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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
-------------------------------
FORM 10-Q
(Mark One)
[ X ] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended June 28, 2003
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ___________ to ____________
Commission file number 0-27312
TOLLGRADE COMMUNICATIONS, INC.
(Exact Name of Registrant as Specified in its Charter)
PENNSYLVANIA 25-1537134
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification Number)
493 NIXON RD.
CHESWICK, PA 15024
(Address of Principal Executive Offices, including zip code)
412-820-1400
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the Registrant is an accelerated filer
(as defined by Rule 12b-2 of the Exchange Act).
Yes X No
--- ---
As of July 31, 2003, there were 13,574,770 shares of the Registrant's
Common Stock, $0.20 par value per share, and no shares of the Registrant's
Preferred Stock, $1.00 par value per share, outstanding.
This report consists of a total of 38 pages. The exhibit index is on page 34.
1
TOLLGRADE COMMUNICATIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 28, 2003
TABLE OF CONTENTS
PAGE NO.
-------
PART I. FINANCIAL INFORMATION
ITEM 1 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED):
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF JUNE 28, 2003 AND
DECEMBER 31, 2002 .........................................................................3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE-MONTH AND SIX-
MONTH PERIODS ENDED JUNE 28, 2003 AND JUNE 29, 2002........................................4
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY FOR
THE THREE-MONTH AND SIX-MONTH PERIODS ENDED JUNE 28, 2003 AND JUNE 29, 2002................5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX-MONTH PERIOD
ENDED JUNE 28, 2003 AND JUNE 29, 2002......................................................6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.......................................7
REPORT OF INDEPENDENT ACCOUNTANTS.........................................................16
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.......................................................................17
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................................30
ITEM 4 CONTROLS AND PROCEDURES...................................................................30
PART II. OTHER INFORMATION
ITEM 5 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......................................31
ITEM 6 EXHIBITS AND REPORTS FILED ON FORM 8-K....................................................31
SIGNATURES.........................................................................................33
EXHIBIT INDEX......................................................................................34
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
JUNE 28, 2003 DECEMBER 31, 2002*
- ------------------------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 28,059,870 $ 33,799,284
Short-term investments 14,181,226 19,328,883
Accounts receivable:
Trade 10,838,281 7,946,276
Other 90,416 152,290
Inventories 13,762,464 14,092,596
Prepaid expenses and other current assets 1,220,056 1,529,968
Refundable income taxes 261,115 637,156
Deferred tax assets 1,672,381 1,404,122
- ------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 70,085,809 78,890,575
Property and equipment, net 8,625,894 7,438,870
Deferred tax assets 3,356,252 2,769,573
Intangibles 44,500,000 38,500,000
Goodwill 20,240,088 16,161,763
Capitalized software costs, net 8,607,096 5,539,002
Other assets 344,096 242,115
============================================================================================================
TOTAL ASSETS $ 155,759,235 $ 149,541,898
============================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,194,892 $ 499,642
Accrued warranty 3,123,011 1,980,520
Accrued expenses 1,531,532 748,576
Accrued salaries and wages 684,319 543,339
Accrued royalties payable 412,102 322,380
Income taxes payable 1,367,576 1,141,293
Deferred income 1,348,582 465,887
- ------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 9,662,014 5,701,637
Deferred tax liabilities 2,228,535 1,484,247
- ------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 11,890,549 7,185,884
Commitments and contingent liabilities -- --
Shareholders' equity:
Common stock, $.20 par value; authorized shares,
50,000,000; issued shares, 13,552,736 in 2002 and
13,574,603 in 2003 2,714,921 2,710,547
Additional paid-in capital 70,737,653 70,489,025
Treasury stock, at cost, 461,800 shares (4,790,783) (4,790,783)
Retained earnings 75,206,895 73,947,225
- ------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 143,868,686 142,356,014
============================================================================================================
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 155,759,235 $ 149,541,898
============================================================================================================
* Amounts derived from audited financial statements
The accompanying notes are an integral part of the
condensed consolidated financial statements.
3
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------------------- ---------------------------------
JUNE 28, 2003 JUNE 29, 2002 JUNE 28, 2003 JUNE 29, 2002
- -----------------------------------------------------------------------------------------------------------------------------
REVENUES:
Products $13,914,800 $12,017,279 $25,485,901 $26,946,658
Services 3,218,747 2,566,631 6,191,069 5,159,526
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES: 17,133,547 14,583,910 31,676,970 32,106,184
- -----------------------------------------------------------------------------------------------------------------------------
COST OF PRODUCT SALES:
Products 6,232,192 4,880,385 11,524,320 10,942,729
Services 976,477 889,342 1,766,047 1,844,216
Amortization of intangibles 510,306 365,040 1,402,884 730,080
- -----------------------------------------------------------------------------------------------------------------------------
7,718,975 6,134,767 14,693,251 13,517,025
- -----------------------------------------------------------------------------------------------------------------------------
GROSS PROFIT: 9,414,572 8,449,143 16,983,719 18,589,159
- -----------------------------------------------------------------------------------------------------------------------------
Selling and marketing 2,420,786 2,224,833 4,391,440 4,642,142
General and administrative 1,828,262 1,268,594 3,565,265 2,794,845
Research and development 3,906,563 3,396,069 7,227,781 7,390,710
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 8,155,611 6,889,496 15,184,486 14,827,697
- -----------------------------------------------------------------------------------------------------------------------------
INCOME FROM OPERATIONS 1,258,961 1,559,647 1,799,233 3,761,462
Interest and other income, net 85,071 200,000 232,493 437,999
- -----------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 1,344,032 1,759,647 2,031,726 4,199,461
Provision for income taxes 510,732 668,794 772,056 1,595,794
=============================================================================================================================
NET INCOME $ 833,300 $ 1,090,853 $ 1,259,670 $ 2,603,667
=============================================================================================================================
EARNINGS PER SHARE INFORMATION:
Weighted average shares of common stock and equivalents:
Basic 13,103,801 13,088,748 13,097,319 13,099,106
Diluted 13,335,006 13,339,053 13,276,042 13,386,081
- -----------------------------------------------------------------------------------------------------------------------------
Net income per common and common equivalent shares:
Basic $ .06 $ .08 $ .10 $ .20
Diluted $ .06 $ .08 $ .09 $ .19
=============================================================================================================================
The accompanying notes are an integral part of the
condensed consolidated financial statements.
4
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 28, 2003
(Unaudited)
ADDITIONAL
PREFERRED COMMON STOCK PAID-IN TREASURY RETAINED
SHARES AMOUNT SHARES AMOUNT CAPITAL STOCK EARNINGS TOTAL
- ----------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 2002 ---- $ ---- 13,552,736 $2,710,547 $70,489,025 $(4,790,783) 73,947,225 $142,356,014
Exercise of common
Stock options ---- ---- 21,867 4,374 193,428 ---- ---- 197,802
Tax benefit from
exercise of stock
options ---- ---- ---- ---- 55,200 ---- ---- 55,200
Net Income ---- ---- ---- ---- ---- ---- 1,259,670 1,259,670
- ----------------------------------------------------------------------------------------------------------------------------
Balance at
June 28, 2003 ---- $ ---- 13,574,603 $2,714,921 $70,737,653 $(4,790,783) 75,206,895 $143,868,686
- ----------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the condensed
consolidated financial statements.
5
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 28, 2003 June 29, 2002
==============================================================================================================================
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,259,670 $ 2,603,667
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 2,542,747 1,878,709
Tax benefit from exercise of stock options 55,200 113,769
Refund and utilization of income taxes paid 376,041 809,667
Deferred income taxes 130,175 214,146
Provision for losses on inventory 180,599 1,318,795
Disposition of slow moving and obsolete inventory (278,432) (446,795)
Provision for allowance for doubtful accounts 343,000 --
Changes in assets and liabilities:
Increase in accounts receivable-trade (3,235,005) (1,707,830)
Decrease in accounts receivable-other 61,874 181,915
Decrease in inventory 1,588,083 1,786,622
Decrease in prepaid expenses and other assets 290,798 82,226
Increase (decrease) in accounts payable 695,251 (537,309)
Increase in accrued warranty 524,991 206,778
Increase in accrued expenses and deferred income 875,563 459,629
Increase (decrease) in accrued salaries and wages 140,980 (27,095)
Increase (decrease) in accrued royalties payable 89,722 (104,110)
Increase in income taxes payable 226,283 153,299
- ------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 5,867,540 6,986,083
- ------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Cheetah (15,108,510) --
Redemption/maturity of investments 6,025,734 4,332,386
Purchase of investments (878,077) (4,557,015)
Capital expenditures (1,843,903) (1,405,757)
Investments in other assets -- (51,523)
- ------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (11,804,756) (1,681,909)
- ------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of treasury stock -- (1,625,808)
Proceeds from exercise of stock options 197,802 278,175
- ------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing activities 197,802 (1,347,633)
- ------------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (5,739,414) 3,956,541
Cash and cash equivalents at beginning of period 33,799,284 32,105,845
- ------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 28,059,870 $ 36,062,386
==============================================================================================================================
The accompanying notes are an integral part of the
condensed consolidated financial statements.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements included
herein have been prepared by Tollgrade Communications, Inc. (the "Company") in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and Article 10 of Regulation S-X. The
condensed consolidated financial statements as of and for the three-month and
six-month periods ended June 28, 2003 should be read in conjunction with the
Company's consolidated financial statements (and notes thereto) included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2002.
