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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
þ | Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the fiscal year ended December 31, 2010
Commission file number 000-27312
TOLLGRADE COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA | 25-1537134 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
|
3120 Unionville Road, Suite 400, Cranberry Twp., Pennsylvania | 16066 | |
(Address of principal executive offices) | (Zip Code) |
Registrants telephone number, including area code: 724-720-1400
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.20 per share | The NASDAQ Stock Market LLC | |
(Title of Class) | (Exchange on which registered) |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. Yes o No þ
Indicate by a check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§
229.405 of this chapter) is not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K. Yes o No þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
The aggregate market value of the voting and non-voting Common Stock of the registrant held by
non-affiliates of the registrant, calculated based on the closing price as of June 30, 2010 on the
NASDAQ Global Select Market, was approximately $80 million.
As of February 28, 2011, the registrant had outstanding 13,007,388 shares of its Common Stock.
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PART I
CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995.
The statements contained in this Annual Report on Form 10-K of Tollgrade Communications, Inc.
(Tollgrade, the Company, us, or we), including, but not limited to the statements contained
in Item 1, Business, and Item 7, Managements Discussion and Analysis of Financial Condition and
Results of Operations, along with statements contained in other reports that we have filed with
the Securities and Exchange Commission (the SEC), external documents and oral presentations,
which are not historical facts are considered to be forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. These statements, which may be expressed in a variety of ways,
including the use of forward-looking terminology such as believe, expect, intend, may,
will, should, could, potential, continue, estimate, plan, or anticipate, or the
negatives thereof, other variations thereon or compatible terminology, relate to, among other
things, our expectation that we will finalize a contract with a major British customer in early
2011 for a significant project, our belief that developments in our LightHouse product line will
help to widen the gap that we believe exists between our products and those of our competitors, and
our belief that our LightHouse product line and managed services offerings will provide us with
growth opportunities, our merger agreement with affiliates of Golden Gate Capital and our
anticipated completion of the transactions contemplated thereby. We do not undertake any
obligation to publicly update any forward-looking statements.
These forward-looking statements, and any forward-looking statements contained in other public
disclosures of the Company which make reference to the cautionary factors contained in this Form
10-K, are based on assumptions that involve risks and uncertainties and are subject to change based
on the considerations described below. We discuss many of these risks and uncertainties in greater
detail in Item 1A of this Annual Report on Form 10-K under the heading Risk Factors. These and
other risks and uncertainties may cause our actual results, performance or achievements to differ
materially from anticipated future results, performance or achievements expressed or implied by
such forward-looking statements.
The following discussion should be read in conjunction with our Managements Discussion and
Analysis of Financial Condition and Results of Operations, and our financial statements and
related notes contained in this Annual Report on Form 10-K.
Item 1. Business.
Tollgrade designs, engineers, markets and supports test system and status monitoring hardware and
software products for the telecommunications industry primarily in the United States and Europe.
We are also actively testing and developing our Lighthouse smart grid monitoring, which service the
utility marketplace.
Our products sold to telecommunications service providers enable them 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 contract 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.
Our LightHouse products are real-time Smart Grid Monitoring solutions, which will allow utility
customers to continuously detect key circuit parameters, and communicate mission critical data
wirelessly to a central location. Our LightHouse products enable visibility into the quality of
power delivery, and the ability to identify key events that might impact reliability and
efficiency. Our solutions will help utilities reveal network events and accurately track system
condition information.
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On May 27, 2009, we sold our cable product line to focus on our core telecommunications market and
customers, and our financial statements now reflect the operating results of our cable product line
as discontinued operations.
We were incorporated in Pennsylvania in 1986, and began operations in 1988. Our principal offices
are located at 3120 Unionville Road, Suite 400, Cranberry Twp., Pennsylvania 16066 and our
telephone number is (724) 720-1400.
We make available free of charge on our Internet website (www.tollgrade.com) our annual reports on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended, as soon as reasonably practicable after we electronically file such material
with, or otherwise furnish it to, the SEC.
You may read and copy any materials that we file with the SEC at the SECs Public Reference Room at
100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that
contains our reports, proxy, information statements and other information that we file with the SEC
(www.sec.gov). Copies of our filings are available free of charge to any shareholder of
record upon written request to the Secretary of Tollgrade Communications, Inc.
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 a third party original equipment manufacturer (OEM) agreement.
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.
Systems Test Products
Our Systems Test Products include the DigiTest product family, which includes our LoopCare software
and DigiTest ICE®, DigiTest EDGE®, DigiTest HUB and DigiTest Measurement Units (DMU)
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
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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. 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.
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 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 26%, 31% and 37% of our total revenues for the
years ended December 31, 2010, 2009 and 2008, respectively.
MCU Products
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
$0.4 million, $0.2 million and $0.4 million during the years ended December 31, 2010, 2009 and
2008, respectively.
Sales of MCU products and related hardware accounted for approximately 15%, 13% and 18% of our
revenue for the years ended December 31, 2010, 2009 and 2008, 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 58%, 56%
and 45% of our total revenues for the years ended December 31, 2010, 2009 and 2008, 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 2010 and 2009,
revenues from this contract were approximately $7.0 and $5.1 million or approximately 15% and 11%
of our total revenues, respectively. 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
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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 revenue results
that we had anticipated. However, in 2010, we completed a successful field trial with a major US
utility company and are expecting commercial orders in 2011. In addition, we secured a product
trial with a major Canadian utility company as well as signing three other utilities to test our
product. We believe that these new product trials along with the successful field trial with the
major US utility customer, that we may begin to realize new revenues from this product line in 2011
and help us secure longer term organic revenue growth.
Operating Segment
We have determined that our business has one operating segment, test assurance. At this time,
almost 100 percent of our product and service revenues relates 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 funded 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 also 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.
In 2010, we refocused our engineering efforts to align our human capital with projects that were we
felt were capable of providing us with the best near term opportunities for revenue and
profitability, as well as customer funded product and software enhancements. We also reduced or
eliminated spending in areas that involved higher risk or required significant investment that were
longer term in nature for possible returns on investment. We continue to support our broad product
portfolio, from our DigiTest, LDU, and MCU hardware as well as our LoopCare, 4TEL and Celerity
software platforms all the while assuring our customers receive the highest level of service. In
addition, we have recently hired additional resources to help bolster our LightHouse product line
for the potential revenue growth that we hope to realize in 2011 and beyond.
As of December 31, 2010, we had an engineering staff of 34 employees, representing 32% of our total
employee workforce. As of December 31, 2009 and 2008, we had an engineering support staff of 55 and
62 employees which comprised 33% and 32% of our total workforce, respectively. Our engineering
staff is primarily located in three locations, Cranberry Twp., Pennsylvania; Piscataway, New
Jersey; and Bracknell, United Kingdom.
During the years ended December 31, 2010, 2009, and 2008, research and development expenses charged
to operations were $6.8 million, $9.4 million and $10.8 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 each of the years ended December 31, 2010 and 2009 was $1.5
million, and for the year ended December 31, 2008 was $1.4 million.
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Sales and Marketing
For our telecommunications offerings, 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 Cranberry Twp., Pennsylvania and Piscataway, New Jersey in the United States and Bracknell,
United Kingdom and Wuppertal, Germany in Europe, as well as having personnel located in Belgium and
Czech Republic.
For our LightHouse product line, we have been utilizing a direct sales approach using certain sales
personnel that also call on some of our telecommunication customers. At the end of 2010, we added
two additional employees to focus more heavily on marketing and business development to help
further penetrate and enhance our focus on the utility marketplace.
As of December 31, 2010, we had a sales and marketing staff of 18 employees, representing 17% of
our total employee workforce. As of December 31, 2009 and 2008, we had a marketing and sales staff
of 27 and 28 people representing 16% of our total workforce for both of these years.
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.
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, Alcatel-Lucent, 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).
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For the year ended December 31, 2010, sales to the large domestic carriers accounted for
approximately 31% of our total revenue, compared to approximately 39% of our total revenue for the same 2009 and 2008 periods. Our
largest customer, AT&T, comprised approximately 23% of our total revenue for both 2010 and 2009,
while in 2008, they comprised approximately 27% of our total revenue. For the year ended December
31, 2010, sales to the European Telcos accounted for approximately 21% of our total revenue,
compared to approximately 22% and 27% of our total revenue for the same 2009 and 2008 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 2010 and 2009, revenues from this
contract were approximately $7.0 and $5.1 million or approximately 15% and 11% of our total
revenues, respectively.
Manufacturing and Quality Control
During 2009, we began the process of outsourcing our in-house manufacturing and production
capabilities to Express Manufacturing Inc. (Express Manufacturing), a global provider of
subcontracting services located in Santa Ana, California. By outsourcing our manufacturing process,
we created more of a variable cost manufacturing model for our business by negotiating fixed costs
to supply our products to end customers on a just-in-time basis rather than have all the fixed
costs associated with an in-house manufacturing process. Express Manufacturing now fulfills 100%
of our manufacturing requirements, including the direct shipment of products to our end customers.
Additionally, 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®, ICE ®, LightHouse®, Telaccord®,
MITS®, Clearview®, MICRO-BANK®, the names and logos for
4TEL®, Celerity® and NETFLARE®. We have common law trademarks in
the names LoopCare, MLT, Clear, the Clear logo, Early Warning, ReportCard, CircuitView,
Network Assurance Simplified, Service Assurance Simplified, Continuous Grid Intelligence,
Minutes Mean Millions, N(x)Test, N(x)DSL, LTSC, and HyFi, and our corporate logo. Team
TollgradeSM is a common law service mark of the Company.
We have two United States patents on MCU products with expiration dates ranging from 2011 to 2014.
In all, we have forty-three patents in the United States, three patents in Belgium, three patents
in Germany, and four patents in the United Kingdom on other telecommunications technology with
expiration dates ranging from 2011 to 2026. In addition, we have eights United States, six
European, two German, and two United Kingdom patent applications pending on our products, some of
which relate to our new 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 or that
the lapsing of any one patent will have a material adverse effect on our business as a whole.
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Backlog
Our order backlog for firm customer purchase orders and signed software maintenance contracts was
$19.1 million at December 31, 2010, compared to backlog of $15.6 million at December 31, 2009. The
backlog at December 31, 2010 and December 31, 2009 includes approximately $13.4 million and $8.4
million, respectively, related to software maintenance contracts. In 2011, we expect to realize
revenues related to the entire backlog at December 31, 2010.
In our reported backlog, we have adopted a policy to only 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, 2010, we had 107 full-time employees, 85 of whom were located in the United
States and 22 of whom were located in Europe. As of December 31, 2009 and 2008, we had 167 and 179
full time employees, of which 141 and 150 where located in the United States and 26 and 29 were
located in Europe, respectively. None of our employees are represented by a collective bargaining
agreement.
Executive Officers of the Company
The executive officers of the Company as of March 10, 2011 and their biographical information are
set forth below.
Edward H. Kennedy
|
Chief Executive Officer, President and Board Member of Tollgrade since June 2009; has served as Chairman of the Board since March 2010 and was named Chief Executive Officer and President in June 2010; prior thereto served as the Chairman, Chief Executive Officer, and President of Rivulet Communications, Inc. from September 2007 until March 2010; prior thereto, served as Venture Partner at Columbia Capital from February 2004 until September 2007; prior thereto, from January 2002 until January 2004, served as President of Tellabs North American Operations and Executive Vice President of Tellabs. From March 1999 until January 2002, Mr. Kennedy was President and Chief Executive Officer (and Co-Founder) of Ocular Networks. He has also held various executive positions at leading telecom equipment companies, including Alcatel and Newbridge Networks Corporation. Mr. Kennedy previously served on the boards of directors of Visual Networks, a publicly-traded, Nasdaq-listed company until its acquisition by Fluke Networks, a division of Danaher Corporation, and Imagine Communications. Mr. Kennedy also currently serves on the board of directors of Hatteras Networks. Age 56. | |
Michael D. Bornak
|
Chief Financial Officer of the Company since November 2009; served as the Companys interim Chief Financial Officer from September 2009 to November 2009; prior thereto served as Chief Financial Officer of Solar Power Industries, Inc. from June 2008 until July 2009; Chief Financial Officer for MHF Logistical Solutions, Inc. from February 2005 to June 2008; Vice President of Finance and Chief Financial Officer of Portec Rail Products, Inc. from January 1998 to February 2005. Mr. Bornak is also a Certified Public Accountant. Age 48. | |
Gregory M. Nulty
|
Vice President, Marketing and Business Development since June 2010; prior thereto served as Sr. Vice President of Product Management and Business Development at Rivulet from 2007 to 2010; Sr. Vice President of Strategic Direction and Business Development at Tellabs/Ocular Networks from 2000 to 2004. Previously, Mr. Nulty held executive technical, strategic planning and marketing positions at companies including Pulsecom, Sprint and Ameritech. Age 57. | |
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 50. |
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Jennifer M. Reinke
|
General Counsel of the Company since November 2009 and Secretary of the Company since December 2009; Assistant General Counsel of the Company from February 2009 to November 2009; Corporate Attorney for the Company from March 2003 to February 2009; served as the Companys Assistant Secretary from March 2003 to December 2009; prior thereto, Associate Attorney with Reed Smith LLP, from August 1998 to March 2003. Age 38. | |
Robert H. King
|
Vice President, Global Sales and Professional Services since June 2010; Vice President, Global Sales and Marketing of the Company from February 2009 until June 2010; 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 49. | |
Joseph G. OBrien
|
Vice President, Human Resources of the Company since October 1997; Director of Employee Development of the Company from April 1997 until October 1997; prior thereto, Coordinator, Elderberry Junction, Goodwill Industries, a charitable organization, from May 1995 until April 1997. Age 51. | |
Thomas J. Kolb
|
Vice President, Operations of the Company since December 2010; prior thereto, Director, Operations Strategy of the Company from December 2008 until December 2010; prior thereto Director North America Trade Compliance for Ericsson Inc. from May 2007 until December 2008 and its Manager of Supply Chain Operations from January 2006 until May 2007; prior to held various supply chain management positions with Marconi and FORE Systems. Age 43 |
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.
There are risks and uncertainties associated with our proposed merger with an affiliate of Golden
Gate Capital.
On February 21, 2011, we entered into an Agreement and Plan of Merger (the Merger Agreement) with
Talon Holdings, Inc., a Delaware corporation (Parent), and Talon Merger Sub, Inc., a Pennsylvania
corporation and a direct wholly-owned subsidiary of Parent (Merger Sub), providing for the merger
of Merger Sub with and into the Company (the Merger), with the Company surviving the Merger as a
wholly-owned subsidiary of Parent. Parent is owned by investment funds managed by Golden Gate
Capital, a San Francisco based private equity firm.
There are a number of risks and uncertainties relating to the Merger. For example, the Merger may
not be consummated or may not be consummated in the timeframe or manner currently anticipated, as a
result of several factors, including, among other things, (a) the occurrence of any event, change
or other circumstances that could give rise to the termination of the Merger Agreement, including a
termination under circumstances that would require us to pay a termination fee; (b) Parents
failure to obtain the necessary equity financing set forth in the equity commitment letter received
in connection with the Merger, or alternative financing, or the failure of any such financing to be
sufficient to complete the Merger and the transactions contemplated by the Merger Agreement; (c)
our net cash balance and minimum company cash as such terms are defined in the Merger Agreement
being less than the amounts set forth therein; (d) failure to obtain shareholder approval or the
failure to satisfy other conditions to completion of the merger, including obtaining required
regulatory approvals; (e) litigation relating to the Merger, including without limitation two
actions which are currently pending and seek to enjoin the consummation of the Merger and other
injunctive relief; (f) the failure of the Merger to close for any other reason.
If the Merger is not completed, the price of our common stock may decline to the extent that the
current market price of our common stock reflects an assumption that the Merger will be
consummated, and such decline may be material. Pending the closing of the Merger, the Merger
Agreement also restricts us from engaging in certain actions without Parents consent, which could
prevent us from pursuing opportunities that may arise prior to the closing of the Merger. Any delay
in closing or a failure to close could have a negative impact on our business and stock price as
well as our relationships with our customers, vendors or employees, as well as a negative impact on
our ability to pursue alternative strategic transactions and/or our ability to implement
alternative business plans. In addition, if the Merger Agreement is terminated, depending on the
circumstances giving rise to termination, we may be required to (i) reimburse Parent the expenses
incurred by Parent, Merger Sub and their affiliates in connection with the Merger Agreement, up to
a
maximum of $1 million, or (ii) pay a termination fee equal to $3 million, plus up to $1 million of
the expenses incurred by Parent, Merger Sub and their affiliates in connection with the Merger
Agreement.
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Our business could be adversely impacted as a result of the proposed Merger.
The proposed Merger could cause disruptions to our business or business relationships, which could
have an adverse impact on our financial condition, results of operations and cash flows. For
example:
| the attention of our management may be directed to transaction-related considerations and may be diverted from the day-to-day operations of our business; | ||
| employees may experience uncertainty about their future roles with us, which might adversely affect our ability to retain and hire key personnel and other employees; and | ||
| vendors, customers or other parties with which we maintain business relationships may experience uncertainty about our future and seek alternative relationships with third parties or seek to alter their business relationships with us. |
In addition, we have incurred, and will continue to incur, significant costs, expenses and fees for
professional services and other transaction costs in connection with the Merger, and many of these
fees and costs are payable by us regardless of whether or not the Merger is consummated.
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.
Certain of 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 may be adversely affected. In particular, MCU sales largely depend upon the rate of
deployment of new, and the retrofitting of existing, DLC systems in the United States. Installation
and replacement of DLC systems are, in turn, driven by a number of factors, including the
availability of capital resources and the demand for new or better POTS. Next generation network
improvements such as FTTP do not require the use of our MCU products as does the present hybrid
POTS network. If our major customers fail to continue to build out their DSL networks and other
projects requiring DLC deployments, or if we otherwise satisfy the domestic telecommunications
markets demand for MCUs, our MCU sales may decline which could adversely affect our future
results.
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 $19.1 million for 2010, $19.9 million for 2009 and $27.0 million in 2008.
If we are unable to continue to derive sales of our 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, if we experience delays in the extension or renewal of certain of the more significant
software maintenance agreements, or if we are unable to reach agreement as to any such renewal or
extension on terms that are favorable to us, or at all, our revenues may be adversely affected.
In addition, in December 2009, one of our major customers for software maintenance, Verizon,
allowed its maintenance contract to expire, deciding instead to purchase maintenance services
through a third party vendor. We signed an interim contract with the third party vendor to provide
for continuation of service while we negotiated the terms of our master agreement, and signed a
master agreement with the third party vendor in April 2010 for our provision of maintenance
services to Verizon. 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 may likely experience significant downward
pricing pressure for these services.
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We are also experiencing 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.
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. Our new products include enhanced hardware solutions and managed services offerings in the
telecommunications market, and our LightHouse smart grid solutions for the power utility market. 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, may occur
more slowly than 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 certain markets in the manner contemplated, and we could be materially
and adversely affected.
Our restructuring efforts and cost reduction plans may be ineffective or may limit our ability to
compete.
During 2010, we significantly restructured our business operations, resulting in the elimination of
48 positions Company-wide. Previously, during 2009, we implemented restructuring initiatives which
included the realignment of existing resources to new projects, reductions in staffing, as well as
other reduction activities. Although we have experienced cost savings from these restructuring and
cost reduction programs and initiatives and we expect that these actions will continue to reduce
costs, 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 providers customer agreements declining more rapidly than
anticipated. Additionally, our overall profitability may be negatively impacted in the event we are
required to incur unanticipated expenses to satisfy obligations assumed under the managed services
agreement.
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A continuing downturn in the global economy may adversely affect our revenue, 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 revenue, 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, revenue 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 during 2010 we brought court action in a foreign jurisdiction in an attempt
to enforce payment. Litigation is ongoing, and 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 revenue, and such impact could be material.
We maintain an investment portfolio, consisting of cash, cash equivalents and investments. These
investments are subject to general credit, liquidity, market, and interest rate risks. If the
global credit market continues to deteriorate, our investment portfolio may be impacted and
potentially creating an other-than-temporary decline in fair value, which would result in an
impairment charge adversely impacting our financial results.
We are dependent upon our ability to attract, retain and motivate our key personnel.
Our success depends on our ability to attract, retain and motivate our key management personnel,
including the Companys CEO, CFO, senior management team members, and key engineers, necessary to
implement our business plan and to grow our business. Despite the adverse economic conditions of
the past several years, competition for certain specific technical and management skill sets is
intense. If we are unable to identify and hire the personnel that we need to succeed, or if one or
more of our key employees were to cease to be associated with the Company, our future results could
be adversely affected.
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 economy in general; | ||
| Subscriber line loss and related reduced demand for wireline telecommunications services; | ||
| Changes or shifts in the technology utilized in the networks; |
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| 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 | ||
| 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 could 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 2010, 2009 and 2008, we performed the required
recoverability tests and determined that certain long-lived assets were impaired in 2009 and 2008.
No impairments occurred in 2010; however, the occurrence of any further triggering events could
result in future 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.
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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 close to 100% 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.
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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 customers organization because decisions to
acquire software licenses and associated system hardware involve the evaluation of the products by
a significant number of customer personnel in various functional and geographic areas, each often
having specific and conflicting requirements. A variety of factors, including actions by
competitors and other factors over which we have little or no control, may cause potential
customers to favor a particular supplier or to delay or forego a purchase.
Many of our products must comply with significant governmental and industry-based regulations,
certifications, standards and protocols, some of which evolve as new technologies are deployed.
Compliance with such regulations, certifications, standards and protocols may prove costly and
time-consuming for us, and we cannot provide assurance that its products will continue to meet
these standards in the future. In addition, regulatory compliance may present barriers to entry in
particular markets or reduce the
profitability of our product offerings. Such regulations, certifications, standards and protocols
may also adversely affect the industries
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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 could 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
FCCs authority to do so, our customers cannot accurately predict the rules which will regulate
their conduct in their respective markets. Changes in the telecommunications regulatory environment
could, among other results, increase our costs of doing business, require our customers to share
assets with competitors or prevent the Company or our customers from engaging in business
activities they may wish to conduct, which could adversely affect our future results.
Similarly, our international customers are subject to a number of governmental regulations.
Regulatory changes affect our customers in several ways, including the introduction of competitive
forces, controls (or removal of controls), and new rules and limits. These and other regulatory
changes may limit our customers, their service offerings, of spending, which could significantly
reduce the demand for our products.
Our limited ability to protect our proprietary information and technology may adversely affect our
ability to compete, and our products could infringe upon the intellectual property rights of
others, resulting in claims against us the results of which could be costly.
Many of our products consist entirely or partly of proprietary technology owned by us. Although we
seek to protect our technology through a combination of copyrights, trade secret laws, contractual
obligations and patents, these protections may not be sufficient to prevent the wrongful
appropriation of our intellectual property, nor will they prevent our competitors from
independently developing technologies that are substantially equivalent or superior to our
proprietary technology. In addition, the laws of some foreign countries do not protect our
proprietary rights to the same extent as the laws of the United States. In order to defend our
proprietary rights in the technology utilized in our products from third party infringement, we may
be required to institute legal proceedings. If we are unable to successfully assert and defend our
proprietary rights in the technology utilized in our products, our future results could be
adversely affected.
Although we attempt to avoid infringing known proprietary rights of third parties in our product
development efforts, we may become subject to legal proceedings and claims for alleged infringement
from time to time in the ordinary course of business. Any claims relating to the infringement of
third-party proprietary rights, even if not meritorious, could result in costly litigation, divert
managements attention and resources, require us to reengineer or cease sales of our products or
require us to enter into royalty or license agreements which are not advantageous to us. In addition, parties making claims may be able
to obtain an injunction, which
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could prevent us from selling our products in the United States or
abroad. We also have contractual obligations with respect to claims of infringement that may be
triggered by such claims, including the payment of third-parties legal costs, indemnification of
third-parties or other contractual responsibilities relative to such claims which may be costly to
us. Further, 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 adversely affected. In
particular, one of our patents for our MCU products expired in 2010 and the other two patents for
our MCU products will expire between 2011 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 Unions lead in
enacting legislation with respect to hazardous substances and waste removal. Although we have
concluded that our test and
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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; |
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| 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, if the Merger is not completed, the price of our common stock may decline to the
extent that the current market price of our common stock reflects an assumption that the Merger
will be consummated, and such decline may be material. Further, in recent years, the stock market
in general, and The NASDAQ Global Select Market and the securities of technology companies in
particular, have experienced extreme price and volume fluctuations. These fluctuations have often
been unrelated or disproportionate to the operating performance of individual companies. These
broad market fluctuations have in the past and may in the future materially and adversely affect
our stock price, regardless of our operating results. In the past, following periods of volatility
in the market price of a companys securities, securities class action litigation has often been
initiated against such company. Such litigation could result in substantial costs and a diversion
of our managements attention and resources that could harm our business regardless of the outcome
of such litigation.
We may be subject from time to time to legal proceedings, and any adverse determinations in these
proceedings could materially harm our business.
We may from time to time be involved in various lawsuits and legal proceedings, which arise in the
ordinary course of business. Litigation matters are inherently unpredictable, and we cannot predict
the outcome of any such matters. If we ultimately lose or settle a case, we may be liable for
monetary damages and other costs of litigation. Even if we are entirely successful in a lawsuit, we
may incur significant legal expenses and our management may expend significant time in the defense.
An adverse resolution of a lawsuit or legal proceeding could negatively impact our financial
position and results of operations.
In addition, we are currently named as a defendant in two actions related to the Merger Agreement
and the transactions contemplated thereby, and may be named as a defendant in additional actions
relating thereto. Plaintiffs in both of the pending cases are seeking to enjoin the Merger and
other injunctive relief. We cannot at this time reasonably predict the outcome of these cases of
whether the plaintiffs may additionally seek monetary relief. An adverse resolution of these
proceedings could negatively impact our financial position and results of operations, and could
delay or prevent the consummation of the Merger.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
Effective February 28, 2011, our headquarters and principal administrative, engineering,
manufacturing, warehouse and maintenance operations are located in a 24,402 square foot facility in
Cranberry Township, Pennsylvania. A new seven year lease for this facility was signed in October
2010 and commenced on March 1, 2011. We previously occupied a 111,600 square foot facility in
Cheswick, Pennsylvania, which is under lease through March 31, 2011.
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.
In addition, we lease 2,422 square feet of space in Wuppertal, Germany, under a lease which
expires on January 31, 2012. This facility is used primarily by sales and customer support
personnel. Lastly, we lease office space in Kontich, Belgium pursuant to a monthly lease
commitment for sales and customer support personnel.
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Item 3. Legal Proceedings.
On February 22, 2011, we announced that we had entered into an Agreement and Plan of Merger (the
Merger Agreement) with Talon Holdings, Inc., a Delaware corporation (Parent), and Talon Merger
Sub, Inc., a Pennsylvania corporation and a direct wholly-owned subsidiary of Parent (Merger
Sub), providing for the merger of Merger Sub with and into the Company (the Merger), with the
Company surviving the Merger as a wholly-owned subsidiary of Parent. Parent is owned by investment
funds managed by Golden Gate Capital, a San Francisco based private equity firm. At the effective
time of the Merger, all of the shares of our outstanding common stock (other than shares held by
us, Parent or Merger Sub) would be acquired by Parent for $10.10 per share in cash. We have
subsequently been named as a defendant in two actions related to the Merger:
| Stephen Tencza v. the Company and each member of the board of directors of the Company (the Directors) filed on February 24, 2011 in the Court of Common Pleas of Allegheny County, Pennsylvania; and | ||
| Vladimir Gusinsky Revocable Trust v. the Company and the Directors filed on March 1, 2011 in the Court of Common Pleas of Allegheny County, Pennsylvania |
The named plaintiffs in the two cases allege breach of the Directors fiduciary duties to our
stockholders. Specifically, the complaints allege that the Directors breached their fiduciary
duties to the stockholders by agreeing to sell the Company without regard to the fairness of the
transaction. We deny these allegations and plan to vigorously defend ourselves. Plaintiffs in both
of the cases are seeking to enjoin the Merger and other injunctive relief. We cannot at this time
reasonably predict the outcome of these cases of whether the plaintiffs may additionally seek
monetary relief.
Item 4. Reserved.
PART II
Item 5. Market for the Registrants Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock is traded on The NASDAQ Global Select Market under the symbol TLGD. The
following table sets forth, by quarter, the high and low sales prices for our common stock for the
years ended December 31, 2010 and December 31, 2009.
2010 | 2009 | |||||||||||||||
High | Low | High | Low | |||||||||||||
First Quarter |
$ | 6.88 | $ | 6.00 | $ | 7.14 | $ | 4.73 | ||||||||
Second Quarter |
$ | 6.90 | $ | 6.11 | $ | 5.95 | $ | 5.04 | ||||||||
Third Quarter |
$ | 8.30 | $ | 6.16 | $ | 6.93 | $ | 4.98 | ||||||||
Fourth Quarter |
$ | 9.50 | $ | 7.12 | $ | 6.83 | $ | 5.49 |
On February 28, 2011, there were 146 holders of record and 13,007,388 million shares outstanding of
the Companys common stock.
We have never paid any dividends on our common stock and do not expect to pay dividends in the
foreseeable future. Our ability to pay dividends is currently restricted by the terms of the
Agreement and Plan of Merger, dated February 21, 2011, among Talon Holdings, Inc. (Parent), Talon
Merger Sub, Inc. and the Company, which restricts us from taking certain actions, including the
payment of dividends from the date of the Merger Agreement until the effective time of the Merger,
without the prior written consent of Parent.
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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, 2010 of $100 invested on
December 31, 2005 in Tollgrades common stock, the Standard & Poors 500 Composite Index and the
NASDAQ Telecomm (IXTC).
The performance graph and related information shall not be deemed soliciting material or be
filed with the Securities and Exchange Commission, nor shall such information be incorporated by
reference to any future filings under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended (the Exchange Act) or otherwise subject to the liabilities under
that Section.
December 31, | December 31, | December 31, | December 31, | December 31, | December 31, | |||||||||||||||||||
2005 | 2006 | 2007 | 2008 | 2009 | 2010 | |||||||||||||||||||
Tollgrade |
100 | 97 | 73 | 44 | 56 | 85 | ||||||||||||||||||
NASDAQ Telecomm (IXTC) |
100 | 128 | 139 | 80 | 118 | 123 | ||||||||||||||||||
S&P 500 |
100 | 114 | 118 | 72 | 89 | 101 |
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Item 6. Selected Financial Data.
The following selected consolidated financial data of the Company has been derived from our audited
consolidated financial statements. The following selected consolidated financial data may not be
representative of our future financial performance and should be read in conjunction with the
consolidated financial statements, the notes to the consolidated financial statements, and
Managements Discussion and Analysis of Financial Condition and Results of Operations, which are
included elsewhere in this report.
