##### 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 27, 2008
 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
(State or other jurisdiction 
of incorporation or organization)
    
    25-1537134
(I.R.S. Employer
Identification No.)
 493 Nixon Rd.
Cheswick, PA 15024
 412-820-1400
 þ o
  Large accelerated filer oAccelerated filer þNon-accelerated filer o(Do not check if a smaller reporting company)Smaller reporting company o o þ




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##### 



TOLLGRADE COMMUNICATIONS, INC.
 Quarterly Report on Form 10-Q
For the Quarter Ended September 27, 2008   Table of Contents
 PAGENO.PART I. FINANCIAL INFORMATIONItem 1 Condensed Consolidated Financial Statements (Unaudited)Condensed Consolidated Balance Sheets as of September 27, 2008
and December 31, 2007 (Unaudited)
    
    
    3Condensed Consolidated Statements of Operations for the three
and nine month periods ended September 27, 2008 and September
29, 2007 (Unaudited)
    
    
    4Condensed Consolidated Statements of Changes in Shareholders
Equity for the nine month period ended September 27, 2008
(Unaudited)
    
    
    5Condensed Consolidated Statements of Cash Flows for the nine
month periods ended September 27, 2008 and September 29, 2007
(Unaudited)
    
    
    6Notes to Condensed Consolidated Financial Statements (Unaudited)
    
    
    7Item 2 Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    21Item 3 Quantitative and Qualitative Disclosures about Market Risk
    
    
    47Item 4 Controls and Procedures
    
    
    47PART II. OTHER INFORMATIONItem 1A Risk Factors
    
    
    48Item 6 Exhibits
    
    
    63SIGNATURES
    
    
    64EXHIBIT INDEX
    
    
    65EX-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 par value) (Unaudited)
 September 27, 2008
    
    December 31, 2007*ASSETSCurrent assets:Cash and cash equivalents
    
    $
    61,241
    
    
    $
    58,222Short-term investments
    
    
    989
    
    
    
    632Accounts receivable:Trade, net of allowance for doubtful accounts of
$330 in 2008 and $478 in 2007
    
    
    10,621
    
    
    
    14,625Other
    
    
    2,535
    
    
    
    2,255Inventories
    
    
    11,295
    
    
    
    13,687Prepaid expenses and deposits
    
    
    825
    
    
    
    1,120Deferred and refundable income taxes
    
    
    297
    
    
    
    503Assets held for sale
    
    
    
    
    
    
    272Total current assets
    
    
    87,803
    
    
    
    91,316Property and equipment, net
    
    
    3,473
    
    
    
    4,279Intangibles
    
    
    38,110
    
    
    
    44,215Other assets
    
    
    339
    
    
    
    333Total assets
    
    $
    129,725
    
    
    $
    140,143LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    670
    
    
    $
    4,214Accrued warranty
    
    
    1,407
    
    
    
    1,937Accrued expenses
    
    
    1,615
    
    
    
    3,148Accrued salaries and wages
    
    
    413
    
    
    
    891Accrued royalties payable
    
    
    210
    
    
    
    707Income taxes payable
    
    
    1,161
    
    
    
    572Deferred revenue
    
    
    4,183
    
    
    
    2,767Total current liabilities
    
    
    9,659
    
    
    
    14,236Pension obligation
    
    
    1,014
    
    
    
    908Deferred tax liabilities
    
    
    2,155
    
    
    
    1,999Total liabilities
    
    
    12,828
    
    
    
    17,143Commitments and contingenciesShareholders equity:Common stock, $0.20 par value; authorized shares,
50,000; issued shares, 13,733 in 2008 and 13,731 in
2007
    
    
    2,744
    
    
    
    2,744Additional paid-in capital
    
    
    73,730
    
    
    
    73,389Treasury stock, at cost, 575 shares in 2008 and 2007
    
    
    (5,900
    )
    
    
    (5,900
    )Retained earnings
    
    
    47,022
    
    
    
    52,863Accumulated other comprehensive loss
    
    
    (699
    )
    
    
    (96
    )Total shareholders equity
    
    
    116,897
    
    
    
    123,000Total liabilities and shareholders equity
    
    $
    129,725
    
    
    $
    140,143
 *
    
    Amounts derived from audited financial statements presented in the Companys Annual Report on
Form 10-K for the year ended December 31, 2007  3




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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data) (Unaudited)
 Three Months Ended
    
