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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC
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FORM 10-Q
(Mark One)
[ X ] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended March 31, 2001
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ___________ to ____________
Commission file number 0-27312
TOLLGRADE COMMUNICATIONS, INC.
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(Exact Name of Registrant as Specified in its Charter)
PENNSYLVANIA 25-1537134
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(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification Number)
493 NIXON RD.
CHESWICK, PA 15024
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(Address of Principal Executive Offices, including zip code)
412-820-1400
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(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
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As of April 30, 2001, there were 13,379,310 shares of the Registrant's
Common Stock, $0.20 par value per share, and no shares of the Registrant's
Preferred Stock, $1.00 par value per share, outstanding.
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This report consists of a total of 19 pages. The exhibit index is on page 18.
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TOLLGRADE COMMUNICATIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2001
TABLE OF CONTENTS
PAGE NO.
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PART I. FINANCIAL INFORMATION
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ITEM 1 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2001 AND DECEMBER 31, 2000 ..........3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE-MONTH PERIODS
ENDED MARCH 31, 2001 AND APRIL 1, 2000.....................................................4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE-MONTH PERIODS
ENDED MARCH 31, 2001 AND APRIL 1, 2000.....................................................5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.......................................6
REVIEW REPORT OF INDEPENDENT ACCOUNTANTS..................................................10
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION................................................................................ 11
PART II. OTHER INFORMATION
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ITEM 1 LEGAL PROCEEDINGS.........................................................................18
ITEM 2 CHANGES IN SECURITIES.....................................................................18
ITEM 3 DEFAULTS UPON SENIOR SECURITIES...........................................................18
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......................................18
ITEM 5 OTHER INFORMATION.........................................................................18
ITEM 6 EXHIBITS AND REPORTS FILED ON FORM 8-K....................................................18
SIGNATURE..........................................................................................19
EXHIBIT INDEX......................................................................................20
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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED) DECEMBER 31,
MARCH 31, 2001 2000
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ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 44,286,657 $ 30,423,783
Short-term investments 26,134,294 28,405,655
Accounts receivable:
Trade 20,007,899 18,775,643
Other 769,541 813,809
Inventories 30,236,246 30,499,482
Prepaid expenses and deposits 548,819 787,098
Refundable taxes due 800,502 8,950,672
Deferred tax assets 1,075,702 983,246
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TOTAL CURRENT ASSETS 123,859,660 119,639,388
Long-term investments 3,925,000 2,750,000
Property and equipment, net 6,994,334 6,503,923
Deferred tax assets 2,512,501 2,380,828
Patents -- 417
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TOTAL ASSETS $ 137,291,495 $ 131,274,556
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LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 372,938 $ 1,874,328
Accrued expenses 2,160,202 1,937,589
Accrued salaries and wages 656,761 2,813,433
Royalties payable 882,464 1,142,478
Income taxes payable 4,261,440 636,938
Deferred income 100,000 100,000
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TOTAL CURRENT LIABILITIES 8,433,805 8,504,766
Deferred tax liabilities 9,950 9,950
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TOTAL LIABILITIES 8,443,755 8,514,716
Shareholders' equity:
Common stock, $.20 par value; authorized shares,
50,000,000; issued shares, 13,363,580 and 13,329,264,
respectively 2,672,716 2,665,853
Additional paid-in capital 66,669,596 66,343,728
Treasury stock, at cost, 386,800 shares, respectively (3,164,975) (3,164,975)
Retained earnings 62,670,403 56,915,234
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TOTAL SHAREHOLDERS' EQUITY 128,847,740 122,759,840
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 137,291,495 $ 131,274,556
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The accompanying notes are an integral part of the
condensed consolidated financial statements.
