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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 June 30, 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.
(Exact Name of Registrant as Specified in its Charter)
PENNSYLVANIA 25-1537134
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification Number)
493 NIXON RD.
CHESWICK, PA 15024
(Address of Principal Executive Offices, including zip code)
412-820-1400
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
As of July 31, 2001, there were 13,452,451 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 24 pages. The exhibit index is on page 23.
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TOLLGRADE COMMUNICATIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2001
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO.
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ITEM 1 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2001 AND DECEMBER 31, 2000 ...........3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE-MONTH AND
SIX-MONTH PERIODS ENDED JUNE 30, 2001 AND JULY 1, 2000.....................................4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX-MONTH PERIODS
ENDED JUNE 30, 2001 AND JULY 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
ITEM 1 LEGAL PROCEEDINGS.........................................................................20
ITEM 2 CHANGES IN SECURITIES.....................................................................20
ITEM 3 DEFAULTS UPON SENIOR SECURITIES...........................................................20
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......................................20
ITEM 5 OTHER INFORMATION.........................................................................20
ITEM 6 EXHIBITS AND REPORTS FILED ON FORM 8-K....................................................21
SIGNATURE...............................................................................................22
EXHIBIT INDEX...........................................................................................23
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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,
JUNE 30, 2001 2000
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ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 42,808,632 $ 30,423,783
Short-term investments 33,607,909 28,405,655
Accounts receivable:
Trade 17,278,181 18,775,643
Other 911,988 813,809
Inventories 24,980,398 30,499,482
Prepaid expenses and deposits 536,243 787,098
Refundable taxes due 633,402 8,950,672
Deferred tax assets 1,031,219 983,246
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TOTAL CURRENT ASSETS 121,787,972 119,639,388
Long-term investments 7,310,000 2,750,000
Property and equipment, net 7,772,251 6,503,923
Deferred tax assets 2,582,182 2,380,828
Patents ----- 417
===================================================================================================================
TOTAL ASSETS $ 139,452,405 $ 131,274,556
===================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $497,508 $ 1,874,328
Accrued expenses 2,249,891 1,937,589
Accrued salaries and wages 528,486 2,813,433
Royalties payable 1,083,843 1,142,478
Income taxes payable 533,242 636,938
Deferred income 100,000 100,000
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TOTAL CURRENT LIABILITIES 4,992,970 8,504,766
Deferred tax liabilities 9,950 9,950
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TOTAL LIABILITIES 5,002,920 8,514,716
Shareholders' equity:
Common stock, $.20 par value; authorized shares,
50,000,000; issued shares, 13,451,951 and 13,329,264,
respectively
2,690,390 2,665,853
Additional paid-in capital 68,450,241 66,343,728
Treasury stock, at cost, 386,800 shares, in 2001 and 2000,
respectively (3,164,975) (3,164,975)
Retained earnings 66,473,829 56,915,234
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TOTAL SHAREHOLDERS' EQUITY 134,449,485 122,759,840
===================================================================================================================
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 139,452,405 $ 131,274,556
===================================================================================================================
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)
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FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
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JUNE 30, 2001 JULY 1, 2000 JUNE 30, 2001 JULY 1, 2000
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REVENUES $21,776,167 $29,666,710 $49,766,169 $52,084,245
COST OF SALES 9,565,550 11,413,382 21,839,833 19,785,042
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GROSS PROFIT 12,210,617 18,253,328 27,926,336 32,299,203
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OPERATING EXPENSES:
Selling and marketing 2,492,496 3,027,461 4,942,320 5,411,144
General and administrative 1,062,146 1,495,334 2,592,298 2,873,057
Research and development 2,749,105 3,098,095 6,108,646 5,688,763
Severance and related expense 400,000 ----- 400,000 -----
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TOTAL OPERATING EXPENSES 6,703,747 7,620,890 14,043,264 13,972,964
INCOME FROM OPERATIONS 5,506,870 10,632,438 13,883,072 18,326,239
Interest and other income, net 790,558 545,441 1,697,535 1,015,254
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INCOME BEFORE INCOME TAXES 6,297,428 11,177,879 15,580,607 19,341,493
Provision for income taxes 2,494,002 4,024,000 6,022,012 6,963,000
==============================================================================================================================
NET INCOME $ 3,803,426 $ 7,153,879 $ 9,558,595 $ 12,378,493
==============================================================================================================================
EARNINGS PER SHARE INFORMATION:
Weighted average shares of common stock and equivalents:
Basic 13,028,498 12,562,822 12,993,558 12,392,619
Diluted 13,404,290 13,318,461 13,391,030 13,217,634