Accordingly, the accompanying condensed consolidated financial statements do not
include all of the information and footnotes required by accounting principles
generally accepted in the United States of America for complete financial
statements, although the Company believes that the disclosures are adequate to
make the information presented not misleading. In the opinion of Company
management, all adjustments considered necessary for a fair presentation of the
accompanying condensed consolidated financial statements have been included, and
all adjustments are of a normal and recurring nature. Operating results for the
three-month and six-month periods ended June 28, 2003 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2003.
2. ACQUISITION AND INTANGIBLE ASSETS
On February 13, 2003, the Company acquired certain assets and assumed certain
liabilities of the Cheetah(TM) Status and Performance Monitoring Product Line
Business ("Cheetah") from Acterna, LLC for approximately $14,300,000 in cash.
The Company also incurred acquisition-related costs of approximately $809,000
for a total estimated cost of approximately $15,109,000. In addition, as part of
the acquisition, contingent purchase consideration of up to $2,400,000 in the
form of an earn-out may be payable based on certain 2003 performance targets for
the acquired business. The acquired assets consist principally of existing sales
order backlog, product inventory, intellectual property, software and related
computer equipment, while the assumed liabilities principally relate to deferred
software maintenance, warranty and other obligations. The $14,300,000 due at
closing and related acquisition expenses were paid from available cash and
short-term investments. The acquisition was recorded under the purchase method
of accounting and accordingly, the results of operations of the acquired
business from February 14, 2003 forward are included in the consolidated
financial statements of the Company.
The Company has made a preliminary allocation of the purchase price to the fair
value of assets acquired and liabilities assumed. The allocation is subject to
change based upon continuing review and determinations. Further, the purchase
price may change due to the earn-out and other provisions in the purchase
agreement, which would require further adjustment to the allocation of purchase
price. Such adjustments may be material.
The following summarizes the estimated, current evaluation of the fair values at
the date of acquisition:
7
Inventories $ 1,160,000
Property and Equipment, net 537,000
Deferred Tax Assets 241,000
Intangible Assets:
Customer Base $ 5,000,000
Cheetah Trademark 1,000,000
Base Software 2,900,000
Proprietary Technology 1,000,000
Sales Order Backlog 600,000 10,500,000
-------------
Goodwill 4,078,000
-----------------------------------------------------------------------------------------------------
Total Assets Acquired $ 16,516,000
-----------------------------------------------------------------------------------------------------
Deferred Income (625,000)
Other Liabilities (782,000)
-----------------------------------------------------------------------------------------------------
Total Liabilities Assumed $ (1,407,000)
-----------------------------------------------------------------------------------------------------
NET ASSETS ACQUIRED $ 15,109,000
-----------------------------------------------------------------------------------------------------
An independent valuation consultant assisted management in its initial
determination of fair value assigned to certain intangible assets other than
goodwill. Discounted future cash flow models were utilized where appropriate.
The Cheetah product line has maintained a significant market share in
cable status and performance monitoring equipment for more than 25 years and has
a large installed customer base, including many of the largest multiple system
cable operators. The Company expects that, on average, approximately 85% of
future revenues attributable to Cheetah products will be derived from this
customer base and, based on prior experience, does not anticipate turnover or
loss of these customers. Therefore, the Company has concluded that the customer
base and Cheetah trademark intangible assets have an indefinitely long life.
Consequently, in accordance with SFAS No. 142, "Goodwill and Other Intangible
Assets", the values assigned to customer base and the Cheetah trademark, as well
as to related goodwill, are not being amortized for financial reporting
purposes.
The Company believes that the base software will be used in future
releases of CheetahNet (TM) (formerly NetMentor(TM)) and other software products
with little change into the foreseeable future. Similarly, the proprietary
technology embedded in transponder hardware is expected to have a relatively
long useful life. Therefore, the Company has determined that the base software
and proprietary software have a remaining useful life of ten years and are being
amortized for financial reporting purposes over that period.
The Company obtained a backlog of customer purchase orders totaling
approximately $2,383,000 in connection with the Cheetah acquisition. Using a
discounted cash flow analysis, the Company determined an acquired value of
$600,000 for this backlog. This asset is being amortized as the related orders
are being realized as sales revenue. Amortization of approximately $517,000 was
recognized in cost of sales in the first six months of 2003 and it is expected
that the balance of $83,000, which is included in prepaid expenses and other
current assets, will be amortized in the third quarter of 2003.
For tax purposes, the Company is amortizing all intangible assets over
15 years.
SFAS No. 142 provides that entities evaluate the remaining useful lives
of intangible assets determined to have indefinite useful lives periodically to
determine whether events and circumstances continue to support an indefinite
useful life and that such assets be tested at least annually for impairment of
value. The
8
Company's policy is to test all intangible assets for impairment in value as
of December 31 of each year or more frequently if events or changes in
circumstances indicate that assets might be impaired.
The following condensed proforma results of operations reflect the
proforma combination of the Company and the acquired Cheetah product line as if
the combination occurred on January 1, 2002.
(In Thousands, Except Per Share Data)
------------------------------------------------------------------------------
Three Months Ended Six Months Ended
---------------------------------- -----------------------------------
Historical Proforma Proforma Proforma
June 28, 2003 June 29, 2002 June 28, 2003 June 29, 2002
------------- ------------- ------------- -------------
Revenues $17,134 $19,980 $33,040 $42,898
- ------------------------------------------------------------------------------------------------------------------
Income from operations 1,259 3,210 2,470 6,114
- ------------------------------------------------------------------------------------------------------------------
Net income 833 2,072 1,677 3,978
- ------------------------------------------------------------------------------------------------------------------
Diluted earnings per share $ 0.06 $ 0.16 $ 0.13 $ 0.30
- ------------------------------------------------------------------------------------------------------------------
The proforma results of operations for the six months ended June 28, 2003
include revenues of Acterna for the Cheetah product line through February 13,
2003, the date of acquisition. Revenues for 2002, cost of sales and operating
expenses for proforma determinations were based on historical Cheetah
information provided by Acterna with proforma adjustments made to adjust gross
margins to 50% of revenues based upon experience to date and to adjust operating
expenses to reflect the Company's financial plan for Cheetah for 2003. These
adjustments were made to reflect significant changes to operations made by the
Company since acquisition. This proforma financial information is presented for
comparative purposes only and is not necessarily indicative of the operating
results that actually would have incurred had the Cheetah product line
acquisition been consummated on January 1, 2002. In addition, these results are
not intended to be a projection of future results.
9
The following information is provided regarding the Company's intangible assets:
As of June 28, 2003 As of December 31, 2002
-------------------------------- --------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
----------- ------------ ----------- ------------
Amortized intangible assets:
Current:
Sales Order Backlog $ 600,000 $ 517,132 $ -- $ --
Long Term:
Developed product software 7,421,945 2,568,600 7,368,100 1,829,098
Base Software - Cheetah 2,900,000 108,750 -- --
Proprietary Technology 1,000,000 37,500 -- --
----------- ----------- ----------- -----------
$11,921,945 $ 3,231,982 $ 7,368,100 $ 1,829,098
=========== =========== =========== ===========
Unamortized intangible assets:
LoopCare trade name $ 1,300,000 $ -- $ 1,300,000 $ --
Base software - LoopCare 5,200,000 -- 5,200,000 --
Post warranty maintenance
service agreements 32,000,000 -- 32,000,000 --
Customer Base - Cheetah 5,000,000 -- -- --
Cheetah Trademark 1,000,000 -- -- --
----------- ----------- ----------- -----------
$44,500,000 $ -- $38,500,000 $ --
=========== =========== =========== ===========
Estimated amortization expense:
For year ended December 31, 2003 $2,422,648
For year ended December 31, 2004 1,874,389
For year ended December 31, 2005 1,874,389
For year ended December 31, 2006 1,509,389
For year ended December 31, 2007 410,292
3. INVENTORIES
At June 28, 2003 and December 31, 2002, inventories consisted of the following:
10
(Unaudited)
June 28, December 31,
2003 2002
------------ ------------
Raw materials . . . . . . . . . . . . . . . . . . . . . . . $ 8,662,800 $ 9,726,789
Work in process . . . . . . . . . . . . . . . . . . . . . 5,388,004 4,518,164
Finished goods . . . . . . . . . . . . . . . . . . . . . . 1,956,660 2,190,476
------------ ------------
$ 16,007,464 $ 16,435,429
Allowance for slow moving and
obsolete inventory (2,245,000) (2,342,833)
------------ ------------
$ 13,762,464 $ 14,092,596
============ ============
Raw materials as of June 28, 2003 include inventories of $623,294
recorded at fair value that were acquired in February 2003 in connection with
the Cheetah acquisition. The Company has engaged a turn-key contractor to fully
manufacture the Cheetah products. This contractor has experience with most of
Cheetah's products and had manufactured the products prior to the 2000
acquisition of the business by Acterna. The contractor purchases the acquired
inventory on an as-needed basis and thereafter will obtain materials from other
sources of supply, minimizing the need for the Company to carry inventory for
the Cheetah operations.
