Attached files
file | filename |
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EX-32 - EX-32 - TOLLGRADE COMMUNICATIONS INC \PA\ | l37955exv32.htm |
EX-10.3 - EX-10.3 - TOLLGRADE COMMUNICATIONS INC \PA\ | l37955exv10w3.htm |
EX-31.2 - EX-31.2 - TOLLGRADE COMMUNICATIONS INC \PA\ | l37955exv31w2.htm |
EX-31.1 - EX-31.1 - TOLLGRADE COMMUNICATIONS INC \PA\ | l37955exv31w1.htm |
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
þ | Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended September 26, 2009
o | Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from
to &nbs
p;
Commission File Number: 000-27312
TOLLGRADE COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania (State or other jurisdiction of incorporation or organization) |
25-1537134 (I.R.S. Employer Identification No.) |
493 Nixon Rd.
Cheswick, PA 15024
(Address of principal executive offices, including zip code)
Cheswick, PA 15024
(Address of principal executive offices, including zip code)
412-820-1400
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§ 229.405) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files).
Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act):
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
As of November 2, 2009, there were 12,693,635 shares of the Registrants Common Stock, $0.20 par
value per share, outstanding.
TOLLGRADE COMMUNICATIONS, INC.
Quarterly Report on Form 10-Q
For the Quarter Ended September 26, 2009
Table of Contents
For the Quarter Ended September 26, 2009
Table of Contents
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Exhibit 10.1 |
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Exhibit 10.2 |
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Exhibit 10.3 |
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Exhibit 31.1 |
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Exhibit 31.2 |
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Exhibit 32 |
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EX-10.3 | ||||||||
EX-31.1 | ||||||||
EX-31.2 | ||||||||
EX-32 |
2
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TOLLGRADE
COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value) (Unaudited)
(In thousands, except par value) (Unaudited)
September 26, 2009 | December 31, 2008 | |||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 65,179 | $ | 57,976 | ||||
Short-term investments |
198 | 2,419 | ||||||
Trade accounts receivable, net of allowance for
doubtful accounts of $1,564 in 2009 and $222 in 2008 |
6,782 | 9,361 | ||||||
Other receivables |
1,239 | 632 | ||||||
Inventories, net |
3,124 | 7,843 | ||||||
Prepaid expenses and deposits |
715 | 1,200 | ||||||
Deferred and refundable tax assets |
717 | 453 | ||||||
Current assets related to discontinued operations |
| 4,314 | ||||||
Total current assets |
77,954 | 84,198 | ||||||
Property and equipment, net |
3,185 | 2,661 | ||||||
Intangibles, net |
34,740 | 36,678 | ||||||
Deferred tax assets |
107 | 81 | ||||||
Other assets |
314 | 262 | ||||||
Noncurrent assets related to discontinued operations |
| 467 | ||||||
Total assets |
$ | 116,300 | $ | 124,347 | ||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 555 | $ | 1,198 | ||||
Accrued warranty |
620 | 927 | ||||||
Accrued expenses |
2,002 | 1,702 | ||||||
Accrued salaries and wages |
2,504 | 459 | ||||||
Income taxes payable |
264 | 267 | ||||||
Deferred revenue |
2,391 | 3,024 | ||||||
Current liabilities related to discontinued operations |
| 1,146 | ||||||
Total current liabilities |
8,336 | 8,723 | ||||||
Pension obligation |
1,046 | 889 | ||||||
Deferred tax liabilities |
2,144 | 1,792 | ||||||
Other tax liabilities |
689 | 489 | ||||||
Total liabilities |
12,215 | 11,893 | ||||||
Commitments and contingencies |
| | ||||||
Shareholders equity: |
||||||||
Common stock, $0.20 par value; 50,000 authorized
shares, issued shares, 13,735 in 2009 and 13,733 in
2008 |
2,744 | 2,744 | ||||||
Additional paid-in capital |
74,675 | 73,923 | ||||||
Treasury stock, at cost, 1,072 shares in 2009 and 2008 |
(8,081 | ) | (8,081 | ) | ||||
Retained earnings |
35,934 | 45,748 | ||||||
Accumulated other comprehensive loss |
(1,187 | ) | (1,880 | ) | ||||
Total shareholders equity |
104,085 | 112,454 | ||||||
Total liabilities and shareholders equity |
$ | 116,300 | $ | 124,347 | ||||
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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Table of Contents
TOLLGRADE
COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data) (Unaudited)
(In thousands, except per share data) (Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 26, | September 27, | September 26, | September 27, | |||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Revenues: |
||||||||||||||||
Products |
$ | 5,016 | $ | 7,417 | $ | 14,986 | $ | 19,419 | ||||||||
Services |
6,310 | 5,481 | 17,300 | 16,782 | ||||||||||||
Total revenues |
11,326 | 12,898 | 32,286 | 36,201 | ||||||||||||
Cost of sales: |
||||||||||||||||
Products |
2,537 | 2,823 | 8,090 | 8,601 | ||||||||||||
Services |
2,137 | 2,207 | 5,497 | 6,018 | ||||||||||||
Amortization of intangible assets |
659 | 772 | 1,949 | 2,353 | ||||||||||||
Impairment of intangible assets |
191 | | 191 | 202 | ||||||||||||
Inventory write-down |
3,070 | | 3,070 | 754 | ||||||||||||
Severance |
502 | | 778 | | ||||||||||||
Total cost of sales |
9,096 | 5,802 | 19,575 | 17,928 | ||||||||||||
Gross profit |
2,230 | 7,096 | 12,711 | 18,273 | ||||||||||||
Operating expenses: |
||||||||||||||||
Selling and marketing |
1,567 | 1,594 | 4,850 | 5,284 | ||||||||||||
General and administrative |
4,111 | 2,205 | 9,525 | 7,003 | ||||||||||||
Research and development |
2,353 | 2,513 | 6,795 | 8,077 | ||||||||||||
Severance |
1,114 | | 1,179 | 453 | ||||||||||||
Other impairments |
293 | | 293 | | ||||||||||||
Total operating expenses |
9,438 | 6,312 | 22,642 | 20,817 | ||||||||||||
(Loss) income from operations |
(7,208 | ) | 784 | (9,931 | ) | (2,544 | ) | |||||||||
Other income |
46 | 264 | 555 | 1,063 | ||||||||||||
(Loss) income before income taxes |
(7,162 | ) | 1,048 | (9,376 | ) | (1,481 | ) | |||||||||
(Benefit) provision for income taxes |
(80 | ) | 277 | 215 | 926 | |||||||||||
(Loss) income from continuing operations |
(7,082 | ) | 771 | (9,591 | ) | (2,407 | ) | |||||||||
Income
(loss) from discontinued operations, net of income taxes |
| 147 | (223 | ) | (3,434 | ) | ||||||||||
Net (loss) income |
$ | (7,082 | ) | $ | 918 | $ | (9,814 | ) | $ | (5,841 | ) | |||||
Earnings per share information: |
||||||||||||||||
Weighted average shares of common stock
and equivalents: |
||||||||||||||||
Basic |
12,682 | 13,173 | 12,681 | 13,170 | ||||||||||||
Diluted |
12,682 | 13,173 | 12,681 | 13,170 | ||||||||||||
(Loss) income per common and common
equivalent shares from continuing
operations: |
||||||||||||||||
Basic |
$ | (0.56 | ) | $ | 0.06 | $ | (0.76 | ) | $ | (0.18 | ) | |||||
Diluted |
$ | (0.56 | ) | $ | 0.06 | $ | (0.76 | ) | $ | (0.18 | ) | |||||
(Loss) income per common and common
equivalent shares from discontinued
operations: |
||||||||||||||||
Basic |
$ | 0.00 | $ | 0.01 | $ | (0.02 | ) | $ | (0.26 | ) | ||||||
Diluted |
$ | 0.00 | $ | 0.01 | $ | (0.02 | ) | $ | (0.26 | ) | ||||||
Net (loss) income per common and common
equivalent shares: |
||||||||||||||||
Basic |
$ | (0.56 | ) | $ | 0.07 | $ | (0.78 | ) | $ | (0.44 | ) | |||||
Diluted |
$ | (0.56 | ) | $ | 0.07 | $ | (0.78 | ) | $ | (0.44 | ) |
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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Table of Contents
TOLLGRADE
COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) (Unaudited)
(In thousands) (Unaudited)
Nine Months Ended | ||||||||
September 26, | September 27, | |||||||
2009 | 2008 | |||||||
Cash flows from operating activities : |
||||||||
Net loss |
$ | (9,814 | ) | $ | (5,841 | ) | ||
Loss from discontinued operations |
223 | 3,434 | ||||||
Adjustments to reconcile net loss to net cash
provided by operating activities |
||||||||
Impairment of intangible assets |
191 | 202 | ||||||
Impairment of other long live assets |
293 | | ||||||
Amortization expense |
1,949 | 2,353 | ||||||
Depreciation expense |
865 | 1,100 | ||||||
Stock-based compensation expense |
720 | 341 | ||||||
Valuation allowance |
| 129 | ||||||
Deferred income taxes |
247 | 190 | ||||||
Inventory write-down |
3,070 | 754 | ||||||
Provision for losses on inventory |
268 | 567 | ||||||
Provision for allowance for doubtful accounts |
1,178 | 178 | ||||||
Changes in assets and liabilities: |
||||||||
Accounts receivable-trade |
1,608 | 6,604 | ||||||
Other receivable |
(588 | ) | (522 | ) | ||||
Inventories |
1,384 | 455 | ||||||
Prepaid expenses, deposits and other assets |
506 | 285 | ||||||
Accounts payable |
(752 | ) | (5,989 | ) | ||||
Accrued warranty |
(307 | ) | (369 | ) | ||||
Accrued expenses, deferred revenue, and salaries & wages |
1,050 | (632 | ) | |||||
Income taxes payable |
(21 | ) | 612 | |||||
Net cash
provided by operating activities of discontinued operations |
12 | 37 | ||||||
Net cash provided by operating activities |
2,082 | 3,888 | ||||||
Cash flows from investing activities: |
||||||||
Proceeds on sale of cable product line |
3,012 | | ||||||
Proceeds from note receivable |
53 | | ||||||
Purchase of short-term investments |
| (2,279 | ) | |||||
Redemption/maturity of short-term investments |
2,220 | 1,922 | ||||||
Purchase of acquired assets |
(300 | ) | | |||||
Purchase of property and equipment |
(505 | ) | (528 | ) | ||||
Sale of assets held for sale |
| 263 | ||||||
Net cash used in investing activities of
discontinued operations |
(57 | ) | (37 | ) | ||||
Net cash provided by (used in) investing activities |
4,423 | (659 | ) | |||||
Net increase in cash and cash equivalents |
6,505 | 3,229 | ||||||
Effect of exchange rate changes on cash and cash
equivalents |
698 | (210 | ) | |||||
Cash and cash equivalents, beginning of period |
57,976 | 58,222 | ||||||
Cash and cash equivalents, end of period |
$ | 65,179 | $ | 61,241 | ||||
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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TOLLGRADE
COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS EQUITY
(In thousands) (Unaudited)
(In thousands) (Unaudited)
Common Stock | Accumulated Other | |||||||||||||||||||||||||||||||
Shares | Amount | Additional Paid-In | Treasury Stock | Retained Earnings | Comprehensive Loss | Total | Comprehensive Loss | |||||||||||||||||||||||||
Balance at December 31, 2008 |
13,733 | $ | 2,744 | $ | 73,923 | $ | (8,081 | ) | $ | 45,748 | $ | (1,880 | ) | $ | 112,454 | |||||||||||||||||
Compensation expense for
options and restricted
stock, net |
2 | | 752 | | | | 752 | |||||||||||||||||||||||||
Foreign currency translation |
| | | | | 693 | 693 | $ | 693 | |||||||||||||||||||||||
Net loss |
| | | | (9,814 | ) | | (9,814 | ) | (9,814 | ) | |||||||||||||||||||||
Comprehensive income |
| | | | | | | $ | (9,119 | ) | ||||||||||||||||||||||
Balance at September 26, 2009 |
13,735 | $ | 2,744 | $ | 74,675 | $ | (8,081 | ) | $ | 35,934 | $ | (1,187 | ) | $ | 104,085 | |||||||||||||||||
The
accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
We report our quarterly results for the first three interim periods based on fiscal quarters ending
on Saturdays and for the fourth interim period ending on December 31. For the periods presented
herein, our fiscal quarters ended September 26, 2009 (13 weeks) and September 27, 2008 (13 weeks).