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
FOR THE THREE MONTHS ENDED
MARCH 31, 2001 APRIL 1, 2000
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REVENUES $27,990,002 $22,417,535
COST OF PRODUCT SALES 12,274,283 8,371,660
GROSS PROFIT 15,715,719 14,045,875
OPERATING EXPENSES:
Selling and marketing 2,449,824 2,383,683
General and administrative 1,530,152 1,377,723
Research and development 3,359,541 2,590,668
Total operating expenses 7,339,517 6,352,074
INCOME FROM OPERATIONS 8,376,202 7,693,801
Interest and other income, net 906,977 469,813
INCOME BEFORE INCOME TAXES 9,283,179 8,163,614
Provision for income taxes 3,528,010 2,939,000
NET INCOME $ 5,755,169 $ 5,224,614
EARNINGS PER SHARE INFORMATION:
Weighted average shares of common stock and equivalents:
Basic 12,957,833 12,218,591
Diluted 13,377,185 13,546,166
Net income per common and common equivalent shares:
Basic $ .44 $ .43
Diluted $ .43 $ .39
The accompanying notes are an integral part of the
condensed consolidated financial statements.
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31, 2001 April 1, 2000
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 5,755,169 $ 5,224,614
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 581,485 375,036
Deferred income taxes (224,129) --
Provision for losses on inventory 23,218 --
Provision for allowance for doubtful accounts 175,000 --
Changes in assets and liabilities:
Increase in accounts receivable-trade (1,407,256) (668,189)
Decrease (increase) in accounts receivable-other 44,268 (158,468)
Decrease (increase) in inventories 240,018 (2,823,494)
Decrease (increase) in prepaid expenses and other assets 238,279 (63,747)
(Decrease) increase in accounts payable (1,501,390) 1,296,659
Increase in accrued expenses and deferred income 222,613 1,379,729
Decrease in accrued salaries and wages (2,156,672) (1,166,093)
(Decrease) increase in royalties payable (260,014) 150,837
Increase (decrease) in income taxes payable 3,624,502 (33,681)
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Net cash provided by operating activities 5,355,091 3,513,203
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CASH FLOWS FROM INVESTING ACTIVITIES:
Redemption/maturity of investments 7,002,881 2,327,854
Purchase of investments (5,906,520) (9,191,819)
Capital expenditures (1,071,479) (1,181,266)
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Net cash provided by (used in) investing activities 24,882 (8,045,231)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options, including related tax
benefits 332,731 7,042,202
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Refund of prior year income taxes paid due to the exercise of stock
options 8,150,170 --
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Net cash provided by financing activities 8,482,901 7,042,202
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Net increase in cash and cash equivalents 13,862,874 2,510,174
Cash and cash equivalents at beginning of period 30,423,783 15,555,810
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Cash and cash equivalents at end of period $ 44,286,657 $ 18,065,984
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The accompanying notes are an integral part of the
condensed consolidated financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements included
herein have been prepared by Tollgrade Communications, Inc. (the "Company") in
accordance with accounting principles generally accepted in the United States of
America for the interim financial information and Article 10 of Regulation S-X.
The condensed consolidated financial statements as of and for the three-month
period ended March 31, 2001 should be read in conjunction with the Company's
consolidated financial statements (and notes thereto) included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2000. Accordingly,
the accompanying condensed consolidated financial statements do not include all
of the information and footnotes required by accounting principles generally
accepted in the United States of America for complete financial statements,
although the Company believes that the disclosures are adequate to make the
information presented not misleading. In the opinion of the Company's
management, all adjustments considered necessary for a fair presentation of the
accompanying condensed consolidated financial statements have been included, and
all adjustments are of a normal and recurring nature. Operating results for the
three-month period ended March 31, 2001 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2001.
2. INVENTORIES
At March 31, 2001 and December 31, 2000, inventories consisted of the following:
(Unaudited)
March 31, December 31,
2001 2000
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Raw materials ..................................... $16,426,879 $14,885,196
Work in progress .................................. 10,499,055 12,981,052
Finished goods .................................... 4,217,312 3,718,234
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$31,143,246 $31,584,482
Reserves for slow moving and
obsolete inventory ............................. (907,000) (1,085,000)
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$30,236,246 $30,499,482
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3. SHORT-TERM AND LONG-TERM INVESTMENTS
Short-term investments at March 31, 2001 and December 31, 2000 consisted of
individual municipal bonds stated at cost, which approximated market value.
