##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
 FORM 10-Q
  þ
    
    Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the quarterly period ended September 29, 2007
 o
    
    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 000-27312
 TOLLGRADE COMMUNICATIONS, INC.
  Pennsylvania
    
    25-1537134(State or other jurisdiction
    
    (I.R.S. Employerof incorporation or organization)
    
    Identification No.)
 493 Nixon Rd.
Cheswick, PA 15024
 412-820-1400
  þ o
  o þ o
  o þ




---



##### 



TOLLGRADE COMMUNICATIONS, INC.
 Quarterly Report on Form 10-Q
For the Quarter Ended September 29, 2007
 Table of Contents
 PAGE NO.PART I. FINANCIAL INFORMATIONItem 1 Condensed Consolidated Financial Statements (unaudited):Condensed Consolidated Balance Sheets as of September 29, 2007 and
December 31, 2006
    
    
    3Condensed Consolidated Statements of Operations for the three and
nine-month periods ended September 29, 2007 and September 30, 2006
    
    
    4Condensed Consolidated Statements of Changes in Shareholders Equity
    
    
    5Condensed Consolidated Statements of Cash Flows for the nine-month
periods ended September 29, 2007 and September 30, 2006
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2 Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    17Item 3 Quantitative and Qualitative Disclosures about Market Risk
    
    
    41Item 4 Controls and Procedures
    
    
    41PART II. OTHER INFORMATIONItem 1A Risk Factors
    
    
    42Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    54Item 6 Exhibits
    
    
    54SIGNATURES
    
    
    56EXHIBIT INDEX
    
    
    57Exhibit 10.1Exhibit 10.2Exhibit 31.1Exhibit 31.2Exhibit 32Exhibit 10.2Exhhibit 31.1Exhibit 31.2Exhibit 32
  2




---



##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (In thousands, except par value) (Unaudited)
 September 29, 2007
    
    
    December 31, 2006*ASSETSCurrent assets:Cash and cash equivalents
    
    $
    46,116
    
    
    $
    57,378Short-term investments
    
    
    7,724
    
    
    
    5,323Accounts receivable:Trade, net of allowance for doubtful
    
    
    18,313
    
    
    
    15,149accounts of $488 in 2007 and $535 in 2006Other
    
    
    1,970
    
    
    
    1,918Inventories
    
    
    13,170
    
    
    
    8,556Prepaid expenses
    
    
    813
    
    
    
    776Deferred tax assets and refundable income tax
    
    
    2,027
    
    
    
    2,939Assets held for sale
    
    
    272
    
    
    
    1,190Total current assets
    
    
    90,405
    
    
    
    93,229Property and equipment, net
    
    
    3,674
    
    
    
    3,301Intangibles and capitalized software, net
    
    
    47,775
    
    
    
    41,487Goodwill
    
    
    24,665
    
    
    
    23,836Other assets
    
    
    332
    
    
    
    499Total assets
    
    $
    166,851
    
    
    $
    162,352LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    2,265
    
    
    $
    1,580Accrued warranty
    
    
    1,989
    
    
    
    2,135Accrued expenses
    
    
    2,755
    
    
    
    2,590Accrued salaries and wages
    
    
    388
    
    
    
    658Accrued royalties payable
    
    
    525
    
    
    
    200Deferred income
    
    
    3,226
    
    
    
    2,783Total current liabilities
    
    
    11,148
    
    
    
    9,946Deferred tax liabilities and other taxes
    
    
    3,600
    
    
    
    2,962Pension obligation
    
    
    787
    
    
    
    Total liabilities
    
    
    15,535
    
    
    
    12,908Contingencies and commitmentsShareholders equity:Preferred
stock, $1.00 par value; 10,000 authorized shares, none issued
    
    
    
    
    
    
    Common stock, $0.20 par value; authorized shares, 50,000; issued shares, 13,731 in
2007 and 13,709
in 2006
    
    
    2,744
    
    
    
    2,742Additional paid-in capital
    
    
    73,403
    
    
    
    72,477Treasury stock, at cost, 575 shares in 2007 and 462 shares in 2006
    
    
    (5,900
    )
    
    
    (4,791
    )Retained earnings
    
    
    81,003
    
    
    
    79,016Accumulated other comprehensive income
    
    
    66
    
    
    
    Total shareholders equity
    
    
    151,316
    
    
    