The accompanying unaudited condensed consolidated financial statements included herein have been
prepared by Tollgrade Communications, Inc. (the Company or Tollgrade) 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 unaudited condensed consolidated financial
statements as of and for the three and nine month periods ended September 26, 2009 should be read
in conjunction with the Companys consolidated financial statements (and notes thereto) included in
the Companys Annual Report on Form 10-K for the year ended December 31, 2008. Accordingly, the
accompanying unaudited condensed consolidated financial statements do not include all of the
information and footnotes required by accounting principles generally accepted in the United States
of America for complete financial statements, although 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 statement of the accompanying unaudited
condensed consolidated financial statements have been included, and all adjustments are of a normal
and recurring nature. Operating results for the three and nine month periods ended September 26,
2009 are not necessarily indicative of the results that may be expected for the year ending
December 31, 2009.
RECENTLY ADOPTED ACCOUNTING GUIDANCE
On September 30, 2009, the Company adopted changes issued by the Financial Accounting Standards
Board (FASB) to the authoritative hierarchy of General Accepted Accounting Principals (GAAP).
These changes establish the FASB Accounting Standards CodificationTM(Codification) as
the source of authoritative accounting principles recognized by the FASB to be applied by
nongovernmental entities in the preparation of Condensed Consolidated Financial Statements in
conformity with GAAP. Rules and interpretive releases of the Securities and Exchange Commission
(SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC
registrants. The FASB will no longer issue new standards in the form of Statements, FASB Staff
Positions, or Emerging Issues Task Force Abstracts; instead the FASB will issue Accounting
Standards Updates. Accounting Standards Updates will not be authoritative in their own right as
they will only serve to update the Codification. These changes and the Codification itself do not
change GAAP. Other than the manner in which new accounting guidance is referenced, the adoption of
these changes had no impact on the Condensed Consolidated Condensed Consolidated Financial
Statements.
Fair Value Accounting
On June 30, 2009, the Company adopted changes issued by the FASB to fair value disclosures of
financial instruments. These changes require a publicly traded company to include disclosures about
the fair value of its financial instruments whenever it issues summarized financial information for
interim reporting periods. Such disclosures include the fair value of all financial instruments,
for which it is practicable to estimate that value, whether recognized or not recognized in the
statement of financial position; the related carrying amount of these financial instruments; and
the method(s) and
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significant assumptions used to estimate the fair value. Other than the required disclosures, the
adoption of these changes had no impact on the Condensed Consolidated Financial Statements.
On June 30, 2009, the Company adopted changes issued by the FASB to fair value accounting. These
changes provide additional guidance for estimating fair value when the volume and level of activity
for an asset or liability have significantly decreased and includes guidance for identifying
circumstances that indicate a transaction is not orderly. This guidance is necessary to maintain
the overall objective of fair value measurements, which is that fair value is the price that would
be received to sell an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date under current market conditions. The adoption of these
changes had no impact on the Condensed Consolidated Financial Statements.
On June 30, 2009, the Company adopted changes issued by the FASB to the recognition and
presentation of other-than-temporary impairments. These changes amend existing other-than-temporary
impairment guidance for debt securities to make the guidance more operational and to improve the
presentation and disclosure of other-than-temporary impairments on debt and equity securities. The
adoption of these changes had no impact on the Condensed Consolidated Financial Statements.
On January 1, 2009, the Company adopted changes issued by the FASB to fair value accounting and
reporting as it relates to nonfinancial assets and nonfinancial liabilities that are not recognized
or disclosed at fair value in the Condensed Consolidated Financial Statements on at least an annual
basis. These changes define fair value, establish a framework for measuring fair value in GAAP, and
expand disclosures about fair value measurements. This guidance applies to other GAAP that require
or permit fair value measurements and is to be applied prospectively with limited exceptions. The
adoption of these changes, as it relates to nonfinancial assets and nonfinancial liabilities, had
no impact on the Condensed Consolidated Financial Statements. These provisions will be applied at
such time a fair value measurement of a nonfinancial asset or nonfinancial liability is required,
which may result in a fair value that is materially different than would have been calculated prior
to the adoption of these changes.
Business Combinations and Consolidation Accounting
Effective January 1, 2009, the Company adopted changes issued by the FASB on April 1, 2009
regarding accounting for business combinations. These changes apply to all assets acquired and
liabilities assumed in a business combination that arise from certain contingencies and requires
(i) an acquirer to recognize at fair value, at the acquisition date, an asset acquired or liability
assumed in a business combination that arises from a contingency if the acquisition-date fair value
of that asset or liability can be determined during the measurement period otherwise the asset or
liability should be recognized at the acquisition date if certain defined criteria are met; (ii)
contingent consideration arrangements of an acquiree assumed by the acquirer in a business
combination be recognized initially at fair value; (iii) subsequent measurements of assets and
liabilities arising from contingencies be based on a systematic and rational method depending on
their nature and contingent consideration arrangements be measured subsequently; and (iv)
disclosures of the amounts and measurement basis of such assets and liabilities and the nature of
the contingencies. These changes were applied to an acquisition we completed in April 2009.
On January 1, 2009, the Company adopted changes issued by the FASB to accounting for business
combinations. While retaining the fundamental requirements of accounting for business combinations,
including that the purchase method be used for all business combinations and for an acquirer to be
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identified for each business combination, these changes define the acquirer as the entity that
obtains control of one or more businesses in the business combination and establishes the
acquisition date as the date that the acquirer achieves control instead of the date that the
consideration is transferred. These changes require an acquirer in a business combination,
including business combinations achieved in stages (step acquisition), to recognize the assets
acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition
date, measured at their fair values as of that date, with limited exceptions. This guidance also
requires the recognition of assets acquired and liabilities assumed arising from certain
contractual contingencies as of the acquisition date, measured at their acquisition-date fair
values. Additionally, these changes require acquisition-related costs to be expensed in the period
in which the costs are incurred and the services are received instead of including such costs as
part of the acquisition price. This guidance was applied to an acquisition we completed in
April 2009.
Other
On June 30, 2009, the Company adopted changes issued by the FASB to accounting for and disclosure
of events that occur after the balance sheet date but before Condensed Consolidated Financial
Statements are issued or are available to be issued, otherwise known as subsequent events.
Specifically, these changes set forth the period after the balance sheet date during which
management of a reporting entity should evaluate events or transactions that may occur for
potential recognition or disclosure in the Condensed Consolidated Financial Statements, the
circumstances under which an entity should recognize events or transactions occurring after the
balance sheet date in its Condensed Consolidated Financial Statements, and the disclosures that an
entity should make about events or transactions that occurred after the balance sheet date. The
adoption of these changes had no impact on the Condensed Consolidated Financial Statements as
management already followed a similar approach prior to the adoption of this new guidance. The
Company has evaluated subsequent events in accordance with the guidance through November 3, 2009
and concluded that no events or transactions required disclosure or recognition in the Condensed
Consolidated Financial Statements.
On January 1, 2009, the Company adopted changes issued by the FASB to accounting for intangible
assets. These changes amend the factors that should be considered in developing renewal or
extension assumptions used to determine the useful life of a recognized intangible asset in order
to improve the consistency between the useful life of a recognized intangible asset outside of a
business combination and the period of expected cash flows used to measure the fair value of an
intangible asset in a business combination. The adoption of these changes had no impact on the
Condensed Consolidated Financial Statements.
On January 1, 2009, the Company adopted changes issued by the FASB to the calculation of earnings
per share. These changes state that unvested share-based payment awards that contain nonforfeitable
rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities
and shall be included in the computation of earnings per share pursuant to the two-class method for
all periods presented. The adoption of these changes had no impact on the Condensed Consolidated
Financial Statements.
RECENTLY ISSUED ACCOUNTING GUIDANCE
In August 2009, the FASB issued changes to fair value accounting for liabilities. These changes
clarify existing guidance that in circumstances in which a quoted price in an active market for the
identical
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liability is not available, an entity is required to measure fair value using either a valuation
technique that uses a quoted price of either a similar liability or a quoted price of an identical
or similar liability when traded as an asset, or another valuation technique that is consistent
with the principles of fair value measurements, such as an income approach (e.g., present value
technique). This guidance also states that both a quoted price in an active market for the
identical liability and a quoted price for the identical liability when traded as an asset in an
active market when no adjustments to the quoted price of the asset are required are Level 1 fair
value measurements. These changes become effective for the Company on October 1, 2009. Management
has determined that the adoption of these changes will not have an impact on the Condensed
Consolidated Financial Statements.
In December 2008, the FASB issued changes to employers disclosures about postretirement benefit
plan assets. These changes provide guidance on an employers disclosures about plan assets of a
defined benefit pension or other postretirement plan. This guidance is intended to ensure that an
employer meets the objectives of the disclosures about plan assets in an employers defined benefit
pension or other postretirement plan to provide users of Condensed Consolidated Financial
Statements with an understanding of the following: how investment allocation decisions are made;
the major categories of plan assets; the inputs and valuation techniques used to measure the fair
value of plan assets; the effect of fair value measurements using significant unobservable inputs
on changes in plan assets; and significant concentrations of risk within plan assets. These changes
become effective for the Company on December 31, 2009. As these changes only require enhanced
disclosures, management has determined that the adoption of these changes will not have an impact
on the Condensed Consolidated Financial Statements.
In October 2009, the FASB issued authoritative guidance on revenue recognition that will become
effective for us beginning July 1, 2010, with earlier adoption permitted. Under the new guidance on
arrangements that include software elements, tangible products that have software components that
are essential to the functionality of the tangible product will no longer be within the scope of
the software revenue recognition guidance, and software-enabled products will now be subject to
other relevant revenue recognition guidance. Additionally, the FASB issued authoritative guidance
on revenue arrangements with multiple deliverables that are outside the scope of the software
revenue recognition guidance. Under the new guidance, when vendor specific objective evidence or
third party evidence for deliverables in an arrangement cannot be determined, a best estimate of
the selling price is required to separate deliverables and allocate arrangement consideration using
the relative selling price method. The new guidance includes new disclosure requirements on how the
application of the relative selling price method affects the timing and amount of revenue
recognition. We believe adoption of this new guidance will not have a material impact on our
financial statements.
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2. ACQUISITIONS AND DISCONTINUED OPERATIONS
On April 15, 2009, we entered into a multi-year managed services agreement with a leading global
network equipment provider, pursuant to which we provide customer support and engineering services
capabilities. We entered into this agreement as part of our continued strategic focus to grow our
managed services business. In connection with the agreement, we acquired certain assets of a
division of the global network equipment provider. The acquisition was recorded under the purchase
method of accounting in accordance generally accepted accounting pronouncements. Accordingly, the
results of operations of the acquired assets are included in our condensed consolidated financial
statements for the three and nine month periods ended September 26, 2009.
