 10.25 to the Companys Form 10-K filed with the SEC on March 25, 1998 (the 1997 Form 10-K). | |
10.5
|
1998 Employee Incentive Compensation Plan, amended and restated as of January 24, 2002, incorporated herein by reference to Exhibit 10.25 to the Companys Form 10-K, filed with the SEC on March 22, 2002 (the 2001 Form 10-K). | |
10.6
|
Lease and License for Alterations dated October 18, 2007 among Tollgrade UK Limited, Tollgrade Communications, Inc., Bedell Corporate Trustees Limited and Atrium Trustees (as Trustees of the Park One Unit Trust), filed as Exhibit 10.2 to the Companys Form 10-Q filed with the SEC on November 8, 2007. | |
10.7
|
Agreement dated November 27, 2006 by and between Knightsbridge Realty L.L.C. and Tollgrade Communications, Inc., filed as Exhibit 10.1 to the Companys Current Report on Form 8-K filed with the SEC on November 30, 2006. | |
10.8
|
Lease Agreement, dated as of August 31, 2005, between Regional Industrial Development Corporation of Southwestern Pennsylvania and the Company, incorporated herein by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K filed with the SEC on September 7, 2005. | |
10.9
|
Amendment of Lease, dated May 22, 2009, between the Regional Industrial Development Corporation of Southwestern Pennsylvania and Tollgrade Communications, Inc., filed as Exhibit 10.3 to the Quarterly Report on Form 10-Q filed with the SEC on August 6, 2009. | |
10.10
|
Amendment of Lease, dated September 14, 2009, between the Regional Industrial Development Corporation of Southwestern Pennsylvania and Tollgrade Communications, Inc., filed herewith. | |
10.11
|
Management Incentive Compensation Plan, as amended, filed as Exhibit 10.1 to the Companys Form 10-Q filed with the SEC on April 27, 2007. | |
10.12
|
Tollgrade Communications, Inc. 2006 Long-Term Incentive Compensation Plan as amended and restated as of August 5, 2009, filed herewith. | |
10.13
|
Form of Stock Option Agreement for Non-Statutory Stock Options granted under the 2006 Long-Term Incentive Compensation Plan, filed as Exhibit 10.1 to the Companys Form 10-Q filed with the SEC on October 27, 2006. | |
10.14
|
Form of Employee Restricted Share Agreement for restricted share grants pursuant to the 2006 Long-Term Incentive Compensation Plan, filed as Exhibit 10.37 to the Companys Form 10-K filed with the SEC on March 17, 2008 (the 2007 Form 10-K). | |
10.15
|
Form of Director Restricted Share Agreement for restricted share grants pursuant to the 2006 Long-Term Incentive Compensation Plan, filed as Exhibit 10.38 to the 2007 Form 10-K. | |
10.16
|
Amendment dated December 13, 2007 to the Management Incentive Compensation Plan, filed as Exhibit 10.39 to the 2007 Form 10-K. |
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Table of Contents
Exhibit | ||
Number | Description | |
10.17
|
Amendment dated December 13, 2007 to the 1995 Long-Term Incentive Compensation Plan, filed as Exhibit 10.40 to the 2007 Form 10-K. | |
10.18
|
Amendment dated December 13, 2007 to the 1998 Long-Term Incentive Compensation Plan, filed as Exhibit 10.41 to the 2007 Form 10-K. | |
10.19
|
Severance Policy, filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on January 31, 2008. | |
10.20
|
Employment Agreement, dated April 10, 2008 between the Company and Joseph A. Ferrara, filed as Exhibit 10.1 to the Current Report on Form 8-K/A filed with the SEC on April 16, 2008. | |
10.21
|
Severance and Retention Agreement dated October 14, 2008 between the Company and Kenneth J. Shebek, filed as Exhibit 10.3 to the Current Report on Form 8-K filed with the SEC on October 22, 2008. | |
10.22
|
Severance Agreement dated October 14, 2008 between the Company and David L. Blakeney, filed as Exhibit 10.2 to the Current Report on Form 8-K filed with the SEC on October 22, 2008. | |
10.23
|
Severance Agreement dated October 14, 2008 between the Company and Gary W. Bogatay, Jr., filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on October 22, 2008. | |
10.24
|
Agreement dated November 21, 2008 between the Company and Samuel C. Knoch, filed as Exhibit 10.1 to the Current Report on Form 8-K/A filed with the SEC on November 26, 2008. | |
10.25
|
Agreement dated November 28, 2008 between the Company and Matthew J. Rosgone, filed as Exhibit 10.1 to the Current Report on Form 8-K/A filed with the SEC on December 3, 2008. | |
10.26
|
Summary of Compensatory Arrangement with Robert H. King, as described in the Current Report on Form 8-K filed with the SEC on February 20, 2009. | |
10.27
|
Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Sara M. Antol, filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on March 19, 2009 (the March 19, 2009 8-K). | |
10.28
|
Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Gary W. Bogatay, Jr. filed as Exhibit 10.2 to the March 19, 2009 8-K. | |
10.29
|
Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Joe OBrien, filed as Exhibit 10.3 to the March 19, 2009 8-K. | |
10.30
|
Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Robert King, filed as Exhibit 10.4 to the March 19, 2009 8-K. | |
10.31
|
Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Grant Cushny, filed as Exhibit 10.5 to the March 19, 2009 8-K. | |
10.32
|
Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and David L. Blakeney, filed as Exhibit 10.6 to the March 19, 2009 8-K. | |
10.33
|
Severance and Retention Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Kenneth J. Shebek, filed as Exhibit 10.7 to the March 19, 2009 8-K. | |
10.34
|
Asset Purchase Agreement by and among Tollgrade Communications, Inc. (PA), Tollgrade Communications, Inc. (DE) and Cheetah Technologies, L.P., dated May 1, 2009, filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on May 5, 2009. | |
10.35
|
Agreement dated September 17, 2009 by and between Tollgrade Communications, Inc. and Gary W. Bogatay, Jr., filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on September 22, 2009. | |
10.36
|
Summary of compensation program for non-employee directors, filed as Exhibit 10.3 to the Quarterly Report on Form 10-Q filed with the SEC on November 3, 2010. | |
10.37
|
Separation and Release Agreement dated November 5, 2009 between Tollgrade Communications, Inc. and Sara M. Antol, filed herewith. | |
10.38
|
Severance Agreement dated November 19, 2009 between Tollgrade Communications, Inc. and Jennifer M. Reinke, filed herewith. | |
10.39
|
Severance Agreement dated November 24, 2009 between Tollgrade Communications, Inc. and Michael D. Bornak, filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on November 30, 2009. | |
21.1
|
List of subsidiaries of the Company, filed as Exhibit 21.1 to the 2007 Form 10-K. | |
23.1
|
Consent of PricewaterhouseCoopers LLP, filed herewith. | |
31.1
|
Certification of Chief Executive Officer, filed herewith. | |
31.2
|
Certification of Chief Financial Officer, filed herewith. | |
32
|
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 350, filed herewith. |
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