    149,444Total liabilities and shareholders equity
    
    $
    166,851
    
    
    $
    162,352
 
 *
    
    Amounts derived from audited financial statements presented in the Companys Annual Report on
Form 10-K for the year ended December 31, 2006.  3




---



##### Table of Contents



TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data) (Unaudited)
 Three Months Ended
    
    
    Nine Months EndedSeptember 29,
    
    
    September 30,
    
    
    September 29,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Revenues:Products
    
    $
    15,530
    
    
    $
    12,053
    
    
    $
    36,979
    
    
    $
    38,828Services
    
    
    5,048
    
    
    
    2,896
    
    
    
    10,822
    
    
    
    9,982Total revenues:
    
    
    20,578
    
    
    
    14,949
    
    
    
    47,801
    
    
    
    48,810Cost of product sales:Products
    
    
    7,305
    
    
    
    5,454
    
    
    
    16,758
    
    
    
    19,238Services
    
    
    1,424
    
    
    
    982
    
    
    
    3,234
    
    
    
    3,601Amortization of intangibles
    
    
    903
    
    
    
    962
    
    
    
    2,041
    
    
    
    2,853Inventory restructuring writedown
    
    
    
    
    
    
    4,346
    
    
    
    
    
    
    
    4,3469,632
    
    
    
    11,744
    
    
    
    22,033
    
    
    
    30,038Gross Profit:
    
    
    10,946
    
    
    
    3,205
    
    
    
    25,768
    
    
    
    18,772Selling and marketing
    
    
    2,853
    
    
    
    2,459
    
    
    
    7,363
    
    
    
    8,081General and administrative
    
    
    2,673
    
    
    
    1,751
    
    
    
    7,121
    
    
    
    5,935Research and development
    
    
    3,694
    
    
    
    3,233
    
    
    
    9,639
    
    
    
    10,484Restructuring expense
    
    
    233
    
    
    
    1,500
    
    
    
    827
    
    
    
    1,500Total operating expenses
    
    
    9,453
    
    
    
    8,943
    
    
    
    24,950
    
    
    
    26,000Income (loss) from operations
    
    
    1,493
    
    
    
    (5,738
    )
    
    
    818
    
    
    
    (7,228
    )Interest income
    
    
    635
    
    
    
    729
    
    
    
    2,151
    
    
    
    1,984Income (loss) before income taxes
    
    
    2,128
    
    
    
    (5,009
    )
    
    
    2,969
    
    
    
    (5,244
    )Provision (benefit) for income taxes
    
    
    702
    
    
    
    (1,759
    )
    
    
    982
    
    
    
    (1,826
    )Net income (loss)
    
    $
    1,426
    
    
    $
    (3,250
    )
    
    $
    1,987
    
    
    $
    (3,418
    )Earnings (loss) per share information:Weighted average shares of common
stock and equivalents:Basic
    
    
    13,207
    
    
    
    13,247
    
    
    
    13,241
    
    
    
    13,236Diluted
    
    
    13,440
    
    
    
    13,247
    
    
    
    13,467
    
    
    
    13,236Net income (loss) per common and
common equivalent shares:Basic
    
    $
    0.11
    
    
    $
    (0.25
    )
    
    $
    0.15
    
    
    $
    (0.26
    )Diluted
    
    $
    0.11
    
    
    $
    (0.25
    )
    
    $
    0.15
    
    
    $
    (0.26
    )
  4




---



##### Table of Contents



Tollgrade
Communications, Inc. and Subsidiaries
 
 Condensed Consolidated Statements of Changes in Shareholders Equity
(In thousands) (Unaudited)
 AccumulatedAdditional
    
    
    
    
    
    
    
    
    
    OtherPreferred Stock
    
    Common Stock
    
    Paid-In
    
    Treasury
    
    Retained
    
    Comprehensive
    
    ComprehensiveShares
    
    Amount
    
    Shares
    
    Amount
    
    Capital
    
    Stock
    
    Earnings
    
    Income
    
    Income
    
    TotalBalance at December
31, 2006
    
    
    
    
    
    $
    
    
    
    
    13,709
    
    
    $
    2,742
    
    
    $
    72,477
    
    
    $
    (4,791
    )
    
    $
    79,016
    
    
    $
    
    
    
    $
    
    
    
    $
    149,444Exercise of common
stock options
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    2
    
    
    
    87
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    89Tax benefit from
exercise of stock
options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10Purchase of
Treasury Stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,109
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,109
    )Share based
compensation
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    
    