On May 27, 2009, we completed the sale of our cable product line to private equity buyers in
Pittsburgh, Pennsylvania. This divesture allows us to continue to focus our business on our core
telecommunications markets and customers as the cable product line no longer supported our
refocused growth strategies.
The assets and liabilities, results of operations and cash flows of the cable product line have
been classified as discontinued operations in the Condensed Consolidated Financial Statements for
all periods presented through the date of sale. Cash flows for cable have been segregated in the
Condensed Consolidated Statement of Cash Flows as separate line items within operating and
investing activities.
The Company determined that the operations and cash flows of the cable product line have been
eliminated from the ongoing operations of the Company as a result of the disposal transaction and
that the Company will not have any significant continuing involvement in the buyers operations.
The following table details selected financial information for the cable product line included
within discontinued operations:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 26, | September 27, | September 26, | September 27, | |||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Revenues: |
||||||||||||||||
Products |
$ | | $ | 1,877 | $ | 2,376 | $ | 5,508 | ||||||||
Services |
| 431 | 723 | 1,278 | ||||||||||||
$ | | $ | 2,308 | $ | 3,099 | $ | 6,786 | |||||||||
Loss from discontinued operations |
||||||||||||||||
Loss from discontinued operations, before tax |
$ | | $ | 147 | $ | (223 | ) | $ | (3,434 | ) | ||||||
Income tax expense |
| | | | ||||||||||||
Loss from discontinued operations, net of tax |
$ | | $ | 147 | $ | (223 | ) | $ | (3,434 | ) |
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The major classes of assets and liabilities related to discontinued operations are as follows:
December 31, 2008 | ||||
ASSETS |
||||
Accounts
receivable trade, net of allowance for doubtful accounts |
$ | 1,199 | ||
Accounts receivable other |
36 | |||
Inventories |
2,830 | |||
Prepaid expenses |
249 | |||
Property and equipment, net |
292 | |||
Intangibles and capitalized software, net |
175 | |||
Assets related to discontinued operations |
$ | 4,781 | ||
LIABILITIES |
||||
Accounts payable |
$ | 66 | ||
Accrued warranty |
664 | |||
Accrued expenses |
142 | |||
Accrued royalties |
15 | |||
Deferred revenue |
259 | |||
Liabilities related to discontinued operations |
$ | 1,146 |
3. FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date. The fair
value hierarchy distinguishes between (1) market participant assumptions developed based on market
data obtained from independent sources (observable inputs) and (2) an entitys own assumptions
about market participant assumptions developed based on the best information available in the
circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which
gives the highest priority to unadjusted quoted prices in active markets for identical assets or
liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of
the fair value hierarchy are described below:
| Level 1 Unadjusted quoted prices in active markets that are accessible at the
measurement date for identical, unrestricted assets or liabilities; |
||
| Level 2 Inputs other than quoted prices included within Level 1 that are observable
for the asset or liability, either directly or indirectly, including quoted prices for
similar assets or liabilities in active markets; quoted prices for identical or similar
assets or liabilities in markets that are not active; inputs other than quoted prices that
are observable for the asset or liability (e.g., interest rates); and inputs that are
derived principally from or corroborated by observable market data by correlation or other
means; and |
||
| Level 3 Inputs that are both significant to the fair value measurement and
unobservable. |
The fair value of cash equivalents was $53.8 million and $48.0 million at September 26, 2009 and
December 31, 2008, respectively. These financial instruments are classified in Level 1 of the fair
value hierarchy.
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4. STOCK COMPENSATION PLANS AND ACCOUNTING FOR STOCK-BASED COMPENSATION EXPENSE
The Plans
We currently sponsor one active stock compensation plan. In March 2006, the Company adopted the
2006 Amended and Restated Long-Term Incentive Compensation Plan (the 2006 Plan), which was
approved by the shareholders on May 9, 2006 and effectively replaced the 1995 Long-Term Incentive
Plan, which by its terms does not allow grants to be made after October 15, 2005. The 2006 Plan
provides that participants may be directors, officers and other employees. At the time it was
adopted, the 2006 Plan authorized up to 1,300,000 shares available for grant. On May 6, 2009, the
Board of Directors approved, subject to shareholder approval, an amendment to the 2006 Plan to
increase the number of shares authorized thereunder from 1,300,000 to 2,800,000. The amendment was
approved by the shareholders at the Companys 2009 Annual Meeting of Shareholders held on August 5,
2009.
Under the 2006 Plan, participants may be granted various types of equity awards, including
restricted shares and/or options to purchase shares of the Companys common stock. The grant price
on any such shares or options is equal to the quoted fair market value of the Companys shares at
the date of the grant, as defined in the 2006 Plan. Restricted shares will vest in accordance with
the terms of the applicable award agreement and the 2006 Plan. The 2006 Plan requires that
non-performance-based restricted stock grants to employees vest in not less than three years, while
performance-based restricted stock grants may vest after one year. Grants of restricted stock to
directors may vest after one year. Options granted generally vest over time. Historically, such
periods have typically been two years with one-third vested at the date of grant, one-third at the
end of one year, and one-third at the end of two years. Beginning in December 2007, stock option
grants have been made with vesting over three years, with one-third of such grants vesting at the
end of each year following the date of grant. The 1998 Employee Incentive Plan (the 1998 Plan) by
its terms does not allow grants to be made after January 29, 2008
Stock-Based Compensation Expense
During the first quarter of 2009, the Compensation Committee of the Board of Directors approved the
grant of a total of 394,000 stock options and 2,351 restricted shares under the 2006 Plan. Of these
grants, 30,000 stock options and 2,351 restricted shares were issued to non-employee directors and
the remaining 364,000 stock options were issued to employees, including the CEO and other key
executive officers. The stock options granted to non-employee directors vested immediately upon
issuance. The restricted share award granted to one non-employee director gave the director the
right to receive the shares one year following the date of grant, regardless of whether the
director is still serving on the Board of Directors, unless the director was removed from the Board
for cause during that time. During the one year restriction period, the director has the right to
vote while the restricted shares are restricted, but is not permitted to trade them. The stock
options granted to employees vest over a three year period, with one-third vesting on each
anniversary of the grant date.
During the second quarter of 2009, the Compensation Committee of the Board of Directors approved
the grant of a total of 25,000 stock options to certain key employees in connection with their
hiring or promotion. No restricted shares were granted in the second quarter of 2009. The stock
options granted
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to employees vest over a three year period, with one-third vesting on each anniversary of the grant
date.
During the third quarter of 2009, the Compensation Committee of the Board of Directors approved the
grant of a total of 48,500 stock options under the 2006 Plan. Of these grants, 35,000 stock options
were issued to non-employee directors and the remaining 13,500 stock options were issued to
employees. The stock options granted to non-employee directors vested immediately upon issuance.
The stock options granted to employees vest over a three year period, with one-third vesting on
each anniversary of the grant date.
Total stock-based compensation expense recognized from continuing operations for the three and nine
month periods ended September 26, 2009 was an expense of $0.2 million and $0.7 million,
respectively. Total stock-based compensation expense recognized from continuing operations for the
three and nine month periods ended September 27, 2008 was $0.2 million $0.3 million, respectively.
The unamortized stock-based compensation expense from continuing operations related to stock
options and restricted stock totaled $1.4 million at September 26, 2009.
Total stock-based compensation expense recognized from discontinued operations for the three and
nine month periods ended September 26, 2009 and September 27, 2008 was an expense of less then $0.1
million for each period.
Transactions involving stock options under the Companys various plans and otherwise are summarized
below:
Number of | Range of | Weighted Average | ||||||||||
Shares | Option Prices | Exercise Price | ||||||||||
Outstanding, December 31, 2008 |
1,605,490 | $ | 3.27 159.19 | $ | 23.08 | |||||||
Granted |
467,500 | 5.17 5.38 | 5.36 | |||||||||
Exercised |
| | | |||||||||
Cancelled/Forfeited/Expired |
(252,921 | ) | 3.27 159.19 | 19.16 | ||||||||
Outstanding, September 26, 2009 |
1,820,069 | $3.27 159.19 | $ | 19.08 | ||||||||
5. SEVERANCE
During the third quarter of 2009, we developed a plan to reduce and restructure our workforce
across all levels of the organization in an effort to reduce costs and to better align our human
resources to ongoing revenue streams. The total severance charge associated with this
plan was approximately $1.4 million of which $0.5 million was recorded as cost of sales expense and
$0.9 million was recorded as an operating expense. Additionally, during the third quarter of 2009,
we incurred $0.2 million of severance charges related to the departure of our former chief
financial officer. We expect no further expenses related to these actions.
During the first half of 2009, we began to outsource in-house manufacturing functions to third
parties and as such reduced our production staff in July 2009. Severance expense related to this
action amounted to approximately $0.1 million and was recorded in the second quarter of 2009. In
addition,
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during the first quarter of 2009, we realigned our research and development staffing to existing
projects and made staff reductions in the areas of field service and sales. Severance expense
associated with this action amounted to approximately $0.2 million. We expect no further expenses
related to these earlier actions.
During the first quarter of 2008, the Company announced a restructuring program which included the
realignment of existing resources to new projects, reduced the Companys engineering, field service
and sales staff along with reducing a number of senior management positions. Total severance
expense associated with that restructuring program was approximately $0.5 million and was recorded
in the first quarter of 2008. We expect no further expenses related to this action.
6. INTANGIBLE ASSETS
The following information is provided regarding the Companys intangible assets (in thousands):
September 26, 2009 | ||||||||||||||||||||
(Unaudited) | ||||||||||||||||||||
Useful | Accumulated | |||||||||||||||||||
Amortizing Intangible Assets: | Life (Years) | Gross | Amortization | Impairments | Net | |||||||||||||||
Post warranty service agreements |
6-50 | $ | 37,856 | $ | 5,064 | $ | | $ | 32,792 | |||||||||||
Technology |
3-10 | 14,003 | 12,329 | 191 | 1,483 | |||||||||||||||
Customer relationships |
5-10 | 933 | 577 | | 356 | |||||||||||||||
Tradenames and other |
3-10 | 538 | 429 | | 109 | |||||||||||||||
Total Intangible Assets |
$ | 53,330 | $ | 18,399 | $ | 191 | $ | 34,740 | ||||||||||||
December 31, 2008 | ||||||||||||||||||||
(Unaudited) | ||||||||||||||||||||
Useful | Accumulated | |||||||||||||||||||
Amortizing Intangible Assets: | Life (Years) | Gross | Amortization | Impairments | Net | |||||||||||||||
Post warranty service agreements |
6-50 | $ | 37,563 | $ | 3,752 | $ | | $ | 33,811 | |||||||||||
Technology |
3-10 | 13,987 | 11,700 | 30 | 2,257 | |||||||||||||||
Customer relationships |
5-10 | 904 | 334 | 112 | 458 | |||||||||||||||
Tradenames and other |
0.5-10 | 534 | 322 | 60 | 152 | |||||||||||||||
Total Intangible Assets |
$ | 52,988 | $ | 16,108 | $ | 202 | $ | 36,678 | ||||||||||||
Differences between reported amortization expense and the
change in reported accumulated amortization may vary because of
foreign Currency translation differences between balance sheet and
income statement.
Amortization
expense is estimated to be $0.6 million for the remainder of 2009 and $2.1
million, $1.7 million, $1.2 million, $1.1 million and $28.0 million for the years ended December
31, 2010, 2011, 2012 and 2013 and thereafter, respectively.
