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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 September 27, 1997
[ ] 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)
412-274-2156
(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 November 1, 1997, there were 5,726,467 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 38 pages. The exhibit index is on page 17.
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TOLLGRADE COMMUNICATIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 27, 1997
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO.
ITEM 1 -- CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 27, 1997
AND DECEMBER 31,1996 ......................................................................3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE-MONTH AND NINE-MONTH
PERIODS ENDED SEPTEMBER 27, 1997 AND SEPTEMBER 28, 1996 ...................................4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE-MONTH
PERIODS ENDED SEPTEMBER 27, 1997 AND SEPTEMBER 28, 1996 ...................................5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.......................................6
REPORT OF INDEPENDENT ACCOUNTANTS .........................................................8
ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION......................................................9
PART II. OTHER INFORMATION
ITEM 1 -- LEGAL PROCEEDINGS.........................................................................15
ITEM 2 -- CHANGES IN SECURITIES.....................................................................15
ITEM 3 -- DEFAULTS UPON SENIOR SECURITIES...........................................................15
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......................................15
ITEM 5 -- OTHER INFORMATION.........................................................................15
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K..........................................................15
SIGNATURE...........................................................................................16
EXHIBIT INDEX.......................................................................................17
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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
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(UNAUDITED)
SEPTEMBER 27, 1997 DECEMBER 31, 1996
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ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,147,053 $ 4,591,273
Short term investments 16,592,411 12,342,592
Accounts receivable:
Trade 7,202,714 5,153,589
Other 689,486 304,434
Inventories 9,419,883 8,569,818
Prepaid expenses and deposits 245,075 549,753
Deferred tax asset 171,730 171,776
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TOTAL CURRENT ASSETS 36,468,382 31,683,235
Property and equipment, net 2,942,601 2,769,657
Deferred tax asset 157,169 157,169
Patents and other assets 10,783 15,569
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TOTAL ASSETS $39,578,935 $34,625,630
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LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,033,032 $ 1,691,928
Accrued expenses 721,156 1,077,151
Accrued salaries and wages 727,198 769,855
Royalties payable 531,660 741,781
Income taxes payable 445,649 170,889
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TOTAL CURRENT LIABILITIES 3,458,694 4,451,604
Deferred tax liability 168,455 168,455
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TOTAL LIABILITIES 3,627,149 4,620,059
SHAREHOLDERS' EQUITY:
Common stock, $.20 par value; authorized shares, 7,000,000;
issued 5,725,667 and 5,620,417, respectively 1,145,133 1,124,083
Additional paid-in capital 25,155,359 24,091,210
Treasury stock, at cost, 2,200 shares (49,775) (49,775)
Unearned compensation (65,386) (106,686)
Retained earnings 9,766,455 4,946,739
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TOTAL SHAREHOLDERS' EQUITY 35,951,786 30,005,571
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $39,578,935 $34,625,630
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The accompanying notes are an integral part of the condensed consolidated
financial statements.
