Attached files
file | filename |
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EX-32 - EX-32 - TOLLGRADE COMMUNICATIONS INC \PA\ | l40979exv32.htm |
EX-31.2 - EX-31.2 - TOLLGRADE COMMUNICATIONS INC \PA\ | l40979exv31w2.htm |
EX-31.1 - EX-31.1 - TOLLGRADE COMMUNICATIONS INC \PA\ | l40979exv31w1.htm |
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One) |
þ | Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended September 30, 2010
o | Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For
the transition period from to
Commission File Number: 000-27312
TOLLGRADE COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania | 25-1537134 | |
(State or other jurisdiction | (I.R.S. Employer | |
of incorporation or organization) | Identification No.) |
493 Nixon Rd.
Cheswick, PA 15024
(Address of principal executive offices, including zip code)
Cheswick, PA 15024
(Address of principal executive offices, including zip code)
412-820-1400
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ Noo
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 (§ 229.405) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files). Yes o Noo
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):
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o Noþ
As of October 27, 2010, there were 12,786,019 shares of the Registrants Common Stock, $0.20 par
value per share, outstanding.
TOLLGRADE COMMUNICATIONS, INC.
Quarterly Report on Form 10-Q
For the Quarter Ended September 30, 2010
Table of Contents
For the Quarter Ended September 30, 2010
Table of Contents
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Exhibit 10.1 |
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Exhibit 31.1 |
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Exhibit 31.2 |
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Exhibit 32 |
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EX-31.1 | ||||||||
EX-31.2 | ||||||||
EX-32 |
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Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value) (Unaudited)
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value) (Unaudited)
September 30, 2010 | December 31, 2009 | |||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 69,564 | $ | 66,046 | ||||
Short-term investments |
3 | 3 | ||||||
Trade accounts receivable, net of allowance for doubtful
accounts of $1,386 and $1,496 in 2010 and 2009 |
9,611 | 6,998 | ||||||
Other receivables |
194 | 1,007 | ||||||
Inventories, net |
1,582 | 2,119 | ||||||
Prepaid expenses and deposits |
610 | 759 | ||||||
Deferred and refundable income taxes |
240 | 196 | ||||||
Total current assets |
81,804 | 77,128 | ||||||
Property and equipment, net |
2,330 | 3,101 | ||||||
Intangibles, net |
5,834 | 7,110 | ||||||
Deferred tax assets |
114 | 119 | ||||||
Other assets |
143 | 229 | ||||||
Total assets |
$ | 90,225 | $ | 87,687 | ||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 1,583 | $ | 927 | ||||
Accrued warranty |
272 | 504 | ||||||
Accrued expenses |
1,398 | 2,456 | ||||||
Accrued salaries and wages |
1,302 | 1,190 | ||||||
Income taxes payable |
700 | 393 | ||||||
Deferred revenue |
2,322 | 2,463 | ||||||
Total current liabilities |
7,577 | 7,933 | ||||||
Pension obligation |
1,034 | 983 | ||||||
Other tax liabilities |
845 | 738 | ||||||
Deferred tax liabilities |
235 | 290 | ||||||
Total liabilities |
9,691 | 9,944 | ||||||
Commitments and contingencies |
| | ||||||
Shareholders equity: |
||||||||
Common stock, $0.20 par value; 50,000 authorized shares,
issued shares, 13,882 in 2010 and 13,788 in 2009 |
2,777 | 2,746 | ||||||
Additional paid-in capital |
76,022 | 75,244 | ||||||
Treasury stock, at cost, 1,162 shares in 2010 and 1,151 in 2009 |
(8,632 | ) | (8,563 | ) | ||||
Retained earnings |
11,600 | 9,543 | ||||||
Accumulated other comprehensive loss |
(1,233 | ) | (1,227 | ) | ||||
Total shareholders equity |
80,534 | 77,743 | ||||||
Total liabilities and shareholders equity |
$ | 90,225 | $ | 87,687 | ||||
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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Table of Contents
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data) (Unaudited)
(In thousands, except per share data) (Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 26, | September 30, | September 26, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Revenue: |
||||||||||||||||
Products |
$ | 4,716 | $ | 5,016 | $ | 13,874 | $ | 14,986 | ||||||||
Services |
6,340 | 6,310 | 19,849 | 17,300 | ||||||||||||
Total Revenue |
11,056 | 11,326 | 33,723 | 32,286 | ||||||||||||
Cost of sales: |
||||||||||||||||
Products |
1,645 | 2,537 | 5,732 | 8,090 | ||||||||||||
Services |
2,081 | 2,137 | 5,937 | 5,497 | ||||||||||||
Amortization of intangible assets |
388 | 659 | 1,177 | 1,949 | ||||||||||||
Impairment of intangible assets |
| 191 | | 191 | ||||||||||||
Inventory write-down |
| 3,070 | | 3,070 | ||||||||||||
Severance |
(98 | ) | 502 | 319 | 778 | |||||||||||
Total cost of sales |
4,016 | 9,096 | 13,165 | 19,575 | ||||||||||||
Gross profit |
7,040 | 2,230 | 20,558 | 12,711 | ||||||||||||
Operating expenses: |
||||||||||||||||
Selling and marketing |
1,243 | 1,567 | 4,579 | 4,850 | ||||||||||||
General and administrative |
1,813 | 4,111 | 5,985 | 9,525 | ||||||||||||
Research and development |
1,428 | 2,353 | 5,468 | 6,795 | ||||||||||||
Severance |
(111 | ) | 1,114 | 1,774 | 1,179 | |||||||||||
Other impairments |
| 293 | | 293 | ||||||||||||
Total operating expenses |
4,373 | 9,438 | 17,806 | 22,642 | ||||||||||||
Income (loss) from operations |
2,667 | (7,208 | ) | 2,752 | (9,931 | ) | ||||||||||
Other income/(expense) |
677 | 46 | (47 | ) | 555 | |||||||||||
Income (loss) before income taxes |
3,344 | (7,162 | ) | 2,705 | (9,376 | ) | ||||||||||
Provision (benefit) for income taxes |
851 | (80 | ) | 648 | 215 | |||||||||||
Income (loss) from continuing operations |
2,493 | (7,082 | ) | 2,057 | (9,591 | ) | ||||||||||
(Loss) from discontinued operations |
| | | (223 | ) | |||||||||||
Net Income (loss) |
$ | 2,493 | ($7,082 | ) | $ | 2,057 | ($9,814 | ) | ||||||||
Per share information: |
||||||||||||||||
Weighted average shares of common stock
and equivalents: |
||||||||||||||||
Basic |
12,723 | 12,682 | 12,697 | 12,681 | ||||||||||||
Diluted |
13,167 | 12,682 | 12,926 | 12,681 | ||||||||||||
Income (loss) per common and common
equivalent shares: |
||||||||||||||||
Basic |
$ | 0.20 | ($0.56 | ) | $ | 0.16 | ($0.78 | ) | ||||||||
Diluted |
$ | 0.19 | ($0.56 | ) | $ | 0.16 | ($0.78 | ) | ||||||||
Income (loss) per common and common
equivalent shares from continuing
operations: |
||||||||||||||||
Basic |
$ | 0.20 | ($0.56 | ) | $ | 0.16 | ($0.76 | ) | ||||||||
Diluted |
$ | 0.19 | ($0.56 | ) | $ | 0.16 | ($0.76 | ) | ||||||||
Net Income (loss) per common and
common equivalent shares from
discontinued operations: |
||||||||||||||||
Basic |
$ | 0.00 | $ | 0.00 | $ | 0.00 | ($0.02 | ) | ||||||||
Diluted |
$ | 0.00 | $ | 0.00 | $ | 0.00 | ($0.02 | ) |
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) (Unaudited)
(In thousands) (Unaudited)
September 30, | September 26, | |||||||
2010 | 2009 | |||||||
Cash flows from operating activities : |
||||||||
Net Income (loss) |
$ | 2,057 | ($9,814 | ) | ||||
Adjustments to reconcile net loss to net cash provided by operating
activities |
||||||||
Loss from discontinued operations |
| 223 | ||||||
Impairment of intangible assets |
| 191 | ||||||
Impairment of other long live assets |
| 293 | ||||||
Amortization expense |
1,177 | 1,949 | ||||||
Depreciation expense |
905 | 865 | ||||||
Stock-based compensation expense |
730 | 720 | ||||||
Deferred income taxes |
(267 | ) | 247 | |||||
Inventory write-down |
| 3,070 | ||||||
Provision for losses on inventory |
(279 | ) | 268 | |||||
Provision for allowance for doubtful accounts |
(92 | ) | 1,178 | |||||
Changes in assets and liabilities: |
||||||||
Accounts receivable-trade |
(3,595 | ) | 1,608 | |||||
Other receivable |
1,918 | (588 | ) | |||||
Inventories |
815 | 1,384 | ||||||
Prepaid expenses, deposits and other assets |
231 | 506 | ||||||
Accounts payable |
674 | (752 | ) | |||||
Accrued warranty |
(219 | ) | (307 | ) | ||||
Accrued expenses, deferred revenue and salaries & wages |
(371 | ) | 1,050 | |||||
Income taxes payable |
(121 | ) | (21 | ) | ||||
