1
Exhibit 13.1
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data of the Company as of December 31, 1993,
1994, 1995, 1996 and 1997 is derived from audited consolidated financial
statements of the Company.
(In thousands, except per share data)
Year Ended December 31,
1993 1994 1995 1996 1997
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STATEMENTS OF OPERATIONS DATA:
Revenues(1) $ 10,089 $ 14,722 $22,310 $37,490 $45,421
Cost of product sales 5,860 8,168 11,329 18,322 20,104
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Gross profit 4,229 6,554 10,981 19,168 25,317
Operating expenses:
Selling and marketing 1,409 1,903 2,953 4,767 5,446
General and administrative 1,079 1,268 1,471 2,552 3,768
Research and development 769 1,585 2,637 3,921 5,945
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Total operating expenses 3,257 4,756 7,061 11,240 15,159
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Income from operations 972 1,798 3,920 7,928 10,158
Other income (expense), net (295) (270) 20 845 899
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Income before income taxes 677 1,528 3,940 8,773 11,057
Provision (benefit) for income taxes 76 (617) 1,418 3,176 4,174
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Net income $ 601 $ 2,145 $ 2,522 $ 5,597 $ 6,883
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Net income applicable to common stock (2) $ 432 $ 1,311 $ 2,522 $ 5,597 $ 6,883
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Earnings per share:
Basic $ .25 $ .49 $ .60 $ 1.02 $ 1.21
Diluted .12 .32 .56 .94 1.15
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Weighted average shares of common stock and equivalents:
Basic 1,707 2,674 4,228 5,501 5,686
Diluted 3,465 4,159 4,504 5,940 5,962
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As of December 31,
1993 1994 1995 1996 1997
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BALANCE SHEET DATA:
Working capital $ 896 $3,195 $21,159 $27,232 $34,570
Total assets 3,590 7,151 25,728 34,626 43,713
Long-term debt, less current portion 1,800 1,400 -- -- --
Shareholders' equity (deficit) (911) 1,387 22,609 30,006 38,101
1993 1994 1995 1996 1997
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OTHER DATA: (3)
Number of employees at year end 71 96 126 184 205
Average revenue per employee $ 142 $ 153 $ 177 $ 204 $ 222
(1) Includes royalty and license fees of $75 and $250 for 1993 and 1997,
respectively.
(2) Net of accretion for redeemable warrants, all of which were redeemed in
February 1995.
(3) Data not derived from Company's audited financial statements.
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MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the "Selected
Consolidated Financial Data" and the Consolidated Financial Statements and notes
thereto appearing elsewhere in this Annual Report to Shareholders.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995.
The statements contained in this Annual Report to Shareholders, specifically
including those 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 may differ materially from expected results included in these
statements. Reference is made to a discussion of the important risk factors
detailed from time to time in the Company's SEC reports, including the report on
Form 10-K for the year ended December 31, 1997, a copy of which may be obtained
from the Company upon written request and without charge (except for the
exhibits thereto).
OVERVIEW
Tollgrade Communications, Inc. (the "Company") was organized in 1986 and began
operations in 1988. The Company designs, engineers, markets and supports
proprietary products which enable local 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
metallic channel unit ("MCU") product line, which includes POTS line testing as
well as alarm-related products, represented more than 94% of the Company's
revenue for the year ended December 31, 1997 and will continue to account for a
majority of Tollgrade's revenues for the foreseeable future.
The Company's revenues include product sales as well as license and royalty fees
paid to the Company for the use of its proprietary technology. 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. For
the year ended December 31, 1997, 86% of revenue was from the five RBOCs, the
two largest of which comprised 54% 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.
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.
Tollgrade 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% for the year ended December 31, 1997. The Company expects its
research and development expenses to continue at significant levels.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES
Revenues for the year ended December 31, 1997 were $45.4 million, and were $7.9
million, or 21.2%, higher than revenues of $37.5 million for the year ended
December 31, 1996. Revenues for both periods consisted almost entirely of
product sales. 1997
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revenues included $250,000 of royalty and license fees while similar fees for
1996 were immaterial. The increase in revenues is primarily associated with the
increase in unit volume sales of the MCU product line as a result of increased
market penetration and customer acceptance. The increase includes revenues of
$0.7 million from six new products introduced in 1997. Overall, increased
product demand is at least partly attributable to technology licensing
agreements and/or joint venture relationships with certain major Digital Loop
Carrier ("DLC") vendors, as well as continued expansion of a marketing program
to train customers in advanced line test system trouble-shooting. 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. 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 important
product lines. Management is focusing on the development of new product lines to
attempt to meet the other requirements of this and other customers.
GROSS PROFIT
Gross profit for 1997 was $25.3 million compared to $19.2 million for 1996,
representing an increase of $6.1 million, or 32.1%. Gross profit as a percentage
of revenues increased to 55.7% for 1997 compared to 51.1% for 1996. The overall
increase in gross profit margin resulted primarily from the increased sales
levels, while improvements in gross margin as a percentage of sales were a
result of increased sales volumes and increased manufacturing efficiencies. The
Company's ability to sustain current gross margin levels will depend on its
success in gaining further cost reductions as well as experiencing a similar mix
of products sold and maintaining current pricing levels.
SELLING AND MARKETING EXPENSE
Selling and marketing expenses consist primarily of personnel costs as well as
commissions and travel expenses of direct sales and marketing personnel, and
costs associated with marketing programs. Selling and marketing expense for 1997
was $5.4 million, or 12.0% of revenues, compared to $4.8 million, or 12.7% of
revenues for 1996. This increase of $0.6 million, or 14.2%, reflects additional
salaries and benefits associated with increased staffing levels to support
expanding product lines and increased consulting and travel expenses associated
with the planned expansion into international markets.
The Company expects selling and marketing expenses to rise commensurate with
increased revenues and selling efforts. The Company is continuing its efforts to
expand its business by marketing new products, developing additional customer
training programs and expanding its international presence.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expenses consist primarily of personnel costs for
finance, administrative and general management personnel as well as accounting
and legal expenses. General and administrative expense for 1997 was $3.8
million, or 8.3%, of revenues, compared to $2.6 million, or 6.8%, of revenues
for 1996. This increase of $1.2 million, or 47.6%, is primarily attributable to
additional salaries and benefits associated with increased staffing levels to
support the expanded business operations and increased travel and business
development activities.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expenses consist primarily of personnel costs and costs
associated with the development of new products. Research and development
expense for 1997 was $5.9 million, an increase of $2.0 million, or 51.6%,
compared to $3.9 million for 1996. The increase was principally due to costs
associated with additional personnel to support new product introductions. As a
percentage of revenues, research and development expense was 13.1% for 1997
compared to 10.5% for 1996. The Company expenses all research and development
costs as they are incurred.
OTHER INCOME AND EXPENSE
Other income, which consists primarily of interest income, was $0.9 million for
1997 compared to $0.8 million for 1996. The increase in other income was
primarily attributable to increased interest income, which resulted from the
increased levels of investable funds.
PROVISION FOR INCOME TAXES
The Company's effective tax rate for 1997 was 37.7% of income before income
taxes, compared to the 36.2% rate in 1996. The slight increase reflects
increases in state taxes offset by benefits from higher levels of tax-exempt
interest and increased credits for research and development.
