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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC
----------------
FORM 10-Q
(Mark One)
[ X ] Quarterly Report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 26, 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 _______
As of November 6, 1998, there were 5,828,464 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 19.
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TOLLGRADE COMMUNICATIONS, INC.
Quarterly Report on Form 10-Q
For the Quarter Ended September 26, 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 September 26, 1998 and
December 31,1997 .....................................................................3
Condensed Consolidated Statements of Operations for the three-month and
nine-month periods ended September 26, 1998 and September 27, 1997....................4
Condensed Consolidated Statements of Cash Flows for the nine-month
periods ended September 26, 1998 and September 27, 1997 ..............................5
Notes to Condensed Consolidated Financial Statements..................................6
Report of Independent Accountants.....................................................8
Item 2 Management's Discussion and Analysis of Results of Operations and
Financial Condition...................................................................9
PART II. OTHER INFORMATION
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Item 1 Legal Proceedings....................................................................17
Item 2 Changes in Securities................................................................17
Item 3 Defaults Upon Senior Securities......................................................17
Item 4 Submission of Matters to a Vote of Security Holders..................................17
Item 5 Other Information....................................................................17
Item 6 Exhibits and Reports on Form 8-K.....................................................17
SIGNATURE..........................................................................................18
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EXHIBIT INDEX......................................................................................19
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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
(Unaudited)
September 26, December 31,
1998 1997
==========================================================================================================
ASSETS
Current assets:
Cash and cash equivalents $5,150,565 $3,183,944
Short term investments 11,032,797 15,666,626
Accounts receivable:
Trade 9,338,966 7,884,683
Other 1,079,962 517,090
Inventories 12,973,812 12,101,114
Prepaid expenses and deposits 206,051 409,252
Deferred tax asset 372,783 213,216
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TOTAL CURRENT ASSETS 40,154,936 39,975,925
Long term investments 5,160,000 600,000
Property and equipment, net 3,426,133 3,001,824
Deferred tax asset 247,513 126,895
Patents and other assets 5,327 8,568
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TOTAL ASSETS $48,993,909 $43,713,212
==========================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 545,455 $ 959,185
Accrued expenses 1,048,926 1,091,990
Accrued salaries and wages 774,073 1,529,525
Royalties payable 580,626 878,780
Income taxes payable 653,384 946,233
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TOTAL CURRENT LIABILITIES 3,602,464 5,405,713
Deferred income 40,000 ----
Deferred tax liability 9,950 206,116
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TOTAL LIABILITIES 3,652,414 5,611,829
Shareholders' equity:
Common stock, $.20 par value; authorized shares,
25,000,000; issued 5,920,164 and 5,727,350,
respectively 1,184,033 1,145,470
Additional paid-in capital 27,487,265 25,232,315
Treasury stock, at cost, 17,500 and 2,200 shares,
respectively (357,978) (70,355)
Unearned compensation ---- (35,934)
Retained earnings 17,028,175 11,829,887
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TOTAL SHAREHOLDERS' EQUITY 45,341,495 38,101,383
==========================================================================================================
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $48,993,909 $43,713,212
==========================================================================================================
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the For the
Three Months Ended Nine Months Ended
Sept. 26, 1998 Sept. 27, 1997 Sept. 26, 1998 Sept. 27, 1997
==========================================================================================================================
REVENUES $10,120,469 $11,362,609 $34,909,333 $32,097,040
COST OF PRODUCT SALES 4,511,004 5,225,317 14,785,953 14,469,083
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GROSS PROFIT 5,609,465 6,137,292 20,123,380 17,627,957
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OPERATING EXPENSES:
Selling and marketing 1,227,629 1,286,864 4,348,831 3,666,999
General and administrative 1,132,867 947,799 3,485,424 2,691,834
Research and development 1,586,704 1,517,571 4,757,156 4,183,425
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TOTAL OPERATING EXPENSES 3,947,200 3,752,234 12,591,411 10,542,258
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INCOME FROM OPERATIONS 1,662,265 2,385,058 7,531,969 7,085,699
Interest and other income, net 103,131 220,887 709,122 637,252
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INCOME BEFORE INCOME TAXES 1,765,396 2,605,945 8,241,091 7,722,951
Provision for income taxes 654,803 999,022 3,042,803 2,903,274
==========================================================================================================================
NET INCOME $1,110,593 $1,606,923 $5,198,288 $4,819,677
==========================================================================================================================
Earnings per share information:
Weighted average shares of common stock and
common stock equivalents
Basic 5,892,894 5,708,583 5,842,308 5,672,689
Diluted 6,048,223 5,955,104 6,004,436 5,956,921
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Net income per common and common equivalent shares:
Basic $.19 $.28 $.89 $.85
Diluted $.18 $.27 $.87 $.81
==========================================================================================================================