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Net income per common and common equivalent shares:
Basic $ .29 $ .57 $ .74 $ 1.00
Diluted $ .28 $ .54 $ .71 $ .94
==============================================================================================================================
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)
Six Months Ended
June 30,
2001 July 1, 2000
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 9,558,595 $12,378,493
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 1,167,907 846,460
Tax benefit from exercise of stock options 1,085,812 6,963,000
Refund of income taxes paid 8,317,270 -----
Deferred income taxes (249,327) -----
Provision for losses on inventory 10,341 251,196
Provision for allowance for doubtful accounts 175,000 -----
Changes in assets and liabilities:
Decrease (increase) in accounts receivable-trade 1,322,462 (1,634,384)
Increase in accounts receivable-other (98,179) (347,745)
Decrease (increase) in inventories 5,508,743 (4,550,709)
Decrease in prepaid expenses and other assets 250,855 40,364
(Decrease) increase in accounts payable (1,376,820) 595,882
Increase (decrease) in accrued expenses and deferred income 312,302 (1,260,665)
Decrease in accrued salaries and wages (2,284,947) (483,579)
(Decrease) increase in royalties payable (58,635) 472,200
Decrease in income taxes payable (103,696) (3,052,958)
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Net cash provided by operating activities 23,537,683 10,217,555
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CASH FLOWS FROM INVESTING ACTIVITIES:
Redemption/maturity of investments 15,206,244 4,624,648
Purchase of investments (24,968,498) (16,149,151)
Capital expenditures (2,435,818) (2,217,263)
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Net cash used in investing activities (12,198,072) (13,741,766)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options 1,045,238 8,741,733
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Net cash provided by financing activities 1,045,238 8,741,733
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Net increase in cash and cash equivalents 12,384,849 5,217,522
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 $42,808,632 $20,773,332
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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 interim financial information and Article 10 of Regulation S-X. The
condensed consolidated financial statements as of and for the three-month and
six-month periods ended June 30, 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 and six-month periods ended June 30, 2001 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2001.
The accompanying condensed consolidated statement of cash flows for the six
months ended July 1, 2000 has been reclassified to reflect tax benefits arising
from the exercise of stock options as an operating cash flow rather than a
financing cash flow in accordance with Emerging Issues Task Force Issue 00-15.
The effect of the reclassification was to increase cash flows from operations
and decrease cash flows from financing for the six -months ended July 1, 2000 by
$6,963,000.
2. INVENTORIES
At June 30, 2001 and December 31, 2000, inventories consisted of the following:
(Unaudited)
June 30, December 31,
2001 2000
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Raw materials .............................................. $13,420,025 $14,885,196
Work in progress ........................................... 8,346,054 12,981,052
Finished goods ............................................. 4,212,319 3,718,234
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25,978,398 31,584,482
Reserves for slow moving and
obsolete inventory ...................................... (998,000) (1,085,000)
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$24,980,398 $30,499,482
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3. SHORT-TERM AND LONG-TERM INVESTMENTS
Short-term investments at June 30, 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 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)
June 30, December 31,
2001 2000
--------------------------- --------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
Financial assets:
Cash and cash equivalents ................ $42,808,632 $42,808,632 $30,423,783 $30,423,783
Short-term and long-term investments...... 40,917,909 40,761,402 31,155,655 31,104,323
----------- ----------- ----------- -----------
$83,726,541 $83,570,034 $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 Six Months Six Months
Ended Ended Ended Ended
June 30, 2001 July 1, 2000 June 30, 2001 July 1, 2000
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Net income ............................ $ 3,803,426 $ 7,153,879 $ 9,558,595 $12,378,493
===========================================================================================================================
Common and common equivalent shares:
Weighted average number of
common shares outstanding
during the period ..................... 13,028,498 12,562,822 12,993,558 12,392,619
Common shares issuable upon exercise of
outstanding stock options:
Diluted ............................ 375,792 755,639 397,472 825,015
Common and common equivalent shares
Outstanding during the period:
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Diluted ............................ 13,404,290 13,318,461 13,391,030 13,217,634
===========================================================================================================================
Earnings per share data
Net income per common and common
Equivalent shares:
Basic .............................. $ .29 $ .57 $ .74 $ 1.00
Diluted ............................ $ .28 $ .54 $ .71 $ .94
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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 half of 2001, the company received $8,317,270 in federal income tax
refunds associated with prior year taxes paid. The remaining current refundable
taxes are 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.