These securities have a maturity of one year or less at date of purchase and/or
contain a callable provision in which the bonds can be
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called within one year from date of purchase. Long-term investments are
comprised of individual municipal bonds with a maturity of more than one year
but less than eighteen months and are stated at cost, which approximated market
value. The primary investment purpose is to provide a reserve for future
business purposes, including acquisitions and capital expenditures. Realized
gains and losses are computed using the specific identification method.
The estimated fair values of the Company's financial instruments are as follows:
(Unaudited)
March 31, December 31,
2001 2000
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Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- ----------- -----------
Financial assets:
Cash and cash equivalents ................ $44,286,657 $44,286,657 $30,423,783 $30,423,783
Short-term and long-term investments ..... 30,059,294 29,998,539 31,155,655 31,104,323
----------- ----------- ----------- -----------
$74,345,951 $74,285,196 $61,579,438 $61,528,106
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4. INCOME PER COMMON SHARE
Net income per share is calculated by dividing net income by the weighted
average number of common shares plus incremental common stock equivalent shares
(shares issuable upon exercise of stock options). Incremental common stock
equivalent shares are calculated for each measurement period based on the
treasury stock method, which uses the monthly average market price per share.
The calculation of net income per common and common equivalent shares follows
(unaudited):
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Three Months Three Months
Ended Ended
March 31, 2001 April 1, 2000
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Net income $ 5,755,169 $ 5,224,614
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Common and common equivalent shares:
Weighted average number of
common shares outstanding
during the period ................................................. 12,957,833 12,218,591
Common shares issuable upon exercise of outstanding stock options:
Diluted ........................................................ 419,352 1,327,575
Common and common equivalent shares outstanding during the period:
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Diluted ........................................................ 13,377,185 13,546,166
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Earnings per share data Net income per common and common Equivalent
shares:
Basic .......................................................... $ .44 $ .43
Diluted ........................................................ $ .43 $ .39
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5. DEFERRED AND REFUNDABLE TAX ASSETS
The Company's current refundable tax assets as of December 31, 2000 included a
tax benefit of $8,950,672 resulting from the exercising of certain nonstatutory
stock options by various directors, officers and other employees under the
Company's stock option programs during 2000. The Company was entitled to a tax
deduction in the tax year ended December 31, 2000 equal to the difference
between the fair market value of the shares received by the option holders upon
exercise and the exercise price of the nonstatutory stock options. During the
first quarter of 2001, the company received $8,150,170 in federal income tax
refunds associated with prior year taxes paid. The remaining current refundable
taxes are primarily related to state income taxes and it is anticipated that
these amounts will be utilized or refunded to the Company during 2001.
6. STOCK REPURCHASE PROGRAM
On April 19, 2001, the Company announced its Board of Directors authorized the
continuation of a share repurchase program that was originally initiated on
April 22, 1997. Under the current extension, the Company may repurchase a total
of one million shares of its common stock before December 31, 2001.
The number of shares that the Company intends to purchase and the time of such
purchases will be determined by the Company at its discretion. The Company plans
to use existing cash and short-term investments to finance any such purchases
Prior to the aforementioned stock repurchase program extension, the Company had
repurchased 382,400 shares of common stock. These repurchased shares are
intended to provide stock under certain employee benefit programs..
7. SUBSEQUENT EVENT
On April 19, 2001, the Company announced a realignment initiative to streamline
operations and reduce operating costs. The realignment reduced the Company's
workforce by approximately 80 positions, primarily in general and administrative
and research and development and support areas. The realignment will generate
approximately $4,300,000 in annual pre-tax savings. The Company recorded a
charge for severance, outplacement and other related costs of approximately
$400,000, or $.02 per share in the second quarter of 2001.