(IN THOUSANDS, EXCEPT PER SHARE DATA AND NUMBER OF EMPLOYEES)
FOR THE YEARS ENDED DECEMBER 31: | 2010 | 2009 | 2008 | 2007 | 2006 | |||||||||||||||
Revenues: |
||||||||||||||||||||
Products |
$ | 19,067 | $ | 19,936 | $ | 26,997 | $ | 36,143 | $ | 35,270 | ||||||||||
Services |
26,579 | 25,005 | 22,055 | 15,689 | 11,736 | |||||||||||||||
Total revenue |
45,646 | 44,941 | 49,052 | 51,832 | 47,006 | |||||||||||||||
Cost of sales: |
||||||||||||||||||||
Products |
8,259 | 11,812 | 14,181 | 15,874 | 14,653 | |||||||||||||||
Services |
7,618 | 7,143 | 6,146 | 4,103 | 3,473 | |||||||||||||||
Amortization of intangible assets |
1,570 | 2,576 | 3,085 | 2,199 | 2,597 | |||||||||||||||
Inventory write-down |
| 3,070 | 759 | | 4,101 | |||||||||||||||
Impairment of long-lived assets |
| 27,151 | 201 | 1,090 | | |||||||||||||||
Severance |
319 | 778 | | | | |||||||||||||||
Total cost of sales |
17,766 | 52,530 | 24,372 | 23,266 | 24,824 | |||||||||||||||
Gross profit/(loss) |
27,880 | (7,589 | ) | 24,680 | 28,566 | 22,182 | ||||||||||||||
Operating expenses: |
||||||||||||||||||||
Selling and marketing |
5,967 | 6,809 | 6,835 | 7,807 | 7,794 | |||||||||||||||
General and administrative |
8,561 | 12,141 | 9,455 | 9,702 | 7,702 | |||||||||||||||
Research and development |
6,841 | 9,411 | 10,789 | 10,987 | 9,088 | |||||||||||||||
Restructuring/severance |
1,826 | 1,180 | 827 | 922 | 566 | |||||||||||||||
Impairment of long-lived assets and goodwill |
| 293 | | 20,036 | | |||||||||||||||
Total operating expenses |
23,195 | 29,834 | 27,906 | 49,454 | 25,150 | |||||||||||||||
Income/(Loss) income from operations |
4,685 | (37,423 | ) | (3,226 | ) | (20,888 | ) | (2,968 | ) | |||||||||||
Other income, net |
9 | 567 | 1,337 | 2,770 | 2,741 | |||||||||||||||
Income/(Loss) income before income taxes |
4,694 | (36,856 | ) | (1,889 | ) | (18,118 | ) | (227 | ) | |||||||||||
Provision/(Benefit) for income taxes |
271 | (874 | ) | 1,137 | 1,220 | (1,213 | ) | |||||||||||||
Income/(Loss) from continuing operations |
4,423 | (35,982 | ) | (3,026 | ) | (19,338 | ) | 986 | ||||||||||||
(Loss) from discontinued operations |
| (223 | ) | (4,089 | ) | (6,815 | ) | (2,820 | ) | |||||||||||
Net Income/(Loss) |
$ | 4,423 | $ | (36,205 | ) | $ | (7,115 | ) | $ | (26,153 | ) | $ | (1,834 | ) | ||||||
Weighted average shares of common stock equivalents: |
||||||||||||||||||||
Basic |
12,736 | 12,683 | 13,102 | 13,219 | 13,239 | |||||||||||||||
Diluted |
13,160 | 12,683 | 13,102 | 13,219 | 13,239 | |||||||||||||||
EARNINGS PER SHARE INFORMATION: |
||||||||||||||||||||
Net Income/(Loss) per common share: |
||||||||||||||||||||
Basic |
$ | 0.35 | $ | (2.85 | ) | $ | (0.54 | ) | $ | (1.98 | ) | $ | (0.14 | ) | ||||||
Diluted |
$ | 0.34 | $ | (2.85 | ) | $ | (0.54 | ) | $ | (1.98 | ) | $ | (0.14 | ) | ||||||
EARNINGS PER SHARE INFORMATION: |
||||||||||||||||||||
Net Income/(Loss) per common share from continuing operations: |
||||||||||||||||||||
Basic |
$ | 0.35 | $ | (2.83 | ) | $ | (0.23 | ) | $ | (1.46 | ) | $ | 0.07 | |||||||
Diluted |
$ | 0.34 | $ | (2.83 | ) | $ | (0.23 | ) | $ | (1.46 | ) | $ | 0.07 | |||||||
EARNINGS PER SHARE INFORMATION: |
||||||||||||||||||||
Net (Loss) per common share from discontinued operations: |
||||||||||||||||||||
Basic |
$ | | $ | (0.02 | ) | $ | (0.31 | ) | $ | (0.52 | ) | $ | (0.21 | ) | ||||||
Diluted |
$ | | $ | (0.02 | ) | $ | (0.31 | ) | $ | (0.52 | ) | $ | (0.21 | ) | ||||||
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(IN THOUSANDS, EXCEPT PER SHARE DATA AND NUMBER OF EMPLOYEES)
FOR THE YEARS ENDED DECEMBER 31: | 2010 | 2009 | 2008 | 2007 | 2006 | |||||||||||||||
BALANCE SHEET DATA: |
||||||||||||||||||||
Working capital |
$ | 77,675 | $ | 69,195 | $ | 75,475 | $ | 77,080 | $ | 83,186 | ||||||||||
Total assets |
91,337 | 87,687 | 124,347 | 140,143 | 162,352 | |||||||||||||||
Pension obligation |
795 | 983 | 889 | 908 | | |||||||||||||||
Shareholders equity |
84,292 | 77,743 | 112,454 | 123,000 | 149,444 |
2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
OTHER DATA: (unaudited) |
||||||||||||||||||||
Number of full-time employees at year-end |
107 | 167 | 179 | 205 | 161 |
Item 7. Managements Discussion and Analysis (MD&A) of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with the other sections of this annual
report on Form 10-K, including Item 1: Business, Item 6: Selected Financial Data and Item 8:
Financial Statements. Unless otherwise specified, any reference to a year is to a year ended
December 31. Additionally, when used in this Form 10-K, unless the context requires otherwise, the
terms we, our, us and the Company refer to Tollgrade Communications, Inc. and its
subsidiaries. Certain statements contained in this MD&A and elsewhere in this report are
forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended that involve risks and
uncertainties. These statements relate to future events or our future financial performance. In
some cases, forward-looking statements can be identified by terminology such as believe,
expect, intend, may, will, should, could, potential, continue, estimate, plan,
or anticipate, or the negatives thereof, other variations thereon or compatible terminology.
These statements involve a number of risks and uncertainties. Actual events or results may differ
materially from any forward-looking statement as a result of various factors, including those
described in Item 1A above under Risk Factors.
Cable Product Line
On May 27, 2009, we completed the sale of our cable product line for consideration of approximately
$3.4 million, subject to adjustment for certain items pursuant to the terms of the sale agreement.
The cable product line no longer supported our refocused growth strategy and this divesture allows
us to continue to focus on our core telecommunications markets and customers. Unless otherwise
indicated, references to revenues and earnings throughout this MD&A and elsewhere in this Form 10-K
refer to revenues and earnings from continuing operations and do not include revenue and earnings
from the discontinued cable product line. Similarly, discussion of other matters in our
Consolidated Financial Statements refers to continuing operations unless otherwise indicated. The
results from this divested product line are reported in discontinued operations.
Overview
Tollgrade Communications, Inc. is a provider of centralized test and measurement systems and
service offerings to the telecommunications market. We design, engineer, and support test systems
and status monitoring hardware and software products for some of the largest telecommunication
companies within the United States and Europe. Our products enable service providers to remotely
diagnose and proactively address problems within their networks. By coupling our hardware and
software offerings together, we provide proactive, centralized test solutions for our customers.
Our service and managed service 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, since 2007, we have been developing a sensor and a software
operating platform for the utility industry that leverages our core competences and years of
experience in scaling test systems in large telecommunication networks and applying that similar
business model to the utility marketplace.
In 2010 we increased our revenue, appointed a new President and Chief Executive Officer in June
and returned the Company to annual profitability for the first time since 2005. We strived
throughout the year to achieve our primary goals of strengthening our business and delivering
improved operating results. In developing our business plan for 2010, we had three guiding
principles:
| First and foremost, to ensure profitability; | ||
| Second, to target resources and spending on legacy products to allow for focused investments; and | ||
| Third, to align the business around growth initiatives and focus our resources on near-term opportunities. |
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Our efforts to return the Company to profitability began in late 2009 and continued aggressively
over the first four months of 2010. By the end of 2009, we successfully outsourced almost 100% of
our in-house manufacturing to Express Manufacturing. This action replaced our fixed overhead cost
structure to support our previous in-house manufacturing process with a variable cost business
model for our hardware product sales that also required less use of our working capital. In
addition, in the fourth quarter of 2009, we eliminated 28 positions across all levels of the
organization that produced approximately $2.4 million in annualized cost savings. In addition,
early in the second quarter of 2010, we further accelerated our efforts to return to profitability
by reducing our workforce by approximately 33% which contributed approximately $5.8 million in
annualized salary and benefits savings. Our workforce reductions were carefully planned so as to
ensure that we were able to achieve our cost reduction goals without sacrificing our ability to
service our customers while also allowing us to focus research and development efforts on projects
that could allow for near-term top line growth. In addition, throughout 2010, we also focused our
attention on a number of non-headcount related costs and achieved substantial cost reductions in
the areas of general and directors and officers insurance, audit costs and cash related board fees.
Through a combination of all of these actions and initiatives, we posted final 2010 revenues of
$45.6 million or a 1.6% growth over 2009 revenues, achieved three consecutive quarters of
profitability from operations, posted annual net income of $4.4 million and basic net income per
share of $0.35, while increasing our cash balance to $72.2 million, a $6.2 million increase over
the $66.0 million cash balance at the end of 2009.
Although we have significantly reduced our operations and research and development departments from
68 and 66 employees at the beginning of 2009 to 36 and 34 employees, respectively, at the end of
2010, we have focused our product efforts on our best opportunities for revenue and profitability
and reduced areas of investment that involved higher risk before any returns could be realized.
For example, we discontinued two yet to be announced projects at the end of the first quarter of
2010 so that we could provide greater attention to a European customer that wanted to purchase our
DigiTest ICE and LoopCare products and software to support their next generation broadband test
capabilities. We ultimately received initial orders in excess of $1.0 million with this customer
and expect additional revenues from this customer in the future. By again concentrating our
resources towards a project with a high probability of future revenues, we also successfully
completed a trial for our LDU telecommunications test products and new software with a major
British customer in the fourth quarter of 2010. We expect to finalize the contract for this
project in early 2011, and we expect to receive significant revenues related to this project over
the next three to five years. Additionally, we will continue to support our broad product
portfolio, including our DigiTest, LDU, and MCU hardware, and our LoopCare, 4TEL and Celerity
software platforms, to ensure that our customers receive the high levels of customer support that
they have grown accustomed to.
We also continue to promote and support our LightHouse product line for the utility industry. Our
trial with a major US utility company concluded successfully last fall with only minor
customer-driven product modifications requested. We have recently completed those product
modifications and received our first commercial orders in early 2011. We are working with that
utility on rolling out a full-scale deployment of the product over the first half of 2011.
Furthermore, we have recently completed another successful trial with a major Canadian utility
customer and have signed three more utility customers to test our product. We are also poised to
launch our next LightHouse software release that we believe will widen the gap that we believe
exists between our product offerings and those of our competitors. With our more than twenty years
of testing large telecommunication networks, we believe that our in-house engineering expertise
further strengthens our ability to service the utility marketplace. Although revenue in this area
of our business has been slower to develop than we anticipated, we believe this market will
provide us with long-term growth.
In 2009, we 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 are deploying and focusing resources in this area as 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. We also continue
to focus our sales and field service support personnel on our maintenance service contracts, and
during 2010, we secured three long-term contract extensions with one major US and two major
European telecommunication providers, thus providing us with predictable revenue streams through
2012.
On February 21, 2011, we entered into an Agreement and Plan of Merger (the Merger Agreement) with
Talon Holdings, Inc., a Delaware corporation (Parent), and Talon Merger Sub, Inc., a Pennsylvania
corporation and a direct wholly-owned subsidiary of Parent (Merger Sub), providing for the merger
of Merger Sub with and into the Company (the Merger), with the Company surviving the Merger as a
wholly-owned subsidiary of Parent. Parent is owned by investment funds managed by Golden Gate
Capital, a San Francisco based private equity firm. At the effective time of the Merger, all of
the shares of our outstanding common stock (other than shares held by us, Parent or Merger Sub)
would be acquired by Parent for $10.10 per share in cash. The Merger Agreement was unanimously
approved by our board of directors. Consummation of the Merger is subject to customary
conditions, including without limitation (i) the approval by the holders of at least a majority of the votes
cast by the outstanding shares of our common stock entitled to vote on the Merger, (ii) the
expiration or early termination of the waiting period applicable to the consummation of the Merger
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, (iii) the absence
of any law or order restraining, enjoining or prohibiting the Merger,
(iv) the absence of any pending litigation challenging the Merger,
and (v) the absence of a material adverse effect on the Company. Moreover, each partys
obligation to consummate the Merger is subject to certain other conditions, including without
limitation (x) the accuracy of the other partys representations and warranties and
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(y) the other partys compliance with its covenants and agreements contained in the Merger Agreement. We expect
the Merger to close during the second quarter of 2011.
Moving into 2011, we believe we will continue to see the benefits of our realigned cost structure,
which has enhanced our ability to maintain profitability even when customers shift their project
timelines. We also have more flexibility to reallocate resources and secure temporary labor to
help us win new projects while maintaining our product and software platforms that are embedded in
our tier one customer base. While some of our larger customers are in the process of upgrading
their access networks and the related service assurance solutions for these networks, there is no
guarantee that these activities will continue or that these customers will adopt our new
technologies which would adversely affect future revenues related to these products and services.
However, our goal is to continue to focus our efforts on near-term customer opportunities,
especially in the managed services area, and with our LightHouse product for the utility market,
while seeking new product and service offerings for our existing and potential new customers.
Results
of Operations for the Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009
Revenue
2010 | 2009 | Change | % | |||||||||||||
System Test Products |
$ | 11,771 | $ | 14,118 | $ | (2,347 | ) | -17 | % | |||||||
MCU |
6,658 | 5,694 | 964 | 17 | % | |||||||||||
Other |
638 | 124 | 514 | 415 | % | |||||||||||
Total Products |
19,067 | 19,936 | (869 | ) | -4 | % | ||||||||||
Managed Services |
7,030 | 5,078 | 1,952 | 38 | % | |||||||||||
Other Services |
19,549 | 19,927 | (378 | ) | -2 | % | ||||||||||
Total Services |
26,579 | 25,005 | 1,574 | 6 | % | |||||||||||
Total Revenue |
$ | 45,646 | $ | 44,941 | $ | 705 | 2 | % | ||||||||
Our total revenues for the year ended December 31, 2010 were $45.6 million, an increase of
$0.7 million, or 2%, compared to our total revenues of $44.9 million for the year ended December
31, 2009. For the full year 2010, our total product revenues amounted to $19.1 million compared to
$19.9 million for the same 2009 period, a decrease of $0.8 million or 4%. For the full year 2010,
our total services revenues amounted to $26.6 million compared to $25.0 million for the same 2009
period, an increase of $1.6 million or 6%.
The overall decrease in our 2010 product line revenue is primarily due to a decline in some of our
legacy system test product lines, including the product families of DigiTest, LDU and N(x)Test and
their associated software applications and license fees. In particular under our System Test
Products, our DigiTest products had lower sales of approximately $1.3 million, our LDU product
sales had lower sales of approximately $0.2 million, and our N(x)Test product line, which was
discontinued last year, experienced a decline in sales of approximately $0.8 million. These
declines are primarily due to a combination of lower customer demand for these products along with
a significant one time buy of our N(x)Test product in 2009. These declines were partially offset
by increased revenues of our MCU product line of $0.9 million, primarily with AT&T, our largest
domestic customer. Lastly, other product revenue increased primarily as a result of additional
sales of our Protocol OEM product of $0.5 million as compared to the prior year when we first
introduced this product. Our product revenues accounted for 42% of our total revenues for 2010
compared to 44% of our total revenues for 2009.
Our services revenue consists primarily of software maintenance for 4TEL and Celerity LTSC, and
LoopCare, project management fees, repair work and managed services. The increase in our 2010
managed service revenue is due to a $2.0 million increase related to our having had a full year of
revenue under our managed services contract with Ericsson during 2010, as opposed to the partial
year of revenue in 2009, as that contract was signed in April of 2009. The increase in other
services revenues, which consist primarily of our software maintenance and repair work, is the
result of additional MCU repairs of approximately $0.5 million, additional DigiTest repairs of
approximately $0.5 million, and additional service revenue of approximately $0.4 million related to
our Protocol OEM product. These increases were partially offset by lower maintenance service
revenues related to LoopCare of approximately $0.8 million and 4TEL of approximately $1.1 million.
Services revenues accounted for approximately 58% of our total revenues for 2010 compared to 56% of
2009 total revenues.
Gross Profit /(Loss)
Our 2010 gross profit was $27.9 million compared to a gross loss of $(7.6) million for the same
2009 period, an increase of approximately $35.5 million. However, included in our 2009 gross
margin was an impairment of long-lived assets of approximately $27.2 million and an inventory
write-down of approximately $3.1 million. The total of these two charges approximated $30.3 million
of our 2009 gross margin. In addition, our 2010 amortization of intangible asset expense decreased
by approximately $1.0 million
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over the same 2009 period due the overall reduction of the carrying
balance of our intangible assets related to the 2009 LoopCare impairment previously discussed. The
culmination of these 2009 charges and expenses that were present in 2009 and not in 2010 along with
the reductions in headcount and cost saving from the outsourcing of our in-house manufacturing were
the primary reasons for our increase in gross profit in 2010.
Selling and Marketing Expenses
2010 | 2009 | Change | % | |||||||||||||
Employee Costs |
$ | 4,516 | $ | 4,780 | $ | (264 | ) | -6 | % | |||||||
Travel Expenses |
508 | 694 | (186 | ) | -27 | % | ||||||||||
Consulting Expenses |
323 | 419 | (96 | ) | -23 | % | ||||||||||
Other |
620 | 916 | (296 | ) | -32 | % | ||||||||||
Total Selling and Marketing Expenses |
$ | 5,967 | $ | 6,809 | $ | (842 | ) | -12 | % | |||||||
Our 2010 total selling and marketing expenses were approximately $6.0 million compared to
approximately $6.8 million in 2009, a decrease of $0.8 million, or 12%. Our total 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 expenses, which individually are not material. The decrease in employee costs
in 2010 is primarily due to additional headcount reductions in 2010, which was the continuation of
our overall cost reduction efforts that began in 2009. These headcount reductions also resulted in
overall savings in travel, consulting, and various other overhead employee related expenses.
General and Administrative Expenses
2010 | 2009 | Change | % | |||||||||||||
Employee Costs |
$ | 3,315 | $ | 3,922 | $ | (607 | ) | -15 | % | |||||||
Legal and Professional Fees |
1,786 | 3,880 | (2,094 | ) | -54 | % | ||||||||||
Stock Compensation |
914 | 855 | 59 | 7 | % | |||||||||||
General Insurance |
348 | 656 | (308 | ) | -47 | % | ||||||||||
Bad Debt |
152 | 1,121 | (969 | ) | -86 | % | ||||||||||
Other |
2,046 | 1,707 | 339 | 20 | % | |||||||||||
Total General and Administrative Expenses |
$ | 8,561 | $ | 12,141 | $ | (3,580 | ) | -29 | % | |||||||
Our 2010 total general and administrative expenses were approximately $8.5 million compared to
approximately $12.1 million in 2009, a decrease of $3.6 million, or 29%. Our general and
administrative expenses consist primarily of employee costs, which include salaries and related
payroll taxes, legal and professional fees, stock compensation expenses, general insurance expense,
bad debt expenses, and other expenses. The decrease in employee costs in 2010 is primarily due to
additional headcount reductions in 2010, which was the continuation of our overall cost reduction
efforts that began in 2009. We also had a concerted effort to reduce costs for legal and other
professional fees and achieved that in the areas of reduced audit fees, other audit related fees
and board fees. In addition, we incurred professional fees in 2009 of approximately $0.7 million
in connection with the contested election of directors and fees related to our evaluation of
potential acquisition candidates, which were not incurred in 2010. General insurance declined by
$0.3 million in 2010 due to a change in insurance providers, revised coverage, and other program
changes. The $1.0 million decrease in bad debt expense 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. Other expense consists of various items
which are individually immaterial.
Research and Development Expenses
2010 | 2009 | Change | % | |||||||||||||
Employee Costs |
$ | 5,797 | $ | 7,977 | $ | (2,180 | ) | -27 | % | |||||||
Professional Fees |
618 | 722 | (104 | ) | -14 | % | ||||||||||
Depreciation |
567 | 622 | (55 | ) | -9 | % | ||||||||||
Other |
(141 | ) | 90 | (231 | ) | -257 | % | |||||||||
Total Research and Development Expenses |
$ | 6,841 | $ | 9,411 | $ | (2,570 | ) | -27 | % | |||||||
Our 2010 total research and development expenses were approximately $6.8 million compared to
approximately $9.4 million in 2009, a decrease of $2.6 million, or 27%. Our research and
development expenses consist primarily of employee costs, which include salaries and related
payroll taxes, professional fees, depreciation expenses and other expenses, which individually are
not material. The decrease in our research and development expenses for 2010 is primarily related
to reductions in the work force, reduced consulting and professional fees, lower depreciation and a
larger portion of our engineering costs allocated to cost of sales due to some of our contractual
agreements which require us to provide engineering development or repair services to our customers.
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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 were 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, (net)
Other income was less than $0.1 million for 2010 as compared to $0.6 million for 2009. This $0.5
million decrease in other income in 2010 is due primarily to a $0.2 million decline in interest
income on our investment balances as a result of the overall decline in economic market conditions,
foreign currency translation losses of $0.1 and an insurance loss reimbursement of $0.2 in 2009 not
realized in 2010.
Income Taxes
For the year ended December 31, 2010, we recorded a total income tax expense of approximately $0.3
million, 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.
For the year ended December 31, 2009, we incurred a total income tax benefit of $0.9 million,
primarily related to the income tax benefit of $1.1 million 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. Additionally, we continued to
record a valuation allowance against U.S. federal, state and certain foreign net operating losses
incurred in 2010, as we believe it is more likely than not that the tax benefit will not be
realizable in future periods. The operating profits in 2010, as well as the tax benefit related to
the intangible asset impairment in 2009, are the primary reasons for the increase of 8% in the
effective tax rate year over year.
Results
of Operations for the Year Ended December 31, 2009 Compared to the Year Ended December 31, 2008
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 | % | ||||||||||
Managed Services |
5,078 | | 5,078 | 100 | % | |||||||||||
Other Services |
19,927 | 22,055 | (2,128 | ) | -10 | % | ||||||||||
Total Services |
25,005 | 22,055 | 2,950 | 13 | % | |||||||||||
Total Revenue |
$ | 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
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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. Our 2009 managed service
revenue of approximately $5.1 million is due entirely to our managed service contract with Ericsson
that was signed in April of 2009. The decrease in other services revenues of approximately $2.1
million, which consist primarily of our software maintenance and repair work, is the result of
lower repairs and the roll-off of certain maintenance contracts. Services revenues accounted for
approximately 56% of our total revenues for 2009 compared to 45% of 2008 total revenues.
Gross (Loss)/profit
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 | % | ||||||||||
Consulting Expenses |
419 | 677 | (258 | ) | -38 | % | ||||||||||
Other |
916 | 776 | 140 | 18 | % | |||||||||||
Total Selling and Marketing Expenses |
$ | 6,809 | $ | 6,835 | $ | (26 | ) | 0 | % | |||||||
Our selling and marketing expenses of $6.8 million for 2009 and 2008 were flat year over year.
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 fees and other
miscellaneous expenses which individually are not material. 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. 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 | % | ||||||||
Legal and 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 General and Administrative Expenses |
$ | 12,141 | $ | 9,455 | $ | 2,686 | 28 | % | ||||||||
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. Our general and administrative
expenses consist primarily of employee costs, which include salaries and related payroll taxes and
benefit related costs, legal and profession professional fees, bad debt expenses, stock
compensation expenses and other expenses which individually are not material. The $2.7 million
increase is primarily attributable to a $1.1 million bad debt
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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 .
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 Research and Development Expenses |
$ | 9,411 | $ | 10,789 | $ | (1,378 | ) | -13 | % | |||||||
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. Our research and development
expenses consist primarily of employee costs, which include salaries and related payroll taxes,
professional fees, depreciation expenses and other expenses, which individually are not material.
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 contracts expiration date on December 31, 2009,
but would instead consolidate its purchase of maintenance services (including LoopCare and 4TEL
post-warranty services) through a single large supplier. 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. In 2009, we also recorded a $0.4 million
charge for impairments in various other long-lived assets.
In 2008 we recorded an impairment charge on certain long-lived assets of $0.2 million.
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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.
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, 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 $72.2 million at December 31, 2010 from
$66.0 million at December 31, 2009. The increase in cash and cash equivalents and short term
investments from December 31, 2009 is largely attributable to positive cash flow 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 $77.7 million as of December 31, 2010, an increase of $8.5 million, or
12%, from the $69.2 million of working capital as of December 31, 2009. Overall, we generated cash
from operating activities of $5.5 million in 2010 compared to $3.7 million in 2009. The $1.8
million increase in cash flow from operating activates is primarily attributable to operating
profits and a decrease in inventory. In 2009, we generated cash from operating activities of $3.7
million 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.
Cash used for investing activities in 2010 was approximately $0.3 million comprised of $0.4 million
in capital expenditures, partially offset by $0.1 million in cash collected from a note
receivable. This compares to the same 2009 period with cash provided by investing activities of
approximately $4.5 million consisting of $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, partially offset by $0.3 million in acquired assets along with capital expenditures of
approximately $0.8 million. During the same 2008 period 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 were $0.4
million, $0.8 million and $0.5 million in the years ended December 31, 2010, 2009 and 2008,
respectively. Planned capital expenditures for 2011 are approximately $1.1 million and are
primarily related to facility upgrades and new office furniture and fixtures at our new Cranberry
location.
Cash provided by financing activities in 2010 was approximately $0.8 million for the year ended
December 31, 2010 as a result of cash received from the exercise of stock grants in the amount of
$0.9 million partially offset by our purchase of shares of our common stock under our stock
re-purchase program. 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 Boards discretion, may be suspended, discontinued or
modified at any time. During
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the first quarter of the year ended December 31, 2010, we acquired
10,636 shares pursuant to this program at a total cost of $0.1 million. During the fourth quarter
of the years ended December 31, 2009 and 2008, we acquired 79,043 and 496,918 shares pursuant to
this program at a total cost of $0.5 million and $2.2 million, respectively.
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 former Cheswick, Pennsylvania headquarters expires on 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; and Wuppertal, Germany, which expire on December 24, 2012, and
January 31, 2012, respectively. 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.
In October 2010, we signed a seven year lease commitment for a new headquarters facility in
Cranberry Twp., Pennsylvania as our Cheswick facility lease expires on March 31, 2011. The new lease
for 24,402 square feet of office and lab space commenced on March 1, 2011 with annual payments of
approximately $0.4 million. We also have a commitment for approximately $0.9 million of leasehold
improvements and other costs related to this new facility that will be paid in the first quarter of
2011.
Minimum annual future commitments as of December 31, 2010 are (in thousands):
Payments due by period
Less than 1 | More than 5 | |||||||||||||||||||
total | year | 1-3 years | 3-5 years | years | ||||||||||||||||
Operating Lease Obligations |
$ | 3,830 | $ | 813 | $ | 1,283 | $ | 818 | $ | 916 | ||||||||||
Purchase Obligations |
922 | 922 | ||||||||||||||||||
Uncertain Tax Obligations |
825 | 825 | ||||||||||||||||||
Pension Obligations |
795 | 795 | ||||||||||||||||||
Total |
$ | 6,372 | $ | 1,735 | $ | 2,108 | $ | 818 | $ | 1,711 | ||||||||||
Our lease expense was $0.8 million in 2010, $1.0 million in 2009, and $1.2 million in 2008.
In addition, we are, from time to time, party to various legal claims and disputes, either asserted
or unasserted, which arise in the ordinary course of business. While the final resolution of these
matters cannot be predicted with certainty, we do not believe that the outcome of any of these
claims will have a material adverse effect on the Companys consolidated financial position, or
annual results of operations or cash flow.
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 our large domestic carriers and European telecommunication customers. Delivery terms of
hardware sales are predominantly FOB origin. Revenue is recognized for these customers upon
shipment against a valid purchase order. Where title and risk of loss do not pass to the customer
until the product reaches the customers delivery site, revenue recognition is deferred until the
customer assumes risk of loss and takes legal title. 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.
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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. The Company determines the fair value of maintenance revenue (post-contract
customer support or PCS) sold together with perpetual licenses based on the contractual renewal
rate for PCS when sold on a standalone basis. Where possible we seek written customer acceptance
prior to revenue recognition, however certain agreements provide for automatic customer acceptance
after the passage of time from delivery and title transfer. 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. The allocation of fair value for a
multiple-element arrangements involving software is based on vendor specific objective evidence, or
in the absence of VSOE for delivered elements, the residual method. Under the residual method, the
Company allocates the residual amount of revenue from the arrangement to hardware and software
licenses at the inception of the license term when VSOE for all undelivered elements, such as PCS,
exists and all other revenue recognition criteria have been satisfied. 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.
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.
Our managed service revenue is recognized in accordance with the terms of each specific contract.
Our current contract is structured with declining revenues over a four year period in accordance
with expected service delivery (primarily call volume) and costs. As such, we recognize revenue
under the proportional performance method using service delivery output measures (call volume) over
the term of the contract.
Intangible Assets
At December 31, 2010, we had net intangible assets of $5.4 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
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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 2010 we did not have impairments related to any of our intangible assets. During 2009, we had a
significant impairment to one of our intangible assets related to the LoopCare product line that
was acquired from Lucent in 2001. At the time of the acquisition, the intangible asset was valued
at $32 million, with an indefinite life. In 2005, we determined that facts and circumstances which
had supported the assignment of an indefinite life to this asset had changed, and we then
determined the intangible asset to have a finite useful life of fifty years. In the fourth quarter
2009, facts and circumstances relating to the Companys LoopCare post-warranty maintenance service
agreements again led us to evaluate the life assigned to this intangible asset, as well as its
valuation. Specifically, in mid-December of 2009, we learned that Verizon, a major customer of our
LoopCare post warranty software maintenance services, was not going to renew its direct contract
with Tollgrade that was due to expire on December 31, 2009. Verizon consolidated several vendor
relationships through a single large global network equipment manufacturer, including both our
LoopCare and 4TEL maintenance contracts. The loss of the direct contract with Verizon was a
triggering event for us to evaluate the fair market value of the LoopCare intangible asset.
Through our overall evaluation process, which included a valuation, we determined that not only the
useful life estimate, but the value of the asset itself, was no longer supported. We ultimately
determined that the LoopCare intangible asset had a fair value of $2.3 million coupled with a
remaining life of fifteen years, versus its remaining carrying value of $29.3 million dollars and a
forty-six year remaining life. We determined 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.
Inventory Valuation
Our inventory cost in 2010 is primarily valued at the purchase price that we will pay the
contractor to manufacture our products after we transitioned virtually 100% of our in-house
manufacturing to a third party sub-contractor as of December 31, 2009. We evaluate our inventories
quarterly 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 on a review of expected customer orders and consumption expected to occur within a 12-18
month 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 quarterly if
applicable. Inventory identified as obsolete is also discarded from time to time when circumstances
warrant. As part of our review process in 2010 we had a positive adjustment to our inventory
reserve of approximately $0.5 million, based on increases in projected consumption and sales of
items previously reserved, as compared to a write-down of approximately $3.1 million in 2009,
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 Accounts and Note receivables
Our 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 $0.1 million bad debt reserve in the fourth
quarter of 2010 and a $1.1 million bad debt reserve in the third quarter of 2009. Both of these
charges related to large international customer. balances whose collectability was deemed to be
uncertain. We also recorded a $0.2 million bad debt reserve in the fourth quarter of 2010 related
to the remaining balance due to us related to the sale of our cable division in 2009.