Net cash provided by operating activities of discontinued operations |
| 12 | ||||||
Net cash provided by operating activities |
3,563 | 2,082 | ||||||
Cash flows from investing activities: |
||||||||
Proceeds on sale of cable product line |
| 3,012 | ||||||
Proceeds from note receivable |
124 | 53 | ||||||
Redemption/maturity of short term investments |
| 2,220 | ||||||
Purchase of acquired assets |
| (300 | ) | |||||
Purchase of property and equipment |
(206 | ) | (505 | ) | ||||
Net cash used in investing activities of discontinued operations |
| (57 | ) | |||||
Net cash (used in)/provided by investing activities |
(82 | ) | 4,423 | |||||
Cash flows from financing activities: |
||||||||
Exercise of common stock options |
104 | | ||||||
Repurchase of treasury stock |
(69 | ) | | |||||
Net cash provided by financing activities |
35 | | ||||||
Net increase in cash and cash equivalents |
3,516 | 6,505 | ||||||
Effect of exchange rate changes on cash and cash equivalents |
2 | 698 | ||||||
Cash and cash equivalents, beginning of period |
66,046 | 57,976 | ||||||
Cash and cash equivalents, end of period |
$ | 69,564 | $ | 65,179 | ||||
Supplemental disclosure of cash flow information: |
||||||||
Cash paid during the period for income taxes |
515 | (8 | ) |
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
(In thousands) (Unaudited)
(In thousands) (Unaudited)
Additional | Accumulated Other | |||||||||||||||||||||||||||||||
Common Stock | Paid-In | Treasury Stock | Retained | Comprehensive | ||||||||||||||||||||||||||||
Shares | Amount | Capital | Shares | Amount | Earnings | Loss | Total | |||||||||||||||||||||||||
Balance at December
31, 2009 |
13,788 | $ | 2,746 | $ | 75,244 | 1,151 | ($8,563 | ) | $ | 9,543 | ($1,227 | ) | $ | 77,743 | ||||||||||||||||||
Exercise of common
stock options |
24 | 5 | 99 | 104 | ||||||||||||||||||||||||||||
Purchase of
treasury stock |
11 | (69 | ) | (69 | ) | |||||||||||||||||||||||||||
Compensation
expense for options
and restricted
stock, net |
70 | 26 | 679 | 705 | ||||||||||||||||||||||||||||
Foreign currency
translation |
(6 | ) | (6 | ) | ||||||||||||||||||||||||||||
Net income |
2,057 | 2,057 | ||||||||||||||||||||||||||||||
Balance at
September 30, 2010 |
13,882 | $ | 2,777 | $ | 76,022 | 1,162 | ($8,632 | ) | $ | 11,600 | ($1,233 | ) | $ | 80,534 | ||||||||||||||||||
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
In 2010, Tollgrade Communications, Inc. (Tollgrade, the Company, we) will report our
quarterly results as of the end of each calendar quarter beginning with the quarter ended March 31,
2010. Prior to 2010, we reported our quarterly results based on fiscal quarters and, as such, our
prior year quarters ended on March 28, 2009, June 27, 2009, September 26, 2009 and December 31,
2009. For comparative purposes, for the third quarter and the first nine months of 2009, we have
evaluated the four days business activity between September 26, 2009 and September 30, 2009 and
found no material differences in revenue, cost of sales, operating expenses, assets, liabilities
and equity that would cause us to restate our 2009 third quarter or nine month financial results.
We have prepared the unaudited condensed consolidated financial statements included herein in
accordance with accounting principles generally accepted in the United States of America for
interim financial information and Article 10 of Regulation S-X. Accordingly, the accompanying
unaudited condensed consolidated financial statements do not include all of the information and
footnotes required by accounting principles generally accepted in the United States of America for
complete financial statements, although we believe that the disclosures are adequate to make the
information presented not misleading. In the opinion of our management, all adjustments considered
necessary for a fair statement of the accompanying unaudited condensed consolidated financial
statements were included, and all adjustments are of a normal and recurring nature. Operating
results for the quarter ended September 30, 2010 are not necessarily indicative of the results that
may be expected for the year ending December 31, 2010. The unaudited condensed consolidated
financial statements as of and for the three month and nine month periods ended September 30, 2010
should be read in conjunction with our consolidated financial statements (and notes thereto)
included in our Annual Report on Form 10-K for the year ended December 31, 2009.
RECENTLY ISSUED ACCOUNTING GUIDANCE
In October 2009, the Financial Accounting Standards Board (FASB) issued revised accounting
guidance for multiple-deliverable arrangements. The amended guidance requires that arrangement
considerations be allocated at the inception of the arrangement to all deliverables using the
relative selling price method and provides for expanded disclosures related to such arrangements.
It is effective for revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010. The company is still evaluating the impact of adopting the
new guidance.
2. FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date. The fair
value hierarchy distinguishes between (1) market participant assumptions developed based on market
data obtained from independent sources (observable inputs) and (2) an entitys own assumptions
about market participant assumptions developed based on the best information available in the
circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which
gives the highest priority to unadjusted quoted prices in active markets for identical assets or
liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of
the fair value hierarchy are described below:
| Level 1 Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities; | ||
| Level 2 Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that |
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are derived principally from or corroborated by observable market data by correlation or other means; and |
| Level 3 Inputs that are both significant to the fair value measurement and unobservable. |
The fair value of cash equivalents was $69.6 million and $66.0 million at September 30, 2010 and
December 31, 2009, respectively. These financial instruments are classified in Level 1 of the fair
value hierarchy.
3. STOCK-BASED COMPENSATION
We currently sponsor one active stock compensation plan. Our 2006 Long-Term Incentive Compensation
Plan (the 2006 Plan) was adopted by our Board of Directors in March 2006 and was approved by our
shareholders in May 2006. The 2006 Plan originally authorized up to 1,300,000 shares for issuance
under the Plan, and was amended during 2009 to increase the number of shares authorized for
issuance to 2,800,000 shares, provided however, that the maximum number of restricted shares of
that total shall be 300,000. This amendment was adopted by our Board of Directors in May 2009 and
approved by our shareholders in August 2009. Awards in the form of stock options, restricted
shares, stock appreciation rights, performance shares or performance units may be granted to
directors, officers and other employees under the 2006 Plan.
Options granted to employees under our equity compensation plans prior to 2007 generally vested
over a two-year period with one-third vesting upon grant. Beginning in 2007, options granted to
employees under the 2006 Plan generally vest over a three-year period, with one-third vesting at
the end of each year during such period. Options granted to non-employee directors are generally
fully vested on the date of the grant. Options granted under our equity compensation plans expire
ten years from the date of the grant. The grant price on any such shares or options is equal to the
fair market value of our shares at the date of the grant, as defined in the 2006 Plan. Restricted
shares and stock appreciation rights will vest in accordance with the terms of the applicable award
agreement and the 2006 Plan. The 2006 Plan requires that non-performance-based restricted stock
grants to employees vest in no less than three years, while performance-based restricted stock
grants may vest after one year. Grants of restricted stock to directors may vest after one year.
Under the terms of the 2006 Plan, during the restriction period, a holder of restricted shares has
the right to vote the shares, but is not permitted to trade them.