As of June 30, 2001, no shares have been repurchased under this program.
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. SEVERANCE AND RELATED EXPENSE
On April 19, 2001, the Company announced a restructuring program 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. As a result of the restructuring program, the
Company recorded a pre-tax charge for severance, outplacement and other related
costs of $400,000 during the second quarter. This realignment is estimated to
generate approximately $4,300,000 in annual pre-tax savings.
During the second quarter of 2001, all terminations of identified personnel were
completed. The Company paid approximately $266,000 for involuntary termination
benefits and other associated costs. The remaining balance of $134,000 is
estimated to be paid over the second half of 2001.
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REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Tollgrade Communications, Inc. and subsidiaries:
We have reviewed the accompanying condensed consolidated balance sheet of
Tollgrade Communications, Inc. and its subsidiaries as of June 30, 2001, and the
related condensed consolidated statements of operations for each of the
three-month and six-month periods ended June 30, 2001 and July 1, 2000 and the
condensed consolidated statement of cash flows for the six month periods ended
June 30, 2001 and July 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, except for the last paragraph of Note 1, as to which the date is August
14, 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.
PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
August 14, 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 69% of the
Company's revenue for the second quarter ended June 30, 2001. 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 19% of the Company's revenue
for the second quarter of 2001. In addition, the Company's new DigiTest Access
Unit ("DAU") provides automated test access of locally non-switched, two wire
circuits and 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 7% 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 2% of the Company's revenue for the second quarter of 2001.
Through the second 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 ("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. Sales of the
Professional Services business accounted for approximately 3% of the Company's
revenue for the second quarter of 2001.
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 second quarter ended
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June 30, 2001, approximately 68% of the Company's total revenue was generated
from sales to these four RBOCs. During the second quarter of 2001, sales to
three RBOCs individually exceeded 10% of consolidated revenues and on a combined
basis, comprised approximately 61% of the Company's revenue for the second
quarter of 2001. In addition, sales to Sprint USA accounted for approximately
23% of the Company's revenues for the second quarter of 2001. 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 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. The
Company's operating results for the second quarter of 2001 reflect several
significant sales incentive-based MCU orders and shipments that were made late
in the second quarter which could affect product sales in the third quarter. The
continued success of the Company's Professional Services business will be vital
to maintaining a solid rate of MCU deployments in the near-term. 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 cable
television industry, and their ability to consolidate their inventory and
product procurement systems could cause fluctuations or delays in the Company's
order patterns. The timing of these orders is also sensitive to the RBOCs
relationships with their various organized labor groups. 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 it serves.
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
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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 continued downturn in the U.S. economy during the
first half of 2001 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. The Company's key Lighthouse customers, which include AT&T
Broadband and RCN Corporation, 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 predict with any level of certainty revenues and earnings per
share beyond the third 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 13% for the second quarter of 2001.
The Company believes that the near-term economic climate is one of challenge and
uncertainty. In addition, the Company believes that future growth may be
affected as a result of the economic slowdown whereby customers 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.