    
    
    829
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    829Foreign currency
translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    66
    
    
    
    66
    
    
    
    66Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,987
    
    
    
    
    
    
    
    1,987
    
    
    
    1,987Comprehensive
income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    

$
    2,053
    
    
    
    Balance at
September 29, 2007
    
    
    
    
    
    
    
    
    
    
    13,731
    
    
    $
    2,744
    
    
    $
    73,403
    
    
    $
    (5,900
    )
    
    $
    81,003
    
    
    $
    66
    
    
    
    
    
    
    $
    151,316
  5




---



##### Table of Contents



TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In thousands) (Unaudited)
 Nine Months EndedSeptember 29,
    
    September 30,2007
    
    2006Cash flows from operating activities:Net income (loss)
    
    $
    1,987
    
    
    $
    (3,418
    )Adjustments to reconcile net income (loss) to net cash
provided by operating activities:Depreciation and amortization
    
    
    3,258
    
    
    
    4,483Compensation expense related to stock plans
    
    
    829
    
    
    
    378Deferred and refundable income taxes
    
    
    1,547
    
    
    
    (1,635
    )Excess tax benefits from share-based compensation
    
    
    (10
    )
    
    
    Restructuring charges
    
    
    313
    
    
    
    5,338Provision for losses on inventories
    
    
    333
    
    
    
    (44
    )Provision for allowance for doubtful accounts
    
    
    96
    
    
    
    19Changes in assets and liabilities, net of acquisition:Accounts receivable-trade
    
    
    525
    
    
    
    (3,770
    )Accounts receivable-other
    
    
    752
    
    
    
    48Inventories
    
    
    (3,730
    )
    
    
    (4,208
    )Prepaid expenses and other assets
    
    
    163
    
    
    
    570Accounts payable
    
    
    215
    
    
    
    (425
    )Accrued warranty
    
    
    (146
    )
    
    
    (87
    )Accrued expenses, deferred income & accrued salaries and
wages
    
    
    (1,988
    )
    
    
    587Accrued royalties payable
    
    
    318
    
    
    
    (421
    )Income taxes payable
    
    
    
    
    
    
    (428
    )Net cash provided by (used in) operating activities
    
    
    4,462
    
    
    
    (3,013
    )Cash flows from investing activities:Purchase of Broadband Test Division (2007) and Emerson
Test Division (2006)
    
    
    (11,952
    )
    
    
    (5,501
    )Purchase of short-term investments
    
    
    (11,608
    )
    
    
    (7,589
    )Redemption/maturity of short-term investments
    
    
    9,207
    
    
    
    18,354Capital expenditures, including capitalized software
    
    
    (1,220
    )
    
    
    (1,003
    )Sale of assets held for sale
    
    
    892
    
    
    
    Net cash (used in) provided by investing activities
    
    
    (14,681
    )
    
    
    4,261Cash flows from financing activities:Repurchase of treasury shares
    
    
    (1,109
    )
    
    
    Proceeds from the exercise of stock options
    
    
    89
    
    
    
    406Excess tax benefits from share-based compensation
    
    
    10
    
    
    
    94Net cash
(used in) provided by financing activities
    
    
    (1,010
    )
    
    
    500Effect of exchange rate changes on cash and cash equivalents
    
    
    (33
    )
    
    
    Net (decrease) increase in cash and cash equivalents
    
    
    (11,262
    )
    
    
    1,748Cash and cash equivalents at beginning of period
    
    $
    57,378
    
    
    $
    49,421Cash and cash equivalents at end of period
    
    $
    46,116
    
    
    $
    51,169
  6




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. BASIS OF PRESENTATION
  RECLASSIFICATIONS
  NEW ACCOUNTING STANDARDS
   7




---



##### Table of Contents



2. STOCK COMPENSATION PLANS AND ACCOUNTING FOR STOCK-BASED COMPENSATION EXPENSE
 The Plans
   Stock-Based Compensation Expense
   8




---



##### Table of Contents



Shares Authorized But Not GrantedSeptember 29, 2007
    
    December 31, 20061998 Employee Incentive Compensation Plan
    
    
    162,723
    
    
    
    153,3732006 Long-term Incentive Compensation Plan
    
    
    1,149,451
    
    
    
    1,276,666
  Number of
    
    
    
    
    