    Nine Months EndedSeptember 27,
    
    September 29,
    
    September 27,
    
    September 29,2008
    
    2007
    
    2008
    
    2007Revenues:Products
    
    $
    9,240
    
    
    $
    15,528
    
    
    $
    24,869
    
    
    $
    36,388Services
    
    
    5,966
    
    
    
    5,050
    
    
    
    18,118
    
    
    
    11,413Total revenues
    
    
    15,206
    
    
    
    20,578
    
    
    
    42,987
    
    
    
    47,801Cost of sales:Products
    
    
    4,251
    
    
    
    7,305
    
    
    
    12,344
    
    
    
    16,758Services
    
    
    1,916
    
    
    
    1,424
    
    
    
    5,826
    
    
    
    3,234Amortization
    
    
    843
    
    
    
    903
    
    
    
    2,711
    
    
    
    2,041Intangible impairment
    
    
    
    
    
    
    
    
    
    
    3,291
    
    
    
    Restructuring
    
    
    
    
    
    
    
    
    
    
    759
    
    
    
    Total cost of sales
    
    
    7,010
    
    
    
    9,632
    
    
    
    24,931
    
    
    
    22,033Gross profit
    
    
    8,196
    
    
    
    10,946
    
    
    
    18,056
    
    
    
    25,768Operating expenses:Selling and marketing
    
    
    1,999
    
    
    
    2,853
    
    
    
    6,596
    
    
    
    7,363General and administrative
    
    
    2,227
    
    
    
    2,673
    
    
    
    7,054
    
    
    
    7,121Research and development
    
    
    3,034
    
    
    
    3,694
    
    
    
    9,880
    
    
    
    9,639Restructuring
    
    
    5
    
    
    
    233
    
    
    
    510
    
    
    
    827Total operating expenses
    
    
    7,265
    
    
    
    9,453
    
    
    
    24,040
    
    
    
    24,950Income (loss) from operations
    
    
    931
    
    
    
    1,493
    
    
    
    (5,984
    )
    
    
    818Interest income
    
    
    264
    
    
    
    635
    
    
    
    1,069
    
    
    
    2,151Income (loss) before taxes
    
    
    1,195
    
    
    
    2,128
    
    
    
    (4,915
    )
    
    
    2,969Provision for income taxes
    
    
    277
    
    
    
    702
    
    
    
    926
    
    
    
    982Net income (loss)
    
    $
    918
    
    
    $
    1,426
    
    
    $
    (5,841
    )
    
    $
    1,987Income (loss) per share information:Weighted average shares of common
stock and equivalents:Basic
    
    
    13,173
    
    
    
    13,207
    
    
    
    13,170
    
    
    
    13,241Diluted
    
    
    13,187
    
    
    
    13,440
    
    
    
    13,170
    
    
    
    13,467Net income (loss) per common share:Basic
    
    $
    0.07
    
    
    $
    0.11
    
    
    $
    (0.44
    )
    
    $
    0.15Diluted
    
    $
    0.07
    
    
    $
    0.11
    
    
    $
    (0.44
    )
    
    $
    0.15
  4




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Tollgrade Communications, Inc. and Subsidiaries
Condensed Consolidated Statements of Changes in Shareholders Equity
(In thousands) (Unaudited)
 AccumulatedOther
    
    
    
    
    
    
    OtherCommon Stock
    
    
    Additional
    
    
    Treasury
    
    
    Retained
    
    
    Comprehensive
    
    
    
    
    
    
    ComprehensiveShares
    
    
    Amount
    
    
    Paid-In
    
    
    Stock
    
    
    Earnings
    
    
    Loss
    
    
    Total
    
    
    LossBalance at December
31, 2007
    
    
    13,731
    
    
    $
    2,744
    
    
    $
    73,389
    
    
    $
    (5,900
    )
    
    $
    52,863
    
    
    $
    (96
    )
    
    $
    123,000Compensation
expense for options
and restricted
stock, net
    
    
    2
    
    
    
    
    
    
    
    341
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    341Foreign currency
translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (603
    )
    
    
    (603
    )
    
    $
    (603
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,841
    )
    
    
    
    
    
    
    (5,841
    )
    
    
    (5,841
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (6,444
    )Balance at
September 27, 2008
    
    
    13,733
    
    
    $
    2,744
    
    
    $
    73,730
    
    
    $
    (5,900
    )
    