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YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
REVENUES
Revenues for the year ended December 31, 1996 were $37.5 million, and were $15.2
million, or 68.0%, higher than revenues of $22.3 million for the year ended
December 31, 1995. Revenues for both periods consisted almost entirely of
product sales. Royalty and license fees were not material for either period. The
increase in revenues is primarily associated with the increase in unit volume
sales of the MCU product line as a result of increased market penetration and
customer acceptance. The increase includes revenues of $5.6 million from eight
new products introduced in 1996. Overall, increased product demand is at least
partly attributable to technology licensing agreements and/or joint venture
relationships with certain major DLC vendors, as well as continued expansion of
a marketing program to train customers in advanced line test system
trouble-shooting. In addition, revenues in the first quarter of 1996 included
$1.3 million associated with the completion of a one-time project for a major
customer. This project was not related to the Company's core MCU line testing
product line.
GROSS PROFIT
Gross profit for 1996 was $19.2 million compared to $11.0 million for 1995,
representing an increase of $8.2 million, or 74.6%. Gross profit as a percentage
of revenues increased to 51.1% for 1996 compared to 49.2% for 1995. The overall
increase in gross profit margin resulted primarily from the increased sales
levels, while improvements in gross margin as a percentage of sales were a
result of increased sales of certain higher-margin products within the MCU
product line as well as reduced unit costs from suppliers and manufacturing
efficiencies. The Company's ability to sustain current gross margin levels will
depend on its success in gaining further cost reductions as well as experiencing
a similar mix of products sold.
SELLING AND MARKETING EXPENSE
Selling and marketing expenses consist primarily of personnel costs as well as
commissions and travel expenses of direct sales and marketing personnel, and
costs associated with marketing programs. Selling and marketing expense for 1996
was $4.8 million, or 12.7% of revenues, compared to $3.0 million, or 13.2% of
revenues for 1995. This increase of $1.8 million, or 61.4%, reflects additional
salaries and benefits associated with increased staffing levels to support
expanding product lines and increased consulting and travel expenses associated
with the planned expansion into international markets.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expenses consist primarily of personnel costs for
finance, administrative and general management personnel as well as accounting
and legal expenses. General and administrative expense for 1996 was $2.6
million, or 6.8%, of revenues, compared to $1.5 million, or 6.6%, of revenues
for 1995. This increase of $1.1 million, or 73.5%, is primarily attributable to
additional salaries and benefits associated with increased staffing levels to
support the expanded business operations, as well as additional costs associated
with being a public company.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expenses consist primarily of personnel costs and costs
associated with the development of new products. Research and development
expense for 1996 was $3.9 million, an increase of $1.3 million, or 48.7%,
compared to $2.6 million for 1995. The increase was principally due to costs
associated with additional personnel to support new product introductions. As a
percentage of revenues, research and development expense was 10.5% for 1996
compared to 11.8% for 1995. The Company expenses all research and development
costs as they are incurred.
OTHER INCOME AND EXPENSE
Other income, which consists primarily of interest income, was $845,000 for 1996
compared to $20,000 for 1995. The increase in other income was primarily
attributable to increased interest income, which resulted from the investment of
the initial public offering proceeds for the entire year of 1996 versus only a
portion of 1995.
PROVISION FOR INCOME TAXES
The Company's effective tax rate for 1996 was 36.2% of income before income
taxes, which was comparable to the 36.0% rate in 1995.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $34.6 million as of December 31, 1997
compared to working capital of $27.2 million as of December 31, 1996. The
increase in working capital can be attributed to operating cash flow (income
from operations before depreciation and amortization) exceeding the requirements
for purchases of property and equipment. Cash provided by oper-
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ations was $2.6 million and $2.0 million for 1997 and 1996, respectively. Net
income was the primary source of cash provided by operations for 1997 and 1996,
offset by increased levels in accounts receivable and inventories due to
increased product sales. Inventories increased 41.2% during the period due to
the investment required to support increased sales of existing products,
introduce new products and to maintain sufficient inventory stocking levels. As
of December 31, 1997, the Company had $19.5 million of cash and cash
equivalents, short-term and long-term investments which are available for
acquisitions and other corporate requirements.
Capital expenditures were $1.2 million for 1997 and were primarily related to
prototype tooling, test fixtures and development systems, computer and office
equipment for increased staff, as well as leasehold improvements made to the
Company's facilities. Capital expenditures were $2.0 million and $1.0 million
for 1996 and 1995, respectively, and were primarily related to office equipment,
test fixtures and development systems, tooling and leasehold improvements. The
Company presently has no material capital expenditure commitments. Planned
capital expenditures for 1998 are anticipated to total approximately $2.0
million. These planned capital projects include test fixtures and development
systems, computer and office equipment and leasehold improvements to the
Company's facilities.
On July 1, 1995, the Company entered into a Credit Agreement with the U.S.
branch of Creditanstalt-Bankverein (the "Bank"), a banking corporation of the
Republic of Austria, replacing an earlier agreement between the Company and the
Bank. Under the Credit Agreement, the Company may borrow up to an amount equal
to 90% of the amount of eligible accounts receivable plus the lesser of $750,000
and 40% of the amount of eligible inventory. Borrowings accrue interest at .5%
above the higher of the Bank's prime rate or the federal funds rate plus .5%.
Loans may not in any event exceed $2.5 million. The Credit Agreement is
collateralized by substantially all of the Company's assets, including accounts
receivable and inventory. The Credit Agreement contains a variety of restrictive
covenants, including prohibitions on the incurrence of additional indebtedness
for borrowed money, dividends and stock repurchases. The Credit Agreement also
requires the Company to be in compliance with certain financial ratios and other
financial requirements. At December 31, 1997, there was $2.5 million available
under the Credit Agreement and there were no outstanding borrowings under the
Credit Agreement. The agreement expires on June 30, 1998, however, the Company
believes its financial position will enable it to negotiate any further credit
agreements on comparable or more favorable terms.
On July 23, 1996, the Board of Directors of the Company declared a dividend of
one preferred stock purchase right for each outstanding share of the Company's
common stock. The rights will be exercisable only if a person or group acquires
or announces a tender or exchange offer for 20% or more of the Company's common
stock. In such an event, each right will entitle shareholders to buy
one-hundredth of a share of a new series of preferred stock at an exercise price
of $115.00. Each one-hundredth of a share of the new preferred stock has terms
designed to make it the economic and voting equivalent of one share of common
stock.
If a person or group acquires 20% or more of the Company's outstanding common
stock, each right not owned by the person or group will entitle its holder to
purchase at the right's exercise price a number of shares of the Company's
common stock (or, at the option of the Company, the new preferred stock) having
a market value of twice the exercise price. Further, at any time after a person
or group acquires 20% or more (but less than 50%) of the outstanding common
stock, the Board of Directors may at its option, exchange part or all of the
rights (other than rights held by the acquiring person or group) for shares of
the Company's common or preferred stock on a one-for-one basis.
If after a person or group acquires 20% or more of the outstanding common stock,
each right will entitle its holder to purchase, at the right's exercise price, a
number of the acquiring company's common shares having a market value at that
time of twice the exercise price.
The Board of Directors is entitled to redeem the rights for one cent per right
at any time before a 20% position has been acquired. The Board of Directors is
also authorized to reduce the 20% thresholds referred to above to not less than
10%.
The rights were not distributed in response to any specific effort to acquire
control of the Company, nor is the Company presently aware of any such effort.