    
    Weighted AverageShares
    
    
    Range of Options Price
    
    
    Exercise PriceOutstanding, December 31, 2006
    
    
    1,358,385
    
    
    $
    7.28-159.19
    
    
    $
    30.24Granted
    
    
    10,000
    
    
    
    9.84
    
    
    
    9.84Exercised
    
    
    (10,500
    )
    
    
    7.56-9.49
    
    
    
    8.49Cancelled
    
    
    (38,121
    )
    
    
    8.49-159.19
    
    
    
    68.61Outstanding, September 29, 2007
    
    
    1,319,764
    
    
    $
    7.28-159.19
    
    
    $
    29.13
 3. RESTRUCTURING
   Balance at
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance atDecember 31,
    
    
    
    
    
    
    Cash
    
    
    Asset write-
    
    
    September 29,2006
    
    
    Expense
    
    
    payments
    
    
    downs
    
    
    2007Facility
rationalization
including employee
costs
    
    $
    341
    
    
    $
    800
    
    
    $
    (641
    )
    
    $
    (286
    )
    
    $
    214Real estate impairment
    
    
    
    
    
    
    27
    
    
    
    
    
    
    
    (27
    )
    
    
    Total
    
    $
    341
    
    
    $
    827
    
    
    $
    (641
    )
    
    $
    (313
    )
    
    $
    214
  9




---



##### Table of Contents



4. ACQUISITION
   Accounts receivable
    
    $
    4,524Inventories
    
    
    1,119Property and equipment
    
    
    551Intangible assets
    
    
    8,124Goodwill
    
    
    823Other
    
    
    21Total assets acquired
    
    
    15,162Deferred income
    
    
    1,545Accounts payable
    
    
    458Pension obligation
    
    
    743Relocation and lease termination
    
    
    464Total liabilities
    
    
    3,210Net assets acquired
    
    $
    11,952
 10




---



##### Table of Contents



(In Thousands, Except Per Share Data)Unaudited Pro Forma
    
    Unaudited Pro FormaThree Months Ended
    
    Three Months EndedSeptember 29, 2007
    
    September 30, 2006Revenues
    
    $
    21,507
    
    
    $
    19,354Income (loss) from operations
    
    
    498
    
    
    
    (8,161
    )Net income (loss)
    
    
    759
    
    
    
    (4,822
    )Basic and diluted earnings (loss)
per share
    
    $
    0.06
    
    
    $
    (0.36
    )
 (In Thousands, Except Per Share Data)Unaudited Pro Forma
    
    
    Unaudited Pro FormaNine Months Ended
    
    
    Nine Months EndedSeptember 29, 2007
    
    
    September 30, 2006Revenues
    
    $
    58,955
    
    
    $
    64,915Income (loss) from operations
    
    
    812
    
    
    
    (11,301
    )Net income (loss)
    
    
    1,983
    
    
    
    (6,073
    )Basic and diluted earnings
(loss) per share
    
    $
    0.15
    
    
    $
    (0.46
    )
  11




---



##### Table of Contents



Accounts receivable
    
    $
    1,827Inventories
    
    
    1,113Property and equipment
    
    
    112Intangible assets
    
    
    1,113Goodwill
    
    
    2,274Total assets acquired
    
    
    6,439Deferred income
    
    
    175Accounts payable
    
    
    636Restructuring
accrual
    
    
    127Total liabilities
    
    
    938Net assets acquired
    
    $
    5,501
  12




---



##### Table of Contents



(In Thousands, Except PerShare Data)Unaudited Pro FormaNine Months EndedSeptember 30, 2006Revenues
    
    $
    50,376(Loss) from operations
    
    $
    (7,218
    )Net (loss)
    
    $
    (3,412
    )Basic and diluted (loss) per share
    
    $
    (0.26
    )
 5. INTANGIBLE ASSETS
  September 29, 2007Amortizing Intangible Assets:
    
    
    
    
    
    
    
    
    
    AccumulatedLife (Years)
    
    
    Gross
    
    
    Amortization
    
    
    NetPost Warranty Service Agreements
    
    
    6-50
    
    
    $
    38,347
    
    
    $
    1,519
    
    
    $
    36,828Technology
    
    
    5-10
    
    
    
    18,640
    
    
    
    13,029
    
    
    
    5,611Customer Relationships
    
    
    5-15
    
    
    
    3,426
    
    
    
    1,042
    
    
    
    2,384Other
    
    
    1-10
    
    
    
    835
    
    
    
    183
    
    
    