Stock-Based Compensation Expense
During the first quarter of 2010, in connection with his appointment as Chairman of the Board, the
Compensation Committee of the Board of Directors approved a grant of stock appreciation rights
(SARS) with respect to 250,000 shares of our common stock to Edward Kennedy. The SARS vest only
upon the satisfaction of certain conditions, none of which are considered probable at September 30,
2010; however, such conditions may be satisfied in the future. In addition, in connection with his
appointment as Chairman, Mr. Kennedy received a grant of 50,000 restricted shares. As Mr. Kennedy,
who has since been named our President and CEO, was a non-employee director at the time of the
grant, the terms of the restricted share award provide that the shares will vest, and the
restrictions on the shares will be lifted, one year from the date of grant, unless Mr. Kennedy is
removed from the Board for cause during that time.
A total of 50,000 restricted shares were also granted under the 2006 Plan during the first quarter
of 2010 to executive officers. Of these grants, 30,000 shares were issued to our former Chief
Executive Officer, and 20,000 shares were issued to our Chief Financial Officer. The terms of these
awards provide that they will vest, and the restrictions on the shares will be released, on the
third anniversary of the grant date, provided in each case that the employee is still in our employ
at such time. The 30,000 restricted shares granted to our former CEO were forfeited when he left
the Company in June 2010.
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During the second quarter of 2010, the Compensation Committee of the Board of Directors awarded
477,500 stock options to certain named executives and other key employees.
During the third quarter of 2010, the Board of Directors resolved to approve awards to non-employee
directors of 8,000 shares of restricted stock with an effective date of October 1, 2010. No
expense for this award was recorded in the third quarter of 2010; however, we will record expense
of approximately $0.4 million in the fourth quarter of 2010 related to this action.
We recognized total stock-based compensation expense of $0.2 million for both the three month
periods ended September 30, 2010 and September 26, 2009, and approximately $0.7 million for both
the nine month periods ended September 30, 2010 and September 26, 2009.
The unamortized stock-based compensation expense from operations related to stock options and
restricted stock totaled $1.9 million at September 30, 2010.
Transactions involving stock options under our current and prior plans and otherwise are summarized
below:
Range of Option | Weighted Average | |||||||||||
Number of Shares | Prices | Exercise Price | ||||||||||
Outstanding, December 31, 2009 |
1,684,795 | $ | 3.27 - $159.19 | $ | 27.29 | |||||||
Granted |
477,500 | $ | 6.43 - $6.48 | $ | 6.48 | |||||||
Exercised |
(24,334 | ) | $ | 4.26 | $ | 4.26 | ||||||
Cancelled/Forfeited/Expired |
(568,308 | ) | $ | 6.09 - $59.35 | $ | 35.39 | ||||||
Outstanding, September 30,
2010 |
1,569,653 | $ | 3.27 - $103.59 | $ | 9.05 | |||||||
4. SEVERANCE
During the first quarter of 2010, we accelerated our efforts to reduce our operating expenses in
order to help position ourselves to achieve stronger profitability levels in the future. As such,
we eliminated 48 positions across all functional levels of the organization in an effort to reduce
our overall cost structure. The total severance charge associated with these actions was
approximately $1.7 million, of which approximately $0.5 million was recorded as cost of sales
expense and $1.2 million was recorded as an operating expense. During the second quarter of 2010,
we incurred a severance charge of $0.9 million related to the departure of our former Chief
Executive Officer. This expense was recorded as an operating expense. In relation to these
actions, and due to changes in certain circumstances related to our planned actions, we recorded
certain positive adjustments to our severance accruals in both the second quarter and third
quarters of 2010 in the amounts of $0.3 million and $0.2 million, respectively. We do not
anticipate any further adjustment related to our workforce reduction or for the departure of our
former Chief Executive Officer and the majority of the cash payments related to these actions was
made during the second quarter of 2010.
During 2009, we had several restructuring plans in order to reduce our headcount and achieve lower
operating costs. During the third quarter of 2009, we developed a plan to reduce and restructure
our workforce across all levels of the organization in an effort to reduce costs in order to better
align our resources to our revenue streams. The total severance charge associated with this plan
was approximately $1.4 million of which $0.5 million was recorded as cost of sales expense and $0.9
million was recorded as an operating expense. Additionally, we incurred $0.2 million of severance
charges related to the departure of our former chief financial officer that was recorded as an
operating cost. During the second quarter of 2009, we decided to outsource almost all of our
in-house manufacturing to a third party vendor and, as such, we reduced our production staffing.
The total severance expense associated with this action was approximately $0.1 million.
During the first quarter of 2009, we implemented a restructuring program pursuant to which we
realigned existing resources to new projects, reduced our field service and sales staffing and
completed other reduction
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activities. The severance costs associated with this program amounted to
approximately $0.3 million, of which approximately $0.2 million was recorded in cost of sales and
approximately $0.1 million was recorded as operating expenses. All cash payments related to these
actions were paid in 2009 and no further expense is expected.
5. INTANGIBLE ASSETS
The following information is provided regarding our intangible assets (in thousands):
September 30, 2010 | ||||||||||||||||||||
Accumulated | Impairments | |||||||||||||||||||
Useful | Amortization | During the | ||||||||||||||||||
Life | and | Reporting | ||||||||||||||||||
Amortizing Intangible Assets: | (Years) | Gross | Impairments | Period | Net | |||||||||||||||
Post warranty service
agreements |
6-15 | $ | 37,644 | $ | 32,965 | $ | | $ | 4,679 | |||||||||||
Technology |
2-10 | 13,992 | 13,131 | | 861 | |||||||||||||||
Customer relationships |
5-15 | 915 | 685 | | 230 | |||||||||||||||
Tradenames and other |
1-10 | 576 | 512 | | 64 | |||||||||||||||
Total Intangible Assets |
$ | 53,127 | $ | 47,293 | $ | 0 | $ | 5,834 | ||||||||||||
December 31, 2009 | ||||||||||||||||||||
Accumulated | Impairments | |||||||||||||||||||
Useful | Amortization | During the | ||||||||||||||||||
Life | and | Reporting | ||||||||||||||||||
Amortizing Intangible Assets: | (Years) | Gross | Impairments | Period | Net | |||||||||||||||
Post warranty service
agreements |
6-15 | $ | 37,779 | $ | 5,438 | $ | 26,960 | $ | 5,381 | |||||||||||
Technology |
2-10 | 14,000 | 12,488 | 191 | 1,321 | |||||||||||||||
Customer relationships |
5-15 | 927 | 613 | | 314 | |||||||||||||||
Tradenames and other |
1-10 | 537 | 443 | | 94 | |||||||||||||||
Total Intangible Assets |
$ | 53,243 | $ | 18,982 | $ | 27,151 | $ | 7,110 | ||||||||||||
Differences between reported amortization expense and the change in reported accumulated
amortization may vary because of foreign currency translation differences between the balance sheet
and income statement.
Amortization expense is estimated to be $0.4 million, $1.2 million, $0.7 million, $0.6 million and
$0.5 million for the remainder of 2010, and each of the years 2011, 2012, 2013 and 2014,
respectively.
Impairments
Long-Lived Assets
We perform impairment reviews of our long-lived assets upon a change in business conditions or upon
the occurrence of a triggering event.
In mid-December 2009, we learned that a major customer of our LoopCare post-warranty software
maintenance services would not renew its direct contract with us for those services following the
contracts expiration date on December 31, 2009. As such, we incurred an impairment charge of
approximately $27.0 million related to this occurrence following our review of the carrying value
of this long-lived asset.
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6. INVENTORIES
Inventories consisted of the following (in thousands):
September 30, 2010 | December 31, 2009 | |||||||
Raw materials |
$ | 3,452 | $ | 3,584 | ||||
Work in process |
644 | 830 | ||||||
Finished goods |
1,946 | 2,352 | ||||||
Total Gross Inventory |
6,042 | 6,766 | ||||||
Reserves for slow
moving and obsolete
inventory |
(4,460 | ) | (4,647 | ) | ||||
Net Inventory |
$ | 1,582 | $ | 2,119 | ||||
7. PRODUCT WARRANTY
Activity in the warranty accrual is as follows (in thousands):
September 30, 2010 | December 31, 2009 | |||||||
Balance at the beginning of the period |
$ | 565 | $ | 926 | ||||
Accruals for warranties issued during
the period |
6 | 894 | ||||||
Settlements during the period |
(299 | ) | (1,316 | ) | ||||
Balance at the end of the period |
$ | 272 | $ | 504 | ||||
8. PER SHARE INFORMATION
Basic income/(loss) per common share is computed by dividing net income/(loss) by the
weighted-average number of common shares outstanding during the reporting period. Diluted
income/(loss) per common share is computed by dividing net income/(loss) by the combination of
dilutive common share equivalents, comprised of shares issuable under our share-based compensation
plans and the weighted-average number of common shares outstanding during the reporting period.