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REVIEW REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Tollgrade Communications, Inc. and subsidiaries:
We have reviewed the accompanying condensed consolidated balance sheet of
Tollgrade Communications, Inc. and its subsidiaries as of March 31, 2001, and
the related condensed consolidated statements of operations and cash flows for
the three-month periods ended March 31, 2001 and April 1, 2000. These financial
statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated interim financial statements
for them to be in conformity with accounting principles generally accepted in
the United States of America.
We previously audited, in accordance with auditing standards generally accepted
in the United States of America, the consolidated balance sheet of Tollgrade
Communications, Inc. and subsidiaries as of December 31, 2000 and the related
consolidated statements of operations, shareholders' equity and cash flows for
the year then ended (not presented herein); and in our report dated January 19,
2001 we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
condensed consolidated balance sheet as of December 31, 2000, is fairly stated
in all material respects in relation to the consolidated balance sheet from
which it has been derived.
/s/ PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
April 11, 2001
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
The following discussion should be read in conjunction with the Condensed
Consolidated Financial Statements and Notes thereto appearing elsewhere in this
report.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995.
The statements contained in the following Management's Discussion and Analysis
of Results of Operations and Financial Condition which are not historical 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. These forward-looking statements represent Tollgrade Communications,
Inc.'s (the "Company") present expectations or beliefs concerning future events.
The Company cautions that such statements must be qualified by important factors
that could cause actual earnings and other results to differ materially from
those achieved in the past or those expected by the Company. These statements as
to management's beliefs, strategies, plans, expectations or opinions in
connection with Company performance, are based on a number of assumptions
concerning future conditions that may ultimately prove to be inaccurate. Such
statements must be qualified by important factors that could cause actual
earnings and other results to differ materially from those achieved in the past
or those expected by the Company. These include:
o Customers' ability to meet established purchase forecasts and their own
growth projections;
o The ability of certain customers to maintain financial strength and access
to capital;
o The ability for sales and marketing partners to meet their own performance
objectives and provide vendor financing to certain local exchange carriers;
o Customers' seasonal buying patterns and the risk of order cancellations;
o Risk of shortage of key components and possibility of limited source of
supply;
o Manufacturing delays and availability of manufacturing capacity; o Intense
competition in the market for the Company's products;
o Rapid technological change along with the need to continually develop new
products and gain customer acceptance and approval;
o The company's dependence on a relatively narrow range of products;
o Competition;
o The company's dependence on key employees;
o Difficulties in managing the Company's growth;
o The Company's dependence upon a small number of large customers and certain
suppliers;
o The Company's dependence upon proprietary rights;
o Risks of third party claims of infringement;
o Possibility of product defects;
o The potential of having excess inventory and risk of parts' obsolescence
should demand for the Company's products decrease unexpectedly; and
o Government regulation.
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OVERVIEW
The Company was organized in 1986 and began operations in 1988. The Company
designs, engineers, markets and supports test system, test access and status
monitoring products for the telecommunications and cable television industries.
The Company's telecommunications proprietary test access products enable
telephone companies to use their existing line test systems to remotely diagnose
problems in "Plain Old Telephone Service" (" POTS") lines containing both copper
and fiber optics. The Company's MCU(R) product line, which includes POTS line
testing as well as alarm-related products, represented approximately 65% of the
Company's revenue for the first quarter ended March 31, 2001. In addition, the
current quarter included sales of $1,300,000, or 4.6% of revenues associated
with a shipment of a one-time order for the Company's Broadcast Program Channel
Unit, for use at the Salt Lake City Winter Olympic Games. The Company's MCU
product line will continue to account for a majority of the Company's revenues
for the foreseeable future.
