<PAGE>
                                                                    Exhibit 13.1





                              [PHOTO]
                              DRIVING CONSUMER
                              BROADBAND ASSURANCE

















                              TOLLGRADE COMMUNICATIONS, INC.
                              2001 ANNUAL REPORT


================================================================================

<PAGE>

[PHOTO]

DRIVING CONSUMER
BROADBAND ASSURANCE

Video on Demand...High-Speed Data Transmission... Digital Subscriber
Line...Video Phones.

These buzzwords all revolve around a single technology: Broadband.

Broadband is the leading-edge technology of tomorrow that utilizes the maximum
amount of bandwidth available to support numerous voice, video and data channels
simultaneously. It's also a technology that we believe should be treated as a
consumer service. And assuring consumer communications networks is what
Tollgrade is all about.

Curiously, the marketplace has been slow to respond to this emerging technology.
Part of the reason for the slower-than-expected growth of broadband has been the
struggle that service providers have had with wide-scale DSL deployment. The
sudden slowdown of the Competitive Local Exchange Carrier (CLEC) industry, which
had been a driving force behind DSL deployment, certainly has limited the
competitive push. At the same time, broadband technology must also overcome the
fact that it has proven too costly and manpower-intensive for Incumbent Local
Exchange Carriers (ILECs) to efficiently deliver to the consumer marketplace.

We believe that using tried-and-true consumer network assurance approaches will
be the key to successful roll-out of these services.

Additionally, over the long-term, there will likely be a move to converge
private line (medium and large businesses) and consumer networks into a single
IP/ATM architecture. There is an increased focus on providing the best
maintenance processes for mature networks. Finally, the industry is seeing an
increased emergence of passive optical networks, which has rejuvenated interest
in "fiber-to-the-curb," or "broadband edge," applications.

These market drivers, coupled with an intense demand for products that reduce
deployment costs, indicate that the broadband world is ripe with opportunity. As
a premier provider of leading-edge test and management solutions for consumer
networks, Tollgrade has positioned itself to contribute significantly to this
next phase of the communication evolution.

================================================================================

<PAGE>

--------------------------------------------------------------------------------
2001 FINANCIAL HIGHLIGHTS

<TABLE>
<CAPTION>
                              (In thousands, except per share data
                                    and number of employees)

                              December 31, 2000    DECEMBER 31, 2001
<S>                               <C>               <C>
OPERATIONS
Total Revenues                     $ 114,426         $  82,239
--------------------------------------------------------------------------------
Net Income                         $  27,495         $  13,675
--------------------------------------------------------------------------------
Earnings Per Share -- Diluted      $    2.06         $    1.02
--------------------------------------------------------------------------------
Weighted Average Shares of Common
    Stock and Equivalents         13,359,270        13,412,037
--------------------------------------------------------------------------------
Number of Employees                      411               341
--------------------------------------------------------------------------------

FINANCIAL POSITION
Total Assets                       $ 131,275         $ 146,630
--------------------------------------------------------------------------------
Working Capital                    $ 111,135         $  67,628
--------------------------------------------------------------------------------
Shareholders' Equity               $ 122,760         $ 140,139
--------------------------------------------------------------------------------
</TABLE>

TABLE OF CONTENTS
<TABLE>
<S>                                   <C>
2001 Financial Highlights...............1
Letter to Shareholders..................2
Driving Broadband Assurance
  to the Consumer Marketplace...........4
Selected Consolidated Financial Data....8
Management's Discussion and
  Analysis of Results of Operations
  and Financial Condition...............9
Statement of Management's
  Responsibility for Financial
  Reporting............................16
Report of Independent Accountants......17
Consolidated Financial Statements......18
Notes to the Consolidated
  Financial Statements.................22
Shareholder Information...............IBC
Board of Directors,
  Executive Council and Officers......IBC
</TABLE>

<TABLE>
<CAPTION>
REVENUES
(DOLLARS IN THOUSANDS)
<S>             <C>
 1997           $45,421*
 1998           $46,277*
 1999           $61,111
 2000           $114,426
 2001           $82,239

*Includes license fees of $250 and $150, respectively
</TABLE>

<TABLE>
<CAPTION>
NET INCOME
(DOLLARS IN THOUSANDS)
<S>             <C>
 1997           $6,883
 1998           $6,967
 1999           $10,623
 2000           $27,495
 2001           $13,675
</TABLE>

<TABLE>
<CAPTION>
DILUTED EARNINGS
PER SHARE
<S>             <C>
 1997           $0.58
 1998           $0.58
 1999           $0.89
 2000           $2.06
 2001           $1.02
</TABLE>

--------------------------------------------------------------------------------

                                       1

================================================================================

<PAGE>

"WE EVOLVED FROM BEING A NICHE
PLAYER TO A MAJOR SYSTEM PROVIDER
BY ACQUIRING LOOPCARE."

--------------------------------------------------------------------------------

[PHOTO]

DEAR SHAREHOLDER,

2001 was a tough year for everyone in the telecommunications equipment industry.
Fortunately, we weathered the storm by continuing to focus on products and
services that help our customers reduce costs and effectively deploy new
services.

    Rather than contracting into our shell and deviating from our strategy,
Tollgrade chose to use this time to build for the consumer broadband future.
Specifically, we evolved from a niche player to a major system provider by
acquiring the LoopCare(TM) OSS (Operations Support System) product from Lucent
Technologies and positioning it with our MCU(R) products, DigiTest(R) system and
Professional Services programs to provide a total solution strategy for assuring
POTS (Plain Old Telephone Services) and consumer broadband networks. We also
remained resolute on focusing on our core competency -- maintaining the quality
of consumer communications networks.

RATHER THAN CONTRACTING INTO OUR SHELL AND DEVIATING FROM OUR STRATEGY,
TOLLGRADE CHOSE TO USE THIS TIME TO BUILD FOR THE CONSUMER BROADBAND FUTURE.

    To achieve our long-term goals, we've also retrenched our staff and made
significant additions to our management team. In addition, we formed new,
non-exclusive distribution agreements with Lucent and Acterna to grow our
business internationally. Our organization also focused on a core group of
product development initiatives tied to specific market segments and major
industry trends related to the consumer broadband world.

    In 2001, our revenue was $82.2 million and our earnings per share was $1.02.
Gross profit was 56 percent of revenue; operating expenses came in at 32
percent. We invested more in research and development as a result of adding more
than 30 developers through the LoopCare acquisition. EBITDA was 27 percent of
revenue, income from operations was approximately 24 percent of revenue and net
income a healthy 17 percent of revenue.

    Last year we embarked upon a significant testability improvement initiative
in the former Ameritech region of SBC. This led to a record year of MCU product
sales in the region as well as significant Professional Services work. We also
undertook a successful testability program in Verizon.

    In SBC, we shipped our first DigiTest systems to the region as part of a
major MLT-1 replacement effort. This included the sale of our ATP (Advanced Test
Package) feature for our LoopCare OSS.

    In addition, our balance sheet remains strong. Despite spending more than
$62 million for LoopCare, we ended the year with $38.7 million in cash and
investments. We have no debt.

    The purchase of LoopCare in 2001 was arguably the most significant event in
our company's history. LoopCare controls the testing of approximately 143
million of the 180 million total POTS telephone lines in the United States.
Globally, you can add another 8 million lines to the mix. By incorporating
LoopCare into our product menu, we now offer a total test and management
solution, which can be economically scalable for both the largest RBOCs
(Regional Bell Operating Companies) and the smallest CLECs (Competitive Local
Exchange Carriers).

--------------------------------------------------------------------------------

                                       2

================================================================================

<PAGE>

--------------------------------------------------------------------------------

    Teaming LoopCare with DigiTest creates a powerful end-to-end network
assurance solution for POTS, as well as consumer broadband services, such as DSL
(Digital Subscriber Line).

    In addition, we gained a highly experienced team of software developers and
engineers and added a seasoned leader in Carol Franklin, our general manager of
software products, who brings nearly 30 years of extensive industry experience.
We also added several other key executives, including Greg Quiggle, who joined
us from Acterna, as executive vice president of marketing; Wylie Etscheid,
executive vice president of business development for software products, who
brought more than 30 years of progressive RBOC experience; and Richard Skaare,
executive vice president of organizational development and communication,
who was formerly the head of global communications at AMP Incorporated.

TEAMING LOOPCARE WITH DIGITEST CREATES A POWERFUL END-TO-END NETWORK ASSURANCE
SOLUTION FOR POTS, AS WELL AS CONSUMER BROADBAND SERVICES, SUCH AS DSL.

    2001 also marked the promotion of Matt Rosgone to executive vice president,
operations and Mark Peterson to president. Matt is the grease that keeps the
wheels of our production function turning. Mark continues to do a great job as
he focuses his efforts on overseeing all of our sales channels.

    With these things in place, we seek to achieve the following goals in 2002:

    First, we want to maintain our franchise as the testability improvement
leader through our Professional Services programs. These efforts, coupled with
broadband edge device growth, sustain MCU sales.

    Second, we will focus on implementing our LTS POTS test head replacement
program among key RBOC customers as a means of upgrading their networks for
consumer broadband services.

    Third, we want to position DigiTest and LoopCare as the system of choice for
DSL pre-qualification and wideband testing.

    Fourth, we intend to introduce a solution for DSL testing at remote
DLC(Digital Loop Carrier) sites. This product will leverage embedded MCU
products with state-of-the-art DigiTest wideband technology.

    Fifth, we want to continue to expand our opportunities in the international
marketplace through our relationships with Acterna, Lucent and Nortel.

    Sixth, we will continue to develop embedded test elements for the broadband
edge market.

2001 REVENUES
BY PRODUCT
(PERCENTAGE OF 2001 REVENUE)

[PIE CHART]
<TABLE>
<S>                     <C>
MCU Products            67.8%
DigiTest                14.5%
LoopCare                 5.4%*
TELACCORD(TM)/DAU        4.9%
LIGHTHOUSE               3.7%
Professional Services    3.5%
Other                    0.2%
* Reflects sales during the 4th quarter 2001 only.
</TABLE>


    We've outlined our strategy for accomplishing these goals on the following
pages. As a premier provider of leading-edge test and management solutions, we
are intent on managing the company for the long-term by providing network
assurance products with a vision for the broadband future.

    On behalf of everyone at our company, please accept our thanks for your
continued support.

Very truly yours,

/s/ CHRISTIAN L. ALLISON
CHRIS ALLISON
CHAIRMAN AND
CHIEF EXECUTIVE OFFICER

--------------------------------------------------------------------------------

                                        3
<PAGE>


DRIVING BROADBAND ASSURANCE
TO THE CONSUMER MARKETPLACE

--------------------------------------------------------------------------------

In 2001, Tollgrade reorganized its internal structure and focused on the
consumer broadband marketplace. As part of this initiative, the company added to
its leadership team by blending key external additions with an already deep team
of existing managers. The result is a diverse executive council (shown in the
photographs on the following pages) that is responsible for establishing
Tollgrade's strategic focus on consumer broadband assurance.

A FOCUS ON CONSUMER
BROADBAND ASSURANCE

Tollgrade Communications develops network assurance products to better enable
telephone and cable operators to efficiently manage their networks in an age of
increased competition, continually evolving technology and ongoing pressure to
control or reduce costs.

[PHOTO]

    Tollgrade's leading-edge test and management solutions allow customers to:
-   Competitively roll out digital broadband services;
-   Fully leverage investments in existing network equipment; and
-   Effectively utilize state-of-the-art technology for installing and remotely
    administering, testing and repairing traditional network infrastructure.

    While initial heavy demand for broadband services had slowed in recent
years, there are signs that interest in these services is once again on the
rise. DSL lines in service in North America rose to nearly 5.5 million at the
end of 2001. In the United States, about 10 percent of the homes currently get
broadband -- up from almost none in 1998. And, according to figures compiled by
the Federal Communications Commission, the rate of adoption for broadband
services compares favorably with the rollout of other consumer electronic
products such as color televisions, cellular phones and compact disc players.

    Thus, as demand for broadband services increases, Tollgrade will provide a
means for service providers to utilize traditional consumer network assurance
approaches for the successful delivery of consumer broadband services.

LEADING-EDGE
PRODUCTS AND SERVICES

With the recent acquisition of Lucent's LoopCare(TM) Test Operations Support
System (OSS), Tollgrade has transformed itself from a hardware-based test and
measurement company to a full-system provider of test and management solutions
for network assurance.

[PHOTO]

    Focused on telecommunications Local Exchange Carriers (LECs), including the
Regional Bell Operating Companies (RBOCs), LoopCare works in concert with
DigiTest(R) and MCU(R) measurement hardware to manage the test process for over
75 percent of the copper facilities in North America.

    In addition, Tollgrade's LIGHTHOUSE(R) cable monitoring system combines
hardware and software to efficiently monitor the Broadband Hybrid-Fiber/Coax
(HFC) system of major cable operators.

    Both systems are focused on efficiently managing the local access network.
Tollgrade's solutions enable service providers to drive new service deployments
while limiting operating expenses and capital investments.

    Tollgrade also complements its hardware and software products with
Professional Services that help companies implement new technologies, migrate to
new test access platforms and maintain current network operations. These
services result in rapid deployment of new services, quicker integration with
existing infrastructure and optimization of current network elements.

ANTICIPATING NETWORK NEEDS

While the basic premise of all communications networks is essentially the same,
most service providers optimize their networks for a specific customer base. For
example, the residential telephony marketplace, served by a CONSUMER ACCESS
NETWORK, requires support for an extremely high volume of low-speed connections
while the business subscriber marketplace, served by a

--------------------------------------------------------------------------------

                                        4

================================================================================

<PAGE>

--------------------------------------------------------------------------------

"THE PURCHASE OF LOOPCARE IN 2001 WAS ARGUABLY THE MOST SIGNIFICANT EVENT IN OUR
COMPANY'S HISTORY."
- CHRIS ALLISON, CHAIRMAN AND CEO

"LONG-TERM, THE PRIVATE-LINE AND CONSUMER ACCESS NETWORKS WILL CONVERGE INTO A
SINGLE, IP/ATM ARCHITECTURE."
- MARK PETERSON, PRESIDENT

[PHOTO]

(l to r): Chris Allison, Chairman & CEO; Mark Peterson, President; Matt Rosgone,
EVP, Operations; Rocky Flaminio, Vice Chairman & CTO; Sam Knoch, CFO.


PRIVATE-LINE ACCESS NETWORK, requires support for a lower volume of very
high-speed connections. Furthermore, these same networks are then enhanced for
the delivery of voice, data and/or video services.

    Recognizing these marketplace dynamics, the foundation of Tollgrade's 2002
marketing strategy is a detailed market segmentation model focusing on the
unique needs of these individual network architectures.

CONSUMER ACCESS NETWORK

This network requires remote test solutions for service providers that deliver
voice and data services to the residential and small business mass market.

[CHART]

As the illustration above indicates, the heart of the consumer access
architecture is the Public Switched Telephone Network (PSTN). Often handling
millions of subscribers on a single voice switch, the Consumer Access Network
provides connections that range from basic "life-line" all the way up to
complex, multi-line voice services. Low-speed data services have traditionally
been offered to these subscribers via the same PSTN. However, the need for
higher-speed connections, such as DSL, has driven the deployment of separate,
Asynchronous Transfer Mode (ATM)-based overlay networks that are much more
efficient for converged voice/data/video traffic.

    The price sensitivity of this market demands a test and management solution
that minimizes dispatches. Doing so enables service providers to responsively
meet the needs of a demanding consumer while minimizing costly operating
expenses.

    With the recent acquisition of LoopCare, Tollgrade has emerged as a leader
within the Consumer Access Test and Management marketplace. Currently managing
the test process for the majority of Plain Old Telephone Service (POTS) lines in
North America, Tollgrade is uniquely positioned to help service providers
transition their existing subscriber base to a host of innovative digital voice
and data services, such as DSL. By upgrading their existing Loop Test System
(LTS) infrastructure, service providers can further optimize current POTS
installation and maintenance processes while supporting new service deployments.

    Providing this upgrade path -- through both product development and industry
partnerships -- is the focus of Tollgrade's DIGITAL LTS and PATCH THE POTS HOLES
strategies. "Digital LTS" will enable service providers to competitively roll
out DSL services by upgrading test and measurement infrastructure. "Patch the
POTS Holes" will focus on utilizing Tollgrade technology to optimize remote
testability and automated flow-through processes for the installation and
maintenance of legacy POTS equipment.

