UNITED STATES
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

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)

Registrant’s telephone number, including area code: 412-820-1400

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 registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 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.

 

 

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

TABLE OF CONTENTS

Part I
Item 1. Business			4
Item 1A. Risk Factors			12
Item 1B. Unresolved Staff Comments			22
Item 2. Properties			22
Item 3. Legal Proceedings			22
Item 4. Reserved			22
Part II
Item 5. Market for the Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities			22
Item 6. Selected Financial Data			25
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations			26
Item 7A. Quantitative and Qualitative Disclosures About Market Risk			38
Item 8. Financial Statements and Supplementary Data			38
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			63
Item 9A. Controls and Procedures			63
Item 9B. Other Information			63
Part III
Item 10. Directors, Executive Officers and Corporate Governance			64
Item 11. Executive Compensation			64
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			64
Item 13. Certain Relationships and Related Transactions and Director Independence			65
Item 14. Principal Accountant Fees and Services			65
Part IV
Item 15. Exhibits and Financial Statement Schedules			65
SIGNATURES			68
EX-10.10
EX-10.12
EX-10.37
EX-10.38
EX-23.1
EX-31.1
EX-31.2
EX-32

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, “Management’s 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 “Management’s 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

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 SEC’s 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.

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™. Stratum’s 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.

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

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

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

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 Tollgrade^SM 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.

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 Ericsson’s acquisition of Marconi Corporation plc’s (“Marconi”) product divisions; Chief Executive Officer of Marconi’s North American operations from June 2005 until January 2006; Vice President of Business Operations of Marconi’s Data Networks Division from February until June 2005 and July 2000 until April 2004; and Vice President of Marketing of Marconi’s 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 Company’s 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 Company’s 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. O’Brien		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.

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 market’s 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

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.

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 provider’s 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 Company’s 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.

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.

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.

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.

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 customer’s 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

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 FCC’s 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 management’s 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

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 Union’s 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

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 company’s securities, securities class action litigation has often been initiated against such company. Such litigation could result in substantial costs and a diversion of our management’s 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.

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 Registrant’s 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 Company’s common stock.

We have never paid any dividends on our common stock and do not expect to pay dividends in the foreseeable future.

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

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 Tollgrade’s common stock, the Standard & Poor’s 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

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 “Management’s 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

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. Management’s 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

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 Corporation’s 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.

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 long–lived 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

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.

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 contract’s 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.

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 year’s 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

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.

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

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 Board’s 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 Company’s 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 Company’s consolidated financial position, or annual results of operations or cash flow.

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 customer’s 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

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 Company’s 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.

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 customer’s 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.

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 & Poor’s. 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 Republic’s 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

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets

Consolidated Statements of Operations

Consolidated Statements of Changes in Shareholders’ Equity

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

Schedule II — Valuation and Qualifying Accounts

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 Company’s 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 Management’s 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 Company’s 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 company’s 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 company’s 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 company’s 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

Tollgrade Communications, Inc. and Subsidiaries
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.

Tollgrade Communications, Inc. and Subsidiaries

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.

Tollgrade Communications, Inc. and Subsidiaries

Consolidated Statements of Changes in Shareholder’s 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