The Company's DigiTest(R) centralized network test system platform focuses on
helping local exchange carriers conduct the full range of fault diagnosis, along
with the ability to qualify, deploy and maintain next generation services that
include Digital Subscriber Line ("DSL") service and Integrated Services Digital
Network ("ISDN") service. The Company's DigiTest system is designed to provide
complete hardware testing for POTS and local loop prequalification for DSL
services. The system currently consists of three integrated pieces of hardware -
the Digital Measurement Node ("DMN"), the Digital Measurement Unit ("DMU"), the
Digital Wideband Unit ("DWU"). When used in an integrated fashion, the DigiTest
system will permit local exchange carriers to perform a complete array of
central office testing including POTS, DSL line prequalification, bridged tap
detection, data rate prediction, and in-service wideband testing. Sales of the
DigiTest product line accounted for approximately 18% of the Company's revenue
for the first quarter of 2001. In addition, the first quarter of 2001 included
initial sales of the Company's new DigiTest Access Unit ("DAU"). The DAU
provides automated test access of locally non-switched, two wire circuits and it
helps facilitate the line sharing or the spectral unbundling process for both
incumbent (ILEC) and competitive local exchange carriers (CLECs). Sales of the
test access products accounted for approximately 5% of total revenue for the
current quarter.
The Company's LIGHTHOUSE(R) cable products consist of a complete cable status
monitoring system that provides a broad testing solution for the Broadband
Hybrid Fiber Coax distribution system. The status monitoring system includes a
host for user interface, control and configuration; a headend controller for
managing network communications; and transponders that are strategically located
within the cable network to gather status reports from power supplies, line
amplifiers and fiber-optic nodes. Sales of the LIGHTHOUSE product line accounted
for approximately 5% of the Company's revenue for the first quarter of 2001.
Through the first quarter of 2001, the Company continued to provide its
Professional Services offering to customers. The cornerstone of the Company's
Professional Services offering is the Testability Improvement Initiatives. These
services may offer the customer the opportunity to make improvements in
testability levels, while training their own staffs in targeted geographic
regions over a defined period of time. By making improvements in the customer's
digital loop carrier
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("DLC") testability levels, the customer's internal repair technicians can make
use of automated systems to diagnose and repair subscriber loop problems thereby
automatically eliminating the need for the involvement of several highly trained
people to test and diagnose line problems. The Professional Services business
levels are not yet considered material to the Company's total revenue.
The Company's telecommunication product sales and services are primarily to the
four Regional Bell Operating Companies ("RBOCs") as well as major independent
telephone companies and to certain digital loop carrier ("DLC") equipment
manufacturers. For the first quarter ended March 31, 2001, approximately 66% of
the Company's total revenue was generated from sales to these four RBOCs. During
the first quarter of 2001, sales to three RBOCs individually exceeded 10% of
consolidated revenues and on a combined basis, comprised approximately 57% of
the Company's net product sales. In addition, sales to an Original Equipment
Manufacturer accounted for approximately 14% of the Company's net product sales.
Due to the Company's present dependency on these key customers , the loss of one
or more of them as a customer, or the reduction of orders for the Company's
products by them could materially and adversely affect the Company.
The Company's operating results have fluctuated and may continue to fluctuate
as a result of various factors, including the timing of orders from and
shipments to the RBOCs and other key customers. This timing is particularly
sensitive to various business factors within each of the RBOCs, including the
RBOCs relationships with their various organized labor groups. In addition, the
markets for the Company's new products, specifically DigiTest and LIGHTHOUSE,
are highly competitive. Due to the rapidly evolving market in which these
products compete, additional competitors with significant market presence and
financial resources could further intensify the competition for these products.
The Company believes that recent changes within the telecommunication
marketplace, including industry consolidation, as well as the Company's ability
to successfully penetrate certain new markets, have resulted in some discounting
and more favorable terms granted to certain customers of the Company. In
addition, the Company experienced certain customer demands to consolidate
product purchases which have translated into large bulk orders. Although the
Company will continue to strive to meet the demands of its customers, which
include delivery of quality products at an acceptable price and on acceptable
terms, there are no assurances that the Company will be successful in
negotiating acceptable terms and conditions pertaining to these large orders.