Dilutive common share equivalents include the dilutive effect of in-the-money options, which is
calculated, based on the average share price for each period using the treasury stock method.
Under the treasury stock method, the exercise price of a share, the amount of compensation cost, if
any, for future service that we have not yet recognized, and the amount of estimated tax benefits
that would be recorded in additional paid-in capital, if any, when the share is exercised are
assumed to be used to repurchase shares in the current period.
When we are in a loss position, we do not include any stock options outstanding with an exercise
price below the average market price, as their effect would be considered anti-dilutive. Since we
reported net income for the three month period and the nine month period ended September 30, 2010,
our per share information for the three month period and nine month period ended September 30, 2010
includes the dilutive effect of 444,390 and 229,029 equivalent shares respectively. Because we
incurred losses during the three and nine month periods ended September 26, 2009, we do not include
the affect of dilutive securities because inclusion would be anti-dilutive to the earnings per
share calculation. As of September 30, 2010 and September 26, 2009, 1,333,700
and 1,680,598 equivalent shares, respectively, were anti-dilutive.
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9. REVENUE CONCENTRATION, MAJOR CUSTOMERS
The following table represents our total sales by major product lines as well as the percentage of
total revenue represented by sales of each such major product line.
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||||
September 30, 2010 | September 26, 2009 | September 30, 2010 | September 26, 2009 | |||||||||||||||||||||||||||||
Test Products |
$ | 3,354 | 30 | % | $ | 3,937 | 35 | % | $ | 9,390 | 28 | % | $ | 10,851 | 34 | % | ||||||||||||||||
MCU |
1,362 | 12 | % | 1,079 | 10 | % | 4,484 | 13 | % | 4,135 | 13 | % | ||||||||||||||||||||
Services |
6,340 | 57 | % | 6,310 | 56 | % | 19,849 | 59 | % | 17,300 | 54 | % | ||||||||||||||||||||
Total |
$ | 11,056 | 100 | % | $ | 11,326 | 100 | % | $ | 33,723 | 100 | % | $ | 32,286 | 100 | % | ||||||||||||||||
As of September 30, 2010, we had approximately $4.2 million of accounts receivable with three
customers, each of which individually exceeded 10% of our September 30, 2010 receivable balances.
As of December 31, 2009, we had approximately $5.4 million of accounts receivable with three
customers, each of which individually exceeded 10% of our December 31, 2009 receivable balances.
The following table represents sales to our customers that individually exceeded 10% of our net
sales:
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||||
September 30, 2010 | September 26, 2009 | September 30, 2010 | September 26, 2009 | |||||||||||||||||||||||||||||
Customer A |
$ | 2,460 | 22 | % | $ | 1,448 | 13 | % | $ | 7,607 | 23 | % | $ | 4,850 | 15 | % | ||||||||||||||||
Customer B |
1,779 | 16 | % | 1,913 | 17 | % | 5,337 | 16 | % | 3,501 | 11 | % | ||||||||||||||||||||
Customer C |
1,477 | 13 | % | 373 | 3 | % | 3,378 | 10 | % | 2,594 | 8 | % | ||||||||||||||||||||
`` |
||||||||||||||||||||||||||||||||
Total |
$ | 5,716 | 52 | % | $ | 3,734 | 33 | % | $ | 16,322 | 48 | % | $ | 10,945 | 34 | % | ||||||||||||||||
Our sales are primarily in the following geographic areas: Domestic (United States); the
Americas (excluding the United States); Europe and Africa; and Asia. The following table
represents sales to our customers based on these geographic locations:
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||||
September 30, 2010 | September 26, 2009 | September 30, 2010 | September 26, 2009 | |||||||||||||||||||||||||||||
Region |
||||||||||||||||||||||||||||||||
Europe/Africa |
$ | 4,131 | 37 | % | $ | 2,464 | 22 | % | $ | 10,680 | 32 | % | $ | 9,537 | 30 | % | ||||||||||||||||
Americas |
1,048 | 9 | % | 1,117 | 10 | % | 1,695 | 5 | % | 2,821 | 9 | % | ||||||||||||||||||||
Asia |
12 | 0 | % | 86 | 1 | % | 1,426 | 4 | % | 585 | 2 | % | ||||||||||||||||||||
Total International |
5,191 | 47 | % | 3,667 | 32 | % | 13,801 | 41 | % | 12,943 | 40 | % | ||||||||||||||||||||
Total Domestic |
5,865 | 53 | % | 7,659 | 68 | % | 19,922 | 59 | % | 19,343 | 60 | % | ||||||||||||||||||||
Total Revenue |
$ | 11,056 | 100 | % | $ | 11,326 | 100 | % | $ | 33,723 | 100 | % | $ | 32,286 | 100 | % | ||||||||||||||||
10. COMPREHENSIVE INCOME
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, 2010 | September 26, 2009 | September 30, 2010 | September 26, 2009 | |||||||||||||
Net Income/(Loss) |
$ | 2,493 | ($7,082 | ) | $ | 2,057 | ($9,814 | ) | ||||||||
Foreign currency
translation |
177 | 73 | (6 | ) | 693 | |||||||||||
Comprehensive
Income/(Loss) |
$ | 2,670 | ($7,009 | ) | $ | 2,051 | ($9,121 | ) | ||||||||
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Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion should be read in conjunction with the Unaudited Condensed Consolidated
Financial Statements and Notes thereto appearing elsewhere in this report. Additionally, when used
in this Form 10-Q unless the context requires otherwise, the terms we, our, and us refer to
Tollgrade Communications, Inc.
CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995.
Managements Discussion and Analysis of Results of Financial Condition and Results of Operations
(this MD&A) should be read in conjunction with our Annual Report on Form 10-K for the year ended
December 31, 2009 (the Form 10-K).
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, which 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 Part II,
Item 1A below 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 the divestiture 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 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 Condensed Consolidated Financial
Statements refers to continuing operations unless otherwise indicated. The results from the
divested product line are reported in discontinued operations.
Overview
Tollgrade Communications, Inc. is a leading provider of centralized test and measurement systems
and service offerings to the telecommunications market. Our products enable our customers to
remotely diagnose and proactively address problems in their networks. Our services and managed
services offerings complement our product solutions as well as provide customer support and
engineering services. In addition, we are also utilizing our core expertise
in service assurance to develop our LightHouse product line for the electric utility market as this
product line is designed to provide power grid monitoring capabilities.
Our Customers
Our customers include the top telecom providers and numerous independent telecom 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 customer groups, the first of which includes AT&T, Verizon
and Qwest (collectively referred to herein as large
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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 Telefónica O2 Czech Republic, a.s.
(collectively referred to herein as the European Telcos).
Backlog
Our order backlog for firm customer purchase orders, software maintenance contracts and managed
services contracts was $17.9 million as of September 30, 2010 compared to a backlog of $15.6
million as of December 31, 2009. The backlog at September 30, 2010 and December 31, 2009 included
approximately $11.7 million and $8.4 million, respectively, related to software maintenance
contracts, which is primarily earned and recognized as income on a straight-line basis during the
remaining terms of these agreements. During the remainder of 2010, we expect to recognize $4.4
million of the September 30, 2010 backlog.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2010 COMPARED TO THREE MONTHS ENDED SEPTEMBER 26, 2009
Revenue
September 30, 2010 | September 26, 2009 | Change | % | |||||||||||||
System Test Products |
$ | 3,354 | $ | 3,937 | ($583 | ) | -15 | % | ||||||||
MCU |
1,362 | 1,079 | $ | 283 | 26 | % | ||||||||||
Total Products |
4,716 | 5,016 | ($300 | ) | -6 | % | ||||||||||
Services |
6,340 | 6,310 | $ | 30 | 0 | % | ||||||||||
Total Revenues |
$ | 11,056 | $ | 11,326 | ($270 | ) | -2 | % |
Our total revenues for the third quarter of 2010 were approximately $11.1 million compared to
total revenues of $11.3 million for the third quarter of 2009.
