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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC
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FORM 10-Q
(Mark One)
[ X ] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended June 27, 1998
[ ] 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)
724-274-2156
(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
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As of July 27, 1998, there were 5,888,171 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 20 pages. The exhibit index is on page 18.
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TOLLGRADE COMMUNICATIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 27, 1998
TABLE OF CONTENTS
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PART I. FINANCIAL INFORMATION PAGE NO.
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ITEM 1 -- CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF JUNE 27, 1998
AND DECEMBER 31,1997.......................................................................3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE-MONTH AND SIX-MONTH
PERIODS ENDED JUNE 27, 1998 AND JUNE 28, 1997..............................................4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX-MONTH
PERIODS ENDED JUNE 27, 1998 AND JUNE 28, 1997..............................................5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.......................................6
REPORT OF INDEPENDENT ACCOUNTANTS..........................................................7
ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION......................................................8
PART II. OTHER INFORMATION
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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..........................................................16
SIGNATURE...............................................................................................17
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EXHIBIT INDEX...........................................................................................18
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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
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(UNAUDITED)
JUNE 27, 1998 DECEMBER 31, 1997
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ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 5,621,098 $ 3,183,944
Short term investments 8,185,996 15,666,626
Accounts receivable:
Trade 12,580,467 7,884,683
Other 324,799 517,090
Inventories 12,300,490 12,101,114
Prepaid expenses and deposits 266,968 409,252
Deferred tax asset 213,216 213,216
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TOTAL CURRENT ASSETS 39,493,034 39,975,925
Long term investments 5,843,000 600,000
Property and equipment, net 3,405,205 3,001,824
Deferred tax asset 126,895 126,895
Patents and other assets 6,408 8,568
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TOTAL ASSETS $48,874,542 $43,713,212
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LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 992,568 $ 959,185
Accrued expenses 852,055 1,091,990
Accrued salaries and wages 1,124,130 1,529,525
Royalties payable 911,015 878,780
Income taxes payable 971,551 946,233
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TOTAL CURRENT LIABILITIES 4,851,319 5,405,713
Deferred income 140,000 --
Deferred tax liability 206,116 206,116
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TOTAL LIABILITIES 5,197,435 5,611,829
SHAREHOLDERS' EQUITY:
Common stock, $.20 par value; authorized shares, 25,000,000;
issued 5,881,362 and 5,727,350, respectively 1,176,272 1,145,470
Additional paid-in capital 26,950,215 25,232,315
Treasury stock, at cost, 17,500 and 3,200 shares, respectively (357,978) (70,355)
Unearned compensation (8,984) (35,934)
Retained earnings 15,917,582 11,829,887
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TOTAL SHAREHOLDERS' EQUITY 43,677,107 38,101,383
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $48,874,542 $43,713,212
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The accompanying notes are an integral part of the condensed consolidated
financial statements.
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
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FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 27, 1998 JUNE 28, 1997 JUNE 27, 1998 JUNE 28, 1997
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REVENUES $14,025,024 $12,115,025 $24,788,864 $20,734,431
COST OF PRODUCT SALES 5,919,637 5,454,400 10,274,949 9,243,766
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GROSS PROFIT 8,105,387 6,660,625 14,513,915 11,490,665
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OPERATING EXPENSES:
Selling and marketing 1,499,318 1,333,946 3,121,202 2,380,135
General and administrative 1,262,850 913,748 2,352,557 1,744,035
Research and development 1,542,450 1,424,600 3,170,452 2,665,854
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TOTAL OPERATING EXPENSES 4,304,618 3,672,294 8,644,211 6,790,024
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INCOME FROM OPERATIONS 3,800,769 2,988,331 5,869,704 4,700,641
Interest and other income, net 417,366 239,377 605,991 416,365
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INCOME BEFORE INCOME TAXES 4,218,135 3,227,708 6,475,695 5,117,006
Provision for income taxes 1,575,000 1,194,247 2,388,000 1,904,252
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NET INCOME $ 2,643,135 $ 2,033,461 $ 4,087,695 $ 3,212,754
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EARNINGS PER SHARE INFORMATION:
Weighted average shares of common stock
and equivalents:
Basic 5,855,207 5,676,862 5,816,867 5,654,543
Diluted 6,007,594 5,942,445 5,982,179 5,957,847
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Net income per common and common
equivalent shares:
Basic $ .45 $ .36 $ .70 $ .57
Diluted $ .44 $ .34 $ .68 $ .54
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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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SIX MONTHS ENDED
JUNE 27, 1998 JUNE 28, 1997
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,087,695 $ 3,212,754
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 601,586 476,513
Deferred income taxes -- 46
Compensation expense for restricted stock 26,950 27,534
Changes in assets and liabilities:
Increase in accounts receivable-trade (4,695,784) (484,402)
Decrease (increase) in accounts receivable-other 192,291 (12,047)
(Increase) decrease in inventories (199,376) 280,252
Decrease in prepaid expenses and deposits 142,284 265,374
Increase (decrease) in accounts payable 33,384 (350,921)
Decrease in accrued expenses, royalties payable, and
deferred income (67,702) (390,696)
Decrease in accrued salaries and wages (405,395) (29,097)
Increase in income taxes payable 25,318 983,955
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Net cash (used in) provided by operating activities (258,749) 3,979,265
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CASH FLOWS FROM INVESTING ACTIVITIES:
Redemption/maturity of short-term / long-term investments 12,931,757 7,154,961
Purchase of short-term/long-term investments (10,694,127) (8,369,177)
Capital expenditures (1,002,806) (562,696)
Purchase of treasury stock (287,623) --
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Net cash provided by (used in) investing activities 947,201 (1,776,912)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the exercise of stock options including related
tax benefits 1,748,702 242,099
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Net cash provided by financing activities 1,748,702 242,099
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Net increase in cash and cash equivalents 2,437,154 2,444,452
Cash and cash equivalents at beginning of period 3,183,944 4,591,273
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Cash and cash equivalents at end of period $5 ,621,098 $ 7,035,725
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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
(UNAUDITED)
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 six-month periods
ended June 27, 1998 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, 1997. 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 six-month periods ended June 27,
1998 are not necessarily indicative of the results that may be expected for the
year ending December 31, 1998.
2. INVENTORY
At June 27, 1998 and December 31, 1997 inventory consisted of the following:
June 27, December 31,
1998 1997
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Raw materials...................................... $ 4,537,389 $ 5,738,576
Work in progress................................... 6,022,638 5,070,113
Finished goods..................................... 1,740,463 1,292,425
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$12,300,490 $12,101,114
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3. SHORT-TERM INVESTMENTS
Short-term investments at June 27, 1998, and December 31, 1997, consisted of
individual U.S. Government and 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 and capital expenditures and to meet working capital requirements.
Long-term investments are comprised of individual municipal bonds with a
maturity of more than one year but less than eighteen months.
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REPORT OF INDEPENDENT ACCOUNTANTS
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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 June 27, 1998, and the
related condensed consolidated statements of operations for the three months and
six months then ended and the condensed consolidated statement of cash flows for
the six 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, 1997 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 27, 1998, 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, 1997, is fairly stated in all material respects in
relation to the consolidated balance sheet from which it has been derived.
/s/ PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
July 14, 1998
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
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OPERATIONS AND FINANCIAL CONDITION
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The following discussion should be read in conjunction with the 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" made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995, including without limitation,
statements as to management's beliefs, strategies, plans, expectations or
opinions in connection with company performance, which are based on a number of
assumptions concerning future conditions that may ultimately prove to be
inaccurate. In addition, while the Company's goal is to continue to achieve
earnings growth at the rate of 20% per annum, this statement, as well as other
forward-looking statements that may be included here, must be qualified by
important factors that could cause actual earnings and other results to differ
materially from those achieved in the past or those expected by the Company.
These include: rapid technological change along with the need to continually
develop new products; the Company's dependence on a single product line;
competition; the Company's dependence on key employees; difficulties in managing
the Company's growth; the Company's dependence upon certain customers and
certain suppliers; the Company's dependence upon proprietary rights; risks of
third party claims of infringement; and government regulation.
IMPACT OF THE YEAR 2000 ISSUE
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 material exposure to contingencies
related to the Year 2000 Issue for the products it has sold.
The Company is currently engaging 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.
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
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well as alarm-related products, represented approximately 94% of the Company's
revenue for the second quarter ended June 27, 1998 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 second quarter ended June 27, 1998, approximately 84% of the Company's total
revenue was generated from sales directly to these five RBOCs, the two largest
of which comprised approximately 62% 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. This
timing is particularly sensitive to various business factors within each of the
RBOC's including the RBOCs relationships with their various organized labor
groups. Certain contracts concerning the RBOCs organized employees are subject
to renegotiation during the third quarter of 1998. The impact, if any, on the
timing of RBOC ordering of the Company's products related to a work disruption
within the RBOCs cannot be determined.