    652Non-Amortizing Intangible
Assets:Tradenames
    
    
    
    
    
    
    2,300
    
    
    
    
    
    
    
    2,300Total Intangible Assets
    
    
    
    
    
    $
    63,548
    
    
    $
    15,773
    
    
    $
    47,775Goodwill
    
    
    
    
    
    $
    24,665
    
    
    $
    
    
    
    $
    24,665
 December 31, 2006Amortizing Intangible Assets:
    
    
    
    
    
    
    
    
    
    AccumulatedLife (Years)
    
    
    Gross
    
    
    Amortization
    
    
    NetPost Warranty Service Agreements
    
    
    50
    
    
    $
    32,000
    
    
    $
    800
    
    
    $
    31,200Technology
    
    
    5-10
    
    
    
    17,912
    
    
    
    12,057
    
    
    
    5,855Customer Relationships
    
    
    5-15
    
    
    
    2,843
    
    
    
    748
    
    
    
    2,095Other
    
    
    1-3
    
    
    
    159
    
    
    
    122
    
    
    
    37Non-Amortizing Intangible Assets:Tradenames
    
    
    
    
    
    
    2,300
    
    
    
    
    
    
    
    2,300Total Intangible Assets
    
    
    
    
    
    $
    55,214
    
    
    $
    13,727
    
    
    $
    41,487Goodwill
    
    
    
    
    
    $
    23,836
    
    
    $
    
    
    
    $
    23,836
 13




---



##### Table of Contents



Life(Years)
    
    
    WeightedAverageAmortizationPeriod(Years)Post-warranty service agreement
    
    
    6-48
    
    
    
    25.6
    
    
    $
    6,347Customer relationships
    
    
    10
    
    
    
    10.0
    
    
    
    583Technology
    
    
    10
    
    
    
    10.0
    
    
    
    644Other
    
    
    2-10
    
    
    
    8.8
    
    
    
    675Total
    
    
    
    
    
    
    
    
    
    $
    8,249
  6. PENSION
  7. INVENTORIES
  September 29, 2007
    
    
    December 31, 2006Raw materials
    
    $
    8,414
    
    
    $
    5,895Work in process
    
    
    3,504
    
    
    
    2,728Finished goods
    
    
    3,439
    
    
    
    2,35815,357
    
    
    
    10,981Reserve for slow moving and obsolete inventory
    
    
    (2,187
    )
    
    
    (2,425
    )$
    13,170
    
    
    $
    8,556
 8. PER SHARE INFORMATION
  14




---



##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 29, 2007
    
    
    September 29, 2007Net Income
    
    $
    1,426
    
    
    $
    1,987Common and common equivalent shares:Weighted average common shares outstanding
    
    
    13,207
    
    
    
    13,241Effect of dilutive securities- stock options
    
    
    233
    
    
    
    22613,440
    
    
    
    13,467Income per share:Basic
    
    $
    0.11
    
    
    $
    0.15Diluted
    
    $
    0.11
    
    
    $
    0.15
 9. PRODUCT WARRANTY
   Nine Months Ended
    
    
    Year EndedSeptember 29, 2007
    
    
    December 31, 2006Balance at the beginning of the period
    
    $
    2,135
    
    
    $
    2,220Accruals for warranties issued during the period
    
    
    1,002
    
    
    
    1,595Settlements during the period
    
    
    (1,148
    )
    
    
    (1,680
    )Balance at the end of the period
    
    $
    1,989
    
    
    $
    2,135
 10. CONTINGENCIES AND COMMITMENTS
  15




---



##### Table of Contents



11. INCOME TAXES
     12. MAJOR CUSTOMERS AND INTERNATIONAL SALES
    16




---



##### Table of Contents



13. SHARE REPURCHASE PROGRAM
  14. COMPREHENSIVE INCOME
  Three Months Ended
    
    
    Nine Months Ended(in thousands)
    
    September 29, 2007
    
    
    September 29, 2007Net income
    
    $
    1,426
    
    
    $
    1,987Foreign currency
translation adjustments
    
    
    66
    
    
    
    66Comprehensive income
    
    $
    1,492
    
    
    $
    2,053
 
 Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 The following discussion should be read in conjunction with the unaudited Condensed Consolidated
Financial Statements and Notes thereto appearing elsewhere in this report.
 17




---



##### Table of Contents



CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
 will, believes, intends, expects, plans, could or may,
  OVERVIEW
 About the Company
  About our customers
  18