    $
    47,022
    
    
    $
    (699
    )
    
    $
    116,897
  5




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TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) (Unaudited)
 Nine Months EndedSeptember 27,
    
    September 29,2008
    
    2007Cash flows from operating activities:Net (loss) income
    
    $
    (5,841
    )
    
    $
    1,987Adjustments to reconcile net (loss) income to net cash
provided by operating activities:Impairment loss
    
    
    3,291
    
    
    
    Depreciation and amortization
    
    
    4,046
    
    
    
    3,258Compensation expense related to stock plans
    
    
    341
    
    
    
    829Valuation allowance
    
    
    129
    
    
    
    145Deferred income taxes
    
    
    190
    
    
    
    1,402Restructuring expense
    
    
    775
    
    
    
    313Provision for losses on inventory
    
    
    375
    
    
    
    333Provision for allowance for doubtful accounts
    
    
    28
    
    
    
    96Changes in assets and liabilities:Accounts receivable-trade
    
    
    6,634
    
    
    
    525Accounts receivable-other
    
    
    (498
    )
    
    
    752Inventories
    
    
    1,277
    
    
    
    (3,730
    )Prepaid expenses and other assets
    
    
    352
    
    
    
    163Accounts payable
    
    
    (6,332
    )
    
    
    215Accrued warranty
    
    
    (527
    )
    
    
    (146
    )Accrued expenses and deferred income
    
    
    (467
    )
    
    
    (1,998
    )Accrued royalties payable
    
    
    (497
    )
    
    
    318Income taxes payable
    
    
    612
    
    
    
    Net cash provided by operating activities
    
    
    3,888
    
    
    
    4,462Cash flows from investing activities:Purchase of Broadband Test Division
    
    
    
    
    
    
    (11,952
    )Purchase of short-term investments
    
    
    (2,279
    )
    
    
    (11,608
    )Redemption/maturity of short-term investments
    
    
    1,922
    
    
    
    9,207Capital expenditures, including capitalized software
    
    
    (565
    )
    
    
    (1,220
    )Sale of assets held for sale
    
    
    263
    
    
    
    892Net cash used in investing activities
    
    
    (659
    )
    
    
    (14,681
    )Cash flows from financing activities:Repurchase of treasury stock
    
    
    
    
    
    
    (1,109
    )Proceeds from exercise of stock options
    
    
    
    
    
    
    89Excess tax benefit from stock-based compensation
    
    
    
    
    
    
    10Net cash used in financing activities
    
    
    
    
    
    
    (1,010
    )Net increase (decrease) in cash and cash equivalents
    
    
    3,229
    
    
    
    (11,229
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    (210
    )
    
    
    (33
    )Cash and cash equivalents at beginning of period
    
    
    58,222
    
    
    
    57,378Cash and cash equivalents at end of period
    
    $
    61,241
    
    
    $
    46,116
  6




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




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
    
    Level 1Unadjusted quoted prices in active markets that are
accessible at the measurement date for identical, unrestricted assets
or liabilities.
    
    Level 2Inputs other than quoted prices included within Level 1 that
are observable for the asset or liability, either directly or
indirectly, including quoted prices for similar assets or liabilities
in active markets; quoted prices for identical or similar assets or
liabilities in markets that are not active; inputs other than quoted
prices that are observable for the asset or liability (e.g., interest
rates); and inputs that are derived principally from or corroborated
by observable market data by correlation or other means.
    
    Level 3Inputs that are both significant to the fair value measurement and unobservable.
   8




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9




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2. STOCK COMPENSATION PLANS AND ACCOUNTING FOR STOCK-BASED COMPENSATION EXPENSE
 The Plans
   Stock-Based Compensation Expense
  10




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Shares Authorized But Not GrantedSeptember 27, 2008
    
    December 31, 20071998 Employee Incentive Compensation Plan
    
    
    
    
    
    
    164,1412006 Long Term Incentive Compensation Plan
    
    
    439,845
    
    
    
    1,169,452
  Number of
    
    Range of
    
    Weighted AverageShares
    
    Option Prices
    
    Exercise PriceOutstanding, December 31, 2007
    
    
    1,440,562
    
    
    $
    7.28-159.19
    
    
    $
    27.28Granted
    
    
    556,400
    
    
    
    6.57
    
    
    
    6.57Exercised
    
    
    
    
    
    
    
    
    