Our product revenue consists primarily of sales of our system test products as well as sales of our
traditional MCU product line. Product revenue was approximately $4.7 million or 43% of our total
third quarter revenue compared to $5.0 million or 44% of our total third quarter revenue for 2009.
Overall, our third quarter 2010 product revenue decreased by approximately $0.3 million or 2%
compared to the same period in the prior year. The decrease in our total product sales is
primarily attributable to a $0.7 million reduction in our LDU/4TEL/Celerity product line and a $0.3
million reduction of our DigiTest system test products due to the timing of customer demand. These
decreases were partially offset by increases of $0.4 and $0.3 in our Protocol and MCU product sales
to certain large domestic carriers, respectively. Our services revenue consists of software
maintenance, managed services agreements, installation oversight and product management services.
Services revenue was approximately $6.3 million or 57% of total third quarter 2010 revenue compared
to $6.3 million or 56% of the total third quarter revenue for 2009. Overall, our third quarter
2010 services revenue was approximately equal to the same period in the prior year as increases in
MCU repair revenue of $0.3 million were offset by $0.3 million of decreases in our LoopCare service
revenues period over period.
Gross Profit
Our gross profit for the third quarter of 2010 was $7.0 million compared to $2.2 million in the
third quarter of 2009, an increase of $4.8 million or 216%. As a percentage of revenues, our gross
profit margin for the third quarter of 2010 improved to 64% versus 20% for the third quarter of
2009. However, our third quarter 2009 gross profit margin included a write-off of inventory of
$3.1 million, an asset impairment of $0.2 million, and severance charges of $0.5 million. These
three 2009 third quarter charges amounted to $3.8 million or
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approximately 34% of our 2009 third
quarter revenues. The primary reasons for our third quarter 2010 gross profit improvement over the
same 2009 period were that these same three charges did not re-occur in 2010, our amortization
expense was lower by approximately $0.3 million and the remaining improvement in our gross profit
and gross profit margin is related to our cost reduction efforts that began in 2009 and continued
into the first four months of 2010. These cost reduction efforts included workforce reductions and
outsourcing almost 100% of our in-house manufacturing.
Selling and Marketing Expenses
September 30, 2010 | September 26, 2009 | Change | % | |||||||||||||
Employee Costs |
$ | 1,033 | $ | 1,044 | ($11 | ) | -1 | % | ||||||||
Travel Expenses |
91 | 245 | (154 | ) | -63 | % | ||||||||||
Consulting Expenses |
27 | 67 | (40 | ) | -60 | % | ||||||||||
Other Expenses |
92 | 211 | (119 | ) | -56 | % | ||||||||||
Total |
$ | 1,243 | $ | 1,567 | ($324 | ) | -21 | % |
Our total selling and marketing expenses were approximately $1.2 million in the third quarter
of 2010 compared to approximately $1.6 million in the third quarter of 2009, a decrease of
approximately $0.3 million, or 21%. Our selling and marketing expenses consist primarily of
employee costs, which include salaries and related payroll taxes, benefits, and commission expenses
as well as related travel expenses and certain consulting expenses and other miscellaneous
expenses. The $0.3 million decrease in our selling and marketing expenses is primarily
attributable to savings in salaries and payroll taxes, benefits and related travel, and consulting
expenses as a result of our recent workforce reduction. Various other expense items resulted in a
decrease quarter over quarter, none of which are individually material. As a percentage of total
third quarter 2010 revenue, selling and marketing expenses decreased to 11% as compared to 14% in
the third quarter of 2009.
General and Administrative Expenses
September 30, 2010 | September 26, 2009 | Change | % | |||||||||||||
Employee Costs |
$ | 870 | $ | 1,159 | ($289 | ) | -25 | % | ||||||||
Legal &
Professional Fees |
425 | 1,322 | (897 | ) | -68 | % | ||||||||||
Bad Debt Expense |
1 | 1,116 | (1,115 | ) | -100 | % | ||||||||||
General Insurance
Expense |
79 | 172 | (93 | ) | -54 | % | ||||||||||
Other Expense |
438 | 342 | 96 | 28 | % | |||||||||||
Total |
$ | 1,813 | $ | 4,111 | ($2,298 | ) | -56 | % |
Our total general and administrative expenses for the third quarter of 2010 were approximately
$1.8 million compared to approximately $4.1 million in the third quarter of 2009, a decrease of
$2.3 million or 56%. General and administrative expenses consist primarily of employee costs,
which include salaries and related payroll taxes and benefit related costs, stock compensation
expenses, legal and professional fees, bad debt expenses, general insurance expenses, and other
various expenses. Our third quarter 2010 general and administrative expenses decreased primarily as
a result of reduced bad debt expense from a write off of a large international account receivable
balance that approximated $1.1 million in the third quarter of 2009 along with a $0.9 million
reduction in legal and professional fees. These legal and professional fees were lower in 2010
because we did not incur the approximately $0.4 million related to the contested election of
directors in 2009 or approximately $0.1 million related to acquisition targets that were ultimately
not pursued, as well as lower board fees, and lower accounting fees resulting from our change in
auditors. In addition, our third quarter 2010 employee costs are lower by approximately $0.3
million due to the workforce reductions that occurred in the fourth quarter of 2009 and the first
quarter 2010, resulting in the elimination of 11 full-time positions over these two time periods.
The decline in our insurance expenses of approximately $0.1 million during the third quarter
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of
2010 was due primarily to changes in our directors and officers insurance program as well as
negotiating lower premiums in our overall general insurance programs. Various other expense items
resulted in a slight increase quarter over quarter, none of which are individually material. As a
percentage of total third quarter 2010 revenue, general and administrative expenses decreased to
16% as compared to 36% in the third quarter of 2009.
Research and Development Expenses
September 30, 2010 | September 26, 2009 | Change | % | |||||||||||||
Employee Costs |
$ | 1,285 | $ | 2,033 | ($748 | ) | -37 | % | ||||||||
Professional Fees |
12 | 212 | (200 | ) | -94 | % | ||||||||||
Depreciation |
141 | 159 | (18 | ) | -11 | % | ||||||||||
Cost of sales allocation |
(362 | ) | (448 | ) | 86 | -19 | % | |||||||||
Other |
352 | 397 | (45 | ) | -11 | % | ||||||||||
Total |
$ | 1,428 | $ | 2,353 | ($925 | ) | -39 | % |
Our research and development expenses for the third quarter of 2010 were approximately $1.4
million compared to approximately $2.4 million in the third quarter of 2009, a decrease of $0.9
million or 39%. Our research and development expenses consist primarily of payroll and related
benefit costs, professional fees, depreciation expenses and other expenses. In addition, because
some of our contractual agreements require us to provide engineering development or repair services
to our customers, a portion of our engineering costs are allocated to cost of sales. Our third
quarter 2010 employee related costs and professional fees have declined by approximately $0.7
million and $0.2 million, respectively, primarily as a result of our recent workforce reductions
and less use of outside contractors as compared to the same prior period. Depreciation expenses
have also declined slightly quarter over quarter as a result of certain assets becoming fully
depreciated faster than new assets are placed into service. The allocation of research and
development charges to cost of sales has decreased by approximately $0.1 million as a result of our
reduced workforce and a shift in the portion of engineering time spent on existing products and
services as compared to research projects period over period. Various other expense items resulted
in a slight decrease quarter over quarter, none of which are individually material. As a
percentage of total third quarter 2010 revenue, research and
development expense decreased to 13% as compared to 21% for the third quarter of 2009.
Severance Expenses
During the first quarter of 2010, we accelerated our efforts to reduce our operating expenses in
order to help position ourselves to achieve stronger profitability levels in the future. As such,
we eliminated 48 positions across all functional levels of the organization in an effort to reduce
our overall cost structure. The total severance charge associated with these actions was
approximately $1.7 million, of which approximately $0.5 million was recorded as cost of sales
expense and $1.2 million was recorded as an operating expense. During the second quarter of 2010,
we incurred a severance charge of $0.9 million related to the departure of our former Chief
Executive Officer. This expense was recorded as an operating expense. In relation to these
actions due to changes in certain circumstances related to our planned actions, we recorded certain
positive adjustments to our severance accrual in the third quarter of 2010 in the amount of $0.2
million. We do not anticipate any further adjustment related to our workforce reduction or for the
departure of our former Chief Executive Officer and the majority of the cash payments related to
these actions were made during the second quarter of 2010.