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Impairments
Long-Lived Assets
We consider the impairment of long-lived assets upon a change in business
conditions or upon the occurrence of a triggering event.
During the third quarter 2009, the Company recorded an impairment of long-lived assets of $0.2
million related to an intangible asset associated with a product line that the Company is discontinuing and $0.3 million of other long-lived assets. The decision to discontinue
the product line was made in the third quarter of 2009. The projected free cash flow to be derived
from the product line was not sufficient to support the intangible asset book value at September
26, 2009. In the third quarter of 2009 our decision to eliminate a product from our development
road map caused the impairment of other long-lived assets.
During the first quarter 2009, the Company recorded an impairment of long-lived assets of $0.2
million as a result of a triggering event. The triggering event, which occurred subsequent to the
end of the quarter but prior to reporting our quarterly results, was that it became probable that
the Company would sell substantially all of the assets of its cable product line. The Company
considered the likelihood of the sale and recorded the charge based on a comparison of the
negotiated price to the net carrying value of the cable product line assets. The impairment was
based on market information that would be considered Level 2 in the fair value hierarchy.
7. INVENTORIES
Inventories consisted of the following (in thousands):
Year Ended | ||||||||
September 26, 2009 | December 31, 2008 | |||||||
(Unaudited) | (Unaudited) | |||||||
Raw materials |
$ | 3,741 | $ | 4,621 | ||||
Work in process |
2,037 | 3,142 | ||||||
Finished goods |
1,999 | 1,782 | ||||||
7,777 | 9,545 | |||||||
Reserves for slow moving and obsolete inventory |
(4,653 | ) | (1,702 | ) | ||||
Net Inventory |
$ | 3,124 | $ | 7,843 | ||||
Throughout 2009, we began to outsource our in-house production capabilities to third-party vendors.
We expect to outsource 100 percent to third parties by the end of 2009. As such, during the third
quarter of 2009, the Company implemented a program to evaluate certain legacy products based on
anticipated future consumption and technological end-of-life cycle. As a result of this
evaluation, we have reserved an additional $3.1 million for slow-moving and obsolete inventory in
the third quarter of 2009.
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8. PRODUCT WARRANTY
Activity in the warranty accrual is as follows (in thousands):
Nine Months Ended | Year Ended | |||||||
September 26, 2009 | December 31, 2008 | |||||||
(Unaudited) | (Unaudited) | |||||||
Balance at the beginning of the period |
$ | 927 | $ | 1,147 | ||||
Accruals for warranties issued during the period |
411 | 1,683 | ||||||
Settlements during the period |
(718 | ) | (1,903 | ) | ||||
Balance at the end of the period |
$ | 620 | $ | 927 | ||||
9. PER SHARE INFORMATION
Net (loss) income per share has been computed in accordance with GAAP for all periods presented.
GAAP requires companies with complex capital structures to report earnings per share on a basic and
diluted basis. Basic earnings per share is computed using the weighted average number of shares
outstanding during the period, while diluted earnings per share is calculated to reflect the
potential dilution that occurs related to issuance of capital stock option grants. The three and
nine month periods ended September 26, 2009 and September 27, 2008 do not include the effect of
dilutive securities because inclusion would be anti-dilutive to the earnings per share calculation.
A reconciliation of net (loss) income per share is as follows (in thousands, except per share
data):
Three Months Ended | Nine Months Ended | |||||||
September 26, 2009 | September 26, 2009 | |||||||
(Unaudited) | (Unaudited) | |||||||
Loss from continuing operations |
$ | (7,082 | ) | $ | (9,591 | ) | ||
Loss from discontinued operations, net of income taxes |
| (223 | ) | |||||
Net loss from operations |
(7,082 | ) | (9,814 | ) | ||||
Common and common equivalent shares: |
||||||||
Weighted average common shares outstanding |
12,682 | 12,681 | ||||||
Effect of dilutive securities stock options |
12,682 | 12,681 | ||||||
Loss per share from continuing operations: |
||||||||
Basic |
$ | (0.56 | ) | $ | (0.76 | ) | ||
Diluted |
$ | (0.56 | ) | $ | (0.76 | ) | ||
Loss per share from discontinued operations: |
||||||||
Basic |
$ | | $ | (0.02 | ) | |||
Diluted |
$ | | $ | (0.02 | ) | |||
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Three Months Ended | Nine Months Ended | |||||||
September 27, 2008 | September 27, 2008 | |||||||
(Unaudited) | (Unaudited) | |||||||
Income (loss) from continuing operations |
$ | 771 | $ | (2,407 | ) | |||
Income
(loss) from discontinued operations, net of income taxes |
147 | (3,434 | ) | |||||
Net income (loss) from operations |
918 | (5,841 | ) | |||||
Common and common equivalent shares: |
||||||||
Weighted average common shares outstanding |
13,173 | 13,170 | ||||||
Effect of dilutive securities stock options |
13,173 | 13,170 | ||||||
Loss per share from continuing operations: |
||||||||
Basic |
$ | 0.06 | $ | (0.18 | ) | |||
Diluted |
$ | 0.06 | $ | (0.18 | ) | |||
Loss per share from discontinued operations |
||||||||
Basic |
$ | 0.01 | $ | (0.26 | ) | |||
Diluted |
$ | 0.01 | $ | (0.26 | ) | |||
As of September 26, 2009 and September 27, 2008, 1.7 and 1.9 million equivalent shares were anti-dilutive,
respectively. Basic earnings per share are
calculated on the actual number of weighted average common shares outstanding for the period, while
diluted earnings per share must include the effect of any dilutive securities.
10. CONTINGENCIES AND COMMITMENTS
We lease office space and equipment under agreements which are accounted for as operating leases.
The office lease for our Cheswick, Pennsylvania facility was extended on September 14, 2009 until
March 31, 2011. The lease for our Piscataway, New Jersey location expires on April 30, 2012. As a
result of our acquisition of the Broadband Test Division, we have leases in Bracknell, United
Kingdom; Kontich, Belgium; and Wuppertal, Germany, which expire on December 24, 2012, April 1,
2012, and January 31, 2010, respectively. The Company is also involved in various month-to-month
leases for research and development and office equipment at all five locations. In addition, one of
the office leases include provisions for possible adjustments in annual future rental commitments
relating to excess taxes, excess maintenance costs that may occur and increases in rent based on
the consumer price index and based on increases in our annual lease commitments; however, none of
these commitments are material.
Future minimum lease payments under operating leases having initial or remaining non-cancellable
lease terms in excess of one year are as follows (in thousands):
At September 26, 2009 | ||||
2009 (remaining period) |
$ | 252 | ||
2010 |
973 | |||
2011 |
618 | |||
2012 |
341 | |||
2013 |
| |||
Thereafter |
| |||
$ | 2,184 | |||
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The lease expense for the three and nine month periods ended September 26, 2009 and September 27,
2008 was $0.2 million and $0.6 million and $0.2 million and $0.8 million, respectively.
In addition, the Company is, from time to time, party to various legal claims and disputes, either
asserted or unasserted, which arise in the ordinary course of business. While the final resolution
of these matters cannot be predicted with certainty, the Company does not believe that the outcome
of any of these claims will have a material adverse effect on the Companys consolidated financial
position, or annual results of operations or cash flow.
11. INCOME TAXES
For the third quarter ended September 26, 2009, we recorded at tax benefit of approximately $0.1
million compared to an income tax expense of approximately $0.2 million for the third quarter of
September 27, 2008. The income tax benefit recorded in the third quarter of 2009 primarily relates
to adjustments from revising our foreign source projected income estimates in certain countries
while the same third quarter 2008 income tax expense was primarily related to foreign income tax
obligations generated by profitable operations in foreign jurisdictions, as well as adjustments to
reserves for uncertain tax positions.
We had unrecognized tax benefits (including penalties and interest) of $0.7 million and $0.5
million on September 26, 2009 and December 31, 2008, respectively, all of which, if recorded, would
impact the 2009 annual effective tax rate. As a result, the amount of
unrecognized tax benefits could change by less than $0.1 million in the next 12 months primarily
due to tax examinations and the expiration of statutes related to specific tax positions.
We recognize interest and penalties related to uncertain tax positions as income tax
expense. As of September 26, 2009 and December 31, 2008, we
had an insignificant amount
of accrued interest related to uncertain tax positions in both foreign and domestic jurisdictions.
As of September 26, 2009, the tax years that remain subject to examination by major jurisdiction
generally are:
United States Federal
|
2006 and forward | |
United States State | 2005 and forward | |
Europe | 2007 and forward |
At September 26, 2009, we intend to permanently reinvest accumulated earnings in foreign
subsidiaries. As a result, deferred taxes have not been provided on foreign earnings at September
26, 2009. If our intention changes and such amounts are expected to be repatriated, deferred taxes
will be provided.
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12. MAJOR CUSTOMERS AND INTERNATIONAL SALES
Our customers include the top telecom providers and numerous independent telecom and broadband
providers around the world. Our primary customers for our telco products and services are large
domestic and European telecommunications service providers. We track our telco sales by two large
customer groups, the first of which includes AT&T, Verizon and Qwest (referred to herein as large
domestic carriers), and the second of which includes certain large international telephone service
providers in Europe, namely British Telecom, Royal KPN N.V., Belgacom S.A., Deutsche Telecom AG
(T-Com) and Telefónica O2 Czech Republic, a.s. (collectively referred to herein as the European
Telcos).
For the third quarter of 2009, sales to the large domestic customers accounted for approximately
33% of our total revenue, compared to approximately 46% of total revenue for the third quarter of
2008. Sales to our largest customer, AT&T, comprised approximately 17% of our total revenue for the
third quarter of 2009, compared to 33% of our total revenue for the third quarter of 2008. Sales in
the third quarter of 2009 and 2008 to the European Telcos accounted for approximately 17% and 23%
respectively, of total revenue.
In the second quarter of 2009, we entered into a multi-year managed services contract with a large
global network equipment provider to provide customer support and engineering services. For the
third quarter of 2009, sales to this customer were $1.9 million, or approximately 17% of total
revenue.
As of September 26, 2009, the Company had approximately $4.5 million of accounts receivable with
four customers, each of which individually exceeded 10% of our September 26, 2009 receivable
balances. As of December 31, 2008, the Company had approximately $4.5 million of accounts
receivable with three customers, each of which individually exceeded 10% of our December 31, 2008
receivable balances.
For the nine months ended September 26, 2009 and September 27, 2008, sales to the large domestic
customers accounted for approximately 40% and 36%, respectively, of our total revenue. Sales to
AT&T comprised approximately 22% and 24% of our total revenue for the nine months ended September
26, 2009 and September 27, 2008, respectively. Sales for the nine months ended September 26, 2009
and September 27, 2008 to the European Telcos accounted for approximately 21% and 44% of total
revenue, respectively. For the nine months ended September 26, 2009, managed service sales to a
large global network equipment provider were $3.5 million accounting for approximately 11% of total
revenue.
International
sales represented approximately $3.7 million or 33% of our total revenue for the
quarter ended September 26, 2009, compared to $4.4 million or approximately 34% for the quarter
ended September 27, 2008. Our international sales were primarily in three geographic areas based
upon customer location for the quarters ended September 26, 2009 and September 27, 2008: the
Americas (excluding the United States); Europe, the Middle East and Africa (EMEA); and Asia.
Sales for the Americas were approximately $1.1 million and $0.5 million, sales for EMEA were $2.5
million and $3.9 million, and sales in Asia were approximately $0.1 million and less then $0.1
million for the quarters ended September 26, 2009 and September 27, 2008, respectively.
