##### 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 24, 2005
 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    493 Nixon Rd.
Cheswick, PA 15024
 412-820-1400
  þ o
  þ o
  o þ




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##### Table of Contents



TOLLGRADE COMMUNICATIONS, INC.
 Quarterly Report on Form 10-Q
For the Quarter Ended September 24, 2005
  
 Table of Contents
 PAGE NO.PART 1. FINANCIAL INFORMATIONItem 1 Condensed Consolidated Financial Statements (unaudited):Condensed Consolidated Balance Sheets as of September 24, 2005 and
December 31, 2004
    
    
    3Condensed Consolidated Statements of Operations for the three month and
nine month periods ended September 24, 2005 and September 25,
2004
    
    
    4Condensed Consolidated Statement of Changes in Shareholders Equity for
the
nine month period ended September 24, 2005
    
    
    5Condensed Consolidated Statements of Cash Flows for the nine month
periods ended September 24, 2005 and September 25, 2004
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Report of Independent Registered Public Accounting Firm
    
    
    15Item 2 Managements Discussion and Analysis of Financial Condition and Results
of Operations
    
    
    16Item 3 Quantitative and Qualitative Disclosures About Market Risk
    
    
    41Item 4 Controls and Procedures
    
    
    41PART II. OTHER INFORMATIONItem 2 Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
    
    
    42Item 6 Exhibits
    
    
    43SIGNATURES
    
    
    44EXHIBIT INDEX
    
    
    45EX-10.2EX-15EX-31.1EX-31.2EX-32
 2




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##### 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 per share amounts)(Unaudited)
 September
    
    
    December24, 2005
    
    
    31, 2004 *ASSETSCurrent assets:Cash and cash equivalents
    
    $
    35,787
    
    
    $
    32,622Short-term investments
    
    
    21,526
    
    
    
    18,537Accounts receivable:Trade, net of allowance for doubtful
accounts of $464 in 2005 and $754 in 2004
    
    
    13,299
    
    
    
    10,691Other
    
    
    1,460
    
    
    
    106Inventory
    
    
    10,279
    
    
    
    12,941Prepaid expenses and other current assets
    
    
    957
    
    
    
    2,543Refundable income taxes
    
    
    752
    
    
    
    964Deferred tax assets
    
    
    1,198
    
    
    
    1,143Total current assets
    
    
    85,258
    
    
    
    79,547Property and equipment, net
    
    
    6,799
    
    
    
    7,860Deferred tax assets
    
    
    205
    
    
    
    176Intangibles, net
    
    
    45,001
    
    
    
    45,108Goodwill
    
    
    18,682
    
    
    
    19,340Capitalized software costs, net
    
    
    4,585
    
    
    
    6,453Receivable from officer
    
    
    154
    
    
    
    156Other assets
    
    
    153
    
    
    
    194Total assets
    
    $
    160,837
    
    
    $
    158,834LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    941
    
    
    $
    1,087Accrued warranty
    
    
    2,067
    
    
    
    2,081Accrued expenses
    
    
    1,972
    
    
    
    1,772Accrued salaries and wages
    
    
    444
    
    
    
    718Accrued royalties payable
    
    
    225
    
    
    
    414Income taxes payable
    
    
    179
    
    
    
    168Deferred income
    
    
    2,108
    
    
    
    2,462Total current liabilities
    
    
    7,936
    
    
    
    8,702Deferred tax liabilities
    
    
    3,298
    
    
    
    2,623Total liabilities
    
    
    11,234
    
    
    
    11,325Commitments and contingent liabilities
    
    
    
    
    
    
    Shareholders equity:Preferred stock, $1.00 par value; authorized shares
10,000,000; issued shares, -0- in 2005 and 2004
    
    
    
    
    
    
    Common stock, $.20 par value; authorized shares, 50,000,000;
issued shares, 13,631,540 in 2005 and13,622,940 in 2004
    
    
    2,726
    
    
    
    2,725Additional paid-in capital
    
    
    71,207
    
    
    
    71,135Treasury stock, at cost, 461,800 shares in 2005 and 2004
    
    
    (4,791
    )
    
    
    (4,791
    )Retained earnings
    
    
    80,461
    
    
    
    78,440Total shareholders equity
    
    
    149,603
    
    
    