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)
Nine Months Ended
Sept. 26, 1998 Sept. 27, 1997
====================================================================================================================
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $5,198,288 $4,819,677
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 864,992 733,411
Deferred income taxes (476,351) 46
Compensation expense for restricted stock 35,934 41,300
Changes in assets and liabilities:
Increase in accounts receivable-trade (1,454,283) (2,049,125)
Increase in accounts receivable-other (562,872) (385,052)
Increase in inventories (872,698) (850,065)
Decrease in prepaid expenses and deposits 203,201 304,678
Decrease in accounts payable (413,730) (658,858)
Decrease in accrued expense and deferred income (3,064) (355,995)
Decrease in royalties payable (298,154) (210,121)
Decrease in accrued salaries and wages (755,452) (42,657)
(Decrease) increase in income taxes payable (292,849) 274,760
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Net cash provided by operating activities 1,172,962 1,621,999
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CASH FLOWS FROM INVESTING ACTIVITIES:
Redemption/maturity of short-term investments 5,643,578 13,425,893
Purchase of short-term/long-term investments (5,569,749) (17,675,742)
Capital expenditures (1,286,060) (901,569)
Purchase of treasury stock (287,623) ----
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Net cash used in investing activities (1,499,854) (5,151,418)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options including related tax 2,293,513 1, 085,199
benefits
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Net cash provided by financing activities 2,293,513 1,085,199
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Net increase (decrease) in cash and cash equivalents 1,966,621 (2,444,220)
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 $5,150,565 $2,147,053
====================================================================================================================
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements included
herein have been prepared by Tollgrade Communications, Inc. (the "Company") in
accordance with generally accepted accounting principles for the interim
financial information and Article 10 of Regulation S-X. The condensed
consolidated financial statements as of and for the three and nine-month periods
ended September 26, 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 nine-month periods ended September
26, 1998 are not necessarily indicative of the results that may be expected for
the year ending December 31, 1998.
2. INVENTORY
At September 26, 1998 and December 31, 1997, inventory consisted of the
following:
(Unaudited)
September 26, December 31 ,
1998 1997
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Raw materials . . . . . . . . . . . . . . . . . . . $5,270,735 $5,738,576
Work in progress. . . . . . . . . . . . . . . . . . 4,280,476 5,070,113
Finished goods. . . . . . . . . . . . . . . . . . . 3,422,601 1,292,425
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$12,973,812 $12,101,114
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3. SHORT-TERM AND LONG-TERM INVESTMENTS
Short-term investments at September 26, 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. Long-term investments are
comprised of individual municipal bonds with a maturity of more than one year
but less than eighteen months. 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
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4. INCOME PER COMMON SHARE
Net income per share is calculated by dividing net income by the weighted
average number of common shares plus incremental common stock equivalent shares
(shares issuable upon exercise of stock options). Incremental common stock
equivalent shares are calculated for each measurement period based on the
treasury stock method, which uses the monthly average market price per share.
The calculation of net income per common and common equivalent shares follows:
========================================================================================================================
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
Sept. 26, 1998 Sept. 27, 1997 Sept. 26, 1998 Sept. 27, 1997
========================================================================================================================
Net income $1,110,593 $1,606,923 $5,198,288 $4,819,677
========================================================================================================================
Common and common equivalent shares:
Weighted average number of
common shares outstanding
during the period.......................... 5,892,894 5,708,583 5,842,308 5,672,689
Common shares issuable upon exercise of
outstanding stock options:
Diluted................................. 155,329 246,521 162,128 284,232
Common and common equivalent shares
outstanding during the period:
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Diluted................................. 6,048,223 5,955,104 6,004,436 5,956,921
========================================================================================================================
Earnings per share data
Net income per common and common
equivalent shares:
Basic................................... $ .19 $ .28 $ .89 $ .85
Diluted................................. $ .18 $ .27 $ .87 $ .81
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REVIEW 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 September 26, 1998, and
the related condensed consolidated statements of operations for the three months
and nine months then ended and the condensed consolidated statement of cash
flows for the nine months then ended. These financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying financial statements for them to be in conformity
with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Tollgrade Communications, Inc. and
subsidiaries as of December 31, 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
October 12, 1998
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
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FINANCIAL CONDITION
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The following discussion should be read in conjunction with the Condensed
Consolidated Financial Statements and Notes thereto appearing elsewhere in this
report.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995.