International
sales represented approximately $11.1 million, or 34% of our total revenue for the nine
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months
ended September 26, 2009 compared to $16.5 million, or 46%, for the nine months ended
September 27, 2008. Our international sales were primarily in three geographic areas based upon
customer location for the nine months ended September 26, 2009: the Americas (excluding the United
States); EMEA; and Asia. Sales in the Americas were $2.8 million and $1.5 million, sales in EMEA
were approximately $7.7 million and $14.2 million, and sales in Asia were $0.6 million and $0.8
million for the nine months ended September 26, 2009 and the nine months ended September 27, 2008,
respectively.
13. SUBSEQUENT EVENT
Our Board of Directors unanimously adopted a new compensation program for non-employee directors on
October 19, 2009. Under the newly adopted program non-employee directors will receive annual
compensation comprised of the following elements: a retainer of $20,000 payable in cash, restricted
stock under our 2006 Long-Term Incentive Compensation Plan having a market value of $35,000 on the
date of grant, a cash retainer of $10,000 and $7,500, respectively, for the Chairperson of the
Audit and Compensation Committees, and a cash retainer of $5,000 for the Chairperson of each of the
Corporate Governance and Investment Committees.
Under the newly adopted program, as compared with the Boards prior compensation program, the Board
reduced the annual cash retainer payable to non-employee directors by $10,000, and reduced the
annual cash retainers paid to the Chairpersons of the Audit, Compensation, Corporate Governance and
Investment Committees by $2,500 for each Committee. In addition, the Board has eliminated
per-meeting fees for the Board and all of its Committees. Effective with the October 19, 2009 Board
meeting, the equity component of the annual compensation for non-employee directors will be granted
on the date of the regularly scheduled meeting of the Board held in October of each year, and the
annual cash retainers will be paid in equal quarterly installments.
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Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion should be read in conjunction with the Unaudited Condensed Consolidated
Financial Statements and Notes thereto appearing elsewhere in this report. Additionally, when used
in this form 10-Q unless the context requires otherwise, the terms we, our, and us refer to
Tollgrade Communications, Inc.
CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995.
This MD&A should be read in conjunction with our annual report on Form 10-K, as amended by Form
10-K/A, for the year ended December 31, 2008 (the Form 10-K).
Certain statements contained in this MD&A and elsewhere in this report are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties. These
statements relate to future events or our future financial performance. In some cases,
forward-looking statements can be identified by terminology such as believe, expect, intend,
may, will, should, could, potential, continue, estimate, plan, or anticipate, or
the negatives thereof, other variations thereon or compatible terminology. These statements involve
a number of risks and uncertainties. Actual events or results may differ materially from any
forward-looking statement as a result of various factors, including those described in Part II,
Item 1A below under Risk Factors.
Cable Product Line
On May 27, 2009 we completed the sale of our cable product line for consideration of approximately
$3.2 million, subject to adjustment for certain items pursuant to the terms of the sale agreement.
The cable product line no longer supported our refocused growth strategy and the divestiture allows
us to continue to focus on our core telecommunications markets and customers. Unless otherwise
indicated, references to revenues and earnings throughout this Managements Discussion &
Analysis refer to revenues and earnings from continuing operations and do not include revenue and
earnings from the discontinued cable product line. Similarly, discussion of other matters in our
Condensed Consolidated Financial Statements refers to continuing operations unless otherwise
indicated. The results from the divested product line are reported in discontinued operations.
Overview
Our traditional product lines and the markets in which we compete have faced continued pressure
throughout the quarter as was the case throughout the first half of 2009. This pressure came
through a variety of sources, including shifting customer spending, the economic slowdown which has
impacted capital expense spending, and competitive market conditions.
Our traditional customer base continues to minimize spending on legacy areas of their networks.
This has resulted in reduced demand for a number of our copper-based products throughout the first
nine months of 2009. Since the end of 2008, the general economic environment has challenged many
companies, including our customers. Our customers, the service providers, are delaying capital
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expense decisions while they wait for the economy to recover and their own businesses to stabilize.
Our quarterly revenue opportunities have declined in step with the delay in their decision
processes. Competitively, our solutions have historically consisted of hardware and software
combinations. Over the past years, competitors have introduced low-cost hardware solutions,
software only solutions, as well as integrated test capabilities within infrastructure products.
These factors have resulted in increased competition for our traditional products.
Lastly, there is a trend in the telecommunications market to outsource functions to companies that
specialize in different areas to attain cost reductions and in some cases, improve service. Our
customers have approached this in two ways. First, a small number have outsourced their entire
network operations to large managed services providers. Second, certain of the larger service
providers are beginning to consolidate vendor relationships to a select group of vendors and feed
smaller suppliers through the larger vendor relationships. While this trend has not affected us in
major accounts to date, certain of our customers now purchase their Tollgrade maintenance through
contracts with larger, third-party suppliers. This practice can create additional pricing pressure as the
intermediary vendor looks to make a profit by managing the complexity
for the service provider.
In response to these conditions and trends, we have taken decisive action to reinforce our position
with our customers while also exploring new markets for growth.
We have focused on improving our already strong customer relationships while aggressively
containing costs. We continue to provide excellent customer support and enhanced capabilities to
our customers. Our customer focus also extends to our proactive efforts to retain and extend our
software support and maintenance contracts. While the service providers actively manage their own
capital expense budgets, we have reduced our cost structure to ensure that the impacts to our
financial results are minimized. We continue to focus on managing and growing our cash and short
term investment balance to enable future investment options.
We have also redirected our spending activities toward new growth initiatives versus spending on
maintenance efforts. Some of these growth areas include new hardware, software and services
offerings for the telecommunications service assurance market. Our new offerings recently launched
and under development include a software platform, Stratum, that can be sold stand-alone or as
part of a service assurance system solution, hardware products that integrate into our service
assurance solutions, and OEM products that will be sold and supported under the Tollgrade brand
name. To continue our focused efforts, we have sold off non-core assets such as our cable product
line in the second quarter 2009, and we are exploring strategic alternatives for our smart grid
power utility product line.
Lastly, through the managed services contract with a large global network equipment provider
executed in April 2009, we have created a new area of opportunity for the Company. We now have the
expertise to provide a new suite of managed services not only to our service provider customers,
but also to additional network equipment manufacturers, thus expanding our target market. We
believe this new platform will provide new growth opportunities for the Company in an area that
builds upon our expertise and experience in test and measurement, enabling us to effectively
respond to our customers trend to use managed services.
We believe that this strategy will enable us to not only weather the economic downturn, but will
position the Company for long-term growth, a return to profitability, and market leadership.
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Products
Services
Our service offerings include software maintenance and support for our operating support systems
(OSS) offerings and hardware maintenance for the test probes, and our professional services,
which are designed to ensure that all of the components of our customers test systems operate
properly. The primary customers for our maintenance and professional services offerings are the
large domestic carriers and international customers. We have a number of large service agreements
with these customers which cover software and, in some cases, hardware maintenance for our
products.
Historically, our services business was comprised of the more traditional POTS-based testability
services, and the revenue stream was largely project-based and as such, difficult to predict.
During the last few years, and primarily as a result of the Broadband Test Division acquisition,
the services business has moved toward more contract-based software maintenance services, the
revenue from which is more predictable. Because of this trend, our focus on our software
applications as part of our refined strategy, and the decline in revenues from our other product
lines, we expect services to continue to comprise a larger percentage of our revenue in the
future.
In addition, we are party to a managed services contract with a large global network equipment
provider to provide customer support and engineering services. Under this agreement, we provide
customer support and engineering services capabilities. The agreement is an important addition to
our services business and is a logical step for us as we offer an expanded portfolio of services to
our current customers as well as new customers.
Telecommunications Test and Measurement Products
Our proprietary telecommunications test and measurement products, which include our System Test and
MCU® products, enable telephone companies to qualify and troubleshoot broadband DSL and IP services
and remotely diagnose problems in POTS lines. Most DSL lines today provide broadband Internet
access for residential and business customers, fed from a central or remote office Digital
Subscriber Line Access Multiplexer (DSLAM) and configured with either a shared POTS voice service
or unbundled from the voice switch entirely (in the case of a competitive local exchange carriers
(CLECs) service offering). Our systems can be used to qualify loops for DSL service as well as
ongoing maintenance and repair of these IP lines. As telecommunications service providers
transition their offerings to IP networks and services (voice, video and data), we are in the
process of upgrading our test systems to support the testing of these services. POTS lines
provide traditional voice service as well as connections for communication devices such as computer
modems and fax machines. POTS excludes non-switched and private lines, such as data communications
service lines, commonly referred to as special services.
An important aspect of efficiently maintaining a telecommunications network is the ability to
remotely test, diagnose and locate any service-affecting problems
within that network. Our
System Test Products are made up of a centralized test operating system integrated into the
customers repair handling database systems, and remote test hardware located at telephone
companies central and remote offices. These systems enable local exchange carriers to conduct a
full range of fault diagnostics in the local loop, the portion of the telephone network that
connects end users to the central office. In addition, line test systems provide the capability to
remotely qualify, deploy and
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maintain services such as DSL and Integrated Services Digital Network (ISDN) services which are
carried over POTS lines. These test systems reduce the time needed to identify and resolve
problems, eliminating or reducing the costs of dispatching a technician to the problem site. Most
POTS line test systems, however, were designed only for use over copper wire line; as a result,
traditional test systems could not access local loops in which fiber-optic technology had been
introduced. Our MCU product line, which is used primarily by large domestic carriers, solved this
problem, extending LoopCare testing from the central office to the fiber-fed remote Digital Loop
Carrier (DLC) lines by mimicking a digital bypass pair, which is essentially a telephone circuit
that connects central test and measurement devices to the copper circuits close to the customer,
i.e., the last mile.
We believe our DigiTest® system is well positioned for the present and future of telecommunication
network testing, combining our line test system with a next generation test platform to provide a
complete test system solution for POTS and DSL local loop prequalification and in-service testing.
During
2008, we determined after a thorough strategic review process to
reposition the Company with a
greater focus on its service assurance offerings. We intend to build upon the strength of our
System Test Products, which are at the center of our service assurance offerings, but with a
greater emphasis on expanding our service assurance software solutions. Our System Test product
software offerings include four separate OSS: LoopCare, 4TEL, Celerity, and LTSC, each having an
established installed base. LoopCare is also the primary application for broadband DSL testing and
can be architected to overlay 4TEL and LTSC to add this functionality to the existing line test
application with the addition of the DigiTest measurement platform. We plan to leverage our
incumbencies with our installed base of software customers, and extend testing coverage to next
generation network architectures through a new software platform called Stratum. Stratums
initial features are based on both existing customer requests for enhanced features and our view of
the trends in the market.
With regard to our software development activities during the third quarter, we launched our next
generation service assurance platform, Stratum, at the Broadband World Forum in Paris. Stratum is
being introduced to telecom providers to help integrate new IP-based network testing initiatives
with existing platforms, thus providing integrated test analysis across a variety of access
technologies. Stratum will support multiple data inputs from a customers network and test
resources, including Tollgrades existing 4TEL®, Celerity® and LoopCare software platforms and
test probes, and perform combinational expert system analysis of faults in the access network to
enable more effective dispatching of field resources. It is able to monitor and collect embedded
performance and measurement data from network equipment, such as DSLAMs, MSANs, OLTs and ONTs; and
from customer premises equipment such as DSL modems, Set Top Boxes and Remote Gateways. Stratum is
currently being deployed in customer trials in the United States and South America.