--------------------------------------------------------------------------------

                                        5

================================================================================

<PAGE>

                          DRIVING BROADBAND ASSURANCE
                          TO THE CONSUMER MARKETPLACE


--------------------------------------------------------------------------------

PRIVATE-LINE ACCESS NETWORK

This network requires remote test solutions for service providers that deliver
high-speed communications services -- including voice, data, and video -- to
medium and large businesses.

[CHART]

Understanding that these business customers often require fixed connections
between multiple locations, the private-line architecture has been traditionally
based on a non-switched network of Time Division Multiplexers (TDM) and Digital
Cross-Connect Systems (DCS). Offering more efficient use of highly valuable
bandwidth and simplified provisioning, most Private-Line Networks have evolved
in recent years to rely upon an ATM infrastructure -- replacing a fixed TDM path
with Permanent Virtual Circuit (PVC).

    In this marketplace, the need for flawless service quality far exceeds any
other. In fact, a vast majority of today's businesses simply can't function
without vital communications services. As a result, Private-Line test and
management solutions must focus on quickly diagnosing complex network problems
-- often involving multiple service providers and networks around the world --
regardless of the cost. Unlike the consumer marketplace, a trouble within the
Private-Line Network can easily cost the business customer -- and service
provider -- thousands of dollars every hour.

    Although Tollgrade is not currently a full system provider for the
Private-Line test and management marketplace, it has focused heavily on enabling
broadband deployments through key industry relationships. Specifically,
Tollgrade develops broadband-focused test solutions that are integrated with
industry leading network element and Private-Line test manufacturers. Leveraging
its breakthrough copper test platform, the Integrated Measurement Unit (IMU),
Tollgrade's IMU ANYWHERE initiative focuses on playing an integral role for test
and management solutions developed in conjunction with industry leaders such as
Lucent, Nortel, Alcatel, and Acterna. These solutions are aimed at providing the
optimal price/performance product for the network edge.

"THE MOST ECONOMICAL WAY TO MANAGE DSL DEPLOYMENT IS NOT AS A SPECIAL SERVICE,
BUT RATHER AS A CONSUMER, MASS MARKET SERVICE."
- WYLIE ETSCHEID EVP, NEW BUSINESS DEVELOPMENT

"WITH MORE THAN 20 YEARS OF PROGRESSIVE DEVELOPMENT BEHIND IT, LOOPCARE PROVIDES
A COMPLETE LOOP SERVICE ASSURANCE SYSTEM FOR POTS AND BROADBAND SERVICES LIKE
DSL."
- CAROL FRANKLIN, GM, SOFTWARE PRODUCTS

[PHOTO]

(l to r): Roger Smith, EVP, Technology; Jim Price, SVP, Systems Engineering;
Rich Bair, EVP, Engineering & Testing; Wylie Etscheid, EVP, Business
Development; Carol Franklin, GM, Software Products

--------------------------------------------------------------------------------

                                        6

================================================================================

<PAGE>

                          DRIVING BROADBAND ASSURANCE
                          TO THE CONSUMER MARKETPLACE


--------------------------------------------------------------------------------

"WE'RE SEEING A SHIFT IN THE MARKETPLACE FROM BUILDING CAPACITY IN THE NETWORK
CORE TO FILLING CAPACITY AT THE NETWORK EDGE."
- GREG QUIGGLE EVP, MARKETING

"INVESTING IN TESTABILITY MAKES SENSE BECAUSE GOOD TESTING REDUCES
COMMUNICATIONS COMPANIES' COSTS AND KEEPS CUSTOMERS SATISFIED."
- STEPHANIE WEDGE VP, PROFESSIONAL SERVICES

[PHOTO]

(l to r): Stephanie Wedge, VP, Professional Services; Joe O'Brien, SVP, Human
Resources; Rich Skaare, EVP, Organizational Development & Communication; Sara
Antol, General Counsel; Greg Quiggle, EVP, Marketing

CABLE BROADBAND NETWORK
This network requires remote test solutions for service providers that deliver
video and data services to the residential marketplace.

[CHART]

The Cable Broadband Network is optimized for the delivery of high-quality video
broadcasts. Recent transitions to a digital HFC architecture have enabled this
same video network to provide extremely cost-effective data services, such as
high-speed Internet access.

    Minimizing dispatches is the focus of a Cable Broad- band test solution.
Doing so, however, requires the unique ability to isolate troubles without
invoking intrusive tests.

    Through disciplined investments in the LIGHTHOUSE product family, Tollgrade
has obtained a technology leadership position within the Cable Broadband
marketplace. Continued digital network build-outs, combined with new cable
monitoring interoperability standards, are creating numerous opportunities to
leverage this leadership position. Tollgrade's strategy, known as ELEPHANT GUN,
focuses on aiming an intensified sales and marketing campaign at premier cable
service providers.

THE IP/ATM INFRASTRUCTURE...
A COMMON NETWORK ELEMENT
Whether a Consumer Access, Private-Line, or Cable Broadband Network, the
industry is transitioning to a unified IP/ATM soft network infrastructure. This
transition will create a common set of challenges to service providers. Remote
verification and trouble isolation in a "virtual" network will continue to
require new and innovative test and management processes. The DIGITAL WITHOUT A
DISPATCH initiative is focused on providing support for these new IP/ATM
processes across Tollgrade's Telecommunications and Cable Broadband solutions.

PROFESSIONAL SERVICES...
BRINGING IT ALL TOGETHER
Service providers face many obstacles in today's turbulent economic times.
Network expertise has been challenged as a result of workforce reductions and
increased pressure to reduce costs by automating test processes.

    Tollgrade's Professional Services can develop testability programs to meet
these challenges by offering a variety of programs that support the planning,
implementation, deployment and maintenance phases of a network's lifecycle.
These programs have been successful because they are managed by some of the most
highly skilled individuals in the industry. These Tollgrade employees have
intimate first-hand network organization knowledge gained from years of
experience in the RBOC testing environment.

--------------------------------------------------------------------------------

                                        7

================================================================================

<PAGE>


SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data of the Company as of December 31, 1997,
1998, 1999, 2000, 2001 and for the years then ended is derived from audited
consolidated financial statements of the Company.

<TABLE>
<CAPTION>
                                   (In Thousands, Except Per Share Data and Number of Employees)
                                                     Years Ended December 31,
                                        1997        1998       1999        2000        2001
---------------------------------------------------------------------------------------------------------------
<S>                                  <C>         <C>        <C>         <C>         <C>
STATEMENTS OF OPERATIONS DATA:
Revenues:
    Products                         $ 45,421    $ 46,277   $ 60,031    $111,957     $77,612
    Services                               --          --      1,080       2,469       4,627
---------------------------------------------------------------------------------------------------------------
                                       45,421      46,277     61,111     114,426      82,239
Cost of sales:
    Products                           20,104      19,620      24,298     40,680      33,134
    Services                               --          --        716       1,958       2,555
    Amortization                           --          --         --          --         365
---------------------------------------------------------------------------------------------------------------
                                       20,104      19,620     25,014      42,638      36,054
---------------------------------------------------------------------------------------------------------------
Gross profit                           25,317      26,657     36,097      71,788      46,185
---------------------------------------------------------------------------------------------------------------
Operating expenses:
    Selling and marketing               5,446       5,704      7,006      12,289       9,160
    General and administrative          3,768       4,128      4,723       6,216       4,827
    Research and development            5,945       6,880      8,757      12,456      12,428
    Severance and related expense          --          --         --          --         291
---------------------------------------------------------------------------------------------------------------
Total operating expense                15,159      16,712     20,486      30,961      26,706
---------------------------------------------------------------------------------------------------------------
Income from operations                 10,158       9,945     15,611      40,827      19,479
Other income, net                         899       1,062        949       2,525       2,796
---------------------------------------------------------------------------------------------------------------
Income before taxes                    11,057      11,007     16,560      43,352      22,275
Provision for income taxes              4,174       4,040      5,937      15,857       8,600
---------------------------------------------------------------------------------------------------------------
Net income                           $  6,883    $  6,967   $ 10,623    $ 27,495    $ 13,675
---------------------------------------------------------------------------------------------------------------

EARNINGS PER SHARE INFORMATION:
Net income per common share: (1)
    Basic                            $   0.61    $   0.60   $   0.92    $   2.18    $   1.05
---------------------------------------------------------------------------------------------------------------
    Diluted                          $   0.58    $   0.58   $   0.89    $   2.06    $   1.02
---------------------------------------------------------------------------------------------------------------
Weighted average shares
    of common stock and equivalents:
    Basic                              11,372      11,683     11,574      12,636      13,038
---------------------------------------------------------------------------------------------------------------
    Diluted                            11,923      11,933     11,959      13,359      13,412
---------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
                                                        As of December 31,
                                        1997        1998       1999        2000        2001
---------------------------------------------------------------------------------------------------------------
<S>                                  <C>         <C>        <C>         <C>         <C>
BALANCE SHEET DATA:
Working capital                      $ 34,570    $ 40,539   $ 49,958    $111,135    $ 67,628
Total assets                           43,713      49,865     66,202     131,275     146,630
Shareholders' equity                   38,101      45,696     57,504     122,760     140,139

                                         1997        1998       1999        2000        2001
---------------------------------------------------------------------------------------------------------------
OTHER DATA: (2)
Number of employees at year end           205         230        282         411         341
Average revenue per employee         $    222     $   201    $   217    $    278    $    241
---------------------------------------------------------------------------------------------------------------
</TABLE>

(1) 1998 includes $.02 per share related to the after-tax effect of net key man
    life insurance proceeds associated with the death of the Company's former
    Chairman R. Craig Allison.
(2) Data is unaudited and not derived from Company's audited financial
    statements.


                                        8

================================================================================

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

The following discussion should be read in conjunction with the "Selected
Consolidated Financial Statements" and notes thereto appearing elsewhere in this
Annual Report to Shareholders.

CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995.

The statements contained in this Annual Report to Shareholders, specifically
those contained in the following Management's Discussion and Analysis of Results
of Operations and Financial Condition which are not historical are
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. These forward-looking statements represent Tollgrade Communications,
Inc.'s (the "Company") present expectations or beliefs concerning future events.
The Company cautions that such statements must be qualified by important factors
that could cause actual earnings and other results to differ materially from
those achieved in the past or those expected by the Company. These statements as
to management's beliefs, strategies, plans, expectations or opinions in
connection with Company performance, are based on a number of assumptions
concerning future conditions that may ultimately prove to be inaccurate. Such
statements must be qualified by important factors that could cause actual
earnings and other results to differ materially from those achieved in the past
or those expected by the Company. These include:
-   General economic conditions and the economic conditions of the
    telecommunications industry;
-   Customers' ability to meet established purchase forecasts and their own
    growth projections;
-   The ability of certain customers to maintain financial strength and access
    to capital;
-   The ability of sales and marketing partners to meet their own performance
    objectives (and, in certain cases, continue to provide vendor financing to
    certain local exchange carriers);
-   Customers' seasonal buying patterns and the risk of order cancellations;
-   Risk of shortage of key manufacturing components and possibility of limited
    source of supply;
-   Manufacturing delays and availability of manufacturing capacity;
-   Intense competition in all markets for the Company's products;
-   Uncertain pace and scope of technological change along with the need to
    continually develop new products and gain customer acceptance and approval;
-   The Company's dependence on a relatively narrow range of products and a
    small number of large customers;
-   The Company's dependence on key employees and upon proprietary rights;
-   Difficulties in managing the Company's growth;
-   The Company's dependence upon certain suppliers;
-   Risks of third party claims of infringement;
-   Risk of product defects; and
-   Changes in government regulation affecting the business of the Company and
    its customers.

The Company does not undertake any obligation to publicly update any
forward-looking statements.

OVERVIEW

The Company was organized in 1986 and began operations in 1988. The Company
designs, engineers, markets and supports test system, test access and status
monitoring products for the telecommunications and cable television industries.
Effective September 30, 2001, the Company purchased certain assets of the
LoopCare(TM) product business from Lucent Technologies, Inc. ("Lucent"). These
assets consisted of LoopCare software base code and developed enhancements, as
well as the rights to existing maintenance contracts for the LoopCare software.
Effective September 30, 2001, revenues from the sales of either software base
code or developed enhancements are reported as part of the Company's revenues
attributable to test system products to which they synergistically relate, while
the revenues from existing and any new maintenance contracts are reflected as
part of the Company's Professional Services revenues. Refer to the Liquidity and
Capital Resources section on page 14 for further discussion regarding this
acquisition.

    The Company has determined that its business has one reportable segment in
the test assurance industry. All product sales are considered components of the
business of testing infrastructure and networks for the telecommunications and
cable television industries. While the Company does internally develop sales
results and other financial results associated with the various product
categories, this information is not considered sufficient for segment reporting
purposes nor does the chief operating decision maker make critical decisions
based solely on this information. Its products and services have similar
economic characteristics, the same or similar production processes and are sold
to similar types or classes of customers in, or entering into, the
telecommunications business through similar distribution means. The LoopCare
software product line business was acquired by the Company to broaden its
DigiTest(R) test platform into a system level offering.

    The Company's telecommunications proprietary test access products enable
telephone companies to use their existing line test systems to remotely diagnose
problems in Plain Old Telephone Service ("POTS") lines containing both copper
and fiber-optics. The Company's MCU(R) product line, which includes POTS line
testing as well as alarm-related products, represented approximately 68% of the
Company's revenue for the year ended December 31, 2001 and will continue to
account for a majority of the Company's revenues for the foreseeable future.

    The Company's DigiTest centralized network test system platform, which
includes the LoopCare software base code and developed enhancements, focuses on
helping local exchange carriers conduct the full range of fault diagnosis, along
with the ability to qualify, deploy and maintain next generation services that
include Digital Subscriber Line ("DSL") service and Integrated Services Digital
Network ("ISDN") service. The Company's DigiTest system is designed to provide
the complete solution for testing POTS and performing local loop
prequalification for DSL services. The system currently consists of the
comprehensive LoopCare diagnostic software, as well as three integrated pieces
of hardware, the Digital Measurement Node ("DMN"), the Digital Measurement Unit
("DMU"), and the Digital Wideband Unit ("DWU").

                                        9

================================================================================

<PAGE>

                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

When used in an integrated fashion, the DigiTest system permits local exchange
carriers to perform a complete array of central office testing including POTS,
DSL line prequalification, bridged tap detection, data rate prediction, and
in-service wideband testing. Sales of the DigiTest product line, including $2.8
million of LoopCare software license right-to-use fees since September 30, 2001,
accounted for approximately 18% of the Company's revenue for the year ended
December 31, 2001.

    The Company's LIGHTHOUSE(R) cable products consist of a complete cable
status monitoring system that provides a broad testing solution for the
Broadband Hybrid-Fiber/Coax distribution system. The status monitoring system
includes a host for user interface, control and configuration; a headend
controller for managing network communications; and transponders that are
strategically located within the cable network to gather status reports from
power supplies, line amplifiers and fiber-optic nodes. Sales of the LIGHTHOUSE
product line accounted for approximately 4% of the Company's revenue for the
year ended December 31, 2001.

    In 2001, sales of the Company's Digital Access Unit ("DAU") were
approximately 5% of the Company's revenue. This access product was being sold
primarily to Sprint in connection with its recently discontinued IONProject.

    Through 2001, the Company continued to build upon and extend its
Professional Services offering to customers. The cornerstone of the Company's
Professional Services business is the Testability Improvement Initiatives. These
services may offer the customer the opportunity to make dramatic improvements in
testability levels, while training their own staffs in targeted geographic
regions over a defined period of time. In this way, the customers' internal
repair technicians can make use of automated systems to diagnose and repair
subscriber loop problems, thereby automatically eliminating the need for the
involvement of several highly trained people to do so. The service offering was
expanded upon the acquisition of software maintenance contracts related to the
LoopCare software product line. Including these software maintenance revenues of
$1.7 million since September 30, 2001, annual Professional Services revenue
accounted for approximately 6.0% of the Company's revenue for the year ended
December 31, 2001.