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TOLLGRADE COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
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FOR THE FOR THE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPT.27, 1997 SEPT.28, 1996 SEPT.27, 1997 SEPT.28, 1996
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REVENUES $11,362,609 $10,080,385 $32,097,040 $27,112,057
COST OF PRODUCT SALES 5,225,317 4,999,944 14,469,083 13,435,042
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GROSS PROFIT 6,137,292 5,080,441 17,627,957 13,677,015
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OPERATING EXPENSES:
Selling and marketing 1,286,864 1,234,448 3,666,999 3,385,308
General and administrative 947,799 671,673 2,691,834 1,746,702
Research and development 1,517,571 1,044,087 4,183,425 2,635,778
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TOTAL OPERATING EXPENSES 3,752,234 2,950,208 10,542,258 7,767,788
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INCOME FROM OPERATIONS 2,385,058 2,130,233 7,085,699 5,909,227
Interest and other income, net 220,887 90,138 637,252 478,810
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INCOME BEFORE INCOME TAXES 2,605,945 2,220,371 7,722,951 6,388,037
Provision for income taxes 999,022 824,695 2,903,274 2,422,695
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NET INCOME $ 1,606,923 $ 1,395,676 $ 4,819,677 $ 3,965,342
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EARNINGS PER SHARE INFORMATION:
Fully diluted weighted average shares of
common stock and equivalents 5,955,104 5,943,265 5,956,921 5,919,579
Net income per common and common equivalent shares:
Primary $ .27 $ .23 $ .81 $ .67
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Fully Diluted $ .27 $ .23 $ .81 $ .67
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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 CASH FLOWS
(Unaudited)
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NINE MONTHS ENDED
SEPT. 27, 1997 SEPT. 28, 1996
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,819,677 $ 3,965,342
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 733,411 416,801
Deferred income taxes 46 (65,951)
Compensation expense for restricted stock 41,300 47,399
Changes in assets and liabilities:
Increase in accounts receivable-trade (2,049,125) (1,304,070)
(Increase) decrease in accounts receivable-other (385,052) 22,576
Increase in inventories (850,065) (2,684,372)
Decrease (increase) in prepaid expenses and deposits 304,678 (144,745)
Increase in other assets ----- (9,336)
(Decrease) increase in accounts payable (658,858) 103,879
(Decrease) increase in accrued expense and royalties payable (608,773) 734,100
Increase in income taxes payable 274,760 743,181
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Net cash provided by operating activities 1,621,999 1,824,804
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CASH FLOWS FROM INVESTING ACTIVITIES:
Redemption/maturity of short-term investments 13,425,893 3,056,986
Purchase of short-term investments (17,675,742) (15,471,874)
Capital expenditures (901,569) (1,527,508)
Patent expenditures ----- (4,760)
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Net cash provided by operating activities (5,151,418) (13,947,156)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the exercise of stock options including related
tax benefits 1, 085,199 205,643
IPO issuance cost ---- (49,290)
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Net cash provided by (used in) financing activities 1,085,199 156,353
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Net increase (decrease) in cash and cash equivalents 2,444,220 (11,965,999)
Cash and cash equivalents at beginning of period 4,591,273 15,157,387
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Cash and cash equivalents at end of period $ 2,147,053 $3,191,388
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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 generally accepted accounting principles for the interim
financial information and Article 10 of Regulation S-X. The condensed
consolidated financial statements as of and for the three and nine-month
periods ended September 27, 1997 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, 1996.
Accordingly, the accompanying condensed consolidated financial statements do
not include all of the information and footnotes required by generally accepted
accounting principles 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 and
nine-month periods ended September 27, 1997 are not necessarily indicative of
the results that may be expected for the year ending December 31, 1997.
2. INVENTORY
At September 27, 1997 and December 31, 1996 inventory consisted of the
following:
(Unaudited)
September 27, December 31,
1997 1996
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Raw materials . . . . . . . . . . . . . . . . . . . . .$4,622,792 $3,816,242
Work in progress. . . . . . . . . . . . . . . . . . . . 3,143,117 3,808,842
Finished goods. . . . . . . . . . . . . . . . . . . . . 1,653,974 944,734
---------- ----------
$9,419,883 $8,569,818
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3. SHORT-TERM INVESTMENTS
Short-term investments at September 27, 1997 consisted of individual U.S.
Government and municipal bonds stated at cost, which approximated market value.
The primary investment purpose is to provide a reserve for future business
purposes, including possible acquisitions, capital expenditures and to meet
working capital requirements.
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4. NEW ACCOUNTING PRONOUNCEMENTS:
In February 1997 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share". SFAS 128
specifies the computation, presentation, and disclosure requirements for
earnings per share. SFAS 128 is effective for financial statements issued for
periods ending after December 15, 1997, including interim periods. The Company
plans to adopt the new standard at year-end 1997 and believes that the impact
of this standard will not have a material impact on the Company's consolidated
earnings per share calculations.
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REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Tollgrade Communications, Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of
Tollgrade Communications, Inc. and subsidiaries as of September 27, 1997, and
the related condensed consolidated statements of operations for the three
months and nine months then ended and the condensed consolidated statements of
cash flows for the nine months then ended. 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 financial statements for them to be in conformity
with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Tollgrade Communications, Inc. and
subsidiaries as of December 31, 1996 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 29, 1997, 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, 1996, is fairly stated in all material respects in
relation to the consolidated balance sheet from which it has been derived.