The statements contained in the following Management's Discussion and Analysis
of Results of Operations and Financial Condition which are not historical are
"forward looking statements" 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. Such statements must be qualified by important factors that could
cause actual earnings and other results to differ materially from those achieved
in the past or those expected by the Company. These include: 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 a small number of large 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 Year 2000 issue exists because many computer systems and applications use
two digit rather than four digit date fields to designate an applicable year. As
a result, the systems and applications may not properly recognize the year 2000
or process data which include it, potentially causing data miscalculations or
inaccuracies or operational malfunctions or failures.
The Company has established a Year 2000 committee to transition the Company's
business applications, computing infrastructure and communication systems into
the next millennium. The objectives of the Year 2000 committee are to ensure all
internal computer systems function correctly in the year 2000, ensure data
exchanged with external organizations conforms to year 2000 standards and ensure
all products sold by the Company conform to year 2000 standards. The Company has
developed an inventory of all Company business systems and corresponding
software applications, and is currently in the process of assessing the business
priority of each system. Each system will be classified by mission criticality
and a determination will be made to either replace or remediate the system
depending upon its importance. In addition, the Year 2000 project will include a
review of the Year 2000 compliance efforts of the Company's key suppliers and
other principal business partners and, as appropriate, the development of joint
business support and continuity plans for Year 2000 issues. While this
initiative is broad in scope, it has been structured to identify and prioritize
efforts for mission critical systems, products and key business partners.
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The inventory and assessment phases have been substantially completed as of
September 26, 1998. The Company has established a Year 2000 test center to
certify all business applications and processes utilized throughout the Company.
To date, more than 300 internal software applications or systems have been
identified for testing. Initial results indicate less than 20% of these
applications do not meet Year 2000 standards, and more importantly, less than 5%
are business critical. During the remainder of 1998 and early 1999, the Year
2000 committee will focus attention to remediation and testing of internal
business systems and contingency planning.
The Company's products with time-of-day ("TOD") clocks in their design have been
tested for successful Year 2000 operation. Products that do not have TOD clocks
have no potential Year 2000 operational issues and therefore have not been
tested. The Company believes that it will have no material exposure to
contingencies related to the Year 2000 Issue for the products it has sold.
In order to ensure year 2000 compliance among the Company's key suppliers and
business partners, the Year 2000 committee has begun the task of developing
surveys to be provided to the suppliers and key customers in addition to
verifying compliance efforts via the supplier and business partners Web site for
Year 2000 compliance-related information. The next step is to examine where and
how outside suppliers and business partners impact the business and apply the
same mission-critical standard to suppliers and business partners that applies
to the Company's own internal systems.
Under the Company's current Year 2000 plan, the target date of June 30, 1999 has
been established for completion of remediation, testing and implementation. The
Company's ability to meet that target date is dependent upon the timely
provision of necessary upgrades and modifications by the Company's suppliers and
customers. 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.
The Company currently estimates the expenses associated with the anticipated
Year 2000 efforts to be approximately $0.1 million through 1999 with an
additional $0.3 million for capital improvement costs to support this project.
The costs expensed to date have been immaterial. The timing of the Company's
expenses may vary and is not necessarily indicative of readiness efforts or
progress to date. The Company anticipates that a portion of the Year 2000
expenses will not be incremental costs, but rather will represent the
redeployment of existing IT resources.
As part of the Year 2000 initiative, the Company is evaluating scenarios that
may occur as a result of the century change and is in the process of developing
contingency and business plans that address potential Year 2000-related
occurrences. These plans are expected to assess the potential for business
disruption and to provide operational back-up, recovery and restoration
alternatives.
The above information is based on the Company's current best estimates. Given
the complexity of the Year 2000 issues and risks, actual results may vary
materially from those anticipated and discussed above. Specific factors that
might cause such differences include, among others, the availability and cost of
personnel trained in this area, the ability to locate and correct all affected
computer systems, applications and products and the timing and success of
remedial efforts of the Company's third party suppliers and business partners.