During the third quarter of 2009, we developed a plan to reduce and restructure our workforce
across all levels of the organization in an effort to reduce costs in order to better align our
resources to our revenue streams. The total severance charge associated with this plan was
approximately $1.4 million, of which $0.5 million was recorded as cost of sales expense and $0.9
million was recorded as an operating expense. Additionally, we
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incurred $0.2 million of severance
charges related to the departure of our former chief financial officer, which was recorded as an
operating cost. All cash payments related to this action were paid in 2009 and no further expense
is expected.
Other Income/(Expense)
Other income for the third quarter of 2010 was approximately $0.7 million as compared to less than
$0.1 million of other income for the third quarter of 2009. This increase of $0.6 million was due
primarily to temporary foreign currency translation adjustments on intercompany loans with our
foreign subsidiaries as a result of the increasing value of the Euro and Pound Sterling against the
U.S. dollar. In prior years, our intercompany loans with our foreign subsidiaries were considered
permanent in nature because no formal loan agreements were in place, thus the foreign exchange
translation adjustments on these loans when converted to U.S. dollars were recorded directly to our
balance sheet. In December 2009, these intercompany loans were formalized into loan agreements
with established maturity dates. In accordance with GAAP, these loans were no longer considered
permanent, but became temporary in nature, and thus the foreign currency translation adjustments on
these loans from Euros and Pounds to U.S. dollars are now recorded directly to the income
statement. In addition, our interest income on our excess cash balances was less than $0.1 million
in the third quarters of 2010 and 2009.
Income Taxes
We recorded an income tax expense of approximately $0.9 million during the third quarter of
2010 compared to an income tax benefit of $0.1 million in the third quarter of 2009. The increase
in tax expense in the third quarter of 2010 is primarily due to profits in our foreign operating
jurisdictions, primarily in our United Kingdom subsidiary.
Although we now have consolidated book income, we continue to generate tax losses resulting from
timing differences in the United States and net operating losses in the United States and in
certain foreign jurisdictions. As a result, we continue to carry a valuation allowance against the
federal, state and certain foreign net operating losses as the tax benefit generated from those
losses is deemed to be likely unrealizable in future periods.
NINE MONTHS ENDED SEPTEMBER 30, 2010 COMPARED TO NINE MONTHS ENDED SEPTEMBER 26, 2009
Revenue
September 30, 2010 | September 26, 2009 | Change | % | |||||||||||||
System Test Products |
$ | 9,390 | $ | 10,851 | ($1,461 | ) | -13 | % | ||||||||
MCU |
4,484 | 4,135 | $ | 349 | 8 | % | ||||||||||
Total Products |
13,874 | 14,986 | ($1,112 | ) | -7 | % | ||||||||||
Services |
19,849 | 17,300 | $ | 2,549 | 15 | % | ||||||||||
Total Revenues |
$ | 33,723 | $ | 32,286 | $ | 1,437 | 4 | % |
Our total revenues for the nine months ended September 30, 2010 were $33.7 million compared to
total revenues of $32.3 million for the nine months ended September 26, 2009, an increase of $1.4
million, or 4%.
Our product revenue consists primarily of sales of our system test products as well as sales of our
traditional MCU product line. Our product revenue was approximately $13.9 million, or 41% of our
total revenues for the first nine months of 2010, compared to approximately $15.0 million, or 46%
of total revenues for the first nine months of 2009. Overall, our 2010 nine month product revenues
decreased by approximately $1.1 million, or
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7%, compared to the same prior year period. The
decrease in our total product sales is primarily attributable to a $1.1 million reduction in our
LDU/4TEL/Celerity product line, a $0.4 million reduction of our DigiTest system test products, and
a $0.4 million reduction in LoopCare and other products due to the timing of customer demand.
These decreases were partially offset by increases of $0.5 and $0.3 in our Protocol and MCU product
sales to certain large domestic carriers respectively.
Offsetting the declines in our product revenues was a $2.5 million, or 15%, increase in our service
revenues over the nine months ended September 30, 2010 compared to the nine months ended September
26, 2009. Our services revenue consists of software maintenance, managed services agreements,
installation oversight and product management services. Services revenue was approximately $19.8
million, or 59% of revenues for the nine months ended 2010 compared
to $17.3 million, or 54%, of revenues over the same 2009 period. The increase is primarily
attributable to our multi-year managed services agreement with Ericsson that we completed during
the second quarter of 2009. Revenues under the Ericsson agreement were approximately $5.3 million
for the nine months ended 2010 compared to $3.3 million for same 2009 period. In addition, revenue
from our new OEM product line which we began to offer in late 2009 amounted to approximately $0.3
million of new revenue in 2010. Finally, net repair revenue increased by approximately $0.2
million during the first nine months of 2010 as compared to the same 2009 period.
Gross Profit
Our gross profit for the nine month period ended 2010 was approximately $20.6 million, compared to
$12.7 million during the same nine month period ended 2009, an increase of $7.9 million, or 62%.
As a percentage of sales, our gross profit margin for the nine month period ended 2010 was 61% as
compared to 39% for the same nine months of 2009. However, our first nine months of 2009 gross
profit margin included a write-off of inventory of $3.1 million, an asset impairment of $0.2
million, and severance charges of $0.8 million. These nine month 2009 charges amounted to $4.1
million, or approximately 13%, of our 2009 nine month revenues. The primary reasons for our nine
month 2010 gross profit improvement over the same 2009 period was that these same three charges did
not re-occur in 2010, our amortization expense was lower by approximately $0.8 million and the
remaining improvement in our gross profit and gross profit margin is related to our cost reduction
efforts that began in late 2009 and continued into the first four months of 2010. These cost
reduction efforts included workforce reductions and outsourcing almost 100% of our in-house
manufacturing.
Selling and Marketing Expenses
September 30, 2010 | September 26, 2009 | Change | % | |||||||||||||
Employee Costs |
$ | 3,505 | $ | 3,346 | $ | 159 | 5 | % | ||||||||
Travel Expenses |
419 | 658 | (239 | ) | -36 | % | ||||||||||
Consulting Expenses |
261 | 304 | (43 | ) | -14 | % | ||||||||||
Other Expenses |
394 | 542 | (148 | ) | -27 | % | ||||||||||
Total |
$ | 4,579 | $ | 4,850 | ($271 | ) | -6 | % |
Our total selling and marketing expenses for the nine months ended 2010 were approximately
$4.6 million compared to approximately $4.9 million over the same nine months ended 2009, a
decrease of approximately $0.3 million or 6%. Our selling and marketing expenses consist
primarily of employee costs, which include salaries and related payroll taxes, benefits, and
commission expenses as well as related travel expenses and certain consulting expenses and other
miscellaneous expenses. The $0.3 million decrease in our selling and marketing expenses is
primarily attributable to savings in travels costs due in part by our workforce reduction and
through better planning of customer visits, lower consulting expense and lower costs in other
expenses, none of which are individually material. These decreases were partially offset by higher
employee related costs due primarily to increased commission and bonus accruals. As a percentage
of total nine month 2010 revenue, selling and marketing expenses decreased to 14% as compared to
15% in the same 2009 period.
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General and Administrative Expenses
September 30, 2010 | September 26, 2009 | Change | % | |||||||||||||
Employee Costs |
$ | 3,025 | $ | 3,458 | ($433 | ) | -13 | % | ||||||||
Legal &
Professional Fees |
1,482 | 3,313 | (1,831 | ) | -55 | % | ||||||||||
General Insurance
Expense |
259 | 512 | (253 | ) | -49 | % | ||||||||||
Bad Debt Expense |
(91 | ) | 1,182 | (1,273 | ) | -108 | % | |||||||||
Other Expense |
1,310 | 1,060 | 250 | 24 | % | |||||||||||
Total |
$ | 5,985 | $ | 9,525 | ($3,540 | ) | -37 | % |
Our general and administrative expenses for the nine months ended 2010 were approximately $6.0
million compared to approximately $9.5 million in the nine months ended 2009, a decrease of $3.5
million or 37%. General and administrative expenses consist primarily of employee costs, which
include salaries and related payroll taxes and benefit related costs, stock compensation expenses,
legal and professional fees, general insurance expenses, bad debt expenses, and other various
expenses. Our nine month 2010 general and administrative expenses decreased primarily as a result
of a reduction in bad debt expense as we wrote off a large international account receivable balance
that approximated $1.1 million in the third quarter of 2009 along with lower legal and professional
fees of approximately $1.8 million.