    The Company's telecommunications product and services sales are primarily to
the four Regional Bell Operating Companies ("RBOCs"), as well as major
independent telephone companies and to certain equipment manufacturers. For the
year ended December 31, 2001, approximately 71% of the Company's total revenue
was generated from sales to the RBOCs, the three largest of which individually
comprised approximately 38%, 14% and 14%, or a combined 66%, of total revenue.
In addition, one major independent telephone company contributed approximately
10.4% of the Company's total revenue. The Company markets and sells its products
directly, as well as through various Original Equipment Manufacturer ("OEM") and
reseller arrangements.

    The Company's operating results have fluctuated and may continue to
fluctuate as a result of various factors, including the timing of orders from,
shipments to, and acceptance of software by the RBOCs and significant
independent telephone companies. This timing is particularly sensitive to
various business factors within each of the company's significant customers
including their relationships with their various organized labor groups. In
addition, the markets for the Company's DigiTest and LIGHTHOUSE products are
highly competitive. Due to the rapidly evolving market in which these products
compete, additional competitors with significant market presence and financial
resources could further intensify the competition for these products.

    The Company believes that recent changes within the telecommunication
marketplace, including industry consolidation, as well as the Company's ability
to successfully penetrate certain new markets, have resulted in some discounting
and more favorable terms granted to certain customers of the Company. In
addition, certain customers have consolidated product purchases that have
translated into large bulk orders. Although the Company will continue to strive
to meet the demands of its customers, which include delivery of quality products
at an acceptable price and on acceptable terms, there are no assurances that the
Company will be successful in negotiating acceptable terms and conditions in its
purchase orders or its customer purchase agreements. Additionally, continuing
consolidation efforts among the RBOCs, and their ability to consolidate their
inventory and product procurement systems could cause fluctuations or delays in
the Company's order patterns. Also, recent efforts in the cable industry to
consolidate as well as to standardize transponders among status monitoring
systems could cause pricing pressure as well as affect deployment within certain
customers of the Company's cable products. These standards were adopted by the
standards setting body in the year 2001 and may adversely affect the Company's
revenues from such products in the year 2002 and in subsequent periods. In
addition, markets for the Company's LIGHTHOUSE products have been, and may
continue to be, difficult for the foreseeable future. The Company cannot predict
such future events or business conditions and the Company's results could be
adversely affected by these industry trends in the primary markets its serves.

    Although international sales to date have not been significant, the Company
believes that certain international markets may offer opportunities. The
addition of the LoopCare software product line may provide further opportunities
to penetrate this market. However, the international telephony markets differ
from those found domestically due to the different types and configurations of
equipment used by those international communication companies to provide
services. In addition, certain competitive elements are found internationally
which do not exist in the Company's domestic markets. These factors, when
combined, have made entrance into these international markets very difficult.
From time to time, the Company has utilized the professional services of various
marketing consultants to assist in defining the Company's international market
opportunities. With the assistance of these consultants and through direct
marketing efforts by the Company, it has been determined that its present MCU
technology offers limited opportunities in certain international markets for
competitive and other technological reasons. The Company continues to evaluate
opportunities for its other products in international markets. However, there
can be no assurance that any continued efforts by the Company will be successful
or that the Company will achieve significant international sales.

    The Company believes that continued growth will depend, in part, on its
ability to design and engineer new products and, therefore, spends a significant
amount on research and development. Research and development expenses as a
percent of revenues were approximately 15% for the year ended December 31, 2001.

    The Company believes that the economic climate will continue to be one of
challenge and uncertainty. In response to such uncertainty, effective April
2001, the Company eliminated approximately 80 positions resulting in $4.3
million of annual savings for which the Company received the pro-rata benefit in
2001. In addition, the Company believes that future growth will be affected as a
result of an overall continued economic slowdown whereby customers may become
even more conservative in their ordering patterns and quantities, and certain
emerging carriers will continue to be hampered by financial instability. Due to
this uncertainty, the Company will continue to evaluate its investments

                                       10

<PAGE>

                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

in production, marketing and research and development expenses and monitor,
control or decrease expense levels, as appropriate.

CRITICAL
ACCOUNTING POLICIES

The Company's financial statements are prepared in conformity with accounting
principles generally accepted in the United States of America. Certain of these
accounting principles are more important than others in gaining an understanding
of the basis upon which the Company's financial statements have been prepared.
The Company considers the following accounting principles to be critical to the
preparation of its consolidated financial statements:

    Revenue Recognition -- The Company markets and sells POTS and broadband test
system hardware, and, since the September 30, 2001 acquisition of LoopCare,
related software. For hardware sales, the Company follows Staff Accounting
Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB 101"). This
bulletin requires, among other things, that revenue only be recognized when
title has transferred and risk of loss has passed to a customer with the
capability to pay, and that there be no significant remaining obligations
related to the sale on the part of the Company. For software perpetual license
fee and maintenance revenue, the Company follows the AICPA's Statement of
Position "Software Revenue Recognition" SOP 97-2 and related modifications. This
statement requires that software license fee revenue be recorded only when
evidence of a sales arrangement exists, the software has been delivered, and a
customer with the capacity to pay has accepted the software leaving no
significant obligations on the part of the Company to perform. Software
maintenance revenue is recognized on a straight-line basis over the period the
respective arrangements are in effect.

    The Company also performs testability consulting work in its Professional
Services group on a time and material basis. Revenue for this work is recognized
on an accrual basis as the work is performed and costs are incurred.

    Segment Information -- The Company applies Statement of Financial Accounting
Standards (SFAS) No. 131, "Disclosures about Segments of an Enterprise and
Related Information." The Company markets and sells several products, but each
have the same or similar economic characteristics, production processes, are
subject to similar regulatory environments, and are sold to the same or similar
types or classes of customers through the same distribution process. The chief
decision maker allocates resources on the whole, rather than on the parts, of
the Company's business. Therefore, the Company has determined that it has one
operating segment and reports its business activities as such.

    Acquisition and Related Intangible Assets -- The Company made a significant
acquisition of assets and assumed certain liabilities of the LoopCare product
line from Lucent effective September 30, 2001. Consideration paid was $62.0
million including deal-related costs. This acquisition was recorded in
accordance with the transitional guidance of SFAS No. 141 which required the
transaction to be recorded under the purchase method of accounting. This method
requires that the purchase price be allocated to identifiable tangible and
intangible assets, with any excess allocated to goodwill. As this transaction
involved primarily the acquisition of intellectual property and contractual
rights, a substantial portion of the purchase price was allocated to intangible
assets and goodwill. With regard to the establishment of fair value for the
intangible assets under the transitional guidance of SFAS No. 141, and for
guidance as to how these intangible assets should be viewed in light of the
transitional rules of SFAS No. 142, the Company engaged a valuation consultant
who is independent of the management and owners of the Company. This independent
valuation consultant assisted the Company in determining that approximately
$45.8 million of the $62.0 million purchase price was allocable to specific
intangible assets at the date of acquisition. Due to the fact that the LoopCare
software has been utilized for over 25 years by the Company's key customers, as
well as being deeply integrated into their basic quality control systems, it was
determined under the transitional guidance of SFASNo. 142 that $38.5 million of
these intangible assets had indefinite lives at the date of acquisition and
would not be subject to amortization. The Company will fully adopt the
provisions of SFAS Nos. 141 and 142 effective January 1, 2002; non-amortizable
intangibles and goodwill will be evaluated under SFAS No. 142 as required in
2002.

    Income Taxes -- The Company follows the provisions of SFAS No. 109,
"Accounting for Income Taxes," in reporting the effects of income taxes in its
consolidated financial statements. Temporary differences between book and
taxable income result in deferred taxes in the Company's consolidated financial
statements. The Company believes all of its deferred tax assets are realizable
at their present recorded values, and, hence, believes there are no requirements
to provide any allowances against such assets.

    Investments -- The Company follows SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," with regard to accounting for its
short- and long-term investments. All of these investments are held in at least
investment-grade municipal bonds and are accounted for as "held-to-maturity"
securities and reflected in the consolidated balance sheet at amortized cost.


YEAR ENDED DECEMBER 31,
2001 COMPARED TO YEAR
ENDED DECEMBER 31, 2000

REVENUES

Revenues for the year ended December 31, 2001 were $82.2 million, and were
$32.2 million or 28.1% lower than the revenues of $114.4 million for the year
ended December 31, 2000. The decrease in revenues is primarily associated with a
decrease in the unit volume sales of traditional MCU products, the Company's
DigiTest system, and the Company's LIGHTHOUSE Cable Status Monitoring System,
offset slightly by an increase in billings related to the Company's Professional
Services business. During 2001, the sales of the Company's MCU product line
decreased by approximately $24.6 million, or 30.6%. This decrease in sales of
the MCU product line resulted primarily from decreased sales to Qwest as that
company's testability initiative matured. In addition, MCU sales decreased to
SBC Communications, Inc. (including Ameritech, Pacific Bell and SNET) during
2001 primarily as a result of a slowdown in the rollout of Project Pronto, that
company's broadband initiative. Also contributing to the decrease in MCU sales
during 2001 were decreased sales of core MCU products to BellSouth and Verizon
primarily associated with slowdowns in programs to upgrade select DLC systems
within certain regions with MCU technology. The MCU product line accounted for
approximately 67.8% of the current year revenues. During 2001, the sales of the
Company's DigiTest product line, including $2.8 million of LoopCare software,
decreased by approximately $6.4 million, or 30.4%. This decrease in DigiTest
sales was primarily the result of decreased direct shipments during 2001 to
Sprint USA and SBC Telecom, Inc., which is the Competitive Local Exchange
Carrier ("CLEC") subsidiary of SBC. The decline in sales of DigiTest to Sprint
occurred in connection with Sprint's decision to discontinue its IONProject,
while SBC Telecom, Inc. substantially curtailed its plan for expansion. In
addition, reduced sales of DigiTest to Nortel Networks and Lucent for deployment
into the domestic CLEC markets, as well as reduced sales to Verizon for the
replacement of certain

                                       11


<PAGE>

                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

Lucent Loop Testing System ("LTS") test head trunks for qualification of copper
lines for Digital Subscriber Line ("DSL") service, contributed to the overall
decrease in DigiTest sales during the current year. This was offset somewhat by
direct sales of DigiTest to SBC Communications, Inc. for MLT-1 replacement, as
well as sales to Nortel in anticipation of distribution in the international
market. Overall, DigiTest sales accounted for approximately 17.8% of the current
year revenues. Revenues from the Company's Professional Services group in 2001
increased by $2.2 million, or 87.4%. This includes $1.7 million of software
maintenance fees associated with the LoopCare acquisition. The Company is
continuing to expand its service offerings in order to provide its customer base
with a full complement of expertise. Professional Services revenue accounted for
5.6% of current year revenues. During 2001, sales of the Company's Digital
Access Unit increased by approximately $3.4 million, from $.6 million in the
prior year. This product was developed to provide cost-effective test access in
applications where it had not been provided for by the equipment manufacturer,
and was primarily being sold to Sprint for use in its recently discontinued
IONProject. Overall, sales of the Company's DAUwere approximately 4.9% of the
Company's revenues. During 2001, sales of the Company's LIGHTHOUSE Cable Status
Monitoring System decreased by approximately $6.8 million, or 69.2%. This
decrease was primarily a result of decreased product sales to RCN Corporation
and AT&T Broadband as a result of their decisions to delay purchases of cable
related equipment. Overall, sales of the LIGHTHOUSE Cable Status Monitoring
System accounted for approximately 3.7% of the current year revenues.

    Revenues from the LoopCare product line in the three-month period ended
December 31, 2001 were $4.5 million, comprised of $2.8 million in license
right-to-use fees and $1.7 million of maintenance fees. Gross margins on these
revenues are substantially higher than other product lines of the Company, and
the resulting impact on earnings was material for this period and the year.
Offsetting these revenue increases were declines for the year and the fourth
quarter in the Company's traditional MCU-related products as less purchasing
incentives were offered by the Company as well as a continued general softening
in the Company's test access markets. The Company expects the softness in its
core equipment markets to continue for the foreseeable future as its key
customers continue to restrict their capital budgets. The Company's strategy
will be to supplement declining revenues from traditional MCU and related
equipment product lines with LoopCare software license right-to-use fee revenue.
As these software license products generally have long development and selling
cycles, creating possibly significant revenue variations, there can be no
assurance that the Company will be successful in the implementation of this
strategy.

    Management continues to believe that there is a possibility that customer
requirements for certain important MCU products which are utilized in legacy DLC
systems may be satisfied at some point. In order to reduce associated risks, the
Company is focusing on the development of new product lines to attempt to meet
the other requirements of customers.

GROSS PROFIT

Gross profit for 2001 was $46.2 million compared to $71.8 million for 2000,
representing a decrease of $25.6 million, or 35.7%. Gross profit as a percentage
of revenues decreased to 56.2% for 2001 compared to 62.7% for 2000. The overall
decrease in gross profit resulted primarily from the decreased sales levels,
while the decline in gross margin as a percentage of sales was a result of
decreased production volumes and associated decreases in cost absorption levels.
To maintain the current gross margin levels, the Company will need to maintain
pricing and gain further cost reductions. Gross margin levels will also depend
on the actual mix of products sold. The LoopCare software product line carries
higher gross margins and the Company's cable products carry lower gross margins
than those earned historically on the Company's telecommunication products. In
addition, if sales of the Company's DigiTest product line increases on an OEM or
reseller basis, the overall margins would decline slightly as a result of a
greater mix of lower-margin OEM sales versus direct sales.

SELLING AND
MARKETING EXPENSE

Selling and marketing expenses consist primarily of personnel costs as well as
commissions and travel expenses of direct sales and marketing personnel, and
costs associated with various promotions and related marketing programs. Selling
and marketing expense for 2001 was $9.2 million, or 11.1% of revenues, compared
to $12.3 million, or 10.7% of revenues for 2000. This decrease of $3.1 million,
or 25.5%, is primarily due to a decrease in the number of sales and marketing
personnel due to a reduction in personnel in April 2001, a decrease in
incentives and commissions associated with the lower sales levels, and cost
reductions in the areas of advertising, promotion and related marketing
activities.

GENERAL AND
ADMINISTRATIVE EXPENSE

General and administrative expenses consist primarily of personnel costs for
finance, administrative and general management personnel as well as accounting
and legal expenses. General and administrative expense for 2001 was $4.8
million, or 5.9% of revenues, compared to $6.2 million, or 5.4% of revenues for
2000. This decrease of $1.4 million, or 22.3%, is primarily attributable to a
decrease in employee recruiting-related expenditures, decreased incentive
compensation, as well as a decrease in certain professional service and
consulting fees.

RESEARCH AND
DEVELOPMENT EXPENSE

Research and development expenses consist primarily of personnel costs and costs
associated with the development of new products and technologies, including
DigiTest and LIGHTHOUSE, and enhancing features of existing products. Research
and development expense for 2001 was $12.4 million, or 15.1%, of revenues,
compared to $12.5 million, or 10.9%, of revenues for 2000. This decrease of $.1
million was principally due to a reduction of engineering personnel in April
2001, offset by the additional personnel acquired as part of the LoopCare
acquisition. The Company expenses all research and development costs as they are
incurred.

OTHER INCOME
AND EXPENSE

Other income, which consists primarily of interest income, was $2.8 million for
2001 compared to $2.5 million for 2000. The increase of $.3 million, or 10.7%,
is primarily attributable to an increase in funds available for investment
between periods.

PROVISIONS
FOR INCOME TAXES

The Company's effective tax rate for 2001 was 38.6% of income before income
taxes, compared to the 36.6% rate in 2000. The increase in the effective income
tax rate was primarily due to higher relative levels of income taxes associated
with expanding business activities.

NET INCOME AND
EARNINGS PER SHARE

For the year ended December 31, 2001, net income was $13.7 million compared to
$27.5 million for the year ended December 31, 2000, representing a decrease of
$13.8 million, or 50.3%. Diluted earnings per common share of $1.02 for 2001
decreased by 50.5%, or

                                       12


<PAGE>

                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

$1.04, from the $2.06 earned in 2000. Diluted weighted average shares of common
stock and equivalents outstanding were 13,412,037 in 2001 compared to 13,359,270
in 2000. This increase in the diluted weighted average shares of common stock
and equivalents outstanding is primarily the result of the effect on 2001 of
exercised stock options. As a percentage of revenues, net income for 2001
decreased to 16.6% from 24.0% in 2000.