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Overview
The Company was organized in 1986 and began operations in 1988. The Company
designs, engineers, markets and supports test access and test extension products
for the telecommunications and cable television industries. The Company's
telecommunication proprietary products enable telephone companies to use their
existing line test systems to remotely diagnose problems in Plain Old Telephone
Service ("POTS") lines containing both copper and fiber optics. The Company's
MCU(R) product line, which includes POTS line testing as well as alarm-related
products, represented approximately 86% of the Company's revenue for the third
quarter ended September 26, 1998 and will continue to account for a majority of
the Company's revenues for the foreseeable future. The Company's cable products
consist of a complete cable status monitoring system that provides a
comprehensive testing solution for the Broadband Hybrid Fiber Coax distribution
system. The status monitoring system consists of a host for user interface,
control and configuration; a headend controller for managing network
communications; and transponders that are strategically located within the cable
network to gather status reports from power supplies, line amplifiers and
fiber-optic nodes.
The Company's telecommunication 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 quarter ended September 26, 1998, approximately 75% of
the Company's total revenue was generated from sales to these five RBOCs, the
two largest of which comprised approximately 59% of revenues. The Company
intends to market and sell its cable products through various Original Equipment
Manufacturer ("OEM") arrangements with cable network equipment manufacturers.
The Company presently has one OEM arrangement under contract and is in the
process of pursuing arrangements with several other OEM partners. Sales for the
Company's cable products for the third quarter of 1998 were not material.
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 RBOCs including the RBOCs relationships with their various
organized labor groups. Certain contracts concerning the RBOCs organized
employees were renegotiated during the third quarter of 1998.
The Company believes that recent changes within the telecommunication
marketplace, including industry consolidation, as well as the Company's ability
to successfully penetrate certain new markets, have resulted in some discounting
and more favorable terms granted to certain 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.
Although the Company will continue to strive to meet the demands of its
customers, which include delivery of quality products at an acceptable price and
on acceptable terms, there are no assurances that the Company will be successful
in negotiating acceptable terms and conditions pertaining to these large orders.
The Company cannot predict such future events or business conditions and the
Company's results may be adversely affected by these industry trends in the
primary markets its serves.
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
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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 15.7% for the third quarter ended September 26,
1998. The Company expects its research and development expenses to continue at
significant levels.
RESULTS OF OPERATIONS - THIRD QUARTER
REVENUES
Revenues for the third quarter of 1998 were $10,120,469 and were $1,242,140, or
10.9% lower than the revenues of $11,362,609 reported for the third quarter of
1997. The Company's sales results for the third quarter of 1998 were primarily
influenced by exacerbation of seasonality, attributable to labor disputes in
August and September at Bell Atlantic and USWest and higher than expected
inventories at Ameritech. 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 third quarter of 1998 was $5,609,465 compared to $6,137,292
for the third quarter of 1997, representing a decrease of $527,827, or 8.6% due
to lower sales as explained above. Gross profit as a percentage of revenues
increased to 55.4% in the third quarter of 1998, compared to 54.0% in the same
quarter last year. The overall increase in gross profit margin as a percentage
of revenues resulted primarily from a more favorable sales mix of certain
higher-margined MCU products.
SELLING AND MARKETING EXPENSE
Selling and marketing expense for the third quarter of 1998 was $1,227,629
compared to $1,286,864 for the third quarter of 1997. This decrease of $59,235,
or 4.6%, reflects a decrease in travel and entertainment expenditures as well as
lower sales commissions as a result of decreased sales levels between periods,
offset in part by the addition of personnel and incurrance of other market
development cost to expand both the domestic and international selling
functions. As a percentage of revenues, selling and marketing expenses increased
to 12.1% in the third quarter of 1998 from 11.3% in the third quarter of 1997,
primarily due to the decreased revenue base discussed above.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense for the third quarter of 1998 was $1,132,867,
an increase of $185,068, or 19.5%, over the $947,799 recorded in the third
quarter of 1997. The increase in general and administrative expense primarily
reflects increases in professional fees including expenditures related to the
cost of recruiting qualified technical personnel. As a percentage of revenues,
general and administrative expenses increased to 11.2% in the third quarter of
1998 from 8.3% in the third quarter of 1997.
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RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense in the third quarter of 1998 was $1,586,704, an
increase of $69,133, or 4.6%, over the $1,517,571 recorded in the third quarter
of 1997. The increase is primarily associated with additional personnel and
related development costs to support new product introductions. The new
personnel were hired for positions in design engineering, hardware and software
development, engineering support, and test engineering. Their efforts are
associated with the development of future products, support for newer products,
and feature enhancements for existing products. As a percentage of revenues,
research and development expense increased to 15.7% in the third quarter of 1998
from 13.4% in the third quarter of 1997, primarily due to the decreased revenue
base discussed above.