If a major customers creditworthiness deteriorates, or if actual defaults are higher than our
historical experience, or if other circumstances arise, our estimates of the recoverability of
amounts due to us could be overstated, and an additional allowance could be required, which could
have a negative impact on our earnings and cash flow.
Income Taxes
We follow the accounting guidance for income taxes, in reporting the effects of income taxes in our
consolidated financial statements. We are subject to income taxes in both the U.S. and numerous
foreign jurisdictions. Significant judgments and estimates are required to determine the
consolidated income tax expense.
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Deferred tax assets and liabilities are determined based on temporary differences between the tax
and financial statement recognition of revenue and expense using enacted tax rates in effect in the
years in which the differences are expected to reverse. We evaluate our ability to recover our
deferred tax assets, based on our current outlook, taking into consideration all positive and
negative evidence. Based on this evaluation, as of December 31, 2010, all U.S. and certain foreign
net operating losses and net deferred tax assets have been eliminated through the recording of a
valuation allowance.
The calculation of our tax liabilities involves dealing with uncertainties in the application of
complex tax laws and regulations in multiple jurisdictions as well as transfer pricing exposures
between jurisdictions. We record tax liabilities for these uncertain tax positions in our current
tax expense. Additionally, we recognize interest and penalties related to uncertain tax positions
in income tax expense.
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 one employee 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 and two employees that were part of our German 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.
These areas involving critical accounting estimates are periodically reviewed and discussed with
the Audit Committee of our Board of Directors.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Our current investment policy limits our investments in financial instruments to cash and cash
equivalents, individual municipal bonds and corporate and government bonds. The use of financial
derivatives and preferred and common stocks is strictly prohibited. We believe that our risk is
minimized through proper diversification along with the requirements that the securities must be of
investment grade with an average rating of A or better by Standard & Poors. We hold our
investment securities to maturity and believe that earnings and cash flows are not materially
affected by changes in interest rates, due to the nature and short-term investment horizon for
which these securities are invested.
In addition, we are exposed to foreign currency translation fluctuations with our international
operations. We do not have any foreign exchange derivative contracts to hedge against foreign
currency exposures. Therefore, we are exposed to the related effects when the foreign currency
exchange rates fluctuate. If the U.S. dollar strengthens against the Euro and/or the British pound
sterling and or the Czech Republics Koruna, the translation rate for these foreign currencies will
decrease, which will have a negative impact on our operating income. Foreign currency translation
fluctuations have no impact on cash flows as long as we continue to reinvest any profits back into
the respective foreign operations.
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Item 8. Financial Statements and Supplementary Data.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
37 | ||||
40 | ||||
41 | ||||
42 | ||||
43 | ||||
44 | ||||
62 |
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Tollgrade Communications, Inc.
Cranberry Twp., PA
Cranberry Twp., PA
We have audited the accompanying consolidated balance sheet of Tollgrade Communications, Inc. and
subsidiaries (the Company) as of December 31, 2010, and the related consolidated statements of
operations, changes in shareholders equity, and cash flows for the year then ended. Our audit
also included the financial statement schedule listed in the Index at Item 15. These financial
statements and financial statement schedule are the responsibility of the Companys management. Our
responsibility is to express an opinion on the financial statements and financial statement
schedule based on our audit. The consolidated financial statements and financial statement
schedule of the Company for the years ended December 31, 2009 and 2008 were audited by other
auditors whose report, dated March 10, 2010, expressed an unqualified opinion on those financial
statements.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects,
the financial position of Tollgrade Communications, Inc. and subsidiaries as of December 31, 2010,
and the results of their operations and their cash flows for the year then ended, in conformity
with accounting principles generally accepted in the United States of America. Also, in our
opinion, such financial statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, present fairly, in all material respects, the information
set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the Companys internal control over financial reporting as of December 31,
2010, based on the criteria established in Internal ControlIntegrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 10,
2011 expressed an unqualified opinion on the Companys internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Pittsburgh, Pennsylvania
March 10, 2011
Pittsburgh, Pennsylvania
March 10, 2011
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Tollgrade Communications, Inc.
Cranberry Twp., PA
Cranberry Twp., PA
We have audited the internal control over financial reporting of Tollgrade Communications, Inc. and
subsidiaries (the Company) as of December 31, 2010, based on criteria established in Internal
Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. The Companys management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal control over financial
reporting, included in the accompanying Managements Report on Internal Control over Financial
Reporting at Item 9A. Our responsibility is to express an opinion on the Companys internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness exists, testing and
evaluating the design and operating effectiveness of internal control based on the assessed risk,
and performing such other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed by, or under the
supervision of, the companys principal executive and principal financial officers, or persons
performing similar functions, and effected by the companys board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A companys internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) 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 (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the
possibility of collusion or improper management override of controls, material misstatements due to
error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2010, based on the criteria established in Internal Control
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated financial statements and financial statement schedule as of
and for the year ended December 31, 2010 of the Company and our report dated March, 10, 2011
expressed an unqualified opinion on those financial statements and financial statement schedule.
/s/ DELOITTE & TOUCHE LLP
Pittsburgh, Pennsylvania
March 10, 2011
Pittsburgh, Pennsylvania
March 10, 2011
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Tollgrade Communications, Inc.
In our opinion, the consolidated balance sheet as of December 31, 2009 and the related consolidated
statements of operations, of changes in shareholders equity and of cash flows for each of the two
years in the period ended December 31, 2009 presents fairly, in all material respects, the
financial position of Tollgrade Communications, Inc. and subsidiaries (the Company) at December
31, 2009, and the results of their operations and their cash flows for each of the two 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 for each of the two years in the period ended December 31, 2009 presents
fairly, in all material respects, the information set forth therein when read in conjunction with
the related consolidated financial statements. These financial statements and financial statement
schedule are the responsibility of the Companys management. Our responsibility is to express
opinions on these financial statements and financial statement schedule based on our audits. We
conducted our audits of these statements 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. An audit includes 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. We
believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
March 10, 2010
Pittsburgh, Pennsylvania
March 10, 2010
39
Table of Contents
Tollgrade Communications, Inc. and Subsidiaries
Consolidated Balance Sheets
In thousands (except par value)
Consolidated Balance Sheets
In thousands (except par value)
December 31, 2010 | December 31, 2009 | |||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 72,194 | $ | 66,046 | ||||
Short-term investments |
3 | 3 | ||||||
Accounts receivable: |
||||||||
Trade, net of
allowance for
doubtful accounts at
$1,583 in 2010 and
$1,496 in 2009 |
7,975 | 6,998 | ||||||
Other |
650 | 1,007 | ||||||
Inventories |
1,373 | 2,119 | ||||||
Prepaid expenses and
deposits |
798 | 759 | ||||||
Deferred and refundable
income taxes |
93 | 196 | ||||||
Total current assets |
83,086 | 77,128 | ||||||
Property and equipment,
net |
2,246 | 3,101 | ||||||
Intangibles |
5,391 | 7,110 | ||||||
Deferred tax assets |
191 | 119 | ||||||
Other assets |
423 | 229 | ||||||
Total assets |
$ | 91,337 | $ | 87,687 | ||||
LIABILITIES AND
SHAREHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 1,867 | $ | 927 | ||||
Accrued warranty |
222 | 504 | ||||||
Accrued expenses |
986 | 2,319 | ||||||
Accrued salaries and
wages |
1,044 | 1,190 | ||||||
Accrued royalties payable |
218 | 137 | ||||||
Income taxes payable |
481 | 393 | ||||||
Deferred revenue |
593 | 2,463 | ||||||
Total current liabilities |
5,411 | 7,933 | ||||||
Pension obligation |
795 | 983 | ||||||
Deferred tax liabilities |
14 | 290 | ||||||
Other tax liabilities |
825 | 738 | ||||||
Total liabilities |
7,045 | 9,944 | ||||||
Commitments and
contingencies |
||||||||
Shareholders equity: |
||||||||
Common stock, $0.20 par
value 50,000 authorized
shares, issued
shares, 14,073 in 2010
and 13,788 in 2009 |
2,815 | 2,746 | ||||||
Additional paid-in
capital |
77,326 | 75,244 | ||||||
Treasury stock, at cost,
1,162 shares in 2010 and
1,151 shares in 2009 |
(8,632 | ) | (8,563 | ) | ||||
Retained earnings |
13,966 | 9,543 | ||||||
Accumulated other
comprehensive loss |
(1,183 | ) | (1,227 | ) | ||||
Total shareholders equity |
84,292 | 77,743 | ||||||
Total liabilities and
shareholders equity |
$ | 91,337 | $ | 87,687 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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Table of Contents
Tollgrade Communications, Inc. and Subsidiaries
Consolidated Statements of Operations
In thousands (except per share data)
Consolidated Statements of Operations
In thousands (except per share data)
Years Ended December 31, | ||||||||||||
2010 | 2009 | 2008 | ||||||||||
Revenues: |
||||||||||||
Products |
$ | 19,067 | $ | 19,936 | $ | 26,997 | ||||||
Services |
26,579 | 25,005 | 22,055 | |||||||||
Total revenues |
45,646 | 44,941 | 49,052 | |||||||||
Cost of sales: |
||||||||||||
Products |
8,259 | 11,812 | 14,181 | |||||||||
Services |
7,618 | 7,143 | 6,146 | |||||||||
Amortization of intangible assets |
1,570 | 2,576 | 3,085 | |||||||||
Inventory write-down |
| 3,070 | 759 | |||||||||
Impairment of long-lived assets |
| 27,151 | 201 | |||||||||
Severance |
319 | 778 | | |||||||||
Total cost of sales |
17,766 | 52,530 | 24,372 | |||||||||
Gross Profit/(Loss) |
27,880 | (7,589 | ) | 24,680 | ||||||||
Operating expenses: |
||||||||||||
Selling and marketing |
5,967 | 6,809 | 6,835 | |||||||||
General and administrative |
8,561 | 12,141 | 9,455 | |||||||||
Research and development |
6,841 | 9,411 | 10,789 | |||||||||
Severance expense |
1,826 | 1,180 | 827 | |||||||||
Impairment of long-lived assets |
| 293 | | |||||||||
Total operating expense |
23,195 | 29,834 | 27,906 | |||||||||
Income/(Loss) from operations |
4,685 | (37,423 | ) | (3,226 | ) | |||||||
Other income, net |
9 | 567 | 1,337 | |||||||||
Income/(Loss) before income taxes |
4,694 | (36,856 | ) | (1,889 | ) | |||||||
Provision/(Benefit) for income taxes |
271 | (874 | ) | 1,137 | ||||||||
Income/(Loss) from continuing operations |
4,423 | (35,982 | ) | (3,026 | ) | |||||||
(Loss) from discontinued operations |
| (223 | ) | (4,089 | ) | |||||||
Net Income/(Loss) |
$ | 4,423 | $ | (36,205 | ) | $ | (7,115 | ) | ||||
PER SHARE INFORMATION: |
||||||||||||
Weighted average shares of common stock and equivalents: |
||||||||||||
Basic |
12,736 | 12,683 | 13,102 | |||||||||
Diluted |
13,160 | 12,683 | 13,102 | |||||||||
Net Income/(Loss) per common share: |
||||||||||||
Basic |
$ | 0.35 | $ | (2.85 | ) | $ | (0.54 | ) | ||||
Diluted |
$ | 0.34 | $ | (2.85 | ) | $ | (0.54 | ) | ||||
Net Income/(Loss) per common share from continuing operations: |
||||||||||||
Basic |
$ | 0.35 | $ | (2.83 | ) | $ | (0.23 | ) | ||||
Diluted |
$ | 0.34 | $ | (2.83 | ) | $ | (0.23 | ) | ||||
Net loss per common share from discontinued operations: |
||||||||||||
Basic |
$ | | $ | (0.02 | ) | $ | (0.31 | ) | ||||
Diluted |
$ | | $ | (0.02 | ) | $ | (0.31 | ) | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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Tollgrade Communications, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders Equity
In thousands
Consolidated Statements of Changes in Shareholders Equity
In thousands
Accumulated | ||||||||||||||||||||||||||||||||||||
Additional | Other | Other | ||||||||||||||||||||||||||||||||||
Common Stock | Paid-In | Treasury Stock | Retained | Comprehensive | Comprehensive | |||||||||||||||||||||||||||||||
Shares | Amount | Capital | Shares | Amount | Earnings | Loss | Total | Income/(Loss) | ||||||||||||||||||||||||||||
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 | |||||||||||||||||||||
Exercise of Common Stock Options |
165 | $ | 33 | $ | 848 | $ | 881 | |||||||||||||||||||||||||||||
Purchase of Treasury Stock |
11 | $ | (69 | ) | $ | (69 | ) | |||||||||||||||||||||||||||||
Compensation
expense for options and restricted stock, net |
120 | $ | 36 | $ | 1,234 | $ | 1,270 | |||||||||||||||||||||||||||||
Actuarial gain, net of tax |
$ | 179 | $ | 179 | $ | 179 | ||||||||||||||||||||||||||||||
Foreign currency translation |
$ | (135 | ) | $ | (135 | ) | $ | (135 | ) | |||||||||||||||||||||||||||
Net Income |
$ | 4,423 | $ | 4,423 | $ | 4,423 | ||||||||||||||||||||||||||||||
Comprehensive Income |
$ | 4,467 | ||||||||||||||||||||||||||||||||||
Balance at December 31, 2010 |
14,073 | $ | 2,815 | $ | 77,326 | 1,162 | $ | (8,632 | ) | $ | 13,966 | $ | (1,183 | ) | 84,292 | |||||||||||||||||||||
The accompanying notes are an integral part of the consolidated financial statements.
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Table of Contents
Tollgrade Communications, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
(In thousands)
Years Ended December 31, | ||||||||||||
2010 | 2009 | 2008 | ||||||||||
Cash flows from operating activities: |
||||||||||||
Net income/(loss) |
$ | 4,423 | $ | (36,205 | ) | $ | (7,115 | ) | ||||
Adjustments to reconcile net loss to net cash provided by operating activities: |
||||||||||||
Loss from discontinued operations |
| 223 | 4,089 | |||||||||
Depreciation and amortization |
2,761 | 3,761 | 4,559 | |||||||||
Impairment of long-lived assets |
| 27,444 | 201 | |||||||||
Valuation allowance |
| | 123 | |||||||||
Compensation expense related to stock plans |
1,270 | 1,236 | 468 | |||||||||
Loss/(Gain) on disposed assets |
12 | (42 | ) | | ||||||||
Deferred income taxes |
(400 | ) | (1,030 | ) | 182 | |||||||
Write-down of inventory |
| 3,070 | 759 | |||||||||
Provision for losses on inventories |
(451 | ) | 231 | 969 | ||||||||
Provision for allowance for doubtful accounts |
165 | 1,119 | 100 | |||||||||
Changes in assets and liabilities, net of acquisitions: |
||||||||||||
Accounts receivable trade & other |
(809 | ) | 3,148 | 4,997 | ||||||||
Inventories |
1,196 | 2,445 | 348 | |||||||||
Prepaid expenses and deposits |
(240 | ) | 284 | (375 | ) | |||||||
Accounts payable |
959 | (1,276 | ) | (3,431 | ) | |||||||
Accrued warranty |
(267 | ) | (434 | ) | (218 | ) | ||||||
Accrued expenses, deferred revenue and salaries and wages |
(2,814 | ) | (310 | ) | (417 | ) | ||||||
Accrued royalties payable |
80 | (152 | ) | (383 | ) | |||||||
Income taxes payable |
(355 | ) | 114 | (287 | ) | |||||||
Net cash provided by discontinued operations: |
| 57 | 38 | |||||||||
Net cash provided by operating activities: |
5,530 | 3,683 | 4,607 | |||||||||
Cash flows from investing activities: |
||||||||||||
Proceeds from sale of assets |
| 3,074 | 265 | |||||||||
Proceeds from note receivable |
124 | 112 | | |||||||||
Purchase of Ericsson test business |
| (300 | ) | | ||||||||
Purchase of investments |
| | (4,266 | ) | ||||||||
Redemption/maturity of investments |
| 2,416 | 2,479 | |||||||||
Capital expenditures |
(416 | ) | (762 | ) | (469 | ) | ||||||
Net cash used in investing activities of discontinued operations: |
| (57 | ) | (38 | ) | |||||||
Net cash (used in)provided by investing activities: |
(292 | ) | 4,483 | (2,029 | ) | |||||||
Cash flows from financing activities: |
||||||||||||
Repurchase of treasury shares |
(69 | ) | (482 | ) | (2,181 | ) | ||||||
Proceeds from the exercise of stock options |
881 | 54 | | |||||||||
Net cash provided by (used in) financing activities: |
812 | (428 | ) | (2,181 | ) | |||||||
Net increase in cash and cash equivalents |
6,050 | 7,738 | 397 | |||||||||
Effect of exchange rate change on cash and cash equivalents |
98 | 332 | (643 | ) | ||||||||
Cash and cash equivalents at beginning of year |
66,046 | 57,976 | 58,222 | |||||||||
Cash and cash equivalents at end of year |
$ | 72,194 | $ | 66,046 | $ | 57,976 | ||||||
Supplemental disclosure of cash flow information: |
||||||||||||
Cash paid during the year for income taxes |
$ | 519 | $ | 7 | $ | 14 |
The accompanying notes are an integral part of the consolidated financial statements.
43
Table of Contents
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION, BUSINESS AND BASIS OF PRESENTATION
Tollgrade Communications, Inc. and subsidiaries design, engineer, market and support centralized
test and measurement systems and service offerings to the telecommunications and power utility
markets in the United States and in certain international markets.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles
in the United States of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date
of the financial statements and the reported amounts of income and expense during the reporting
period. The actual results of the Company could differ from those estimates.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated.
CASH AND CASH EQUIVALENTS
We consider highly liquid investments with a maturity of less than three months at the date of
purchase to be cash equivalents. Substantially all of the Companys cash and cash equivalents are
maintained at one financial institution. No collateral or security is provided on these deposits,
other than $250,000 of deposits which is insured by the Federal Deposit Insurance Corporation.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is based on our assessment of the collectability of customer
accounts and our note receivable. 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.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of our international operations are translated into U.S. dollars using
month-end spot exchange rates, while revenues and expenses are translated at monthly 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.
INVENTORIES
Our inventory is stated at the lower of cost or market. We evaluate our inventories quarterly 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 on a
review of expected customer orders and consumption expected to occur within a 12-18 month 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 quarterly, if applicable.
Inventory identified as obsolete is also discarded from time to time when circumstances warrant.
In 2010, we sold approximately $0.5 million of items previously reserved, as compared to a
write-down of approximately $3.1 million in 2009, primarily related to slow moving and obsolete
inventory.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is provided on a straight-line basis over
the estimated useful lives of the respective assets. Leasehold improvements are amortized over the
relative lease term or the estimated useful life, whichever is shorter. The cost of renewals and
betterments that extend the lives or productive capacities of properties and equipment is
capitalized. Expenditures for normal repairs and maintenance are charged to operations as incurred.
The cost of property and equipment retired or otherwise disposed of and the related accumulated
depreciation or amortization are removed from the accounts, and any resulting gain or loss is
reflected in current operations.
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Table of Contents
VALUATION OF LONG-LIVED ASSETS
We assess potential impairments to our long-lived assets when there is evidence that events or
changes in circumstances indicate that the carrying amount of an asset may not be recovered. An
impairment loss is recognized when the carrying amount of the long-lived asset is not recoverable
and exceeds its fair value. The carrying amount of a long-lived asset is not recoverable if it
exceeds the sum of the undiscounted cash flows expected to result from the use and eventual
disposition of the asset. Any required impairment loss is measured as the amount by which the
carrying amount of a long-lived asset exceeds its fair value and is recorded as a reduction in the
carrying value of the related asset and a charge to operating results.
PRODUCT WARRANTY
We record estimated warranty costs on the accrual basis of accounting. These warranty reserves are
recorded by applying the five year historical returns percentage to the current level of product
shipments within the agreed-upon warranty period. The costs associated with servicing these
warranties are updated at least annually.
REVENUE RECOGNITION
We market and sell test system hardware and related software to the telecommunications industry. We
follow the revenue recognition accounting guidance for recognizing hardware and software sales.
This guidance requires, among other things, that revenue should be recognized only when title has
transferred and risk of loss has passed to a customer with the capability to pay, and that there
are no significant remaining obligations related to the sale. The bulk of our hardware sales are
made to our large domestic carriers and European telecommunication customers. Delivery terms of
hardware sales are predominantly FOB origin. Revenue is recognized for these customers upon
shipment against a valid purchase order. Where title and risk of loss do not pass to the customer
until the product reaches the customers delivery site, revenue recognition is deferred until the
customer assumes risk of loss and takes legal title. 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. The Company determines the fair value of maintenance revenue (post-contract
customer support or PCS) sold together with perpetual licenses based on the contractual renewal
rate for PCS when sold on a standalone basis. Where possible we seek written customer acceptance
prior to revenue recognition, however certain agreements provide for automatic customer acceptance
after the passage of time from delivery and title transfer. 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. The allocation of fair value for a
multiple-element arrangements involving software is based on vendor specific objective evidence, or
in the absence of VSOE for delivered elements, the residual method. Under the residual method, the
Company allocates the residual amount of revenue from the arrangement to hardware and software
licenses at the inception of the license term when VSOE for all undelivered elements, such as PCS,
exists and all other revenue recognition criteria have been satisfied. 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.
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.
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Our managed service revenue is recognized in accordance with the terms of each specific contract.
Our current contract is structured with declining revenues over a four year period in accordance
with expected service delivery (primarily call volume) and costs. As such, we recognize revenue
under the proportional performance method using service delivery output measures (call volume) over
the term of the contract.
COST OF SALES
Cost of sales includes the charges associated with the cost of procuring our products. These
manufacturing costs consist primarily of material cost, outside manufacturing costs, salaries and
wages, depreciation and amortization expenses, rent expense, inventory write-downs, obsolescence,
and slow-moving reserves as well as warranty costs, and other overhead costs. As of December 31,
2009, almost all in-house production had been outsourced to a third party sub-contractor.
SHIPPING AND HANDLING COSTS
Costs incurred for shipping and handling are included in the cost of equipment. Amounts billed to a
customer for shipping and handling are reported as revenue.
INTANGIBLE ASSETS
Accounting guidance for goodwill and other intangible assets, requires that indefinite-lived
intangible assets and goodwill be tested for impairment on an annual basis or more frequently if
events or changes in circumstances indicate that the carrying value of such assets may not be
recoverable. If the carrying amount exceeds its fair value, an impairment charge is recognized in
the amount by which the carrying value exceeds fair value. During 2010 and 2009, we had no
goodwill or indefinite-lived intangible assets.
The values assigned to finite-lived assets were determined using an undiscounted cash flow model
and no residual value. Furthermore, the accounting guidance requires purchased intangible assets
with a finite life to be amortized over their useful lives using a methodology which reflects the
pattern in which the economic benefit of the assets is consumed. Amortization of these assets is
generally straight-line. All amortization of intangible assets is recorded in cost of sales.
Finite-lived intangibles and their related useful lives are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of the asset may not be recoverable
or the period of economic benefit has changed. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of the related asset or group of assets to
estimated undiscounted future cash flows expected to be generated by the asset or group of assets.
If the carrying amount of an asset exceeds its fair value, which is generally estimated based on
future cash flows, an impairment charge is recognized by the amount by which the carrying amount of
an asset exceeds the fair value of the asset. If the estimate of an intangible assets remaining
useful life would be changed, the remaining carrying amount of the intangible asset would be
amortized prospectively over the revised remaining useful life.
At the end of 2009, we had a triggering event which required us to review the recoverability of the
intangible asset associated with our Loopcare post-warranty software maintenance agreements.
Through our evaluation process, we determined that the fair value of this asset approximated $2.3
million compared to its then remaining carrying value of $29.3 million and as such, took an
impairment charge of approximately $27.0 million in the fourth quarter of 2009. The premise of the
valuation is based on the highest and best use of the asset by market participants. There were no
impairments to intangible assets for the year ended December 31, 2010.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs, which consist primarily of employee related costs, are charged to
operations as incurred; however, certain research and development costs that apply to specific
customer application/support work or repair and maintenance work are captured and allocated back to
cost of sales. As of December 31, 2010, 2009, and 2008, research and development costs that were
allocated back to cost of sales amounted to $1.5 million, $1.5 million and $1.4 million,
respectively.
INCOME TAXES
In accordance with accounting guidance for income taxes, deferred tax assets and liabilities are
determined based on the temporary differences between the tax and financial statement recognition
of revenue and expense using enacted tax rates in effect in the years in which the differences are
expected to reverse. Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized.
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SEGMENT INFORMATION
We follow the accounting guidance for disclosures about segments of an enterprise and related
information. This statement establishes standards for reporting information about operating
segments, products and services, geographic areas and major customers in annual and interim
financial statements. We manage and operate our business as one operating segment. Operating
results are regularly reviewed by our chief operating decision maker regarding decisions about the
allocation of resources and to assess performance.
RECLASSIFICATIONS
In the statement of cash flows we consolidated the change in accounts receivable trade and accounts
receivable other in the prior year amounts to conform to the current year presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
Revenue Recognition for Multiple-Deliverable Arrangements: In October 2009, new accounting
guidance was issued for revenue arrangements with multiple deliverables that are outside the scope
of the software revenue recognition guidance. Under the new accounting guidance, when vendor
specific objective evidence or third party evidence for deliverables in an arrangement cannot be
determined, a best estimate of the selling price is required to separate deliverables and allocate
arrangement consideration using the relative selling price method. The new guidance includes new
disclosure requirements on how the application of the relative selling price method affects the
timing and amount of revenue recognition. This guidance is effective prospectively for revenue
arrangements entered into or materially modified in fiscal years beginning on or after June 15,
2010. The Company is still evaluating the impact of adopting the new guidance. The impact on the
Companys financial position, results of operations and cash flows will depend on the types of
future arrangements.
Revenue Recognition for Certain Arrangements that Include Software Elements: In October 2009,
new accounting guidance was issued for revenue arrangements that include both tangible products and
software elements. This new accounting guidance affects companies that sell or lease tangible
products in an arrangement that contains software that is more than incidental to the tangible
product as a whole. Additionally, clarification is given regarding what guidance should be used in
allocation and measuring revenue. This guidance is effective prospectively for revenue arrangements
entered into or materially modified in fiscal years beginning on or after June 15, 2010. The
Company is still evaluating the impact of adopting this new guidance. The impact on the Companys
financial position, results of operations and cash flows will depend on the types of future
arrangements.
2. ACCOUNTING FOR STOCK-BASED COMPENSATION
We currently sponsor one active stock compensation plan. Our 2006 Amended and Restated 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.
The 2006 Plan was intended to replace our 1995 Long-Term Incentive Compensation Plan (the 1995
Plan) and the 1998 Employee Incentive Compensation Plan (the 1998 Plan), the terms of which
provided that no further awards could be granted under these plans beyond October 15, 2005 and
January 29, 2008, respectively.
Options granted to employees prior to 2007 under our equity compensation plans 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.
As of December 31, 2010 and December 31, 2009, there were 1,306,787 and 1,577,557 shares authorized
but not granted under the 2006 Plan, respectively. During 2010 and 2009, the Company granted from
the 2006 Plan 502,501 and 615,500 options to 32 and 37 employees, respectively. There were no
options granted by the Company from the 1998 Plan in 2010 and 2009.
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During 2010 and 2009, the Board of Directors approved the issuance of 148,000 and 45,037 restricted
shares under the 2006 Plan, respectively. In March 2010, 50,000 restricted shares were granted to
our Board Chairman, then serving as a non-employee director. In October 2010, 48,000 restricted
shares were issued to the non-employee members of our Board of Directors. In March 2010, 30,000
restricted shares were issued to the former Chief Executive Officer and 20,000 restricted shares
were issued to the current Chief Financial Officer, however the 30,000 restricted shares granted to
our former CEO were forfeited when he left the Company in June 2010. The 45,037 restricted shares
granted during 2009 were issued to eight non-employee members of our Board of Directors. The
restricted share awards granted during 2009 and 2010 to non-employee directors were subject to a
one-year period of restriction, and provide each director the right to receive the shares one year
following the date of grant, regardless of whether the director is still serving on the Board of
Directors, unless the director is removed from the Board for cause during the period of
restriction. During the one year restriction period, directors can vote but are not permitted to
trade restricted shares.
During the first quarter of 2010, 250,000 cash settled stock appreciation rights were granted to
Mr. Kennedy in his capacity as our Board Chairman, who was then serving as a non-employee director.
Vesting of these rights will not occur unless certain objectives are met. During the second
quarter of 2010, Mr. Kennedy became an employee and assumed the role of president and chief
executive officer.
During 2008, 9,077 restricted shares were granted to employees, certain of which were subject to
performance-based restrictions, and the remainder of which were subject to time-based restrictions.
Of the 9,077 restricted shares awarded during 2008, 6,720 have since been forfeited under the
terms of such awards, either due to termination of employment during the period of restriction or
because we did not achieve the required performance targets.
Stock-Based Compensation Expense
Stock based compensation is based on the fair value of share-based payment awards on the date of
grant using the black-scholes option pricing model and the following weighted average assumptions
for the options granted during the years ended December 31, 2010, 2009 and 2008:
Stock Options | ||||||||||||
Year Ended | Year Ended | Year Ended | ||||||||||
December 31, 2010 | December 31, 2009 | December 31, 2008 | ||||||||||
Weighted average grant date fair values |
$ | 3.19 | $ | 2.60 | $ | 2.68 | ||||||
Expected life (in years) |
5 | 5 | 5 | |||||||||
Risk free interest rate |
2.01 | % | 1.90 | % | 2.80 | % | ||||||
Expected Volatility |
55.01 | % | 53.80 | % | 48.10 | % |
Expected volatility is based on historical stock price over the estimated holding period. The
estimated holding period is primarily based on historical experience. The expected life of options
granted is based on historical stock option exercise data. The risk free rate is based upon the
treasury note applicable for that specific holding period.