The distribution of the rights will not affect the
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Company's reported earnings and is not taxable to shareholders or to the
Company. Shareholders will not receive any documents evidencing their rights
unless and until the rights become exercisable. Until that time, the rights will
not trade separately from the common stock. The rights will expire on August 15,
2006.
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 purchased 12,800 shares of the Company's
common stock under this program.
The impact of inflation on both the Company's financial position and the results
of operations has been minimal and is not expected to adversely affect 1997
results. The Company's financial position enables it to meet cash requirements
for operations and capital expansion programs.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruption of operations, including among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
The Company is currently assessing whether its existing computer systems will
properly utilize dates beyond December 31, 1999. If modifications are required
for its existing systems and the modifications are not completed on a timely
basis, the Year 2000 Issue could have a material impact on the operations of the
Company. The Company believes that it has no exposure to contingencies related
to the Year 2000 Issue for the products it has sold.
The Company plans to engage in formal communication with all of its significant
suppliers and large customers to determine the extent to which the Company is
vulnerable to those third parties' failure to remediate their own Year 2000
Issue. There can be no guarantee that the systems of other companies on which
the Company's systems rely will be timely converted, or that a failure to
convert by another company, or a conversion that is incompatible with the
Company's systems, would not have a material adverse effect on the Company.
Presently, the Company does not have an estimate for the costs of the project
and the date on which the Company plans to complete the Year 2000 modifications,
if any. However, based upon the Company's initial assessment, the Company
believes that the costs of the project will not be material.
ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income," which
establishes standards for reporting and displaying comprehensive income and its
components in a full set of general-purpose financial statements. This
Statement, which is effective for financial statements for fiscal years
beginning after December 15, 1997, requires that all items that are required to
be recognized under accounting standards as components of comprehensive income
be reported in a financial statement that is displayed with the same prominence
as other financial statements. Additionally, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information," which establishes
standards for the way that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports. This Statement, which is effective for financial statements
for fiscal years beginning after December 15, 1997, also establishes standards
for related disclosures about products and services, geographic areas and major
customers. Management is currently evaluating the implication of these
statements from both an operations and financial reporting perspective.
BACKLOG
The Company's backlog consists of firm customer purchase orders for the
Company's various products. At December 31, 1997 the Company had backlog of $1.6
million, a $0.7 million increase from the December 31, 1996 backlog of $0.9
million. The increase was due largely to the receipt of certain orders under
Original Equipment Manufacturer ("OEM") arrangements scheduled for shipment in
the first quarter of 1998 and beyond.
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
STATEMENT OF MANAGEMENT'S RESPONSIBILITY
FOR FINANCIAL REPORTING
The accompanying consolidated financial statements of Tollgrade Communications,
Inc. and Subsidiaries have been prepared by management, who are responsible for
their integrity and objectivity. The statements have been prepared in conformity
with generally accepted accounting principles and include amounts based on
management's best estimates and judgements. Financial information elsewhere in
this Annual Report is consistent with that in the financial statements.
Management has established and maintains a system of internal control designed
to provide reasonable assurance that assets are safeguarded and that the
financial records reflect the authorized transactions of the Company. The system
of internal control includes widely communicated statements of policies and
business practices that are designed to require all employees to maintain high
ethical standards in the conduct of Company affairs. The internal controls are
augmented by organizational arrangements that provide for appropriate delegation
of authority and division of responsibility.
The financial statements have been audited by Coopers & Lybrand L.L.P.,
Independent Public Accountants. As part of their audit of the Company's 1997
financial statements, Coopers & Lybrand L.L.P. considered the Company's system
of internal control to the extent they deemed necessary to determine the nature,
timing and extent of their audit tests. The Independent Public Accountants'
Report follows.
The Board of Directors pursues its responsibility for the Company's financial
reporting through its Audit Committee, which is composed entirely of outside
directors. The Audit Committee has met periodically with the Independent Public
Accountants and management. The Independent Public Accountants had direct access
to the Audit Committee, with and without the presence of management
representatives, to discuss the results of their audit work and their comments
on the adequacy of internal accounting controls and the quality of financial
reporting.
/s/ CHRISTIAN L. ALLISON
------------------------
Christian L. Allison
Chief Executive Officer
/s/ SAMUEL C. KNOCH
-------------------------------------
Samuel C. Knoch
Chief Financial Officer and Treasurer
January 27, 1998
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REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of Tollgrade Communications, Inc.:
We have audited the accompanying consolidated balance sheets of Tollgrade
Communications, Inc. and subsidiaries as of December 31, 1996 and 1997, and the
related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Tollgrade Communications, Inc. and subsidiaries as of December 31, 1996 and
1997, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 1997 in conformity with
generally accepted accounting principles.
/s/ COOPERS & LYBRAND L.L.P.
----------------------------
COOPERS & LYBRAND L.L.P.
Pittsburgh, Pennsylvania
January 27, 1998
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
ASSETS December 31, 1996 December 31, 1997
- --------------------------------------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents $ 4,591,273 $ 3,183,944
Short-term investments 12,342,592 15,666,626
Accounts receivable:
Trade 5,153,589 7,884,683
Other 304,434 517,090
Inventories 8,569,818 12,101,114
Prepaid expenses and deposits 549,753 409,252
Deferred tax asset 171,776 213,216
- --------------------------------------------------------------------------------------------------------------
Total current assets 31,683,235 39,975,925
Long-term investments -- 600,000
Property and equipment, net 2,769,657 3,001,824
Deferred tax asset 157,169 126,895
Patents and other assets 15,569 8,568
- --------------------------------------------------------------------------------------------------------------
Total assets $34,625,630 $43,713,212
- --------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------------------------------------
Current liabilities:
- --------------------------------------------------------------------------------------------------------------
Accounts payable $ 1,691,928 $ 959,185
Accrued expenses 1,077,151 1,091,990
Accrued salaries and wages 769,855 1,529,525
Royalty payable 741,781 878,780
Income taxes payable 170,889 946,233
- --------------------------------------------------------------------------------------------------------------
Total current liabilities 4,451,604 5,405,713
Deferred tax liability 168,455 206,116
- --------------------------------------------------------------------------------------------------------------
Total liabilities 4,620,059 5,611,829
Commitments
Shareholders' equity:
Preferred stock, $1.00 par value; authorized shares,
10,000,000 issued shares, -0- in 1996 and 1997, respectively -- --
Common stock, $.20 par value; authorized shares, 7,000,000;
issued shares, 5,620,417 in 1996 and 5,727,350 in 1997 1,124,083 1,145,470
Additional paid-in capital 24,091,210 25,232,315
Treasury stock, at cost, 2,200 shares in 1996 and 3,200 in 1997 (49,775) (70,355)
Unearned compensation (106,686) (35,934)
Retained earnings 4,946,739 11,829,887
- --------------------------------------------------------------------------------------------------------------
Total shareholders' equity 30,005,571 38,101,383
- --------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $34,625,630 $43,713,212
- --------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the
consolidated financial statements.