Additionally, continuing consolidation efforts among the RBOCs, and their
ability to consolidate their inventory and product procurement systems could
cause fluctuations or delays in the Company's order patterns. Also, recent
efforts in the cable status monitoring industry to standardize transponders
among status monitoring systems could cause pricing pressure as well as affect
deployment within certain customers of the Company's cable products. These
standards, if adopted by the standards setting body, are expected to become
final in the year 2001 and may affect the Company's revenues from such products
in subsequent periods. The Company cannot predict such future events or business
conditions and the Company's results may be adversely affected by these industry
trends in the primary markets its serves.
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Although international sales to date have not been significant, the Company
believes that certain international markets may offer opportunities. However,
the international telephony markets differ from those found domestically due to
the different types and configurations of equipment used by those international
communication companies to provide services. In addition, certain competitive
elements also are found internationally which do not exist in the Company's
domestic markets. These factors, when combined, have made entrance into these
international markets very difficult. From time to time, the Company has
utilized the professional services of various marketing consultants to assist in
defining the Company's international market opportunities. With the assistance
of these consultants and through direct marketing efforts by the Company, it has
been determined that its present MCU technology offers limited opportunities in
certain international markets for competitive and other technological reasons.
However, the Company continues to evaluate opportunities for its other products
in international markets. There can be no assurance that any continued efforts
by the Company will be successful or that the Company will achieve significant
international sales.
The Company believes that the rapid downturn in the U.S. economy during the
first quarter has had a dramatic effect on capital spending across all
industries, including the telecommunications and cable television industries.
Several of the Company's key RBOC customers have announced capital spending
reductions in 2001. In addition, sales of DigiTest to a certain OEM partner in
the first quarter of 2001 included bulk quantities of product that will most
likely meet the ultimate end users product requirements for the next several
quarters. The Company's key Lighthouse customers, which include AT&T BIS and
RCN, have announced capital spending deferrals until their current excess
inventories are consumed. The Company believes that, as a result of the current
economic environment as well as the items just mentioned, it is difficult to
assume near-term growth from core markets and predicting with any level of
certainty beyond the second quarter of 2001 is not possible. On April 19, 2001,
the Company announced plans to implement certain cost reduction initiatives that
included the elimination of approximately 80 positions within the general and
administrative, research and development and support areas. This realignment
will generate approximately $4,300,000 in annual pre-tax savings, or $.20 per
share. The Company recorded a pre-tax charge for severance, outplacement and
other related costs of approximately $400,000, or $.02 in the second quarter of
2001.
The Company believes that continued growth will depend, in part, on its ability
to design and engineer new products and, therefore, spends a significant amount
on research and development. Research and development expenses as a percentage
of revenues were approximately 12% for the first quarter of 2001.
The Company believes that the near-term economic climate could be one of
challenge and uncertainty. In addition, the Company believes that future growth
may be affected as a result of an overall near-term economic slowdown whereby
customers may become more conservative in their ordering patterns and
quantities, or that certain emerging carriers become financially unstable. Due
to this uncertainty, the Company will evaluate its investments in marketing and
research and development expenses and monitor, control or decrease expense
levels as appropriate.
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RESULTS OF OPERATIONS - FIRST QUARTER
REVENUES
Revenues for the first quarter of 2001 of $27,990,002 were $5,572,467, or 24.9%,
higher than the revenues of $22,417,535 reported for the first quarter of 2000.
The increase in revenues for the first quarter of 2001 was primarily
attributable to an increase in unit volume sales of core MCU line testing
products to Verizon, SBC Communications, Inc. (including Ameritech, Pacific Bell
and SNET) and BellSouth. The increase in MCU sales to Verizon and BellSouth were
related primarily to special incentive programs within their regional networks
to improve testability rates system-wide, while the increase in sales of MCU's
to SBC represented the continued roll out of its Project Pronto, a broadband
initiative, and its continued effort to improve testability in their multi-state
region. The current quarter also included increased shipments of the Company's
next generation DigiTest system products primarily to Nortel Networks as well as
initial shipments of the Company's DAU product to Sprint USA. In addition, the
current quarter also included a $1,300,000 shipment of the Company's Broadcast
Program Channel Unit to Qwest related to a one-time order for use at the Salt
Lake City Winter Olympic Games. Periodic fluctuations in customer orders and
backlog result from a variety of factors, including but not limited to, the
timing of significant orders and shipments, and are not necessarily indicative
of long-term trends in sales of the Company's products.