    
    Cancelled/Forfeited/Expired
    
    
    135,876
    
    
    
    6.57-32.90
    
    
    
    15.40Outstanding, September 27,
2008
    
    
    1,861,086
    
    
    $
    6.57-159.19
    
    
    $
    21.95
 3. RESTRUCTURING
   Balance at
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance atDecember
    
    Restructuring
    
    Cash
    
    Asset
    
    September31, 2007
    
    charge/expense
    
    payments
    
    writedowns
    
    27, 2008Severance
    
    $
    
    
    
    $
    494
    
    
    $
    (493
    )
    
    $
    
    
    
    $
    1Inventory write-down
    
    
    
    
    
    
    738
    
    
    
    
    
    
    
    (738
    )
    
    
    Total
    
    $
    
    
    
    $
    1,232
    
    
    $
    (493
    )
    
    $
    (738
    )
    
    $
    1
  11




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Balance at
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance atDecember
    
    
    
    
    
    Cash
    
    Asset
    
    September31, 2007
    
    Expense
    
    payments
    
    writedowns
    
    27, 2008Facility
rationalization
including employee
costs
    
    $
    103
    
    
    $
    29
    
    
    $
    (116
    )
    
    $
    (16
    )
    
    $
    Real estate impairment
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    (8
    )
    
    
    Total
    
    $
    103
    
    
    $
    37
    
    
    $
    (116
    )
    
    $
    (24
    )
    
    $
    
    4. ACQUISITION
  12




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Accounts receivable
    
    $
    4,579Inventories
    
    
    1,428Property and equipment
    
    
    454Intangible assets
    
    
    7,937Goodwill
    
    
    1,122Other
    
    
    26Total assets acquired
    
    
    15,546Deferred income
    
    
    1,588Accounts payable
    
    
    709Pension obligations
    
    
    870Relocation and lease termination accrual
    
    
    524Total liabilities
    
    
    3,691Net assets acquired
    
    $
    11,855
  (In Thousands, Except Per Share Data)Unaudited Pro Forma
    
    Unaudited Pro FormaThree Months Ended
    
    Nine Months EndedSeptember 29, 2007
    
    September 29, 2007Revenues
    
    $
    21,507
    
    
    $
    58,955Income from operations
    
    
    498
    
    
    
    812Net income
    
    
    759
    
    
    
    1,983Basic and diluted earnings per share
    
    $
    0.06
    
    
    $
    0.15
  13




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5. INTANGIBLE ASSETS
  September 27, 2008Useful
    
    
    (Unaudited)Life
    
    
    
    
    
    
    AccumulatedAmortizing Intangible Assets:
    
    (Years)
    
    
    Gross
    
    
    Amortization
    
    
    Impairments
    
    
    NetPost warranty service agreements
    
    
    6-50
    
    
    $
    38,078
    
    
    $
    3,428
    
    
    $
    
    
    
    $
    34,650Technology
    
    
    2-10
    
    
    
    18,792
    
    
    
    14,726
    
    
    
    1,396
    
    
    
    2,670Customer relationships
    
    
    5-15
    
    
    
    3,611
    
    
    
    1,399
    
    
    
    1,676
    
    
    
    536Tradenames and other
    
    
    0.5-10
    
    
    
    817
    
    
    
    344
    
    
    
    219
    
    
    
    254Total Intangible Assets
    
    
    
    
    
    $
    61,298
    
    
    $
    19,897
    
    
    $
    3,291
    
    
    $
    38,110
 Useful
    
    
    December 31, 2007Life
    
    
    
    
    
    
    AccumulatedAmortizing Intangible Assets:
    
    (Years)
    
    
    Gross
    
    
    Amortization
    
    
    Impairments
    
    
    NetPost warranty service agreements
    
    
    6-50
    
    
    $
    38,204
    
    
    $
    2,019
    
    
    $
    
    
    
    $
    36,185Technology
    
    
    2-10
    
    
    
    19,249
    
    
    
    13,858
    
    
    
    448
    
    
    
    4,943Customer relationships
    
    
    5-15
    
    
    
    3,626
    
    
    
    1,190
    
    
    
    
    
    
    
    2,436Tradenames and other
    
    
    0.5-10
    
    
    
    2,635
    
    
    
    169
    
    
    
    1,815
    
    
    
    651Total Intangible Assets
    
    
    
    
    