YEAR ENDED DECEMBER 31,
2000 COMPARED TO YEAR
ENDED DECEMBER 31, 1999

REVENUES

Revenues for the year ended December 31, 2000 were $114.4 million, and were
$53.3 million or 87.2% higher than the revenues of $61.1 million for the year
ended December 31, 1999. The increase in revenues was primarily associated with
an increase in the unit volume sales of core MCU products, increased sales
associated with the Company's next generation DigiTest system, increased sales
of the Company's LIGHTHOUSE Cable Status Monitoring System, as well as increased
billings related to the Company's Professional Services business. During 2000,
the Company increased the sales of its MCU product line by approximately $32.8
million, or 68.9%. This increase in sales of the MCU product line resulted
primarily from increased sales to SBC Communications, Inc. (including Ameritech,
Pacific Bell, and SNET) associated with Project Pronto, that company's broadband
initiative. In addition, MCU sales increased to Verizon (formerly Bell Atlantic)
during 2000 primarily as a result of certain ongoing remediation programs
launched by the Company to improve Verizon's MLT testability and flow-through
capabilities. Also contributing to the increase in MCU sales during 2000 were
increased sales of core MCU products to BellSouth primarily associated with a
program to upgrade select DLC systems within certain regions from remote
terminal test devices to MCU technology. The MCU product line accounted for
approximately 70.2% of revenues for the year. During 2000, the sales of the
Company's DigiTest product line increased by approximately $14.4 million, or
218.4%. This increase in DigiTest sales was primarily the result of increased
direct shipments during 2000 to Sprint USA and SBC Telecom, Inc., which is the
Competitive Local Exchange Carrier ("CLEC") subsidiary of SBC. In addition,
sales of DigiTest to Nortel Networks and Lucent for deployment into the CLEC
markets, as well as sales to Verizon for the replacement of certain Lucent Loop
Testing System ("LTS") test head trunks for qualification of copper lines for
Digital Subscriber Line ("DSL") service, contributed to the overall increase in
DigiTest sales during the current year. Overall, DigiTest sales accounted for
approximately 18.4% of the current year revenues. During 2000, the sales of the
Company's LIGHTHOUSE Cable Status Monitoring System increased by approximately
$5.5 million, or 126.9%. This increase was primarily a result of increased
product sales to RCN Corporation, offset slightly by a decrease in sales during
the current year to AT&T Broadband as a result of their decision to delay
purchases of cable related equipment. Overall, sales of the LIGHTHOUSE Cable
Status Monitoring System accounted for approximately 8.6% of the current year
revenues.

GROSS PROFIT

Gross profit for 2000 was $71.8 million compared to $36.1 million for 1999,
representing an increase of $35.7 million, or 98.9%. Gross profit as a
percentage of revenues increased to 62.7% for 2000 compared to 59.1% for 1999.
The overall increase in gross profit resulted primarily from the increased sales
levels, while improvements in gross margin as a percentage of sales were a
result of a favorable sales mix in relation to higher-margined products, as well
as increased sales volumes and associated manufacturing efficiencies.
Maintaining the Company's current gross margin levels is contingent on its
ability to negotiate price increases and gain further cost reductions.
Furthermore, continuing gross margin levels will depend on the actual mix of
products sold which will include the effect of the Company's cable products that
carry lower gross margins than earned historically on the Company's
telecommunication products. In addition, if the sales mix of the Company's
DigiTest product line increases with partner companies, such as Nortel Networks
or Lucent, the overall margins would decline slightly as a result of a greater
mix of lower-margin OEM sales versus direct sales.

SELLING AND
MARKETING EXPENSE

Selling and marketing expenses consist primarily of personnel costs as well as
commissions and travel expenses of direct sales and marketing personnel, and
costs associated with various promotions and related marketing programs. Selling
and marketing expense for 2000 was $12.3 million, or 10.7% of revenues, compared
to $7.0 million, or 11.5% of revenues for 1999. This increase of $5.3 million,
or 75.4%, was primarily due to an increase in the number of sales and marketing
personnel to support new product introductions and enhance customer support, as
well as an increase in commissions associated with the increased sales level and
increased expenditures on advertising, promotion and related marketing
activities.

GENERAL AND
ADMINISTRATIVE EXPENSE

General and administrative expenses consist primarily of personnel costs for
finance, administrative and general management personnel as well as accounting
and legal expenses. General and administrative expense for 2000 was $6.2
million, or 5.4% of revenues, compared to $4.7 million, or 7.7% of revenues for
1999. This increase of $1.5 million, or 31.6%, was primarily attributable to an
increase in employee recruiting- related expenditures, increased legal expenses
as well as an increase in certain professional service and consulting fees.

RESEARCH AND
DEVELOPMENT EXPENSE

Research and development expenses consist primarily of personnel costs and costs
associated with the development of new products and technologies, including
DigiTest and LIGHTHOUSE, and enhancing features of existing products. Research
and development expense for 2000 was $12.5 million, or 10.9%, of revenues,
compared to $8.8 million, or 14.3%, of revenues for 1999. This increase of $3.7
million, or 42.3%, was principally due to the addition of personnel to support
new product development activities and the project costs associated with product
development. The Company expenses all research and development costs as they are
incurred.

OTHER INCOME AND EXPENSE

Other income, which consists primarily of interest income, was $2.5 million for
2000 compared to $1.0 million for 1999. The increase of $1.5 million, or 166.2%,
was primarily attributable to an increase in funds available for investment
between periods.

PROVISIONS
FOR INCOME TAXES

The Company's effective tax rate for 2000 was 36.6% of income before income
taxes, compared to the 35.9% rate in 1999. The increase in the effective income
tax rate was primarily due to higher relative levels of state income taxes
associated with expanding business activities.

                                       13

================================================================================

<PAGE>

                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

NET INCOME AND
EARNINGS PER SHARE

For the year ended December 31, 2000, net income was $27.5 million compared to
$10.6 million for the year ended December 31, 1999, representing an increase of
$16.9 million, or 158.8%. Diluted earnings per common share of $2.06 for 2000
increased by 131.5%, or $1.17, from the $.89 earned in 1999. Diluted weighted
average shares of common stock and equivalents outstanding were 13,359,270 in
2000 compared to 11,958,976 in 1999. This increase in the diluted weighted
average shares of common stock and equivalents outstanding was primarily the
result of the effect of an increase in the average share price of common stock
between periods. As a percentage of revenues, net income for 2000 increased to
24.0% from 17.4% in 1999.

LIQUIDITY AND
CAPITAL RESOURCES

On September 30, 2001, the Company completed the acquisition of the software
assets of LoopCare from Lucent for approximately $62,000,000 in cash. The
transaction was consummated pursuant to an Asset Purchase Agreement, entered
into on September 28, 2001. The assets consisted principally of software and
related computer equipment. The equipment was used by Lucent in support of the
software and the Company presently intends to continue to use the equipment for
the same purpose. The Company used available cash and short-term investments to
finance the acquisition. LoopCare is the Plain Old Telephone Services ("POTS")
test system used by all of the Regional Bell Operating Companies. The test
system measures loop parameters, gathers provisioning and operational
information from the network elements, and analyzes data. The software products
include the Mechanized Loop Testing (MLT) system that currently tests more than
151 million lines in telecommunication networks worldwide. LoopCare, which
incorporates the expertise derived from the MLT system, supports xDSL, ISDN,
POTS and coin service on local metallic wire and DLC loops. The LoopCare
solution, which currently works with the Company's existing DigiTest test system
platform, measures the metallic parameters of the loop to detect shorts,
grounds, opens, or other metallic faults that could affect DSL service; measures
the broadband spectral density of the noise on the loop; identifies the location
and length of bridged taps that affect DSL service; predicts the downstream and
upstream data rate that the loop can support; and recommends the most effective
remedial action to improve the data rate on lines that cannot support the rate
requested by the subscriber.

    The revenues from this product line include perpetual initial Right To Use
("RTU") fees, as well as fees associated with annual maintenance contracts.
These maintenance fees are based upon various service levels selected by the
customer. The Company recognizes revenue from the RTU fees in accordance with
the American Institute of Certified Public Accountants Statement of Position
("SOP") 97-2, "Software Revenue Recognition," SOP 98-9 "Modification of SOP
97-2, Software Revenue Recognition, With Respect to Certain Transactions," and
Emerging Issues Task Force Issue 01-03. When the arrangement with the customer
includes future obligations for which fair value does not exist or when customer
acceptance is required, revenue is recognized when those obligations have been
met or customer acceptance has been received and collection is assured. The
customer's network planning and purchase decisions for these software systems
normally involve a significant commitment of its resources and a lengthy
evaluation and qualification process. Revenue from maintenance support services
will be deferred and then recognized on a straight-line basis over the period of
the maintenance contract. The Company may experience fluctuations in its RTU
fees in future periods. As the Company cannot predict such future events or
business conditions the Company's results may be adversely affected by these
trends. The LoopCare acquisition has been recorded in accordance with the
transitional guidance of Statement of Financial Accounting Standards (SFAS) No.
141 under the purchase method of accounting and, accordingly, the results of
operations of LoopCare for the period beginning September 30, 2001 forward, have
been included in the consolidated financial statements of the Company.
Independent valuation consultants assisted management in its determination of
the fair values of certain intangible assets acquired. Intangible assets valued
at September 30, 2001 include the LoopCare trade name ($1.3 million), base
software ($5.2 million), capitalized software costs on developed software ($7.3
million), and post warranty maintenance service agreements ($32.0 million). Of
the intangible assets identified, only capitalized software costs on developed
software of $7.3 million have been determined to have a definite life, which has
been estimated at five years, and will be amortized over that period. The
remaining intangibles, which amount to $38.5 million, have been determined to
have indefinite lives due to the degree of integration and resulting dependency
on the related software and intellectual property by the Company's key customers
who have utilized the software for over 25 years. If circumstances would change
such that these intangible assets were, in fact, collectively determined to have
a definite life, the accounting rules would require that these assets be
amortized over such lives and, although such amortization would represent a
non-cash charge, it would be material to the Company's consolidated statements
of operations. The Company has followed the transitionary provisions of SFAS No.
142, and will evaluate all intangibles including goodwill periodically, in
accordance with that accounting standard.

    The Company had working capital of $67.6 million as of December 31, 2001
compared to working capital of $111.1 million as of December 31, 2000. The
decrease of $43.5 million, or 39.2%, can be attributed to operating cash flow
(income from operations before depreciation and amortization) offset by the
purchase of the LoopCare business product line for $62.0 million, including
deal-related expenses, in cash. Significant changes during 2001 in the composite
elements of working capital include a substantial decrease in accounts
receivable-trade and inventories due to a substantial decline in sales
activities due to current overall economic conditions, and corresponding
adjustments made by the Company in forecasted production volumes to meet such
lowered demands. In addition, as expected in 2001, the Company received $7.7
million of net tax refunds due largely to net operating loss carrybacks
resulting from the exercise of certain of the Company's nonstatutory stock
options and the associated tax deductions related thereto. As of December 31,
2001, the Company had $38.7 million of cash and cash equivalents, short-term
investments and long-term investments, which are unrestricted and available for
corporate purposes, including acquisitions and other general working capital
requirements. In addition, effective December 20, 2001, the Company executed a
five-year $25.0 million Unsecured Revolving Credit Facility (the "Facility")
with a bank. In accordance with the terms of the Facility, the proceeds must be
used for general corporate purposes, working capital needs, and in connection
with certain acquisitions, as defined. The Facility contains certain standard
covenants with which the Company must comply, including a minimum fixed charge
ratio, a minimum defined level of tangible net worth and a restriction on the
amount of capital expenditures that can be made on an annual basis, among
others.

                                       14

================================================================================

<PAGE>

                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

Commitment fees are payable quarterly at 0.25% of the unused commitment.
As of December 31, 2001, there were no outstanding borrowings under the
Facility. No borrowings for working capital are currently anticipated, as the
Company believes internally generated funds will be sufficient to sustain
working capital requirements for the foreseeable future.

    The Company made capital expenditures of $3.5 million in 2001, primarily
related to the acquisition of land adjacent to the Company's current
manufacturing facility, as well as production test equipment and fixtures.
Capital expenditures were $4.5 million and $2.3 million for 2000 and 1999,
respectively, and were primarily related to upgrades to the IT infrastructure,
office equipment, test fixtures and development systems, tooling and leasehold
improvements. Planned capital expenditures for 2002 are anticipated to total
approximately $4.1 million. These planned capital projects include test fixtures
and development systems, and computer and office equipment.

    The Board of Directors has authorized the continuation of a share repurchase
program it started in 1997. Under the current extension, the Company may
repurchase a total of one million shares of its common stock before December 31,
2002. Since the initial repurchase program was instituted in April of 1997, and
as of December 31, 2001, the Company has repurchased 382,400 shares of common
stock. The repurchased shares are authorized to be utilized under certain
employee benefit programs. The number of shares the Company intends to purchase
and the time of such purchases will be determined by the Company at its
discretion. The Company will use existing cash and short-term investments to
finance the purchases.

    The impact of inflation on both the Company's financial position and the
results of operations have been minimal and are not expected to adversely affect
2002 results. The Company's financial position enables it to meet cash
requirements for operations and capital expansion programs.

COMMITMENTS

The Company has commitments under various non-cancelable leases; these leases
relate primarily to real estate in Cheswick, Pennsylvania and Bridgewater, New
Jersey which house the Company's operations. Rentals due beyond December 31,
2001 under these agreements amount to $1.1 million in 2002 and approximately
$0.5 million annually through 2006. The Company also entered into a line of
credit Facility discussed in the "Liquidity and Capital Resources" section of
this MDA. Commitment fees associated with this Facility are as outlined in that
discussion.

QUANTITATIVE AND
QUALITATIVE DISCLOSURES
ABOUT MARKET RISK

The Company's current investment policy limits its investments in financial
instruments to cash and cash equivalents, individual municipal bonds, and
corporate and government bonds. The use of financial derivatives and preferred
and common stocks is strictly prohibited. The Company believes it minimizes its
risk through proper diversification along with the requirements that the
securities must be of investment grade with an average rating of "A" or better
by Standard &Poor's. The Company holds its investment securities to maturity and
believes that earnings and cash flows are not materially affected by changes in
interest rates, due to the nature and short-term investment horizon for which
these securities are invested.

KEY RATIOS

The Company's days sales outstanding ("DSOs") in accounts receivable trade,
based on twelve months rolling revenue, was 43 and 61 days as of December 31,
2001 and December 31, 2000, respectively. The Company's inventory turnover ratio
was 1.3 and 1.8 turns for December 31, 2001 and December 31, 2000, respectively.
Approximately $2,000,000 in inventory was returned to the Company's component
vendors for credit during 2001 associated with a program addressed to decrease
on hand inventory levels commensurate with current sales levels.

BACKLOG

As of December 31, 2001, the Company's backlog was $4.9 million compared to the
backlog at December 31, 2000 of $8.2 million. The Company's backlog consists of
firm customer purchase orders for the Company's various products. The Company
believes that customers are returning to a more typical seasonal-based ordering
pattern where the first quarter of the year is typically lower than the
preceding quarter. The shippable backlog entering the first quarter of 2001 is
lower than 2000 levels. Periodic fluctuations in customer orders and backlog
result from a variety of factors, including but not limited to the timing of
significant orders and shipments. While these fluctuations could impact
short-term results, management believes these fluctuations are not necessarily
indicative of long-term trends in sales of the Company's products.

ACCOUNTING
PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes standards for
reporting information about various derivative financial instruments and
accounting for their change in fair value. The Company does not hold or issue
derivative instruments for hedging purposes and therefore the adoption of this
standard in 2000 did not have a material effect on the consolidated financial
position or results of operations of the Company.

    In December 1999, the Staff of the Securities and Exchange Commission issued
Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements"
("SAB 101"), which provides guidance related to revenue recognition. The Company
has adopted this standard in 2000 and doing so did not have a material effect on
its business, results of operations and financial condition.