GROSS PROFIT
Gross profit for the first quarter of 2001 was $15,715,719 compared to
$14,045,875 for the first quarter of 2000, representing an increase of
$1,669,844, or 11.9%. Gross profit as a percentage of revenues decreased to
56.1% in the first quarter of 2001, compared to 62.7% in the same quarter last
year. The overall decrease in gross profit as a percentage of sales resulted
primarily from the costs associated with the introduction of the new DAU
product, lower margins associated with the sale of the Broadcast Program Channel
Units, as well as an increase in allocated unit costs arising from lower
production volume. The Company's gross margin continues to be highly sensitive
to the mix of products shipped. Revenues from the Company's DigiTest test
platform, which is being marketed aggressively on both a direct and OEM sale
basis, in what is becoming an extremely competitive environment, may become a
larger portion of the Company's total revenues in 2001. To the extent that such
increased DigiTest revenues are attributable either to OEM sales or to product
deployment into applications downstream from the central office, the Company
believes that actual overall margins may decline slightly from their current
levels.
SELLING AND MARKETING EXPENSE
Selling and marketing expense for the first quarter of 2001 was $2,449,824
compared to $2,383,683 for the first quarter of 2000. This increase of $66,141,
or 2.8%, is primarily due to an increase in the number of sales and marketing
personnel that were added during 2000 to support new product introductions and
enhance customer support, offset in part by a decrease in overall general
advertising, promotion and related marketing activities resulting from certain
cost containment initiatives initiated at the beginning of the year to control
discretionary costs. As a percentage of revenues, selling and marketing expenses
decreased slightly to 8.8% in the first quarter of 2001 from 10.6% in the first
quarter of 2000.
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GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense for the first quarter of 2001 was $1,530,152,
an increase of $152,429, or 11.1%, from the $1,377,723 recorded in the first
quarter of 2000. The increase in general and administrative expense primarily
reflects an increase in the contingency provision for potential bad debts as
well as an increase in proxy solicitation and distribution-related costs. As a
percentage of revenues, general and administrative expenses decreased to 5.5% in
the first quarter of 2001 from 6.1% in the first quarter of 2000.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense in the first quarter of 2001 was $3,359,541, an
increase of $768,873, or 29.7%, over the $2,590,668 recorded in the first
quarter of 2000. The increase is primarily associated with additional personnel
added during 2000. The new personnel were hired for positions in design
engineering, hardware and software development, engineering support, and test
engineering. As a percentage of revenues, research and development expense
increased to 12.0% in the first quarter of 2001 from 11.6% in the first quarter
of 2000.
INTEREST AND OTHER INCOME
Interest and other income consists primarily of interest income. For the first
quarter of 2001, interest and other income was $906,977 compared to $469,813 for
the first quarter of 2000, representing an increase of $437,164, or 93.1%. This
increase is primarily a result of additional funds available for investment
purposes during the current period.
PROVISION FOR INCOME TAXES
The provision for income taxes for the first quarter of 2001 was $3,528,010, an
increase of $589,010, or 20.0%, from the $2,939,000 for the first quarter of
2000. The effective income tax rate for the first quarter of 2000 was
approximately 38.0% of pretax income compared to the 36.0% effective income tax
rate for the first quarter of 2000. The increase in the effective income tax
rate was primarily due to higher relative levels of state income taxes
associated with expanding business activities.