RESULTS OF OPERATIONS - SECOND QUARTER
REVENUES
Revenues for the second quarter of 2001 of $21,776,167 were $7,890,543, or
26.6%, lower than the revenues of $29,666,710 reported for the second quarter of
2000. The decrease in revenues for the second quarter of 2001 was primarily
attributable to a decrease in unit volume sales of core MCU line testing
products to SBC Communications, Inc. (including Ameritech, Pacific Bell and
SNET) due to a slow-down of that company's DSL rollout, called Project Pronto, a
broadband initiative. Sales of MCU's to Qwest also decreased in the second
quarter of 2001 as that company evaluates their testability improvement programs
within their region. In addition, sales of OEM-related MCU products decreased as
a result of cutbacks in deployments of certain next-generation Digital Loop
Carrier (DLC) systems. The current quarter also included decreased shipments of
the Company's next generation DigiTest system products to Sprint and Nortel
Networks, while shipments of the Company's new DAU product to Sprint USA
increased. Sales of the LIGHTHOUSE product also decreased between periods as a
result of AT&T's Broadband's decision to delay purchases of cable-related
equipment, as well as a slow-down by RCN Corporation in deploying cable status
monitoring systems. The second quarter 2001 revenue did include certain
significant sales incentive-based MCU orders and shipments that occurred late in
the quarter. These sales incentives included bulk sales of MCU's to BellSouth,
Verizon and Qwest. The Company believes that these bulk purchases of MCU's will
ultimately help facilitate those customers ability to improve their regional
testability rates upon deployment of these units. In certain cases, the Company
will support the customer in deploying these MCU's within their respective
regions. Due to the significance and timing of these MCU shipments and the
Company's reliance on our customer's ability to successfully deploy these units
in a timely fashion, the sales of MCU's in the third quarter of 2001 could be
affected should these customers not place equivalent orders for MCU shipments
during that period. Periodic fluctuations in customer orders and backlog result
from a variety of
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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 second quarter of 2001 was $12,210,617 compared to
$18,253,328 for the second quarter of 2000, representing a decrease of
$6,042,711, or 33.1%. Gross profit as a percentage of revenues decreased to
56.1% in the second quarter of 2001, compared to 61.5% in the same quarter last
year. The overall decrease in gross profit as a percentage of sales resulted
primarily from an increase in allocated unit costs arising from lower production
volume, the impact of the sales incentive programs for bulk-buys of MCU's
mentioned above, as well as the product mix of sales. The Company's gross margin
continues to be highly sensitive to the mix of products sold. 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 second quarter of 2001 was $2,492,496
compared to $3,027,461 for the second quarter of 2000. This decrease of
$534,965, or 17.7%, is primarily due to reduced discretionary spending on
general advertising, promotion and related marketing activities as well as
reduced salaries and related costs associated with the cost realignment. As a
percentage of revenues, selling and marketing expenses increased to 11.4% in the
second quarter of 2001 from 10.2% in the second quarter of 2000.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense for the second quarter of 2001 was
$1,062,146, a decrease of $433,188, or 29.0%, from the $1,495,334 recorded in
the second quarter of 2000. The decrease in general and administrative expense
primarily reflects the decrease in salaries and related costs associated with
the cost realignment, reduced expenditures on professional services and reduced
recruiting-related costs. As a percentage of revenues, general and
administrative expenses decreased to 4.9% in the second quarter of 2001 from
5.0% in the second quarter of 2000.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense in the second quarter of 2001 was $2,749,105, a
decrease of $348,990, or 11.3%, over the $3,098,095 recorded in the second
quarter of 2000. The decrease is primarily associated with the decrease in
salaries and related costs associated with the cost realignment as well as
reductions in certain project-related costs for materials and supplies. As a
percentage of revenues, research and development expense increased to 12.6% in
the second quarter of 2001 from 10.4% in the second quarter of 2000.
SEVERANCE AND RELATED EXPENSE
On April 19, 2001, the Company announced a cost realignment initiative. The
restructuring program resulted in workforce reduction charges of $400,000
related to the cost of severance and related benefits for the termination of
approximately 80 employees, as well as exit costs consisting of consulting and
legal fees. During the second quarter of 2001, all terminations of identified
personnel were completed. The Company paid approximately $266,000 for
involuntary termination benefits and other associated costs during the second
quarter of 2001. The remaining portion of the severance and related reserve is
expected to be utilized over the second half of 2001. The Company
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expects annualized pre-tax savings of $4,300,000, or $.20 per share after-tax,
associated with this cost realignment initiative.
INTEREST AND OTHER INCOME
Interest and other income consists primarily of interest income. For the second
quarter of 2001, interest and other income was $790,558 compared to $545,441 for
the second quarter of 2000, representing an increase of $245,117, or 44.9%. 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 second quarter of 2001 was $2,494,002, a
decrease of $1,529,998, or 38.0%, from the $4,024,000 for the second quarter of
2000. The effective income tax rate for the second quarter of 2001was
approximately 39.6% of pretax income compared to the 36.0% effective income tax
rate for the second 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 second quarter of 2001 was
$3,803,426, a decrease of $3,350,453, or 46.8%, from the $7,153,879 recorded in
the second quarter of 2000. Basic and diluted earnings per common share of $.29
and $.28, respectively, for the second quarter of 2001 decreased by $.28 and
$.26, or 49.1% and 48.1%, from the $.57 and $.54, respectively, earned in the
second quarter of 2000. The second quarter of 2001 includes approximately
$400,000, or $.02 per share after-tax, related to the charge for severance and
related costs. Basic and diluted weighted average common and common equivalent
shares outstanding were 13,028,498 and 13,404,290, respectively, in the second
quarter of 2001 compared to 12,562,822 and 13,318,461, respectively, in the
second quarter of 2000. As a percentage of revenues, net income for the second
quarter of 2001 decreased to 17.5% compared to the 24.1% for the second quarter
of 2000.