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
1995 1996 1997
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Revenues $ 22,309,629 $ 37,489,949 $ 45,421,135
Cost of product sales 11,328,660 18,321,677 20,104,202
Gross profit 10,980,969 19,168,272 25,316,933
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Operating expenses:
Selling and marketing 2,953,223 4,767,339 5,446,102
General and administrative 1,471,222 2,551,959 3,767,925
Research and development 2,636,770 3,921,091 5,944,819
- --------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 7,061,215 11,240,389 15,158,846
- --------------------------------------------------------------------------------------------------------------------------------
Income from operations 3,919,754 7,927,883 10,158,087
Other income (expense):
Interest expense (58,583) (3,076) (3,271)
Interest and other income 78,656 848,569 901,981
- --------------------------------------------------------------------------------------------------------------------------------
20,073 845,493 898,710
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Income before income taxes 3,939,827 8,773,376 11,056,797
Provision for income taxes 1,418,000 3,176,753 4,173,649
- --------------------------------------------------------------------------------------------------------------------------------
Net income $ 2,521,827 $ 5,596,623 $ 6,883,148
- --------------------------------------------------------------------------------------------------------------------------------
EARNINGS PER SHARE INFORMATION:
Weighted average shares of common stock and equivalents:
Basic 4,227,648 5,500,884 5,686,182
Diluted 4,503,712 5,939,662 5,961,540
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Net income per common share:
Basic $ .60 $ 1.02 $ 1.21
Diluted .56 .94 1.15
- --------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the
consolidated financial statements.
15
11
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Additional
Preferred Stock Common Stock Paid-in
Shares Amount Shares Amount Capital
- --------------------------------------------------------------------------------------------------------------
Balance at December 31, 1994 958,721 $958,721 2,591,427 $ 518,286 $ 3,834,386
Receipt of stock subscriptions -- -- -- -- --
Issuance of common stock through
private placement offering,
net of offering costs -- -- 463,337 92,667 2,054,255
Conversion of preferred stock
to common stock (958,721) (958,721) 958,721 191,744 766,977
Restricted stock:
Issuance of common stock -- -- 18,960 3,792 185,803
Compensation charged to expense,
net -- -- -- -- --
Tax benefit from vesting of
restricted stock -- -- -- -- 29,200
Cancellation of treasury stock -- -- (74,200) (14,840) (13,360)
Issuance of common stock
through initial public offering,
net of offering costs -- -- 1,485,585 297,117 15,481,761
Net income -- -- -- -- --
- --------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 -- -- 5,443,830 1,088,766 22,339,022
Issuance costs for initial
public offering in 1995 -- -- -- -- (55,889)
Exercise of common stock options -- -- 179,027 35,805 439,005
Restricted stock - compensation
charged to expense, net -- -- -- -- --
Shares forfeited -- -- (2,440) (488) (8,999)
Tax benefit from exercise of
stock options -- -- -- -- 1,378,071
Net income -- -- -- -- --
- --------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 -- -- 5,620,417 1,124,083 24,091,210
EXERCISE OF COMMON STOCK OPTIONS -- -- 107,283 21,457 456,759
RESTRICTED STOCK - COMPENSATION
CHARGED TO EXPENSE, NET -- -- -- -- --
SHARES FORFEITED -- -- (350) (70) (18,338)
TAX BENEFIT FROM EXERCISE OF
STOCK OPTIONS -- -- -- -- 702,684
PURCHASE OF TREASURY STOCK -- -- -- -- --
NET INCOME -- -- -- -- --
BALANCE AT DECEMBER 31, 1997 -- $ -- 5,727,350 $1,145,470 $25,232,315
- --------------------------------------------------------------------------------------------------------------
Retained
Earnings
Subscriptions Treasury Unearned (Accumulated
Receivable Stock Compensation Deficit) Total
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1994 $(681,830) $(28,200) $(42,873) $( 3,171,711) $ 1,386,779
Receipt of stock subscriptions 681,830 -- -- -- 681,830
Issuance of common stock through
private placement offering,
net of offering costs -- -- -- -- 2,146,922
Conversion of preferred stock
to common stock -- -- -- -- --
Restricted stock:
Issuance of common stock -- -- (189,595) -- --
Compensation charged to expense,
net -- -- 63,939 -- 63,939
Tax benefit from vesting of
restricted stock -- -- -- -- 29,200
Cancellation of treasury stock -- 28,200 -- -- --
Issuance of common stock
through initial public offering,
net of offering costs -- -- -- -- 15,778,878
Net income -- -- -- 2,521,827 2,521,827
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 -- -- (168,529) (649,884) 22,609,375
Issuance costs for initial
public offering in 1995 -- -- -- -- (55,889)
Exercise of common stock options -- (49,775) -- -- 425,035
Restricted stock - compensation
charged to expense, net -- -- 52,356 -- 52,356
Shares forfeited -- -- 9,487 -- --
Tax benefit from exercise of
stock options -- -- -- -- 1,378,071
Net income -- -- -- 5,596,623 5,596,623
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 -- (49,775) (106,686) 4,946,739 30,005,571
EXERCISE OF COMMON STOCK OPTIONS -- -- -- -- 478,216
RESTRICTED STOCK - COMPENSATION
CHARGED TO EXPENSE, NET -- -- 52,344 -- 52,344
SHARES FORFEITED -- -- 18,408 -- --
TAX BENEFIT FROM EXERCISE OF
STOCK OPTIONS -- -- -- -- 702,684
PURCHASE OF TREASURY STOCK -- (20,580) -- -- (20,580)
NET INCOME -- -- -- 6,883,148 6,883,148
BALANCE AT DECEMBER 31, 1997 $ -- $(70,355) ($35,934) $ 11,829,887 $38,101,383
- -------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the
consolidated financial statements.
16
12
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
1995 1996 1997
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 2,521,827 $ 5,596,623 $ 6,883,148
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 342,310 688,323 1,005,744
Deferred income taxes 692,000 (77,990) 26,495
Provision for losses on inventory 60,000 95,000 --
Compensation expense for restricted stock 63,939 52,356 52,344
Changes in assets and liabilities:
Increase in accounts receivable-trade (892,290) (2,582,356) (2,731,094)
Decrease (increase) in accounts receivable-other 29,222 (192,716) (212,656)
Increase in inventories (3,250,474) (2,643,352) (3,531,296)
(Increase) decrease in prepaid expenses and deposits (109,982) (398,302) 140,501
Increase (decrease) in accounts payable 457,809 (275,517) (732,743)
Increase in accrued expenses and royalty payable 389,048 1,679,404 911,508
Increase in income taxes payable 66,194 86,089 775,344
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 369,603 2,027,562 2,587,295
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchase of short-term investments -- (20,690,542) (19,567,255)
Redemption/maturity of short-term investments 74,219 8,347,950 15,643,221
Capital expenditures (1,040,062) (1,993,541) (1,230,910)
Patent expenditures (3,405) (4,760) --
Purchase of treasury stock -- -- (20,580)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (969,248) (14,340,893) (5,175,524)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net Repayments under line of credit (865,719) -- --
Payments on long-term debt (1,800,000) -- --
Purchase of stock warrants (1,253,708) -- --
Proceeds from issuance of common stock, net of
issuance costs 2,146,922 -- --
Proceeds from the exercise of stock options
including related tax benefits -- 1,803,106 1,180,900
Proceeds from initial public offering, net of
issuance costs 16,107,694 (55,889) --
Receipt of stock subscriptions 681,830 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 15,017,019 1,747,217 1,180,900
- ------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 14,417,374 (10,566,114) (1,407,329)
Cash and cash equivalents at beginning of year 740,013 15,157,387 4,591,273
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 15,157,387 $ 4,591,273 $ 3,183,944
- ------------------------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ 79,101 $ 3,076 $ 3,271
Cash paid during the year for income taxes 658,765 2,013,981 2,420,460
Noncash financing and operating activities:
Issuance of restricted common stock at no cost 189,595 -- --
Tax benefit from vesting of restricted stock 29,200 -- --
Conversion of preferred stock to common stock 951,721 -- --
Conversion of preferred stock to common stock in treasury 7,000 -- --
Issuance costs for initial public offering in
accounts payable 328,816 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the
consolidated financial statements.