/s/ Coopers & Lybrand L.L.P.
Pittsburgh, Pennsylvania
October 10, 1997
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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 the
Company's present expectations or beliefs concerning future events. The Company
cautions that such statements are qualified by important factors that could
cause actual results to differ materially from those in the forward-looking
statements. Results actually achieved thus may differ materially from expected
results included in these statements. Those factors which specifically relate
to the Company's business include the following: rapid technological change
along with the need to continually develop new products; dependence on a single
product line; competition; dependence on key employees; management of Company's
growth; dependence on certain customers; dependence on certain suppliers;
fluctuations in operating results; proprietary rights and risks of third party
claims of infringement; and government regulation.
OVERVIEW
The Company was organized in 1986 and began operations in 1988. The Company
designs, engineers, markets and supports proprietary products which 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 91%
of the Company's revenue for the third quarter ended September 27, 1997 and
will continue to account for a majority of the Company's revenues for the
foreseeable future.
The Company's product sales are primarily to the five Regional Bell Operating
Companies ("RBOCs") as well as major independent telephone companies such as
Sprint and to certain digital loop carrier ("DLC") equipment manufacturers. For
the third quarter ended September 27, 1997, approximately 85% of the Company's
total revenue was generated from sales to these five RBOCs, the two largest of
which comprised approximately 44% of revenues. 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.
Management believes that during fiscal year 1998 there is a possibility that
one of the Company's major customers will have satisfied a substantial portion
of its requirements for certain of the Company's product lines. Management is
focusing on the development of new product lines to meet the requirements of
this and other customers.
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Although international sales to date have not been significant, the Company
believes the international markets offer opportunities. The Company intends to
focus additional sales, marketing and development resources on increasing its
international presence; however, there can be no assurance that these efforts
will be successful or that the Company will achieve significant international
sales.
The Company believes that continued growth will depend 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 percent of
revenues were approximately 13.4% for the third quarter ended September 27,
1997. The Company expects its research and development expenses to continue at
significant levels.
On July 18, 1997, the United States Court of Appeals for the Eighth Circuit
issued an opinion vacating, in part, the Federal Communication Commission's
Interconnection Order promulgated under the Telecommunications Act of 1996 (the
"Act") in Iowa Utilities Board, et. al. v. FCC, et al (consolidated cases
beginning at no. 96-3321). In the opinion, the court vacated the FCC's pricing
rules on the basis that the FCC exceeded its jurisdiction in promulgating
pricing rules regarding local telephone service, and asserting that the Act
grants state commissions, not the FCC, authority to determine the rates
involved in the implementation of the local competition provisions of the Act.
In addition, the court vacated the FCC's "pick and choose" rule implemented
under subsection 252(I) of the Act which allowed a local exchange carrier to
select among individual provisions of other interconnection agreements
previously negotiated between an incumbent local exchange carrier and other
requesting carriers, without being required to accept the terms and conditions
of the agreements in their entirety. Among other actions taken by the court, it
also upheld most of the unbundling regulations promulgated by the FCC in the
Interconnection Order. To date, it remains uncertain how this decision and the
actions of state commissions required as a result will affect the Company's
future results of operations.
Historically, the Company has utilized one key independent subcontractor to
perform a majority of the circuit board assembly and in-circuit testing work on
its products. The Company has also utilized other subassembly subcontractors on
a more limited basis. During the third quarter, 1997, the key subassembly
subcontractor notified the Company that due to a change in its business
strategy only customers that provide certain volume levels of business would be
sought or retained. As a result of this evaluation, the key subassembly
subcontractor notified the Company that its services would no longer be
available effective January 1, 1998. The Company is in the process of phasing
out the use of that subcontractor, and is beginning to utilize on a more
extensive basis, two of the other subassembly subcontractors that had been
utilized by the Company on a more limited basis in the past. By the end of
1997, the Company expects to have its subassembly requirements met by these two
subcontractors. Although the Company is striving to complete a seamless
transition, there is a risk that transitional issues could cause delays in the
Company's production requirements which could have an adverse effect on the
Company's results of operations.