---



##### Table of Contents



PRODUCTS
 TELECOMMUNICATION TEST SYSTEMS
  DigiTest
 ® 
  19




---



##### Table of Contents



Broadband Test Division
  20




---



##### Table of Contents



N(x)Test, N(x)DSL-3 and LTSC
  MCU
 ®
 21




---



##### Table of Contents



CABLE TESTING PRODUCTS
  ® ®
  SERVICES
  BACKLOG
   22




---



##### Table of Contents



OPERATING SEGMENT
  INTERNATIONAL SALES
    23




---



##### Table of Contents



APPLICATION OF CRITICAL ACCOUNTING POLICIES
  Revenue Recognition
    24




---



##### Table of Contents



Goodwill and Intangible Assets
   25




---



##### Table of Contents



26




---



##### Table of Contents



Sensitivity Analysis
  YearsRemaining
    
    
    Carrying
    
    
    RollingOriginal
    
    
    Life at
    
    
    Value at
    
    
    ProjectedAsset Description
    
    Life
    
    
    09/29/07
    
    
    09/29/07
    
    
    Amortization(in millions)LoopCareBase Software
    
    
    10
    
    
    
    4.00
    
    
    $
    1.8
    
    
    $
    0.5Post-Warranty Maintenance
Service Agreements
    
    
    50
    
    
    
    48.00
    
    
    
    30.7
    
    
    
    0.6CheetahBase Software
    
    
    10
    
    
    
    5.25
    
    
    
    1.6
    
    
    
    0.3Proprietary Technology
    
    
    10
    
    
    
    5.25
    
    
    
    0.5
    
    
    
    0.1Customer Base
    
    
    15
    
    
    
    10.25
    
    
    
    1.7
    
    
    
    0.3EmersonProprietary Technology
    
    
    5
    
    
    
    3.50
    
    
    
    0.5
    
    
    
    0.2Customer Relationship
    
    
    5
    
    
    
    3.50
    
    
    
    0.1
    
    
    
    BTDPost
Warranty Maintenance Service Agreements
    
    
    48
    
    
    
    47.85
    
    
    
    1.5
    
    
    
    0.4Post
Warranty Maintenance Service Agreements
    
    
    20
    
    
    
    19.85
    
    
    
    3.7
    
    
    
    0.7Post
Warranty Maintenance Service Agreements
    
    
    10
    
    
    
    9.85
    
    
    
    0.7
    
    
    
    0.2Post
Warranty Maintenance Service Agreements
    
    
    6
    
    
    
    5.85
    
    
    
    0.2
    
    
    
    0.1Technology
    
    
    10
    
    
    
    9.85
    
    
    
    0.6
    
    
    
    0.1Customer Relationship
    
    
    10
    
    
    
    9.85
    
    
    
    0.5
    
    
    
    0.2Other
    
    
    2-10
    
    
    
    1.85-9.85
    
    
    
    1.4
    
    
    
    0.4$
    45.5
    
    
    $
    4.1
  27




---



##### Table of Contents



Reviews for Impairment
     28




---



##### Table of Contents



Inventory Valuation
   Allowance for Doubtful Accounts
   Income Taxes
  29




---



##### Table of Contents



Warranty
  Long-Lived Assets Held for Sale
   Restructuring Accrual
  Pension Benefits
  30




---



##### Table of Contents



Stock-Based Compensation
  Foreign Currency Translation
   RESULTS OF OPERATIONS
 THIRD QUARTER OF 2007 COMPARED TO THIRD QUARTER OF 2006
 Revenues
   31




---



##### Table of Contents



32




---



##### Table of Contents



Gross Profit
  Selling and Marketing Expense
  General and Administrative Expense
 .
 Research and Development Expense
  33




---



##### Table of Contents



Restructuring Expense
     Interest Income
  Income Taxes
  Net Income (Loss) and Income (Loss) Per Share
  34




---



##### Table of Contents



NINE MONTHS ENDED SEPTEMBER 29, 2007 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2006
 Revenues
     35




---



##### Table of Contents



Gross Profit
  Selling and Marketing Expense
  36




---



##### Table of Contents



General and Administrative Expense
  Research and Development Expense
  Restructuring Expense
    Interest Income
  37




---



##### Table of Contents



Provision for Income Taxes
  Net Income (Loss) and Earnings (Loss) Per Share
  LIQUIDITY AND CAPITAL RESOURCES
     38