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Transactions involving stock options under our various plans and otherwise are summarized below:
Range of | Weighted Average | ||||||||||||
Number of Shares | Exercise Price | Exercise Price | |||||||||||
Outstanding December 31, 2007 |
1,440,562 | $ | 3.27-159.19 | $ | 27.28 | ||||||||
Granted |
684,400 | 3.27-6.57 | $ | 5.97 | |||||||||
Exercised (A) |
| | | ||||||||||
Cancelled/Forfeited/Expired |
(519,472 | ) | 6.57-55.90 | $ | 12.16 | ||||||||
Outstanding December 31, 2008 |
1,605,490 | 3.27-159.19 | $ | 23.08 | |||||||||
Granted |
615,500 | 5.17-5.86 | $ | 5.47 | |||||||||
Exercised (A) |
(10,000 | ) | 5.87-6.48 | $ | 6.11 | ||||||||
Cancelled/Forfeited/Expired |
(526,195 | ) | 3.27-159.19 | $ | 19.10 | ||||||||
Outstanding December 31, 2009 |
1,684,795 | 3.27-159.19 | $ | 27.29 | |||||||||
Granted |
502,501 | 6.48-8.52 | $ | 6.58 | |||||||||
Exercised (A) |
(164,527 | ) | 5.35 | $ | 5.35 | ||||||||
Cancelled/Forfeited/Expired |
(709,777 | ) | 5.99-51.45 | $ | 32.40 | ||||||||
Outstanding December 31, 2010 |
1,312,992 | 3.27-32.90 | $ | 8.03 | |||||||||
Number of Shares | |||||||||||||
Options exercisable at: |
|||||||||||||
December 31, 2008 |
937,757 | $ | 35.14 | ||||||||||
December 31, 2009 |
957,353 | $ | 27.29 | ||||||||||
December 31, 2010 |
612,335 | $ | 9.97 |
(A) | The intrinsic value associated with exercised options which represent the difference between the strike price and the market value of Tollgrade stock at the time of exercise was approximately $1.3 million in 2010 and less than $0.1 million in 2009 and 2008, respectively. |
The following table summarized the status of stock options, outstanding and exercisable, at
December 31, 2010:
Stock Options Outstanding | Stock Options Exercisable | |||||||||||||||||||||||||||
Number Outstanding | Weighted Average | Weighted | (B) Aggregate | Number Exercisable | Weighted | (B) Aggregate | ||||||||||||||||||||||
Range of Exercise | as of December 31, | Remaining | Average Exercise | Intrinsic | as of December 31, | Average Exercise | Intrinsic | |||||||||||||||||||||
Prices | 2010 | Contractual Life | Price ($) | Value ($) | 2010 | Price ($) | Value ($) | |||||||||||||||||||||
$ 3.27-5.38 |
195,498 | 7.48 | $ | 5.18 | $ | 801,587 | 102,826 | $ | 5.27 | $ | 412,112 | |||||||||||||||||
5.74-6.03 |
148,000 | 8.91 | 5.96 | 491,150 | 72,669 | 5.89 | 246,324 | |||||||||||||||||||||
6.43-6.43 |
5,000 | 9.49 | 6.43 | 14,250 | | 0 | ||||||||||||||||||||||
6.48-6.48 |
442,500 | 9.46 | 6.48 | 1,239,000 | | 0 | ||||||||||||||||||||||
6.57-6.57 |
228,771 | 5.65 | 6.57 | 619,970 | 168,617 | 6.57 | 456,952 | |||||||||||||||||||||
7.78-8.49 |
155,840 | 2.97 | 8.16 | 174,594 | 130,840 | 8.10 | 154,844 | |||||||||||||||||||||
9.49-28.7 |
120,883 | 1.38 | 20.13 | 120,883 | 20.13 | |||||||||||||||||||||||
31.44-31.44 |
3,000 | 0.02 | 31.44 | 3,000 | 31.44 | |||||||||||||||||||||||
32.28-32.28 |
2,500 | 0.12 | 32.28 | 2,500 | 32.28 | |||||||||||||||||||||||
32.90-32.90 |
11,000 | 0.97 | 32.90 | 11,000 | 32.90 | |||||||||||||||||||||||
Total $3.27-32.90 |
1,312,992 | 6.81 | $ | 8.03 | $ | 3,340,551 | 612,335 | $ | 9.97 | $ | 1,270,232 | |||||||||||||||||
(B) | The aggregate intrinsic value in the preceding table represents the difference between the strike price and the market value of Tollgrade stock on December 31, 2010, which was $9.28. The total number of exercisable shares in-the-money was 474,952 and 116,001 shares on December 31, 2010 and December 31, 2009, respectively. |
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Weighted Average | ||||||||||||||||
Weighed Average | Remaining | Aggregate Intrinsic | ||||||||||||||
No. of Shares | Exercise Price | Contractual Life | Value (1) | |||||||||||||
Vested |
612,335 | $ | 9.97 | 4.27 | $ | 1,270,232 | ||||||||||
Expected to Vest |
700,657 | $ | 8.07 | 6.73 | $ | 2,070,319 | ||||||||||
Total |
1,312,992 | $ | 8.03 | 6.81 | $ | 3,340,551 | ||||||||||
(1) | The aggregate intrinsic value in the preceding table represents the difference between the strike price and the market value of Tollgrade stock on December 31, 2010, which was $9.28. |
Unrecognized compensation cost related to stock options and restricted shares granted under our
equity incentive plans which is expected to be incurred through 2012 was $1.7 million on December
31, 2010. The unrecognized compensation cost is expected to be recognized over a weighted average
period of three years. During 2010 and 2009, we recorded cash received from the exercise of stock
options of $1.0 million and $0.1 million respectively. During 2008, there were no stock option
exercises.
3. ACQUISITIONS AND DISCONTINUED OPERATIONS
On April 15, 2009, we entered into a multi-year managed services agreement with Ericsson, pursuant
to which we provide customer support and engineering service capabilities. We entered into this
agreement as part of our continued strategic focus to grow our managed services business. In
connection with the agreement, we paid $0.3 million for certain assets and hired 22 of their
employees. The acquisition was recorded under the purchase method of accounting in accordance with
generally accepted accounting pronouncements. Accordingly, the results of operations of the
acquired assets are included in our consolidated financial statements for the period ended December
31, 2009.
On May 27, 2009, we completed the sale of our cable product line to private equity buyers in
Pittsburgh, Pennsylvania, and recorded a gain of less than $0.1 million. This divesture allowed us
to continue our business focus on our core telecommunications markets and customers.
The assets and liabilities, results of operations and cash flows of the cable product line have
been classified as discontinued operations in the consolidated financial statements for all periods
presented through the date of sale. Cash flows for cable have been segregated in the consolidated
statement of cash flows as separate line items within operating and investing activities.
The following table details selected financial information for the cable product line included
within discontinued operations:
Twelve Months Ended | ||||||||
December 31, 2009 | December 31, 2008 | |||||||
Revenues: |
||||||||
Products |
$ | 2,376 | $ | 6,377 | ||||
Services |
723 | 1,795 | ||||||
$ | 3,099 | $ | 8,172 | |||||
Loss from discontinued operations |
||||||||
Loss from discontinued operations, before tax |
$ | (223 | ) | $ | (4,089 | ) | ||
Income tax expense |
| | ||||||
Loss from discontinued operations, net of tax |
$ | (223 | ) | $ | (4,089 | ) |
4. INTANGIBLES
We perform impairment reviews of our long-lived assets upon a change in business conditions or upon
the occurrence of a triggering event. In 2010, we recorded no impairments related to our intangible
assets. In mid-December 2009, a major customer notified us that they would not be renewing their
LoopCare post-warranty software maintenance service agreement with us following the contracts
expiration date on December 31, 2009, but would instead consolidate their purchase of maintenance
services (including LoopCare and 4TEL post-warranty services) through a single large supplier.
Based on this triggering event and following the appropriate accounting guidance, we evaluated
the carrying value of the intangible asset related to our LoopCare post-warranty intangible asset
using an undiscounted cash flow model, Step 1 impairment review, and found the asset to be
impaired. We then performed a valuation of this asset to help determine its fair value. Through
this valuation process, we determined that the fair value of this asset approximated $2.3 million
compared to its current carrying value of $29.3 million and, as such, took an impairment charge of
approximately $27 million in the fourth quarter of 2009. The fair value measurement would be
considered a Level 3 measurement as
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the valuation performed to determine the fair value utilized an
income approach, specifically, an excess earnings approach. The Companys significant inputs used
in determining the fair value included the Companys forecasted revenues, direct costs, deprecation
and the associated contributory asset charges. The Company used a present value factor of 14% and
an estimated 15 year period of forecasted revenues and costs based on the estimated useful life of
the intangible asset. The assumptions used were based on a market participants view. In addition,
through this valuation process, we determined that a fifteen year life, instead of a remaining
forty six year life, for this asset is more indicative of current market and technological
conditions, as well as the anticipated future ability to extend existing maintenance agreements.
In 2008 we determined that certain long-lived assets, primarily related to assets acquired as part
of our Emerson acquisition, were impaired and an impairment loss of $0.2 million was recorded to
reflect these assets at their fair market value.
The following information is provided regarding our intangible assets (in thousands):
December 31, 2010 | ||||||||||||||||||||
Accumulated | Impairments During | |||||||||||||||||||
Amortization and | the Reporting | |||||||||||||||||||
Useful Life (Years) | Gross | Impairments | Period | Net | ||||||||||||||||
Amortizing Intangible Assets: |
||||||||||||||||||||
Post Warranty Service Agreements |
6-15 | $ | 37,539 | $ | 33,113 | | $ | 4,426 | ||||||||||||
Technology |
2-10 | 13,986 | 13,275 | | 711 | |||||||||||||||
Customer Relationships |
5-15 | 905 | 704 | | 201 | |||||||||||||||
Trade names and other |
0.5-10 | 574 | 521 | | 53 | |||||||||||||||
Total Intangible Assets |
$ | 53,004 | $ | 47,613 | | $ | 5,391 | |||||||||||||
December 31, 2009 | ||||||||||||||||||||
Accumulated | Impairments During | |||||||||||||||||||
Amortization and | the Reporting | |||||||||||||||||||
Useful Life (Years) | Gross | Impairments | Period | Net | ||||||||||||||||
Amortizing Intangible Assets: |
||||||||||||||||||||
Post Warranty Service Agreements |
6-15 | $ | 37,779 | $ | 5,438 | $ | 26,960 | $ | 5,381 | |||||||||||
Technology |
2-10 | 14,000 | 12,488 | 191 | 1,321 | |||||||||||||||
Customer Relationships |
5-15 | 927 | 613 | | 314 | |||||||||||||||
Trade names and other |
0.5-10 | 537 | 443 | | 94 | |||||||||||||||
Total Intangible Assets |
$ | 53,243 | $ | 18,982 | $ | 27,151 | $ | 7,110 | ||||||||||||
Amortization expense was $1.6 million, $2.6 million, and $3.1 million for the years ended
December 31, 2010, 2009, and 2008, respectively.
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 expected to be approximately $1.2, $0.7, $0.6, $0.5 and $0.4 million for
each of the years ended December 31, 2011, 2012, 2013, 2014 and 2015, respectively.
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5. INVENTORIES
Inventories consisted of the following (in thousands):
December 31, 2010 | December 31, 2009 | |||||||
Raw materials |
$ | 804 | $ | 1,019 | ||||
Work in process |
179 | 344 | ||||||
Finished goods |
390 | 756 | ||||||
Total Inventory |
1,373 | 2,119 | ||||||
Our 2010 inventory decreased as a result of the realization of a full year of outsourced
management of our production process resulting in a more timely and efficient sourcing process.
Throughout 2009, we began a program to completely out-source our in-house production capabilities
and completed this process as of December 31, 2009. During the third quarter of 2009, we
implemented a program to evaluate certain legacy products based on anticipated future consumption
and technological end-of-life cycle. As a result of this evaluation, we wrote-off $3.1 million for
slow moving and obsolete inventory in the third quarter of 2009.
6. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following (in thousands):
Years | December 31, 2010 | December 31, 2009 | ||||||||||
Test equipment and tooling |
3-5 | $ | 2,354 | $ | 10,747 | |||||||
Office equipment and fixtures |
5-7 | 4,295 | 10,187 | |||||||||
Leasehold Improvements |
1-6 | 2,868 | 2,777 | |||||||||
Gross Property and Equipment |
9,517 | 23,711 | ||||||||||
Less accumulated depreciationa and amortization |
(7,271 | ) | (20,610 | ) | ||||||||
Net Property and Equipment |
$ | 2,246 | $ | 3,101 | ||||||||
Depreciation expense was $1.2 million in 2010 and 2009, and $1.4 million in 2008.
7. PRODUCT WARRANTY
Activity in the warranty accrual is as follows (in thousands):
December 31, 2010 | December 31, 2009 | |||||||
Balance at the beginning of the year |
$ | 504 | $ | 926 | ||||
Accruals for warranties issued during the year |
251 | 894 | ||||||
Settlements during the year |
(533 | ) | (1,316 | ) | ||||
Balance at the end of the year |
$ | 222 | $ | 504 | ||||
8. PENSIONS
We sponsor contributory or noncontributory defined benefit plans for four active European employees
and five other pensioners that have left our employment. Benefits under these plans are based upon
years of service and final average pensionable earnings, or a minimum benefit based upon years of
service, whichever is greater.
As part of a 2007 acquisition, we assumed three defined benefit pension plans: one which related to
two employees based in the Netherlands, one which related to four employees based in Belgium and
one which related to three employees based in Germany. The Netherlands and Belgian pension plan
assets are invested in insurance contracts that are valued based upon the underlying mutual funds
and pooled investments and approximates the policies net cash surrender value. As of December 31,
2010 and 2009, the pension plan assets are considered Level 3 investments within the fair value
hierarchy. Since our German plan has no plan assets as of December 31, 2010, we would be
responsible for the $0.7 million underfunded position of this plan by utilizing cash from our
general operating bank accounts.
We use a December 31 measurement date for our pension plans and may have an interim measurement
date if significant events occur. Below are details related to pension benefits.
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Pension | Pension | |||||||
Benefits | Benefits | |||||||
(in thousands) | 2010 | 2009 | ||||||
Change in projected benefit obligation: |
||||||||
Projected benefit obligation at January 1, |
$ | 1,425 | $ | 1,257 | ||||
Curtailments |
(42 | ) | (70 | ) | ||||
Service cost |
74 | 80 | ||||||
Interest cost |
77 | 76 | ||||||
Plan participants contributions |
| 5 | ||||||
Actuarial loss(gains) |
(184 | ) | (35 | ) | ||||
Effect of foreign currency |
(107 | ) | 41 | |||||
Gross benefits paid |
(12 | ) | | |||||
Projected benefit obligation at December 31, |
$ | 1,231 | $ | 1,424 | ||||
2010 | 2009 | |||||||
Change in fair value of plan assets: |
||||||||
Fair value of plan assets at January 1, |
$ | 442 | $ | 368 | ||||
Employer contributions |
17 | 24 | ||||||
Plan participants contributions |
| 5 | ||||||
Actual return on plan assets (net of cost) |
22 | 32 | ||||||
Effect of foreign currency |
(33 | ) | 12 | |||||
Gross benefits paid |
(12 | ) | | |||||
Fair value of plan assets at December 31, |
$ | 436 | $ | 441 | ||||
Unfunded status of plans at December 31, |
$ | 795 | $ | 983 | ||||
2010 | 2009 | |||||||
Amounts recognized in accumulated other comprehensive income: |
||||||||
Prior service cost |
| | ||||||
Actuarial gains |
$ | 286 | $ | 106 | ||||
Total |
$ | 286 | $ | 106 | ||||
At December 31, 2010 and 2009, the following amounts were recognized in the consolidated balance
sheet:
Pension | Pension | |||||||
Benefits | Benefits | |||||||
(in thousands) | 2010 | 2009 | ||||||
Noncurrent assets |
$ | | $ | | ||||
Noncurrent liabilities |
795 | 983 | ||||||
Net amount recognized at December 31, |
$ | 795 | $ | 983 | ||||
Other changes in plan assets and benefit obligations recognized in other comprehensive income:
2010 | 2009 | 2008 | ||||||||||
Curtailments (gain)/loss |
$ | | $ | (6 | ) | $ | | |||||
Current year actuarial (gain)/loss |
$ | (190 | ) | 17 | (87 | ) | ||||||
Amortization of actuarial gain/(loss) |
$ | 3 | 5 | | ||||||||
Foreign currency exchange rate change |
$ | 8 | (3 | ) | ||||||||
Total recognized in other comprehensive income |
$ | (179 | ) | $ | 13 | $ | (87 | ) |
The accumulated benefit obligation for all defined benefit pension plans at December 31, 2010 and
2009 was as follows:
Pension | Pension | |||||||
Benefits | Benefits | |||||||
(in thousands) | 2010 | 2009 | ||||||
Projected benefit obligation in excess of plan assets: |
||||||||
Projected benefit obligation |
$ | 1,231 | $ | 1,424 | ||||
Fair value of plan assets |
$ | 436 | $ | 441 | ||||
Accumulated benefit obligation in excess of plan assets: |
||||||||
Accumulated benefit obligation |
$ | 1,041 | $ | 1,126 | ||||
Fair value of plan assets |
$ | 436 | $ | 441 |
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Following are the details of the net periodic benefit costs related to the pension plans:
Pension | Pension | |||||||
Benefits | Benefits | |||||||
(in thousands) | 2010 | 2009 | ||||||
Components of net periodic benefit cost: |
||||||||
Service cost |
$ | 74 | $ | 80 | ||||
Interest cost |
77 | 76 | ||||||
Actuarial (gain) |
(2 | ) | (4 | ) | ||||
Curtailment (gain) |
(42 | ) | (65 | ) | ||||
Expected return on plan assets |
(16 | ) | (15 | ) | ||||
Net periodic benefit cost |
$ | 91 | $ | 72 | ||||
Employer contributions in 2011 are expected to be less than $20,000. The amount of accumulated
other comprehensive income expected to be recognized in net periodic pension cost during 2011
related to prior service cost and actuarial gains is insignificant.
(in thousands) | ||||
Expected benefit payments: |
||||
2011 2015 |
$ | 3 | ||
2016 2020 |
$ | 248 |
Assumptions used to determine the benefit obligation at December 31, 2010 and 2009 and net periodic
benefit cost for the years ended December 31, 2010 and 2009 are detailed below:
2010 | 2009 | |||||||
Weighted-average assumptions used to determine the benefit obligation | ||||||||
Discount rate |
5.75 | % | 5.75 | % | ||||
Rate of compensation increase |
3.00 | % | 3.00 | % |
2010 | 2009 | |||||||
Weighted-average assumptions used to determine the net benefit costs |
||||||||
Discount rate |
5.75 | % | 6.00 | % | ||||
Rate of compensation increase |
3.00 | % | 3.00 | % | ||||
Expected annual return on plan assets |
4.00 | % | 3.80 | % |
The company is currently using a 4.0% assumed rate of return on plan assets. This rate was
determined based upon Euro zone government and corporate bond yields of 10 year and 30 year
maturities.
9. LICENSE AND ROYALTY FEES
We have entered into several technology license agreements with certain major Digital Loop Carrier
vendors and major Operation Support System equipment manufacturers under which we have been granted
access to the licensors patent technology and the right to manufacture and sell the patent
technology in our product line. We are obligated to pay royalty fees, as defined, through the terms
of these license agreements. Under these agreements, license and royalty fees are due only upon
purchase of the technology or shipment of units; there are no contingent payment provisions in any
of these arrangements. The terms of these agreements automatically renew (unless earlier
terminated) for periods ranging from one to five years, except for one, which has a perpetual term.
Royalty fees of $0.4 million were incurred in both 2010 and 2009 and in 2008 were $0.5 million. and
are included in cost of product sales in the accompanying consolidated statements of operations.
10. INCOME TAXES
For financial reporting purposes, income/(loss) before income taxes includes the following
components (in thousands):
2010 | 2009 | 2008 | ||||||||||
U.S. |
$ | 2,165 | $ | (36,657 | ) | $ | (3,154 | ) | ||||
Foreign |
$ | 2,529 | $ | 199 | $ | 1,265 | ||||||
Total |
$ | 4,694 | $ | (36,458 | ) | $ | (1,889 | ) | ||||
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The provision (benefit) for income taxes consisted of the following (in thousands):
2010 | 2009 | 2008 | ||||||||||
Current: |
||||||||||||
Federal |
$ | (43 | ) | $ | (202 | ) | $ | (16 | ) | |||
Foreign |
507 | 482 | 777 | |||||||||
State |
23 | 15 | 7 | |||||||||
487 | 295 | 768 | ||||||||||
Deferred: |
||||||||||||
Federal |
(262 | ) | (1,105 | ) | | |||||||
Foreign |
54 | (32 | ) | 369 | ||||||||
State |
(8 | ) | (32 | ) | | |||||||
(216 | ) | (1,169 | ) | 369 | ||||||||
$ | 271 | $ | (874 | ) | $ | 1,137 | ||||||
Reconciliation of the federal statutory rate to the effective tax rates are as follows:
Years Ended December 31, | ||||||||||||
2010 | 2009 | 2008 | ||||||||||
Federal statutory tax rate |
34 | % | -34 | % | -34 | % | ||||||
State income taxes |
1 | % | -1 | % | | |||||||
Foreign income taxes |
-17 | % | | -1 | % | |||||||
Valuation allowance |
-15 | % | 35 | % | 49 | % | ||||||
Tax contingency reserve |
3 | % | 1 | % | 5 | % | ||||||
Intangible write down |
| -3 | % | | ||||||||
Other |
-1 | % | 0 | % | | |||||||
5 | % | -2 | % | 19 | % |
The current income tax expense recorded for 2010 primarily relates to income tax obligations
generated by profitable operations in our foreign jurisdictions. The federal current income tax
benefit recorded for 2009 primarily related to a refund of the 2008 net operating loss carryback to
tax year 2003. Additionally, the 2010 and 2009 current expense is a result of adjustments to
reserves for uncertain tax positions to reflect current requirements under the accounting guidance
for income tax uncertainties. The federal and state deferred tax benefit recorded for 2010 is
primarily a result of adjustments to the deferred tax valuation allowance. The federal and state
deferred tax benefit recorded for 2009 is attributable to the write down of the LoopCare software
maintenance intangible asset for book purposes. The write down reduces book basis below tax basis.
The foreign deferred tax expense recorded in 2010 and the tax benefit in 2009 relates primarily to
temporary differences arising as a result of life differentials between book and tax on intangible
and fixed assets. State current tax expense in 2010 and 2009 is primarily attributable to taxes
generated in a state which levies obligations based on margin.
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The components of and changes in the deferred tax assets and liabilities recorded in the
accompanying balance sheets at December 31, 2010 and 2009 were as follows (in thousands):
December 31, 2010 | December 31, 2009 | |||||||
Deferred Tax Assets: |
||||||||
Excess of tax basis over book basis for: |
||||||||
Property and equipment |
$ | 10 | $ | 295 | ||||
Goodwill and intangible assets |
8,991 | 10,233 | ||||||
Inventory |
1,534 | 691 | ||||||
Reserves recorded for: |
||||||||
Warranty |
46 | 44 | ||||||
Inventory |
1,158 | 1,649 | ||||||
Allowance for doubtful accounts |
554 | 524 | ||||||
Severance |
29 | 138 | ||||||
Federal net operating loss carryforward |
10,840 | 9,737 | ||||||
State net operating loss carryforward |
4,052 | 4,152 | ||||||
Stock based compensation |
726 | 774 | ||||||
Unrealized foreign exchange |
| 453 | ||||||
Pension benefit |
48 | 42 | ||||||
Other |
33 | 31 | ||||||
Gross deferred tax assets |
28,021 | 28,763 | ||||||
Valuation allowance |
(27,449 | ) | (28,567 | ) | ||||
Deferred tax assets |
$ | 572 | $ | 196 | ||||
Deferred Tax Liabilities: |
||||||||
Excess of book basis over tax basis for: |
||||||||
Intangible assets |
$ | (57 | ) | $ | (78 | ) | ||
Property and equipment |
(323 | ) | (154 | ) | ||||
Other |
(15 | ) | (117 | ) | ||||
Total deferred tax liabilities |
(395 | ) | (349 | ) | ||||
Net deferred taxes |
$ | 177 | $ | (153 | ) | |||
Reconciliation to the consolidated balance sheet: |
||||||||
Deferred tax assets current: |
$ | | $ | 18 | ||||
Deferred tax assets noncurrent: |
191 | 119 | ||||||
Deferred tax liabilities noncurrent: |
(14 | ) | (290 | ) | ||||
Net deferred tax liabilities |
$ | 177 | $ | (153 | ) | |||
We record net deferred tax assets to the extent we believe these assets will more likely than
not be realized. Management has
evaluated the available positive and negative evidence to estimate if future taxable income will be
generated to utilize the existing deferred tax assets. Based on the evaluation, it has been
determined that it is more likely than not that the deferred tax assets will not be realized in
future periods. As a result, a full valuation has been recorded on the deferred tax assets.
At December 31, 2010, it is our intention to permanently reinvest accumulated earnings of our
foreign subsidiaries in those operations. As a result, deferred taxes have not been provided on
foreign earnings at December 31, 2010. It is not practicable to estimate the amount of deferred
tax liability related to investments in these foreign subsidiaries. If our intentions change and
such amounts are expected to be repatriated, deferred taxes will be provided.
At December 31, 2010, we had gross federal, state and foreign net operating loss carryforwards of
$29.1 million, $46.8 million, and $2.7 million, respectively. We also had an AMT tax credit
carryforward of $0.1 million. Our U.S. federal and state income tax net operating loss and tax
credit carryforwards expire at various dates through 2031 if not utilized. Our income tax net
operating loss carryforwards related to our foreign operations have an indefinite life. We believe
that it is more likely than not that the benefit from the federal, state and foreign net operating
loss carryforwards will not be realized in future periods. In recognition of this risk, we have
provided a full valuation on these net operating loss carryforwards and tax credits. The valuation
allowance on the net operating loss carryforwards increased by $1.0 million in 2010
We are subject to periodic audits of our various tax returns by government agencies which could
result in possible tax liabilities. Although the outcome of these matters cannot currently be
determined, we do not believe that amounts, if any, which may be required to be paid by reason of
such audits will have a material adverse effect on our financial statements.
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Unrecognized Tax Benefits Tabular Reconciliation (in thousands)
2010 | 2009 | 2008 | ||||||||||
Beginning balance January 1, |
$ | 738 | $ | 489 | $ | 272 | ||||||
Additional uncertain tax positions |
132 | 285 | 244 | |||||||||
Reductions due to settlements with taxing authorities |
(18 | ) | | | ||||||||
Reductions due to expirations of statute of limitations |
(27 | ) | (36 | ) | (27 | ) | ||||||
Ending balance December 31, |
$ | 825 | $ | 738 | $ | 489 | ||||||
We include interest and penalties related to uncertain tax positions in income tax expense., and at
December 31, 2010, 2009 and 2008, our accrual for interest and penalties related to uncertain tax
positions was insignificant. Unrecognized tax benefits are included in other tax liabilities on
the balance sheet.
We are no longer subject to examination by various U.S. taxing authorities for years before 2007.
Our US federal income tax return for the 2007 tax year was recently under audit by the IRS. The
audit was concluded in 2010 and no adjustments were made to the tax return. The company was not
subject to examinations by foreign jurisdictions prior to 2007.
At this time, we do not expect unrecognized tax benefits to significantly change within the next
twelve months. The total amount of the companys unrecognized tax benefits at December 31, 2010 is
$0.8 million, of which all would impact the companys effective tax rate, if recognized.
11. COMMITMENTS AND CONTINGENCIES
We lease office space and equipment under agreements which are accounted for as operating leases.
The office lease for our Cheswick, Pennsylvania facility was extended on September 14, 2009 until
March 31, 2011. The lease for our Piscataway, New Jersey office expires on April 30, 2012. We also
have office leases in Bracknell, United Kingdom; and Wuppertal, Germany, which expire on December
24, 2012, and January 31, 2012 respectively. 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.
In October 2010, we signed a seven year lease commitment for a new headquarters facility in
Cranberry Twp., Pennsylvania to replace our existing Cheswick facility lease which expires on March 31,
2011. The new lease for 24,402 square feet of office and lab space will commence on March 1, 2011
with annual payments of approximately $0.4 million. We also have a commitment for approximately
$0.9 million of leasehold improvements and other costs related to this facility that will be paid
in the first quarter of 2011.
Future minimum lease payment under operating leases having initial or remaining non-cancellable
lease terms in excess of one year are as follows (in thousands):
At December 31, 2010 | ||||
2011 |
$ | 813 | ||
2012 |
671 | |||
2013 |
612 | |||
2014 |
422 | |||
2015 |
396 | |||
Thereafter |
916 | |||
$ | 3,830 | |||
Our lease expense was $0.8 million in 2010, $1.0 million in 2009 and $1.2 million in 2008.
In addition, we are, from time to time, party to various legal claims and disputes, either asserted
or unasserted, which arise in the ordinary course of business. While the final resolution of these
matters cannot be predicted with certainty, we do not believe that the outcome of any of these
claims will have a material adverse effect on our consolidated financial position, or annual
results of operations or cash flow.
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12. MAJOR CUSTOMERS, REVENUE CONCENTRATION AND DEPENDENCE ON CERTAIN SUPPLIERS
The following table represents our total sales by major product lines as well as the % of their
sales on total revenue
2010 | 2009 | 2008 | ||||||||||||||||||||||
System Test Products |
$ | 11,771 | 26 | % | $ | 14,118 | 31 | % | $ | 18,061 | 37 | % | ||||||||||||
MCU |
6,658 | 15 | % | 5,694 | 13 | % | 8,936 | 18 | % | |||||||||||||||
Other |
638 | 1 | % | 124 | 0 | % | | 0 | % | |||||||||||||||
Total Products |
19,067 | 42 | % | 19,936 | 44 | % | 26,997 | 55 | % | |||||||||||||||
Managed Services |
7,030 | 15 | % | 5,078 | 11 | % | | 0 | % | |||||||||||||||
Other Services |
19,549 | 43 | % | 19,927 | 44 | % | 22,055 | 45 | % | |||||||||||||||
Total Services |
26,579 | 58 | % | 25,005 | 56 | % | 22,055 | 45 | % | |||||||||||||||
Total Revenue |
$ | 45,646 | 100 | % | $ | 44,941 | 100 | % | $ | 49,052 | 100 | % | ||||||||||||
As of December 31, 2010, we had approximately $3.0 million of accounts receivable with two
customers, each of which individually exceeded 10% of our December 2010 receivable balances. As of
December 31, 2009, we had approximately $5.4 million of accounts receivable with five customers,
each of which individually exceeded 10% of our December 31, 2009 receivable balances.
The following table represents sales to our customers that individually exceeded 10% of our net
sales:
December 31, 2010 | December 31, 2009 | December 31, 2008 | ||||||||||||||||||||||
Company A |
$ | 10,359 | 23 | % | $ | 10,262 | 23 | % | $ | 13,436 | 27 | % | ||||||||||||
Company B |
7,034 | 15 | % | 5,254 | 12 | % | | 0 | % | |||||||||||||||
Company C |
5,441 | 12 | % | 4,534 | 10 | % | 3,796 | 8 | % | |||||||||||||||
Company D |
2,014 | 4 | % | 3,118 | 7 | % | 7,448 | 15 | % | |||||||||||||||
Company E |
1,144 | 3 | % | 4,523 | 10 | % | 4,554 | 9 | % | |||||||||||||||
Total |
$ | 25,992 | $ | 27,691 | $ | 29,234 | ||||||||||||||||||
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:
December 31, 2010 | December 31, 2009 | December 31, 2008 | ||||||||||||||||||||||
Region : |
||||||||||||||||||||||||
Europe/Africa
|
$ | 15,569 | 34 | % | $ | 12,479 | 28 | % | $ | 18,029 | 37 | % | ||||||||||||
Americas
|
2,044 | 5 | % | 3,408 | 8 | % | 2,390 | 5 | % | |||||||||||||||
Asia
|
1,436 | 3 | % | 1,079 | 2 | % | 828 | 1 | % | |||||||||||||||
Total International
|
19,049 | 42 | % | 16,966 | 38 | % | 21,247 | 43 | % | |||||||||||||||
Total Domestic
|
26,597 | 58 | % | 27,975 | 62 | % | 27,805 | 57 | % | |||||||||||||||
Total Revenue
|
$ | 45,646 | 100 | % | $ | 44,941 | 100 | % | $ | 49,052 | 100 | % | ||||||||||||
We utilize two key contract manufactures to perform a majority of the circuit board assembly
and in-circuit testing work on our telecommunication products. We paid each of these two contract
manufacturers $3.6 million and $0.2 million in 2010, $2.6 million and $0.3 million in 2009 and $3.4
million and $0.4 million in 2008, respectively.