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RESULTS OF OPERATIONS - THIRD QUARTER
REVENUES
Revenue for the third quarter of 1997 were $11,362,609 and were $1,282,224, or
12.7% higher than the revenues of $10,080,385 reported for the third quarter of
1996. The increase in revenues for the third quarter was primarily attributable
to an increase in unit volume sales of the MCU line testing products as a
result of increased market penetration and customer acceptance. This increased
product demand is at least partly attributable to technology licensing
agreements and/or joint venture relationships with certain major DLC equipment
manufacturers, as well as continued expansion of a marketing program to train
customers in advanced line test system trouble-shooting.
GROSS PROFIT
Gross profit for the third quarter of 1997 was $6,137,292 compared to
$5,080,441 for the third quarter of 1996, representing an increase of
$1,056,851, or 20.8%. Gross profit as a percentage of revenues increased to
54.0% in the third quarter of 1997, compared to 50.4% in the same quarter last
year. The overall increase in gross profit margin resulted primarily from
increased sales levels, while improvements in gross margin as a percentage of
revenues were a result of increased sales of certain higher-margined products
within the MCU product line.
SELLING AND MARKETING EXPENSE
Selling and marketing expense for the third quarter of 1997 was $1,286,864
compared to $1,234,448 for the third quarter of 1996. This increase of $52,416,
or 4.2%, is due to the addition of personnel associated with the expansion of
marketing and communications functions and the development of domestic and
international markets. As a percentage of revenues, selling and marketing
expenses decreased to 11.3% in the third quarter of 1997 from 12.2% in the
third quarter of 1996, primarily due to the increased revenue base discussed
above.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense for the third quarter of 1997 was $947,799,
an increase of $276,126, or 41.1%, over the $671,673 recorded in the third
quarter of 1996. The increase in general and administrative expense primarily
reflects additional salaries and benefits associated with increased staffing
levels to support expanded business operations, increased international travel
costs, as well as increased costs associated with recruiting-type activities.
As a percentage of revenues, general and administrative expenses increased to
8.3% in the third quarter of 1997 from 6.7% in the third quarter of 1996.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense in the third quarter of 1997 was $1,517,571,
an increase of $473,484, or 45.3%, over the $1,044,087 recorded in the third
quarter of 1996. The increase is primarily associated with additional personnel
and related development costs to support new product introductions. The new
personnel were hired for positions in design engineering, hardware and software
development, engineering support, and test engineering. Their efforts are
associated with the development of future products, support for newer products,
and feature enhancements for existing products. As a percentage of revenues,
research and development expense increased to 13.4% in the third quarter of
1997 from
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10.4% in the third quarter of 1996.
INTEREST AND OTHER INCOME
Interest and other income consists primarily of interest income. For the third
quarter of 1997, interest and other income was $220,887 compared to $90,138 for
the third quarter of 1996, representing an increase of $130,749, or 145.1%. The
increase was primarily attributable to increased interest income, which
resulted from an overall increase in funds available for investment between
comparable periods.
PROVISION FOR INCOME TAXES
The provision for income taxes for the third quarter of 1997 was $999,022, an
increase of $174,327, or 21.1%, from $824,695 for the third quarter of 1996.
The effective income tax rate increased to approximately 38.3% in the third
quarter of 1997, compared to approximately 37.1% in the third quarter of 1996.
The increased provision for income taxes was primarily due to increased
earnings levels of the Company between comparable periods. The increase in the
effective tax rate between periods reflects certain refinements for the
estimated effective tax rate for fiscal year 1997.
NET INCOME
As a result of the above factors, net income for the third quarter of 1997 was
$1,606,923, an increase of $211,247, or 15.1%, over the $1,395,676 recorded in
the third quarter of 1996. Primary and fully diluted earnings per common share
of $.27 for the third quarter of 1997 increased by $.04, or 17.4%, from the
$.23 per share earned in the third quarter of 1996. Fully diluted weighted
average common and common equivalent shares outstanding were 5,955,104 in the
third quarter of 1997 compared to 5,943,265 in the third quarter of 1996. As a
percentage of revenues, net income for the third quarter of 1997 increased to
14.1% compared to the 13.8% for the third quarter of 1996.