4. SHORT-TERM INVESTMENTS
Short-term investments at June 28, 2003 and December 31, 2002 consisted of
individual municipal bonds stated at cost, which approximated market value.
These securities have maturities of one year or less at date of purchase and/or
contain a callable provision in which the bonds can be called within one year
from date of purchase. The primary investment purpose is to provide a reserve
for future business purposes, including acquisitions and capital expenditures.
Realized gains and losses are computed using the specific identification method.
The Company classifies its investment in all debt securities as "held to
maturity," as the Company has the positive intent and ability to hold the
securities to maturity.
The estimated fair values of the Company's financial instruments are as follows:
(Unaudited)
June 28, 2003 December 31, 2002
-------------------------------- --------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- ----------- -----------
Financial assets:
Cash and cash equivalents ................. $28,059,870 $28,059,870 $33,799,284 $33,799,284
Short-term investments .................... 14,181,226 14,156,172 19,328,883 19,257,039
----------- ----------- ----------- -----------
$42,241,096 $42,216,042 $53,128,167 $53,056,323
=========== =========== =========== ===========
11
5. INCOME PER COMMON SHARE
Net income per share is calculated by dividing net income by the weighted
average number of common shares plus incremental common stock equivalent shares
(shares issuable upon exercise of stock options). Incremental common stock
equivalent shares are calculated for each measurement period based on the
treasury stock method, which uses the monthly average market price per share.
The calculation of net income per common and common equivalent shares follows
(unaudited):
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 28, 2003 June 29, 2002 June 28, 2003 June 29, 2002
- -----------------------------------------------------------------------------------------------------------------
Net income ......................... $ 833,300 $ 1,090,853 $ 1,259,670 $ 2,603,667
=================================================================================================================
Common and common equivalent shares:
Weighted average number of
common shares outstanding
during the period .................. 13,103,801 13,088,748 13,097,319 13,099,106
Common shares issuable upon exercise
of outstanding stock options:
Diluted ......................... 231,205 250,305 178,723 286,975
Common and common equivalent shares
Outstanding during the period:
- -----------------------------------------------------------------------------------------------------------------
Diluted ......................... 13,335,006 13,339,053 13,276,042 13,386,081
=================================================================================================================
Earnings per share data
Net income per common and common
Equivalent shares:
Basic ........................... $ .06 $ .08 $ .10 $ .20
Diluted ......................... $ .06 $ .08 $ .09 $ .19
12
6. ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company has two stock-based employee compensation plans. The Company
accounts for these plans under the recognition and measurement provisions of APB
Opinion No. 25, "Accounting for Stock Issued to Employees." Under these
provisions, stock- based employee compensation cost is not reflected in net
income for any year, as all options granted under the plans had an exercise
price equal to the market value of the underlying common stock on the date of
grant. If the Company had elected to recognize compensation cost for these stock
options based on the fair value method set forth in SFAS No. 123, "Accounting
for Stock-Based Compensation," net income and earnings per share would have
reflected the pro forma amounts indicated below:
Three Months ended Six Months ended
-------------------------------- --------------------------------
June 28, 2003 June 29, 2002 June 28, 2003 June 29, 2002
------------- ------------- ------------- -------------
Net income, as reported ...................... $ 833,300 $ 1,090,853 $ 1,259,670 $ 2,603,667
Deduct: Total stock-based compensation expense
based on the fair value method for all awards,
net of related tax effects ................... 443,367 1,333,259 1,006,680 2,867,661
----------- ----------- ----------- -----------
Pro forma net income ......................... $ 389,933 $ (242,406) $ 252,990 $ (263,994)
=========== =========== =========== ===========
Earnings (loss) per share:
Basic - as reported ........................ $ 0.06 $ 0.08 $ 0.10 $ 0.20
Basic - pro forma .......................... $ 0.03 $ (0.02) $ 0.02 $ (0.02)
Diluted - as reported ....................... $ 0.06 $ 0.08 $ 0.09 $ 0.19
Diluted - pro forma ......................... $ 0.03 $ (0.02) $ 0.02 $ (0.02)
7. ACCOUNTING PRONOUNCEMENTS
On August 15, 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Accounting Standard (SFAS) No. 143, "Accounting for Asset
Retirement Obligations.". The Company adopted this statement on January 1, 2003
and such adoption did not have a material effect on the Company's financial
statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting For Costs Associated
With Exit Or Disposal." SFAS No. 146 nullifies Emerging Issues Task Forces
(EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred
in a Restructuring)." The new Statement requires that a liability for a cost
associated with an exit or disposal activity be recognized and measured
initially at fair value only when the liability is incurred. SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002. This statement did not have a material effect on the Company's financial
position or results of operations.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 requires that upon
issuance of a guarantee, a guarantor must recognize a liability for the fair
value of an
13
obligation assumed under a guarantee. FIN 45 also requires additional
disclosures by a guarantor in its interim and annual financial statements about
the obligations associated with guarantees issued. The recognition provisions of
FIN 45 are effective for any guarantees issued or modified after December 31,
2002. The provisions of FIN 45 did not have a material impact on the Company's
results of operations or financial position.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." This Statement amends SFAS No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition to SFAS No. 123's fair value method of accounting for stock-based
employee compensation. This Statement also amends the disclosure provision of
SFAS No. 123 and APB No. 28, Interim Financial Reporting, to require disclosure
in the summary of significant accounting policies footnote in the financial
statements of the effects of an entity's accounting policy with respect to
stock-based employee compensation on reported net income and earnings per share
in annual and interim financial statements. The Company has elected to continue
to follow the disclosure-only provisions of SFAS No. 123 and adopted the
disclosure provisions of SFAS No. 148.
On January 17, 2003, the FASB issued FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities - an interpretation of ARB No. 51" ("FIN 46"). FIN
46 clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements", to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN 46 was
effective for the Company after January 31, 2003 and did not have a material
impact on the Company's results of operations or financial condition.
In April 2003, the FASB issued Statement No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging." This Statement amends and clarifies
financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities under FASB Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
was effective for the Company after April 30, 2003 and did not have a material
impact on the Company's results of operations or financial condition.
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). This
statement was effective for the Company after May 31, 2003 and did not have a
material impact on the Company's results of operations or financial condition.
8. PRODUCT WARRANTY
The Company records estimated warranty costs on the accrual basis of accounting.
Warranty accruals are determined by applying historical returns to the current
level of product shipments and the cost experience associated therewith. In the
case of software, accruals are based on the expected cost of providing services
within the agreed-upon warranty period. Activity in the warranty accrual is as
follows:
14
Three Months Ended Six Months Ended
-------------------------------- --------------------------------
June 28, 2003 June 29, 2002 June 28, 2003 June 29, 2002
- -------------------------------------------------------------------------------------------------------------------------------
Balance at the beginning of the period $ 3,046,000 $ 2,318,000 $ 1,981,000 $ 2,068,000
Accruals for warranties issued
during the period 348,000 110,000 665,000 228,000
Accruals related to pre-existing warranties (104,000) -- 147,000 261,000
Cheetah opening accrual -- -- 617,000 --
Settlements during the period (167,000) (153,000) (287,000) (282,000)
- -------------------------------------------------------------------------------------------------------------------------------
Balance at the end of the period $ 3,123,000 $ 2,275,000 $ 3,123,000 $ 2,275,000
===============================================================================================================================
The Company has reflected a $617,000 entry on the Cheetah opening balance sheet
to provide an estimated accrual for pre-acquisition warranty costs for the
Cheetah products. The Company utilized the historical warranty experience of
CheetahLight(TM) (formerly LIGHTHOUSE(TM)) to estimate applicable Cheetah
warranty expense.
15
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Tollgrade Communications, Inc. and subsidiaries:
We have reviewed the accompanying condensed consolidated balance sheet of
Tollgrade Communications, Inc. and its subsidiaries as of June 28, 2003, and the
related condensed consolidated statements of operations for each of the
three-month and six-month periods ended June 28, 2003 and June 29, 2002 and the
condensed consolidated statement of cash flows for the three-month and six-month
periods ended June 28, 2003 and June 29, 2002 and the statement of changes in
shareholders' equity for the six-month period ended June 28, 2003. These
financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated interim financial statements
for them to be in conformity with accounting principles generally accepted in
the United States of America.