    $
    63,714
    
    
    $
    17,236
    
    
    $
    2,263
    
    
    $
    44,215
  Impairments
 Long-Lived Assets
   14




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6. PENSION
  7. INVENTORY
  September 27, 2008(Unaudited)
    
    December 31, 2007Raw materials
    
    $
    6,520
    
    
    $
    8,393Work in process
    
    
    3,190
    
    
    
    3,582Finished goods
    
    
    3,468
    
    
    
    4,32113,178
    
    
    
    16,296Reserves for slow moving and obsolete inventory
    
    
    (1,883
    )
    
    
    (2,609
    )$
    11,295
    
    
    $
    13,687
 8. PER SHARE INFORMATION
  15




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Three Months Ended
    
    
    Nine Months EndedSeptember 27, 2008
    
    
    September 27, 2008(Unaudited)
    
    
    (Unaudited)Net income (loss)
    
    $
    918
    
    
    $
    (5,841
    )Common and common equivalent shares:Weighted average common shares outstanding
    
    
    13,173
    
    
    
    13,170Effect of dilutive securities  restricted stock
    
    
    14
    
    
    
    13,187
    
    
    
    13,170Income (loss) per share:Basic
    
    $
    0.07
    
    
    $
    (0.44
    )Diluted
    
    $
    0.07
    
    
    $
    (0.44
    )
 Three Months Ended
    
    
    Nine Months EndedSeptember 29, 2007
    
    
    September 29, 2007(Unaudited)
    
    
    (Unaudited)Net 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 EndedSeptember 27, 2008
    
    
    Year Ended(Unaudited)
    
    
    December 31, 2007Balance at the beginning of the period
    
    $
    1,937
    
    
    $
    2,135Accruals for warranties issued during the period
    
    
    1,226
    
    
    
    1,680Settlements during the period
    
    
    (1,756
    )
    
    
    (1,878
    )Balance at the end of the period
    
    $
    1,407
    
    
    $
    1,937
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10. CONTINGENCIES AND COMMITMENTS
   At September 27, 20082008 (remaining period)
    
    $
    2082009
    
    
    8142010
    
    
    6602011
    
    
    6262012
    
    
    456Thereafter
    
    
    $
    2,764
    11. INCOME TAXES
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12. MAJOR CUSTOMERS AND INTERNATIONAL SALES
  18




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13. STOCK REPURCHASE PROGRAM
  14. SUBSEQUENT EVENTS
   19




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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 Unaudited 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.
  Overview
  
    
    Focusing our efforts on the substantial and growing telco service assurance market,
where we have a significant installed customer base, by leveraging our current position
and expanding into adjacent markets.
    
    Leveraging new potential partnerships to allow us to expand our system solutions
into adjacent market segments.
    
    Continuing to actively manage the performance and results in all areas of our
business.
    
    Continuing our internal review process to look for opportunities to accelerate our
business strategy and focus our efforts along the way.
    
    Enhancing the management team capabilities to support the refocused strategy.
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General Business Trends
     22




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Our Customers
  23




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Our Solutions
 Telecommunications Solutions
      24




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Cable Solutions
  ®
  25




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Services
    BACKLOG
  26




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OPERATING SEGMENT
  INTERNATIONAL SALES
   27




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RECENT ACCOUNTING PRONOUNCEMENTS
   28




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
    
    Level 1Unadjusted quoted prices in active markets that are accessible at the
measurement date for identical, unrestricted assets or liabilities.
 
    
    Level 2Inputs other than quoted prices included within Level 1 that are observable for
the asset or liability, either directly or indirectly, including quoted prices for similar
assets or liabilities in active markets; quoted prices for identical or similar assets or
liabilities in markets that are not active; inputs other than quoted prices that are
observable for the asset or liability (e.g., interest rates); and inputs that are derived
principally from or corroborated by observable market data by correlation or other means.
 