    147,509Total liabilities and shareholders equity
    
    $
    160,837
    
    
    $
    158,834
 
 *
    
    Amounts derived from audited financial statementsThe accompanying notes are an integral part of the condensed consolidated financial
statements. 3




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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
   For the
    
    
    For theThree Months Ended
    
    
    Nine Months EndedSeptember
    
    
    September
    
    
    September
    
    
    September24, 2005
    
    
    25, 2004
    
    
    24, 2005
    
    
    25, 2004Revenues:Products
    
    $
    13,573
    
    
    $
    10,358
    
    
    $
    38,411
    
    
    $
    37,080Services
    
    
    3,229
    
    
    
    3,280
    
    
    
    9,757
    
    
    
    9,631Total revenues:
    
    
    16,802
    
    
    
    13,638
    
    
    
    48,168
    
    
    
    46,711Cost of product sales:Products
    
    
    5,987
    
    
    
    4,556
    
    
    
    18,211
    
    
    
    16,836Services
    
    
    911
    
    
    
    945
    
    
    
    2,642
    
    
    
    2,803Amortization of intangibles
    
    
    543
    
    
    
    510
    
    
    
    1,624
    
    
    
    1,493Impairment of acquired software
    
    
    424
    
    
    
    
    
    
    
    424
    
    
    
    7,865
    
    
    
    6,011
    
    
    
    22,901
    
    
    
    21,132Gross Profit:
    
    
    8,937
    
    
    
    7,627
    
    
    
    25,267
    
    
    
    25,579Selling and marketing
    
    
    1,918
    
    
    
    2,198
    
    
    
    6,594
    
    
    
    7,053General and administrative
    
    
    1,911
    
    
    
    1,849
    
    
    
    5,640
    
    
    
    5,445Research and development
    
    
    3,465
    
    
    
    3,853
    
    
    
    10,554
    
    
    
    12,160Severance
    
    
    
    
    
    
    269
    
    
    
    775
    
    
    
    269Total operating expenses
    
    
    7,294
    
    
    
    8,169
    
    
    
    23,563
    
    
    
    24,927Income (loss) from operations
    
    
    1,643
    
    
    
    (542
    )
    
    
    1,704
    
    
    
    652Interest and other income, net
    
    
    313
    
    
    
    109
    
    
    
    828
    
    
    
    267Income (loss) before income taxes
    
    
    1,956
    
    
    
    (433
    )
    
    
    2,532
    
    
    
    919Provision (benefit) for income
taxes
    
    
    372
    
    
    
    (159
    )
    
    
    511
    
    
    
    248Net income (loss)
    
    $
    1,584
    
    
    $
    (274
    )
    
    $
    2,021
    
    
    $
    671Earnings (loss) per share
information:Weighted average shares of
common stock and equivalents:Basic
    
    
    13,162
    
    
    
    13,148
    
    
    
    13,162
    
    
    
    13,134Diluted
    
    
    13,221
    
    
    
    13,148
    
    
    
    13,202
    
    
    
    13,263Net income (loss) per common and
common equivalent shares:Basic
    
    $
    0.12
    
    
    $
    (0.02
    )
    
    $
    0.15
    
    
    $
    0.05Diluted
    
    $
    0.12
    
    
    $
    (0.02
    )
    
    $
    0.15
    
    
    $
    0.05
  4




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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS EQUITY
 For the Nine Months Ended September 24, 2005
 
 AdditionalPreferred Stock
    
    
    Common Stock
    
    
    Paid-In
    
    
    Treasury
    
    
    RetainedShares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Earnings
    
    
    Stock
    
    
    Earnings
    
    
    TotalBalance at
December 31,
2004
    
    
    
    
    
    $
    
    
    
    
    13,623
    
    
    $
    2,725
    
    
    $
    71,135
    
    
    $
    (4,791
    )
    
    $
    78,440
    
    
    $
    147,509Exercise of
common stock
options
    
    
    
    
    
    
    
    
    
    
    9
    
    
    
    1
    
    
    
    64
    
    
    
    
    
    
    
    
    
    
    
    65Tax benefit
from exercise
of stock
options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    8Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,021
    
    
    
    2,021Balance at
September 24, 2005
    
    
    
    
    
    $
    
    
    