We previously audited in accordance with auditing standards generally accepted
in the United States of America, the consolidated balance sheet as of December
31, 2002, and the related consolidated statements of operations, shareholders'
equity and of cash flows for the year then ended (not presented herein), and in
our report dated January 22, 2003 we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying condensed consolidated balance sheet as of December 31, 2002,
is fairly stated in all material respects in relation to the consolidated
balance sheet from which it has been derived.
/s/ PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
July 15, 2003
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
The following discussion should be read in conjunction with the Condensed
Consolidated Financial Statements and Notes thereto appearing elsewhere in this
report.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995.
The statements contained in this Quarterly Report on Form 10-Q, including, but
not limited to those contained in Item 2- Management's Discussion and Analysis
of Results of Operations, along with statements in other reports filed with the
Securities and Exchange Commission (the "SEC"), external documents and oral
presentations, which are not historical facts are considered "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 "will," "believes," "intends," "expects,"
"plans," or "may," or the negatives thereof, other variations thereon or
comparable terminology, relate to, among other things, projected cash flows
which are used in the valuation of intangible assets, the anticipated results of
negotiations for purchase orders and other customer purchase agreements, the
ability to utilize deferred and refundable tax assets, opportunities which the
Services group offers to customers, the potential loss of certain customers, the
timing of orders from customers, the effect of consolidations in the markets to
which Tollgrade Communications, Inc. (the "Company") sells, the effects of the
economic slowdown in the telecommunications and cable industries, the
possibility of future provisions for slow moving and obsolete inventory, and the
effect on earnings and cash flows of changes in interest rates. The Company does
not undertake any obligation to publicly update any forward-looking statements.
These forward-looking statements and other forward-looking statements contained
in other public disclosures of the Company which make reference to the
cautionary factors contained in this Form 10-Q are based on assumptions that
involve risks and uncertainties and are subject to change based on the
considerations described below. These risks, uncertainties and other factors may
cause actual results, performance or achievements to differ materially from
anticipated future results, performance or achievements expressed or implied by
such forward looking statements. Therefore, the Company wishes to caution each
reader of this Form 10-Q to consider the following factors and certain other
factors discussed herein and in other past reports including, but not limited
to, prior year Annual Reports and Form 10-K and Form 10-Q reports filed with the
SEC. The factors discussed herein may not be exhaustive. Therefore, the factors
discussed herein should be read together with other reports and documents that
are filed by the Company with the SEC from time to time, which may supplement,
modify, supersede or update the factors listed in this document.
General economic conditions and the economic conditions of the
telecommunications and cable industries, including the effect of subscriber line
loss and competition for the Company's Regional Bell Operating Company ("RBOC")
customers from wireless, cable providers and other carriers entering the local
telephone service market can and have affected the capital budgets of the
Company's customers. If such conditions result in a further reduction of such
budgets, the Company's revenues could be adversely affected.
If the Company's customers find themselves unable to meet their established
purchase forecasts and their own growth projections, such customers may curtail
their purchases of the Company's products, which would adversely affect the
Company's revenues.
17
If the Company would be unable to establish or maintain customer or sales
distribution or original equipment manufacturer ("OEM") relationships relating
to the Cheetah cable status and performance monitoring product line, it could
affect the rate of incoming orders, which would adversely affect the Company's
sales and revenues.
If the financial strength of certain of the Company's major customers should
deteriorate or such customers should encounter difficulties in accessing
capital, the ability of such customers to purchase and pay for the Company's
products could be impaired, with a corresponding adverse effect on the Company's
revenues.
If third parties with whom the Company has entered into sales and marketing
partnerships should fail to meet their own performance objectives, customer
demand for the Company's products could be adversely affected, which would have
an adverse effect on the Company's revenues.
Seasonal fluctuations in customer demand for the Company's products can create
corresponding fluctuations in period-to-period revenues, and any increases in
the rate of order cancellations by customers could adversely affect future
revenues.
The carrying value of certain intangible assets, including goodwill, acquired by
the Company from Lucent Technologies, Inc. ("Lucent") and Acterna, LLC could be
impaired if changing market conditions indicate that lower than anticipated cash
flows will be produced by such intangible assets.
If the Company were to encounter a shortage of key manufacturing components from
limited sources of supply, or to experience manufacturing delays caused by
reduced manufacturing capacity or integration issues related to the acquisition
of the Cheetah product line, the loss of key assembly subcontractors or other
factors, the Company's ability to produce and ship its manufactured products
could be adversely affected, with an adverse effect upon revenues.
Disputes between the Company's customers and their organized labor groups could
cause those customers to reduce or curtail their purchase of the Company's
products until such disputes are resolved. An RBOC customer is currently in
collective bargaining negotiations with the International Brotherhood of
Electrical Workers and the Communications Workers of America covering 27
contracts and approximately 79,000 employees. If such negotiations are not
successful and employee work stoppages ensue, that customer's order flow for
Company products could be severely curtailed with a resultant adverse effect on
the Company's financial statements.
The introduction of improved products or services or reduced prices by the
Company's competitors could reduce the demand for the Company's products and
services and adversely affect revenues.
If the Company proves unable to respond effectively to technological change in
its industry, such as an evolution of the telephone network from circuit to
packet-based, by developing new products and services and obtaining customer
approval and acceptance of its products and services, demand for the Company's
products and services could be adversely affected, which would adversely affect
revenues.
The Company is dependent on a relatively narrow range of products and a small
number of large customers. As a result, the failure of one or a small number of
the Company's products to gain or maintain acceptance in the marketplace, or the
decision by one or a few of the Company's customers to curtail their purchases
of the Company's products could have an adverse effect on revenues.
If one or more of a small number of key employees of the Company were to cease
to be associated with the Company, the Company's future results could be
adversely affected.
18
If the Company is unable to successfully assert and defend its proprietary
rights in the technology utilized in its products, its future results could be
adversely affected. If third parties were able to successfully assert that the
Company's use of technology infringed upon the proprietary rights of others, the
future results of the Company could be adversely affected.
If one or more of the Company's products were to prove to be defective, the
Company's relationships with its customers could be jeopardized and the Company
could be subject to potential liability, adversely affecting the Company's
future results.
If for any reason demand for the Company's products should decrease, including
the successful development of a secondary market for the Company's products by a
third party, the Company could continue to find itself with excess inventory and
obsolete parts on hand, which could adversely affect future results.
Changes in government regulation, such as modification or repeal of The
Telecommunications Act of 1996, increasing the costs of doing business by the
Company or its customers, or preventing the Company or its customers from
engaging in business activities they may wish to conduct, could adversely affect
the Company's future results.
The Company has recently completed certain acquisitions and expects to pursue
additional acquisitions and new business opportunities in the future as part of
its business strategy. If the Company fails to integrate successfully the
operations and products of acquired businesses, or if such acquisitions subject
the Company to unexpected liabilities and claims, the Company's future results
could be adversely affected.
The Company's 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, the ability of the Company to market current or newly developed products
suitable for international markets, the ability of the Company to obtain and
maintain successful distribution and resale channels, and foreign currency
exchange rates. Reductions in the demand for or the sales of the Company's
products in international markets could adversely affect future results.
OVERVIEW
The Company was organized in 1986, began operations in 1988 and completed its
initial public offering in 1995. The Company designs, engineers, markets and
supports test system, test access and status and performance monitoring products
for the telecommunications and cable television industries. In 2001, the Company
purchased certain assets of the LoopCare(TM) product business from Lucent. The
acquired assets consisted principally of LoopCare software base code and
developed enhancements, as well as the rights to existing maintenance contracts
for the LoopCare software, while the assumed liabilities principally relate to
deferred software maintenance and warranty obligations under contract. Revenues
from the sales of LoopCare software base code or developed enhancements are
either reported separately or as part of the Company's revenues attributable to
test system products in which the software is an essential functional component,
while the revenues from maintenance contracts are reflected as part of the
Company's Services revenues.
On February 13, 2003, the Company purchased certain assets and assumed certain
liabilities related to the Cheetah(TM) Status and Performance Monitoring Product
Line from Acterna, LLC. The acquired assets consisted principally of existing
sales order backlog, product inventory, intellectual property, software and
19
related computer equipment, while the liabilities assumed principally related to
deferred software maintenance, warranty and other obligations.