NET INCOME AND EARNINGS PER SHARE
As a result of the above factors, net income for the first quarter of 2001 was
$5,755,169, an increase of $530,555, or 10.2%, from the $5,224,614 recorded in
the first quarter of 2000. Basic and diluted earnings per common share of $.44
and $.43, respectively, for the first quarter of 2001 increased by $.01 and
$.04, or 2.3% and 10.3%, from the $.43 and $.39, respectively, earned in the
first quarter of 2000. Basic and diluted weighted average common and common
equivalent shares outstanding were 12,957,833 and 13,377,185, respectively, in
the first quarter of 2001 compared to 12,218,591 and 13,546,166, respectively,
in the first quarter of 2000. As a percentage of revenues, net income for the
first quarter of 2001 decreased to 20.6% compared to the 23.3% for the first
quarter of 2000.
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LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2001, the Company had working capital of $115,425,855, which
represented an increase of $4,291,233, or 3.9%, from the $111,134,622 of working
capital as of December 31, 2000. The increase in working capital can be
attributed primarily to net income before depreciation and amortization and
proceeds from the exercise of stock options exceeding the Company's
requirements for purchases of property and equipment of $1,071,479 and the
purchases of long-term investments of $1,175,000.
On April 19, 2001, the Company announced its Board of Directors authorized the
continuation of a share repurchase program it first started on April 22, 1997.
Under the current extension, the Company may repurchase a total of one million
shares of its common stock before December 31, 2001. The number of shares that
the Company intends to purchase and the time of such purchases will be
determined by the Company at its discretion. The Company plans to use existing
cash and short-term investments to finance any such purchases.
Prior to the aforementioned stock repurchase program extension, the company had
repurchased 382,400 shares of common stock. These repurchased shares are
intended to provide stock under certain employee benefit programs.
The Company's days sales outstanding (DSO's) in accounts receivable trade was 62
and 61 days as of March 31, 2001 and December 31, 2000, respectively. The
Company's inventory turnover ratio remained unchanged at 1.8 turns as of March
31, 2001 and December 31, 2001. Approximately $2,000,000 in inventory was
returned to vendors for credit during the first quarter of 2001 associated with
a program addressed to decrease on hand inventory levels commensurate with
current sales levels. Management believes that operating cash flow and cash
reserves are adequate to finance currently planned capital expenditures and to
meet the overall liquidity needs of the Company.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's current investment policy limits its investments in financial
instruments to cash and cash equivalents, individual municipal bonds, and
corporate and government bonds. The use of financial derivatives and preferred
and common stocks is strictly prohibited. The Company believes it minimizes its
risk through proper diversification along with the requirements that the
securities must be of investment grade with an average rating of "A" or better
by Standard & Poor's. The Company holds its investment securities to maturity
and believes that earnings and cash flows are not materially affected by changes
in interest rates, due to the nature and short-term investment horizon for which
these securities are invested.
BACKLOG
The Company's backlog consists of firm customer purchase orders. As of March 31,
2001, the Company had a backlog of $5,605,349 compared to $8,224,460 at
December 31, 2000 and $15,191,025 at April 1, 2000. Approximately 60% of the
current backlog is currently scheduled for shipment in the second quarter of
2001. Periodic fluctuations in customer orders and backlog result from a variety
of factors, including but not limited to the timing of significant orders and
shipments. While these fluctuations could impact short-term results, they are
not necessarily indicative of long-term trends in sales of the Company's
products.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
The following exhibits are being filed with this report:
Exhibit
Number Description
------- -----------
15 Letter re unaudited interim financial information
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SIGNATURE
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: May 15, 2001 /S/ CHRISTIAN L. ALLISON
-----------------------------------------------
Christian L. Allison
Chairman, President and Chief Executive Officer
Dated: May 15, 2001 /S/ SAMUEL C. KNOCH
-----------------------------------------------
Samuel C. Knoch
Chief Financial Officer and Treasurer
Dated: May 15, 2001 /S/ BRADLEY N. DINGER
-----------------------------------------------
Bradley N. Dinger
Controller
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EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
Exhibit
Number Description
------- -----------
15 Letter re unaudited interim financial information
20