    In July 2001, the FASB issued SFAS No 141, "Business Combinations" and SFAS
No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 established
accounting and reporting standards for business combinations. SFAS No. 142
established accounting and reporting standards for acquired goodwill and other
intangible assets, specifically, how they should be treated upon, and subsequent
to, their acquisition. Both SFAS No. 141 and SFAS No. 142 are required to be
applied in fiscal years beginning after December 15, 2001; however, early
adoption is permitted. Both statements contain transitional provisions which
require that these statements be applied to all business combinations initiated
after June 30, 2001. The Company followed the transitional provisions of SFAS
No. 141 and SFAS No. 142 during the fourth quarter of fiscal year 2001 as it
related to its recent acquisition of the LoopCare product line. The Company will
adopt the full provisions of these statements on January 1, 2002. The Company
does not believe the adoption of these standards will have a material effect on
its financial statements.

    On August 15, 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." On October 4, 2001, FASB issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." The Company
will adopt these statements on January 1, 2003 and is presently evaluating the
impact they may have on the Company.

                                       15

================================================================================

<PAGE>

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES

STATEMENT OF MANAGEMENT'S RESPONSIBILITY
FOR FINANCIAL REPORTING


The accompanying consolidated financial statements of Tollgrade Communications,
Inc. and Subsidiaries have been prepared by management, who are responsible for
their integrity and objectivity. The statements have been prepared in conformity
with generally accepted accounting principles and include amounts based on
management's best estimates and judgments. Financial information elsewhere in
this Annual Report is consistent with that in the financial statements.

    Management has established and maintains a system of internal control
designed to provide reasonable assurance that assets are safeguarded and that
the financial records reflect the authorized transactions of the Company. The
system of internal control includes widely communicated statements of policies
and business practices that are designed to require all employees to maintain
high ethical standards in the conduct of Company affairs. The internal controls
are augmented by organizational arrangements that provide for appropriate
delegation of authority and division of responsibility.

    The financial statements have been audited by PricewaterhouseCoopers LLP,
Independent Accountants. As part of their audit of the Company's 2001 financial
statements, PricewaterhouseCoopers LLP considered the Company's system of
internal control to the extent they deemed necessary to determine the nature,
timing and extent of their audit tests. The Report of Independent Accountants
follows.

    The Board of Directors pursues its responsibility for the Company's
financial reporting through its Audit Committee, which is composed entirely of
outside directors. The Audit Committee has met periodically with the Independent
Public Accountants and management. The Independent Public Accountants had direct
access to the Audit Committee, with and without the presence of management
representatives, to discuss the results of their audit work and their comments
on the adequacy of internal accounting controls and the quality of financial
reporting.

                                          /s/ CHRISTIAN L. ALLISON
                                          Christian L. Allison
                                          Chairman and Chief Executive Officer

                                          /s/ SAMUEL C. KNOCH
                                          Samuel C. Knoch
                                          Chief Financial Officer and Treasurer

                                          January 21, 2002

                                       16

<PAGE>

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders of Tollgrade Communications, Inc. and
Subsidiaries:

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, changes in shareholders' equity and cash
flows present fairly, in all material respects, the financial position of
Tollgrade Communications, Inc. and its subsidiaries at December 31, 2001 and
2000, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.


PRICEWATERHOUSECOOPERS LLP
/s/ PRICEWATERHOUSECOOPERS LLP


Pittsburgh, Pennsylvania
January 21, 2002

                                       17
<PAGE>
Tollgrade Communications, Inc. and Subsidiaries
Consolidated Balance Sheets

<TABLE>
<CAPTION>
ASSETS                                                                           December 31, 2000        DECEMBER 31, 2001
------------------------------------------------------------------------------------------------------------------------------
<S>                                                                              <C>                     <C>
Current assets:
      Cash and cash equivalents                                                  $       30,423,783      $       32,105,845
      Short-term investments                                                             28,405,655               6,489,323
      Accounts receivable:
           Trade                                                                         18,775,643               9,296,551
           Other                                                                            813,809                 320,501
      Inventories                                                                        30,499,482              22,183,616
      Prepaid expenses and deposits                                                         787,098                 916,723
      Refundable income taxes                                                             8,950,672               1,396,736
      Deferred tax assets                                                                   983,246               1,116,756
------------------------------------------------------------------------------------------------------------------------------
Total current assets                                                                    119,639,388              73,826,051
      Long-term investments                                                               2,750,000                 150,000
      Property and equipment, net                                                         6,503,923               8,012,546
      Deferred tax assets                                                                 2,380,828               2,812,987
      Intangibles                                                                                --              38,500,000
      Goodwill                                                                                   --              16,161,763
      Capitalized software costs, net                                                            --               6,935,000
      Other assets                                                                              417                 231,614
------------------------------------------------------------------------------------------------------------------------------
Total assets                                                                     $      131,274,556      $      146,629,961
------------------------------------------------------------------------------------------------------------------------------

LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------------------------------------------------------------------------------------------------
Current liabilities:
      Accounts payable                                                           $        1,874,328      $          805,398
      Accrued warranty                                                                    1,045,000               2,068,000
      Accrued expenses                                                                      892,589                 691,697
      Accrued salaries and wages                                                          2,813,433                 329,126
      Accrued royalties payable                                                           1,142,478                 397,451
      Income taxes payable                                                                  636,938               1,433,554
      Deferred income                                                                       100,000                 472,674
------------------------------------------------------------------------------------------------------------------------------
Total current liabilities                                                                 8,504,766               6,197,900
      Deferred tax liabilities                                                                9,950                 293,477
------------------------------------------------------------------------------------------------------------------------------
Total liabilities                                                                         8,514,716               6,491,377
Commitments and contingent liabilities                                                           --                      --
Shareholders' equity:
      Preferred stock, $1.00 par value; authorized shares,
           10,000,000; issued shares, -0- in 2000 and 2001                                       --                      --
      Common stock, $.20 par value--authorized shares,
           50,000,000; issued shares, 13,329,264 in 2000
           and 13,513,119 in 2001                                                         2,665,853               2,702,624
      Additional paid-in capital                                                         66,343,728              70,010,254
       Treasury stock, at cost, 386,800 shares
           in 2000 and 2001                                                              (3,164,975)             (3,164,975)
      Retained earnings                                                                  56,915,234              70,590,681
------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity                                                              122,759,840             140,138,584
------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity                                       $      131,274,556      $      146,629,961
------------------------------------------------------------------------------------------------------------------------------
</TABLE>

The accompanying notes are an integral part of the consolidated financial
statements.

                                       18

<PAGE>

Tollgrade Communications, Inc. and Subsidiaries
Consolidated Statements of Operations

<TABLE>
<CAPTION>
                                                                                    Years Ended December 31,
                                                                          1999                2000                2001
---------------------------------------------------------------------------------------------------------------------------------
<S>                                                                  <C>                 <C>                  <C>
Revenues:
      Products                                                       $ 60,031,005        $ 111,957,560        $ 77,611,861
      Services                                                          1,080,098            2,468,537           4,627,210
---------------------------------------------------------------------------------------------------------------------------------
                                                                       61,111,103          114,426,097          82,239,071

Cost of sales:
      Products                                                         24,298,741           40,680,034          33,134,366
      Services                                                            715,677            1,957,945           2,555,039
      Amortization                                                             --                   --             365,000
---------------------------------------------------------------------------------------------------------------------------------
                                                                       25,014,418           42,637,979          36,054,405
---------------------------------------------------------------------------------------------------------------------------------
Gross profit                                                           36,096,685           71,788,118          46,184,666
---------------------------------------------------------------------------------------------------------------------------------
Operating expenses:
      Selling and marketing                                             7,006,118           12,288,646           9,159,227
      General and administrative                                        4,722,970            6,216,427           4,827,120
      Research and development                                          8,756,551           12,456,337          12,427,859
      Severance and related expense                                            --                   --             291,401
---------------------------------------------------------------------------------------------------------------------------------
Total operating expense                                                20,485,639           30,961,410          26,705,607
---------------------------------------------------------------------------------------------------------------------------------
Income from operations                                                 15,611,046           40,826,708          19,479,059
Other (expense) income:
      Interest expense                                                     (1,549)                  --                  --
      Interest and other income                                           950,380            2,525,460           2,796,213
---------------------------------------------------------------------------------------------------------------------------------
Total other income (expense)                                              948,831            2,525,460           2,796,213
---------------------------------------------------------------------------------------------------------------------------------
Income before taxes                                                    16,559,877           43,352,168          22,275,272
Provision for income taxes                                              5,937,000           15,857,000           8,599,825
---------------------------------------------------------------------------------------------------------------------------------
Net income                                                           $ 10,622,877        $  27,495,168        $ 13,675,447
---------------------------------------------------------------------------------------------------------------------------------

EARNINGS PER SHARE INFORMATION:
---------------------------------------------------------------------------------------------------------------------------------
Weighted average shares of common stock and equivalents:
      Basic                                                            11,573,580           12,636,284          13,037,906
      Diluted                                                          11,958,976           13,359,270          13,412,037
---------------------------------------------------------------------------------------------------------------------------------
Net income per common share:
      Basic                                                          $       0.92        $        2.18        $       1.05
      Diluted                                                        $       0.89        $        2.06        $       1.02
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>

The accompanying notes are an integral part of the consolidated financial
statements.

                                       19

<PAGE>

Tollgrade Communications, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity

<TABLE>
<CAPTION>
                                                                                          Additional
                                    Preferred Stock             Common Stock                Paid-in
                                  Shares     Amount        Shares          Amount           Capital
--------------------------------------------------------------------------------------------------------
                                <S>         <C>         <C>             <C>              <C>
Balance at
   December 31, 1998                 --      $   --      11,840,928       $2,368,186      $26,319,679


Exercise of common
   stock options                     --          --         261,352           52,270        2,123,652

Tax benefit from exercise
   of stock options                  --          --              --               --          385,237

Purchase of
   treasury stock                    --          --              --               --               --

Net income                           --          --              --               --               --
--------------------------------------------------------------------------------------------------------
Balance at
   December 31, 1999                 --          --      12,102,280        2,420,456       28,828,568


Exercise of common
   stock options                     --          --       1,226,984          245,397       11,580,460

Tax benefit from exercise
   of stock options                  --          --              --               --       25,934,700

Net income                           --          --              --               --               --
--------------------------------------------------------------------------------------------------------
Balance at
   December 31, 2000                 --          --      13,329,264        2,665,853       66,343,728


EXERCISE OF COMMON
   STOCK OPTIONS                     --          --         183,855           36,771        1,626,764

TAX BENEFIT FROM EXERCISE
   OF STOCK OPTIONS                  --          --              --               --        2,039,762

NET INCOME                           --          --              --               --               --
--------------------------------------------------------------------------------------------------------
BALANCE AT
   DECEMBER 31, 2001                 --      $   --      13,513,119       $2,702,624      $70,010,254
--------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
                                      Treasury          Retained
                                        Stock           Earnings           Total
---------------------------------------------------------------------------------------
<S>                                <C>               <C>              <C>
Balance at
   December 31, 1998                $(1,789,287)      $18,797,189       $45,695,767


Exercise of common
   stock options                             --                --         2,175,922

Tax benefit from exercise
   of stock options                          --                --           385,237

Purchase of
   treasury stock                    (1,375,688)               --        (1,375,688)

Net income                                   --        10,622,877        10,622,877
---------------------------------------------------------------------------------------
Balance at
   December 31, 1999                 (3,164,975)       29,420,066        57,504,115


Exercise of common
   stock options                             --                --        11,825,857

Tax benefit from exercise
   of stock options                          --                --        25,934,700

Net income                                   --        27,495,168        27,495,168
---------------------------------------------------------------------------------------
Balance at
   December 31, 2000                 (3,164,975)       56,915,234       122,759,840


EXERCISE OF COMMON
   STOCK OPTIONS                             --                --         1,663,535

TAX BENEFIT FROM EXERCISE
   OF STOCK OPTIONS                          --                --         2,039,762

NET INCOME                                   --        13,675,447        13,675,447
---------------------------------------------------------------------------------------
BALANCE AT
   DECEMBER 31, 2001                $(3,164,975)      $70,590,681      $140,138,584
---------------------------------------------------------------------------------------
</TABLE>

The accompanying notes are an integral part of the consolidated financial
statements.

                                       20

<PAGE>

Tollgrade Communications, Inc. and Subsidiaries
Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>
                                                                            Years Ended December 31,
                                                                  1999               2000              2001
-----------------------------------------------------------------------------------------------------------------
<S>                                                           <C>               <C>               <C>
Cash flows from operating activities:
      Net income                                              $ 10,622,877      $ 27,495,168      $ 13,675,447
Adjustments to reconcile net income to net
      cash provided by operating activities:
           Depreciation and amortization                         1,252,743         1,910,245         2,692,322
           Tax benefit from exercise of stock options              385,237        15,044,372         2,039,762
           Refundable income taxes paid                                 --                --         7,714,229
           Deferred income taxes                                  (253,512)         (481,541)         (442,435)
           Provision for losses on inventory                       393,000           743,129           299,845
           Provision for allowance for doubtful accounts           100,000            22,189           175,000
Changes in assets and liabilities:
      Decrease (increase) in accounts receivable -- trade       (3,077,184)       (7,932,588)        9,304,092
      Decrease (increase) in accounts receivable -- other          (34,475)         (478,654)        1,390,808
      Decrease (increase) in inventory                          (4,526,976)      (13,906,864)        8,016,021
      (Increase) decrease in prepaid expenses
           and deposits                                           (109,521)         (325,164)            7,875
      (Decrease) increase in accounts payable                      224,690           962,559        (1,068,929)
      Increase (decrease) in accrued expenses
           and deferred income                                   1,160,928          (291,760)          (80,218)
      (Decrease) increase in accrued royalties payable              80,718           348,789          (745,027)
      (Decrease) increase in accrued salaries and wages          1,407,565           603,960        (2,484,307)
      Increase (decrease) in income taxes payable                1,655,130        (1,806,671)          796,616
-----------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities                        9,281,220        21,907,169        41,291,101
-----------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
      Purchase of investments                                  (15,183,124)      (38,637,741)      (29,030,595)
      Redemption/maturity of investments                        14,618,612        23,848,762        53,546,927
      Capital expenditures                                      (2,272,485)       (4,076,074)       (3,528,528)
      Investments in other assets                                       --                --          (231,615)
      Purchase of treasury stock                                (1,375,688)               --                --
      Purchase of LoopCare business from Lucent                         --                --       (62,028,763)
-----------------------------------------------------------------------------------------------------------------
Net cash used in investing activities                           (4,212,685)      (18,865,053)      (41,272,574)
-----------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
      Proceeds from the exercise of stock options                2,175,922        11,825,857         1,663,535
-----------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities                        2,175,922        11,825,857         1,663,535
-----------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents                        7,244,457        14,867,973         1,682,062
-----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of period                 8,311,353        15,555,810        30,423,783
-----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period                    $ 15,555,810      $ 30,423,783      $ 32,105,845
-----------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
      Cash paid during the year for interest                  $      1,549      $         --      $         --
      Cash paid during the year for income taxes              $  4,078,830      $  3,145,422      $  6,801,560
-----------------------------------------------------------------------------------------------------------------
Supplemental disclosure of non-cash activity:
      Acquisition related receivable                          $         --      $         --      $    897,000
      Tax benefit from the exercise of stock options          $         --      $ 10,890,328      $         --
-----------------------------------------------------------------------------------------------------------------
</TABLE>

The accompanying notes are an integral part of the consolidated financial
statements.


                                       21
<PAGE>

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.  ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION, BUSINESS AND BASIS OF PRESENTATION

Tollgrade Communications, Inc. (the Company) designs, engineers, markets and
supports test system, test access and status monitoring products and test
software for the telecommunications and cable television industries. The
Company's telecommunications proprietary test access products enable telephone
companies to use their existing line test systems to remotely diagnose problems
in Plain Old Telephone Service (POTS) lines containing both copper and fiber
optics. The Company's test system products, specifically the DigiTest test
platform, focus on helping local exchange carriers conduct the full range of
fault diagnosis along with the ability to prequalify, deploy and maintain
next-generation services including Digital Subscriber Line service. The
Company's cable products consist of a complete cable status monitoring system
that provides a comprehensive testing solution for the Broadband Hybrid Fiber
Coax distribution system. The status monitoring system consists of a host for
user interface, control and configuration; a headend controller for managing
network communications; and transponders that are strategically located within
the cable network to gather status reports from power supplies, line amplifiers
and fiber-optic nodes. The Company was organized in 1986 and began operations in
1988. The Company acquired, for cash, the LoopCare product line business,
effective September 30, 2001. See Note 2.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of income and expense during the reporting period. Actual
results could differ from those estimates.