The Company has determined that its business has one reportable segment in the
test assurance industry. All product sales are considered components of the
business of testing infrastructure and networks for the telecommunications and
cable television industries. Although the Company does internally develop sales
results associated with the various product categories, this information is not
considered sufficient for segment reporting purposes and the chief operating
decision maker does not make critical decisions or allocate assets based solely
on this information. The Company's products and services have similar economic
characteristics, the same or similar production processes, and are sold to
similar types or classes of customers in, or entering into, the
telecommunications and cable businesses through similar distribution means. The
LoopCare software product line was acquired by the Company to broaden its
DigiTest(R) test platform into a system level offering and as a competitive
defense to protect the Company's MCU(R) and DigiTest products' market share. The
Cheetah products were acquired to establish the Company as the market leader
within the global cable broadband marketplace. The new Cheetah operation and
CheetahLight(TM) (formerly LIGHTHOUSE(TM)) combined provide a complete line of
solutions for customers network monitoring needs.
The Company's proprietary telecommunications test access products enable
telephone companies to use their existing line test systems to remotely diagnose
problems in "Plain Old Telephone Service" ("POTS") lines containing both copper
and fiber optics. The Company's MCU product line, which includes POTS line
testing as well as alarm-related products, represented approximately 37% of the
Company's revenue for the second quarter ended June 28, 2003. The Company's MCU
product line is expected to continue to account for a substantial portion of the
Company's revenues.
The Company's DigiTest centralized network test system platform, which includes
certain LoopCare software base code and developed enhancements, focuses on
helping local exchange carriers conduct the full range of fault diagnoses, along
with the ability to qualify, deploy and maintain next generation services that
include Digital Subscriber Line ("DSL") service and Integrated Services Digital
Network ("ISDN") service. The Company also sells LoopCare base code software
primarily to competitive local exchange carriers ("CLECs") to be used with test
heads other than the Company's DigiTest products. The Company's DigiTest system
is designed to provide the complete solution for testing POTS and performing
local loop prequalification for DSL services. The system currently consists of
the comprehensive LoopCare diagnostic software, as well as integrated pieces of
hardware, including the Digital Measurement Node ("DMN"), the Digital
Measurement Unit ("DMU"), the Digital Wideband Unit ("DWU") and the newly
released Digital Wideband Node ("DWN"). The Company has also recently released
its newly developed DigiTest EDGE(TM) test head as a global platform for
broadband test applications. The new DWN and EDGE products have not contributed
to revenues through the second quarter of 2003. When used in an integrated
fashion, the DigiTest system permits local exchange carriers to perform a
complete array of central office testing including POTS, DSL line
prequalification, bridged tap detection, data rate prediction, and in-service
wideband testing. Sales of the DigiTest product line accounted for approximately
7.1% of the Company's revenue for the second quarter of 2003.
The Company's LoopCare software products consist primarily of engineered
enhancements to the LoopCare base code software, which result in increased
connectivity and versatility of LoopCare within the customers' existing quality
assurance systems. Sales of LoopCare software products separate and unrelated to
DigiTest system products accounted for approximately 5.4% of total second
quarter 2003 revenue.
The Company's cable hardware products comprised approximately 31.2% of second
quarter 2003 revenue, of which 21.8% were contributed by the Cheetah brand group
of products acquired during the first quarter of 2003 and 9.4% were contributed
by the re-branded CheetahLight cable products. The combined product lines, which
are being integrated, offer a complete cable status and performance monitoring
system that provides a broad
20
testing solution for the broadband Hybrid Fiber Coax distribution system. The
offerings include the CheetahLight and CheetahNet(TM) (formerly NetMentor(TM))
software systems and maintenance, head-end controllers, return path switch
hardware, transponders and other equipment which gather status and performance
reports from power supplies, line amplifiers and fiber optic nodes.
The cornerstones of the Company's Services offerings are the Testability
Improvement Initiatives. These Services may offer the customer the opportunity
to make improvements in testability levels, while training their own staffs in
targeted geographic regions over a defined period of time. In this way, the
customers' internal repair technicians can make use of automated systems to
diagnose and repair subscriber loop problems, thereby automatically eliminating
the need for the involvement of several highly trained employees. The Services
business was considerably expanded upon the acquisition of software maintenance
contracts related to the LoopCare and CheetahNet software product lines.
Including software maintenance revenues, Services revenue accounted for
approximately 18.8% of the Company's revenue for the second quarter ended June
28, 2003.
The Company's primary customers for its telecommunication products and services
are the four RBOCs as well as major independent telephone companies and certain
digital loop carrier ("DLC") equipment manufacturers. For the second quarter
ended June 28, 2003, approximately 52% of the Company's total revenue was
generated from sales to these four RBOC customers. During the second quarter of
2003, sales to two RBOC customers (Verizon and Bell South) individually exceeded
10% of consolidated revenues and on a combined basis, comprised approximately
34% (18% and 16%, respectively) of the Company's net sales. Due to the Company's
present dependency on these key customers, the potential loss of one or more of
them as a customer or their reduction of orders for the Company's products could
materially and adversely affect the Company.
The Company's operating results have fluctuated and may continue to fluctuate as
a result of various factors, including the timing of orders from, shipments to,
and acceptance of software by the RBOC customers and significant independent
telephone companies. This timing is particularly sensitive to various business
factors within each of the RBOC customers, including their relationships with
various organized labor groups and an increasing tendency for the RBOC customers
to place large orders for shipment of hardware and software toward the end of a
quarter. An RBOC customer is currently in collective bargaining negotiations
with the International Brotherhood of Electrical Workers and the Communications
Workers of America covering 27 contracts and approximately 79,000 employees. If
such negotiations are not successful and employee work stoppages ensue, that
customer's order flow for Company products could be severely curtailed with a
resultant adverse effect on the Company's financial statements. In addition, the
markets for the Company's products, specifically, LoopCare, DigiTest and
Cheetah, are highly competitive. Due to the rapidly evolving market in which
these products compete, additional competitors with significant market presence
and financial resources could further intensify the competition for these
products.
The Company believes that recent and continuing changes within the
telecommunication marketplace, including industry consolidation, as well as the
Company's ability to successfully penetrate certain new markets, have required
it to grant more favorable terms to some of its customers. In addition, certain
customers have consolidated product purchases that have translated into large
bulk orders. These customers, partly in response to discounting programs, tend
to place large bulk orders toward the end of a quarter for shipment of large
quantities of hardware and software in the last month of the quarter. Although
the Company will continue to strive to meet the demands of its customers, which
include the delivery of quality products at an acceptable price and on
acceptable terms, there can be no assurance that the Company will be successful
in negotiating acceptable terms and conditions in customer purchase orders or
customer purchase agreements. Additionally, continuing efforts among the RBOC
customers to consolidate their inventory and product procurement systems could
cause fluctuations or delays in the Company's order patterns. Consolidation in
the cable industry, as well as the adoption of industry standards to allow
transponders to function among various
21
status monitoring systems, could and have caused pricing pressure as competitors
have begun lowering product pricing, which may adversely affect revenues from
sales of the Company's cable products. Moreover, further evolution of cable
industry standards could eliminate the need for some of the Company's customers
to purchase certain status monitoring equipment otherwise required for
proprietary implementations, which could adversely affect revenues. In addition,
markets for the Company's cable products have been and may continue to be highly
competitive and difficult for the foreseeable future. The Company cannot predict
such future events or business conditions and the Company's results could be
adversely affected by these industry trends in the primary markets its serves.
International sales were approximately 4.8% of total revenues in the second
quarter ended June 28, 2003. The Company believes that certain international
markets may offer further opportunities. The addition of the LoopCare software
product line, including the Lucent OEM resale arrangement for the LoopCare
product, has enhanced the Company's ability to penetrate these markets. The
CheetahNet operations also have a viable international acceptance and presence.
Further, the Company enjoys a stream of LoopCare and CheetahNet software
maintenance revenue from international sources. However, the international
telephony markets differ from those found domestically due to the different
types and configurations of equipment used by those international communication
companies to provide services. In addition, certain competitive elements are
found internationally which do not exist in the Company's domestic markets.
These factors, when combined, have made entrance into international markets very
difficult. From time to time, the Company has utilized the professional services
of various marketing consultants to assist in defining the Company's
international market opportunities. With the assistance of these consultants and
through direct marketing efforts by the Company, it has been determined that its
present MCU technology offers limited opportunities in certain international
markets for competitive and other technological reasons. The Company continues
to actively pursue opportunities for its other products including its LoopCare
software products in international markets. The Cheetah cable products have a
presence and acceptance in Europe and China and the Company intends to
capitalize and expand upon that presence. However, there can be no assurance
that continued efforts by the Company will be successful or that the Company
will achieve significant international sales. In addition, Lucent, while
continuing to market its DSL services, has reduced its research and development
efforts in this area, which could have an adverse effect on the Company's
deployment of LoopCare internationally through the Lucent OEM channel. In
addition, the Company's LoopCare OEM resale agreement with Lucent expires on
September 30, 2003, and although the Company is engaged in discussions to renew
that agreement, there can be no guarantee that such agreement will be completed,
which could eliminate sales through this channel. Further, the international
markets introduce the risk of loss from currency fluctuations. While the Company
endeavors to price its products in U. S. dollars, this is not always possible
and may be less so in the future. Many international customers are also small
and undercapitalized which will present possible exposure to credit losses to a
greater degree than has historically been seen from domestic customers.