The Company believes that recent changes within the telecommunication
marketplace, including industry consolidation, as well as the Company's ability
to successfully penetrate certain new markets, have resulted in some discounting
and more favorable terms to certain of the Company's customers. In addition, the
Company has recently experienced certain customer demands to consolidate product
purchases which have translated into large bulk orders during the quarter.
Although the Company will continue to strive to meet the demands of our
customers, which include delivery of quality products at an acceptable price and
on acceptable terms, there are no assurances that the Company will be successful
in negotiating acceptable terms and conditions pertaining to these large orders.
Since the Company cannot predict future events or business conditions, the
Company's results may be adversely affected by these industry trends in the
primary markets it serves.
The Company 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.
Although international sales to date have not been significant, the Company
believes certain 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 11.0% for the second quarter ended June 27, 1998.
The Company expects its research and development expenses to continue at
significant levels.
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RESULTS OF OPERATIONS - SECOND QUARTER
REVENUES
Revenue for the second quarter of 1998 were $14,025,024 and were $1,909,999, or
15.8%, higher than the revenues of $12,115,025 reported for the second quarter
of 1997. The increase in revenues for the second 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. In
addition, 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. Periodic fluctuations
in customer orders and backlog result from a variety of factors, including but
not limited to the timing of significant orders and shipments, and are not
necessarily indicative of long-term trends in sales of the Company's products.
GROSS PROFIT
Gross profit for the second quarter of 1998 was $8,105,387 compared to
$6,660,625 for the second quarter of 1997, representing an increase of
$1,444,762, or 21.7%. Gross profit as a percentage of revenues increased to
57.8% in the second quarter of 1998, compared to 55.0% 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 second quarter of 1998 was $1,499,318
compared to $1,333,946 for the second quarter of 1997. This increase of
$165,372, or 12.4%, is primarily attributable to the addition of personnel
associated with the expansion of certain sales administration and marketing
functions as well as the costs associated with the continuing development of
domestic and international markets. As a percentage of revenues, selling and
marketing expenses decreased to 10.7% in the second quarter of 1998 from 11.0%
in the second quarter of 1997, primarily due to the increased revenue base
discussed above.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense for the second quarter of 1998 was
$1,262,850, an increase of $349,102, or 38.2%, over the $913,748, recorded in
the second quarter of 1997. The increase in general and administrative expense
primarily reflects additional salaries and benefits associated with increased
staffing levels to support expanded business operations as well as increased
costs associated with personnel recruiting activities. As a percentage of
revenues, general and administrative expenses increased to 9.0% in the second
quarter of 1998 from 7.5% in the second quarter of 1997.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense in the second quarter of 1998 was $1,542,450,
an increase of $117,850, or 8.3%, over the $1,424,600, recorded in the second
quarter of 1997. The increase is primarily
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associated with additional personnel and related engineering 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
decreased to 11.0% in the second quarter of 1998 from 11.8% in the second
quarter of 1997.
INTEREST AND OTHER INCOME
For the second quarter of 1998, interest and other income was $417,366 compared
to $239,377 for the second quarter of 1997, representing an increase of
$177,989, or 74.4%. Interest and other income for the second quarter of 1998
included net key man life insurance proceeds of approximately $156,000
associated with the death of the Company's former Chairman R. Craig Allison.
PROVISION FOR INCOME TAXES
The provision for income taxes for the second quarter of 1998 was $1,575,000, an
increase of $380,753, or 31.9%, from $1,194,247, for the second quarter of 1997.
This increase was due primarily to higher levels of taxable income. The
effective income tax rate for the second quarter of 1998 increased .3% over the
second quarter of 1997, which is immaterial.
NET INCOME AND EARNINGS PER SHARE
As a result of the above factors, net income for the second quarter of 1998 was
$2,643,135, an increase of $609,674, or 30.0%, over the $2,033,461, recorded in
the second quarter of 1997. Basic and diluted earnings per common share of $.45
and $.44, respectively, for the second quarter of 1998 increased by 25.0% and
29.4%, respectively, or $.09 and $.10, from the $.36 and $.34 , respectively
earned in the second quarter of 1997. The second quarter of 1998 includes
approximately $226,000, or $.04 per share, related to the after-tax effect of
net key man life insurance as previously discussed above. Excluding the effect
of net key man life insurance proceeds, net income increased $383,674, or
18.9%, while diluted earnings per share for the second quarter of 1998 increased
17.6% to $.40 per share. Basic and diluted weighted average common and common
equivalent shares outstanding were 5,855,207 and 6,007,594, respectively in the
second quarter of 1998 compared to 5,676,862 and 5,942,445, respectively in the
second quarter of 1997. As a percentage of revenues, net income for the second
quarter of 1998 increased to 18.8% compared to the 16.8% for the second quarter
of 1997. Excluding the effect of net key man life insurance proceeds, net income
as a percentage of revenues for the second quarter of 1998 increased to 17.2%.