    
    13,632
    
    
    $
    2,726
    
    
    $
    71,207
    
    
    $
    (4,791
    )
    
    $
    80,461
    
    
    $
    149,603
  5




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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
  Nine Months EndedSeptember
    
    
    September24, 2005
    
    
    25, 2004Cash flows from operating activities:Net income
    
    $
    2,021
    
    
    $
    671Adjustments to reconcile net income to net cash provided by operating
activities:Depreciation and amortization
    
    
    3,515
    
    
    
    3,440Tax benefit from exercise of stock options
    
    
    8
    
    
    
    65Deferred income taxes
    
    
    591
    
    
    
    97Provision for losses on inventory
    
    
    237
    
    
    
    37Impairment of acquired software
    
    
    424
    
    
    
    Provision for allowance for doubtful accounts
    
    
    80
    
    
    
    (51
    )Changes in assets and liabilities:(Increase) decrease in accounts receivable-trade
    
    
    (2,688
    )
    
    
    17(Increase) decrease in accounts receivable-other
    
    
    (875
    )
    
    
    3Decrease (increase) in inventory
    
    
    2,425
    
    
    
    (63
    )Decrease in prepaid expenses and other assets
    
    
    1,629
    
    
    
    74Decrease (increase) in refundable taxes
    
    
    212
    
    
    
    (41
    )Decrease in accounts payable
    
    
    (146
    )
    
    
    (372
    )Decrease in accrued warranty
    
    
    (14
    )
    
    
    (122
    )Increase in accrued expenses and deferred income
    
    
    25
    
    
    
    519Decrease in accrued royalties payable
    
    
    (189
    )
    
    
    (192
    )Decrease in accrued salaries and wages
    
    
    (274
    )
    
    
    (332
    )Increase in income taxes payable
    
    
    11
    
    
    
    51Net cash provided by operating activities
    
    
    6,992
    
    
    
    3,801Cash flows from investing activities:Purchase of short-term investments
    
    
    (15,479
    )
    
    
    (9,291
    )Redemption/maturity of short-term investments
    
    
    12,490
    
    
    
    7,481Capital expenditures, including capitalized software
    
    
    (903
    )
    
    
    (2,040
    )Investments in other assets
    
    
    
    
    
    
    (715
    )Net cash used in investing activities
    
    
    (3,892
    )
    
    
    (4,565
    )Cash flows from financing activities:Proceeds from exercise of stock options
    
    
    65
    
    
    
    270Net cash provided by financing activities
    
    
    65
    
    
    
    270Net increase (decrease) in cash and cash equivalents
    
    
    3,165
    
    
    
    (494
    )Cash and cash equivalents at beginning of period
    
    
    32,622
    
    
    
    31,060Cash and cash equivalents at end of period
    
    $
    35,787
    
    
    $
    30,566
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. BASIS OF PRESENTATION
   2. ACCOUNTING FOR STOCK-BASED COMPENSATION
  Three Months Ended
    
    
    Nine Months Ended(In Thousands)
    
    
    (In Thousands)September
    
    
    September
    
    
    September
    
    
    September24, 2005
    
    
    25, 2004
    
    
    24, 2005
    
    
    25, 2004Net income (loss), as reported
    
    $
    1,584
    
    
    $
    (274
    )
    
    $
    2,021
    
    
    $
    671Deduct: Total stock-based
compensation expense based on
the fair value method for all
awards, net of related tax
effects
    
    
    73
    
    
    
    50
    
    
    
    81
    
    
    
    243Pro forma net income (loss)
    
    $
    1,511
    
    
    $
    (324
    )
    
    $
    1,940
    
    
    $
    428
 7




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Three Months Ended
    
    
    Nine Months Ended(In Thousands)
    
    
    (In Thousands)September
    
    
    September
    
    
    September
    
    
    September24, 2005
    
    
    25, 2004
    
    
    24, 2005
    
    
    25, 2004Earnings (loss) per share:Basic  as reported
    
    $
    0.12
    
    
    $
    (0.02
    )
    
    $
    0.15
    
    
    $
    0.05Basic  pro forma
    
    $
    0.11
    
    
    $
    (0.02
    )
    
    $
    0.15
    
    
    $
    0.03Diluted  as reported
    
    $
    0.12
    
    
    $
    (0.02
    )
    