The Company believes that its future growth will continue to be affected by the
economic slowdown in the telecommunications industry as established RBOC and
large incumbent local exchange carrier ("ILEC") customers strive to further
reduce their capital and operating expense budgets, which will directly impact
RBOC and ILEC ordering patterns and quantities. The Company believes that the
RBOC and large ILEC customers are being adversely affected by subscriber line
losses and the after-effects of overspending in 1999 and 2000, as well as by
competition from cable and wireless carriers and other carriers entering the
local telephone service market. In addition, certain emerging carriers continue
to be hampered by financial instability caused in large part by a lack of access
to capital. Due to the effect of these adverse conditions, the Company will
continue to evaluate its investments in production, marketing and research and
development expenses and will monitor, control or decrease expense levels, as
appropriate.
The Company also believes that future growth will depend, in part, on its
ability to design and engineer new products and, therefore, the Company incurs
significant research and development costs. Research and
22
development expenses as a percentage of revenues were approximately 23% in both
the second quarter of 2003 and the second quarter of 2002.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The Company's financial statements are prepared in conformity with accounting
principles generally accepted in the United States of America. Certain of these
accounting principles are more critical than others in gaining an understanding
of the basis upon which the Company's financial statements have been prepared. A
comprehensive review of these policies is contained in the Company's 2002 Annual
Report on Form 10-K filed on March 26, 2003 and in the Quarterly Report on Form
10-Q for the period ending March 29, 2003 filed on May 13, 2003. There have been
no significant changes in these policies or the application thereof during the
second quarter of 2003.
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF THE RESULTS OF OPERATIONS AND FINANCIAL CONDITION OF
THE COMPANY SHOULD BE READ IN CONJUNCTION WITH THE RESPONSE TO PART I, ITEM 1 OF
THIS REPORT
SECOND QUARTER OF 2003 COMPARED TO SECOND QUARTER OF 2002
REVENUES
The Company's Revenues for the second quarter of 2003 were $17,134,000,
$2,550,000 or 17.5% higher than the revenues of $14,584,000 reported for the
second quarter of 2002. The second quarter 2003 results include revenues for the
Cheetah product line that the Company acquired on February 13, 2003.
MCU product line revenues decreased in the second quarter of 2003 due primarily
to slower deployments by RBOC customers, who continued to restrain capital
spending in traditional POTS line areas such as Digital Loop Carrier deployment
due to continuing subscriber line losses. Decreases in direct MCU sales to RBOC
and other customers were partially offset by sales increases of $923,000 to
original equipment manufacturers. Sales of MCU products were $6,387,000 in the
second quarter of 2003, a decrease of $1,201,000 from the year earlier period.
MCU sales comprised 37.3% of total second quarter 2003 revenues compared to
52.0% for the second quarter of 2002. MCU sales are expected to continue to
account for a substantial portion of the Company's revenues for the foreseeable
future. As the product life cycle for the MCU product continues to mature,
however, there is an increasing possibility that customer requirements for
certain legacy MCU products may be satisfied, which would result in lower
revenues to the Company.
Sales of the Company's DigiTest system products, which include LoopCare
software, increased 21.1% between quarterly periods due primarily to new sales
to an RBOC customer for Loop Test System (LTS) modernization as well as an
initial DigiTest system sale to a new CLEC customer. DigiTest product sales for
the second quarter of 2003 were $1,230,000, an increase of $214,000 from the
year earlier quarter, and represented 7.2% of total revenue for the current
quarter compared to 7.0% for the second quarter of 2002.
Sales of LoopCare software products separate and unrelated to DigiTest system
products were $929,000 for the second quarter of 2003, a reduction of $1,393,000
or 60.0% from the second quarter of 2002. LoopCare revenue for the second
quarter of 2002 included $1,244,000 from a significant software enhancement sale
to an RBOC customer and no such significant sale existed in the second quarter
of 2003. LoopCare software product sales comprised 5.4% of total revenues during
the second quarter of 2003, compared to 15.9% for the corresponding quarter of
2002.
23
Services revenues, which include installation oversight and project management
services provided to RBOC and other customers and fees for LoopCare and Cheetah
software maintenance, were approximately $3,219,000 in the second quarter of
2003, or 18.8% of total quarterly revenues. Services revenues increased $652,000
over the results of the second quarter of 2002. Revenue from CheetahNet software
maintenance fees amounted to $387,000 of this increase.
Overall sales of cable hardware and software products were $5,370,000 in the
second quarter of 2003, an increase of $4,374,000 or 439% from the prior year's
quarter. The new Cheetah line contributed $3,731,000 to this increase.
CheetahLight (formerly LIGHTHOUSE) product sales were $1,639,000 in the second
quarter of 2003, an increase of 64.6% from the $996,000 reported for the year
earlier period based primarily on the strength of shipments to a new domestic
customer. Combined sales of cable status monitoring system products amounted to
31.3% of total second quarter 2003 revenue compared to 6.8% for the prior year
quarter.
Periodic fluctuations in customer orders and backlog result from a variety of
factors, including but not limited to, the timing of significant orders from,
shipments to, and acceptance of software by RBOC customers, and are not
necessarily indicative of long-term trends in sales of the Company's products.
GROSS PROFIT
Gross profit for the second quarters of 2003 and 2002 were $9,415,000 and
$8,449,000, respectively, representing an increase of $966,000 or 11.4% from the
results of the prior year's quarter. Gross profit as a percentage of revenues
decreased to 54.9% in the second quarter of 2003 compared to 57.9% in the same
quarter last year. The decrease in gross profit as a percentage of sales
resulted primarily from lower sales in the second quarter of 2003 of higher
margin LoopCare software and the effect of the new Cheetah business that
produces comparatively lower margins due to the highly competitive CATV markets.
Margins were also negatively affected in the second quarter of 2003 by higher
provisions for warranty expense of $134,000. On the other hand, the expense for
slow moving and obsolete inventory was $645,000 higher in the second quarter of
2002 compared to the second quarter of 2003. There was also improvement in
Services margins in 2003 due primarily to productivity gains. The Company's
gross margin is and will continue to be highly sensitive to the mix of products
shipped, the level of operations and the level of reserves required for slow
moving and obsolete inventory.
SELLING AND MARKETING EXPENSE
Selling and marketing expense for the second quarter of 2003 was $2,421,000
compared to $2,225,000 for the second quarter of 2002. The increase of $196,000
or 8.8% is due primarily to the inclusion of Cheetah expenses of $353,000, with
such increase partially offset by fewer employees and lower commissions, travel
and discretionary expenses in other areas of the business. As a percentage of
revenues, selling and marketing expenses decreased from 15.3% in the second
quarter of 2002 to 14.1% in the second quarter of 2003.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense for the second quarter of 2003 was
$1,828,000, an increase of $559,000 or 44.1% from the $1,269,000 recorded in the
second quarter of 2002. The increase is attributable to the inclusion of the
Cheetah operations of $252,000, which includes a provision for doubtful accounts
of $143,000, and higher business insurance, incentive compensation and
professional service costs. As a percentage of revenues, general and
administrative expenses increased to 10.7% in the second quarter of 2003 from
8.7% in the second quarter of 2002.
24
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense in the second quarter of 2003 was $3,907,000,
an increase of $511,000 or 15.0% from the $3,396,000 recorded in the second
quarter of 2002. The increase resulted for the most part from the inclusion of
the Cheetah business research and development expenses of $726,000 and higher
prototype expenses, partially offset by a general reduction in work force at the
end of the third quarter of 2002. As a percentage of revenues, research and
development expense decreased to 22.8% in the second quarter of 2003 from 23.3%
in the year earlier quarter.
INTEREST AND OTHER INCOME
Interest and other income is composed primarily of interest income in both
quarterly periods. Interest and other income was $85,000 in the second quarter
of 2003 compared to $200,000 for the second quarter of 2002, a decrease of
$115,000 or 57.5%. This decrease was the result of both the lower market yields
on short-term interest bearing investments compared with the prior year quarter
and fewer funds available for investment due to the acquisition of the Cheetah
business in February 2003.
PROVISION FOR INCOME TAXES
The provision for income taxes for the second quarter of 2003 was $511,000, a
decrease of $158,000 or 23.6% from the $669,000 recorded for the second quarter
of 2002. The effective income tax rate for both periods was approximately 38% of
pretax income.