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RESULTS OF OPERATIONS YEAR-TO-DATE
REVENUES
For the first six months of 2001, revenues were $49,766,169 compared to
$52,084,245 for the first six months of 2000, representing a decrease of
$2,318,076, or 4.5%. The decrease in revenues for the first six months of 2001
was primarily attributable to a decrease in unit volume sales of core MCU line
testing products to SBC Communications, Inc. (including Ameritech, Pacific Bell
and SNET) due to a slow-down of that company's DSL rollout, called Project
Pronto, a broadband initiative. MCU-related sales to Qwest also decreased as
that company evaluates their various testability improvement programs. In
addition, sales of OEM-related MCU products decreased with cutbacks in some
next-generation Digital Loop Carrier (DLC) systems deployments. As a result of
certain of the Company's sales incentive programs, sales of MCU's to both
Verizon and BellSouth increased as those customers work toward improving their
regional testability rates. The first six months also included increased
shipments of the Company's next generation DigiTest system products to Lucent
and Nortel Networks, offset somewhat by decreased shipments to Sprint USA
between periods. In addition, sales of the Company's new DAU product to Sprint
USA continued. Sales of the LIGHTHOUSE product decreased between periods as a
result of AT&T's Broadband's decision to delay purchases of cable related
equipment, as well as a slow-down by RCN Corporation in deploying cable status
monitoring systems. 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 six months of 2001 was $27,926,336 compared to
$32,299,203 for the first six months of 2000, representing a decrease of
$4,372,867, or 13.5%. Gross profit as a percentage of revenues decreased to
56.1% in the first six months of 2001 compared to 62.0% in the same period last
year. The overall decrease in gross profit as a percentage of sales resulted
primarily from an increase in allocated unit costs arising from lower production
volume; the introduction of the new DAU product and lower margins associated
with the sale of the Broadcast Program Channel Units during the first quarter of
2001. The Company's gross margin continues to be highly sensitive to the mix of
products sold.
SELLING AND MARKETING EXPENSE
Selling and marketing expense for the first six months of 2001 was $4,942,320
compared to $5,411,144 for the first six months of 2000. This decrease of
$468,824, or 8.7%, is primarily due to reduced discretionary spending on general
advertising, promotion and related marketing activities as well as reduced
salaries and related costs associated with the cost realignment. As a percentage
of revenues, selling and marketing expenses decreased to 9.9% in the first six
months of 2001 from 10.4% in the same period last year.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense for the first half of 2001 was $2,592,298, a
decrease of $280,759, or 9.8%, from the $2,873,057 recorded for the first six
months of 2000. The decrease in general and administrative expense primarily
reflects reduced expenditures on professional services, decreased recruiting
related costs and decreased travel expenditures. This decrease was offset
somewhat by an increase in a contingency provision for potential bad debts. As a
percentage of revenues, general and administrative expenses decreased to 5.2% in
the first half of 2001 from 5.5% in the same period last year.
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RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense in the first half of 2001 was $6,108,646, an
increase of $419,883, or 7.4%, over the $5,688,763 recorded in the first half of
2000. The increase is primarily associated with additional personnel and
associated costs to support product development offset somewhat by a decrease in
certain performance-based compensation reserves. As a percentage of revenues,
research and development expenses increased to 12.3% in the first half of 2001
from 10.9% during the first half of 2001.
SEVERANCE AND RELATED EXPENSE
Refer to the section entitled Results of Operations - Second Quarter for a
discussion on severance and related expenses.
INTEREST AND OTHER INCOME
Interest and other income consists primarily of interest income. For the first
half of 2001, interest and other income was $1,697,535 compared to $1,015,254
for the first half of 2000, representing an increase of $682,281, or 67.2%. 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 half of 2001 was $6,022,012, a
decrease of $940,988, or 13.5%, from the $6,963,000 for the first half of 2000.