RESULTS OF OPERATIONS - YEAR TO DATE
REVENUES
For the first nine months of 1997, revenues were $32,097,040 compared to
$27,112,057 for the first nine months of 1996, representing an increase of
$4,984,983 or 18.4%. The increase in revenues for the nine month period was
primarily attributable to an increase in unit sales volume of the MCU line
testing products as a result of increased market penetration and customer
acceptance. In addition, increased product demand is at least partly
attributable to technology and licensing agreements and/or joint venture
relationships with certain major DLC equipment manufacturers, as well as
continued expansion of a marketing program to train customers in advanced line
test system trouble-shooting. MCU line testing and synchronization product
revenue increased $5,486,000, or 22.4%, in the nine month period ended
September 27, 1997 compared to first nine months of 1996.
GROSS PROFIT
For the nine months of 1997, gross profit increased to $17,627,957 compared to
$13,677,015 for the first nine months of 1996, representing an increase of
$3,950,942, or 28.9%. As a percentage of revenues, gross profit increased to
54.9% in the first nine months of 1997 compared to 50.4% in the same period for
1996. The overall increase in gross profit margin resulted primarily from
increased sales levels, while
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improvements in gross margin as a percentage of revenues were a result of
increased sales of certain higher-margined products within the MCU product
line.
SELLING AND MARKETING EXPENSE
For the first nine months of 1997, selling and marketing expense totaled
$3,666,999 compared to $3,385,308 for the first nine months of 1996,
representing an increase of $281,691, or 8.3%. The increase is due to the
addition of new personnel associated with the expansion of customer technical
support, expansion of marketing and communication functions and the development
of domestic and international markets. As a percentage of revenues, selling and
marketing expense decreased to 11.4% in the first nine months of 1997 from
12.5% for the same period of 1996. The decrease was due primarily to the
increased revenue base discussed above.
GENERAL AND ADMINISTRATIVE EXPENSE
For the first nine months of 1997, general and administrative expense totaled
$2,691,834 compared to $1,746,702 for the first nine months of 1996,
representing an increase of $945,132, or 54.1%. The increase in general and
administrative expense primarily reflects the addition of personnel to support
expanded business requirements for accounting, legal, operations, investor
relations and administrative support, as well as increased international travel
costs. As a percentage of revenues, general and administrative expense
increased to 8.4% for the first nine months of 1997 from 6.4% for the same
period of 1996.
RESEARCH AND DEVELOPMENT EXPENSE
For the first nine months of 1997, research and development expense totaled
$4,183,425 compared to $2,635,778 for the first nine months of 1996,
representing an increase of $1,547,647, or 58.7%. The increase was due to
engineering and development costs associated with the addition of new
personnel, as well as other costs associated with new product development. As a
percentage of revenues, research and development expense increased to 13.0% in
the first nine months of 1997 from 9.7% for the first nine months of 1996.
INTEREST AND OTHER INCOME
Interest and other income consists primarily of interest income. For the first
nine months of 1997, interest and other income was $637,252 compared to
$478,810 for the first nine months of 1996, representing an increase of
$158,442, or 33.1%. This was primarily attributable to increased interest
income, which resulted from an overall increase in funds available for
investment between comparable periods.
PROVISIONS FOR INCOME TAXES
The provision for income taxes for the first nine months of 1997 was $2,903,274
which was an increase of $480,579, or 19.8%, from $2,422,695 for the first nine
months of 1996. The effective tax rate was 37.6% for the first nine months of
1997 versus 37.9% for the comparable period in the prior year. The increased
provision for income taxes was primarily due to increased earnings levels of
the Company between comparable periods, while the decrease in effective tax
rate reflects the estimated benefit related to R&D tax credits which are
available during the entire year of 1997 but were not available during the
first half of 1996.