INTEREST AND OTHER INCOME
Interest and other income consists primarily of interest income. For the third
quarter of 1998, interest and other income was $103,131 compared to $220,887 for
the third quarter of 1997, representing a decrease of $117,756, or 53.3%. The
third quarter of 1998 includes interest expense of $95,545 related to
settlements of certain prior years' tax returns. Excluding this interest
expense, interest and other income decreased $22,211, or 10.1%, primarily as a
result of slightly lower effective interest yields on the Company's short-term
investments.
PROVISION FOR INCOME TAXES
The provision for income taxes for the third quarter of 1998 was $654,803, a
decrease of $344,219, or 34.5%, from $999,022 for the third quarter of 1997.
This was largely due to lower pre-tax earnings. In addition, the effective
income tax rate decreased to approximately 37.1% in the third quarter of 1998,
compared to approximately 38.3% in the third quarter of 1997. The decrease in
the effective tax rate between periods reflects certain refinements for the
estimated effective tax rate for fiscal year 1998.
NET INCOME AND EARNINGS PER SHARE
As a result of the above factors, net income for the third quarter of 1998 was
$1,110,593, a decrease of $496,330, or 30.9%, from the $1,606,923 recorded in
the third quarter of 1997. Basic and diluted earnings per common share of $.19
and $.18, respectively, for the third quarter of 1998 decreased by $.09 and
$.09, respectively, or 32.1% and 33.3% from the $.28 and $.27, respectively,
earned in the third quarter of 1997. Basic and diluted weighted average common
and common equivalent shares outstanding were 5,892,894 and 6,048,223,
respectively, in the third quarter of 1998 compared to 5,708,583 and 5,955,104,
respectively, in the third quarter of 1997. As a percentage of revenues, net
income for the third quarter of 1998 decreased to 11.0% compared to the 14.1%
for the third quarter of 1997.
RESULTS OF OPERATIONS - YEAR TO DATE
REVENUES
For the first nine months of 1998, revenues were $34,909,333 compared to
$32,097,040 for the first nine months of 1997, representing an increase of
$2,812,293 or 8.8%. The increase in revenues for the nine month period was
primarily attributable to an increase in unit sales volume of the MCU line
testing products as a result of increased market penetration and customer
acceptance. In addition, increased product demand is at least partly
attributable to technology and licensing agreements and/or joint venture
relationships with certain major DLC equipment manufacturers, as well as
continued expansion of a marketing program to train customers in advanced line
test system trouble-shooting.
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GROSS PROFIT
For the nine months of 1998, gross profit increased to $20,123,380 compared to
$17,627,957 for the first nine months of 1997, representing an increase of
$2,495,423, or 14.2%. As a percentage of revenues, gross profit increased to
57.6% in the first nine months of 1998 compared to 54.9% 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 nine months of 1998, selling and marketing expense totaled
$4,348,831 compared to $3,666,999 for the first nine months of 1997,
representing an increase of $681,832, or 18.6%. 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
12.5% in the first nine months of 1998 from 11.4% for the same period of 1997.
GENERAL AND ADMINISTRATIVE EXPENSE
For the first nine months of 1998, general and administrative expense totaled
$3,485,424 compared to $2,691,834 for the first nine months of 1997,
representing an increase of $793,590, or 29.5%. The increase in general and
administrative expense primarily reflects increases in professional fees
including expenditures related to the cost of recruiting qualified technical
personnel. As a percentage of revenues, general and administrative expense
increased to 10.0% for the first nine months of 1998 from 8.4% for the same
period of 1997.
RESEARCH AND DEVELOPMENT EXPENSE
For the first nine months of 1998, research and development expense totaled
$4,757,156 compared to $4,183,425 for the first nine months of 1997,
representing an increase of $573,731, or 13.7%. The increase was due to
engineering and development costs associated with the addition of new personnel,
as well as other costs associated with new product development. As a percentage
of revenues, research and development expense increased to 13.6% in the first
nine months of 1998 from 13.0% for the first nine months of 1997.
INTEREST AND OTHER INCOME
For the first nine months of 1998, interest and other income was $709,122
compared to $637,252 for the first nine months of 1997, representing an increase
of $71,870, or 11.3%. Interest and other income for the nine 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.
Additionally, the first nine months of 1998 included interest expense of $95,545
related to settlements of certain prior years' tax returns. Excluding the effect
of the aforementioned net life insurance proceeds and interest expense, interest
and other income increased $11,415, or 1.8%.