13. SHORT-TERM INVESTMENTS
The estimated fair values of our financial instruments, which are classified as Level 1, are as
follows (in thousands):
December 31, 2010 | December 31, 2009 | |||||||||||||||
Carrying Amount | Fair Value | Carrying Amount | Fair Value | |||||||||||||
Financial assets: |
||||||||||||||||
Cash and cash equivalents |
$ | 72,194 | $ | 72,194 | $ | 66,046 | $ | 66,046 | ||||||||
Short-term investments |
$ | 3 | $ | 3 | $ | 3 | $ | 3 |
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The 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 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. |
14. PER SHARE INFORMATION
Basic earnings per common share are computed by dividing net income by the weighted-average number
of common shares outstanding during the reporting period. Diluted earnings per common share is
computed by dividing net income by the combination of dilutive common share equivalents, comprised
of shares issuable under our share-based compensation plans and the weighted-average number of
common shares outstanding during the reporting period. Dilutive common share equivalents include
the dilutive effect of in-the-money shares, which are calculated based on the average share price
for each period using the treasury stock method. Under the treasury stock method, the exercise
price of a share, the amount of compensation cost, if any, for future service that we have not yet
recognized, and the amount of estimated tax benefits that would be recorded in additional paid-in
capital, if any, when the share is exercised are assumed to be used to repurchase shares in the
current period. We do not include any stock options outstanding with an exercise price below the
average market price, as their effect would be considered anti-dilutive.
As of December 31, 2010, 2009 and 2008, 1,113,030, 1,682,327, and 1,840,760 of equivalent shares,
respectively, were anti-dilutive. Basic earnings per share are calculated on the actual number of
weighted average common shares outstanding for the period, while diluted earnings per share must
include the effect of any dilutive securities
Earnings per share are as follows (in thousands except per share information):
December 31, 2010 | December 31, 2009 | December 31, 2008 | ||||||||||
Net Income/(Loss) |
$ | 4,423 | $ | (36,205 | ) | $ | (7,115 | ) | ||||
Weighted average common shares outstanding |
12,736 | 12,683 | 13,102 | |||||||||
Effect of dilutive securities stock options |
424 | | | |||||||||
13,160 | 12,683 | 13,102 | ||||||||||
Income/(Loss) per common share: |
||||||||||||
Basic |
$ | 0.35 | $ | (2.85 | ) | $ | (0.54 | ) | ||||
Diluted |
$ | 0.34 | $ | (2.85 | ) | $ | (0.54 | ) | ||||
Income/(Loss) per common share from continuing operations: |
||||||||||||
Basic |
$ | 0.35 | $ | (2.83 | ) | $ | (0.23 | ) | ||||
Diluted |
$ | 0.34 | $ | (2.83 | ) | $ | (0.23 | ) | ||||
Loss per common share from discontinued operations: |
||||||||||||
Basic |
$ | | $ | (0.02 | ) | $ | (0.31 | ) | ||||
Diluted |
$ | | $ | (0.02 | ) | $ | (0.31 | ) | ||||
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15. EMPLOYEE DEFINED CONTRIBUTION PLANS
We offer our employees a 401(k) benefit plan. Eligible employees, as defined in the plan, may
contribute up to 20% of eligible compensation, not to exceed the statutory limit. We do not make
matching contributions to the plan. We also offer a group personnel pension plan to employees of
our United Kingdom subsidiary. Eligible employees, as defined in the plan, may contribute up to
100% of eligible compensation, not to exceed the statutory limit. For this plan, we make matching
contributions of up to 6% of eligible compensation. Our expense related to the Plan totaled less
than $0.1 million for each of the years ended December 31, 2010, 2009 and 2008, respectively.
16. SEVERANCE EXPENSE
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. All cash payments related to these actions were paid in 2010 an no
further expense is expected.
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.
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17. QUARTERLY FINANCIAL DATA (Unaudited)
The following tables present unaudited quarterly operating results for each of our last eight
fiscal quarters. This information has been prepared by us on a basis consistent with our audited
financial statements and includes all adjustments (consisting only of normal recurring adjustments)
that we consider necessary for a fair statement of the data. Such quarterly results are not
necessarily indicative of the future results of operations. We reported our quarterly results for
the first three interim periods of 2010 based on fiscal quarters ending March 31, 2010, June 30,
2010 and September 30, 2010 and for the fourth interim period ended on December 31, 2010. We
reported our quarterly results for the first three interim periods of 2009 based on fiscal quarters
ending March 28, 2009, June 27, 2009 and September 26, 2009 and for the fourth interim period ended
December 31, 2009. For comparative purposes, we have evaluated the slight day changes between last
years quarterly end dates and the new quarter end dates we used for 2010 and found no material
differences in revenue, cost of sales, operating expenses, assets, liabilities and equity that
would have impacted our quarter financial statement presentations.
March 31, 2010 | June 30, 2010 | September 30, 2010 | December 31, 2010 | |||||||||||||
Revenue |
$ | 11,167 | $ | 11,500 | $ | 11,056 | $ | 11,923 | ||||||||
Gross profit |
6,492 | 7,026 | 7,040 | 7,322 | ||||||||||||
Net (Loss)/Income |
$ | (1,663 | ) | $ | 1,227 | $ | 2,493 | $ | 2,366 | |||||||
(Loss)/Earnings Per Share Information |
||||||||||||||||
Weighted average shares |
||||||||||||||||
Basic |
12,656 | 12,649 | 12,723 | 12,851 | ||||||||||||
Diluted |
12,656 | 12,815 | 13,167 | 13,594 | ||||||||||||
Basic |
$ | (0.13 | ) | $ | 0.10 | $ | 0.20 | $ | 0.18 | |||||||
Diluted |
$ | (0.13 | ) | $ | 0.10 | $ | 0.19 | $ | 0.17 |
March 28, 2009 | June 27, 2009 | September 26, 2009 | December 31, 2009 | |||||||||||||
Revenue |
$ | 10,317 | $ | 10,643 | $ | 11,326 | $ | 12,655 | ||||||||
Gross profit |
5,284 | 5,197 | 2,230 | (20,300 | ) | |||||||||||
Net Loss |
$ | (1,223 | ) | $ | (1,509 | ) | $ | (7,082 | ) | $ | (26,391 | ) | ||||
(Loss) Per Share Information |
||||||||||||||||
Weighted average shares |
||||||||||||||||
Basic |
12,679 | 12,681 | 12,682 | 12,690 | ||||||||||||
Diluted |
12,679 | 12,681 | 12,682 | 12,690 | ||||||||||||
Basic |
$ | (0.09 | ) | $ | (0.12 | ) | $ | (0.56 | ) | $ | (2.08 | ) | ||||
Diluted |
$ | (0.09 | ) | $ | (0.12 | ) | $ | (0.56 | ) | $ | (2.08 | ) |
18. SUBSEQUENT EVENTS
On February 21, 2011, we entered into an Agreement and Plan of Merger (the Merger Agreement) with
Talon Holdings, Inc., a Delaware corporation (Parent), and Talon Merger Sub, Inc., a Pennsylvania
corporation and a direct wholly-owned subsidiary of Parent (Merger Sub), providing for the merger
of Merger Sub with and into the Company (the Merger), with the Company surviving the Merger as a
wholly-owned subsidiary of Parent. Parent is owned by investment funds managed by Golden Gate
Capital, a San Francisco based private equity firm. At the effective time of the Merger, all of
the shares of our outstanding common stock (other than shares held by us, Parent or Merger Sub)
would be acquired by Parent for $10.10 per share in cash. The Merger Agreement was unanimously
approved by our board of directors. Consummation of the Merger is subject to customary
conditions, including without limitation (i) the approval by the holders of at least a majority of
the votes cast by the outstanding shares of our common stock entitled to vote on the Merger, (ii)
the expiration or early termination of the waiting period applicable to the consummation of the
Merger under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, (iii) the
absence of any law or order restraining, enjoining or prohibiting the
Merger, (iv) the absence of any pending litigation challenging the Merger,
and (v) the absence of a material adverse effect on the Company. Moreover, each
partys obligation to consummate the Merger is subject to certain other conditions, including
without limitation (x) the accuracy of the other partys representations and warranties and (y) the
other partys compliance with its covenants and agreements contained in the Merger Agreement. We
expect the Merger to close during the second quarter of 2011.
We have subsequently been named as a defendant in two actions related to the Merger, which were
filed on February 24 and March 1, 2011, respectively, in the Allegheny County Court of Common
Pleas, as described in Part I, Item 3, Legal Proceedings..
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SCHEDULE II
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 2010, 2009 and 2008
(In thousands)
(In thousands)
Col. A | Col. B | Col C. | Col. D | Col. E | ||||||||||||||||
Balance at | Additions | Balance at | ||||||||||||||||||
Beginning | Charged to | Charged to | End | |||||||||||||||||
of Year | Expense | Other Accounts | Deductions | of Year | ||||||||||||||||
Allowance for doubtful accounts: |
||||||||||||||||||||
Year ended December 31, 2010
|
$ | 1,496 | 259 | | (172 | ) | $ | 1,583 | ||||||||||||
Year ended December 31, 2009
|
$ | 222 | 1,274 | | | $ | 1,496 | |||||||||||||
Year ended December 31, 2008
|
$ | 309 | 100 | | (187 | ) | $ | 222 | ||||||||||||
Warranty reserve: |
||||||||||||||||||||
Year ended December 31, 2010
|
$ | 504 | 251 | | (533 | ) | $ | 222 | ||||||||||||
Year ended December 31, 2009
|
$ | 926 | 894 | | (1,316 | ) | $ | 504 | ||||||||||||
Year ended December 31, 2008
|
$ | 1,148 | 1,682 | | (1,904 | ) | $ | 926 | ||||||||||||
Valuation allowance on net deferred tax assets: |
||||||||||||||||||||
Year ended December 31, 2010
|
$ | 28,567 | | (1,118 | ) | | $ | 27,449 | ||||||||||||
Year ended December 31, 2009
|
$ | 15,848 | | 12,719 | | $ | 28,567 | |||||||||||||
Year ended December 31, 2008
|
$ | 12,655 | 123 | 3,070 | | $ | 15,848 |
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
As of December 31, 2010, we have carried out an evaluation, under the supervision of, and with the
participation of, our management, including our principal executive officer and principal financial
officer, of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15
under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, the principal
executive officer and principal financial officer concluded that our disclosure controls and
procedures (as defined in Rules 13a-15(e) under the Securities Exchange Act of 1934) were effective
to ensure that information required to be disclosed by the Company in the reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported within the time
periods specified by the SECs rules and forms, and that such information is accumulated and
communicated to our management, including our principal executive officer and principal financial
officer, as appropriate, to allow timely decisions regarding required financial disclosure.
Managements Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over
financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control
over financial reporting is a process designed by, or under the supervision of our principal
executive and principal financial officers, and effected by our board of directors, management and
other personnel, to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A companys internal control over financial reporting includes
those policies and procedures that (i) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
Our management assessed the effectiveness of our internal control over financial reporting as of
December 31, 2010. In making this assessment, our management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control-Integrated Framework. Our management has concluded that, as of December 31, 2010, our
internal control over financial reporting was effective.
The effectiveness of the Companys internal control over financial reporting as of December 31,
2010, has been audited by Deloitte & Touche LLP, an independent registered public accounting firm,
as stated in their report which appears herein.
Evaluation of Changes in Internal Controls over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rule
13a-15(f) under the Securities Exchange Act of 1934) during the quarter ended December 31, 2010
that have materially affected, or are reasonably likely to materially affect our internal control
over financial reporting.
Item 9B. Other Information.
The employment of our former Vice President of Operations, who was a named executive officer in our
most recent proxy statement, was voluntarily terminated on December 27, 2010.
On
February 1, 2011, the Company established the 2011 commission program for our Vice President,
Global Sales and Services, who is a named executive officer. Under the program, Mr. King will be
eligible to receive commission compensation at a rate which is equal to a percentage of the
Companys 2011 revenue. At the base rate, Mr. King will be paid commission at the rate of 0.2%
in addition to his base salary of $234,840. If the Company achieves its revenue plan established
for 2011 (the 2011 Revenue Plan), retroactive to January 1, 2011, Mr. King will be eligible to
receive straight commission (in lieu of and not in addition to his base salary) at the plan rate
of 0.95%, and for any portion of the Companys 2011 revenue which exceeds the 2011 Revenue Plan, at
the over plan rate of 3.0%. Once the Companys 2011 Revenue Plan is achieved, Mr. Kings 2011
compensation will be recalculated in accordance with the appropriate commission rates retroactive
to January 1, 2011, and amounts previously paid to him in the form of base salary and at the base
commission rate will be credited toward the recalculated amount. In the event that the Company
does not achieve its 2011 Revenue Plan, Mr. King will receive as compensation his base salary and
commission earned at the base rate.
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PART III
Item 10. Directors, Executive Officers and Corporate Governance
Set forth below is a brief biography of each of our non-employee directors, which includes in
each case the particular experience, qualifications attributes and/or skills that contributed to
the Boards conclusion that such individual should serve as a director. A biography of Mr.
Kennedy, our Chairman, CEO and President, appears above in Part I, Item 1, under the heading,
Executive Officers of the Company.
Scott C. Chandler, age 49, has served on our Board of Directors since August 2009. Mr.
Chandler currently serves as Managing Partner of Franklin Court Partners, LLC (FCP), a private
company that provides strategic advisory services, merger and acquisition advisory services and
private equity and debt for growth companies in the technology and broadband communications
sectors. Prior to founding FCP in 2002, from 1998 to 2001 Mr. Chandler served as Chief Financial
Officer (1998 2000) and Senior Vice President (2000 2001) for RHYTHMS NetConnections, Inc.
(Rhythms), a leading provider of broadband services utilizing digital subscriber line technology.
From 1996 to 1998, Mr. Chandler served as President and Chief Executive Officer of C-COR, a
leading supplier of broadband telecommunications equipment. In addition to serving on Tollgrades
Board, since 2004, Mr. Chandler has served as a director of Cimetrix Inc., where he is also
Chairman of the Audit Committee of the Board of Directors, and has served as a director of
Disaboom, Inc. since 2009, also serving as Audit Committee Chairman. Mr. Chandler also serves as a
director for certain privately held companies. Previously, Mr. Chandler served as a director for
Paradyne Networks, Inc. from 2003 until 2007, as well as for several privately held companies. Mr.
Chandler holds a Master of Business Administration degree from the Wharton School of Business at
the University of Pennsylvania, and a Bachelor of Arts degree from Whitworth University. Mr.
Chandler brings an insight to the Board based on significant operational and financial experience
at companies in the telecommunications industry, coupled with the perspective of a strategic
advisor to companies in areas related to our business. Mr. Chandlers experience also qualifies
him to serve as a financial expert on the Audit Committee of our Board of Directors.
Richard H. Heibel, M.D., age 64, has served on our Board of Directors since January 1996, and
is one of the original founding investors in Tollgrade. Dr. Heibel currently serves as Professor
of Internal Medicine at Lake Erie College of Osteopathic Medicine of Bradenton, a medical school,
since July 2004. In addition to his service on Tollgrades Board, Dr. Heibel has been a board
member of ChemDAQ Inc. since May 2006. Additionally, Dr. Heibel has served as an officer and
director of HRISD, a privately held company since 2000. Formerly, Dr. Heibel was a practicing,
Board-certified cardiologist with the firm Consultants in Cardiology. Throughout the course of Dr.
Heibels career, he has served on the boards of directors of multiple start-up companies. Dr.
Heibel holds an M.D. from the University of Pittsburgh and a Bachelor of Arts degree from Gannon
College. Dr. Heibel brings to the Board a perspective based on his membership on the Board since
1996, and his knowledge of our company dating back to its original formation, during which time he
has acquired significant experience and understanding of the operations and issues confronting our
business.
Charles E. Hoffman, age 62, has served on our Board since July 2009. Previously, from June
2001 until his retirement in April 2008, Mr. Hoffman served as the President, Chief Executive
Officer and a director of Covad Communications Group, Inc., a nationwide provider of integrated
voice and data communications. From January 1998 to June 2001, Mr. Hoffman served as President and
Chief Executive Officer of Rogers Wireless, Inc., a Canadian communications and media company.
Since June 2006, Mr. Hoffman has served as a director of Synchronoss Technologies Inc., a provider
of on-demand transaction management solutions to the communication service provider market, in
addition, Mr. Hoffman has served on the board of directors of Softlayer Holdings, Inc., a private
company, since November 2010 following its merger with The Planet, where he had served as director
since June 2006. From January 2005 until April 2010, Mr. Hoffman served as a director of Chordiant
Software, Incorporated, a provider of customer experience software and services. Mr. Hoffman holds
a Master of Business Administration degree and a Bachelor of Science degree from the University of
Missouri at St. Louis. Mr. Hoffmans more than thirty years of global executive experience in the
telecommunications and broadband industries bring to the Board a deep knowledge and breadth of
experience in our markets and in the needs of our customers. In addition, Mr. Hoffman brings to
the Board valuable board and compensation committee leadership experience and knowledge and
understanding of corporate governance issues affecting public companies.
Robert W. Kampmeinert, age 67, has served on our Board of Directors since January 1996, and
served as our Lead Independent Director from May 2009 to March 2010. From July 2005 until December
2009, Mr. Kampmeinert served as Chairman and Executive Vice President of Janney Montgomery Scott
LLC, an investment firm, where he currently serves as Senior Advisor. Previously, Mr. Kampmeinert
served as Chairman, President and Chief Executive Officer of the investment firm, Parker/Hunter
Incorporated. In addition to serving on Tollgrades Board, Mr. Kampmeinert serves on the board of
directors of Industrial Scientific Corporation, a privately held company. Mr. Kampmeinert holds a
Master of Business Administration degree from Harvard University and a Bachelor of Science degree
in economics from Lehigh University. Having served as the president and chief executive officer of
an investment firm for twenty years, Mr. Kampmeinert brings to the Board valuable executive
leadership experience, a wealth of knowledge of organizational and operational management, and an in-depth understanding of
investment banking and financial markets.
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Edward B. Meyercord, III, age 45, has served on our Board of Directors since August 2009. Mr.
Meyercord is currently the Chief Executive Officer and Director of Critical Alert Systems LLC, a
private company that provides wireless communications services, where he has served since July
2010. Prior to Critical Alert Systems, he was the founder and President of Council Rock Advisors
LLC, a private company that provides advisory, capital-raising and management consulting services.
In addition, since October 2009, Mr. Meyercord has served as a director of Extreme Networks, Inc.,
a publicly traded company that provides converged Ethernet network infrastructure that support
data, voice and video for enterprises and service providers, and was
named Chairman of the Extreme Networks board in March 2011. From December 2006 until January
2009, Mr. Meyercord served as Chief Executive Officer and President and as a director of Cavalier
Telephone & TV, a privately held voice and data services provider based in Richmond, Virginia. From
January 2004, until its sale to Cavalier in December 2006, Mr. Meyercord served as Chief Executive
Officer and President and as a director of Talk America, Inc., a publicly traded company that
provided phone and internet services to consumers and small businesses. He served as President and
a director of Talk America from 2001 until 2003 and as its Chief Financial Officer and Chief
Operating Officer from 2000 until 2001. Mr. Meyercord joined Talk America in September of 1996 as
the Executive Vice President, Marketing and Corporate Development. Prior to joining TalkAmerica,
Mr. Meyercord was a Vice President in the Global Telecommunications Corporate Finance Group at
Salomon Brothers, Inc., based in New York. Prior to Salomon Brothers, Mr. Meyercord worked in the
corporate finance department at PaineWebber Incorporated. Mr. Meyercord holds a Master of Business
Administration degree from the Stern School of Business at New York University and a Bachelor of
Arts degree in economics from Trinity College. Mr. Meyercord brings to the Board perspective of an
executive with experience on the service provider side of the telecommunications industry and can
offer the Board guidance on the issues confronting our customers. Mr. Meyercords experience also
qualifies him to serve as a financial expert on the Audit Committee.
Jeffrey M. Solomon, age 44, has served on our Board of Directors since August 2009.
Currently, Mr. Solomon is the Chief Operating Officer and Head of the Investment Banking of Cowen
Group, Inc., a diversified financial services company, where he oversees the companys investment
bank and investment strategy. Prior to the combination of Ramius LLC and Cowen Group in November
2009, Mr. Solomon served as a Managing Member of Ramius and a member of Ramius Executive Committee
and Management Board, where he was jointly responsible for overseeing Ramius multi-strategy and
single strategy investment platforms, and prior thereto was responsible for managing a number of
specific investment portfolios at Ramius, as well as for overseeing Ramius technology, operations
and finance functions. Mr. Solomon joined Ramius when it was founded in 1994. From 1991 to 1994,
Mr. Solomon was at Republic New York Securities Corporation, the brokerage affiliate of Republic
National Bank (now part of the HSBC Group). Prior to joining Republic, Mr. Solomon was in the
Mergers and Acquisitions Group at Shearson Lehman Brothers. Mr. Solomon was also part of the
internal corporate finance team at Shearson Lehman Brothers that worked closely with senior
management in evaluating the companys operations, capital usage and investment strategies,
including the acquisition and disposition of corporate assets. Currently, Mr. Solomon serves on the
Board of Directors of Hale & Hearty Soups, a New York based restaurant chain, and NuGo Nutrition,
the manufacturer of NuGo Nutrition Bars. Mr. Solomon holds a Bachelor of Arts degree in economics
from the University of Pennsylvania. As a representative of our largest shareholder, Mr. Solomon
offers the Board key insights and perspectives from our shareholders point of view. In addition,
Mr. Solomons financial and investment experience provide the Board with expertise and insight into
the issues confronting our business and our industry.
Other Information
SEC regulations require us to describe certain legal proceedings which occurred during the
past ten years, including bankruptcy and insolvency filings involving companies of which a director
previously served as an executive officer. Mr. Chandler served as an executive officer of Rhythms
until September 2001. In August 2001, Rhythms voluntarily filed for reorganization under Chapter
11 of the U.S. Bankruptcy Code. The Board of Directors does not believe that this proceeding is
material to an evaluation of Mr. Chandlers ability to serve as a Director.
Executive Officers
Information related to our executive officers is included in Part I, Item 1, under the caption
Executive Officers of the Company.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our directors and officers, and persons who own
more than ten percent of our common stock (collectively, the Section 16 Persons) to file with the
SEC and Nasdaq initial reports of ownership and reports of changes in ownership of our common
stock. Such persons are required by SEC regulations to furnish us with copies of all Section 16(a)
reports that they file. Based solely upon our review of the copies of such forms we have received,
or written representations from certain Section 16 Persons that no Section 16(a) reports were
required for such persons, we believe that for our year ended December 31, 2010, the Section 16 Persons complied with all Section 16(a) filing requirements
applicable to them, except that Forms 4 were filed late for (a) the exercise by David Blakeney, a
named executive officer, of stock options on May 20, 2010, and (b) the June 17, 2010 grant of
options to David Blakeney, Edward Kennedy, Robert King, Mark Lang, Joseph OBrien, Jennifer Reinke,
and Ken Shebek.
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Code of Ethics; Code of Business Conduct
The Board has adopted a Code of Ethics for Senior Executives and Financial Officers (the Code
of Ethics), which is applicable to our Chief Executive Officer, Chief Financial Officer, Corporate
Controller, and other senior executive or financial officers performing similar functions. In
addition, all directors and employees, including those subject to the Code of Ethics, are subject
to our Code of Business Conduct and Ethics (the Code of Business Conduct), which covers issues
generally applicable to all of our employees, such as conducting business honestly and ethically,
avoiding conflicts of interest, complying with all laws, prohibiting insider trading and loans to
our executive officers and directors, and protecting our confidential information. The Code of
Ethics and the Code of Business Conduct are each a code of ethics within the meaning of Item 406
of the Securities and Exchange Commissions (SEC) Regulation S-K. Copies of the Code of Ethics
and the Code of Business Conduct are available on our website at
www.tollgrade.com.
Audit Committee
Our Board of Directors has a standing Audit Committee. The Audit Committees responsibilities
include appointing an independent registered public accounting firm to audit our financial
statements, reviewing and approving the results of the audit, reviewing the scope, adequacy and
results of our internal control procedures, reviewing our quarterly and annual financial statements
and reviewing and approving any non-audit services to be provided by our independent registered
public accounting firm.
The Audit Committee is comprised of Messrs. Hoffman (Chairman), Chandler and Meyercord. Each
member of the Audit Committee has been determined by the Board of Directors to be independent as
that term is defined by both Rule 10A-3 under the Exchange Act and the Nasdaq listing standards.
In addition, the Board has determined that each of Mr. Chandler and Mr. Meyercord is an audit
committee financial expert as that term is defined in Item 407(d)(5) of Regulation S-K.
Item 11. Executive Compensation
COMPENSATION DISCUSSION AND ANALYSIS
Overview
The Compensation Committee of the Board of Directors establishes and regularly reviews our
compensation philosophy, strategy and objectives, and oversees the compensation programs in place
for our executive management. This Compensation Discussion and Analysis describes our compensation
programs during 2010 for those executive officers and former executive officers identified in the
summary compensation table below. In particular, our named executive officers include (i) Edward
H. Kennedy, our Chief Executive Officer and President, (ii) Michael D. Bornak, our Chief Financial
Officer and Treasurer, and (iii) our three most highly compensated executive officers other than
our CEO and CFO who were serving as of the end of our last completed fiscal year, namely, David L.
Blakeney, our VP, Research and Development, Robert H. King, our VP, Global Sales and Services, and
Gregory M. Nulty, our VP, Marketing and Business Development. In addition, disclosure is being
provided for Joseph A. Ferrara, our former CEO, who served in that capacity for a portion of 2010.
Compensation Objectives and Philosophy
Our compensation for named executive officers is generally designed to attract and retain
executive officers of outstanding ability, to motivate the Companys executive management to
achieve the Companys business objectives and to align the interests of the Companys executive
management with the long-term interests of our shareholders.
Setting Executive Compensation
Pursuant to its charter, the Compensation Committee is responsible for reviewing our executive
compensation programs to ensure that they are consistent with our compensation objectives and
philosophy, to review trends in management compensation, to oversee the development of new
compensation plans and, when necessary, to approve the revision of existing plans. In addition,
the Compensation Committee is responsible for reviewing the performance and approving the annual
compensation, including salary, incentive bonus, and equity compensation, for executive officers.
To help achieve the goal of motivating executive management to achieve our business objectives, and
in order to establish a meaningful link between compensation and achievement of corporate
performance, the Compensation Committee generally establishes the executive compensation
program for the upcoming fiscal year at the substantially the same time as our overall operating
plan is set.
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To assist the Compensation Committee in its annual review of executive compensation, the
Companys senior management prepares a tally sheet for each of our named executive officers for
review by the Committee. Each tally sheet lists all elements of the executives compensation,
including possible payouts in connection with a termination of employment, whether in connection
with a change-in-control or otherwise. These tally sheets allow the Compensation Committee to
consider the entire compensation package of each executive prior to making further compensation
decisions.
Use of Compensation Consultants and Peer Group Company Data
The Compensation Committee has used third party compensation consultants from time to time as
a resource to assist the Committee in discharging its responsibilities. In recent years, the
Compensation Committee has engaged the services of Towers Watson (or its predecessor, Towers
Perrin) (Towers).
In August and December 2008, at the direction of the Compensation Committee, management asked
Towers to review our program for providing change in control benefits to members of senior
management, including the programs eligibility factors, and the terms of the benefits provided.
Both management and the Committee sought to evaluate and redefine the program to reduce costs and
to more closely align with then-current market practices. Towers based its analysis on its
experience and understanding of the market, rather than on specific benefit programs provided by
peer group or other competitor companies.
More recently, in October 2009, Towers assisted the Compensation Committee in identifying an
appropriate peer group for benchmarking executive compensation in order to assist the Committee in
making executive compensation decisions for 2010. Ultimately, the Committee selected the following
twenty companies, which were found to be comparable to the Company in both size and industry:
Westell Technologies Inc., Acme Packet Inc., Zhone Technologies Inc., LeCroy Corp., Communications
Systems Inc., Echelon Corp., Comverge Inc., Network Equipment Technologies Inc., Optical Cable
Corp., Sunrise Telecom Inc., Numerex Corp., Frequency Electronics Inc., Telular Corp., ADDvantage
Technologies Group Inc., Micronetics Inc., Alliance Fiber Optic Products Inc., Aware Inc., MOCON
Inc., Image Sensing Systems Inc., and CyberOptics Corp. Following identification of the peer
group, Towers gathered market data about the base salaries, bonuses and equity compensation
provided by these companies, presenting data at the 25th and 75th
percentiles, and at the median. The Compensation Committee believes that this data is a helpful
reference point in assessing the competitiveness of executive officer compensation, and this data
is among the factors considered by the Committee in establishing executive compensation, consistent
with our overall compensation philosophy. In January 2010, at the request of the Compensation
Committee, Towers benchmarked the compensation of our then-current named executive officers against
this peer group (the 2010 Compensation Report).
In each of the above-described instances, Towers was engaged by management at the direction of
the Compensation Committee. In addition to the services described above, Towers also provided
certain actuarial services for the Company during 2010, for which we paid less than $120,000 in
fees.
Tax Considerations
Section 162(m) of Internal Revenue Code (the Code) disallows any federal income tax
deductions for a company for compensation paid to its named executive officers in excess of $1
million each in any taxable year, with certain exceptions, including for compensation paid pursuant
to shareholder-approved, performance-based compensation plans. Our 2006 Long-Term Incentive
Compensation Plan, as amended and restated (our Equity Compensation Plan), is structured to
permit grants of stock options and certain other awards to be eligible for this performance-based
exception. As such, compensation expense upon exercise of the options or receipt and/or vesting of
the awards is deductible by the Company. Bonus payments made under our Management Incentive
Compensation Plan (MICP) are not eligible for the performance-based exception, since the MICP has
not been approved by our shareholders. The Compensation Committee intends to continue to take
whatever actions are necessary to minimize our non-deductible compensation expense, while at the
same time maintaining flexibility in determining our executive compensation. Currently, none of
the named executive officers overall compensation approaches levels that would affect our
non-deductible compensation expense under Section 162(m).
We generally consider and seek to minimize the impact of Section 409A of the Code and the
regulations promulgated under Section 409A. Under Section 409A, unless a nonqualified deferred
compensation plan complies with rules relating to the timing of deferrals and distributions, all
deferred amounts become immediately taxable and there is an additional 20% penalty tax, to the
extent the compensation is not subject to a substantial risk of forfeiture and has not previously
been included in gross income. Our bonus and equity compensation plans (including the MICP and our
Equity Compensation Plan) were each amended in December 2007 to exclude them from the effects of
Section 409A of the Code, and our subsequently executed agreements with executives were drafted to
minimize the impact of Section 409A of the Code. During December 2010, we amended the severance
agreements in place with
our executive officers consistent with IRS guidance issued in 2010 in a further attempt to
minimize the effects of Section 409A.
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Components of Named Executive Officer Compensation
Our compensation program for executives principally consists of the following elements: base
salary, incentive bonus program (or a commission program, in the case of our top sales executive),
long-term equity compensation, traditionally provided in the form of stock options or restricted
stock, executive level severance benefits, an additional long-term disability policy, and benefits
generally available to all employees. In addition, certain of our executives have change in
control benefits. Each component of compensation is evaluated by the Compensation Committee based
on the factors described below.