PRINCIPLES OF CONSOLIDATION

The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany
transactions have been eliminated.

CASH AND CASH EQUIVALENTS

The Company considers highly liquid investments with a maturity of three months
or less when purchased to be cash equivalents. Substantially all of the
Company's cash and cash equivalents are maintained at one financial institution.
No collateral or security is provided on these deposits, other than $100,000 of
deposits per financial institution insured by the Federal Deposit Insurance
Corporation.

INVESTMENTS

Short-term investments at December 31, 2001 and December 31, 2000 consisted of
individual municipal bonds stated at cost, which approximated market value.
These securities have maturities of one year or less at date of purchase and/or
contain a callable provision in which the bonds can be called within one year
from date of purchase. Long-term investments are comprised of individual
municipal bonds with a maturity of more than one year but less than eighteen
months and are stated at amortized cost, which approximated market value. The
primary investment purpose is to provide a reserve for future business purposes,
including acquisitions and capital expenditures. Realized gains and losses are
computed using the specific identification method.

        The Company classifies its investment in all debt securities as "held to
maturity" as the Company has the positive intent and ability to hold the
securities to maturity which is in accordance with Statement of Financial
Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt
and Equity Securities."

INVENTORIES

Inventories are stated at the lower of cost or market, with cost determined on
the first-in, first-out method. The Company provides appropriate reserves for
any inventory deemed slow moving or obsolete.

PROPERTY AND EQUIPMENT

Property and equipment is stated at cost and depreciated on a straight-line
method over the estimated useful lives. Leasehold improvements are amortized
over the related lease period or the estimated useful life, whichever is
shorter.

        The cost of renewals and betterments that extend the lives or productive
capacities of properties is capitalized. Expenditures for normal repairs and
maintenance are charged to operations as incurred. The cost of property and
equipment retired or otherwise disposed of and the related accumulated
depreciation or amortization are removed from the accounts, and any resulting
gain or loss is reflected in current operations. Major maintenance costs are
expensed as incurred.



                                       22
<PAGE>

PRODUCT WARRANTY

The Company records estimated warranty costs on the accrual basis of accounting.
These reserves are based on applying historical returns to the current level of
product shipments and the cost experience associated therewith. In the case of
software, the reserves are based on the cost of performing specification
updates.

REVENUE RECOGNITION

Revenue from product sales is recognized at the time of shipment when both risk
of loss and title has transferred to the customer, which coincides with shipment
of related products, and collection is reasonably assured. Software license
revenue is recognized in accordance with the AICPA's Statement of Position
("SOP") 97-2, "Software Revenue Recognition," SOP 98-9 "Modification of SOP
97-2, Software Revenue Recognition With Respect to Certain Transactions," and
Emerging Issues Task Force Issue 01-03. Revenue from software license, which is
comprised of fees for perpetual licenses derived from contracts with corporate
customers, is recognized when persuasive evidence of an arrangement exists, upon
delivery of the product, acceptance by the customer and receipt of a signed
notice indicating that no significant Company obligations exist, the fee is
fixed or determinable, and collectibility is probable. Revenue from Professional
Services (testability consulting) is recognized upon services being rendered.
Reimbursement for out-of-pocket costs is recognized as revenue and
simultaneously recognized as the cost of product sales. Revenue from
Professional Services also includes revenue from maintenance agreements.
Maintenance revenue is generally recognized on a straight-line basis over the
life of the related agreement, which is typically one year. Customer advances
and amounts due from customers in excess of revenue recognized are recorded as
deferred income. Revenue for license and royalty fees is recognized when earned.

        In December 1999, the Staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin 101, "Revenue Recognition in Financial
Statements" ("SAB 101"), which provides guidance related to revenue recognition.
The Company has adopted this standard in 2000 and the impact did not have a
material effect on its business, results of operations and financial condition.

IMPAIRMENT OF LONG-LIVED ASSETS

Long-lived assets and intangible assets to be held and used are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of such assets may not be recoverable. Determination of
recoverability is based on an estimate of undiscounted future cash flows
resulting from the use of the asset and its eventual disposition. Measurement of
an impairment loss for long-lived assets and certain identifiable intangible
assets that management expects to hold and use is based on the fair value of the
asset.

RESEARCH AND DEVELOPMENT COSTS

Research and development costs are charged to operations as incurred.

CAPITALIZED SOFTWARE DEVELOPMENT COSTS

Any costs incurred to establish the technological feasibility of software to be
sold or otherwise marketed are expensed as research and development costs. Costs
incurred subsequent to the establishment of technological feasibility, and prior
to the general availability of the product to the public are capitalized and
subsequently amortized under the straight-line method. The Company defines
technological feasibility as coding and testing in accordance with detailed
program designs.

INCOME TAXES

The Company follows the provisions of SFAS No. 109, "Accounting for Income
Taxes" (SFAS 109). Under SFAS 109, deferred tax liabilities and assets are
determined based on the "temporary differences'' between the financial statement
carrying amounts and the tax basis of assets and liabilities using enacted tax
rates in effect in the years in which the differences are expected to reverse.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized.

SEGMENT INFORMATION

The Company follows the provisions of SFAS No. 131 "Disclosures about Segments
of an Enterprise and Related Information, Financial Reporting for Segments of a
Business." This statement establishes standards for reporting information about
operating segments, products and services, geographic areas and major customers
in annual and interim financial statements. The Company manages and operates its
business as one segment.


                                       23
<PAGE>

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes standards for
reporting information about various derivative financial instruments and
accounting for their change in fair value. The Company does not hold or issue
derivative instruments for hedging purposes and therefore this standard in 2001
did not have a material effect on the consolidated financial position or results
of operations of the Company.


2.  ACQUISITION

On September 30, 2001, the Company acquired certain assets and assumed certain
liabilities of the LoopCare(TM) Product line from Lucent Technologies, Inc.
("Lucent") for approximately $62,029,000 in cash which includes approximately
$2,200,000 of acquisition-related costs. The LoopCare software product
integrates with and enhances the value of the Company's core products, resulting
in a significant competitive advantage in the marketplace. The assets consisted
principally of rights to existing contracts, software and related computer
equipment, while the liabilities were principally related to software warranties
currently under contract and deferred income which results from customer
contractual billings and advances in excess of revenue recognized in income. The
finalization of the purchase price with the seller has not been completed and is
subject to negotiation between the parties. The Company does not believe that
the final adjusted price will vary materially from recorded amounts. The Company
used available cash and short-term investments to finance the acquisition.
LoopCare is the Plain Old Telephone Services ("POTS") test system used
universally by the Regional Bell Operating Companies. The LoopCare acquisition
has been recorded under the purchase method of accounting and, accordingly, the
results of operations of the LoopCare business since October 1, 2001 have been
included in the consolidated financial statements.

        The following summarizes the estimated fair values at the date of
acquisition:

<TABLE>
<S>                                                                            <C>                <C>
  Current assets                                                                                  $      855,000
  Property and equipment, net                                                                            307,000
    Intangible assets:
          LoopCare trade name                                                  $   1,300,000
          Base software                                                            5,200,000
          Developed product software                                               7,300,000
          Post warranty maintenance service agreements                            32,000,000          45,800,000
                                                                                  ----------
    Goodwill                                                                                          16,161,763
    --------------------------------------------------------------------------------------------------------------
    Total assets acquired                                                                         $   63,123,763
    --------------------------------------------------------------------------------------------------------------
    Deferred income                                                                                   (1,076,000)
    Warranty reserve                                                                                     (19,000)
    --------------------------------------------------------------------------------------------------------------
    Total liabilities assumed                                                                         (1,095,000)
    --------------------------------------------------------------------------------------------------------------
    NET ASSETS ACQUIRED                                                                           $   62,028,763
    --------------------------------------------------------------------------------------------------------------
</TABLE>

        An independent valuation consultant assisted management in its
determination of fair value assigned to certain intangible assets other than
goodwill. Discounted future cash flow models were utilized where appropriate.

        The base software has a historically long life cycle and the Company
intends to maintain the software and to continue to develop new LoopCare
features. Consequently, it was assumed that the base software and the LoopCare
trade name have an indefinitely long life. This software has been in use and
embedded within the Company's key customers' operating systems for over 25
years. Similarly, the maintenance service agreements are expected to generate
revenues into perpetuity and are assumed to have an indefinite life. The
developed product software is estimated to have a useful life of approximately
five years and the Company believes it can continue to market the product over
that period. Rapid development of improved replacement products is not expected
due to the relatively small customer base and the cost to develop new software.
The Company has utilized the transitional guidance of Statement of Financial
Accounting Standards (SFAS) No. 141, "Business Combinations" and SFAS No. 142,
"Goodwill and Other Intangible Assets" which were issued in July 2001. SFAS No.
141 requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 and that goodwill, as well as any
intangible assets believed to have an indefinite useful life, shall not be
amortized for financial reporting purposes.

        Based on the aforementioned and the Company's belief that there are no
legal, regulatory, contractual, competitive or economic limitations on the
useful lives of the LoopCare trade name, the base software and the maintenance
service agreements, these assets are deemed to have an indefinite useful life
and, along with goodwill, are not being amortized. In addition, based on the
foregoing analysis, the developed product software is being amortized over five
years. For tax purposes, the Company is amortizing all intangible assets over 15
years.




                                       24
<PAGE>

        SFAS No. 142 also provides that entities evaluate the remaining useful
lives of intangible assets determined to have indefinite useful lives
periodically to determine whether events and circumstances continue to support
an indefinite useful life and that such assets be tested at least annually for
impairment of value. Any determined impairment in value from the carrying
amounts shall result in an impairment loss to the extent of that excess. The
effective date and transition rules of SFAS No. 142 require that the Company
develop a methodology to measure impairment of the intangible assets by June 30,
2002 and to begin to measure for impairment of value by December 31, 2002.

        The following condensed proforma results of operations reflect the
proforma combination of the Company and the acquired LoopCare business as if the
combination occurred on January 1, 2000:


<TABLE>
<CAPTION>
                                                     (In Thousands, Except Per Share Data)
                                                                   Proforma
                                               December 31, 2000                December 31, 2001
----------------------------------------------------------------------------------------------------
<S>                                             <C>                             <C>
Revenues                                        $       127,916                 $        95,629
----------------------------------------------------------------------------------------------------
Income from operations                          $        45,465                 $        23,728
----------------------------------------------------------------------------------------------------
Net income                                      $        26,774                 $        15,610
----------------------------------------------------------------------------------------------------
Net income per common share:
      Basic                                     $          2.12                 $          1.20
----------------------------------------------------------------------------------------------------
      Diluted                                   $          2.00                 $          1.16
----------------------------------------------------------------------------------------------------
</TABLE>

The results of operations for the LoopCare product line business included above
include the twelve-month periods ending September 30, 2000 and 2001. Other
proforma adjustments include an estimated allocation of selling, general and
administrative expenses to the LoopCare operations based upon budgeted costs for
2002 and proforma amortization of the developed product software over five
years. Proforma adjustments were also made to take into account the cost of
money in connection with the acquisition costs. This was projected by reducing
interest income at historical earning rates for working capital deemed to have
been available to apply to the acquisition costs and projecting interest expense
on borrowed funds for residual acquisition costs at the historical prime rates
of interest plus 1.5%. Adjustments were also made to reflect the tax
consequences of the foregoing proforma adjustments.

3.  INVENTORIES
Inventories consisted of the following:

<TABLE>
<CAPTION>
                                                         December 31, 2000       DECEMBER 31, 2001
-----------------------------------------------------------------------------------------------------
<S>                                                        <C>                     <C>
Raw materials                                               $ 14,885,196            $ 11,697,886
Work in process                                               12,981,052               6,443,549
Finished goods                                                 3,718,234               5,153,181
-----------------------------------------------------------------------------------------------------
                                                            $ 31,584,482            $ 23,294,616
-----------------------------------------------------------------------------------------------------
Reserves for slow moving and obsolete inventory               (1,085,000)             (1,111,000)
-----------------------------------------------------------------------------------------------------
                                                            $ 30,499,482            $ 22,183,616
-----------------------------------------------------------------------------------------------------
</TABLE>

4.  PROPERTY AND EQUIPMENT

Property and equipment consisted of the following:

<TABLE>
<CAPTION>
                                                       Years             December 31, 2000              DECEMBER 31, 2001
---------------------------------------------------------------------------------------------------------------------------
<S>                                                    <C>                <C>                         <C>
Test equipment and tooling                              3-5                $        5,900,085          $        6,617,117
Office equipment and fixtures                           5-7                         4,735,551                   5,853,773
Leasehold improvements                                  1-6                         2,059,764                   2,036,329
---------------------------------------------------------------------------------------------------------------------------
                                                                                   12,695,400                  14,507,219
Less accumulated depreciation and amortization                                      6,191,477                   8,117,330
---------------------------------------------------------------------------------------------------------------------------
Subtotal                                                                   $        6,503,923          $        6,389,889
---------------------------------------------------------------------------------------------------------------------------
Land                                                                       $               --          $        1,622,657
---------------------------------------------------------------------------------------------------------------------------
                                                                           $        6,503,923          $        8,012,546
---------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                       25
<PAGE>

5.  SHAREHOLDERS' EQUITY

COMMON STOCK

The Company has 50,000,000 authorized shares which have a par value of $.20 per
share. As of December 31, 2000 and 2001, there were 13,329,264 and 13,513,119
issued shares, respectively.

STOCK REPURCHASE PROGRAM

On April 19, 2001, the Company announced its Board of Directors authorized the
continuation of a share repurchase program that was originally initiated on
April 22, 1997. Prior to this extension, the Company had repurchased 382,400
shares of common stock. The Company was authorized to repurchase a total of one
million shares of its common stock before December 31, 2001. Through December
31, 2001, no additional shares were repurchased under this extended program.

        On January 24, 2002, the Board of Directors authorized the continuation
of the share repurchase program under which the Company may repurchase a total
of one million shares of its common stock before December 31, 2002.

STOCK COMPENSATION PLANS

Under the Company's stock compensation plans, directors, officers and other
employees may be granted options to purchase shares of the Company's common
stock. The option price on all outstanding options is equal to the fair market
value of the stock at the date of the grant, as defined. The options generally
vest ratably over a two-year period, with one-third vested upon grant. The
Company's option programs cover all employees and are used to attract and retain
qualified personnel in all positions.