These legal and professional fees were lower in 2010 because we did not incur the approximately
$1.3 million in fees related to the contested election of directors in 2009 and potential
acquisition targets that were ultimately not pursued, as well as lower board fees and accounting
fees from our change in auditors. In addition, our nine month 2010 employee costs are lower by
approximately $0.4 million due to the workforce reductions that occurred in the fourth quarter of
2009 and the first quarter 2010 that resulted in the elimination of 11 full-time positions over
these two time periods. The decline in our insurance expenses of approximately $0.3 million during
the first nine months of 2010 was due primarily to changes in our directors and officers insurance
program as well as negotiating lower premiums in our overall general insurance programs. Various
other expense items resulted in a $0.2 million increase over the nine months ended 2010 compared to
the same 2009 time period, none of which are individually material. As a percentage of total nine
month 2010 revenue, general and administrative expenses decreased to 18% as compared to 30% over
the nine months ended 2009.
Research and Development Expenses
September 30, 2010 | September 26, 2009 | Change | % | |||||||||||||
Employee Costs |
$ | 4,700 | $ | 6,068 | ($1,368 | ) | -23 | % | ||||||||
Professional Fees |
474 | 492 | (18 | ) | -4 | % | ||||||||||
Depreciation |
430 | 507 | (77 | ) | -15 | % | ||||||||||
Cost of sales
allocation |
(1,068 | ) | (1,311 | ) | 243 | -19 | % | |||||||||
Other |
932 | 1,039 | (107 | ) | -10 | % | ||||||||||
Total |
$ | 5,468 | $ | 6,795 | ($1,327 | ) | -20 | % |
Our research and development expenses for the nine months ended 2010 were approximately $5.5
million compared to approximately $6.8 million for the first nine months of 2009, a decrease of
approximately $1.3 million, or 20%. Our research and development expenses consist primarily of
payroll and related benefit costs, professional fees, depreciation expenses and other expenses. In
addition, because some of our contractual agreements require us to provide engineering development
or repair services to our customers, a portion of our engineering costs are allocated to cost of
sales. The primary reason for the decrease in our research and development expenses during the
nine months ended 2010 is the reduction in employee related costs of approximately $1.4 million as
a result of our workforce reductions that began in late 2009 and were completed over the first four
months of 2010. Depreciation expenses have also declined by approximately $0.1 million
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over the nine months ended 2010 compared to the same 2009 period as a result of certain assets
becoming fully depreciated faster than new assets are placed in service. The allocation of research
and development charges to cost of sales has decreased by approximately $0.2 million as a result of
our reduced workforce and a shift in the portion of engineering time spent on existing products and
services as compared to research projects period over period. Various other expense items resulted
in a decrease of approximately $0.1 million over the nine months ended 2010 compared to the same
2009 period, none of which are individually material. As a percentage of total nine month 2010
revenue, research and development expenses decreased to 16% as compared to 21% for the same 2009
period.
Severance Expenses
During the first quarter of 2010, we accelerated our efforts to reduce our operating expenses in
order to help position ourselves to achieve stronger profitability levels in the future. As such,
we eliminated 48 positions across all functional levels of the organization in an effort to reduce
our overall cost structure. The total severance charge associated with these actions was
approximately $1.7 million of which approximately $0.5 million was recorded as cost of sales
expense and $1.2 million was recorded as an operating expense. During the second quarter of 2010,
we incurred a severance charge of $0.9 million related to the departure of our former Chief
Executive Officer. This expense was recorded as an operating expense. In relation to these
actions due to changes in certain circumstances related to our planned actions, we recorded certain
positive adjustments to our severance accruals in both the second quarter and third quarters of
2010 in the amounts of $0.3 million and $0.2 million, respectively. We do not anticipate any
further adjustment related to our workforce reduction or for the departure of our former Chief
Executive officer and the majority of the cash payments related to these actions was made during
the second quarter of 2010.
During 2009, we had several restructuring plans in order to reduce our headcount and achieve lower
operating costs. During the third quarter of 2009, we developed an initial plan to reduce and
restructure our workforce across all levels of the organization in an effort to reduce costs in
order to better align our resources to our revenue streams. The total severance charge associated
with this plan was approximately $1.4 million of which $0.5 million was recorded as cost of sales
expense and $0.9 million was recorded as an operating expense. Additionally, we incurred $0.2
million of severance charges related to the departure of our former chief financial officer that
was recorded as an operating cost. During the second quarter of 2009, we decided to outsource
almost all of our in-house manufacturing to a third party vendor and, as such, we reduced our
production staffing. The total severance expense associated with this action was approximately
$0.1 million.
During the first quarter of 2009, we implemented a restructuring program pursuant to which we
realigned existing resources to new projects, reduced our field service and sales staffing and
completed other reduction activities. The severance costs associated with this program amounted to
approximately $0.3 million of which approximately $0.2 million was recorded in cost of sales and
approximately $0.1 million was recorded as operating expenses. All cash payments related to these
actions were paid in 2009 and no further expense is expected.
Other Income/(Expense)
Other expense for the nine months ended 2010 was less than $0.1 million compared to other income of
approximately $0.6 million for the same 2009 period. This change of approximately $0.6 million is
due primarily to the collection of an insurance settlement in the prior year in the amount of
approximately $0.2 million and higher interest income in 2009 of approximately $0.2 million.
Additionally, we incurred approximately $0.1 million of non-cash temporary foreign currency
translation adjustments on intercompany loans in the 2010 period that we did not incur in the same
2009 period. In prior years, our intercompany loans with our foreign subsidiaries were considered
permanent in nature because no formal loan agreements were in place, thus the foreign exchange
translation adjustments on these loans when converted to U.S. dollars were recorded directly to our
balance sheet. In December 2009, these intercompany loans were formalized into loan agreements
with established maturity dates. In accordance with GAAP, these loans were no longer considered
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permanent, but became temporary in nature, and thus the foreign currency translation adjustments on
these loans from Euros and Pounds to U.S. dollars are now recorded directly to the income
statement. In addition, our interest income on our excess cash balances was approximately $0.1
million in the nine months ended 2010 as compared to approximately $0.2 million in the nine months
ended 2009.
Income Taxes
We recorded an income tax expense of approximately $0.6 million and $0.2 million during the nine
months ended 2010 and 2009, respectively. The increase in tax expense in the nine months ended 2010
is primarily due to higher profits in our foreign operating jurisdictions, primarily in our United
Kingdom subsidiary.
Although we now have consolidated book income, we continue to generate tax losses resulting from
timing differences in the United States and net operating losses in the United States and in
certain foreign jurisdictions. As a result, we continue to carry a valuation allowance against the
federal, state and certain foreign net operating losses as the tax benefit generated from those
losses is deemed to be likely unrealizable in future periods.
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 sources of liquidity are our operating cash flows
and cash on our balance sheet. Our cash and cash equivalents 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. In October 2010, our international
subsidiaries repaid approximately $4.8 million in intercompany loans, originated in 2007, to one of
our domestic subsidiaries.
Our cash and cash equivalents and short-term investments increased to $69.6 million at September
30, 2010 from $66.0 million at December 31, 2009. The $3.6 million increase in cash and cash
equivalents and short term investments from December 31, 2009 is primarily
attributable to an increase in cash generated from operations. We believe we have sufficient cash
balances to meet our cash flow requirements and growth objectives over the next twelve months.
We had working capital of $74.2 million at September 30, 2010, an increase of $5.0 million from
$69.2 million of working capital as of December 31, 2009. The increase in working capital was due
primarily to operating profits and an increase in trade accounts receivables offset by a reduction
of $0.6 million in accounts payable due to the timing of vendor payments.
Net cash provided by operating activities for the nine months ended September 30, 2010 was
approximately $3.6 million compared to net cash provided by operating activities of $2.1 million
for the same period in the prior year. The increase in net cash provided by operating activities
of $1.5 million for the first nine months of 2010 is primarily attributable to operating profits, a
decrease in inventory due to a coordinated effort to manage inventory on a just in time basis, and
an increase in accounts payable as a result of the volume and timing of vendor payments. The net
cash provided by operations of $2.1 million for the nine months period ending September 26, 2009 is
primarily attributable to lower levels of inventories, accounts receivable, and accrued expenses.