Base Salary
A fixed base salary is paid to executive officers, including the named executive officers, at
a level designed to enable us to attract, motivate and retain qualified executives. Base salaries
for our named executive officers are determined on the basis of the following factors: scope of
responsibilities, experience, skill level, personal performance, and competitiveness, which is
assessed based on market data provided by our third party compensation consultants. No particular
weight is assigned to any one factor, as the Committee will consider these factors as a whole in
reviewing and setting executive compensation as it deems appropriate and necessary to support our
overall business objectives. Base salaries of named executive officers generally are considered by
the Compensation Committee annually as part of our performance review process, as well as in
connection with a promotion or other change of position or level of responsibility and in
connection with hiring. Any increases in the salaries of our named executive officers other than
the CEO are recommended by the CEO to the Compensation Committee. Any increases to the base
salaries of the named executive officers are based on a review and assessment of the individuals
performance (conducted by the CEO for all other named executive officers, and by the independent
directors of the Board for the CEO), Company performance and affordability, and on competitive
market factors. None of our named executive officers received merit or other pay increases during
2010. In making compensation decisions for 2010, the Compensation Committee considered the 2010
Compensation Report prepared by Towers, and found base salaries to be appropriate in light of
competitive and general economic conditions, as well as in context of total executive compensation.
The Committee determined on that basis, consistent with managements recommendation, not to
provide for any increases to named executive officers base salaries for 2010.
For 2011, the Compensation Committee has determined to increase named executive officer base
salaries by three percent (3%). The increase for 2011 was made in recognition of the Companys
improved financial performance during 2010, the expected annual savings that the Company would
realize in connection with the relocation of its headquarters in 2011, and the fact that employees
generally had not received annual salary increases since January 2008.
CEO Base Salary
Mr. Kennedys base salary was set by the Compensation Committee at the time of his appointment
as CEO and President in June 2010. Mr. Kennedys salary was set at an amount considered to be
consistent with the base salary of the former chief executive officer and was confirmed in an
employment agreement with Mr. Kennedy, which was executed in September 2010. Mr. Kennedys
agreement provides that his salary will be subject to increases or decreases from time to time as
determined by the Compensation Committee, based on an assessment of his performance as determined
by our independent directors. Mr. Kennedys agreement provides for mandatory annual increases
based on the average percentage increase in base salary, if any, of the CEO and his direct reports
for the prior two full calendar years.
Bonus and Non-Equity Incentive Plan Compensation
The Company has in place a Management Incentive Compensation Plan (the MICP), which provides
for the payment of cash incentive compensation bonuses to participants in the plan for achievement
of performance criteria. The Compensation Committee is charged with administering the MICP and for
establishing the performance criteria applicable to each award year. Performance criteria are
generally established for each award year at the same time that the Companys operating plan for
the year is set, which the Compensation Committee believes is helpful in establishing a meaningful
link between compensation and achievement of the Companys performance objectives. In addition, as
the administrator of the MICP, the Compensation Committee is permitted to grant bonuses under the
plan from time to time in its sole discretion based on such criteria as it determines. The stated
objectives of the MICP are as follows:
| to increase profitability and growth in a manner that is consistent with the goals of the Company, its shareholders and its employees; | ||
| to provide the potential for executive compensation that is competitive with other similarly situated technology companies in our peer group; |
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| to attract and retain personnel of outstanding ability and encourage excellence in the performance of individual responsibilities; | ||
| to motivate and reward those members of management who contribute to our success; and | ||
| to allow the Compensation Committee flexibility to administer the MICP to reflect the changing organizational goals and objectives of the Company. |
With the exception of Mr. King, who as the executive leader of our sales team participates in
a separate, commission-based program, each of our named executive officers was a participant in the
MICP during 2010.
The participation percentages for participants in the MICP and the initial performance
criteria to be applied for the 2010 award year (the 2010 Bonus Plan) were approved by the
Compensation Committee in February 2010. Participation percentages for Messrs. Kennedy and Nulty,
who were hired after February 2010, were approved by the Compensation Committee at the time of
their employment. For each of our named executive officers entitled to participate in the 2010
Bonus Plan, the target cash bonus amount (the Target Bonus Amount) was calculated based on a
percentage of their respective base salaries (the participation percentage). The participation
percentage for Mr. Kennedy is 45%, the participation percentage for Messrs. Bornak and Nulty is
35%, and the participation percentage for Mr. Blakeney is 25%. Mr. Ferraras participation
percentage was established at 45%, however, since his employment terminated during the plan year,
he did not receive any payments under the 2010 Bonus Plan. In establishing the participation
percentages for our named executive officers, the Compensation Committee considered the benchmark
data included in the 2010 Compensation Report, as well as the total compensation of each named
executive officer.
The payment of bonuses, and the amount of any bonuses paid, under the 2010 Bonus Plan was made
subject to the satisfaction of performance thresholds associated with Adjusted EBITDA (defined as
earnings before interest, taxes, depreciation and amortization, adjusted to exclude the effects of
any proposed or completed merger and acquisition activities, and any severance or restructuring
charges), revenue, and individual performance objectives for 2010 (Performance Thresholds). The
2010 Bonus Plan identifies three levels of Performance Thresholds for each of Adjusted EBITDA and
revenue, with the medium threshold representing performance consistent with the Companys operating
plan for 2010. The Performance Thresholds were initially established in February 2010, and the
Performance Thresholds for Adjusted EBITDA were later increased following reorganization activities
in connection with which the Companys Adjusted EBITDA objectives were increased. The Compensation
Committee increased the Adjusted EBITDA Performance Thresholds under the 2010 Bonus Plan in an
effort to ensure that the 2010 Bonus Plan remain in line with the Companys overall performance
objectives.
As originally approved and as later adjusted, seventy percent (70%) of the bonus amount paid
to each participant under the 2010 Bonus Plan was made subject to satisfaction of the thresholds
established for Adjusted EBITDA, ten percent (10%) of the bonus amount paid was made subject to
satisfaction of the thresholds established for revenue, and the remaining twenty percent (20%) of
the bonus amount paid was made subject to satisfaction of individual performance objectives
consistent with the Companys strategic objectives. The Committee established these performance
measures and assigned these allocation percentages consistent with our objectives of restoring the
Company to profitability during 2010 and driving revenue through new product success and near term
opportunities, and to incentivize those in the best position to affect our overall performance to
meet their individual objectives, which are linked to initiatives that we believe will position the
Company for both near-term and long-term success. The individual performance objectives for our CEO
were established by our Board of Directors and for each other named executive officer participating
in the 2010 Plan have been established by our CEO. In any event, the 2010 Bonus Plan provided that
no bonuses will be paid unless at least the lowest Performance Threshold for Adjusted EBITDA were
met.
Amounts paid under the 2010 Bonus Plan were to be scaled based on actual Company performance,
as provided below. In particular, for achievement of the low thresholds, participants would
receive 50% of the applicable Target Bonus Amount. For achievement of the medium (operating plan)
Performance Thresholds, our named executive officers would earn only 60% of the Target Bonus Amount
for achievement of the medium (operating plan) thresholds, while non-executive participants would
be paid 100% of the Target Bonus Amount. On the other hand, for achievement of the high
Performance Thresholds, executive officers would earn 200% of Target Bonus Amounts. This scale was
determined by the Compensation Committee in order to closely align executive compensation with
Company performance, and to meaningfully incentivize executive management to exceed the Companys
operating plan.
The table below provides the participation percentages of those of our named executive
officers who were entitled to participate in the 2010 Bonus Plan, and the full amounts that each of
them would be entitled to receive under the 2010 Bonus Plan under each of three scenarios which
assume that (I) the low threshold is met for both Adjusted EBITDA and revenue, (II) the medium
threshold is met for both Adjusted EBITDA and revenue and (III) the high threshold is met for both
Adjusted EBITDA and revenue, and that in each case individual performance objectives are fully
satisfied. To receive payment under the 2010 Bonus Plan, an executive was required to have
remained employed by the Company at the time of payment.
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(I) Low | (II) Medium | |||||||||||||||||||||||
Salary Percentage | Threshold | Threshold | (III) High Threshold | |||||||||||||||||||||
for computing | 2010 Salary | Target Bonus Amount | Bonus Amounts | Bonus Amounts | Bonus Amounts | |||||||||||||||||||
Name | Target Bonus Amount | ($) | ($) | Achieved ($) | Achieved ($) | Achieved ($) | ||||||||||||||||||
Edward H. Kennedy |
45 | % | 350,000 | 157,500 | 78,750 | 94,500 | 315,000 | |||||||||||||||||
Joseph A. Ferrara* |
45 | % | 350,000 | 157,500 | 78,750 | 94,500 | 315,000 | |||||||||||||||||
Michael D. Bornak |
35 | % | 250,000 | 87,500 | 43,750 | 52,500 | 175,000 | |||||||||||||||||
Gregory M. Nulty |
35 | % | 240,000 | 84,000 | 42,000 | 50,400 | 168,000 | |||||||||||||||||
David L. Blakeney |
25 | % | 200,018 | 50,005 | 25,003 | 30,003 | 100,010 | |||||||||||||||||
Kenneth J. Shebek* |
25 | % | 200,018 | 50,005 | 25,003 | 30,003 | 100,010 |
* | Employment terminated during 2010, and therefore ineligible for all or part of the MICP award as described below. |
In May 2010, at the recommendation of management and with the objective of maintaining
and enhancing employee morale, the Compensation Committee approved the payment of the low
threshold bonus amounts as soon as they were achieved during 2010, with any remaining bonus
amounts earned to be paid following the conclusion of the 2010 award year. Accordingly, the named
executive officers who then remained employed by the Company received payments under the MICP for
2010 in November 2010 and in January 2011, in the following amounts:
November 2010 | Total Amount Earned | |||||||||||
Payment | January 2011 | under 2010 Bonus | ||||||||||
Name | ($) | Payment ($) | Plan ($) | |||||||||
Edward H. Kennedy |
32,138 | 71,452 | 103,590 | |||||||||
Joseph A. Ferrara |
| | | |||||||||
Michael D. Bornak |
30,625 | 68,088 | 98,713 | |||||||||
Gregory M. Nulty |
17,140 | 38,108 | 55,248 | |||||||||
David L. Blakeney |
17,502 | 38,911 | 56,413 | |||||||||
Kenneth J. Shebek |
17,502 | | 17,502 |
The November 2010 payments reflect achievement of the low threshold for Adjusted EBITDA
in November 2010. The January 2011 payments reflect the remainder of bonus amounts earned based on
the Companys full year 2010 performance, as well as satisfaction of individual performance
objectives. Specifically, the Company exceeded the medium threshold for Adjusted EBITDA and the
low threshold for revenue, and each of the named executive officers fully met their individual
performance objectives. Former executive officers were not eligible to receive payments made after
the date of termination of employment. Accordingly, Mr. Ferrara, whose employment terminated in
June 2010, was not eligible to receive either of the payments made under the 2010 Bonus Plan, and
Mr. Shebek, whose employment terminated in December 2010, was not eligible to participate in the
January 2011 payment.
Commission Program for VP, Global Sales and Services
As the executive leader of our worldwide sales organization, Mr. King participated in a
commission program during 2010 (the 2010 Commission Program), which was approved by the
Compensation Committee of the Board of Directors with the concurrence of the full Board.
Under the 2010 Commission Program, Mr. King was eligible to receive commission compensation at
a rate which is equal to a percentage of the Companys 2010 revenue. At the base rate, Mr. King
was eligible to be paid commission at the rate of 0.2% in addition to a base salary of $228,000.
If the Company achieved its revenue plan established for 2010, subject to adjustments provided in
the Commission Program (the 2010 Revenue Plan), retroactive to January 1, 2010, Mr. King was
eligible to receive straight commission (in lieu of and not in addition to his base salary) at the
plan rate of 1%, and for any portion of the Companys 2010 revenue which exceeded the 2010
Revenue Plan, at the over plan rate of 3%. The 2010 Commission Program provided that once the
Companys 2010 Revenue Plan was achieved, Mr. Kings 2010 compensation would be recalculated in
accordance with the appropriate commission rates retroactive to January 1, 2010, and amounts
previously paid to him in the form of base salary and at the base commission rate would be credited
toward the recalculated amount.
Based on the Companys performance during 2010, Mr. King received the plan rate of commission
under the 2010 Commission Program, and the total amount paid to Mr. King for 2010 performance
(including amounts originally paid to him in the form of salary and base rate commission) was
$463,368.
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On
February 1, 2011, with the approval of the Compensation Committee, the Company established
Mr. Kings commission program for 2011 (the 2011 Commission Program). Under the 2011 Commission
Program, he will be eligible to receive commission compensation at a rate which is equal to a
percentage of the Companys 2011 revenue. At the base rate, Mr. King will be paid commission at
the rate of 0.2% in addition to his base salary of $234,840. If the Company achieves its revenue
plan established for 2011 (the 2011 Revenue Plan), retroactive to January 1, 2011, Mr. King will
be eligible to receive straight commission (in lieu of and not in addition to his base salary) at
the plan rate of 0.95%, and for any portion of the Companys 2011 revenue which exceeds the 2011
Revenue Plan, at the over plan rate of 3.0%. Once the Companys 2011 Revenue Plan is achieved,
Mr. Kings 2011 compensation will be recalculated in accordance with the appropriate commission
rates retroactive to January 1, 2011, and amounts previously paid to him in the form of base salary
and at the base commission rate will be credited toward the recalculated amount. In the event that
the Company does not achieve its 2011 Revenue Plan, Mr. King will receive as compensation his base
salary and commission earned at the base rate.
Equity Compensation
A key component of our named executive officers compensation is paid in the form of equity.
Equity compensation is designed to link the interests of the named executive officer to our
long-term performance and is awarded pursuant to the terms of our Equity Compensation Plan. The
traditional form of equity compensation granted has been non-qualified stock options and in more
limited instances, restricted shares. The Compensation Committee considers a number of factors
when awarding equity grants to named executive officers, which include advice of outside
consultants with respect to market practices and other factors, management input (except as to the
recipients own grants), individual recipients overall compensation, individual job performance
data, corporate performance data, and accounting and tax implications, including the expense of the
grant.
Awards are typically granted for employees and executive officers, if at all, at a regularly
scheduled meeting of the Compensation Committee. Any grants to new hires or in connection with
promotions are intended to be made at the next regularly scheduled Compensation Committee meeting.
The grant date will be the same date as the Compensation Committees approval date. In addition,
given that Mr. Kennedy was a non-employee director for part of 2010, he was eligible to receive and
received an equity grant as described under the heading Director Compensation.
Stock Options
Stock option awarded to executives give them the right to purchase a specific number of shares
of our common stock at future dates, at a price established on the date the award is granted (under
our Equity Compensation Plan, the fair market value of a share on the date of grant). Executives
can exercise this right as the options vest, or become exercisable, during the life of the option
(generally ten years). The ultimate value of stock options awarded to our executives will depend
on the Companys stock performance over time. As such, the Committee believes that stock options
help to create a link between the individual interests of our executives and the interests of our
shareholders. In addition, because options granted to executives vest over time, the Committee
believes that stock option awards help to promote executive retention. Stock options granted to
executives typically vest over a three-year period, with one-third of the award granting on each of
the first, second, and third anniversaries of the date of grant.
Restricted Shares
Restricted shares awarded to executives give the executives the right to receive a specific
number of shares of our common stock, subject to time-based restrictions, performance conditions,
or both, which are established at the time of the grant. Under our Equity Compensation Plan,
restricted shares which are not subject to the satisfaction of performance conditions must be
subject to a restricted period (i.e., a period during which the shares could not be sold or
transferred) of at least three years, and those subject to performance conditions must be subject
to at least a one-year restricted period. Like stock options, the value of restricted shares will
be driven by our stock performance, and, as such, these awards help to align the interests of our
executives with those of our shareholders.
Size of Equity Grants
The size of equity awards to executive officers is determined based on consideration of a
variety of factors, including the competitive analysis and advice provided by outside consultants,
the role of the executive, and the Compensation Committees view of the executives ability to
impact our financial results and drive shareholder value. In addition, the size of grants which
are made in connection with an executives joining the Company are based on historical awards
granted to executives in comparable roles, the size of award necessary to attract qualified
candidates, and individual negotiations.
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2010 Equity Awards
In March 2010, the Compensation Committee awarded 30,000 shares of restricted stock to Mr.
Ferrara and 20,000 shares of restricted stock to Mr. Bornak, in each case subject to a three year
period of restriction. Also in March 2010 in connection with his appointment as Chairman of the
Board of Directors, the Compensation Committee awarded 50,000 shares of restricted stock and
250,000 stock appreciation rights to Mr. Kennedy. As Mr. Kennedy was a non-employee director at
that time, his restricted share award was made subject to a one year period of restriction,
consistent with the Companys practice in relation to awards to non-employee directors. The terms
of Mr. Kennedys stock appreciation rights provided that they would vest only in the event of a
corporate transaction (as defined in the award agreement). The Committee granted these awards with
the objective of linking the interests of executive management and our Board Chairman with those of
our shareholders and to align their compensation with the successful execution of our strategy to
enhance shareholder value, particularly in view of the critical roles that each of them were
expected to play in establishing and executing our strategic priorities and objectives.
In June 2010, following his appointment to the office of CEO, Mr. Kennedy recommended that the
Compensation Committee approve the grant of stock options to certain employees, including the named
executive officers who had not participated in the March 2010 grants. These grants were intended
to assist with retention and to further align the interests of award recipients with those of our
shareholders.
Post-Employment Compensation
Change in Control and Severance Agreements
The Compensation Committee believes that properly structured change in control benefits
further the best interests of our shareholders in that they serve to minimize the distraction
caused by a potential transaction and reduce the risk that key executives will leave the Company
before a transaction deemed to be in the best interests of our shareholders is completed. In
structuring a change in control benefit program, the Committee will weigh the benefits to the
Company of granting such benefits against the potential costs to the Company of the program. In
certain cases, the Compensation Committee may award enhanced severance benefits to our executives.
The Compensation Committee has adopted a tiered approach to executive severance and change in
control benefits, providing enhanced severance benefits to executives, including all of our named
executive officers, and providing change in control benefits to our CEO, CFO, General Counsel, and
VP, Marketing and Business Development.
A tiered approach was originally adopted based on an evaluation conducted by our Compensation
Committee from August 2008 through March 2009, and was intended to align our executive severance
and change in control benefits more closely with market practice and to control the cost of such
benefits. In connection with this review, the Compensation Committee considered the following
factors: market data furnished by Towers in August and December 2008, the number of employees that
were parties to existing change in control agreements and the terms of such agreements, the extent
to which the terms were consistent with the published requirements of the Corporate Governance
Policies and Guidelines issued by RiskMetrics Group ISS, a proxy advisory firm for many
institutional investors, our ongoing business and executive needs, and the overall cost of the
program.
The Compensation Committee approved this tiered approach and strategy at a meeting held in
January 2009. In February 2010, the Compensation Committee revisited its determination to extend
change in control benefits to our CFO and General Counsel, given that we had experienced changes in
the individuals serving in each of those positions in late 2009. The Committee determined to again
extend change in control benefits to our CFO and General Counsel upon substantially the same terms
as had been extended to those formerly serving in these roles. Subsequently, in June 2010, in
connection with the hiring of our VP, Marketing and Business Development, the Compensation
Committee approved the extension of change in control benefits to him, based on the key role that
he would serve in shaping the future strategic direction of the Company, and the key role that he
would be expected to play in any transaction involving the Company. In September 2010, the
Compensation Committee approved the Companys employment agreement with Mr. Kennedy, following his
June 2010 appointment as CEO, which includes provisions for enhanced severance and other benefits
in the event Mr. Kennedys employment is terminated in connection with a change in control.
Descriptions of the terms of the Mr. Kennedys employment agreement, the change in control and
severance agreements executed between the Company and Messrs. Bornak and Nulty, and the severance
agreements with Messrs. King and Blakeney are described in detail under the heading Employment
Agreement, Separation of Employment and Change-in-Control Agreements.
Perquisites and Other Benefits
The Company provides to each of our named executive officers a long-term disability policy,
and a related tax-gross up payment associated with the Company-paid premiums on the policy. The
Compensation Committee believes that this benefit is desirable in order to assist in attracting and
retaining high-quality executive officers. Mr. Kennedy is
entitled to receive this benefit pursuant to the terms of his employment agreement. Each of our named executive officers received
this benefit during the period of their employment by the Company during 2010.
During 2010, the named executive officers did not receive any other perquisites or other
benefits that are not generally available to all employees. Tollgrade does not maintain a deferred
compensation or pension plan for its named executive officers other than the 401(k) plan offered to
all employees and does not provide any contributions to the 401(k) on behalf of any named executive
officers.
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Summary Compensation Table
The table below sets forth certain information regarding compensation of our (i) CEO, (ii) our
former CEO who also served in that capacity during a portion of 2010, (iii) our CFO, and (iv) our
three most highly compensated executive officers other than our CEO and CFO who were serving as of
December 31, 2010.
Stock Awards | Option Awards | Non-Equity Incentive | All Other | |||||||||||||||||||||||||||||
Name/Principal Position | Year | Salary ($) | Bonus ($) | ($)(1) | ($)(1) | Plan Compensation ($) | Compensation ($) | Total ($) | ||||||||||||||||||||||||
Edward H. Kennedy |
2010 | 197,313 | | (3) 315,000 | (3),(4) 1,280,760 | (5) 103,590 | (6), (7) 54,056 | 1,950,719 | ||||||||||||||||||||||||
CEO and
President(2) |
||||||||||||||||||||||||||||||||
Joseph A. Ferrara |
2010 | 153,611 | | (9) | | | (7),(10) 824,139 | 977,750 | ||||||||||||||||||||||||
Former CEO and President(8) |
2009 | 351,346 | 94,500 | | 354,564 | | 2,680 | 803,090 | ||||||||||||||||||||||||
2008 | 350,000 | | | | | 2,633 | 352,633 | |||||||||||||||||||||||||
Michael D. Bornak |
2010 | 250,000 | | (11) 126,000 | | (5) 98,713 | (7) 2,716 | 477,429 | ||||||||||||||||||||||||
CFO and Treasurer |
2009 | (7) 91,546 | 17,500 | | 141,975 | | | 251,021 | ||||||||||||||||||||||||
Robert H. King |
2010 | | | | (4) 78,585 | (12) 463,368 | (7) 2,114 | 544,067 | ||||||||||||||||||||||||
VP, Global Sales and Services |
2009 | 220,179 | | | 89,031 | 74,348 | 1,328 | 384,886 | ||||||||||||||||||||||||
2008 | 3,270 | | | | | | 3,270 | |||||||||||||||||||||||||
Gregory M. Nulty |
2010 | (13) 130,000 | (14) 10,000 | | (4) 157,170 | (5) 55,248 | (7) 1,975 | 354,393 | ||||||||||||||||||||||||
VP, Marketing and
Business Development |
||||||||||||||||||||||||||||||||
David L. Blakeney |
2010 | 200,018 | | | (4) 62,868 | (5) 56,413 | (7) 1,341 | 320,640 | ||||||||||||||||||||||||
VP, Research and Development |
2009 | 200,787 | 30,003 | | | | | 230,790 | ||||||||||||||||||||||||
2008 | 34,619 | | | 53,015 | | | 87,634 | |||||||||||||||||||||||||
Notes to Summary Compensation Table: | ||
(1) | The amounts in the Stock Awards and Option Awards columns reflect the aggregate grant date fair value of awards computed in accordance with FASB ASC Topic 718. Assumptions used in calculating these amounts are included in Note 2 to our audited financial statements for the years ended December 31, 2010, December 31, 2009 and December 31, 2008, appearing in this Annual Report on Form 10-K, and in our Annual Reports on Form 10-K filed with the SEC on March 10, 2010 and March 13, 2009, respectively. | |
(2) | Until his appointment as our CEO and President effective June 8, 2010, Mr. Kennedy served as one of the Companys non-employee directors during 2010 (serving as Chairman since March 2010). Amounts reflected in the Summary Compensation Table include, where noted, compensation that Mr. Kennedy received solely in his capacity as a non-employee director. All other amounts were earned by Mr. Kennedy for his service during 2010 as our CEO and President. Mr. Kennedys base salary as CEO and President was $350,000 during 2010. | |
(3) | On March 23, 2010, Mr. Kennedy was awarded 50,000 restricted shares and 250,000 stock appreciation rights in connection with his service as the non-executive Chairman of the Board of Directors. The entire amount reflected under the Stock Awards column is attributable to the restricted shares award, and $809,250 of the amount reflected under the Option Awards column is attributable the award of stock appreciation rights, which were received by Mr. Kennedy solely in his capacity as a non-employee director. | |
(4) | On June 17, 2010, each of Messrs. Kennedy, King, Nulty and Blakeney received stock option awards, the details of which are summarized in the Grant of Plan-Based Awards table. | |
(5) | As described above under the heading, Bonus and Non-Equity Incentive Plan Compensation, each of our named executive officers who remained employed at the time of payment, received cash incentive compensation for performance during 2010 pursuant to the terms of our Management Incentive Compensation Plan. | |
(6) | Mr. Kennedy received cash compensation of $52,030 for his service as a non-employee director during 2010 prior to his becoming employed as the Companys CEO and President. |
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(7) | As described above under the heading, Perquisites and Other Benefits, for each of our named executive officers, the Company pays the premiums on an additional, long-term disability policy, and provides the executive with a tax-gross up payment in connection with the Company-paid premiums. These amounts are included in the All Other Compensation column of the Summary Compensation Table as follows: Kennedy $2,026; Ferrara $2,370; Bornak - $2,716; King $2,114; Nulty $1,975; Blakeney $1,341. | |
(8) | During 2010, Mr. Ferrara served as CEO and President until June 8, 2010. | |
(9) | Mr. Ferrara received an award of 30,000 restricted shares on March 23, 2010; however the awards were forfeited in connection with his termination of employment on June 8, 2010. | |
(10) | The amount reflected under the column All Other Compensation for Mr. Ferraras 2010 compensation includes $2,370 for the long-term disability insurance benefit described in note 7, above, $10,096 paid at the time of employment termination for unused vacation, and pursuant to the agreements in effect between Mr. Ferrara and the Company, $794,500 severance paid at the time of employment termination, $9,173 for continuation of benefits during 2010 following termination of employment, and $8,000 for reimbursement of executive outplacement services fees. A description of Mr. Ferraras employment agreement, including the separation and mutual release agreement executed with Mr. Ferrara, is included under the heading Employment Agreement, Separation of Employment and Change-in-Control Agreements. | |
(11) | On March 23, 2010, Mr. Bornak received an award of 20,000 restricted shares, the details of which are included in the Grant of Plan-Based Awards table. | |
(12) | As described above, under the heading Commission Program for VP, Global Sales and Services, pursuant to Mr. Kings Commission Program for 2010, he earned $463,368 in commission for performance during 2010. Commission amounts were earned in lieu of, and not in addition to, salary. | |
(13) | Mr. Nulty was hired in June 2010 with an annual salary of $240,000. The amount reflected for Mr. Nultys 2010 salary reflects his having been employed for a partial year. | |
(14) | In connection with the start of his employment, Mr. Nulty was paid a one-time signing bonus of $10,000. |
Grant of Plan-Based Awards Table
The table below sets forth certain information concerning plan-based awards granted during the
year ended December 31, 2010 to each of the named executive officers.
All Other Option | ||||||||||||||||||||||||||||||||||||||||||||
Estimated Possible Payouts Under | Estimated Future Payouts Under | All Other Stock | Awards; Number of | Grant Date Fair | ||||||||||||||||||||||||||||||||||||||||
Non-Equity Incentive Plan Awards(1) | Equity Incentive Plan Awards | Awards; Number of | Securities | Exercise or Base | Value of Stock and | |||||||||||||||||||||||||||||||||||||||
Threshold | Target | Maximum | Threshold | Target | Maximum | Shares of Stock or | Underlying Options | Price of Option | Option Awards | |||||||||||||||||||||||||||||||||||
Name | Grant Date | ($) | ($) | ($) | ($) | ($) | ($) | Units (#) | (#)(2) | Awards ($/Sh) | ($)(3) | |||||||||||||||||||||||||||||||||
Edward H. Kennedy |
78,750 | 94,500 | 315,000 | |||||||||||||||||||||||||||||||||||||||||
3/23/2010 | (4) 50,000 | 315,000 | ||||||||||||||||||||||||||||||||||||||||||
3/23/2010 | (4) 250,000 | 6.31 | 809,250 | |||||||||||||||||||||||||||||||||||||||||
6/17/2010 | 150,000 | 6.48 | 471,510 | |||||||||||||||||||||||||||||||||||||||||
Joseph A. Ferrara |
78,750 | 94,500 | 315,000 | |||||||||||||||||||||||||||||||||||||||||
3/30/2010 | (5) 30,000 | |||||||||||||||||||||||||||||||||||||||||||
Michael D. Bornak |
43,750 | 52,500 | 175,000 | |||||||||||||||||||||||||||||||||||||||||
3/26/2010 | (6) 20,000 | 126,000 | ||||||||||||||||||||||||||||||||||||||||||
Robert H. King |
(7) 465,000 | |||||||||||||||||||||||||||||||||||||||||||
6/17/2010 | 25,000 | 6.48 | 78,585 | |||||||||||||||||||||||||||||||||||||||||
Gregory M. Nulty |
42,000 | 50,400 | 168,000 | |||||||||||||||||||||||||||||||||||||||||
6/17/2010 | 50,000 | 6.48 | 157,170 | |||||||||||||||||||||||||||||||||||||||||
David L. Blakeney |
25,003 | 30,003 | 100,010 | |||||||||||||||||||||||||||||||||||||||||
6/17/2010 | 20,000 | 6.48 | 62,868 |
Notes to Grant of Plan-Based Awards Table: | ||
(1) | A description of the Companys 2010 non-equity incentive plan for Messrs. Kennedy, Ferrara, Bornak, Nulty and Blakeney, including the amounts actually paid under the plan, is included above under the heading, Bonus and Non-Equity Incentive Plan Compensation. A description of the 2010 non-equity incentive plan for Mr. King, including the amounts actually paid thereunder, is included above under the heading, Commission Program for VP, Global Sales and Services. |
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(2) | Except where otherwise specifically noted in other footnotes, options granted vest in three equal installments on each of the first, second, and third anniversaries of the date of grant and expire ten years from the date of grant. | |
(3) | Amounts reflect the grant date fair value of awards computed in accordance with FASB ASC Topic 718. Assumptions used in calculating these amounts are included in Note 2 to our audited financial statements for the year ended December 31, 2010 appearing in this Annual Report on Form 10-K. | |
(4) | The awards of 50,000 restricted shares and 250,000 stock appreciation rights were granted to Mr. Kennedy in his capacity as non-executive Chairman of the Board of Directors, and prior to his becoming employed by the Company as its President and CEO. The restricted share award will vest on the first anniversary of the date of grant. The stock appreciation rights will vest only in the event and upon the effectiveness of a corporate transaction as defined in the (award agreement). | |
(5) | The award of 30,000 restricted shares to Mr. Ferrara in March 2010 was scheduled to vest on the third anniversary of the grant date; however the award was forfeited in its entirety in connection with Mr. Ferraras termination of employment in June 2010 pursuant to the terms of the 2006 Long-Term Incentive Plan. | |
(6) | The award of 20,000 restricted shares to Mr. Bornak in March 2010 is scheduled to vest on the third anniversary of the date of grant. | |
(7) | Under the terms of Mr. Kings non-equity incentive compensation plan, if Mr. King were to reach the target amount of commissions under his non-equity incentive plan, commissions would be paid in lieu of, and not in addition to, his base salary of $228,000. A description of the 2010 non-equity incentive plan for Mr. King, including the amounts actually paid thereunder, is included above under the heading, Commission Program for VP, Global Sales and Services. |
Outstanding Equity Awards at Fiscal Year-End 2010
The following table sets forth certain information concerning outstanding equity awards for
our named executive officers as of December 31, 2010.