17
13
TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
ORGANIZATION AND BASIS OF PRESENTATION:
Tollgrade Communications, Inc. (the "Company") designs, engineers, markets and
supports its proprietary electronic equipment for use by 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 was organized in 1986 and began operations in 1988.
USE OF ESTIMATES:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of income and expense during the reporting period. Actual
results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION:
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany
transactions have been eliminated.
CASH AND CASH EQUIVALENTS:
The Company considers highly liquid investments with a maturity of three months
or less when purchased to be cash equivalents. Substantially all of the
Company's cash and cash equivalents is maintained at one financial institution.
No collateral or security is provided on these deposits, other than $100,000 of
deposits per financial institution insured by the Federal Deposit Insurance
Corporation.
INVESTMENTS:
Short-term investments at December 31, 1996 and 1997 consist of a treasury note
and/or 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. The primary investment purpose is to provide a
reserve for future business purposes, including possible acquisitions, capital
expenditures and to meet working capital requirements. Long-term investments are
individual municipal bonds with a maturity of more than one year but less than
eighteen months.
In May 1993, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." The Company adopted the new
accounting and disclosure rules for this standard in the first quarter of 1996.
The Company classifies its investment in all debt securities as
"held-to-maturity."
INVENTORIES:
Inventories are stated at the lower of cost or market, with cost determined on
the first-in, first-out method. The Company provides appropriate reserves for
any inventory deemed slow moving or obsolete.
PROPERTY AND EQUIPMENT:
Property and equipment is stated at cost. Property and equipment is depreciated
on a straight-line method over their estimated useful lives ranging from 3 to 7
years. Leasehold improvements are amortized over the related lease period or the
estimated useful life, whichever is shorter.
The cost of renewals and betterments that extend the lives or productive
capacities of properties is capitalized. Expenditures for normal repairs and
maintenance are charged to operations as incurred. The cost of property and
equipment retired or otherwise disposed of and the related accumulated
depreciation or amortization are removed from the accounts and any resulting
gain or loss is reflected in current operations.
PATENTS:
The costs of patents are being amortized on a straight-line method over a period
of five years.
18
14
PRODUCT WARRANTY:
The Company records estimated warranty costs on the accrual basis of accounting.
These reserves are based on applying historical returns and cost experience to
the current level of product shipments.
REVENUE RECOGNITION:
Revenue from product sales is recognized at the time of shipment. Revenue for
license and royalty fees is recognized when earned.
RESEARCH AND DEVELOPMENT COSTS:
Research and development costs are charged to operations in the year incurred.
INCOME TAXES:
The Company follows the provisions of SFAS No. 109, "Accounting for Income
Taxes" (SFAS 109). Under SFAS 109, deferred tax liabilities and assets are
determined based on the "temporary differences" between the financial statement
carrying amounts and the tax basis of assets and liabilities using enacted tax
rates in effect in the years in which the differences are expected to reverse.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized.
PER SHARE INFORMATION:
Net income per share has been computed in accordance with the provisions of SFAS
No. 128, "Earnings Per Share" for all periods presented. The statement requires
companies with complex capital structures to report earnings per share on a
basic and diluted basis, as defined. Basic earnings per share are calculated on
the actual number of weighted average common shares outstanding for the period,
while diluted earnings per share must include the effect of any dilutive
securities. All prior periods have been restated in accordance with SFAS No.
128. A reconciliation of earnings per share is as follows:
December 31,
1995 1996 1997
- ---------------------------------------------------------------------------------------------------------------------------
Net Income $ 2,521,827 $ 5,596,623 $ 6,883,148
- ---------------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding 4,227,648 5,500,884 5,686,182
- ---------------------------------------------------------------------------------------------------------------------------
Effect of dilutive securities - stock options 276,064 438,778 275,358
- ---------------------------------------------------------------------------------------------------------------------------
4,503,712 5,939,662 5,961,540
- ---------------------------------------------------------------------------------------------------------------------------
Earnings per share:
Basic $ .60 $ 1.02 $ 1.21
- ---------------------------------------------------------------------------------------------------------------------------
Diluted $ .56 $ .94 $ 1.15
- ---------------------------------------------------------------------------------------------------------------------------
Pursuant to the requirements of the Securities and Exchange Commission, common,
restricted and convertible preferred shares issued by the Company during the
twelve months immediately preceding the initial public offering (See Note 2)
plus the number of shares issuable upon exercise of stock options and warrants
granted during this period, have been included in the calculation of the shares
used in computing net income per share as if they were outstanding for 1995
through the date of the initial public offering (using the treasury stock method
and the public offering price in calculating equivalent shares).
2. INITIAL PUBLIC OFFERING:
On December 14, 1995, the Company completed an initial public offering of common
stock, receiving net proceeds (after deduction of underwriting discounts and
other offering costs of $2,048,142) of $15,778,878 from the sale of 1,485,585
shares of common stock at the initial public offering price of $12 per share.
3. STOCK SPLIT:
On October 16, 1995, the Board of Directors approved a seven-for-ten reverse
split of its common stock which was ratified on November 12, 1995 by the
shareholders. All references in the accompanying consolidated financial
statements to the number of shares of common stock and convertible preferred
stock were retroactively restated to reflect the seven-for-ten reverse stock
split.
19
15
4. INVENTORIES:
Inventories consisted of the following:
December 31, 1996 DECEMBER 31, 1997
- ---------------------------------------------------------------------------------------------------------------------------
Raw materials $ 3,816,242 $ 5,738,576
Work in process 3,808,842 5,070,113
Finished goods 944,734 1,292,425
- ---------------------------------------------------------------------------------------------------------------------------
$ 8,569,818 $ 12,101,114
- ---------------------------------------------------------------------------------------------------------------------------
5. PROPERTY AND EQUIPMENT:
Property and equipment consisted of the following:
December 31, 1996 DECEMBER 31, 1997
- ---------------------------------------------------------------------------------------------------------------------------
Test equipment and tooling $ 1,715,227 $ 2,409,088
Office equipment and fixtures 1,672,929 2,143,567
Leasehold improvements 854,637 921,049
- ---------------------------------------------------------------------------------------------------------------------------
4,242,793 5,473,704
Less accumulated depreciation and amortization 1,473,136 2,471,880
- ---------------------------------------------------------------------------------------------------------------------------
$ 2,769,657 $ 3,001,824
- ---------------------------------------------------------------------------------------------------------------------------
In March 1995, the Financial Accounting Standards Board issued SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." This statement requires review and measurement methods to
calculate impairment of long-lived assets whenever events or circumstances
indicate that the carrying amount of an asset may not be recoverable. The
Company adopted this standard in 1996 and the standard did not impact the
financial position and results of operations of the Company in 1996 or 1997.
6. DEBT:
FINANCING AGREEMENT:
During 1994, the Company maintained a financing agreement with the U.S. branch
of Creditanstalt-Bankverein, a banking corporation of the Republic of Austria.