Our legacy MCU products plug into DLC systems, the large network transmission systems used by
telephone companies to link the copper and fiber-optic portions of the local loop. MCU products
allow our customers to extend their line testing capabilities to all of their POTS lines served by
a DLC system regardless of whether the system is fed by a copper or fiber optic link. DLC systems,
which are located at telephone companies central offices and at remote sites within local user
areas, effectively multiplex the services of a single fiber-optic line into multiple copper lines.
In many instances, several DLC systems are located at a single remote site to create multiple local
loops that serve several thousand different end-user homes and businesses. Generally, for every DLC
remote site, customers will deploy at least two MCU line-testing products. One of three patents for
our legacy MCU products
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will expire during 2010, and we expect that the loss of this patent protection will permit greater
competition within this market segment that could cause our revenues from this product line to
decline.
Electric Utility Monitoring Products
The Companys LightHouse product line is designed to provide power grid monitoring capabilities to
electric utilities. Research and investment throughout 2007 and 2008 enabled the general
availability of the first release of the product line during the first quarter of 2009. The test
system solution currently consists of line mounted sensors, aggregators, and centralized software
providing an end to end solution for power providers to efficiently monitor their overhead
distribution circuits in real time. A LightHouse sensor, mounted directly on the electrical
conductor, will continuously monitor key circuit parameters and transmit data over a wireless
network to a central location, reducing time of detecting a problem on the grid, identifying its
location and restoring service. LightHouse is intended to be an innovative means for electric power
utilities to deploy technology to provide real-time grid intelligence to detect faults and help
minimize the impact of outages while optimizing the utilization of assets. The system is designed
to improve the overall efficiency of energy delivery, improve customer satisfaction and improve the
financial performance of the electric utilities.
As part of our ongoing strategic review that started in fall 2008 and continued in the third
quarter of 2009, we began evaluating the alternatives for this particular product line to determine
the fit with our longer term strategic focus. We are exploring a number of alternatives including
the sale of the division, possible joint ventures, or a reduction or elimination of the resources
dedicated to the product line. Although a final decision has not been made in regards to the
future of this product line, we intend to reach a final decision on a path forward by the end of
2009.
Our Customers
Our customers include the top telecom providers and numerous independent telecom and broadband
providers around the world. Our primary customers for our telco products and services are large
domestic and European telecommunications service providers. We track our telco sales by two large
customer groups, the first of which includes AT&T, Verizon and Qwest (referred to herein as large
domestic carriers), and the second of which includes certain large international telephone service
providers in Europe, namely British Telecom, Royal KPN N.V., Belgacom S.A., Deutsche Telecom AG
(T-Com) and Telefónica O2 Czech Republic, a.s. (collectively referred to herein as the European
Telcos).
For the third quarter of 2009, sales to the large domestic customers accounted for approximately
33% of our total revenue, compared to approximately 46% of total revenue for the third quarter of
2008. Sales to our largest customer, AT&T, comprised approximately 17% of our total revenue for the
third quarter of 2009, compared to 33% of our total revenue for the third quarter of 2008. Sales in
the third quarter of 2009 and 2008 to the European Telcos accounted for approximately 17% and 23%
respectively, of total revenue.
In the second quarter of 2009, we entered into a multi-year managed services contract with a large
global network equipment provider to provide customer support and engineering services. For the
third quarter of 2009, sales to this customer were $1.9 million, or approximately 17% of total
revenue.
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As of September 26, 2009, the Company had approximately $4.5 million of accounts receivable with
four customers, each of which individually exceeded 10% of our September 26, 2009 receivable
balances. As of December 31, 2008, the Company had approximately $4.5 million of accounts
receivable with three customers, each of which individually exceeded 10% of our December 31, 2008
receivable balances.
For the nine months ended September 26, 2009 and September 27, 2008, sales to the large domestic
customers accounted for approximately 40% and 36%, respectively, of our total revenue. Sales to
AT&T comprised approximately 22% and 24% of our total revenue for the nine months ended September
26, 2009 and September 27, 2008, respectively. Sales for the nine months ended September 26, 2009
and September 27, 2008 to the European Telcos accounted for approximately 21% and 44% of total
revenue, respectively. For the nine months ended September 26, 2009, managed service sales to a
large global network equipment provider were $3.5 million accounting for approximately 11% of total
revenue.
Backlog
Our order backlog for firm customer purchase orders, software maintenance contracts and managed
services contracts was $16.3 million as of September 26, 2009, compared to a backlog of $15.1
million as of December 31, 2008. The backlog at September 26, 2009 and December 31, 2008 included
approximately $7.2 million and $12.0 million, respectively, related to software maintenance
contracts, which is primarily earned and recognized as income on a straight-line basis during the
remaining terms of these agreements. The decline in software maintenance backlog is associated
with three individual customer contracts. Because two of the contracts are up for renewal at the
end of 2009, the backlog at September 26, 2009 only includes one quarter from each of these
contracts in the total amount. The third customer contract expired in June of 2009 and, although
this contract was renewed shortly after the end of the third quarter 2009 for an additional one
year period, backlog at September 26, 2009 does not include revenue from this contract. On a
sequential basis, backlog decreased to $16.3 million at September 26, 2009 from $17.7 million at
June 27, 2009. We expect that approximately 28% of the current total backlog will be recognized as
revenue in the fourth quarter 2009. We are currently in discussions with certain large domestic
and international customers to finalize agreements to renew their expiring multi-year software
maintenance contracts, and we are also pursuing opportunities to bolster our managed service
revenues.
RESULTS OF OPERATIONS FROM CONTINUING OPERATIONS
THREE MONTHS ENDED SEPTEMBER 26, 2009 COMPARED TO THREE MONTHS ENDED SEPTEMBER 27, 2008
Revenues
Our revenues for the third quarter of 2009 were $11.3 million compared to revenues of $12.9 million
for the third quarter of 2008.
Product revenue consists of sales of our system test products as well as sales of our traditional
MCU product line. Product revenues were approximately $5.0 million or 44.2% of total third quarter
revenues compared to $7.4 million or 57.5% of the total third quarter revenue for 2008. Overall,
our
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third quarter 2009 product revenues decreased by approximately $2.4 million or 32.4% compared to
the same period in the prior year. The decrease is primarily attributable to our legacy MCU
product line which had sales of approximately $1.1 million during the third quarter of 2009, a
decrease of $2.1 million compared to sales of $3.2 million in the same prior period. Although we
expect continued sales of this product line into the foreseeable future, this is a mature product
line with sales that do fluctuate based on an unpredictable demand, but we believe this product
lines sales will continue to decline over time. In addition to the decline of our MCU revenue,
sales of the our system test products were down slightly to $3.9 million in the third quarter of
2009, a decrease of $0.3 million, compared to sales of $4.2 million in the third quarter of 2008.
System test products revenue includes sales of DigiTest products including DigiTest ICE, LDU and
N(x)Test test probe hardware products as well as custom software applications and licenses. Third
quarter 2009 sales of system test hardware products were lower largely as a result of declines in
software applications revenue.
Services revenue consists of software maintenance and managed services agreements and installation
oversight and product management services provided to customers. Services revenue was
approximately $6.3 million or 55.7% of total third quarter of 2009 revenues compared to $5.5
million or 42.5% of the total third quarter revenue for 2008 Overall, our third quarter 2009
service revenue increased by approximately $0.8 million or 15.1% compared to the same period in the
prior year. The increase was primarily attributable to a multi-year managed services agreement
that we completed during the second quarter 2009 that added approximately $1.9 million in new
revenue during the third quarter of 2009. The increase was offset, in part, by the lack of a
signed software maintenance agreement with a large international customer, lower repairs revenue
and the effect of changes in foreign exchange rates.
Gross Profit
Gross profit for the third quarter of 2009 was $2.2 million compared to $7.1 million in the third
quarter of 2008. As a percentage of sales, our third quarter 2009 gross margin was 49.4% for our
product sales and 66.1% for our service sales compared to 61.9% for our product sales and 59.7% of
our service sales during the same 2008 period. The decrease in our product sales margins relates
to a change in product mix from higher margin hardware units sold during the third quarter of 2008
as well as lower volumes of software applications revenue. Additionally, lower overall product
sales volumes contributed to the decline in product sales margins as there was less volume to
absorb fixed overhead costs. The increase in our services sales margins relates primarily to the
reduction in workforce that occurred during the first quarter of 2009.
As a percentage of sales, gross profit for the third quarter of 2009 was 19.7% versus
55.0% for the third quarter of 2008. Included in 2009 gross profit is a $3.1 million reserve
for obsolete and slow-moving inventory, a $0.5 million severance charge related to our planned
workforce reduction, and an intangible asset impairment charge that was related, in part, to the
write-down of certain inventory items that were included as part of our overall inventory
write-down.
Selling and Marketing Expense
Selling and marketing expense was $1.6 million in the third quarter of 2009 which is consistent
with the third quarter of 2008. This expense consists primarily of payroll and employee benefit
related costs, consulting, advertising and promotional expenses as well as travel related costs.
As a percentage
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of revenues, selling and marketing expenses increased to 13.8% in the third quarter of 2009 from
12.4% in the third quarter of 2008.
General and Administrative Expense
General and administrative expenses for the third quarter of 2009 were $4.1 million compared to
$2.2 million in the third quarter of 2008, an increase of $1.9 million or 86.4%. General and
administrative expenses normally consist of payroll and employee benefit related costs, insurance
expense and professional services and legal fees. However, during the third quarter of 2009, these
expenses also included a $1.1 million bad debt expense related to one of our large international
contracts whose collectability management has deemed to be uncertain, proxy contest expenses
related to the election of directors that approximated $0.4 million, $0.1 million in additional
professional and legal fees related to a potential acquisition that was not pursued beyond the due
diligence stage and $0.1 million related to an employee relocation. As a percentage of revenues,
general and administrative expenses increased to 36.3% in the third quarter of 2009 from 17.1% in
the third quarter of 2008 primarily as a result of the charges mentioned above.
Research and Development Expense
Research and development expense, which consists primarily of payroll and benefit related costs,
associated with ongoing customer support, decreased $0.2 million, or 6.4%, to $2.4 million in the
third quarter of 2009. The third quarter 2009 decline is primarily attributable to cost
control efforts and the effect of changes in foreign currency exchange rates. As a percentage of
revenues, research and development expense for the third quarter of 2009 increased slightly to
20.8% compared to 19.5% for the third quarter of 2008.
Severance Expense
During the third quarter of 2009, we developed a plan to reduce and restructure our workforce
across all levels of the organization in an effort to reduce costs and to better align our human
resources to match our ongoing revenue streams. The total severance charge associated with this
action was $1.4 million of which $0.5 million was noted above and recorded as part of cost of sales
and $0.9 million was recorded as an operating expense. In addition, the Company also incurred a
third quarter 2009 charge of $0.2 million related to the settlement of contractual obligations
incurred in connection with the departure of our former chief financial officer.
Other Impairments
During the third quarter of 2009, we recorded other impairment charges of approximately $0.3
million. Included in this charge is approximately $0.2 million related to the write-off of certain
obsolete software licenses as well as the write-down of a Company owned investment by approximately
$0.1 million.
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Other Income
Other income for the third quarter of 2009 was less then $0.1 million compared to $0.3 million for
the third quarter of 2008. Other income, which is due primarily to interest earnings on cash and cash equivalents and short-term investments, decreased in the third quarter 2009
compared to the third quarter 2008 due to declines in prevailing interest rates.