---



##### Table of Contents



KEY RATIOS
  NEW ACCOUNTING STANDARDS
  39




---



##### Table of Contents



COMMITMENTS AND CONTRACTUAL OBLIGATIONS
     40




---



##### Table of Contents



Minimum
annual future commitments as of September 29, 2007 are (in
millions):
 Payments due by periodRemainingTotal
    
    in 2007
    
    2008
    
    2009
    
    2010
    
    2011
    
    ThereafterOperating
Lease Obligations
    
    $
    2.5
    
    
    $
    0.4
    
    
    $
    0.9
    
    
    $
    0.5
    
    
    $
    0.3
    
    
    $
    0.3
    
    
    $
    0.1Purchase Obligations
    
    0.3
    
    
    0.1
    
    
    0.2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    FIN 48 Obligations
    
    
    0.1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.1Pension Obligations
    
    
    0.8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.8Total
    
    $
    3.7
    
    
    $
    0.5
    
    
    $
    1.1
    
    
    $
    0.5
    
    
    $
    0.3
    
    
    $
    0.3
    
    
    $
    1.0
   
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 Item 4. CONTROLS AND PROCEDURES
   41




---



##### Table of Contents



PART II. OTHER INFORMATION
 
 Item 1A. RISK FACTORS
  We depend upon a few major customers for a majority of our revenues, and the loss of any of these
customers, or the substantial reduction in the products that they purchase from us, would
significantly reduce our revenues and net income.
  
    
    the conditions of the communications market and the economy in general;
    
    subscriber line loss and related reduced demand for wireline telecommunications services;
    
    changes or shifts in the technology utilized in the networks;
    
    labor disputes between our customers and their collective bargaining units;
    
    the failure of our customers to meet established purchase forecasts and growth projections;
    
    competition among the RBOCs, competitive exchange carriers and wireless telecommunications
and cable providers; and
    
    reorganizations, including management changes, at one or more of our customers or
potential customers.
  42




---



##### Table of Contents



Our operating results may vary from quarter to quarter, causing our stock price to fluctuate.
  General market delays have been caused by customers not yet finalizing their transitions and
approach to upgrading access network service assurance solutions.
  Our Services business is subject to a trend of reduced capital spending for our products by our
major customers.
  43




---



##### Table of Contents



We have completed, and may pursue additional acquisitions, which could result in the disruption of
our current business, difficulties related to the integration of acquired businesses, and
substantial expenditures.
   The failure of acquired assets to meet expectations, or a decline in our fair value determined by
market prices of our stock, could indicate impairment of our intangible assets and result in
impairment charges.
   44




---



##### Table of Contents



The sale of our products is dependent upon our ability to satisfy the proprietary requirements of
our customers.
  The sale of our products is dependent on our ability to respond to rapid technological change,
including evolving industry-wide standards, and may be adversely affected by the development, and
acceptance by our customers, of new technologies which may compete with or reduce the demand for
our products.
    45




---



##### Table of Contents



Our reliance on third parties to manufacture certain aspects of our products involves risks,
including delays in product shipments and reduced control over product quality.
  Our future sales in international markets are subject to numerous risks and uncertainties.
   We face intense competition, which could result in our losing market share or experiencing a
decline in our gross margins.
  46




---



##### Table of Contents



Our future results are dependent on our ability to establish, maintain and expand our distribution
channels and our existing third-party distributors.
  The sales cycle for our system products is long, and the delay or failure to complete one or more
large transactions in a quarter could cause our operating results to fall below our expectations.
  47




---



##### Table of Contents



We depend on sales of our MCU products for a meaningful portion of our revenues, but this product
is mature and its sales will continue to decline.
   48




---



##### Table of Contents



Our continued emphasis on our network assurance and testing solutions and cable status monitoring
products, and on software products in particular, could have a material adverse effect on our
profitability.
    Our customers are subject to an evolving governmental regulatory environment that could
significantly reduce the demand for our products or increase our costs of doing business.
   49




---



##### Table of Contents



Our limited ability to protect our proprietary information and technology may adversely affect our
ability to compete, and our products could infringe upon the intellectual property rights of
others, resulting in claims against us the results of which could be costly.
   The success of some of our products is dependent on our ability to maintain licenses to technology
from the manufacturers of systems with which our products must be compatible.
  If we are unable to satisfy our customers specific product quality, certification or network
requirements, our business could be disrupted and our financial condition could be harmed.
  50