At December 31, 1994, the financing agreement, as amended on July 8, 1994,
provided for a revolving line of credit up to $1,000,000 and for a $2,000,000
term loan. Balances outstanding as of December 31, 1994 were $865,719 under the
line of credit and $2,000,000 under the term loan.
During April 1995, the Company repaid the entire balance outstanding of $865,719
on the line of credit. In addition, on February 9, 1995, the Company used the
proceeds from a private placement and rights offerings to repay the balance
outstanding on the term loan of $1,800,000 (refer to Note 7).
On July 1, 1995, the Company entered into a new credit agreement with the U.S.
Branch of Creditanstalt-Bankverein providing for maximum borrowing of $2,500,000
under a revolving line of credit. This agreement has been extended to June 30,
1998. Borrowings under the line are limited to 90% of eligible accounts
receivable plus the lesser of $750,000 and 40% of eligible inventory and accrue
interest at .5% above the higher of the bank's prime rate or the federal funds
rate plus .5%. The financing agreement is collateralized by substantially all of
the Company's assets, including accounts receivable and inventory, and contains
certain financial covenants including the prohibition on the incurrence of
additional indebtedness for borrowed money and the payment of dividends. At
December 31, 1997, there were no outstanding borrowings under the credit
agreement.
7. SHAREHOLDERS' EQUITY:
PREFERRED STOCK:
The non-voting preferred stock, issued prior to 1994, was redeemable at the
option of the Company, at a price equal to the issuance price, plus 13% of the
issuance price for each year the shares are outstanding, limited to 165% of the
issuance price. The preferred stock had a liquidation value equal to the
issuance price reduced by the amount of preferred stock dividends paid. In
addition, the preferred stock was convertible into shares of common stock at any
time, on a one-for-one basis.
20
16
In 1994, 367,938 shares of preferred stock were converted to common stock.
During 1995, the remaining shares of preferred stock were converted into 958,721
shares of common stock.
COMMON STOCK:
The Company has 7,000,000 authorized shares which have a par value of $ .20 per
share. As of December 31, 1996 and 1997, there are 5,620,417 and 5,727,350
issued shares, respectively.
RIGHTS OFFERING:
On September 19, 1994, the Company offered for sale to every common or preferred
shareholder non-transferable rights to subscribe to one share of common stock at
a purchase price of $5 per share for every four shares of common or preferred
stock held on that date. During September 1994, the Company sold 140,944 shares
of common stock under the rights offering for an aggregate price of $704,720. As
of December 31, 1994, the rights offering was closed. Subscriptions receivable
related to this offering totaled $129,566 at December 31, 1994, which were
collected in 1995. The proceeds from the offering were reduced by $34,188 for
costs incurred in connection with the offering.
PRIVATE PLACEMENT OFFERING:
During January and February 1995, the Company sold 463,337 shares of common
stock at an issue price of $5 per share in a private placement offering for an
aggregate price of $2,316,685. These proceeds were reduced by $201,503 for costs
incurred in connection with the offering, of which $31,740 was incurred in 1994.
STOCK REPURCHASE PROGRAM:
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
purchases. As of December 31, 1997, the Company had purchased 1,000 shares of
the Company's common stock under this program.
RESTRICTED STOCK:
In May 1989, the Company adopted the Tollgrade Communications, Inc. Restricted
Stock Employee Incentive Plan (the "Plan"), which provides for the granting of
restricted common stock to key employees. A maximum of 140,000 shares were
issuable under the Plan. During 1995, 18,960 shares of restricted stock under
the Plan were issued. Additionally, prior to 1995, the Company had granted a
total of 193,134 shares of restricted common stock to certain key employees, of
which 22,403 were granted under the provisions of the Plan. Effective upon
approval by the Company's Board of Directors of the 1995 Long-Term Incentive
Compensation Plan, the Plan was terminated. No shares of restricted stock were
granted under the 1995 Long-Term Incentive Compensation Plan in 1996 and 1997.
All shares of restricted stock were issued at no cost. Generally, the recipients
of the restricted stock are required to continue in the employment of the
Company for three to five years after the date of issuance for ownership to
vest. The unearned compensation related to the restricted stock is being charged
to expense over the vesting period using the market value at the issuance dates,
ranging from $.571 to $10.00, as determined by the Board of Directors.
Compensation expense was $63,939, $52,356 and $52,344 in 1995, 1996 and 1997,
respectively. In 1995, 1996 and 1997, -0-, 2,440 and 350 shares of restricted
stock, respectively, were forfeited due to the termination of certain employees.
Accordingly, the compensation expense recorded for these shares in prior periods
amounting to $-0-, $9,487 and $18,408 was reversed in 1995, 1996 and 1997,
respectively. At December 31, 1997, all shares of restricted common stock
granted had vested with the exception of the 18,960 shares granted under the
Plan in 1995, which vest in August 1998.
STOCK COMPENSATION PLANS:
Under the Company's stock compensation plans, officers and other employees may
be granted options to purchase shares of the Company's common stock. The option
price on all outstanding options is equal to the fair market value of the stock
at the date of the grant.
21
17
On April 22, 1997, the shareholders of the Company approved an amendment of the
1995 Long-Term Incentive Compensation Plan to increase the number of shares
authorized for issuance under the plan by 375,000 and to allow for inclusion of
non-employee directors under the plan. The shares authorized but not granted
under the Company's stock option plans were 126,168 at December 31, 1996 and
357,973 at December 31, 1997.
Prior to and during 1995, 1996 and 1997, certain employees of the Company were
granted stock options under the 1995 Long-Term Incentive Compensation Plan and
various other agreements. The Company has adopted the disclosure-only provisions
of SFAS No. 123 "Accounting for Stock-based Compensation," but applies
Accounting Principles Board Opinion No. 25 and related interpretations in
accounting for its plans. If the Company had elected to recognize compensation
cost for these stock options based on the fair value at the grant dates for
awards granted under those plans in 1995, 1996 and 1997 consistent with the
method prescribed by SFAS No. 123, net income and earnings per share would have
been changed to the pro forma amounts indicated below:
Year Ended
December 31, 1995 December 31, 1996 DECEMBER 31, 1997
- ---------------------------------------------------------------------------------------------------------------------------
Net income As reported $ 2,521,827 $ 5,596,623 $ 6,883,148
Pro forma $ 2,113,201 $ 4,687,153 $ 5,805,709
- ---------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share As reported $ .56 $ .94 $ 1.15
Pro forma $ .47 $ .79 $ .97
The fair value of the stock options used to compute pro forma net income and
earnings per share disclosures is the estimated present value at grant date
using the Black-Scholes option-pricing model with the following weighted average
assumptions for 1995, 1996 and 1997: expected volatility of 40.4%; a risk free
interest rate of 5.44% in 1995, 5.64% in 1996 and 6.10% in 1997; and an expected
holding period of 4 years. The weighted average fair value of stock options,
calculated using the Black-Scholes option-pricing model, granted during the year
ended 1995, 1996 and 1997 is $5.40, $10.71 and $8.54, respectively.