Income Taxes
We recorded an income tax benefit of $0.1 million during the third quarter of 2009 compared to an
income tax expense of $0.2 million in the third quarter of 2008. The income tax benefit recorded in
the third quarter of 2009 primarily relates to adjustments from revising our foreign source
projected income estimates in certain countries while the same third quarter 2008 income tax
expense was primarily related to foreign income tax obligations generated by profitable operations
in foreign jurisdictions, as well as adjustments to reserves for uncertain tax positions.
We continue to record a valuation allowance against U.S. federal, state and certain
foreign net operating losses from continuing and discontinued operations incurred in the third
quarter of 2009 as the tax benefit generated from those losses was deemed to be likely unrealizable
in future periods. The effective tax rate on the loss from continuing operations decreased to 1.1%
for the third quarter 2009 from 26.4% for the third quarter 2008.
Loss from Continuing Operations and Loss Per Share from Continuing Operations
Our loss for the third quarter of 2009 increased $7.9 million to a net loss of $7.1 million
compared to a net income of $0.8 million for the third quarter 2008, primarily as a result of the
reasons stated above. For the third quarter of 2009, the Company incurred a basic and diluted loss
from continuing operations per common share of ($0.56), compared to income of $0.06 per basic and
diluted common share recorded in the third quarter of 2008. Basic and diluted weighted average
common and common equivalent shares outstanding were 12.7 million for the third quarter of 2009.
NINE MONTHS ENDED SEPTEMBER 26, 2009 COMPARED TO NINE MONTHS ENDED SEPTEMBER 27, 2008
Revenues
Our revenues for the nine months ended September 26, 2009 were $32.3 million compared to revenues
of $36.2 million for the nine months ended September 27, 2008.
Product revenue consists of sales of our system test products as well as sales of our traditional
MCU product line. Product revenues were approximately $15.0 million or 46.4% of total nine month
revenues compared to $19.4 million or 53.6% of the total nine month revenue for 2008. Overall, our
nine month 2009 product revenues decreased by approximately $4.4 million or 22.8% compared to the
same period in the prior year. The decrease is primarily attributable decreased sales volumes of
our system test products revenue and our MCU product lines. Sales of our system test products
were $10.9 million during the first nine months of 2009, a decrease of $3.2 million, compared to
sales of $14.1 million during the first nine months of 2008. System test products revenue includes
sales of
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DigiTest products including DigiTest ICE, LDU and N(x)Test test probe hardware products as well
as custom software applications and licenses. Nine month 2009 sales of system test hardware
products were lower largely than the same 2008 period largely as a result of the completion of
multiple major international hardware contracts in 2008.
In addition, our legacy MCU product line revenue decreased by $1.2 million as we had sales of
approximately $4.1 million during the first nine months of 2009 compared to sales of $5.3 million
in the same prior period. Although we expect continued sales of this product line into the
foreseeable future, this is a mature product line with sales that do fluctuate based on an
unpredictable demand, but we believe this product lines sales will continue to decline over time.
Services revenue consists of software maintenance and managed services agreements and installation
oversight and product management services provided to customers. Services revenue were $17.3
million or 53.6% of total nine month 2009 revenues compared to $16.8 million or 46.4% of the total
nine month revenue for 2008 Overall, our nine month 2009 service revenue increased by
approximately $0.5 million or 3.1% compared to the same period in the prior year. The increase is
primarily attributable to a new multi-year managed services agreement that we completed during the
second quarter 2009 that has added approximately $3.5 million in new revenue in 2009. This
increase was offset, in part, by declines in service revenues from existing product lines, in
particular, the consolidation of certain LoopCare software maintenance contracts and lower repair
revenues and foreign exchange rate declines as the strength of the dollar fell in 2009 compared to
the same period in 2008.
Gross Profit
Gross profit for the first nine months of 2009 was $12.7 million compared to $18.3 million in the
same period of the prior year. As a percentage of sales, our nine month 2009 gross margin was 46.0
% for our product sales and 68.2% for our service sales compared to 55.7% for our product sales
and 64.1% of our service sales during the same 2008 period. The decrease in our product sales
margins relates to a change in product mix from higher margin hardware units sold during the nine
months ended September 27, 2008 as well as the adverse impact of a stronger United States of
America dollar during 2009. Additionally, lower overall product sales volumes contributed to the
decline in product sales margins as there was less volume to absorb fixed overhead costs. The
increase in our services sales margins relates primarily to the reduction in workforce that
occurred during the first quarter of 2009.
As a percentage of sales, our overall gross profit for the nine month period ending September 26,
2009 was 39.4% versus 50.5% for the same period in 2008. Included in our 2009 gross profit is a
$3.1 million reserve for obsolete and slow-moving inventory, a $0.8 million charge related to our
planned workforce reduction, and an impairment charge related primarily to the write-down of an
intangible asset that related to our inventory write-down. For the same period in 2008, we
incurred an inventory reserve of approximately $0.8 million and impairment charge of approximately
$0.2 million
Selling and Marketing Expense
Selling and marketing expense was $4.9 million over the first nine months of 2009 compared to $5.3
million of expense incurred in the same 2008 time period, a decrease of $0.4 million or 8.2% . The
decrease is primarily related to approximately $0.3 million of consultancy savings that was
incurred in 2008, but not 2009. Overall selling and marketing expense consists primarily of payroll
and employee
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benefit related costs, consulting, advertising and promotional expenses as well as travel related
costs. As a percentage of revenues, selling and marketing expenses increased slightly to 15.0%
during the first nine months of 2009 compared to 14.6% for the same 2008 period.
General and Administrative Expense
General and administrative expenses for the first nine months of 2009 was approximately $9.5
million compared to $7.0 million during the same prior period in 2008, an increase of $2.5 million
or 36.0%. General and administrative expenses normally consist of payroll and employee benefit
related costs, insurance expense and professional services and legal fees. However, during the
third quarter of 2009, these expenses included a $1.1 million bad debt expense related to one of
our large international contracts whose collectability management has deemed to be uncertain. In
addition, during the first nine months of 2009, we incurred legal and professional service fees of
approximately $0.7 million in connection with the contested election of directors, $0.6 million in
professional and legal fees related to potential acquisition candidates that were not pursued
beyond the due diligence stage and $0.1 million related to an employee relocation. As a percentage
of revenues, general and administrative expenses increased to 29.5% during the first nine months of
2009 from 19.3% during the same 2008 period, primarily as a result of the charges mentioned above.
Research and Development Expense
Research and development expense, which includes costs, associated with ongoing customer support
and consists primarily of payroll and benefit related costs, decreased $1.3 million, or 15.9%, to
$6.8 million during the first nine months of 2009. The nine month 2009 decline is primarily
attributable to a reduction in workforce during 2008. As a percentage of revenues, research and
development expense for the first nine months of 2009 decreased slightly to 21.0% compared to 22.3%
for the same 2008 period.
Severance Expense
During the third quarter of 2009, we developed a plan to significantly reduce and restructure our
workforce across all levels of the organization in an effort to reduce costs and to better align
our human resources to match ongoing revenue streams. The total severance charge associated with
this action was $1.4 million of which $0.5 million was noted above and recorded as part of cost of
sales and $0.9 million was recorded as an operating expense. In addition, we also incurred a third
quarter 2009 charge of $0.2 million related to the settlement of contractual obligations with the
departure of our former chief financial officer.
During the first and second quarter of 2009, we implemented certain initiatives aimed at increasing
efficiency and decreasing costs which included reductions in our professional services, operations
and marketing staff. Severance expenses associated with this action was $0.4 million.
In total for the nine month period ended September 26, 2009, severance charges amounted to
$2.0 million compared to $0.5 million in the nine month period ended September 27, 2008.
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Other Impairments
During the nine month period ended September 26, 2009, we recorded other impairment charges of
approximately $0.3 million. Included in this charge is approximately $0.2 million related to the
write-off of certain obsolete software licenses as well as the write-down of a Company-owned
investment by approximately $0.1 million.
Other Income
Other income for the nine months ended September 26, 2009 was $0.6 million compared to $1.1 million
for the nine months ended September 27, 2008. Other income, which is due primarily to interest
earnings on cash and cash equivalents and short-term investments, decreased for the
nine months ended September 26, 2009 due to declines in prevailing interest rates.
Income Taxes
Income taxes for the nine months ended September 26, 2009 were $0.2 million compared to $.9 million
for the same 2008 period. The income tax expense for both nine month periods primarily relates to
foreign income tax obligations generated by profitable operations in certain foreign jurisdictions.
We continue to record a valuation allowance against U.S. federal, state and certain
foreign net operating losses from continuing and discontinued operations incurred in the nine
months ended September 26, 2009 as the tax benefit generated from those losses was deemed to be
likely unrealizable in future periods. The effective tax rate on the loss from continuing
operations decreased to 2.3% for the nine months ended September 26, 2009 from 62.5% for the nine
months ended September 27, 2008.
Loss from Continuing Operations and Loss Per Share from Continuing Operations
Our loss for the nine months ended September 26, 2009 increased $7.2 million or 298.5% to net loss
of $9.6 million compared to a net loss of $2.4 million for the nine months ended September 27, 2008
primarily for the reasons stated above. For the nine months ended September 26, 2009, our basic
and diluted loss from continuing operations per common share was ($0.76), compared to a loss of
($0.18) per basic and diluted common share recorded in the nine months ended September 27, 2008.
Basic and diluted weighted average common and common equivalent shares outstanding were 12.7
million for the nine months ended September 26, 2009.
LIQUIDITY AND CAPITAL RESOURCES
We have historically met our working capital and capital expenditure requirements, including
funding for expansion of operations, through net cash flows provided by operating activities. Our
principal source of liquidity is our operating cash flows and cash on our balance sheet. In
addition, there are no material restrictions on the ability to transfer and remit funds among our
international affiliated companies. We believe we have sufficient cash balances to meet our cash
flow requirements and growth objectives over the next twelve months.
We had working capital of $69.6 million at September 26, 2009, a decrease of $5.9 million from
$75.5 million of working capital as of December 31, 2008. The decrease in working capital was due
primarily to the decrease in receivables as a result of improved collection efforts and the reserve
of
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$1.1 million related to a foreign receivable we deemed uncollectable, a $3.1 million reserve for
obsolete and slow-moving inventory, an accrual of $1.6 million related to severance charges due to
our planned workforce reduction and lower payable balances offset by cash received from the sale of
one of our product lines. As of September 26, 2009, we had approximately $65.4 million in cash,
cash equivalent and short term investments, which are available for corporate purposes, including
acquisitions and other general working capital requirements.
Net cash provided by operating activities for the nine months ended September 26, 2009 was $2.1
million compared to net cash provided of $3.9 million for the same period in the prior year. The
change in net cash provided by operating activities is largely attributable to less cash usage as a
result of cost saving initiatives as well as changes in certain working capital items.
Cash provided by investing activities was $4.4 million for the nine months ended September 26, 2009
compared to cash used in investing activities of $0.7 million for the nine months ended September
27, 2008. The cash provided for the nine months ended September 26, 2009 was primarily due to the
proceeds from the sale of the cable product line and the redemption of short-term investments.
We are party with a bank to a three-year $25.0 million Unsecured Revolving Credit Facility
(the Facility), which includes a $2.0 million letter of credit sub-facility, expiring on December
19, 2009. In accordance with the terms of the Facility, the proceeds must be used for general
corporate purposes, working capital needs, and in connection with certain acquisitions, as defined.
The Facility contains certain standard covenants with which the Company must comply, including a
minimum fixed charge coverage 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. Our borrowings are limited by the calculation of our maximum leverage ratio, which is
calculated on a quarterly basis. Interest is payable on any revolving credit amounts utilized
under the Facility at prime, or the prevailing Euro rate plus 0.75% to 1.5% depending on the ratio
of consolidated total indebtedness of the Borrower and its subsidiaries to consolidated EBITDA.