Option Awards | Stock Awards | |||||||||||||||||||||||||||||||||||
Equity Incentive | Equity Incentive | |||||||||||||||||||||||||||||||||||
Number of | Plan Awards: Number | Equity Incentive | Plan Awards: Market | |||||||||||||||||||||||||||||||||
Securities | Number of Securities | of Securities | Market Value of | Plan Awards: Number | or Payout Value of | |||||||||||||||||||||||||||||||
Underlying | Underlying | Underlying | Shares or Units of | of Unearned Shares, | Unearned Shares, | |||||||||||||||||||||||||||||||
Unexercised Options | Unexercised Options | Unexercised | Number of Shares or | Stock That Have Not | Units or Other | Units or Other | ||||||||||||||||||||||||||||||
(#) | (#) | Unearned Options | Option Exercise | Option Expiration | Units of Stock That | Vested | Rights That Have | Rights That Have | ||||||||||||||||||||||||||||
Name | Exercisable | Unexercisable | (#) | Price ($) | Date(1) | Have Not Vested (#) | ($)(2) | Not Vested (#) | Not Vested ($) | |||||||||||||||||||||||||||
Edward H. Kennedy |
50,000 | 464,000 | ||||||||||||||||||||||||||||||||||
35,000 | 5.17 | 7/20/2019 | ||||||||||||||||||||||||||||||||||
150,000 | 6.48 | 6/17/2020 | ||||||||||||||||||||||||||||||||||
(3) 250,000 | 6.31 | 3/23/2020 | ||||||||||||||||||||||||||||||||||
Joseph A. Ferrara |
72,508 | 7.78 | 6/8/2011 | |||||||||||||||||||||||||||||||||
Michael D. Bornak |
20,000 | 185,600 | ||||||||||||||||||||||||||||||||||
16,667 | 33,333 | 6.03 | 12/10/2019 | |||||||||||||||||||||||||||||||||
Robert H. King |
8,333 | 16,667 | 5.38 | 1/26/2019 | ||||||||||||||||||||||||||||||||
3,333 | 6,667 | 5.32 | 5/12/2019 | |||||||||||||||||||||||||||||||||
| 25,000 | 6.48 | 6/17/2020 | |||||||||||||||||||||||||||||||||
Gregory M. Nulty |
50,000 | 6.48 | 6/17/2020 | |||||||||||||||||||||||||||||||||
David L. Blakeney |
| 11,666 | 3.27 | 10/20/2018 | ||||||||||||||||||||||||||||||||
| 20,000 | 6.48 | 6/17/2020 |
Notes to Outstanding Equity Awards at Fiscal Year End 2010 Table: | ||
(1) | Except in the case of Mr. Ferraras options, the option expiration dates stated are based on the original terms of the grant. Under the terms of our 2006 Long-Term Incentive Compensation Plan, non-qualified stock options that are exercisable at the time of termination of employment under certain circumstances must be exercised on or before the earlier of the expiration date or the date which is one year following termination of employment. Mr. Ferraras employment terminated on June 8, 2010, and as such his options will expire on June 8, 2011. |
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(2) | Market value of unvested shares is based on $9.28 per share, which was the closing price of our common stock on December 31, 2010. | |
(3) | Award of 250,000 stock appreciation rights, which, subject to vesting, represent the right to receive the difference between fair market value on the date of exercise and the exercise price of $6.31. This award was granted to Mr. Kennedy in his capacity as non-executive Chairman of the Board of Directors, and prior to his becoming employed by the Company as its CEO and President. |
Option Exercises and Stock Vested
The table below sets forth on an aggregated basis certain information concerning exercises of
stock options and similar instruments and each vesting of stock during the year ended December 31,
2010 by each of the named executive officers.
Option Awards | Stock Awards | |||||||||||||||
Number of Shares | Value Realized on | Number of Shares | Value Realized on | |||||||||||||
Name | Acquired on Exercise (#) | Exercise ($) | Acquired on Vesting (#) | Vesting ($) | ||||||||||||
Edward H. Kennedy |
| | 6,098 | 45,003 | ||||||||||||
Joseph A. Ferrara |
74,158 | 140,405 | 2,870 | 21,956 | ||||||||||||
Michael D. Bornak |
| | | | ||||||||||||
Robert H. King |
| | | | ||||||||||||
Gregory M. Nulty |
| | | | ||||||||||||
David L. Blakeney |
23,334 | 93,919 | | |
Employment Agreement, Separation of Employment and Change-in-Control Agreements
Employment Agreement with Edward H. Kennedy
In September 2010, the Company entered into an employment agreement with Mr. Kennedy relating
to his continuing employment with the Company. Mr. Kennedys employment agreement has an initial
term through June 30, 2013. The term will be automatically extended for successive additional
terms of three years, unless terminated by either the Company or Mr. Kennedy with at least a sixty
day notice prior to the end of the then-current term.
Mr. Kennedys agreement provides for an annual base salary of $350,000, with such increases or
decreases from time to time as the Compensation Committee may determine, subject to mandatory
annual increases based on the average percentage increase in base salary, if any, of our executive
council (as defined in Mr. Kennedys agreement) for the prior two full calendar years. Mr. Kennedy
is also entitled to receive annual bonuses based upon achievement of performance objectives
established by the Compensation Committee pursuant to the MICP. Mr. Kennedy is also eligible to
receive long-term disability coverage of $10,000 per month during the term of the disability.
While serving as CEO during the term of the agreement, the Company has agreed to nominate Mr.
Kennedy on its slate of Board of Director candidates and to recommend to our shareholders that Mr.
Kennedy be elected to the Board.
The agreement provides for certain severance payments upon termination of Mr. Kennedys
employment. Such payments vary depending upon the circumstances of termination. If Mr. Kennedys
employment is terminated because of his death, disability or retirement, Mr. Kennedy (or in the
event of his death, Mr. Kennedys spouse or estate if his spouse does not survive him) is entitled
to receive a pro rata portion, based upon the number of months of Mr. Kennedys employment during
the year of termination, of any annual bonus program or agreement in effect for the year of
termination based upon the then-projected achievement of performance objectives for the year.
If, within six months prior to a change-in-control (as defined in the agreement) or three
years after a change-in-control, Mr. Kennedys employment is terminated by the Company without
cause or is terminated by Mr. Kennedy with good reason, Mr. Kennedy is entitled to receive a
severance payment of three times the sum of:
(i) | the greater of (a) his annual base salary on the date of termination (provided that in the case of good reason for termination, the date immediately preceding the date of the event that gave rise to the good reason for termination shall be used instead of the date of termination) or (b) his annual base salary in effect when the change-in-control occurred, plus | ||
(ii) | the greater of (a) his average annual cash award for the two calendar years prior to the date of termination (provided that in the case of good reason for termination, the date immediately preceding the date of the event that gave rise to |
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the good reason for termination shall be used instead of the date of termination) or (b) his average annual cash award for the two calendar years prior to the date of the change-in-control. |
In addition, Mr. Kennedy shall be entitled to receive payment of reasonable executive
placement agency fees for a period not to exceed two years and the continuation of certain medical,
pension and other benefits for a three-year period. Finally, outstanding stock appreciation rights,
stock options and restricted stock awards that did not immediately become vested upon the
occurrence of the change-in-control shall automatically become vested and any such stock options
and stock appreciation rights shall be exercisable thereafter until the stated expiration date of
the stock appreciation right or stock option.
In the event of a change in control, if we assume these payments were triggered as of December
31, 2010, the following table provides an estimate of the amount payable to Mr. Kennedy:
Base salary ($350,000) x 3 |
$ | 1,050,000 | ||
Average bonus payment ($103,590) x3 |
310,770 | |||
Estimated annual benefits ($28,000) x3 |
84,000 | |||
Estimated outplacement fees (15% of base salary) |
52,500 | |||
Acceleration of vesting of options, stock appreciation rights
and restricted shares (based on closing stock price (9.28) and
awards outstanding on 12/31/10) |
1,626,500 | |||
Total |
$ | 3,123,770 |
If Mr. Kennedys employment is terminated by the Company without cause or is terminated
by Mr. Kennedy with good reason, and the change-in-control scenario above is not applicable, Mr.
Kennedy will be entitled to receive two times the sum of:
(i) his annual base salary in effect on the date of termination, plus
(ii) his average annual cash award for the two calendar years prior to the date of
termination.
In addition, Mr. Kennedy shall be entitled to receive payment of reasonable executive
placement agency fees for a period not to exceed two years and the continuation of certain medical,
pension and other benefits for a two-year period. If we assume these payments were triggered as of
December 31, 2010, the following table provides an estimate of the amount payable to Mr. Kennedy:
Base Salary ($350,000) x 2
|
$ | 700,000 | ||
Average Bonus Payment ($103,590) x2
|
207,180 | |||
Estimated annual benefits ($28,000) x2
|
56,000 | |||
Estimated outplacement fees (15% of base salary)
|
52,500 | |||
Total
|
$ | 1,015,680 |
For purposes of the severance payments described above, the Companys notice of
non-renewal of Mr. Kennedys agreement shall be considered termination of Mr. Kennedys employment
by the Company without cause for termination. A thirty day cure period applies under Mr. Kennedys
agreement if the Company terminates his employment with cause for termination or if Mr. Kennedy
terminates his employment with good reason for termination.
The receipt of any severance payments under the agreement are subject to Mr. Kennedy signing
and not revoking for a period of seven days a separation and mutual release of claims agreement.
Pursuant to his agreement, Mr. Kennedy agrees to resign from all positions that he holds with the
Company or its subsidiaries, including, without limitation, as a member of the Board of Directors,
immediately following the termination of his employment for any reason, if the Board of Directors
so requests.
Further, if any payment or payments due to Mr. Kennedy or otherwise payable or distributable
for his benefit in connection with a change-in-control (whether pursuant to his employment
agreement or otherwise, and including any amounts resulting from the acceleration of any stock
options or other equity-based incentive award) results in an excise tax pursuant to Section 4999 of
the Code or its successor taxing provision or additional taxes pursuant to Section 409A of the Code
or its successor taxing provision, the Company will pay Mr. Kennedy certain gross-up payments.
The gross-up payments shall be in an amount which, after payment by Mr. Kennedy of all taxes (and
any interest or penalties), including any income tax, excise tax or additional tax pursuant to
Section 409A of the Code imposed on the gross-up payment, Mr. Kennedy would retain an amount of the
gross-up payment equal to the amount of the excise tax and taxes pursuant to Section 409A of the
Code imposed on his change-in-control payments and benefits. On February 20, 2011, the Company
also entered into an amendment to its agreement with Mr. Kennedy, for the purpose of clarifying
that the tax gross-up provision was applicable to equity based awards.
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Mr. Kennedys agreement represents his sole entitlement to severance payments and benefits in
connection with termination of his employment.
Employment Agreement with Joseph A. Ferrara
In April 2008, the Company entered into an employment agreement with Mr. Ferrara relating to
his employment with the Company. Mr. Ferraras employment agreement had an initial term through
January 31, 2011. The terms of Mr. Ferraras employment agreement were identical in all material
respects to those described above with respect to Mr. Kennedy, including his base salary and
entitlement to change in control and severance payments. Mr. Ferrara was employed by the Company
until June 8, 2010.
Given that Mr. Ferrara left the Company on June 8, 2010, if a change of control event had been
triggered as of December 31, 2010, Mr. Ferrara would not have been eligible to receive such a
payment. Mr. Ferraras agreement represented his sole entitlement to severance payments and
benefits in connection with termination of his employment. The terms of his particular severance
arrangement are described immediately below under the sub-heading Separation and Mutual Release
Agreement.
Separation and Mutual Release Agreement with Joseph A. Ferrara
Effective June 8, 2010, Mr. Ferrara left the Company as CEO and President and resigned as
director of the Company. In connection with his separation from the Company, Mr. Ferrara and the
Company entered into a separation and mutual release agreement dated as of June 18, 2010.
Consistent with the terms of Mr. Ferraras employment agreement, he received a severance payment in
the amount of two times his salary at the time of termination, plus two times his average bonus for
the prior two years. In addition, for the two-year period following his termination, Mr. Ferrara
is entitled to the continuation of medical, dental and vision insurance benefits and his long-term
disability benefit (and related tax gross-up), and reimbursement for executive outplacement
services. The total amount paid to Mr. Ferrara as severance, and estimated total amounts
associated with the continuation of benefits and outplacement services reimbursement, is set forth
below:
Base salary ($350,000) x 2 |
$ | 700,000 | ||
Average Bonus Payment ($47,250) x 2 |
94,500 | |||
Continuation of benefits and long-term disability gross-up |
39,610 | |||
Outplacement fees (entitled to up to 15% of base salary) |
52,500 | |||
Total |
$ | 886,610 |
Mr. Ferrara is also eligible to remain covered under director and officer indemnification
and insurance (including applicable tax gross-up payments) as may be required in connection with
his separation.
In exchange for these payments, Mr. Ferrara agreed to a two-year standstill agreement that
extends until June 18, 2012. During this time, Mr. Ferrara agrees not to acquire or offer to
acquire more than five percent of the Companys common stock, have any involvement, directly or
indirectly, in any merger, consolidation, business combination, asset purchase (other than routine
purchases in the ordinary course of business) or other similar transaction with the Company or its
affiliates, solicit proxies and other similar activities, be involved in a partnership or group
as defined in the Exchange Act with respect to the Companys common stock or otherwise act in any
manner to influence the management, Board or policies of the Company or seek a position on the
Board, or engage in other similar conduct. Mr. Ferrara and the Company also entered into standard
mutual release and covenant not to sue, non-disparagement, and representations and warranties
relating to execution of the agreement.
Severance and Change in Control Agreements with Michael D. Bornak and Gregory M. Nulty
The Company entered into an agreement with Mr. Bornak in March 2010, and an agreement with Mr.
Nulty in June 2010, each of which provides for the payment of severance and other benefits in the
event of such persons involuntary termination of employment without cause (including his
termination of employment for good reason). Each agreement has an initial term of three years and
will be automatically extended for successive two year periods unless terminated either by the
executive or by the Company upon at least sixty days written notice prior to the end of the then
current term. Each agreement provides that if the executives employment is terminated by the
Company without cause or by the executive for good reason, and such termination does not occur in
connection with a change in control (as defined in the agreement), the executive will be entitled
to receive a lump sum cash payment in an amount equal to his annual base salary. In addition, each
executive would be entitled to receive payment of executive placement agency fees of up to $6,000
and to the continuation of certain health and welfare benefits for a period of twelve months.
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If we assume these severance payments were triggered as of December 31, 2010, the following
table provides an estimate of the amounts that would have been payable to Mr. Bornak and to Mr.
Nulty:
Bornak | Nulty | |||||||
Base salary |
$ | 250,000 | $ | 240,000 | ||||
Estimated annual benefits (one year) |
16,000 | 16,000 | ||||||
Outplacement fees |
6,000 | 6,000 | ||||||
Total |
$ | 272,000 | $ | 262,000 |
If the employment of either executive is terminated by the Company either six months before or
within two years after a change in control, or is terminated by him for good reason for termination
within such period, the executive will be entitled to receive a lump sum cash payment equal to an
amount that is two times the sum of (a) the greater of (i) his annual base salary for the year then
in effect (or in effect on the date immediately preceding the date of the event which gave rise to
the good reason for termination) or (ii) his annual base salary for the year in effect on the date
of the change in control, and (b) the greater of (i) the average annual cash award that he received
as incentive compensation or bonus for the two calendar years immediately preceding the termination
date (or the date immediately preceding the date of the event which gave rise to the good reason
for termination) or (ii) the average annual cash award that he received as incentive compensation
or bonus for the two calendar years immediately preceding the date of the change in control. In
addition to the foregoing, the executive would be entitled to receive payment of executive
placement agency fees of up to $6,000 and to the continuation of certain health and welfare
benefits for a period of twenty-four months.
If we assume these change in control payments were triggered as of December 31, 2010, the
following table provides an estimate of the amounts that would have been payable to Mr. Bornak and
Mr. Nulty:
Bornak | Nulty | |||||||
Base salary x2 |
$ | 500,000 | $ | 480,000 | ||||
Average bonus x2 |
116,214 | 110,496 | ||||||
Estimated annual benefits x2 |
32,000 | 32,000 | ||||||
Outplacement fees |
6,000 | 6,000 | ||||||
Acceleration of vesting of options and restricted
shares based on closing stock price ($9.28) and
awards outstanding at 12/31/10 |
293,932 | 140,000 | ||||||
Total |
$ | 942,146 | $ | 768,496 |
Receipt of the payments and benefits described above would be subject to the executive signing
a separation and mutual release of claims agreement. Each agreement further includes
confidentiality provisions and covenants against competition, and represents the executives sole
entitlement to severance payments and benefits in connection with termination of employment. Mr.
Bornaks agreement replaces a severance agreement previously entered into between the Company and
Mr. Bornak at the time that he joined the Company, which had provided for a six month severance
benefit and no additional or separate benefit in the event termination were to have occurred in
connection with a change in control.
On February 20, 2011, the Company entered into amendments to its respective agreements with
Messrs. Bornak and Nulty. The amendments eliminated the provision of the agreement that required
payments due under the agreement to be reduced to the maximum amount that could be paid to the
executive without incurring an excise tax on excess parachute payments, and added in its place a
tax gross-up provision. Under the added provision, if payments made under the agreement or
otherwise, including any payments, benefits, distributions and deemed amounts received under any
other agreement or resulting from the acceleration of the vesting of any stock options or other
equity-based incentive awards, were subject to the excise tax on excess parachute payments, an
additional payment would be made to restore the after-tax payments to the same amount that the
executive would have retained if the excise tax had not been imposed.
Severance Agreements with David L. Blakeney and Robert H. King
In March 2009, the Company entered into agreements with Messrs. Blakeney and King relating to
severance payments to be made to each in the event of his involuntary termination of employment
without cause (each a Severance Agreement). Each Severance Agreement has an initial term of three
years, and will be automatically extended for successive two year periods unless terminated by
either party upon not less than sixty days written notice prior to the end of the then-current
term.
Under each Severance Agreement, if the executives employment is terminated by the Company
without cause (as defined in the Severance Agreements), he would be entitled to receive a lump sum
cash payment in an amount equal to his annual base salary. He would also be entitled to receive
payment of executive placement agency fees of up to $6,000 and to the continuation of certain
health and welfare benefits for a period of twelve months.
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If we assume this payment were triggered as of December 31, 2010, the following table provides
an estimate of the amount that would have been payable to Mr. Blakeney and to Mr. King:
Blakeney | King | |||||||
Base salary |
$ | 200,018 | $ | 228,000 | ||||
Estimated annual benefits (one year) |
16,000 | 16,000 | ||||||
Outplacement fees |
6,000 | 6,000 | ||||||
Total |
$ | 222,018 | $ | 250,000 |
Receipt of these payments and benefits is subject to the executive signing a separation and
mutual release of claims agreement. Each Severance Agreement further includes confidentiality
provisions and covenants against competition. Each Severance Agreement represents the executives
sole entitlement to severance payments and benefits in connection with termination of employment,
and specifically replaces agreements for post-employment compensation previously entered into
between the Company and these executives.
Director Compensation
The table below sets forth certain information regarding compensation of non-employee
directors that served during 2010. Mr. Kennedy served as a non-employee director until his
appointment as CEO and President effective June 8, 2010. Therefore, his director compensation has
been included in the Summary Compensation Table, rather than in the table below.
Non-Employee | Fees Earned or Paid | |||||||||||||||
Director Name | in Cash ($) | Stock Awards ($)(1) | Option Awards ($)(1) | Total ($) | ||||||||||||
Scott C. Chandler |
20,000 | 58,560 | | 78,560 | ||||||||||||
Richard H. Heibel, M.D. |
21,935 | 58,560 | | 80,495 | ||||||||||||
Charles E. Hoffman |
36,440 | 58,560 | | 95,000 | ||||||||||||
Robert W. Kampmeinert |
21,250 | 58,560 | | 79,810 | ||||||||||||
Edward B.
Meyercord, III |
23,179 | 58,560 | | 81,739 | ||||||||||||
Jeffrey M. Solomon |
20,000 | 58,560 | | 78,560 |
Note (1): | Amounts reflect the grant date fair value of awards computed in accordance with FASB ASC Topic 718. Assumptions used in calculating these amounts are included in Note 2 to our audited financial statements for the year ended December 31, 2010 appearing in this Annual Report on Form 10-K. |
Non-Employee Director Compensation
Our compensation program for non-employee directors provides for annual compensation comprised
of an annual cash retainer of $20,000, an additional annual cash retainer for the Chairpersons of
our Audit Committee ($10,000), Compensation Committee ($7,500) and Corporate Governance Committee
($5,000), and an annual grant of restricted shares. As originally adopted by the Board in October
2009, the program also called for an additional annual retainer for the Chairman of our Investment
Committee ($5,000); however our Investment Committee was dissolved in May 2010.
The initial size of the restricted share award for non-employee directors was established at a
number of shares with a fair market value of $35,000, based on the fair market value of our stock
on the date of grant. Accordingly, in October 2009, each director was awarded 6,098 shares of
restricted stock. At its September 2010 meeting, the Board reviewed the equity portion of its
annual compensation program, and based on factors which included the previously approved award
level, improvements in Company performance over the prior year, and the Board-adopted guidelines
for stock ownership by non-employee directors, the Board determined to increase the number of
shares to 8,000 for the 2010 award. Effective October 1, 2010, each non-employee director received
a grant of 8,000 restricted shares.
In connection with the March 2010 appointment of Mr. Kennedy as Chairman of the Board of
Directors, given the Boards expectation that Mr. Kennedy would play an active role in shaping the
strategic direction of the Company, the Board adopted a compensation program for the role of
non-employee Chairman of the Board. This compensation program was comprised of an annual cash
retainer of $200,000, a one-time grant of 50,000 restricted shares, and a one-time grant of 250,000
stock appreciation rights to vest upon a corporate transaction (as defined in the award agreement).
As Mr. Kennedy was subsequently appointed President and CEO in June 2010, all of the compensation
that Mr. Kennedy received as Board Chairman is included in the Summary Compensation
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Table and in the Grant of Plan-Based Awards Table. Mr. Kennedy currently serves as Chairman,
President and CEO. As an employee of the Company, Mr. Kennedy does not receive separate
compensation for his service as Board Chairman.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information as to the beneficial ownership of our
common stock as of February 28, 2011, for (i) each director; (ii) each of the named executive
officers named in the Summary Compensation Table; (iii) each other person who is known by us to
beneficially own 5% or more of our common stock; and (iv) all directors and executive officers as a
group. The information in the table concerning beneficial ownership is based upon information
furnished to Tollgrade by or on behalf of the persons named in the table, or in the case of the
persons identified in the foregoing clause (iii), in filings with the SEC.
Name and Address of | Amount and Nature of | Percentage of Common Stock | |||||||
Beneficial Owner(1) | Beneficial Ownership (2) | Outstanding (3) | |||||||
Edward H. Kennedy |
(4)(5) | 91,098 | * | ||||||
Michael D. Bornak |
(4)(6) | 36,667 | * | ||||||
David L. Blakeney |
23,334 | * | |||||||
Robert H. King |
(4) | 19,999 | * | ||||||
Gregory M. Nulty |
0 | | |||||||
Scott C. Chandler |
(7) | 16,598 | * | ||||||
Richard H. Heibel |
(4)(7)(8) | 119,973 | * | ||||||
Charles E. Hoffman |
(4)(7) | 49,098 | * | ||||||
Robert W. Kampmeinert |
(4)(7) | 50,764 | * | ||||||
Edward B. Meyercord, III |
(7) | 16,798 | * | ||||||
Jeffrey M. Solomon |
(7)(9) | 2,109,055 | 16.25% | ||||||
All directors and executive officers
as a group (14 persons) |
(4) (9) | 2,580,884 | 19.88 | ||||||
Ramius LLC 599 Lexington Avenue 20th Floor New York, NY 10022 |
(10) | 2,094,957 | 16.14 | ||||||
Bradford
Capital Partners 133 Freeport Rd. Pittsburgh, PA 15215 |
(11) | 1,547,053 | 11.91 | ||||||
Dimensional
Fund Advisors LP Palisades West, Building One, 6300 Bee Cave Road Austin, Texas 78746 |
(12) | 1,073,801 | 8.27 | ||||||
Royce &
Associates, LLC 745 Fifth Avenue New York, NY 10151 |
(13) | 828,060 | 6.38 | ||||||
Renaissance
Technologies, LLC 800 Third Avenue New York, NY 10022 |
(14) | 709,800 | 5.47 | ||||||
Wellington
Management Company, LLP 280 Congress Street Boston, MA 02210 |
(15) | 666,200 | 5.13 | ||||||
Wellington
Trust Company, NA c/o Wellington Management Company, LLP 280 Congress Street Boston, MA 02210 |
(16) | 666,200 | 5.13 |
* Less than 1%
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Notes to Security Ownership of Certain Beneficial Owners and Management Table:
(1) | If not provided above, the address of listed shareholders is c/o Tollgrade Communications, Inc., 3120 Unionville Rd, Suite 400, Cranberry Twp., PA 16066. | |
(2) | Under regulations of the SEC, a person who has or shares voting or investment power with respect to a security is considered a beneficial owner of the security. Voting power is the power to vote or direct the voting of shares, and investment power is the power to dispose of or direct the disposition of shares. Unless otherwise indicated in the other footnotes below, each person has sole voting power and sole investment power as to all shares listed opposite his name. The inclusion of any shares of stock deemed to be beneficially owned does not constitute an admission of beneficial ownership of those shares. | |
(3) | In computing the percentage ownership of any person, the number of shares outstanding includes 13,007,388 shares of common stock outstanding as of February 28, 2011, plus any shares subject to outstanding stock options exercisable within 60 days after February 28, 2011, held by the applicable person or persons. | |
(4) | Includes options there were exercisable on or within 60 days of February 28, 2011 of such individual for the following number of shares: Kennedy (35,000), Bornak (16,667), King (19,999), Heibel (35,000), Hoffman (35,000), Kampmeinert (35,000) and other executive officers as a group (80,481). | |
(5) | Includes 50,000 restricted share units issued to Mr. Kennedy on March 23, 2010, which vest on March 23, 2011. | |
(6) | Includes 20,000 restricted shares granted to Mr. Bornak on March 26, 2010, which vest on March 26, 2013. | |
(7) | Includes 8,000 restricted shares granted to each of our non-employee directors on October 1, 2010, which vest on October 1, 2011. | |
(8) | Includes 32,246 shares held by the spouse of Dr. Heibel, as to which Dr. Heibel shares voting and dispositive power. | |
(9) | Includes 965,199 shares held by Ramius Value and Opportunity Master Fund Ltd., 794,514 shares held by Ramius Navigation Master Fund Ltd., and 335,244 shares held by Ramius Enterprise Master Fund Ltd., which Mr. Solomon may be deemed to beneficially own as described in Note 10, below. Mr. Solomon disclaims beneficial ownership of such shares except to the extent of his pecuniary interest therein. | |
(10) | Information taken solely from the Form 4 filed with the SEC on May 1, 2010 by Ramius LLC, C4S & Co LLC, Peter A. Cohen, Morgan B. Stark, Thomas W. Strauss, Jeffrey M. Solomon, Cowen Group, Inc. and RGC Holdings, LLC (collectively the Reporting Persons for purposes of this footnote 10). Based on the matters reported in such filing, as of May 1, 2010: |
| Ramius Value and Opportunity Master Fund Ltd. (Value and Opportunity Master Fund) is the beneficial owner of 965,199 shares. | ||
| Ramius PB, Ltd. is the beneficial owner of 794,514 shares. | ||
| Ramius Navigation Master Fund Ltd. is the beneficial owner of 335,244 shares. | ||
| RCG PB Ltd. (RCG PB), as the sole shareholder of Navigation Master Fund, may be deemed to beneficially own the common stock beneficially owned by Navigation Master Fund. |
Each Reporting Person (other than Ramius Enterprise Master Fund Ltd, Value and Opportunity Master Fund, Ramius Navigation Master Fund Ltd and RCG PB) disclaims beneficial ownership of the shares of common stock except to the extent of his or its pecuniary interest therein. | ||
As the sole member of Ramius Advisors, LLC (Ramius Advisors), the investment advisor of Ramius Enterprise Master Fund Ltd (Enterprise Master Fund), Ramius LLC (Ramius) may be deemed to beneficially own the shares of common stock beneficially owned by Enterprise Master Fund. As the sole member of Ramius, Cowen Group, Inc. (Cowen) may be deemed to beneficially own the shares of common stock beneficially owned by Enterprise Master Fund. As a significant shareholder of Cowen, RCG Holdings LLC (RCG Holdings) may be deemed to beneficially own the shares of common stock beneficially owned by Enterprise Master Fund. As the managing member of RCG Holdings, C4S, & Co., L.L.C. (C4S) may be deemed to beneficially own the shares of common stock beneficially owned by Enterprise Master Fund. As the managing members of C4S, each of Messrs. Cohen, Stark, Solomon and Strauss may be deemed to beneficially own the shares of common stock beneficially owned by Enterprise Master Fund. | ||
As the sole member of Ramius Advisors, the investment advisor of Ramius Navigation Master Fund Ltd (Navigation Master Fund), Ramius may be deemed to beneficially own the shares of common stock beneficially owned by Navigation Master Fund. As the sole member of Ramius, Cowen may be deemed to beneficially own the shares of common stock beneficially owned by Navigation Master Fund. As a significant shareholder of Cowen, RCG Holdings may be deemed to beneficially own the shares of common stock beneficially owned by Navigation Master Fund. As the managing member of RCG Holdings, C4S may be deemed to beneficially own the shares of common stock beneficially owned by Navigation Master Fund. As the |
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managing members of C4S each of Peter A. Cohen, Morgan B. Stark, Jeffrey M. Solomon and Thomas W. Strauss may be deemed to beneficially own the shares of common stock beneficially owned by Navigation Master Fund. | ||
As the sole member of RCG Starboard Advisors, LLC (RCG Starboard Advisors), the investment manager of Ramius Value and Opportunity Master Fund Ltd (Value and Opportunity Master Fund)., Ramius may be deemed to beneficially own the shares of common stock beneficially owned by Value and Opportunity Master Fund. As the sole member of Ramius, Cowen may be deemed to beneficially own the shares of common stock beneficially owned by Value and Opportunity Master Fund. As a significant shareholder of Cowen, RCG Holdings may be deemed to beneficially own the shares of common stock beneficially owned by Value and Opportunity Master Fund. As the managing member of RCG Holdings, C4S may be deemed to beneficially own the shares of common stock beneficially owned by Value and Opportunity Master Fund. As the managing members of C4S, each of Messrs. Cohen, Stark, Solomon and Strauss may be deemed to beneficially own the shares of common stock beneficially owned by Value and Opportunity Master Fund. | ||
As the sole member of Ramius Advisors, the investment advisor of RCG PB, Ramius may be deemed to beneficially own the shares of common stock beneficially owned by RCG PB. As the sole member of Ramius, Cowen may be deemed to beneficially own the shares of common stock beneficially owned by RCG PB. As the majority shareholder of Cowen, RCG Holdings may be deemed to beneficially own the shares of common stock beneficially owned by RCG PB. As the managing member of RCG Holdings, C4S may be deemed to beneficially own the shares of common stock beneficially owned by RCG PB. As the managing members of C4S, each of Messrs. Cohen, Stark, Solomon and Strauss may be deemed to beneficially own the shares of common stock beneficially owned by RCG PB. | ||
(11) | Information taken solely from the Schedule 13D/A filed with the SEC on December 1, 2008 reflecting ownership of our common stock as of December 1, 2008. The filing reflects that Bradford Capital Partners, BCP Investment LLC, Stephen J. Lynch and Joseph L. Calihan have shared voting and dispositive power over 1,547,053 shares. No more recent filings were available as of February 2011. | |
(12) | Information taken solely from the Schedule 13G/A filed on February 11, 2011 reflecting ownership of our common stock as of December 31, 2011. The filing indicates that Dimensional Fund Advisors LP, an investment adviser registered under Section 203 of the Investment Advisors Act of 1940, furnishes investment advice to four investment companies registered under the Investment Company Act of 1940, and serves as investment manager to certain other commingled group trusts and separate accounts (such investment companies, trusts and accounts, collectively referred to as the Funds). The filing reflects that Dimensional Fund Advisors LP has sole voting power over 1,057,376 shares and has sole power over 1,073,801 shares. In certain cases, subsidiaries of Dimensional Fund Advisors LP may act as an adviser or sub-adviser to certain Funds. In its role as investment advisor, sub-adviser and/or manager, neither Dimensional Fund Advisors LP or its subsidiaries (collectively, Dimensional) possess voting and/or investment power over the securities of the Issuer that are owned by the Funds, and may be deemed to be the beneficial owner of the shares of the Issuer held by the Funds. However, according to the filing, all securities reported are owned by the Funds. The filing indicates that Dimensional disclaims beneficial ownership of such securities and shall not be construed as an admission that the reporting person or any of its affiliates is the beneficial owner of any securities covered by this Schedule 13G for any other purposes than Section 13(d) of the Securities Exchange Act of 1934. | |
(13) | Information taken solely from the Schedule 13G/A filed with the SEC on January 25, 2011 reflecting ownership of our common stock as of December 31, 2010. The filing reflects that Royce & Associates, LLC has sole voting and dispositive power over 828,060 shares. Accordingly to the Schedule 13 G/A, the interests of one account, Royce Opportunity Fund, an investment company registered under the Investment Company Act of 1940 and managed by Royce & Associates, LLC amounted to 651,988 shares or 5.1% of the total shares outstanding. | |
(14) | Information taken solely from the Schedule 13G/A filed with the SEC on February 14, 2011 reflecting ownership of our common stock as of December 31, 2010. The filing indicates that it was filed pursuant to a joint filing agreement between Renaissance Technologies LLC (RTC), James H. Simons and Renaissance Technologies Holdings Corporation (RTHC). The filing reflects that each of RTC, in its capacity as investment advisor, and RTHC beneficially owns and has sole voting and dispositive power over 790,800 shares of our common stock. Certain funds and accounts managed by RTC have the right to receive dividends and proceeds from the sale of the securities covered by the filing. According to the filing, as of January 1, 2010, James H. Simons ceased to be the beneficial owner of any of these shares. | |
(15) | Information taken solely from the Schedule 13G filed with the SEC on February 14, 2011 reflecting ownership of our common stock as of December 31, 2010. The filing reflects that Wellington Management, in its capacity as investment adviser, may be deemed to beneficially own 666,200 of our shares or 5.21% which are held of record by clients of Wellington Management. According to the Schedule 13G, the securities are owned of record by clients of Wellington Management and those clients have the right to receive, or the power to direct the receipt of, dividends from, or the proceeds from the sale of, such securities. According to the Schedule 13G, no such client is known to have such right or power with respect to more than five percent of this class of securities other than Wellington Trust, which is disclosed in the Note below. | |
(16) | Information taken solely from the Schedule 13G filed with the SEC on February 14, 2011 reflecting ownership of our common stock as of December 31, 2010. The filing reflects that Wellington Trust, in its capacity as investment adviser, may be deemed |
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to beneficially own 666,200 of our shares or 5.21% which are held of record by clients of Wellington Trust. According to the Schedule 13G, the securities are owned of record by clients of Wellington Trust and those clients have the right to receive, or the power to direct the receipt of, dividends from, or the proceeds from the sale of, such securities. According to the Schedule 13G, no such client is known to have such right or power with respect to more than five percent of this class of securities. |
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information about the Companys Common Stock that may be issued upon
the exercise of options outstanding under its equity compensation plans and the number of
securities remaining available for future issuance under its equity compensation plans as of
December 31, 2010.