    
    Level 3Inputs that are both significant to the fair value measurement and
unobservable.
    29




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APPLICATION OF CRITICAL ACCOUNTING POLICIES
  Revenue Recognition
    31




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Goodwill and Intangible Assets
   32




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33




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Sensitivity Analysis
  YearsTwelve-monthRemaining
    
    Carrying
    
    RollingLife at
    
    Value at
    
    ProjectedAsset Description
    
    Life
    
    9/27/08
    
    9/27/08
    
    Amortization(in millions)LoopCareBase Software
    
    
    10
    
    
    
    3.00
    
    
    $
    1.3
    
    
    $
    0.5Post-Warranty
Maintenance Service
Agreements
    
    
    50
    
    
    
    47.00
    
    
    
    30.1
    
    
    
    0.6EmersonProprietary Technology
    
    
    5
    
    
    
    2.50
    
    
    
    0.3
    
    
    
    0.1Broadband Test DivisionPost-Warranty
Maintenance Service
Agreements
    
    
    48
    
    
    
    46.85
    
    
    
    1.1
    
    
    
    0.3Post-Warranty
Maintenance Service
Agreements
    
    
    20
    
    
    
    18.85
    
    
    
    2.8
    
    
    
    0.6Post-Warranty
Maintenance Service
Agreements
    
    
    10
    
    
    
    8.85
    
    
    
    0.6
    
    
    
    0.1Post-Warranty
Maintenance Service
Agreements
    
    
    6
    
    
    
    4.85
    
    
    
    0.1
    
    
    
    Technology
    
    
    3-10
    
    
    
    1.85-8.85
    
    
    
    0.6
    
    
    
    0.1Customer Relationships
    
    
    10
    
    
    
    8.85
    
    
    
    0.5
    
    
    
    0.2Other
    
    
    0.5-10
    
    
    
    0.25-9.25
    
    
    
    0.7
    
    
    
    0.4$
    38.1
    
    
    $
    2.9
  Goodwill and Indefinite Lived Assets
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Inventory Valuation
  35




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Allowance for Doubtful Accounts
   Income Taxes
  Warranty
  Long-Lived Assets Held for Sale
  36




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Restructuring Accrual
   Pension Benefits
  37




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Stock-Based Compensation
  Foreign Currency Translation
   RESULTS OF OPERATIONS
 THIRD QUARTER OF 2008 COMPARED TO THIRD QUARTER OF 2007
 Revenues
    38




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Gross Profit
  39




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Selling and Marketing Expense
  General and Administrative Expense
 .
 Research and Development Expense
  Restructuring Expense
  Interest Income
  Income Taxes
  40




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Net Income and Income Per Share
  NINE MONTHS ENDED SEPTEMBER 27, 2008 COMPARED TO NINE MONTHS ENDED SEPTEMBER 29, 2007
 Revenues
    41




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Gross Profit
  Selling and Marketing Expense
  General and Administrative Expense
  42




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Research and Development Expense
  Restructuring Expense
   Balance at
    
    Restructuring
    
    
    
    
    
    
    
    
    
    Balance atDecember 31, 2007
    
    charge/expense
    
    Cash payments
    
    Asset write-downs
    
    September 27, 2008Severance
    
    $
    
    
    
    $
    494
    
    
    $
    (493
    )
    
    $
    
    
    
    $
    1Inventory write-down
    
    
    
    
    
    
    738
    
    
    
    
    
    
    
    (738
    )
    
    
    Total
    
    $
    
    
    
    $
    1,232
    
    
    $
    (493
    )
    
    $
    (738
    )
    
    $
    1
  Interest Income
  Income Taxes
  43




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Net (Loss) Income and (Loss) Earnings Per Share
  LIQUIDITY AND CAPITAL RESOURCES
     44




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KEY RATIOS
  COMMITMENTS AND CONTRACTUAL OBLIGATIONS
  45




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Minimum annual future commitments as of September 27, 2008 are (in thousands):
 Payments due by periodTotal
    
    2008
    
    2009
    
    2010
    
    2011
    
    2012
    
    ThereafterOperating Lease
Obligations
    
    $
    2,413
    
    
    $
    187
    
    
    $
    732
    
    
    $
    577
    
    
    $
    544
    
    
    $
    373
    
    
    $
    Purchase Obligations
    
    
    277
    
    
    
    60
    
    
    
    134
    
    
    
    44
    
    
    
    22
    
    
    
    17
    
    
    
    FIN 48 Obligations
    
    
    457
    
    
    
    
    
    
    
    
    
    
    
    457
    
    
    
    
    
    
    
    
    
    
    
    Pension Obligations
    
    
    1,014
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,014Total
    
    $
    4,161
    
    
    $
    247
    
    
    $
    866
    
    
    $
    1,078
    
    
    $
    566
    
    
    $
    390
    
    
    $
    1,014
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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
   