    $
    0.15
    
    
    $
    0.05Diluted  pro forma
    
    $
    0.11
    
    
    $
    (0.02
    )
    
    $
    0.15
    
    
    $
    0.03
 3. ACQUISITION
  8




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4. INTANGIBLE ASSETS
  As of September 24, 2005
    
    
    As of December 31, 2004(In Thousands)
    
    
    (In Thousands)Gross
    
    
    
    
    
    
    
    
    
    
    GrossCarrying
    
    
    
    
    
    
    Accumulated
    
    
    Carrying
    
    
    AccumulatedAmount
    
    
    Impairment
    
    
    Amortization
    
    
    Amount
    
    
    AmortizationAmortized intangible assets:Cheetah sales order backlog,
included in inventory
    
    $
    543
    
    
    $
    
    
    
    $
    543
    
    
    $
    543
    
    
    $
    543Exclusivity agreement
    
    
    715
    
    
    
    
    
    
    
    214
    
    
    
    715
    
    
    
    107Total Amortized Intangibles
    
    $
    1,258
    
    
    $
    
    
    
    $
    757
    
    
    $
    1,258
    
    
    $
    650Non-amortized intangible assets:LoopCare trade name
    
    $
    1,300
    
    
    $
    
    
    
    $
    
    
    
    $
    1,300
    
    
    $
    Base software  LoopCare
    
    
    5,200
    
    
    
    
    
    
    
    
    
    
    
    5,200
    
    
    
    Post warranty maintenance
service agreements
    
    
    32,000
    
    
    
    
    
    
    
    
    
    
    
    32,000
    
    
    
    Customer Base  Cheetah
    
    
    5,000
    
    
    
    
    
    
    
    
    
    
    
    5,000
    
    
    
    Cheetah Trademark
    
    
    1,000
    
    
    
    
    
    
    
    
    
    
    
    1,000
    
    
    
    Total Non-Amortized
Intangibles
    
    $
    44,500
    
    
    $
    
    
    
    $
    
    
    
    $
    44,500
    
    
    $
    Total Intangibles
    
    $
    45,758
    
    
    $
    
    
    
    $
    757
    
    
    $
    45,758
    
    
    $
    650Capitalized software:Developed product software
    
    $
    7,664
    
    
    $
    
    
    
    $
    5,961
    
    
    $
    7,591
    
    
    $
    4,817Base software  Cheetah
    
    
    2,900
    
    
    
    
    
    
    
    773
    
    
    
    2,900
    
    
    
    556Proprietary technology
    
    
    1,000
    
    
    
    
    
    
    
    267
    
    
    
    1,000
    
    
    
    192Acquired software
    
    
    538
    
    
    
    424
    
    
    
    92
    
    
    
    538
    
    
    
    11Total capitalized software
(long term)
    
    $
    12,102
    
    
    $
    424
    
    
    $
    7,093
    
    
    $
    12,029
    
    
    $
    5,576Goodwill
    
    $
    18,682
    
    
    $
    
    
    
    $
    
    
    
    $
    19,340
    
    
    $
    
   2005 (Remaining 3 months)
    
    $
    5222006
    
    $
    1,7172007
    
    $
    6022008
    
    $
    5822009
    
    $
    455Thereafter
    
    $
    1,208
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5. INVENTORY
  September
    
    
    December24, 2005
    
    
    31, 2004Raw materials
    
    $
    5,848
    
    
    $
    7,631Work in process
    
    
    4,069
    
    
    
    4,442Finished goods
    
    
    2,019
    
    
    
    2,28811,936
    
    
    
    14,361Reserve for slow moving and obsolete inventory
    
    
    (1,657
    )
    
    
    (1,420
    )$
    10,279
    
    
    $
    12,941
 6. SHORT-TERM INVESTMENTS
    September 24, 2005
    
    
    December 31, 2004Carrying
    
    
    
    
    
    
    CarryingAmount
    
    
    Fair Value
    
    
    Amount
    
    
    Fair ValueFinancial assets:Cash and cash equivalents
    
    $
    35,787
    
    
    $
    35,787
    
    
    $
    32,622
    
    
    $
    32,622Short-term investments
    
    
    21,526
    
    
    