NET INCOME AND EARNINGS PER SHARE
As a result of the above factors, net income for the second quarter of 2003 was
$833,000, a decrease of $258,000 or 23.6% from the $1,091,000 recorded in the
second quarter of 2002. Basic and diluted earnings per common share of six cents
for the second quarter of 2003 decreased by two cents (25.0%) from the eight
cents earned in the second quarter of 2002. Basic and diluted weighted average
common and common equivalent shares outstanding were 13,103,801 and 13,335,006,
respectively, in the second quarter of 2003 compared to 13,088,748 and
13,339,053, respectively, in the second quarter of 2002. As a percentage of
revenues, net income for the second quarter of 2003 decreased to 4.9% compared
to 7.5% for the second quarter of 2002.
RESULTS OF OPERATIONS YEAR-TO-DATE
SIX MONTHS ENDED JUNE 28, 2003 COMPARED TO SIX MONTHS ENDED JUNE 29, 2002
REVENUES
For the first six months of 2003, revenues were $31,677,000 compared to
$32,106,000 for the first six months of 2002, representing a decrease of
$429,000 or 1.3%.
The decrease in revenues for the first six months of 2003 resulted primarily
from slower deployments of the MCU product line caused by the continuing budget
restrictions of the RBOCs as well as the effects from subscriber line losses and
diminishing DLC deployment, with such factors partially offset by increases in
shipments to original equipment manufacturers. Sales of the Company's MCU
products, which decreased by $6,211,000 between the six-month periods, comprised
34.2% of total revenue for the first six months of 2003 compared to 53.1% for
the year earlier period.
25
Sales of the Company's DigiTest system products, which include LoopCare
software, increased $552,000 or 21.4% between six-month periods due primarily to
strong sales of DigiTest hardware to certain RBOC customers and sales of
hardware and related LoopCare software to new CLEC customers. These gains were
offset to a great extent by the discontinuation of Sprint USA's ION project and
a reduction in sales to Sprint Canada. Sales of DigiTest products represented
9.9% of total revenue for the first six months of 2003 compared to 8.0% for the
first six months of 2002.
Sales of LoopCare software products separate and unrelated to DigiTest system
products were $2,699,000 in the first six months of 2003, a reduction of
$2,698,000 or 50% between the six-month periods. Sales in 2003 were made
primarily to two RBOC customers. In the first six months of 2002, 68% of the
Company's LoopCare revenues resulted from significant software enhancement sales
to a third RBOC customer. LoopCare product software sales comprised 8.5% of
total revenues during the first six months of 2003 compared to 16.8% in the year
earlier period.
The Company's Service revenues for the first six months of 2003 were $6,191,000,
which represents 19.5% of total six-month revenue and an increase of $1,032,000
over the similar period in 2002. The increase is due primarily to the inclusion
of $484,000 from software maintenance related to the new Cheetah product line
and increased LoopCare software maintenance of $345,000. The balance of Services
revenue relates to installation oversight and project management services.
Service revenues are derived primarily from RBOC customers.
Overall sales of CATV hardware and software products were $8,788,000, an
increase of $7,122,000 or 427% from results of the first six months of 2002. The
new Cheetah line contributed $6,006,000 to this increase. CheetahLight (formerly
LIGHTHOUSE) product sales were $2,782,000, an increase of 67% from the
$1,666,000 reported for the year earlier period based primarily on the strength
of shipments to a new domestic customer. Combined sales of cable status
monitoring system products amounted to 27.7% of total revenue for the first six
months of 2003 compared to 5.2% for the same period of 2002.
GROSS PROFIT
Gross profit for the first six months of 2003 was $16,984,000 compared to
$18,589,000 for the first six months of 2002, representing a decrease of
$1,605,000 or 8.6%. Gross profit as a percentage of revenues decreased to 53.6%
in the first six months of 2003, compared to 57.9% in the same period last year.
The overall decrease in gross profit as a percentage of sales resulted primarily
from lower sales in the first six months of 2003 of higher margin LoopCare
software and the effect of the new Cheetah business that produces comparatively
lower margins due to the highly competitive CATV markets. Margins were also
negatively affected in the 2003 six month period by higher provisions for
warranty expense of $323,000. On the other hand, the expense for slow moving and
obsolete inventory was $1,138,000 higher in the first six months of 2002
compared to the first six months of 2003. There was also improvement in Services
margins in 2003 due primarily to productivity gains. The Company's gross margin
is and will continue to be highly sensitive to the mix of products shipped, the
level of operations and the level of reserves required for slow moving and
obsolete inventory.
SELLING AND MARKETING EXPENSE
Selling and marketing expense for the first six months of 2003 was $4,391,000
compared to $4,642,000 for the first six months of 2002. This decrease of
$251,000 or 5.4% was incurred despite the first time inclusion of expenses of
$511,000 related to the Cheetah operations. Cost reductions in other areas
resulted primarily from decreased travel, commissions and salaries and wages. As
a percentage of revenues, selling and marketing expenses decreased to 13.9% in
the first six months of 2003 from 14.5% in the same period of 2002.
26
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense for the first six months of 2003 was
$3,565,000, an increase of $770,000 or 27.6% from the $2,795,000 recorded in the
first six months of 2002. The increase is attributable primarily to the addition
of $504,000 in expenses from the Cheetah operations, which included $343,000 of
provisions for bad debts. Expenses also increased for business insurance,
incentive compensation and professional services. As a percentage of revenues,
general and administrative expenses increased to 11.3% in the first six months
of 2003 from 8.7% in the same period of 2002.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense for the first six months of 2003 was
$7,228,000, a decrease of $163,000 or 2.2%, from the $7,391,000 recorded in the
first six months of 2002. The overall decrease is net of $1,047,000 of new
expenses from the Cheetah operations and results primarily from savings
associated with a general reduction in work force at the end of the third
quarter of 2002. As a percentage of revenues, research and development expense
decreased to 22.8% in the first six months of 2003 from 23.0% in the similar
period of 2002.
INTEREST AND OTHER INCOME
Interest and other income is composed primarily of interest income in both
semiannual periods. For the first six months of 2003, interest and other income
was $232,000 compared to $438,000 for the first six months of 2002, a decrease
of $206,000 or 47.0%. This decrease was the result of both lower market yields
on short-term interest bearing investments compared with the prior year period
and fewer funds available for investment due to the acquisition of the Cheetah
business in February 2003.
PROVISION FOR INCOME TAXES
The provision for income taxes for the first six months of 2003 was $772,000, a
decrease of $824,000 or 51.6% from the $1,596,000 recorded for the first six
months of 2002. The effective income tax rate for both periods was approximately
38% of pretax income.
NET INCOME AND EARNINGS PER SHARE
As a result of the above factors, net income for the first six months of 2003
was $1,260,000, a decrease of $1,344,000, or 51.6%, from the $2,604,000 recorded
in the first six months of 2002. Basic and diluted earnings per common share of
ten cents and nine cents, respectively, for the first six months of 2003
decreased by ten cents, or 50.0% and 52.6%, from the twenty cents and nineteen
cents, respectively, earned in the first six months of 2002. Basic and diluted
weighted average common and common equivalent shares outstanding were 13,097,319
and 13,276,042, respectively, in the first six months of 2003 compared to
13,099,106 and 13,386,081, respectively, in the first six months of 2002. As a
percentage of revenues, net income for the first six months of 2003 decreased to
4.0% compared to 8.1% for the first six months of 2002.
CHEETAH ACQUISITION
On February 13, 2003, the Company acquired certain assets and assumed certain
liabilities of the Cheetah(TM) Status and Performance Monitoring Product Line
from Acterna, LLC for approximately $14,300,000 in cash. The Company also
incurred acquisition related costs of approximately $809,000 for a total cost of
approximately $15,109,000. In addition, as part of the agreement, contingent
purchase consideration of up to
27
$2,400,000 in the form of an earn-out may be payable based on certain 2003
performance targets for the acquired business. The acquired assets consisted
principally of existing sales order backlog, product inventory, intellectual
property, software and related computer equipment, while the assumed liabilities
principally related to deferred software maintenance, warranty and other
obligations. The $14,300,000 due at closing and related acquisition expenses
were paid from available cash and short-term investments. The Company believes
the acquired business complements its current cable operations and positions the
Company as a leading supplier of testing equipment and software for the cable
industry. The acquisition was recorded under the purchase method of accounting
and accordingly, the results of operations of the acquired business from
February 14, 2003 forward are included in the consolidated financial statements
of the Company. The purchase price allocation will be finalized when all
relevant amounts have been determined. Adjustments will be made to the various
assets acquired and liabilities assumed based on final valuations, and such
adjustments may be material.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $60,424,000 as of June 28, 2003, a decrease
of $12,765,000 or 17.4%, from the $73,189,000 of working capital as of December
31, 2002. The decrease in working capital is a result of the purchase of the
Cheetah operations and related acquisition expenses for $15,109,000 in cash on
February 13, 2003, partially offset by working capital generated from operations
in excess of purchases of property and equipment. As of June 28, 2003, the
Company had $42,241,000 of cash, cash equivalents and short-term investments
that are unrestricted and available for corporate purposes, including
acquisitions and other general working capital requirements.