No. of securities remaining available for |
||||||||||||
future issuance under | ||||||||||||
No. of securities | equity compensation | |||||||||||
to be issued upon | plans (excluding | |||||||||||
exercise of | Weighted average | securities to be issued | ||||||||||
outstanding | exercise price of | upon exercise of | ||||||||||
options | outstanding options | outstanding options | ||||||||||
Equity compensation plans approved by security
holders |
||||||||||||
1995 Long-Term Incentive Compensation Plan (1) |
142,382 | $ | 14.99 | | ||||||||
2006 Long-Term Incentive Compensation Plan |
1,117,277 | $ | 6.33 | 1,306,787 | ||||||||
Equity compensation plans not approved by security
holders |
||||||||||||
1998 Employee Incentive Compensation Plan (1) |
53,333 | $ | 24.96 | | ||||||||
Total: |
1,312,992 | 1,306,787 |
(1) | No further grants may be made under these plans. |
See Note 2 to the consolidated financial statements for additional information regarding the
Companys equity compensation plans
Item 13. | Certain Relationships and Related Transactions, and Director Independence |
Related Party Transaction Policy
On January 23, 2007, the Board of Directors approved a Statement of Policy with Respect to
Related Party Transactions, a copy of which is available on our
website at www.tollgrade.com. The
policy sets forth our procedures with respect to the monitoring, review, approval and ratification
of related party transactions (as defined in the policy).
Tollgrade recognizes that related party transactions can present potential or actual conflicts
of interest and may raise questions about whether those transactions are consistent with the best
interests of Tollgrade and its shareholders. As a general matter, it is our policy to avoid or
minimize related party transactions; however, we recognize that there are situations where related
party transactions may be consistent with the best interests of Tollgrade and its shareholders.
The definition of related party transaction excludes transactions available to all employees
generally, transactions involving less than $5,000 when aggregated with all similar transactions,
or the related partys interest arises solely from the ownership of our common stock and the
holders of our common stock receive the same benefit on a pro-rata basis (i.e. dividends).
Pursuant to this policy, the Board of Directors determined that the Audit Committee of the
Board is best suited to monitor, review, approve and/or ratify related party transactions.
Accordingly, at each calendar years first regularly scheduled Audit Committee meeting, management
will disclose and make a recommendation with respect to any proposed related party transactions for
that calendar year, if any, including the proposed aggregate value of such transactions, if
applicable. After its review, the Audit Committee will approve or disapprove the related party
transactions and, at each subsequently scheduled meeting, management will update the Audit
Committee as to any material change to those proposed transactions.
In the event management recommends any further related party transactions after the first
calendar year meeting, the transactions may be presented to the Audit Committee for approval or
preliminarily entered into by management subject to ratification by the Audit Committee. If ratification does not occur, management must make all reasonable
efforts to cancel or rescind the
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transaction. If a related party transaction is ongoing or
completed and it is disapproved by the Audit Committee, the Audit Committee will consider the
impact on any directors independence and evaluate the circumstances of the transaction to
determine if termination, rescission, disciplinary action or changes to this policy are
appropriate.
The Audit Committee will consider the relevant facts and circumstances of the transaction
including (if applicable) but not limited to: (i) the benefits to Tollgrade, (ii) the impact on any
directors independence, (iii) the availability of other sources for comparable products or
services, (iv) the terms of the transaction, (v) the terms available to unrelated third parties or
to employees generally, and (vi) whether the potential transaction is consistent with the Code of
Ethics and Code of Business Conduct. The Audit Committee is authorized to approve those related
party transactions that are in or are not inconsistent with the best interests of Tollgrade and its
shareholders and that are consistent with the Code of Ethics and Code of Business Conduct. Other
related party transactions should be disapproved by the Audit Committee and should not be entered
into.
No director may participate in any review, discussion or approval of a related party
transaction for which he or she is a related party, except that the director must provide all
material information concerning the related party transaction to the Audit Committee.
If a related party transaction will be ongoing, the Audit Committee may establish guidelines
for our management to follow in its ongoing dealings with the related party. Thereafter, the Audit
Committee, on at least an annual basis, shall review and assess ongoing relationships with the
related party to determine whether they are in compliance with the Audit Committees guidelines and
that the transaction remains appropriate.
Related Party Transactions
Tollgrade did not enter into any related party transactions in 2010 and no related party
transactions are currently proposed.
Director Independence
The Board has determined that each of our non-employee directors, and each member of the
Boards Audit, Compensation and Corporate Governance Committees, is an independent director under
the applicable Nasdaq listing standards, as well as the stricter standard for independence adopted
by the Board in the Boards Guidelines on Corporate Governance Matters.
Item 14. | Principal Accounting Fees and Services |
For the year ended December 31, 2010, our independent registered public accounting firm was
Deloitte & Touche LLP (Deloitte). For the year ended December 31, 2009, our independent
registered public accounting firm was PricewaterhouseCoopers LLP (PwC). The table below reflects
the fees and expenses for services rendered by PwC for the year ended December 31, 2009, and the
fees and expenses for services rendered by Deloitte for the year ended December 31, 2010.
Applicable Fees | Year ended December 31, 2009 | Year ended December 31, 2010 | ||||||
Audit Fees |
$ | 598,585 | $ | 327,600 | ||||
Audit-Related Fees |
57,800 | | ||||||
Tax Fees |
13,998 | 154,553 | ||||||
All Other Fees |
207,000 | 40,271 | ||||||
Total Fees |
$ | 877,383 | $ | 522,424 |
Audit Fees consisted of fees and expenses for professional services rendered by PwC for the
year ended December 31, 2009, and by Deloitte for the year ended December 31, 2010, for (a) the
audits of our annual consolidated financial statements and internal control over financial
reporting, (b) the reviews of the unaudited condensed consolidated financial statements included in
our quarterly reports on Form 10-Q during such year, and (c) in each case other services normally
provided in connection with regulatory filings.
Audit-Related Fees for the year ended December 31, 2009 consisted of fees and expenses for
audit-related services rendered by PwC for the year ended December 31, 2009 in connection with our
acquisition of certain assets in connection with a managed services contract in April 2009, and our
disposition of the assets related to our cable product line in May 2009.
Tax Fees consisted of fees and expenses for professional services rendered to us for tax
compliance, tax advice and tax planning by PwC for the year ended December 31, 2009 and by Deloitte
for the year ended December 31, 2010.
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All Other Fees for the year ended December 31, 2009 consisted of fees and expenses of
PwC, which were associated with due diligence efforts related to a potential transaction that we
ultimately determined not to pursue.
Since May 2003, the Audit Committee has required that all non-audit services to be performed
by outside independent registered public accounting firms be approved in advance by the Audit
Committee, and in October 2003, the Audit Committee Charter was amended to that effect. All audit
and non-audit services provided by PwC in 2009 and by Deloitte in 2010 were approved in advance by
the Audit Committee, and no fees were paid to PwC or to Deloitte under a de minimus exception that
waives pre-approval for certain non-audit services.
PART IV
Item 15. Exhibits and Financial Statement Schedules.
(a) The following documents have been filed as part of this report or, where noted, incorporated
by reference:
(1) | Financial Statements | ||
The financial statements of the Company are listed in the Index to Consolidated Financial Statements | |||
(2) | Financial Statement Schedule | ||
The financial statement schedule filed in response to Item 8 and Item 15(d) of Form 10-K, Schedule II (Valuation and Qualifying Accounts), is listed in the Index to Consolidated Financial Statements | |||
(3) | The following exhibits are included herewith and made a part hereof: |
Exhibit | ||
Number | Description | |
2.1
|
Agreement and Plan of Merger, dated as of February 21, 2011, by and among Talon Merger Sub, Inc., a Pennsylvania corporation, Talon Holdings, Inc., a Delaware corporation, and Tollgrade Communications, Inc., a Pennsylvania corporation, incorporated by reference to Exhibit 2.1 to the Companys Report on Form 8-K, filed with the SEC on February 25, 2011 | |
3.1
|
Amended and Restated Articles of Incorporation of the Company (the Articles) as amended through May 6, 1998 (conformed copy), incorporated herein by reference to Exhibit 3.1 to the Annual Report of Tollgrade Communications, Inc. (the Company) on Form 10-K, filed with the Securities and Exchange Commission (the SEC) on March 24, 1999 (the 1998 10-K) | |
3.1a
|
Statement with Respect to Shares dated July 23, 1996 (conformed copy), incorporated herein by reference to Exhibit 3.1a to the 1998 10-K | |
3.1b
|
Amendment to Articles incorporated herein by reference, filed on the Companys Report on Form 8-K filed with the SEC on May 21, 2007 | |
3.2
|
Amended and Restated Bylaws of the Company filed as Exhibit 3.2 to the Companys Report on Form 8-K filed with the SEC on May 21, 2007 | |
10.1
|
Lease and License for Alterations dated October 18, 2007 among Tollgrade UK Limited, Tollgrade Communications, Inc., Bedell Corporate Trustees Limited and Atrium Trustees (as Trustees of the Park One Unit Trust), filed as Exhibit 10.2 to the Companys Form 10-Q filed with the SEC on November 8, 2007 | |
10.2
|
Agreement dated November 27, 2006 by and between Knightsbridge Realty L.L.C. and Tollgrade Communications, Inc., filed as Exhibit 10.1 to the Companys Report on Form 8-K filed with the SEC on November 30, 2006 | |
10.3
|
Lease Agreement, dated as of August 31, 2005, between Regional Industrial Development Corporation of Southwestern Pennsylvania and the Company, incorporated herein by reference to Exhibit 10.1 to the Companys Report on Form 8-K filed with the SEC on September 7, 2005 | |
10.4
|
Amendment of Lease, dated May 22, 2009, between the Regional Industrial Development Corporation of Southwestern Pennsylvania and Tollgrade Communications, Inc., filed as Exhibit 10.3 to the Quarterly Report on Form 10-Q filed with the SEC on August 6, 2009 |
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Exhibit | ||
Number | Description | |
10.5
|
Amendment of Lease, dated September 14, 2009, between the Regional Industrial Development Corporation of Southwestern Pennsylvania and Tollgrade Communications, Inc., filed as Exhibit 10.10 to the Companys Form 10-K filed with the SEC on March 10, 2010 (the 2009 10-K) | |
10.6
|
Lease Agreement dated October 13, 2010 between CBP 110 LP and Tollgrade Communications, Inc., filed herewith | |
10.7 *
|
1995 Long-Term Incentive Compensation Plan, amended and restated as of January 24, 2002, incorporated herein by reference to Exhibit B to the 2002 Proxy Statement of the Company, filed with the SEC on March 22, 2002 | |
10.8 *
|
Form of Stock Option Agreement for Non-Statutory Stock Options granted under the 1995 Long-Term Incentive Compensation Plan, incorporated herein by reference to Exhibit 10.2 to the Companys Form 10-Q, filed with the SEC on November 12, 1996 | |
10.9 *
|
Amendment dated December 13, 2007 to the 1995 Long-Term Incentive Compensation Plan, filed as Exhibit 10.40 to the Companys Form 10-K filed with the SEC on March 17, 2008 (the 2007 10-K) | |
10.10 *
|
1998 Employee Incentive Compensation Plan, amended and restated as of January 24, 2002, incorporated herein by reference to Exhibit 10.25 to the Companys Form 10-K, filed with the SEC on March 22, 2002 (the 2001 10-K) | |
10.11 *
|
Amendment dated December 13, 2007 to the 1998 Long-Term Incentive Compensation Plan, filed as Exhibit 10.41 to the 2007 10-K | |
10.12 *
|
Tollgrade Communications, Inc. 2006 Long-Term Incentive Compensation Plan as amended and restated as of August 5, 2009, filed as Exhibit 10.12 to the 2009 10-K | |
10.13 *
|
Form of Stock Option Agreement for Non-Statutory Stock Options granted under the 2006 Long-Term Incentive Compensation Plan, filed as Exhibit 10.1 to the Companys Form 10-Q filed with the SEC on October 27, 2006 | |
10.14 *
|
Form of Employee Restricted Share Agreement for restricted share grants pursuant to the 2006 Long-Term Incentive Compensation Plan, filed as Exhibit 10.37 to the Companys Form 10-K filed with the SEC on March 17, 2008 (the 2007 10-K) | |
10.15 *
|
Form of Director Restricted Share Agreement for restricted share grants pursuant to the 2006 Long-Term Incentive Compensation Plan, filed as Exhibit 10.38 to the 2007 10-K | |
10.16 *
|
Stock Appreciation Rights Agreement dated March 25, 2010 between the Company and Edward H. Kennedy, filed herewith | |
10.17 *
|
Management Incentive Compensation Plan, as amended, filed as Exhibit 10.1 to the Companys Form 10-Q filed with the SEC on April 27, 2007 | |
10.18 *
|
Amendment dated December 13, 2007 to the Management Incentive Compensation Plan, filed as Exhibit 10.39 to the 2007 10-K | |
10.19 *
|
Appendix I to Management Incentive Compensation Plan for 2010 Award Year, adopted February 19, 2010, filed as Exhibit 10.1 to the Companys Form 10-Q filed with the SEC on May 6, 2010 | |
10.20 *
|
Severance Policy, filed as Exhibit 10.1 to the Report on Form 8-K filed with the SEC on January 31, 2008 | |
10.21 *
|
Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Joe OBrien, filed as Exhibit 10.3 to the March 19, 2009 8-K | |
10.22 *
|
Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Robert King, filed as Exhibit 10.4 to the March 19, 2009 8-K | |
10.23 *
|
Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and David L. Blakeney, filed as Exhibit 10.6 to the March 19, 2009 8-K | |
10.24 *
|
Form of Amendment to Severance Agreement dated December 15, 2010 in effect between the Company and each of David L. Blakeney, Robert H. King and Joseph G. OBrien, filed herewith | |
10.25 *
|
Summary of 2010 Commission Program for Robert H. King, as described in the Report on Form 8-K filed with the SEC on April 30, 2010 |
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Exhibit | ||
Number | Description | |
10.26*
|
Summary of 2011 Commission Program for Robert H. King, filed herewith | |
10.27*
|
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 Report on Form 8-K, filed with the SEC on September 29, 2010 | |
10.28*
|
Amendment dated February 20, 2011 to the Agreement dated September 23, 2010 by and between the Company and Edward H. Kennedy, incorporated by reference to Exhibit 10.2 of the Companys Report on Form 8-K, filed with the SEC on February 25, 2011 | |
10.29*
|
Agreement dated March 12, 2010 between Tollgrade Communications, Inc. and Michael D. Bornak, filed as Exhibit 10.1 to the Companys Report on Form 8-K, filed with the SEC on March 24, 2010 | |
10.30*
|
Agreement dated March 12, 2010 between Tollgrade Communications, Inc. and Jennifer M. Reinke, filed herewith | |
10.31*
|
Agreement dated June 21, 2010 between Tollgrade Communications, Inc. and Gregory M. Nulty, filed herewith | |
10.32*
|
Form of Amendment dated December 15, 2010 to Agreement in effect between the Company and each of Michael D. Bornak, Gregory M. Nulty and Jennifer M. Reinke, filed herewith | |
10.33*
|
Amendment dated February 20, 2011 to Agreement in effect between the Company and Michael D. Bornak, incorporated by reference to Exhibit 10.1 of the Companys Report on Form 8-K, filed with the SEC on February 25, 2011 | |
10.34*
|
Amendment dated February 20, 2011 to Agreement in effect between the Company and Gregory M. Nulty, filed herewith | |
10.35*
|
Amendment dated February 20, 2011 to Agreement in effect between the Company and Jennifer M. Reinke, filed herewith | |
10.36*
|
Separation and Mutual Release Agreement, dated June 18, 2010, between Tollgrade Communications, Inc. and Joseph A. Ferrara, filed as Exhibit 10.2 to the Companys Form 10-Q filed with the SEC on August 3, 2010 | |
10.37*
|
Severance Agreement, dated December 7, 2010, between the Company and Thomas J. Kolb, filed herewith | |
21.1
|
List of subsidiaries of the Company, filed as Exhibit 21.1 to the 2007 Form 10-K | |
23.1
|
Consent of Deloitte & Touche LLP, filed herewith | |
23.2
|
Consent of PricewaterhouseCoopers LLP, filed herewith | |
31.1
|
Certification of Chief Executive Officer, filed herewith | |
31.2
|
Certification of Chief Financial Officer, filed herewith | |
32
|
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 350, filed herewith |
* | Management contract or compensatory plan, contract or arrangement required to be filed by Item 601(b)(10)(iii) of Regulation S-K. | |
Copies of the exhibits filed as part of this Form 10-K are available free of charge to any shareholder of record upon written request to the Secretary, Tollgrade Communications, Inc., 3120 Unionville Road, Suite 400, Cranberry Twp., PA 16066. | ||
LoopCare is a trademark of Tollgrade Communications, Inc. | ||
N(x)Test is a trademark of Tollgrade Communications, Inc. | ||
LTSC is a trademark of Tollgrade Communications, Inc. | ||
®Tollgrade is a registered trademark of Tollgrade Communications, Inc. | ||
®DigiTest is a registered trademark of Tollgrade Communications, Inc. | ||
®ICE is a registered trademark of Tollgrade Communications, Inc. | ||
®LightHouse is a registered trademark of Tollgrade Communications, Inc. | ||
®EDGE is a registered trademark of Tollgrade Communications, Inc. | ||
®MCU is a registered trademark of Tollgrade Communications, Inc. | ||
®4TEL is a registered trademark of Tollgrade Communications, Inc. | ||
®Celerity is a registered trademark of Tollgrade Communications, Inc. | ||
All other trademarks are the property of their respective owners. |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized as of March 10, 2011.
TOLLGRADE COMMUNICATIONS, INC. |
||||
By | /s/ Edward H. Kennedy | |||
Edward H. Kennedy | ||||
Chief Executive Officer and President | ||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the Company and in the capacities indicated as of March
10, 2011.
Signature | Title | |
/s/ Edward H. Kennedy
|
Chairman, Chief Executive Officer and President (Principal Executive Officer) |
|
/s/ Scott C. Chandler
|
Director | |
/s/ Richard H. Heibel
|
Director | |
/s/ Charles E. Hoffman
|
Director | |
/s/ Robert W. Kampmeinert
|
Director | |
/s/ Edward B. Meyercord
|
Director | |
/s/ Jeffrey M. Solomon
|
Director | |
/s/ Michael D. Bornak
|
Chief Financial Officer and Treasurer (Principal Financial Officer) |
|
/s/ Mark C. Lang
|
Corporate Controller (Principal Accounting Officer) |
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EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
(Pursuant to Item 601 of Regulation S-K)
Exhibit | ||
Number | Description | |
2.1
|
Agreement and Plan of Merger, dated as of February 21, 2011, by and among Talon Merger Sub, Inc., a Pennsylvania corporation, Talon Holdings, Inc., a Delaware corporation, and Tollgrade Communications, Inc., a Pennsylvania corporation, incorporated by reference to Exhibit 2.1 to the Companys Report on Form 8-K, filed with the SEC on February 25, 2011 | |
3.1
|
Amended and Restated Articles of Incorporation of the Company (the Articles) as amended through May 6, 1998 (conformed copy), incorporated herein by reference to Exhibit 3.1 to the Annual Report of Tollgrade Communications, Inc. (the Company) on Form 10-K, filed with the Securities and Exchange Commission (the SEC) on March 24, 1999 (the 1998 10-K) | |
3.1a
|
Statement with Respect to Shares dated July 23, 1996 (conformed copy), incorporated herein by reference to Exhibit 3.1a to the 1998 10-K | |
3.1b
|
Amendment to Articles incorporated herein by reference, filed on the Companys Report on Form 8-K filed with the SEC on May 21, 2007 | |
3.2
|
Amended and Restated Bylaws of the Company filed as Exhibit 3.2 to the Companys Report on Form 8-K filed with the SEC on May 21, 2007 | |
10.1
|
Lease and License for Alterations dated October 18, 2007 among Tollgrade UK Limited, Tollgrade Communications, Inc., Bedell Corporate Trustees Limited and Atrium Trustees (as Trustees of the Park One Unit Trust), filed as Exhibit 10.2 to the Companys Form 10-Q filed with the SEC on November 8, 2007 | |
10.2
|
Agreement dated November 27, 2006 by and between Knightsbridge Realty L.L.C. and Tollgrade Communications, Inc., filed as Exhibit 10.1 to the Companys Report on Form 8-K filed with the SEC on November 30, 2006 | |
10.3
|
Lease Agreement, dated as of August 31, 2005, between Regional Industrial Development Corporation of Southwestern Pennsylvania and the Company, incorporated herein by reference to Exhibit 10.1 to the Companys Report on Form 8-K filed with the SEC on September 7, 2005 | |
10.4
|
Amendment of Lease, dated May 22, 2009, between the Regional Industrial Development Corporation of Southwestern Pennsylvania and Tollgrade Communications, Inc., filed as Exhibit 10.3 to the Quarterly Report on Form 10-Q filed with the SEC on August 6, 2009 | |
10.5
|
Amendment of Lease, dated September 14, 2009, between the Regional Industrial Development Corporation of Southwestern Pennsylvania and Tollgrade Communications, Inc., filed as Exhibit 10.10 to the Companys Form 10-K filed with the SEC on March 10, 2010 (the 2009 10-K) | |
10.6
|
Lease Agreement dated October 13, 2010 between CBP 110 LP and Tollgrade Communications, Inc., filed herewith | |
10.7
|
1995 Long-Term Incentive Compensation Plan, amended and restated as of January 24, 2002, incorporated herein by reference to Exhibit B to the 2002 Proxy Statement of the Company, filed with the SEC on March 22, 2002 | |
10.8
|
Form of Stock Option Agreement for Non-Statutory Stock Options granted under the 1995 Long-Term Incentive Compensation Plan, incorporated herein by reference to Exhibit 10.2 to the Companys Form 10-Q, filed with the SEC on November 12, 1996. | |
10.9
|
Amendment dated December 13, 2007 to the 1995 Long-Term Incentive Compensation Plan, filed as Exhibit 10.40 to the Companys Form 10-K filed with the SEC on March 17, 2008 (the 2007 10-K) | |
10.10
|
1998 Employee Incentive Compensation Plan, amended and restated as of January 24, 2002, incorporated herein by reference to Exhibit 10.25 to the Companys Form 10-K, filed with the SEC on March 22, 2002 (the 2001 10-K) | |
10.11
|
Amendment dated December 13, 2007 to the 1998 Long-Term Incentive Compensation Plan, filed as Exhibit 10.41 to the 2007 10-K |
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Exhibit | ||
Number | Description | |
10.12
|
Tollgrade Communications, Inc. 2006 Long-Term Incentive Compensation Plan as amended and restated as of August 5, 2009, filed as Exhibit 10.12 to the 2009 10-K | |
10.13
|
Form of Stock Option Agreement for Non-Statutory Stock Options granted under the 2006 Long-Term Incentive Compensation Plan, filed as Exhibit 10.1 to the Companys Form 10-Q filed with the SEC on October 27, 2006 | |
10.14
|
Form of Employee Restricted Share Agreement for restricted share grants pursuant to the 2006 Long-Term Incentive Compensation Plan, filed as Exhibit 10.37 to the Companys Form 10-K filed with the SEC on March 17, 2008 (the 2007 10-K) | |
10.15
|
Form of Director Restricted Share Agreement for restricted share grants pursuant to the 2006 Long-Term Incentive Compensation Plan, filed as Exhibit 10.38 to the 2007 10-K | |
10.16
|
Stock Appreciation Rights Agreement dated March 25, 2010 between the Company and Edward H. Kennedy, filed herewith | |
10.17
|
Management Incentive Compensation Plan, as amended, filed as Exhibit 10.1 to the Companys Form 10-Q filed with the SEC on April 27, 2007 | |
10.18
|
Amendment dated December 13, 2007 to the Management Incentive Compensation Plan, filed as Exhibit 10.39 to the 2007 Form 10-K | |
10.19
|
Appendix I to Management Incentive Compensation Plan for 2010 Award Year, adopted February 19, 2010, filed as Exhibit 10.1 to the Companys Form 10-Q filed with the SEC on May 6, 2010 | |
10.20
|
Severance Policy, filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on January 31, 2008 | |
10.21
|
Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Joe OBrien, filed as Exhibit 10.3 to the March 19, 2009 8-K | |
10.22
|
Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and Robert King, filed as Exhibit 10.4 to the March 19, 2009 8-K | |
10.23
|
Severance Agreement dated March 17, 2009 between Tollgrade Communications, Inc. and David L. Blakeney, filed as Exhibit 10.6 to the March 19, 2009 8-K | |
10.24
|
Form of Amendment to Severance Agreement dated December 15, 2010 in effect between the Company and each of David L. Blakeney, Robert H. King and Joseph G. OBrien, filed herewith | |
10.25
|
Summary of 2010 Commission Program for Robert H. King, as described in the Report on Form 8-K filed with the SEC on April 30, 2010 | |
10.26
|
Summary of 2011 Commission Program for Robert H. King, filed herewith | |
10.27
|
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 Report on Form 8-K, filed with the SEC on September 29, 2010 | |
10.28
|
Amendment dated February 20, 2011 to the Agreement dated September 23, 2010 by and between the Company and Edward H. Kennedy, incorporated by reference to Exhibit 10.2 of the Companys Report on Form 8-K, filed with the SEC on February 25, 2011 | |
10.29
|
Agreement dated March 12, 2010 between Tollgrade Communications, Inc. and Michael D. Bornak, filed as Exhibit 10.1 to the Companys Report on Form 8-K, filed with the SEC on March 24, 2010 | |
10.30
|
Agreement dated March 12, 2010 between Tollgrade Communications, Inc. and Jennifer M. Reinke, filed herewith | |
10.31
|
Agreement dated June 21, 2010 between Tollgrade Communications, Inc. and Gregory M. Nulty, filed herewith | |
10.32
|
Form of Amendment dated December 15, 2010 to Agreement in effect between the Company and each of Michael D. Bornak, Gregory M. Nulty and Jennifer M. Reinke, filed herewith | |
10.33
|
Amendment dated February 20, 2011 to Agreement in effect between the Company and Michael D. Bornak, incorporated by reference to Exhibit 10.1 of the Companys Report on Form 8-K, filed with the SEC on February 25, 2011 |
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Exhibit | ||
Number | Description | |
10.34
|
Amendment dated February 20, 2011 to Agreement in effect between the Company and Gregory M. Nulty, filed herewith | |
10.35
|
Amendment dated February 20, 2011 to Agreement in effect between the Company and Jennifer M. Reinke, filed herewith | |
10.36
|
Separation and Mutual Release Agreement, dated June 18, 2010, between Tollgrade Communications, Inc. and Joseph A. Ferrara, filed as Exhibit 10.2 to the Companys Form 10-Q filed with the SEC on August 3, 2010 | |
10.37
|
Severance Agreement, dated December 7, 2010, between the Company and Thomas J. Kolb, filed herewith | |
21.1
|
List of subsidiaries of the Company, filed as Exhibit 21.1 to the 2007 Form 10-K | |
23.1
|
Consent of Deloitte & Touche LLP, filed herewith | |
23.2
|
Consent of PricewaterhouseCoopers LLP, filed herewith | |
31.1
|
Certification of Chief Executive Officer, filed herewith | |
31.2
|
Certification of Chief Financial Officer, filed herewith | |
32
|
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 350, filed herewith |
92