---



##### Table of Contents



If our accounting controls and procedures are circumvented or otherwise fail to achieve their
intended purposes, our business could be seriously harmed.
  If we ship products that contain defects, the market acceptance of our products and our reputation
will be harmed and our customers could seek to recover their damages from us.
  We are dependent upon our ability to attract, retain and motivate our key personnel.
  Consolidations in, or a continued slowdown in, the telecommunications industry could harm our
business.
  51




---



##### Table of Contents



Our expenses are relatively fixed in the short term, and we may be unable to adjust spending to
compensate for unexpected revenue shortfalls.
  We rely on software that we have licensed from third-party developers to perform key functions in
our products.
  We are affected by a pattern of product price decline in certain markets, which can harm our
business.
  52




---



##### Table of Contents



Our common stock price may be extremely volatile.
  
    
    General market and economic conditions;
    
    Changes in the telecommunications industry;
    
    Actual or anticipated variations in operating results;
    
    Announcements of technological innovations, new products or new
services by us or by our competitors or customers;
    
    Changes in financial estimates or recommendations by stock market
analysts regarding us or our competitors;
    
    Announcements by us or our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments;
    
    Announcements by our customers regarding end market conditions and the
status of existing and future infrastructure network deployments;
    
    Additions or departures of key personnel; and
    
    Future equity or debt offerings or our announcements of these offerings.
   We may be subject from time to time to legal proceedings, and any adverse determinations in these
proceedings could materially harm our business.
  53




---



##### Table of Contents



Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 (c)
    
    During the quarter ended September 29, 2007 the Company
repurchased the following shares of its common stock.
 (d)Maximum number(c)
    
    
    (or approximateTotal number of
    
    
    dollar value) ofshares purchased
    
    
    shares that may(a)
    
    
    (b)
    
    
    as part of publicly
    
    
    yet be purchasedTotal number of
    
    
    Average price paid
    
    
    announced plans
    
    
    under the plans orPeriod
    
    shares purchased
    
    
    per share
    
    
    or programs
    
    
    programsJuly 1-July 31
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,000,000August 1-August 31
    
    
    113,491
    
    
    $
    9.78
    
    
    
    113,491
    
    
    
    886,509September 1-
September 29
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    886,509TOTAL
    
    
    113,491
    
    
    $
    9.78
    
    
    
    113,491
  
 Item 6. EXHIBITS
   ExhibitNumber
    
    Description10.1
    
    Severance Agreement dated July 5, 2007 between Tollgrade
Communications, Inc. and Joseph A. Ferrara, filed on Form 8-K on
August 1, 2007 and incorporated herein by reference.10.2
    
    Lease and License for Alterations dated October 18, 2007 among
Tollgrade UK Limited, Tollgrade Communications, Inc., Bedell
Corporate Trustees Limited and Atrium Trustees (as Trustees of the
Park One Unit Trust), filed herewith.31.1
    
    Certification of Chief Executive Officer, filed herewith.31.2
    
    Certification of Chief Financial Officer, filed herewith.32
    
    Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18.U.S.C. Section 350, filed herewith.
 54




---



##### Table of Contents



®  ®  ®  ®  ®
 55




---



##### Table of Contents



SIGNATURES
  Tollgrade Communications, Inc.(Registrant)Dated: November 8, 2007
    
    /s/ Mark B. PetersonMark B. PetersonChief Executive OfficerDated: November 8, 2007
    
    /s/ Samuel C. KnochSamuel C. KnochChief Financial Officer and TreasurerDated: November 8, 2007
    
    /s/ Sean M. ReillySean M. ReillyController
 56




---



##### Table of Contents



EXHIBIT INDEX
  ExhibitNumber
    
    Description10.1
    
    Severance Agreement dated July 5, 2007 between Tollgrade
Communications, Inc. and Joseph A. Ferrara, filed on Form 8-K on
August 1, 2007 and incorporated herein by reference.10.2
    
    Lease and License for Alterations dated October 18, 2007 among
Tollgrade UK Limited, Tollgrade Communications, Inc., Bedell
Corporate Trustees Limited and Atrium Trustees (as Trustees of the
Park One Unit Trust), filed herewith.31.1
    
    Certification of Chief Executive Officer, filed herewith.31.2
    
    Certification of Chief Financial Officer, filed herewith.32
    
    Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18.U.S.C. Section 350, filed herewith.
 57