    21,527
    
    
    
    18,537
    
    
    
    18,538$
    57,313
    
    
    $
    57,314
    
    
    $
    51,159
    
    
    $
    51,160
 7. RETIREMENT EXPENSE
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8. COST ALIGNMENT
  9. PER SHARE INFORMATION
   Three Months Ended
    
    
    Nine Months EndedSeptember
    
    
    September
    
    
    September
    
    
    September24, 2005
    
    
    25, 2004
    
    
    24, 2005
    
    
    25, 2004Net income (loss)
    
    $
    1,584
    
    
    $
    (274
    )
    
    $
    2,021
    
    
    $
    671Common and common equivalent shares:Weighted average common shares
outstanding
    
    
    13,162
    
    
    
    13,148
    
    
    
    13,162
    
    
    
    13,134Effect of
dilutive securities 
stock options
    
    
    59
    
    
    
    
    
    
    
    40
    
    
    
    12913,221
    
    
    
    13,148
    
    
    
    13,202
    
    
    
    13,263Earnings (loss) per share:Basic
    
    $
    0.12
    
    
    $
    (0.02
    )
    
    $
    0.15
    
    
    $
    0.05Diluted
    
    $
    0.12
    
    
    $
    (0.02
    )
    
    $
    0.15
    
    
    $
    0.05
  11




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10. RECEIVABLE FROM OFFICER
  11. PRODUCT WARRANTY
   Nine Months Ended
    
    
    Year EndedSeptember 24, 2005
    
    
    December 31, 2004Balance
at the beginning of the
period
    
    $
    2,081
    
    
    $
    2,150Accruals for warranties
issued
during the period
    
    
    1,042
    
    
    
    1,435Settlements
during the period
    
    
    (1,056
    )
    
    
    (1,504
    )Balance at the end of the
period
    
    $
    2,067
    
    
    $
    2,081
 12. CONTINGENCIES AND COMMITMENTS
  13. MAJOR CUSTOMERS
  12




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14. INTERNATIONAL SALES
  15. GOODWILL
     16. INCOME TAXES
  13




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17. ACCOUNTING PRONOUNCEMENTS
   14




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PricewaterhouseCoopers LLP
 15




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Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
 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.
 will, believes, intends, expects, plans, could or may,
  16




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OVERVIEW
 About the Company
     About its customers
  17




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PRODUCTS
 TELECOMMUNICATION TEST SYSTEMS
  DigiTest and LoopCare
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
    
    the Common Object Request Broker Architecture (CORBA)-based Application Programming
Interface;
    
    Benchmark Data Base;
    
    DSL Testing;
    
    the Advanced Testhead Feature Package;
    
    Batch Testing;
    
    Fax Unalert;
    
    Loop Length Reporting;
    
    Enabling Flow Through by Re-Classification of VER 55-58 Codes;
    
    LoopCare TCP/IP Communications Network; and
    
    Testing Voice Services in a Broadband Passive Optical Network (bPON).
 MCU
  CABLE TESTING PRODUCTS
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SERVICES
  BACKLOG
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REPORTING SEGMENT
  INTERNATIONAL SALES
  APPLICATION OF CRITICAL ACCOUNTING POLICIES
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GOODWILL
     INCOME TAXES
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RESULTS OF OPERATIONS
 THE FOLLOWING DISCUSSION OF THE RESULTS OF OPERATIONS AND FINANCIAL CONDITION OF THE COMPANY SHOULD
BE READ IN CONJUNCTION WITH PART I, ITEM 1 OF THIS REPORT
 THIRD QUARTER OF 2005 COMPARED TO THIRD QUARTER OF 2004
 Revenues
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Gross Profit
  Selling and Marketing Expense
  General and Administrative Expense
 .
 Research and Development Expense
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Interest and Other Income
  Provision (Benefit) for Income Taxes
  Net Income (Loss) and Earnings (Loss) Per Share
  NINE MONTHS ENDED SEPTEMBER 24, 2005 COMPARED TO NINE MONTH ENDED SEPTEMBER 25, 2004
 Revenues
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Gross Profit
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Selling and Marketing Expense
  General and Administrative Expense
 .
 Research and Development Expense
  Retirement Expense
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Interest and Other Income
  Provision for Income Taxes
  Net Income and Earnings Per Share
  CHEETAH ACQUISITION
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LIQUIDITY AND CAPITAL RESOURCES
     RELATED PARTY TRANSACTION
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KEY RATIOS
  ACCOUNTING PRONOUNCEMENTS
   RISK FACTORS THAT MIGHT AFFECT FUTURE OPERATING RESULTS AND FINANCIAL CONDITION
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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 telecommunications market and the economy in general;
    