Net cash used in investing activities was approximately $0.1 million for the nine months ended
September 30, 2010, which was primarily related to capital expenditures of approximately $0.2
million to support our operations partially offset from approximately $0.1 million of collections
from a note receivable related to the sale of our cable product line in 2009. Net cash provided by
investing activities of $4.4 million for the nine
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month ended September 26, 2009 was primarily
related to proceeds from the sale of our cable product line of approximately $3.0 million and the
redemption of a short term investment in the amount of approximately $2.2 million. These increases
in cash were offset by the use of cash of approximately $0.3 million related to the purchase of
certain assets from Ericsson in the second quarter of 2009 and $0.5 million of capital expenditures
to support our operations.
Net cash provided in financing activities was approximately $34,000 for the nine month period ended
September 30, 2010 as the result of cash received from the exercise of stock grants in the amount
of $103,000 partially offset by our purchase of approximately 10,600 shares of our common stock
under our stock repurchase program for approximately $69,000.
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 expires on March 31, 2011. The lease for
our Piscataway, New Jersey location expires on April 30, 2012. We also have office leases in
Bracknell, United Kingdom and Wuppertal, Germany, which expire on December 24, 2012 and January 31,
2011, respectively, and we lease office space in Kontich, Belgium pursuant to a lease commitment
which continues monthly until terminated by either party. We are also involved in various
month-to-month leases for research and development and office equipment at all locations.
In October 2010, we signed a seven year lease commitment for a new headquarters facility in
Cranberry Pennsylvania as our existing Cheswick facility lease expires on March 31, 2011. The new
lease for 24,402 square feet of office and lab space commences on April 1, 2011 with annual lease
payments of approximately $0.4 million.
Minimum annual future commitments due by period are (in thousands):
More | ||||||||||||||||||||
Less than 1 | 1-3 | 3-5 | than 5 | |||||||||||||||||
Total | year | years | years | years | ||||||||||||||||
Operating Lease
Obligations |
4,013 | $ | 194 | $ | 1,469 | $ | 1,038 | $ | 1,312 | |||||||||||
Severance Obligation |
92 | 92 | 0 | 0 | 0 | |||||||||||||||
Uncertain Tax Obligations |
845 | 0 | 845 | 0 | 0 | |||||||||||||||
Pension Obligations |
1,034 | 0 | 0 | 0 | 1,034 | |||||||||||||||
Total |
$ | 5,984 | $ | 286 | $ | 2,314 | $ | 1,038 | $ | 2,346 | ||||||||||
Our lease expense for both the three and nine month periods ended September 30, 2010 and
September 26, 2009 was $0.2 million and $0.6 million, respectively.
In addition, we are, from time to time, party to various legal claims and disputes, either asserted
or unasserted, which arise in the ordinary course of business. While the final resolution of these
matters cannot be predicted with certainty, we do not believe that the outcome of any of these
claims will have a material adverse effect on our consolidated financial position, or annual
results of operations or cash flow.
Application of Critical Accounting Policies
The preparation of financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of
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revenues and expenses during the reporting period. Therefore, the determination of estimates
requires the exercise of judgment based on various assumptions and other factors such as historical
experience, economic conditions, and in some cases, actuarial techniques. Actual results may
differ from those estimates. A discussion of market risks affecting us can be found in
Quantitative and Qualitative Disclosures about Market Risk in this Quarterly Report on Form 10-Q.
A summary of our significant accounting policies and application of these policies are included in
the Notes to Consolidated Financial Statements and in MD&A included in the Form 10-K. Management
believes that the application of these policies on a consistent basis enables us to provide useful
and reliable financial information about our operating results and financial condition. There were
no changes to our critical accounting policies during the third quarter of 2010.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our current investment policy limits our investments in financial instruments to cash and cash
equivalents, individual municipal bonds and corporate and government bonds. The use of financial
derivatives and preferred and common stocks is strictly prohibited. We believe that our risk is
minimized through proper diversification along with the requirements that the securities must be of
investment grade with an average rating of A or better by Standard & Poors. We hold our
investment securities to maturity and believe that earnings and cash flows are not materially
affected by changes in interest rates, due to the nature and short-term investment horizon for
which these securities are invested.
In addition, we are exposed to foreign currency translation fluctuations with our international
operations. We do not have any foreign exchange derivative contracts to hedge against foreign
currency exposures. Therefore, we are exposed to the related effects when the foreign currency
exchange rates fluctuate. If the U.S. dollar strengthens against the Euro and/or the British pound
sterling and or the Czech Republics Koruna, the translation rate for these foreign currencies will
decrease, which will have a negative impact on our operating income. Foreign currency translation
fluctuations have no impact on cash flows as long as we continue to reinvest any profits back into
the respective foreign operations.
Item 4. CONTROLS AND PROCEDURES
Our Chief Executive Officer and the Chief Financial Officer and Treasurer (our principal executive
officer and principal financial officer, respectively) have concluded, based on their evaluation as
of the end of the period covered by this report, that our disclosure controls and procedures
pursuant to Rule 13a-15 of the Securities Exchange Act of 1934 are effective to ensure that
information required to be disclosed in our reports filed or submitted under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time
periods specified in the SECs rules and forms, and include controls and procedures designed to
ensure that information required to be disclosed by the Company in such reports is accumulated and
communicated to our management, including the Chief Executive
Officer and the Chief Financial Officer and Treasurer, as appropriate, to allow timely decisions
regarding required disclosure.
There were no changes in our internal controls over financial reporting (as defined in Rule
13a-15(f) under the Securities Exchange Act of 1934) that occurred during the quarter ended
September 30, 2010 that have materially affected or are reasonably likely to materially affect our
internal controls over financial reporting.
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PART II. OTHER INFORMATION
Item 1A. RISK FACTORS
In addition to the other information set forth in this Form 10-Q, we wish to caution each reader of
this Form 10-Q to carefully consider the factors discussed in Part I, Item 1A, Risk Factors in
the Form 10-K, which could materially affect our business, financial condition or future results.
There are no material changes in our risk factors from those disclosed in the Form 10-K.
Item 6. EXHIBITS
(a) | Exhibits: |
The following exhibits are being filed with this report:
Exhibit | ||
Number | Description | |
10.1
|
Agreement dated September 23, 2010 by and between Tollgrade Communications, Inc. and Edward H. Kennedy, incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K, filed with the SEC on September 29, 2010. | |
31.1
|
Certification of Chief Executive Officer, filed herewith. | |
31.2
|
Certification of Chief Financial Officer, filed herewith. | |
32
|
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18.U.S.C. Section 350, filed herewith. |
LoopCare is a trademark of Tollgrade Communications, Inc.
®Tollgrade is a registered trademark of Tollgrade Communications, Inc.
®DigiTest is a registered trademark of Tollgrade Communications, Inc.
®MCU is a registered trademark of Tollgrade Communications, Inc. ®4TEL is a trademark of Tollgrade Communications, Inc.
®Celerity is a trademark of Tollgrade Communications, Inc.
All other trademarks are the property of their respective owners.
®Tollgrade is a registered trademark of Tollgrade Communications, Inc.
®DigiTest is a registered trademark of Tollgrade Communications, Inc.
®MCU is a registered trademark of Tollgrade Communications, Inc. ®4TEL is a trademark of Tollgrade Communications, Inc.
®Celerity is a trademark of Tollgrade Communications, Inc.
All other trademarks are the property of their respective owners.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Tollgrade Communications, Inc. (Registrant) |
||||
Dated: October 28, 2010 | ||||
/s/ Edward H. Kennedy | ||||
Edward H. Kennedy | ||||
Chief Executive Officer and President | ||||
Dated: October 28, 2010 | ||||
/s/ Michael D. Bornak | ||||
Michael D. Bornak | ||||
Chief Financial Officer and Treasurer |
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EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
(Pursuant to Item 601 of Regulation S-K)
Exhibit | ||
Number | Description | |
10.1
|
Agreement dated September 23, 2010 by and between Tollgrade Communications, Inc. and Edward H. Kennedy, incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K, filed with the SEC on September 29, 2010. | |
31.1
|
Certification of Chief Executive Officer, filed herewith. | |
31.2
|
Certification of Chief Financial Officer, filed herewith. | |
32
|
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18.U.S.C. Section 350, filed herewith. |
26