RESULTS OF OPERATIONS - YEAR TO DATE
REVENUES
For the first six months of 1998, revenues were $24,788,864 compared to
$20,734,431 for the first six months of 1997, representing an increase of
$4,054,433 or 19.6%. The increase in revenues for the six month period was
primarily attributable to an increase in unit sales volume of the MCU line test
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
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of a marketing program to train customers in advanced line test system
trouble-shooting.
GROSS PROFIT
For the six months of 1998, gross profit increased to $14,513,915 compared to
$11,490,665 for the first six months of 1997, representing an increase of
$3,023,250, or 26.3%. As a percentage of revenues, gross profit increased to
58.6% in the first six months of 1998 compared to 55.4% in the same period for
1997. 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
For the first six months of 1998, selling and marketing expense totaled
$3,121,202 compared to $2,380,135 for the first six months of 1997, representing
an increase of $741,067, or 31.1%. This increase is primarily attributable to
the addition of personnel associated with the expansion of certain sales
administration and marketing functions as well as the costs associated with the
continuing development of domestic and international markets. As a percentage of
revenues, selling and marketing expense increased to 12.6% in the first six
months of 1998 from 11.5% for the same period of 1997.
GENERAL AND ADMINISTRATIVE EXPENSE
For the first six months of 1998, general and administrative expense totaled
$2,352,557 compared to $1,744,035 for the first six months of 1997, representing
an increase of $608,522, or 34.9%. The increase in general and administrative
expense primarily reflects additional salaries and benefits associated with
increased staffing levels to support expanded business operations, increased
costs associated with personnel recruiting activities as well as increased
international travel. As a percentage of revenues, general and administrative
expense increased to 9.5% for the first six months of 1998 from 8.4% for the
same period of 1997.
RESEARCH AND DEVELOPMENT EXPENSE
For the first six months of 1998, research and development expense totaled
$3,170,452 compared to $2,665,854 for the first six months of 1997, representing
an increase of $504,598 or 18.9%. The increase is primarily associated with
additional personnel and related engineering 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 decreased to 12.8% in
the first six months of 1998 from 12.9% for the first six months of 1997.
INTEREST AND OTHER INCOME
For the first six months of 1998, interest and other income was $605,991
compared to $416,365 for the first six months of 1997, representing an increase
of $189,626, or 45.5%. Interest and other income for the first six months of
1998 included net key man life insurance proceeds of approximately $156,000
associated with the death of the Company's former Chairman R. Craig Allison.
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PROVISIONS FOR INCOME TAXES
The provision for income taxes for the first six months of 1998 was $2,388,000
which was an increase of $483,748, or 25.4%, from $1,904,252 for the first six
months of 1997. This increase was due primarily to higher levels of taxable
income. The effective tax rate for the first six months of 1998 was .3% lower
than that experienced in the comparable period in the prior year, which is
immaterial.
NET INCOME AND EARNINGS PER SHARE
For the first six months of 1998, net income was $4,087,695 compared to
$3,212,754 for the first six months of 1997, representing an increase of
$874,941, or 27.2%. Basic and diluted earnings per common share of $.70 and
$.68, respectively, for the first half of 1998 increased by 22.8% and 25.9%,
respectively, or $.13 and $.14, from the $.57 and $.54 , respectively earned in
the first half of 1997. The first six months of 1998 includes approximately
$226,000, or $.04 per share, related to the after-tax effect of net key man life
insurance as previously discussed above. Excluding the effect of net key man
life insurance proceeds, net income increased $648,941, or 20.2%, while diluted
earnings per share for the first six months of 1998 increased 18.5% to $.64 per
share. Basic and diluted weighted average common and common equivalent shares
outstanding were 5,816,867 and 5,982,179, respectively in the first half of 1998
compared to 5,654,543 and 5,957,847 respectively in the first half of 1997.