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PROVISIONS FOR INCOME TAXES
The provision for income taxes for the first nine months of 1998 was $3,042,803
which was an increase of $139,529, or 4.8%, from $2,903,274 for the first nine
months of 1997. This increase was due to increased levels of pre-tax income. In
addition, the effective tax rate was 36.9% for the first nine months of 1998
versus 37.6% for the comparable period in the prior year. The decrease in the
effective tax rate between periods reflects certain refinements for the
estimated effective tax rate for fiscal year 1998.
NET INCOME AND EARNINGS PER SHARE
For the first nine months of 1998, net income was $5,198,288 compared to
$4,819,677 for the first nine months of 1997, representing an increase of
$378,611, or 7.9%. Basic and diluted earnings per common share of $.89 and $.87,
respectively, for the first nine months of 1998 increased by 4.7% and 7.4%,
respectively, or $.04 and $.06, from the $.85 and $.81 , respectively earned in
the first nine months of 1997. The first nine 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 $152,611, or 3.2%,
while diluted earnings per share for the first nine months of 1998 increased
2.5% to $.83 per share. Basic and diluted weighted average common and common
equivalent shares outstanding were 5,842,308 and 6,004,436, respectively in the
first nine months of 1998 compared to 5,672,689 and 5,956,921, respectively in
the first nine months of 1997. As a percentage of revenues, net income for the
first nine months of 1998 decreased to 14.9% from 15.0% in the comparable period
in the prior year.
LIQUIDITY AND CAPITAL RESOURCES
At September 26, 1998, the Company had working capital of $36,552,472, which
represented an increase of $1,982,260, or 5.7%, 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) and proceeds from the exercise of stock options
exceeding requirements for purchases of property and equipment and funding of
the Company's stock buyback program. Significant components of the Company's
change in working capital include an increase in cash and cash equivalents which
include the effect of cash received as a result of stock option exercises and
net collections, an increase in inventories to meet expected demand which did
not materialize during the third quarter of 1998 as well as an increase in
accounts receivable-trade which 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 second quarter of 1998 as previously discussed. Most
significantly offsetting these increases was a decrease in short-term
investments of $4,634,000, the majority of such funds were reclassified to
long-term investments and as such are still available for general corporate use
upon maturity. This reclassification reflects the Company's strategy to migrate
to individual municipal bonds with a maturity of more than one year and less
than eighteen months and was undertaken to maximize investment income levels.
Management believes that operating cash flow and cash reserves are adequate to
finance currently planned capital expenditures and to meet the overall liquidity
needs of the Company.
The Company made capital expenditures of $1,286,060 in the first nine months of
1998 and were primarily related to an upgrade of the MIS infrastructure,
production test equipment and fixtures, as
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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, 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
purchase 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 September 26, 1998, the Company had purchased 15,300 shares of
common stock under this program. Subsequent to September 26, 1998, the Company
purchased an additional 74,200 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 September 26, 1998, the Company had a backlog
of $2,147,707 compared to $1,554,495 at December 31, 1997 and $1,823,785 at
September 27, 1997. The increase in backlog for the quarter occurred due to
customer orders exceeding product shipments during the period. Backlog as of
September 26, 1998 includes a customer order for $507,500 of a new MCU product
expected to be certified and final compliance tested by December 31, 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.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
- --------------------------
None.
ITEM 2. CHANGES IN SECURITIES
- ------------------------------
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- ----------------------------------------
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
None.
ITEM 5. OTHER INFORMATION
- --------------------------
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
(a) Exhibits:
The following exhibits are being filed with this report:
Exhibit
Number Description
------ -----------
15 Letter re unaudited interim financial information
27 Financial Data Schedule
(b) Reports on Form 8-K:
The Company did not file any Current Report on Form 8-K during the
quarter ended September 26, 1998.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Tollgrade Communications, Inc.
(Registrant)
Dated: November 9, 1998 /s/ Christian L. Allison
---------------------------------------
Christian L. Allison
Chairman, Chief Executive Officer & Director
Dated: November 9, 1998 /s/ Samuel C. Knoch
---------------------------------------
Samuel C. Knoch
Chief Financial Officer and Treasurer
Dated: November 9, 1998 /s/ Bradley N. Dinger
---------------------------------------
Bradley N. Dinger
Controller
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EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
Exhibit
Number Description
------ -----------
15 Letter re unaudited interim financial information
27 Financial Data Schedule
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