Letter of credit fees are payable on letters of credit outstanding quarterly at the rate of 0.75%
to 1.5% depending on the ratio of consolidated total indebtedness of the Borrower and its
subsidiaries to consolidated EBITDA, and annually at the rate of 1/8% beginning with letter of
credit issuance. Commitment fees are payable quarterly at the rate of 0.25% per annum on the
average unused commitment. As of September 26, 2009 and currently, there are no outstanding
borrowings under the Facility, and we are in compliance with all debt covenants. We do not
anticipate any short-term borrowings for working capital as we believe our cash reserves and
internally generated funds will be sufficient to sustain working capital requirements for the
foreseeable future. As of the date of this report, we are working with the bank on a new credit
facility which should be in place prior to the December 19, 2009 expiration date.
COMMITMENTS AND CONTRACTUAL OBLIGATIONS
We lease office space and equipment under agreements which are accounted for as operating leases.
During the third quarter 2009, the office lease for our Cheswick, Pennsylvania facility was
extended and now expires on March 31, 2011. The lease for our Piscataway, New Jersey location
expires on April 30, 2012. As a result of the Broadband Test Division acquisition, we have leases
in Bracknell, United Kingdom; Kontich, Belgium; and Wuppertal, Germany, which expire on December
24, 2012, April 1, 2012, and January 31, 2010, respectively. We are also involved in various
month-to-month leases for research and development and office equipment at all five locations. In
addition, one of the office leases include provisions for possible adjustments in annual future
rental commitments relating
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to excess taxes, excess maintenance costs that may occur and increases in rent based on the
consumer price index and based on increases in our annual lease commitments; however, none of these
commitments are material.
Included in the commitment schedule below are certain pension obligations. As a result of our
acquisition of the Broadband Test Division, we assumed a defined benefit pension plan for three
employees based in our German location. The total pension obligation as of September 26, 2009 was
approximately $1.0 million. The increase in pension obligation from December 31, 2008 through
September 26, 2009 primarily relates to increases in the Companys benefit obligation due to
increases in the related employees years of service.
Minimum annual future commitments as of September 26, 2009 are (in thousands):
Payments due by period | ||||||||||||||||||||||||||||
Total | 2009 | 2010 | 2011 | 2012 | 2013 | Thereafter | ||||||||||||||||||||||
Operating Lease
Obligations |
$ | 1,999 | $ | 238 | $ | 916 | $ | 561 | $ | 284 | $ | | $ | | ||||||||||||||
Purchase Obligations |
380 | 368 | 12 | | | | | |||||||||||||||||||||
FIN 48 Obligations |
692 | | 692 | | | | | |||||||||||||||||||||
Total |
$ | 3,071 | $ | 606 | $ | 1,620 | $ | 561 | $ | 284 | $ | | $ | | ||||||||||||||
The lease expense for the three and nine month periods ended September 26, 2009 was $0.2 million
and $0.6 million, respectively. The lease expense for the three and nine month periods ended
September 27, 2008 was $0.2 and $0.8 million, respectively.
In addition, the Company is, from time to time, party to various legal claims and disputes, either
asserted or unasserted, which arise in the ordinary course of business. While the final resolution
of these matters cannot be predicted with certainty, the Company does not believe that the outcome
of any of these claims will have a material adverse effect on the Companys consolidated financial
position, or annual results of operations or cash flow.
Application of Critical Accounting Policies
The preparation of financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reporting period.
Therefore, the determination of estimates requires the exercise of judgment based on various
assumptions and other factors such as historical experience, economic conditions, and in some
cases, actuarial techniques. Actual results may differ from those estimates. A discussion of
market risks affecting the Company can be found in Quantitative and Qualitative Disclosures about
Market Risk in this Quarterly Report on Form 10-Q.
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A summary of the Companys significant accounting policies and application of these policies are
included in the Notes to Consolidated Financial Statements and in Managements Discussion and
Analysis included in the Companys Annual Report on Form 10-K for the year ended December 31, 2008.
Management believes that the application of these policies on a consistent basis enables the
Company to provide useful and reliable financial information about the Companys operating results
and financial condition. There were no changes to our critical accounting policies during the
third quarter of 2009.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our current investment policy limits our investments in financial instruments to cash and cash
equivalents, individual municipal bonds and corporate and government bonds. The use of financial
derivatives and preferred and common stocks is strictly prohibited. We believe that our risk is
minimized through proper diversification along with the requirements that the securities must be of
investment grade with an average rating of A or better by Standard & Poors. We hold our
investment securities to maturity and believe that earnings and cash flows are not materially
affected by changes in interest rates, due to the nature and short-term investment horizon for
which these securities are invested.
Item 4. CONTROLS AND PROCEDURES
The Chief Executive Officer and the interim Chief Financial Officer and Treasurer 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 Companys
disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934
are effective to ensure that information required to be disclosed 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 SECs rules and forms,
and include controls and procedures designed to ensure that information required to be disclosed by
the Company in such reports is accumulated and communicated to the Companys management, including
the Chief Executive Officer and the interim Chief Financial Officer and Treasurer, as appropriate,
to allow timely decisions regarding required disclosure.
There were no changes in the Companys internal controls over financial reporting (as defined in
Rule 13a-15(f) under the Securities Exchange Act of 1934) that occurred during the fiscal quarter
ended September 26, 2009 that have materially affected or are reasonably likely to materially
affect these controls.
PART II. OTHER INFORMATION
Item 1A. RISK FACTORS
In addition to the other information set forth in this Form 10-Q, we wish to caution each reader of
this Form 10-Q to carefully consider the factors discussed in Part II, Item 1A, Risk Factors in
our Annual Report on Form 10-K for the year ended December 31, 2008 (our 2008 Form 10-K) and in
our subsequently filed Quarterly Reports on Form 10-Q for the first and second quarters of 2009,
which
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could materially affect our business, financial condition or future results. There have been no
material changes in our risk factors from those disclosed in our 2008 Form 10-K and our
subsequently filed Reports on Form 10-Q.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On August 5, 2009, we held our annual shareholders meeting. At the meeting, shareholders
voted upon the following three proposals:
Election of Directors
Nominee for Director | For | Withheld | ||||||
Joseph A. Ferrara |
11,262,566 | 71,987 | ||||||
Charles E. Hoffman |
11,260,797 | 73,956 | ||||||
Jeffrey M. Solomon |
8,014,525 | 49,900 | ||||||
Edward B. Meyercord III |
8,013,492 | 50,933 | ||||||
Scott C. Chandler |
5,195,952 | 2,867,073 | ||||||
Brian C. Mullins |
3,214,325 | 56,203 | ||||||
James J. Barnes |
2,612,270 | 658,058 | ||||||
David S. Egan |
2,608,110 | 663,618 |
Messrs. Ferrara, Hoffman, Solomon, Meyercord and Chandler were elected to the Board of Directors
for one year terms to expire at the annual meeting of shareholders in 2010 and in each case until
his successor is elected and qualified. The terms of Directors Richard H. Heibel, Edward Kennedy
and Robert W. Kampmeinert continued after the meeting and will expire at the annual meeting of
shareholders in 2010 and in each case until his successor is elected and qualified.
Ratification of the appointment of PricewaterhouseCoopers LLP as the Companys independent
registered public accounting firm for the fiscal year ending December 31, 2009
For | Against | Abstain | ||||||
11,205,194 |
116,366 | 13,193 |
The appointment was ratified.
Approval of an Amendment to the Companys 2006 Long-Term Incentive Compensation Plan, as amended
and restated, to increase the number of authorized shares issuable thereunder by 1,500,000 shares:
For | Against | Abstain | ||||||
8,342,499 |
1,423,472 | 1,568,782 |
The amendment was approved.
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Item 6. EXHIBITS
(a) | Exhibits: |
The following exhibits are being filed with this report:
Exhibit | ||
Number | Description | |
10.1
|
Agreement dated September 17, 2009 by and between Tollgrade
Communications, Inc. and Gary W. Bogatay, Jr. (incorporated by
reference to Exhibit 10.1 to the Companys Current Report on Form
8-K filed with the SEC on September 22, 2009) |
|
10.2
|
Tollgrade Communications, Inc. 2006 Long-Term Incentive
Compensation Plan, as amended and restated on August 5, 2009
(incorporated by reference to Exhibit 99 to the Companys
Registration Statement on Form S-8 filed with the SEC on November
2, 2009) |
|
10.3
|
Summary of Compensation Program for Non-Employee Directors,
adopted October 19, 2009, filed herewith |
|
31.1
|
Certification of Chief Executive Officer, filed herewith. | |
31.2
|
Certification of Chief Financial Officer, filed herewith. | |
32
|
Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18.U.S.C. Section 350, filed herewith. |
LoopCare is a trademark of Tollgrade Communications, Inc.
ICE is a trademark of Tollgrade Communications, Inc.
N(x)Test is a trademark of Tollgrade Communications, Inc.
LTSC is a trademark of Tollgrade Communications, Inc.
Stratum is a trademark of Tollgrade Communications, Inc.
®Tollgrade is a registered trademark of Tollgrade Communications, Inc.
®DigiTest is a registered trademark of Tollgrade Communications, Inc.
®MCU is a registered trademark of Tollgrade Communications, Inc.
®4TEL is a trademark of Tollgrade Communications, Inc.
®Celerity is a trademark of Tollgrade Communications, Inc.
All other trademarks are the property of their respective owners.
ICE is a trademark of Tollgrade Communications, Inc.
N(x)Test is a trademark of Tollgrade Communications, Inc.
LTSC is a trademark of Tollgrade Communications, Inc.
Stratum is a trademark of Tollgrade Communications, Inc.
®Tollgrade is a registered trademark of Tollgrade Communications, Inc.
®DigiTest is a registered trademark of Tollgrade Communications, Inc.
®MCU is a registered trademark of Tollgrade Communications, Inc.
®4TEL is a trademark of Tollgrade Communications, Inc.
®Celerity is a trademark of Tollgrade Communications, Inc.
All other trademarks are the property of their respective owners.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Tollgrade Communications, Inc. (Registrant) |
||||
Dated: November 3, 2009 | ||||
/s/ Joseph A. Ferrara | ||||
Joseph A. Ferrara | ||||
Chairman, Chief Executive Officer and President | ||||
Dated: November 3, 2009
/s/ Michael D. Bornak | ||||
Interim Chief Financial Officer and | ||||
Treasurer |
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EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
(Pursuant to Item 601 of Regulation S-K)
Exhibit | ||
Number | Description | |
10.1
|
Agreement dated September 17, 2009 by and between Tollgrade
Communications, Inc. and Gary W. Bogatay, Jr. (incorporated by
reference to Exhibit 10.1 to the Companys Current Report on
Form 8-K filed with the SEC on September 22, 2009) |
|
10.2
|
Tollgrade Communications, Inc. 2006 Long-Term Incentive
Compensation Plan, as amended and restated on August 5, 2009
(incorporated by reference to Exhibit 99 to the Companys
Registration Statement on Form S-8 filed with the SEC on
November 2, 2009) |
|
10.3
|
Summary of Compensation Program for Non-Employee Directors,
adopted October 19, 2009, filed herewith |
|
31.1
|
Certification of Chief Executive Officer, filed herewith. | |
31.2
|
Certification of Chief Financial Officer, filed herewith. | |
32
|
Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18.U.S.C. Section 350, filed herewith. |
40