    subscriber line loss and related reduced demand for telecommunications services;
    
    changes or shifts in the technology utilized in the networks;
    
    labor disputes between our customers and their collective bargaining units;
    
    the failure 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.
  Our operating results may vary from quarter to quarter, causing our stock price to fluctuate.
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The sales cycle for our software products is long, and the delay or failure to complete one or more
large license transactions in a quarter could cause our operating results to fall below our
expectations.
   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.
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Our Services business is subject to a trend of reduced capital spending by our major customers.
  We recently emphasized our network assurance and testing software solutions and cable status
monitoring products.
   The sale of our products is dependent upon our ability to satisfy the proprietary requirements of
our customers and to respond to rapid technological change, including evolving industry-wide
standards.
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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.
   Our limited ability to protect our proprietary information and technology may adversely affect our
ability to compete.
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Our products could infringe the intellectual property rights of others, and resulting claims
against us could be costly and require us to enter into disadvantageous license or royalty
arrangements.
   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.
  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.
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We have completed, and may pursue additional acquisitions, which will complicate our management
tasks and could result in substantial expenditures.
  The failure of acquired assets to meet expectations, or a decline on our fair value determined by
market prices of our stock, could indicate impairment of our intangible assets and result in
impairment charges.
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Our future sales in international markets are subject to numerous risks and uncertainties.
  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.
  Our future results are dependent on our ability to establish, maintain and expand our distribution
channels and our existing third-party distributors.
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We face intense competition, which could result in our losing market share or experiencing a
decline in our gross margins.
   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.
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Our expenses are relatively fixed in the short term, and we may be unable to adjust spending to
compensate for unexpected revenue shortfalls.
  Our restructuring and cost reduction plans may be ineffective or may limit our ability to compete.
  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.
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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.
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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 Item 4. CONTROLS AND PROCEDURES
   
 PART II. OTHER INFORMATION
 
 Item 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
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Item 6. EXHIBITS
   ExhibitNumber
    
    Description10.1
    
    Lease between Regional Industrial Development Corporation of
Southwestern Pennsylvania and Tollgrade Communications, Inc.
dated August 31, 2005, filed as Exhibit 10.1 to the Report on
Form 8-K filed with the SEC on September 7, 2005.10.2
    
    Seventh Extension Agreement, dated September 29, 2005,
between Tollgrade Communications, Inc. and Dictaphone
Corporation, filed herewith15
    
    Letter re audited interim financial information31.1
    
    Certification of Chief Executive Officer, filed herewith31.2
    
    Certification of Chief Financial Officer, filed herewith32
    
    Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18.U.S.C. Section 350, filed herewith
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SIGNATURES
  Tollgrade Communications, Inc.  (Registrant)
 Dated: November 3, 2005
    
    
    
    /s/ Mark B. PetersonMark B. PetersonChairman and Chief Executive OfficerDated: November 3, 2005
    
    
    
    /s/ Samuel C. KnochSamuel C. KnochChief Financial Officer and TreasurerDated: November 3, 2005
    
    
    
    /s/ Sean M. ReillySean M. ReillyController
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EXHIBIT INDEX
 ExhibitNumber
    
    Description10.1
    
    Lease between Regional Industrial Development Corporation of
Southwestern Pennsylvania and Tollgrade Communications, Inc.
dated August 31, 2005, filed as Exhibit 10.1 to the Report on
Form 8-K filed with the SEC on September 7, 2005.10.2
    
    Seventh Extension Agreement, dated September 29, 2005,
between Tollgrade Communications, Inc. and Dictaphone
Corporation, filed herewith15
    
    Letter re audited interim financial information31.1
    
    Certification of Chief Executive Officer, filed herewith31.2
    
    Certification of Chief Financial Officer, filed herewith32
    
    Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18.U.S.C. Section 350, filed herewith
 45