13
14
LIQUIDITY AND CAPITAL RESOURCES
At June 27, 1998, the Company had working capital of $34,641,494, which
represented an increase of $71,282 or 0.2%, from the $34,570,212 of working
capital as of December 31, 1997. The increase in working capital can be
attributed primarily to operating cash flow (income from operations before
depreciation and amortization) exceeding the requirements for purchases of
property and equipment. The Company's change in working capital includes an
increase in accounts receivable trade of $4,695,784, offset by an increase in
long-term investment of $5,243,000. The increase in long-term investments
reflects the Company's investment policy to migrate to individual municipal
bonds with a maturity of more than one year but less than eighteen months when
more favorable investment yields can be earned. The increase in accounts
receivable trade reflects the recent granting of more favorable terms to certain
of the Company's customers and that relate to the large bulk purchases made
during the current quarter as previously discussed. 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 $1,002,806 in the first six months of
1998 and were primarily related to an upgrade of the MIS infrastructure,
production test equipment and fixtures, as well as leasehold improvements made
to the Company's facilities. The Company presently has no material capital
expenditure commitments.
As of May 31, 1998, the Company terminated its $2,500,000 bank line of credit.
The Company believes that, based upon its current financial position, that the
line of credit was not necessary to be continued at the present time.
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 15,300 shares of common stock
under this program.
BACKLOG
The Company's backlog consists of firm customer purchase orders for the
Company's various products. As of June 27, 1998 the Company had a backlog of
$2,202,611 compared to $1,554,495 at December 31, 1997 and $3,481,359 at March
28, 1998. The decrease in backlog for the current quarter over the first quarter
occurred due to product shipments exceeding customer orders during the second
quarter of 1998. 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.
14
15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
- -----------------------------------
None.
ITEM 2. CHANGES IN SECURITIES
- ---------------------------------------
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- -----------------------------------------
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -------------------------------------------------------------
On May 5, 1998 the Company held its annual shareholders meeting. At
the meeting, each of Richard H. Heibel and Robert W. Kampmeinert were elected to
the Board of Directors for a three year term expiring at the annual meeting of
shareholders in 2001. The terms of Directors Christian L. Allison, Daniel P.
Barry and David S. Egan continued after the meeting and will expire at the
annual meeting of shareholders in 1999. The terms of Directors James J. Barnes
and Rocco L. Flaminio also continued after the meeting and will expire at the
annual meeting of shareholders in 2000. In addition, the Company's Articles of
Incorporation were amended to increase the number of authorized shares to 25
million. Also, the shareholders ratified the appointment of
PricewaterhouseCoopers LLP (formerly Coopers & Lybrand L.L.P.) as the Company's
independent auditors for fiscal year 1998. The results of the voting were as
follows:
Total Votes
Cast For Against Withheld Abstained
---- --- ------- -------- ---------
Election of Directors:
- ----------------------
Richard H. Heibel 4,995,160 4,859,876 -- 135,284 --
Robert W.Kampmeinert 4,995,160 4,817,394 -- 177,766 --
Amendment to the
- ----------------
Articles of
- -----------
Incorporation 4,995,160 4,176,344 805,888 -- 12,928
- -------------
Ratification of
- ---------------
Appointment of
- --------------
Coopers & Lybrand 4,995,160 4,975,420 7,012 -- 12,728
- -----------------
L.L.P
- -----
ITEM 5. OTHER INFORMATION
- ---------------------------
None.
15
16
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- -------------------------------------------
(a) Exhibits:
The following exhibits are being filed with this report:
Exhibit
Number Description
------ -----------
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 June 27, 1998.
16
17
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
TOLLGRADE COMMUNICATIONS, INC.
(REGISTRANT)
Dated: August 10, 1998 /S/ CHRISTIAN L. ALLISON
--------------------------------------------
CHRISTIAN L. ALLISON
CHAIRMAN, CHIEF EXECUTIVE OFFICER & DIRECTOR
Dated: August 10, 1998 /S/ SAMUEL C. KNOCH
--------------------------------------------
SAMUEL C. KNOCH
CHIEF FINANCIAL OFFICER AND TREASURER
Dated: August 10, 1998 /S/ BRADLEY N. DINGER
--------------------------------------------
BRADLEY N. DINGER
CONTROLLER
17
18
EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
Exhibit
Number Description
------ -----------
11.1 Statement re Computation of Per Share Earnings
15 Letter re unaudited interim financial information
27 Financial Data Schedule
18