Transactions involving stock options under the Company's various stock option
plans and otherwise are summarized below:
Number of Shares Range of Option Price Weighted Average Exercise Price
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding, December 31, 1994 481,600 $ .957 - $ 5.50 $ 2.52
Granted 333,982 12.00 - 15.00 12.65
Exercised ---- ---- ----
Cancelled (105,000) 4.41 4.41
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding, December 31, 1995 710,582 .957 - 15.00 7.00
Granted 201,500 21.75 - 25.75 25.33
Exercised (179,027) 1.43 - 15.00 2.67
Cancelled (3,000) 12.00 12.00
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding, December 31, 1996 730,055 .957 - 25.75 13.10
Granted 135,750 17.50 - 25.13 21.50
Exercised (107,283) .957 - 17.50 4.42
Cancelled (5,055) 12.00 - 15.00 13.81
- ---------------------------------------------------------------------------------------------------------------------------
OUTSTANDING, DECEMBER 31, 1997 753,467 $ .957 - $ 25.75 $ 15.84
- ---------------------------------------------------------------------------------------------------------------------------
Options exercisable at: Number of Shares Weighted Average Exercise Price
- ---------------------------------------------------------------------------------------------------------------------------
December 31, 1995 578,694 $ 5.61
December 31, 1996 542,369 10.33
DECEMBER 31, 1997 615,289 14.17
22
18
The following table summarizes the status of the stock options, outstanding and
exercisable at December 31, 1997:
Stock Options Outstanding Stock Options Exercisable
- ---------------------------------------------------------------------------------------------------------------------------
Weighted Average
Range of Exercise Remaining Weighted Average Weighted Average
Prices Shares Contractual Life Exercise Price Shares Exercise Price
- ---------------------------------------------------------------------------------------------------------------------------
$.957 89,000 1 year $ .957 89,000 $ .957
- ---------------------------------------------------------------------------------------------------------------------------
$2.14 30,100 1 year $ 2.14 30,100 $ 2.14
- ---------------------------------------------------------------------------------------------------------------------------
$12.00 to $17.50 302,617 8 years $ 12.76 298,949 $ 12.70
- ---------------------------------------------------------------------------------------------------------------------------
$21.00 to $25.75 331,750 9.3 years $ 23.89 197,240 $ 24.20
- ---------------------------------------------------------------------------------------------------------------------------
Total 753,467 $ 15.84 615,289 $ 14.17
- ---------------------------------------------------------------------------------------------------------------------------
Subsequent to December 31, 1997, the Board of Directors granted an additional
86,000 options to officers of the Company pursuant to the 1995 Long-Term
Incentive Compensation Plan, as well as an additional 81,000 options to
non-officers of the Company pursuant to a separate plan established by the Board
of Directors on January 29, 1998.
REDEEMABLE WARRANTS:
In association with the bank financing agreement (refer to Note 6), the Company
issued to the bank over a four year period, at no cost, warrants to purchase
shares of common stock in the amount of 438,798 shares. The warrants were
exercisable by the bank up to six years from the termination date of the
financing agreement. The $250,738 value assigned to the warrants was recorded as
a discount on the related debt.
The warrants contained an anti-dilutive provision if additional shares of stock
(other than through a stock split) were issued for a consideration per share
less than market value. In addition, the warrants granted the bank, at its sole
option, the right to require the Company to repurchase all or any portion of the
warrants on or after April 30, 1994. The repurchase price was the fair market
value of the common stock purchasable with the warrants, as defined in the
financing agreement.
On July 8, 1994, the Company entered into an agreement with the bank under which
the repurchase provisions of the warrants were eliminated and a stock redemption
agreement was established. Under the stock redemption agreement, the
consideration to be paid per share would be the market value of the shares on
the day of the offer.
In December 1994, the bank offered to sell all of its warrants to the Company at
$2.86 per warrant through February 15, 1995. On February 9, 1995, the Company
repurchased all of the warrants from the bank at the price of $2.86 per warrant
for an aggregate purchase price of $1,253,708. As a result of such repurchase,
the stock redemption agreement was terminated.
SERIES A JUNIOR PARTICIPATING PREFERRED STOCK PURCHASE RIGHTS:
In order to protect shareholder value in the event of an unsolicited offer to
acquire the Company, on July 23, 1996, the Board of Directors of the Company
declared a dividend of one preferred stock purchase right for each outstanding
share of the Company's common stock. The dividend was payable on August 15, 1996
to shareholders of record as of that date. The aforementioned rights are
exercisable only if a person or group acquires or announces an offer to acquire
20% or more of the Company's common stock. In such an event, each right will
entitle shareholders to buy one-hundredth of a share of a new series of
preferred stock at an exercise price of $115.00. Each one-hundredth of a share
of the new preferred stock has terms designed to make it the economic and voting
equivalent of one share of common stock.
If a person or group acquires 20% or more of the Company's outstanding common
stock, each right not owned by the person or group will entitle its holder to
purchase at the right's exercise price a number of shares of the Company's
common stock (or, at the option of the Company, the new preferred stock) having
a market value of twice the exercise price. Further, at any time after a person
or group acquires 20% or more (but less than 50%) of the outstanding common
stock, the Board of Directors may at its option, exchange part or all of the
rights (other than rights held by the acquiring person or group) for shares of
the Company's common or preferred stock for a one-for-one basis. Each right
further provides that if the Company is acquired in a merger or other business
transaction, each right will entitle its
23
19
holder to purchase, at the right's exercise price, a number of the acquiring
company's common shares having a market value at that time of twice the exercise
price.
The Board of Directors is entitled to redeem the rights for one cent per right
at any time before a 20% position has been acquired. The Board of Directors is
also authorized to reduce the 20% thresholds referred to above to not less than
10%.
8. LICENSE AND ROYALTY FEES:
The Company has entered into several technology license agreements with certain
major Digital Loop Carrier ("DLC") vendors under which the Company has been
granted access to the licensor's patent technology and the right to manufacture
and sell the patent technology in the Company's product line. The Company is
obligated to pay royalty fees, as defined, through the terms of these license
agreements. Royalty fees of $1,075,800, $1,893,000 and $2,014,000 were incurred
in 1995, 1996 and 1997, respectively, and are included in cost of product sales
in the accompanying consolidated statements of operations.
9. INCOME TAXES:
The provision for income taxes consisted of the following:
December 31,
1995 1996 1997
- ---------------------------------------------------------------------------------------------------------------------------
Current:
Federal $ 641,400 $ 2,938,491 $ 3,726,200
State 84,600 316,252 421,000
- ---------------------------------------------------------------------------------------------------------------------------
726,000 3,254,743 4,147,200
- ---------------------------------------------------------------------------------------------------------------------------
Deferred:
Federal 640,000 (111,056) (28,160)
State 52,000 33,066 54,609
- ---------------------------------------------------------------------------------------------------------------------------
692,000 (77,990) 26,449
- ---------------------------------------------------------------------------------------------------------------------------
$ 1,418,000 $ 3,176,753 $ 4,173,649
- ---------------------------------------------------------------------------------------------------------------------------
Reconciliations of the federal statutory rate to the effective tax rates are as
follows:
December 31,
1995 1996 1997
- ---------------------------------------------------------------------------------------------------------------------------
Federal statutory tax rate 34% 34% 34%
Research and development tax credit (3) (1) (2)
State income taxes 5 2 3
Other ---- 1 3
- ---------------------------------------------------------------------------------------------------------------------------
Effective tax rate 36% 36% 38%
- ---------------------------------------------------------------------------------------------------------------------------
The components of net deferred tax assets and liabilities were as follows:
December 31,
1996 1997
- ---------------------------------------------------------------------------------------------------------------------------
State net operating loss carryforwards $ 58,750 $ ----
Other, net 101,740 133,995
- ---------------------------------------------------------------------------------------------------------------------------
Total net deferred tax assets $ 160,490 $ 133,995
- ---------------------------------------------------------------------------------------------------------------------------
The Company had a state tax operating loss carryforward at December 31, 1996 of
approximately $500,000 which was utilized in 1997.