        On February 19, 1999, the Board of Directors approved a proposal to
increase the number of shares under the 1995 Long-Term Incentive Compensation
Plan ("the 1995 Plan") by 230,000 shares, with a corresponding cancellation of a
simlar number of shares under the 1998 Employee Incentive Compensation Plan
("the 1998 Plan"). The shareholders approved this action on May 6, 1999. On
December 14, 2000, the Board of Directors of the Company approved a proposal to
increase the number of shares available under the 1998 Plan by 200,000 shares,
from 740,000 to 940,000 shares. On May 23, 2001, the shareholders approved an
amendment to the Company's 1995 Plan, as adopted by the Board of Directors on
January 25, 2001, to increase the number of shares available under the Plan by
275,000 shares, from 2,210,000 to 2,485,000. The aggregate number of shares of
the Company's Common Stock which may be issued under the 1995 Plan and the 1998
Plan is 2,485,000 and 940,000 shares, respectively, subject to proportionate
adjustment in the event of stock splits and similar events. On January 24, 2002,
the Board of Directors approved a proposal to increase the number of shares
available under the 1998 Plan by 50,000 shares, from 940,000 to 990,000 shares.
That same date, the Board also approved a proposal to increase the number of
shares available under the 1995 Plan by 200,000. Such increase is subject to
shareholder approval at the Company's annual meeting, to be held May 7, 2002.
The maximum number of shares which may be awarded under the 1995 Plan to any one
Named Executive Officer during any calendar year of the life of the plan is
200,000 shares. All full-time active employees of the Company, excluding
officers and directors, are eligible to participate in the 1998 Plan. The
Company has 1,836,384 total shares reserved under the option plans. The shares
authorized but not granted under these plans at December 31, 2000 and 2001 were
as follows:

<TABLE>
<CAPTION>
                                                                  Shares Authorized But Not Granted
                                                   December 31, 2000                            DECEMBER 31, 2001
-------------------------------------------------------------------------------------------------------------------
<S>                                                     <C>                                          <C>
1995 Long-Term Incentive Compensation Plan                193,373                                      161,182
1998 Employee Incentive Compensation Plan                 188,626                                        1,572
-------------------------------------------------------------------------------------------------------------------
Total                                                     381,999                                      162,754
-------------------------------------------------------------------------------------------------------------------
</TABLE>

        The Company has adopted the disclosure-only provisions of SFAS No. 123
"Accounting for Stock-Based Compensation," but applies Accounting Principles
Board Opinion No. 25 and related interpretations in accounting for its plans. If
the Company had elected to recognize compensation cost for these stock options
based on the fair value at the grant dates for awards granted under those plans
in 1999, 2000 and 2001 consistent with the method prescribed by SFAS No. 123,
net income and earnings per share would have been changed to the pro forma
amounts indicated below:

<TABLE>
<CAPTION>
                                                                         Years Ended December 31,
                                                         1999                     2000                   2001
--------------------------------------------------------------------------------------------------------------------
<S>                                                <C>                      <C>                   <C>
Net income                        As reported      $     10,622,877         $     27,495,168      $     13,675,447
                                  Pro forma        $      8,889,233         $     19,734,070      $      6,732,052
--------------------------------------------------------------------------------------------------------------------
Diluted earnings per share        As reported      $            .89         $           2.06      $           1.02
                                  Pro forma        $            .74         $           1.48      $            .50
--------------------------------------------------------------------------------------------------------------------
</TABLE>


                                       26
<PAGE>

        The fair value of the stock options used to compute pro forma net income
and earnings per share disclosures is the estimated present value at grant date
using the Black-Scholes option-pricing model with the following weighted average
assumptions for 1999, 2000 and 2001: expected volatility of 51.9% in 1999, 77.0%
in 2000 and 87.7% in 2001; a risk-free interest rate of 4.97% in 1999, 5.83% in
2000 and 3.65% in 2001; and an expected holding period of 4 years. Using the
Black-Scholes option-pricing model, the weighted average fair value of stock
options granted during 1999, 2000 and 2001, is $4.76, $58.36 and $17.84 per
share, respectively.

        Transactions involving stock options under the Company's various stock
option plans and otherwise are summarized below:

<TABLE>
<CAPTION>
                                                                                                                 Weighted Average
                                             Number of Shares            Range of Option Price                    Exercise Price
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>                       <C>                                       <C>
Outstanding, December 31, 1998                   2,122,439             $  6.00000 - $ 13.56250                    $     9.08
Granted                                            432,000                7.50000 -   17.25000                         10.41
Exercised                                         (256,220)               6.00000 -   12.87500                          8.30
Cancelled                                         (103,196)               6.00000 -   13.56250                         10.18
-----------------------------------------------------------------------------------------------------------------------------------
Outstanding, December 31, 1999                   2,195,023                6.00000 -   17.25000                          9.38
Granted                                            416,625               51.62500 -  159.18750                         95.84
Exercised                                       (1,223,793)               6.00000 -   51.62500                          9.59
Cancelled                                          (24,615)               6.00000 -  159.18750                         28.96
-----------------------------------------------------------------------------------------------------------------------------------
Outstanding, December 31, 2000                   1,363,240                6.00000 -  159.18750                         35.25
Granted                                            560,650               20.53000 -   38.00000                         27.60
Exercised                                         (183,855)               6.00000 -   21.70000                          9.05
Cancelled                                          (66,405)               6.00000 -  159.18750                         61.00
-----------------------------------------------------------------------------------------------------------------------------------
OUTSTANDING, DECEMBER 31, 2001                   1,673,630             $  6.00000 - $159.18750                    $    34.55
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
                                                                            Weighted Average
Options exercisable at:                        Number of Shares              Exercise Price
-----------------------------------------------------------------------------------------------
<S>                                            <C>                           <C>
December 31, 1999                                 1,660,425                     $    9.49
December 31, 2000                                   997,680                         21.92
DECEMBER 31, 2001                                 1,219,648                     $   30.41
-----------------------------------------------------------------------------------------------
</TABLE>

        The following table summarizes the status of the stock options,
outstanding and exercisable, at December 31, 2001:

<TABLE>
<CAPTION>
                                                Stock Options Outstanding                    Stock Options Exercisable
-----------------------------------------------------------------------------------------------------------------------
                                      Number         Weighted Average        Weighted                      Weighted
          Range of Exercise         Outstanding          Remaining            Average                       Average
               Prices             as of 12/31/01     Contractual Life     Exercise Price      Shares    Exercise Price
-----------------------------------------------------------------------------------------------------------------------
<S>              <C>              <C>                <C>                <C>                <C>          <C>
  $    6.00000 - $    7.28130          250,433            5.78             $    6.78          250,433    $    6.78
-----------------------------------------------------------------------------------------------------------------------
  $    7.50000 - $    9.26570          215,788            6.69                  8.22          215,788         8.22
-----------------------------------------------------------------------------------------------------------------------
  $    9.81250 - $   12.87500          238,366            5.67                 11.30          238,366        11.30
-----------------------------------------------------------------------------------------------------------------------
  $   13.56250 - $   21.92500          201,333            8.98                 19.60          106,671        18.22
-----------------------------------------------------------------------------------------------------------------------
  $   28.39500 - $   28.39500          216,508            9.78                 28.40           80,353        28.40
-----------------------------------------------------------------------------------------------------------------------
  $   28.70000 - $   38.00000          177,150            9.71                 32.45           69,073        32.51
-----------------------------------------------------------------------------------------------------------------------
  $   55.89850 - $   71.87500          145,918            8.95                 56.12          106,240        56.10
-----------------------------------------------------------------------------------------------------------------------
  $  103.59375 - $  103.59375           21,500            8.80                103.59           14,338       103.59
-----------------------------------------------------------------------------------------------------------------------
  $  117.34400 - $  117.34400          179,167            8.62                117.34          120,015       117.34
-----------------------------------------------------------------------------------------------------------------------
  $  159.18750 - $  159.18750           27,467            8.53                159.19           18,371       159.19
-----------------------------------------------------------------------------------------------------------------------
                 TOTAL               1,673,630            7.87              $  34.55        1,219,648     $  30.41
-----------------------------------------------------------------------------------------------------------------------
</TABLE>

                                       27
<PAGE>


SERIES A JUNIOR PARTICIPATING PREFERRED STOCK PURCHASE RIGHTS

In order to protect shareholder value in the event of an unsolicited offer to
acquire the Company, on July 23, 1996, the Board of Directors of the Company
declared a dividend of one preferred stock purchase right for each outstanding
share of the Company's common stock. The dividend was payable on August 15, 1996
to shareholders of record as of that date. The aforementioned rights are
exercisable only if a person or group acquires or announces an offer to acquire
20% or more of the Company's common stock. In such an event, each right will
entitle shareholders to buy one-hundredth of a share of a new series of
preferred stock at an exercise price of $115.00. Each one-hundredth of a share
of the new preferred stock has terms designed to make it the economic and voting
equivalent of one share of common stock.

        If a person or group acquires 20% or more of the Company's outstanding
common stock, each right not owned by the person or group will entitle its
holder to purchase at the right's exercise price a number of shares of the
Company's common stock (or, at the option of the Company, the new preferred
stock) having a market value of twice the exercise price. Further, at any time
after a person or group acquires 20% or more (but less than 50%) of the
outstanding common stock, the Board of Directors may at its option, exchange
part or all of the rights (other than rights held by the acquiring person or
group) for shares of the Company's common or preferred stock on a one-for-one
basis. Each right further provides that if the Company is acquired in a merger
or other business transaction, each right will entitle its holder to purchase,
at the right's exercise price, a number of the acquiring company's common shares
having a market value at that time of twice the exercise price.

        The Board of Directors is entitled to redeem the rights for one cent per
right at any time before a 20% position has been acquired. The Board of
Directors is also authorized to reduce the 20% thresholds referred to above to
not less than 10%.


6.  LICENSE AND ROYALTY FEES

The Company has entered into several technology license agreements with certain
major Digital Loop Carrier (DLC) vendors and major Operation Support System
(OSS) equipment manufacturers under which the Company has been granted access to
the licensor's patent technology and the right to manufacture and sell the
patent technology in the Company's product line. The Company is obligated to pay
royalty fees, as defined, through the terms of these license agreements. Under
these agreements, license and royalty fees are due only upon purchase of the
technology or shipment of units; there are no contingent payment provisions in
any of these arrangements. Royalty fees of $2,011,930, $2,910,803 and $1,832,981
were incurred in 1999, 2000 and 2001, respectively, and are included in cost of
product sales in the accompanying consolidated statements of operations.


7.  INCOME TAXES

The provision for income taxes consisted of the following:

<TABLE>
<CAPTION>
                                           Years Ended December 31,
                                1999                 2000                     2001
--------------------------------------------------------------------------------------
<S>                       <C>                 <C>                    <C>
Current:
      Federal              $  5,478,412        $  14,212,441          $   8,192,841
--------------------------------------------------------------------------------------
      State                     712,100            2,126,100                849,419
--------------------------------------------------------------------------------------
                              6,190,512           16,338,541              9,042,260
--------------------------------------------------------------------------------------
Deferred:
      Federal                  (221,011)            (434,521)              (355,700)
      State                     (32,501)             (47,020)               (86,735)
--------------------------------------------------------------------------------------
                               (253,512)            (481,541)              (442,435)
--------------------------------------------------------------------------------------
                           $  5,937,000        $  15,857,000          $   8,599,825
--------------------------------------------------------------------------------------
</TABLE>

        Reconciliations of the federal statutory rate to the effective tax rates
are as follows:

<TABLE>
<CAPTION>
                                                                    Years Ended December 31,
                                                1999                          2000                          2001
--------------------------------------------------------------------------------------------------------------------
<S>                                            <C>                           <C>                           <C>
Federal statutory tax rate                       34%                           35%                           35%
      State income taxes                          3                             5                             3
      Foreign sales corporation tax benefit      (1)                           --                            --
      Other                                      --                            (3)                            1
--------------------------------------------------------------------------------------------------------------------
      Effective tax rate                         36%                           37%                           39%
--------------------------------------------------------------------------------------------------------------------
</TABLE>

                                       28
<PAGE>


        The components of and changes in the deferred tax assets and liabilities
recorded in the accompanying balance sheets at December 31, 2000 and 2001 were
as follows:

<TABLE>
<CAPTION>
                                                                    Deferred
                                                   December 31,      Expense                       December 31,
                                                      1999          (Credit)          Other            2000
-----------------------------------------------------------------------------------------------------------------
<S>                                             <C>              <C>               <C>           <C>
DEFERRED TAX ASSETS:
Excess of tax basis over book basis for:
   Property and equipment                       $     121,808    $     (63,082)    $       --     $    184,890
   Inventory                                          247,182          (74,621)            --          321,803

Reserves recorded for:
   Warranty                                           234,000         (173,550)            --          407,550
   Inventory                                          257,400         (165,750)            --          423,150
   Allowance for
        doubtful accounts                              70,670           (7,330)            --           78,000
Net operating loss carryforward                                                     1,939,656        1,939,656
Other                                                  11,817            2,792             --            9,025
-----------------------------------------------------------------------------------------------------------------
Total deferred tax assets                       $     942,877                                     $  3,364,074
-----------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
                                                      Deferred
                                                       Expense                       December 31,
                                                      (Credit)          Other            2001
--------------------------------------------------------------------------------------------------
<S>                                                 <C>               <C>          <C>
DEFERRED TAX ASSETS:
Excess of tax basis over book basis for:
   Property and equipment                           $ (160,287)       $     --     $   345,177
   Inventory                                           (56,162)             --         377,965

Reserves recorded for:
   Warranty                                           (398,970)             --         806,520
   Inventory                                           (10,140)             --         433,290
   Allowance for
        doubtful accounts                              (68,250)             --         146,250
Net operating loss carryforward                             --         160,293       1,779,363
Other                                                  (32,153)             --          41,178
--------------------------------------------------------------------------------------------------
Total deferred tax assets                                                          $ 3,929,743
--------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<S>                                         <C>             <C>               <C>            <C>
DEFERRED TAX LIABILITIES:
Excess of book basis over tax basis for:
   Goodwill & Intangibles
   Property and equipment
   Other                                           (9,950)                                           (9,950)
-------------------------------------------------------------------------------------------------------------
Total deferred tax liabilities              $      (9,950)                                   $       (9,950)
-------------------------------------------------------------------------------------------------------------

-------------------------------------------------------------------------------------------------------------
Net deferred taxes                          $     932,927   $     (481,541)   $  1,939,656   $    3,354,124
Reconciliation to the balance sheet:
   Current portion
        of deferred tax assets                    575,251                                           983,246
   Long-term portion
        of deferred tax liabilities                (9,950)                                           (9,950)
-------------------------------------------------------------------------------------------------------------
Long-term deferred
        tax asset                           $     367,626                                    $    2,380,828
-------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<S>                                          <C>             <C>              <C>
DEFERRED TAX LIABILITIES:
Excess of book basis over tax basis for:
   Goodwill & Intangibles                          258,403                         (258,403)
   Property and equipment                           25,124                          (25,124)
   Other                                                                             (9,950)
-----------------------------------------------------------------------------------------------
Total deferred tax liabilities                                                $    (293,477)
-----------------------------------------------------------------------------------------------

-----------------------------------------------------------------------------------------------
Net deferred taxes                           $    (442,435)  $      160,293   $   3,636,266
Reconciliation to the balance sheet:
   Current portion
        of deferred tax assets                                                    1,116,756
   Long-term portion
        of deferred tax liabilities                                                (293,477)
-----------------------------------------------------------------------------------------------
Long-term deferred
        tax asset                                                             $   2,812,987
-----------------------------------------------------------------------------------------------
</TABLE>


The deferred tax asset from net operating loss carryforwards is applicable to
Pennsylvania which allows a ten-year carryforward with a $2,000,000 cap on
deductions each year. Unused carryforward losses will expire in 2010.

8. LINE OF CREDIT

Effective December 20, 2001, the Company executed a five-year $25,000,000
Unsecured Revolving Credit Facility (the "Facility") with a bank. In accordance
with the terms of the Facility, the proceeds must be used for general corporate
purposes, working capital needs, and in connection with certain acquisitions, as
defined. The Facility contains certain standard covenants with which the Company
must comply, including a minimum fixed charge ratio, a minimum defined level of
tangible net worth and a restriction on the amount of capital expenditures that
can be made on an annual basis, among others. Interest is payable on any amounts
utilized under the Facility at prime, or the prevailing Euro rate plus 1.0% to
1.5% depending on the fixed charge coverage ratio, at the option of the Company.
Commitment fees are paid quarterly at the rate of 0.25% per annum on the average
unused commitment. At December 31, 2001, there were no amounts outstanding under
the Facility.

9. LEASE COMMITMENTS

The Company leases office space and equipment under agreements which are
accounted for as operating leases. The office lease for the Cheswick facility
expires December 31, 2002 and may be extended for an additional 3 years. The
equipment leases expire in August 2005 for the Cheswick facility and January
2007 for the Bridgewater facility. The Company is also involved in various
month-to-month leases for research and development equipment. In addition,

                                       29
<PAGE>

the office lease includes provisions for possible adjustments in annual future
rental commitments relating to excess taxes and excess maintenance costs that
may occur.

<TABLE>
<CAPTION>
         Minimum annual future rental commitments under noncancelable leases
         as of December 31 are:
<S>                                                                   <C>
         2002........................................................  $1,137,146
         2003........................................................     533,302
         2004........................................................     533,302
         2005........................................................     507,879
         2006........................................................     457,032
</TABLE>

        The rent expense for all lease commitments was $599,615, $731,320 and
$890,943 in 1999, 2000 and 2001, respectively.

In October of 2001, the Company entered into a lease agreement for a facility in
Bridgewater, New Jersey. The lease commenced on January 21, 2002 and will expire
on January 21, 2007.


10.  MAJOR CUSTOMERS, REVENUE CONCENTRATION AND DEPENDENCE ON CERTAIN SUPPLIERS

The Company designs, engineers, markets and supports test system, test access
and status monitoring products for the telecommunications and cable television
industries. Sales are concentrated primarily with the four Regional Bell
Operating Companies (RBOCs) as well as major independent telephone companies and
to certain digital loop carrier equipment manufacturers. Sales are primarily
from the Company's metallic channel unit (MCU) product line. The MCU product
line accounted for approximately 68% of the Company's net product sales for
2001. The Company expects that revenues from MCU products will continue to
account for a majority of the Company's revenues for the foreseeable future. The
DigiTest product line accounted for approximately 18% of the Company's net
product sales for 2001.