The Company has in place a five-year $25.0 million Unsecured Revolving Credit
Facility (the "Facility") with a bank. Under the terms of the Facility, the
proceeds must be used for general corporate purposes, working capital needs, and
in connection with certain acquisitions. The Facility contains certain standard
covenants with which the Company must comply, including a minimum fixed charge
ratio, a minimum defined level of tangible net worth and a restriction on the
amount of capital expenditures that can be made on an annual basis, among
others. Commitment fees are payable quarterly at a rate of 0.25% of the unused
commitment. The Facility was amended in February 2003 in connection with the
acquisition of the Cheetah operations to adjust the determination of base net
worth. As of June 28, 2003 and currently, there are no outstanding borrowings
under the Facility, and the Company is in compliance with all debt covenants.
Borrowings for working capital are not currently anticipated, as the Company
believes its cash reserves and internally generated funds will be sufficient to
sustain working capital requirements for the foreseeable future.
Excluding the acquisition of Cheetah, planned capital expenditures for 2003 are
approximately $3,000,000. These planned capital projects include test fixtures
and development systems, computer and office equipment. Startup capital for the
new Cheetah operations totaled approximately $1,857,000, consisting of new
MIS/IT infrastructure as well as leasehold improvements.
The Board of Directors has authorized the continuation of a share repurchase
program initiated in 1997. Under the current extension, the Company may
repurchase a total of one million shares of its common stock before December 31,
2003. The Company has repurchased 461,800 shares of common stock since the
repurchase program was instituted. The repurchased shares are authorized for use
under certain employee benefit programs. The Company at its discretion will
determine the number of shares and the timing of such purchases, which will be
made using existing cash and short-term investments. No such shares have been
acquired in 2003.
28
COMMITMENTS
The Company leases office space and equipment under agreements that are
accounted for as operating leases. The office lease for the Cheswick facility
expires December 31, 2003 and is extended to December 31, 2005. The equipment
leases expire in August 2005 for the Cheswick facility and January 2007 for the
Bridgewater facility. On February 18, 2003, the Company entered into a lease for
office space to house the Cheetah operations in Sarasota, Florida under a
five-year lease expiring on April 26, 2008. The Company is also involved in
various month-to-month leases for research and development equipment. In
addition, the office lease includes provisions for possible adjustments in
annual future rental commitments relating to excess taxes and excess maintenance
costs that may occur. Minimum annual future rental commitments under
non-cancelable leases as of June 28, 2003 are:
2003 (Six Months) $ 790,000
2004 1,594,000
2005 1,592,000
2006 860,000
2007 432,000
2008 (Six Months) 102,000
KEY RATIOS
The Company's days sales outstanding (DSO) in accounts receivable trade, based
on the past twelve months rolling revenue, were 73 and 53 days as of June 28,
2003 and December 31, 2002, respectively. This increase is due primarily to the
fact that a much higher percentage of total quarterly revenue was recorded in
June of the second quarter of 2003 compared to December in the fourth quarter of
2002. The Company's inventory turnover ratio was 1.6 turns as of June 28, 2003
and 1.4 as of December 31, 2002. Management believes that operating cash flow
and cash reserves are adequate to both finance currently planned capital
expenditures and meet the overall liquidity needs of the Company.
OFF-BALANCE SHEET ARRANGEMENTS
The Company does not engage in transactions or arrangements with unconsolidated
or other special purpose entities.
BACKLOG
The Company's backlog consists of firm customer purchase orders and signed
software maintenance agreements. As of June 28, 2003, the Company had a backlog
of $8,122,000 compared to $7,179,000 at December 31, 2002 and $7,395,000 at June
29, 2002. The backlog at June 28, 2003 includes approximately $4,200,000 related
to software maintenance contracts, which will be earned and recognized as income
on a straight-line basis during the remaining terms of the underlying
agreements. Including these maintenance billings, the Company expects that
approximately 40% of current backlog will be recognized as revenue in the third
quarter of 2003. As of March 29, 2003, two of the Company's RBOC LoopCare annual
maintenance agreements were under negotiation and extension. One of those
agreements was signed during the second quarter of 2003. The second agreement
was signed subsequent to the end of the second quarter and thus is not included
in the backlog as of June 28, 2003. 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. While these fluctuations could
impact short-term results, they are not necessarily indicative of long-term
trends in sales of the Company's products.
29
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's current investment policy limits its 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. The Company believes it minimizes its
risk through proper diversification along with the requirements that the
securities must be of investment grade with an average rating of "A" or better
by Standard & Poor's. The Company holds its investment securities to maturity
and believes that earnings and cash flows will not be materially affected by
changes in interest rates, due to the nature and short-term investment horizon
for which these securities are invested.
ITEM 4. CONTROLS AND PROCEDURES
The Chief Executive Officer and the Chief Financial Officer of the Company (its
principal executive officer and principal financial officer, respectively) have
concluded, based on their evaluation as of the end of the period covered by this
report, that the Company's disclosure controls and procedures are effective to
ensure that information required to be disclosed by the Company in the reports
filed or submitted by it under the Securities Exchange Act of 1934, as amended,
is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms, and include controls and procedures
designed to ensure that information required to be disclosed by the Company in
such reports is accumulated and communicated to the Company's management,
including the Chief Executive Officer and Chief Financial Officer, as
appropriate to allow timely decisions regarding required disclosure.
There were no changes in the Company's internal control over financial reporting
or in other factors during the period covered by this report that have
materially affected or are likely to materially affect these controls.
30
PART II. OTHER INFORMATION
ITEM 5. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 13, 2003, the Company held its annual shareholders meeting. At the
meeting, James J. Barnes and Brian C. Mullins were elected to the Board of
Directors for three-year terms expiring at the annual meeting of shareholders in
2006. The term of Director Rocco L. Flaminio expired as of the 2003 shareholder
meeting. The terms of Directors Richard H. Heibel, M.D. and Robert W.
Kampmeinert continued after the meeting and will expire at the annual meeting of
shareholders in 2004. The terms of Directors Christian L. Allison, Daniel P.
Barry and David S. Egan also continued after the meeting and will expire at the
annual meeting of shareholders in 2005. The results of the voting were as
follows:
-------------------------------------------------------------------------------------------------------------
NOMINEE FOR DIRECTOR TOTAL VOTES CAST FOR AGAINST WITHHELD ABSTAINED
-------------------------------------------------------------------------------------------------------------
James J. Barnes 12,844,166 9,155,771 --- 3,688,395 ---
-------------------------------------------------------------------------------------------------------------
Brian C. Mullins 12,844,166 11,677,740 --- 1,166,426 ---
-------------------------------------------------------------------------------------------------------------
ITEM 6. EXHIBITS AND REPORTS FILED ON FORM 8-K
(a) Exhibits: The following exhibits are being filed with this report:
Exhibit
Number Description
------- -----------
15 Letter re unaudited interim financial information
31.1 Rule 13a - 14(a) Certification of Chief Executive Officer,
filed herewith
31.2 Rule 13a - 14(a) Certification of Chief Financial Officer,
filed herewith
32 Rule 13a -14(b) Certifications of Chief Executive Officer and
Chief Financial Officer, filed herewith
(b) Reports on Form 8-K:
1. A Report on Form 8-K was filed on April 16, 2003 under
Regulation FD, which contained as an exhibit the Company's
Earnings Release for the first quarter 2003.
2. An amendment to the Report on Form 8-K originally filed on
February 13, 2003 was filed on April 28, 2003, to state that
proforma financial information was not required to be filed
pursuant to Article 11 of Regulation S-X.
31
3. A report on Form 8-K was filed on April 30, 2003 under
Regulation FD, which contained as an exhibit a shareholder
presentation.
4. A report on Form 8-K was filed on May 15, 2003 under
Regulation FD, which contained as an exhibit a shareholder
presentation.
32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
TOLLGRADE COMMUNICATIONS, INC.
(REGISTRANT)
Dated: August 12, 2003 /S/ CHRISTIAN L. ALLISON
-----------------------------------
CHRISTIAN L. ALLISON
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
Dated: August 12, 2003 /S/ SAMUEL C. KNOCH
-----------------------------------
SAMUEL C. KNOCH
CHIEF FINANCIAL OFFICER AND TREASURER
Dated: August 12, 2003 /S/ CHARLES J. SHEARER
-----------------------------------
CHARLES J. SHEARER
CONTROLLER
33
EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
Exhibit
Number Description
------- -----------
15 Letter re unaudited interim financial information
31.1 Rule 13a - 14(a) Certification of Chief Executive Officer,
filed herewith
31.2 Rule 13a - 14(a) Certification of Chief Financial Officer,
filed herewith
32 Rule 13a - 14(b) Certifications of Chief Executive Officer and
Chief Financial Officer, filed herewith
34