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NET INCOME
For the first nine months of 1997, net income was $4,819,677 compared to
$3,965,342 for the first nine months of 1996, representing an increase of
$854,335, or 21.5%. Fully diluted earnings per common share of $.81 for the
first nine months of 1997 increased by $.14, or 20.9%, from the $.67 per share
earned in the first nine months of 1996. Fully diluted weighted average common
and common equivalent shares outstanding were 5,956,921 in the first nine
months of 1997 compared to 5,919,579 in the first nine months of 1996. As a
percentage of revenues, net income for the first nine months of 1997 increased
to 15.0% from 14.6% in the comparable period in the prior year.
LIQUIDITY AND CAPITAL RESOURCES
At September 27, 1997, the Company had working capital of $33,009,688, which
represented an increase of $5,778,057, or 21.2%, from the $27,231,631 of
working capital as of December 31, 1996. The increase in working capital can be
attributed primarily to operating cash flow (income from operations before
depreciation and amortization) exceeding requirements for purchases of property
and equipment. 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.
The Company made capital expenditures of $901,569 in the first nine months of
1997 and were primarily related to test fixtures and development systems,
computer and office equipment for increased staff, as well as leasehold
improvements made to the Company's facilities. The Company presently has no
material capital expenditure commitments.
As of and through September 27, 1997, the Company had not borrowed any amounts
against its $2,500,000 available bank line of credit. The credit agreement has
been extended to June 30, 1998 on terms similar to those previously in effect.
On April 22, 1997 the Company's Board of Directors authorized a program to
repurchase up to 200,000 shares of its common stock over the next two years.
The shares will be utilized to provide stock under certain employee benefit
programs. 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
the repurchases. To date, the Company has not purchased any stock under this
program.
BACKLOG
The Company's backlog consists of firm customer purchase orders for the
Company's various products. As of September 27, 1997 the Company had a backlog
of $1,823,785 compared to $912,507 at December 31, 1996 and $1,385,102 at June
28, 1997. The increase in backlog for the quarter occurred due to customer
orders exceeding product shipments during the period, resulting in part from
increased order levels compared to the previous quarter. 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.
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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
------ -----------
10.1 Change in Control Agreement, entered
into July 17, 1997 between the Company and
Timothy O'Brien, together with a schedule
listing substantially a similar agreement
with Joe O'Brien.
10.2 Stock Option Agreement entered into October
15, 1997 between the Company and Mark
Peterson, together with a schedule listing
substantially similar agreements with John
Benedict, Bradley N. Dinger, Joe O'Brien and
Timothy O'Brien.
10.3 Amendment , dated February 21, 1997, to
Technical Information Agreement relating to
Metallic Channel Units Types A and B, dated
February 1, 1993, between American Telephone
and Telegraph Company ("AT&T") (licensor)
and the Company (licensee).
11.1 Statement re Computation of Per Share Earnings
15 Letter re unaudited interim financial information
27 Financial Data Schedule
(b) Reports on Form 8-K:
The Company did not file any Current Report on Form 8-K during the
quarter ended September 27, 1997.
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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: November 10, 1997 /S/ CHRISTIAN L. ALLISON
----------------------------------
CHRISTIAN L. ALLISON
CHIEF EXECUTIVE OFFICER & DIRECTOR
Dated: November 10, 1997 /S/ SAMUEL C. KNOCH
----------------------------------
SAMUEL C. KNOCH
CHIEF FINANCIAL OFFICER
Dated: November 10, 1997 /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
------ -----------
10.1 Change in Control Agreement, entered
into July 17, 1997 between the Company and
Timothy O'Brien, together with a schedule
listing substantially a similar agreement
with Joe O'Brien.
10.2 Stock Option Agreement entered into October
15, 1997 between the Company and Mark
Peterson, together with a schedule listing
substantially similar agreements with John
Benedict, Bradley N. Dinger, Joe O'Brien and
Timothy O'Brien.
10.3 Amendment , dated February 21, 1997, to
Technical Information Agreement relating to
Metallic Channel Units Types A and B, dated
February 1, 1993, between American Telephone
and Telegraph Company ("AT&T") (licensor)
and the Company (licensee).
11.1 Statement re Computation of Per Share Earnings
15 Letter re unaudited interim financial information
27 Financial Data Schedule
17