 Item 4. CONTROLS AND PROCEDURES
  47




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PART II. OTHER INFORMATION
 
 Item 1A. RISK FACTORS
  Our future growth depends to a large extent upon our ability to reposition the Company with a
greater focus on our service assurance testing offerings to the telecom market.
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Our cost reduction plans may be ineffective or may limit our ability to compete.
  A downturn in the global economy may adversely affect our revenues, results of operations and
financial condition.
  
    
    rising interest rates and poor availability of credit,
    
    a slowdown in the rate of growth of the United States economy,
    
    erosion of the U.S. dollar relative to foreign currencies in jurisdictions where we
transact business,
    
    a slowdown in the rate of growth of other countries that we serve,
    
    significant act of terrorism which disrupts global trade or consumer confidence,
    
    geopolitical tensions including war and civil unrest, and
    
    reduced levels of economic activity or disruption of international transportation.
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We are dependent upon our ability to attract, retain and motivate our key personnel.
  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 and services that they purchase from us,
would significantly reduce our revenues and net income.
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
    
    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 large telcos, 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.
  We may experience reduced product sales caused by customers transitioning their access network
service assurance solutions.
  Our Services business is subject to a trend of reduced spending for our products by our major
customers.
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We have completed, and may pursue additional acquisitions, which could result in the disruption of
our current business, increased near-term expenses, 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
additional impairment charges.
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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.
  53




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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.
  54




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We face intense competition, which could result in our losing market share or experiencing a
decline in our gross margins.
   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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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.
   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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The continued adoption of industry-wide standards in the cable industry could have a material
adverse effect on our profitability.
  The presence of available open source software could adversely affect our ability to maximize
revenue from software products.
  If our new development efforts in new markets fail to result in products which meet our customers
needs, or if our customers fail to accept our new products, our revenues will be adversely
affected.
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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, and our products could infringe upon the intellectual property rights of
others, resulting in claims against us the results of which could be costly.
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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.
  If our accounting controls and procedures are circumvented or otherwise fail to achieve their
intended purposes, our business could be seriously harmed.
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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 may incur significant liabilities if we fail to comply with environmental regulations.
  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.
  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;
    
    The fact that we no longer receive research coverage by sell-side market analysts;
    
    Announcements by us or our competitors of significant acquisitions, strategic
partnerships, joint ventures or capital commitments;
    
    Responses to our announcement of completion of our strategic review process;
    
    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 6. EXHIBITS
   ExhibitNumber
    
    Description10.1
    
    Severance agreement dated October 14, 2008 between Tollgrade
Communications, Inc. and Gary W. Bogatay, Jr., filed as Exhibit
10.1 to the Companys Current Report on Form 8-K filed with the
SEC on October 22, 2008.10.2
    
    Severance agreement dated October 14, 2008 between Tollgrade
Communications, Inc. and David L. Blakeney, filed as Exhibit 10.2
to the Companys Current Report on Form 8-K filed with the SEC on
October 22, 2008.10.3
    
    Severance and Retention agreement dated October 14, 2008 between
Tollgrade Communications, Inc. and Kenneth J. Shebek, filed as
Exhibit 10.3 to the Companys Current Report on Form 8-K filed
with the SEC on October 22, 2008.31.1
    
    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.
 
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SIGNATURES
  Tollgrade Communications, Inc.
(Registrant)Dated: November 6, 2008/s/ Joseph A. FerraraJoseph A.  FerraraChief Executive Officer and President  /s/ Gary W. Bogatay, Jr.Gary W. Bogatay, Jr.Chief Financial Officer and Treasurer 64




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EXHIBIT INDEX
 ExhibitNumber
    
    Description10.1
    
    Severance agreement dated October 14, 2008 between Tollgrade
Communications, Inc. and Gary W. Bogatay, Jr., filed as Exhibit
10.1 to the Companys Current Report on Form 8-K filed with the
SEC on October 22, 2008.10.2
    
    Severance agreement dated October 14, 2008 between Tollgrade
Communications, Inc. and David L. Blakeney, filed as Exhibit 10.2
to the Companys Current Report on Form 8-K filed with the SEC on
October 22, 2008.10.3
    
    Severance and Retention agreement dated October 14, 2008 between
Tollgrade Communications, Inc. and Kenneth J. Shebek, filed as
Exhibit 10.3 to the Companys Current Report on Form 8-K filed
with the SEC on October 22, 2008.31.1
    
    Certification of the 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
 65