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10. LEASE COMMITMENTS:
The Company leases office space and equipment under agreements which are
accounted for as operating leases. The office lease expires December 31, 1998
and may be extended up to an additional 12 years. The equipment lease expires in
May 2002. The Company is also involved in various month-to-month leases for
research and development equipment. In addition, the office lease includes
provisions for possible adjustments in annual future rental commitments relating
to excess taxes and excess maintenance costs that may occur. The Company made
additional rental payments of $4,727 and $1,619 in 1997 and 1996, respectively,
and no additional rental payments in 1995.
Minimum annual future rental commitments under noncancelable leases as of
December 31 are:
1998.........................................................$397,985
1999...........................................................26,578
2000...........................................................26,578
2001...........................................................26,578
2002............................................................8,859
The rent expense for all lease commitments was approximately $273,000,
$335,000 and $354,000 in 1995, 1996 and 1997, respectively.
11. MAJOR CUSTOMERS, REVENUE CONCENTRATION AND DEPENDENCE ON CERTAIN SUPPLIERS:
The Company sells precision electronic equipment to companies in the
telecommunications industry primarily in the United States. Sales are
concentrated primarily with the five Regional Bell Operating Companies (RBOCs)
as well as major independent telephone companies such as Sprint. Sales are
primarily from the Company's metallic channel unit ("MCU") product line. The MCU
product line accounted for more than 94% of the Company's net product sales for
1997. The Company expects that revenues from MCU products will continue to
account for a majority of the Company's revenues for the foreseeable future.
Sales to the RBOCs accounted for approximately 95%, 86% and 86% of the Company's
net product sales for fiscal years 1995, 1996 and 1997, respectively. During
fiscal years 1995, 1996 and 1997, sales to two RBOCs comprised 65%, 60% and 54%,
respectively, of the Company's net product sales. At December 31, 1996 and 1997,
accounts receivable-trade included in the consolidated balance sheets related to
these two RBOCs was approximately $3,034,000 and $3,819,000, respectively. Due
to the Company's present dependency on the RBOCs, the loss of one or more of the
RBOCs as a customer, or the reduction of orders for the Company's products by
the RBOCs, could materially and adversely affect the Company.
For a portion of 1997 and prior years, the Company utilized one key independent
subcontractor to perform a majority of the circuit board assembly and in-circuit
testing work on its products. The Company also utilized other subassembly
contractors 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 be phased out, at the
latest, during early 1998. The Company is in the process of phasing out the use
of the subcontractor, and is now utilizing two other subassembly subcontractors
that had been utilized by the Company on a more limited basis in the past. In
addition, proprietary design integrated circuits, which are a key component of
certain products, are the design and property of the manufacturer from which
they are purchased. The license agreements under which the proprietary design
integrated circuits are supplied can be terminated on relatively short notice.
The loss of such license agreements or a reduction in the capacity for any
reason of the Company's key subassembly contractors could cause a delay in
manufacturing and a possible loss of sales, which would affect operating results
adversely.
12. EMPLOYEE BENEFIT PLANS:
The Company adopted a 401(k) benefit plan effective March 1, 1996. Eligible
employees, as defined in the plan, may contribute up to 20% of eligible
compensation, as defined. The Company does not make any matching contributions
to the plan.
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STATEMENTS OF OPERATIONS DATA BY QUARTER:
The following table presents unaudited quarterly operating results for each of
the Company's last eight fiscal quarters. This information has been prepared by
the Company on a basis consistent with the Company's audited financial
statements and includes all adjustments (consisting only of normal recurring
adjustments) that the Company considers necessary for a fair presentation of the
data. Such quarterly results are not necessarily indicative of the future
results of operations.
(In thousands, except per share data)
Quarter Ended
(Unaudited)
March 31, June 30, Sept. 30, Dec. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1996 1996 1996 1996 1997 1997 1997 1997
- ---------------------------------------------------------------------------------------------------------------------------
Revenues $6,849 $10,182 $10,080 $10,379 $8,619 $12,115 $11,363 $13,324
Cost of product sales 3,463 4,971 5,000 4,888 3,789 5,454 5,226 5,635
- ---------------------------------------------------------------------------------------------------------------------------
Gross profit 3,386 5,211 5,080 5,491 4,830 6,661 6,137 7,689
Operating expenses:
Selling and marketing 892 1,259 1,234 1,382 1,046 1,334 1,287 1,779
General and administrative 480 596 672 804 831 914 948 1,075
Research and development 713 878 1,044 1,286 1,241 1,425 1,517 1,762
- ---------------------------------------------------------------------------------------------------------------------------
Total operating expenses 2,085 2,733 2,950 3,472 3,118 3,673 3,752 4,616
- ---------------------------------------------------------------------------------------------------------------------------
Income from operations 1,301 2,478 2,130 2,019 1,712 2,988 2,385 3,073
Other income, net 204 184 90 367 177 239 221 261
- ---------------------------------------------------------------------------------------------------------------------------
Income before income taxes 1,505 2,662 2,220 2,386 1,889 3,227 2,606 3,334
Provision for income taxes 548 1,050 824 754 710 1,194 999 1,270
- ---------------------------------------------------------------------------------------------------------------------------
Net income $ 957 $ 1,612 $ 1,396 $ 1,632 $1,179 $2,033 $ 1,607 $ 2,064
- ---------------------------------------------------------------------------------------------------------------------------
Net income per common share
Basic $ .18 $ .30 $ .25 $ .29 $ .21 $ .36 $ .28 $ .36
Diluted $ .16 $ .27 $ .23 $ .27 $ .20 $ .34 $ .27 $ .35
Weighted average shares
of common stock and equivalents:
Basic 5,444 5,446 5,504 5,612 5,632 5,677 5,709 5,725
Diluted 5,858 5,942 5,940 5,978 5,976 5,942 5,955 5,975
COMMON STOCK MARKET PRICES
The Company's Common Stock has been included for quotation on the Nasdaq
National Market System under the Nasdaq symbol "TLGD" since the Company's
initial public offering in December 1995. The following table sets forth, for
the periods indicated, the high and low closing sale prices for the Common Stock
on such market:
High Low
- ----------------------------------------------------------------
1996:
First Quarter $18-1/4 $14-1/2
Second Quarter 27 17-7/8
Third Quarter 24-1/2 20-3/4
Fourth Quarter 31 22-1/2
1997:
FIRST QUARTER $30-3/4 $18-1/4
SECOND QUARTER 24 17
THIRD QUARTER 23-1/2 20
FOURTH QUARTER 26-3/8 20-1/2
At March 3, 1998, the Company had 410 holders of record of its Common Stock and
5,837,766 shares outstanding.
The Company has never paid any dividends on its common stock and does not expect
to pay cash dividends in the foreseeable future. In addition, the Company is
prohibited from paying dividends under the terms of a credit agreement with
Creditanstalt Corporate Finance. (See Note 6 in the accompanying consolidated
financial statements).
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