The effective income tax rate for the second quarter of 2001 was approximately
38.7% of pretax income compared to the 36.0% effective income tax rate for the
prior year period. 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 half of 2001 was
$9,558,595, a decrease of $2,819,898, or 22.8%, from the $12,378,493 recorded in
the first half of 2000. Basic and diluted earnings per common share of $.74 and
$.71, respectively, for the first half of 2001 decreased by $.26 and $.23, or
26.0% and 24.5%, from the $1.00 and $.94, respectively, earned in the first half
of 2000. The first half of 2001 includes approximately $400,000, or $.02 per
share after-tax, related to the charge for severance and related costs that was
recorded in the second quarter of 2001. Basic and diluted weighted average
common and common equivalent shares outstanding were 12,993,558 and 13,391,030,
respectively, in the first half of 2001 compared to 12,392,619 and 13,217,634,
respectively, in the first half of 2000. As a percentage of revenues, net income
for the first half of 2001 decreased to 19.2% compared to the 23.8% for the
first half of 2000.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2001, the Company had working capital of $116,795,001, which
represented an increase of $5,660,379, or 5.1%, 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 and proceeds from the exercise of stock
options exceeding the Company's requirements for purchases of property and
equipment of $2,435,818. The Capital expenditures for the first half of 2001
include approximately $1,450,000 associated with the purchase of certain land
parcels that surround the current leased facility. This purchase was made to
provide for future expansion of parking and/or new building structures should
they become necessary to support the business operation.
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,
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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. As of June 30, 2001, no shares have been repurchased under this
program.
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
58 and 61 days as of June 30, 2001 and December 31, 2000, respectively. The
Company's inventory turnover ratio was 1.9 turns and 1.8 turns as of June 30,
2001 and December 31, 2000. Approximately $2,000,000 in inventory was returned
to vendors for credit during the first half 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 June 30,
2001, the Company had a backlog of $4,340,747 compared to $8,224,460 at December
31, 2000 and $11,591,177 at July 1, 2000. Approximately 61% of the current
backlog is currently scheduled to be sold in the third 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
On May 3, 2001, the Company held its annual shareholders meeting. At
the meeting, Richard H. Heibel, M.D. and Robert W. Kampmeinert were elected to
the Board of Directors for a three-year term expiring at the annual meeting of
shareholders in 2004. The terms of Directors Christian L. Allison, Daniel P.
Barry, and David S. Egan also continued after the meeting and will expire at the
annual meeting of shareholders in 2002. The terms of Directors James J. Barnes
and Rocco L. Flaminio also continued after the meeting and will expire at the
annual meeting of shareholders in 2003. In addition, the Company's 1995
Long-term Incentive Compensation Plan was amended to increase the number of
shares of Common Stock authorized under the plan by 275,000 shares. Also, the
shareholders ratified the appointment of PricewaterhouseCoopers LLP as the
Company's independent auditors for fiscal year 2001. The results of the voting
were as follows:
Total Votes
Cast For Against Withheld Abstained
---- --- ------- -------- ---------
Election of Directors:
- ---------------------
Richard H. Heibel, M.D. 11,865,329 11,406,738 ----- 458,591 -----
Robert W. Kampmeinert 11,865,329 10,992,353 ----- 872,976 -----
Amendment to the Company's 1995 Long-term
Incentive Compensation Plan 11,865,329 9,651,326 2,165,910 ----- 48,093
Ratification of Appointment of 11,865,329 11,707,133 71,002 ----- 87,194
PricewaterhouseCoopers LLP
ITEM 5. OTHER INFORMATION
None.
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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
(b) Reports on Form 8-K:
The Company did not file any Current Report on Form 8-K during the
quarter ended June 30, 2001.
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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: August 17, 2001 /S/ CHRISTIAN L. ALLISON
------------------------------------
CHRISTIAN L. ALLISON
CHAIRMAN, PRESIDENT AND
CHIEF EXECUTIVE OFFICER
Dated: August 17, 2001 /S/ SAMUEL C. KNOCH
------------------------------------
SAMUEL C. KNOCH
CHIEF FINANCIAL OFFICER AND TREASURER
Dated: August 17, 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
23