        Sales to the RBOCs accounted for approximately 61%, 64% and 71% of the
Company's net product sales for fiscal years 1999, 2000 and 2001, respectively.
During fiscal years 1999 and 2000, sales to four RBOCs individually exceeded 10%
of consolidated revenues and on a combined basis, comprised 61% (individually,
18%, 17%, 16% and 10%) and 64% (individually, 29%, 14%, 11% and 10%),
respectively, of the Company's net product sales. During 2001, sales to three
RBOCs individually exceeded 10% of consolidated revenues and, on a combined
basis, comprised 66% (individually, 38%, 14% and 14%) of the Company's net
product sales. Sales to an Original Equipment Manufacturer accounted for
approximately 11%, 4% and 5% of the Company's net product sales for fiscal years
1999, 2000 and 2001, respectively. In addition, sales to a large independent
carrier accounted for approximately 10%, 12% and 11% of the Company's net
product sales for fiscal years 1999, 2000 and 2001, respectively. Due to the
Company's present dependency on the RBOCs, the loss of one or more of the RBOCs
as a customer, or the reduction of orders for the Company's products by the
RBOCs, could materially and adversely affect the Company.

        The Company utilizes two key independent subcontractors to perform a
majority of the circuit board assembly and in-circuit testing work on its
products. The Company also utilizes other subassembly contractors on a more
limited basis. The loss of the subcontractors could cause delays in the
Company's ability to meet production obligations and could have a material
adverse effect on the Company's results of operations. In addition, shortages of
raw material to, or production capacity constraints at, the Company's
subcontractors could negatively affect the Company's ability to meet its
production obligations and result in increased prices for affected parts. Any
such reduction may result in delays in shipments of the Company's products or
increases in the price of components, either of which could have a material
adverse impact on the Company.


11.  EMPLOYEE BENEFIT PLANS

The Company has a 401(k) benefit plan. Eligible employees, as defined in the
plan, may contribute up to 20% of eligible compensation, not to exceed the
statutory limit. The Company does not make matching contributions to the plan.


12.  DEFERRED AND REFUNDABLE TAX ASSETS

The Company's current refundable tax assets as of December 31, 2000 and 2001
include tax benefits of $8,950,672 and $1,396,736, respectively, resulting from
the exercising of certain nonqualified stock options by various directors,
officers and other employees under the Company's various stock option programs
during 2000 and 2001. The Company is entitled to a tax deduction equal to the
difference between the fair market value of the shares received by the option
holders upon exercise and the exercise price of the nonqualified stock options.
The Company received $8,417,270 in 2001 in federal and state refunds in taxes
paid in prior years. It is anticipated that the current deferred and refundable
tax assets as of December 31, 2001 will be substantially utilized in 2002 either
through refunds of prior year taxes paid or the elimination of income taxes due.


                                       30
<PAGE>


13.  SEVERANCE AND RELATED EXPENSE

On April 19, 2001, the Company announced a restructuring program to implement
certain cost reduction initiatives that included the elimination of
approximately 80 positions within the general and administrative, research and
development and support areas. The restructuring program resulted in a pre-tax
charge for severance, outplacement and other related costs of $291,000 in 2001.

14.  RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 141, "Business Combinations" and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 established
accounting and reporting standards for business combinations. SFAS No. 142
established accounting and reporting standards for acquired goodwill and other
intangible assets, specifically, how they should be treated upon, and subsequent
to, their acquisition. Both SFAS No. 141 and SFAS No. 142 are required to be
applied in fiscal years beginning after December 15, 2001; however, early
adoption is permitted. SFAS No. 142 statements contain provisions which require
that these statements be applied to all business combinations initiated after
June 30, 2001. The Company utilized the transitional guidance of SFAS No. 141
and SFAS No. 142 in connection with the LoopCare acquisition on September 30,
2001. The Company will adopt the full provisions of these statements on January
1, 2002. The Company does not believe the adoption of these standards will have
a material effect on its financial statements.

        On August 15, 2001, the FASB issued SFASNo. 143, "Accounting for Asset
Retirement Obligation." On October 4, 2001, FASB issued SFASNo. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets." The Company will adopt
these statements on January 1, 2003 and is presently evaluating the impact they
may have on the Company.

15.  SHORT- AND LONG-TERM INVESTMENTS

The estimated fair values of the Company's financial instruments are as follows:

<TABLE>
<CAPTION>
                                                        December 31, 2000                            DECEMBER 31, 2001
                                           ----------------------------------------------------------------------------------------
                                                 Carrying                Fair                CARRYING                 FAIR
                                                  Amount                 Value                AMOUNT                  VALUE
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                        <C>                    <C>                   <C>                    <C>
Financial assets:
Cash and cash equivalents                  $      30,423,783      $     30,423,783      $      32,105,845      $     32,105,845
Short-term and long-term investments              31,155,655            31,104,323              6,639,323             6,658,247
-----------------------------------------------------------------------------------------------------------------------------------
                                           $      61,579,438      $     61,528,106      $      38,745,168      $     38,764,092
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

16. PER SHARE INFORMATION

Net income per share has been computed in accordance with the provisions of SFAS
No. 128, "Earnings Per Share" for all periods presented. On February 10, 2000,
the Company's Board of Directors authorized a two-for-one stock split of the
Company's common stock, payable in the form of a 100 percent stock dividend. On
March 20, 2000, shareholders of record received one additional share of common
stock for each share of common stock held of record on February 28, 2000. All
share and per share information reflects the two-for-one split of the Company's
common stock. SFASNo. 128 requires companies with complex capital structures to
report earnings per share on a basic and diluted basis, as defined. Basic
earnings per share are calculated on the actual number of weighted average
common shares outstanding for the period, while diluted earnings per share must
include the effect of any dilutive securities. All prior periods have been
restated in accordance with SFAS No. 128. A reconciliation of earnings per share
is as follows:

<TABLE>
<CAPTION>
                                                                                  Years Ended December 31,
                                                              1999                       2000                       2001
---------------------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>                        <C>                        <C>
Net Income                                           $       10,622,877         $       27,495,168         $       13,675,447
---------------------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding                   11,573,580                 12,636,284                 13,037,906
---------------------------------------------------------------------------------------------------------------------------------
Effect of dilutive securities - stock options                   385,396                    722,986                    374,131
---------------------------------------------------------------------------------------------------------------------------------
                                                             11,958,976                 13,359,270                 13,412,037
---------------------------------------------------------------------------------------------------------------------------------
Earnings per share:
  Basic                                              $              .92         $             2.18         $             1.05
---------------------------------------------------------------------------------------------------------------------------------
  Diluted                                            $              .89         $             2.06         $             1.02
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                       31
<PAGE>

STATEMENTS OF OPERATIONS DATA BY QUARTER

The following table presents unaudited quarterly operating results for each of
the Company's last eight fiscal quarters. This information has been prepared by
the Company on a basis consistent with the Company's audited financial
statements and includes all adjustments (consisting only of normal recurring
adjustments) that the Company considers necessary for a fair presentation of the
data. Such quarterly results are not necessarily indicative of the future
results of operations.

            (In Thousands, Except Net Income Per Common Share Data)
                           Quarter Ended (Unaudited)

<TABLE>
<CAPTION>
                                     March 31,     June 30,     Sept. 30,     Dec. 31,
                                       2000          2000         2000         2000
-----------------------------------------------------------------------------------------
<S>                                 <C>          <C>          <C>           <C>
Revenues:
   Products                         $   21,776   $   29,074   $    29,228   $   31,882
   Services                                642          593           560          672
-----------------------------------------------------------------------------------------
                                        22,418       29,667        29,788       32,554
Cost of Sales:
   Products                              7,971       10,947        10,368       11,395
   Services                                401          467           473          617
   Amortization of intangibles
-----------------------------------------------------------------------------------------
                                         8,372       11,414        10,841       12,012
-----------------------------------------------------------------------------------------
Gross Profit                            14,046       18,253        18,947       20,542
-----------------------------------------------------------------------------------------
Operating Expenses:
   Selling and marketing                 2,384        3,028         3,440        3,438
   General and administrative            1,378        1,495         1,591        1,752
   Research and development              2,590        3,098         3,178        3,589
   Severance and related expense
-----------------------------------------------------------------------------------------
Total Operating Expense                  6,352        7,621         8,209        8,779
-----------------------------------------------------------------------------------------
Income from Operations                   7,694       10,632        10,738       11,763
Other Income, Net                          470          546           662          848
-----------------------------------------------------------------------------------------
Income Before Taxes                      8,164       11,178        11,400       12,611
Provision for Income Taxes               2,939        4,024         4,104        4,790
-----------------------------------------------------------------------------------------
Net Income                          $    5,225   $    7,154   $     7,296   $    7,821
-----------------------------------------------------------------------------------------

EARNINGS PER SHARE INFORMATION:

Weighted average shares of common
   stock and equivalents:
     Basic                              12,219       12,563        12,821       12,940
     Diluted                            13,546       13,318        13,460       13,434

Net income per common share:
     Basic                          $     0.43   $     0.57   $      0.57   $     0.60
     Diluted                        $     0.39   $     0.54   $      0.54   $     0.58
-----------------------------------------------------------------------------------------


<CAPTION>
                                     MARCH 31,      JUNE 30,     SEPT. 30,     DEC. 31,
                                       2001           2001         2001          2001
-------------------------------------------------------------------------------------------
<S>                                 <C>           <C>          <C>           <C>
Revenues:
   Products                         $    27,464   $   21,177   $    15,077   $   13,894
   Services                                 526          599           961        2,541
-------------------------------------------------------------------------------------------
                                         27,990       21,776        16,038       16,435
Cost of Sales:
   Products                              11,851        9,047         7,158        5,076
   Services                                 423          517           508        1,107
   Amortization of intangibles                                                      365
-------------------------------------------------------------------------------------------
                                         12,274        9,564         7,666        6,548
-------------------------------------------------------------------------------------------
Gross Profit                             15,716       12,212         8,372        9,887
-------------------------------------------------------------------------------------------
Operating Expenses:
   Selling and marketing                  2,450        2,493         2,023        2,194
   General and administrative             1,530        1,062         1,020        1,215
   Research and development               3,360        2,749         2,639        3,681
   Severance and related expense                         400                       (109)
-------------------------------------------------------------------------------------------
Total Operating Expense                   7,340        6,704         5,682        6,981
-------------------------------------------------------------------------------------------
Income from Operations                    8,376        5,508         2,690        2,906
Other Income, Net                           907          790           801          298
-------------------------------------------------------------------------------------------
Income Before Taxes                       9,283        6,298         3,491        3,204
Provision for Income Taxes                3,528        2,494         1,361        1,217
-------------------------------------------------------------------------------------------
Net Income                          $     5,755   $    3,804   $     2,130   $    1,987
-------------------------------------------------------------------------------------------

EARNINGS PER SHARE INFORMATION:

Weighted average shares of common
   stock and equivalents:
     Basic                               12,958       13,028        13,066       13,095
     Diluted                             13,377       13,404        13,378       13,472

Net income per common share:
     Basic                          $      0.44   $     0.29   $      0.16   $     0.15
     Diluted                        $      0.43   $     0.28   $      0.16   $     0.15
-------------------------------------------------------------------------------------------
</TABLE>

--------------------------------------------------------------------------------

COMMON STOCK MARKET PRICES

The Company's Common Stock has been included for quotation on The Nasdaq
National Market System under the Nasdaq symbol "TLGD" since the Company's
initial public offering in December 1995. The following table sets forth, for
the periods indicated, the high and low sales prices for the Common Stock on
such market:

<TABLE>
<CAPTION>
                             High       Low
-----------------------------------------------------
<S>                      <C>          <C>
2000:
      First Quarter      $    84.00  $   16.06
      Second Quarter         147.19      31.50
      Third Quarter          168.88      78.63
      Fourth Quarter         148.00      25.75
2001:
      FIRST QUARTER      $    52.50  $   15.25
      SECOND QUARTER          40.35      18.75
      THIRD QUARTER           29.35      18.00
      FOURTH QUARTER          34.55      18.45
-----------------------------------------------------
</TABLE>

        At January 31, 2002, the Company had 190 holders of record of its Common
Stock and 13,521,836 shares outstanding.

        The Company has never paid any dividends on its Common Stock and does
not expect to pay cash dividends in the foreseeable future.


                                       32
<PAGE>

SHAREHOLDER INFORMATION

SHAREHOLDERS ANNUAL MEETING

The Annual Meeting of Shareholders of Tollgrade Communications, Inc., will be
held at The Syria Mosque, 1877 Shriners Way, Cheswick, PA 15024, on Tuesday, May
7, 2002, at 1:30 p.m. Notice of the meeting and proxy materials were included
with this Annual Report.

TRANSFER AGENT AND SHAREHOLDER INQUIRIES

The Company's transfer agent is Mellon Investor Services, L.L.C. Inquiries
concerning transfer requirements, lost certificates and change of address should
be directed to:
   Mellon Investor Services, L.L.C.
      P.O. Box 3315
      South Hackensack, NJ 07606
            or:
      85 Challenger Road
      Ridgefield Park, NJ 07660
      1-800-756-3353
   TDDfor Hearing Impaired:
      1-800-231-5469
   Foreign Shareholders:
      201-329-8660
   TDDForeign Shareholders:
      201-329-8354
   www.mellon-investor.com.
All other inquiries should be directed to:
   Tollgrade Communications, Inc.
   Investor Relations Department
   493 Nixon Road
   Cheswick, PA 15024
   1-800-878-3399
   www.tollgrade.com.


FORM 10-K

A copy of the Tollgrade Communications, Inc. Form 10-K for 2001, which will be
filed with the Securities and Exchange Commission during the first quarter of
2002, is available without attachments at no charge upon written request.
Inquiries should be directed to the Investor Relations Department, Tollgrade
Communications, Inc., 493 Nixon Road, Cheswick, PA 15024.


INDEPENDENT AUDITORS

PricewaterhouseCoopers LLP, Pittsburgh, Pennsylvania.


COUNSEL

Reed Smith LLP, Pittsburgh, Pennsylvania.


STOCK MARKET LISTING

Tollgrade Communications, Inc. is listed on The Nasdaq Stock Market.(SM) Symbol:
TLGD.

BOARD OF DIRECTORS

[PHOTO]
CHRIS ALLISON
Chairman and
Chief Executive Officer

[PHOTO]
JAMES J. BARNES
Attorney at Law,
Reed Smith
LLP

[PHOTO]
DANIEL P.BARRY
Private Investor,
Director of Respironics, Inc.

[PHOTO]
ROBERT W. KAMPMEINERT
Chairman,
President and
Chief Executive Officer,
Parker/Hunter Incorporated

[PHOTO]
ROCCO L. FLAMINIO
Vice Chairman
and Chief Technology
Officer

[PHOTO]
RICHARD H. HEIBEL, M.D.
Board Certified Cardiologist
(retired)

[PHOTO]
DAVID S.EGAN
Chief Marketing Officer,
Reed Smith LLP

EXECUTIVE COUNCIL AND OFFICERS

CHRIS ALLISON
Chairman and Chief Executive Officer

SARA M. ANTOL
General Counsel and Corporate Secretary

RICHARD A. BAIR, JR.
Executive Vice President, Engineering and Testing

WYLIE E. ETSCHEID, JR.
Executive Vice President of Business Development, Software Products

ROCCO L. FLAMINIO
Vice Chairman and Chief Technology Officer

CAROL M. FRANKLIN
General Manager, Software Products

SAMUEL C. KNOCH
Chief Financial Officer and Treasurer

JOSEPH G. O'BRIEN
Senior Vice President, Human Resources

MARK B. PETERSON
President

GREGORY L. QUIGGLE
Executive Vice President, Marketing

JAMES N. PRICE
Senior Vice President, Systems Engineering

MATTHEW J. ROSGONE
Executive Vice President, Operations

CHARLES J. SHEARER
Controller

RICHARD A. SKAARE
Executive Vice President, Organizational Development and Communication

ROGER A. SMITH
Executive Vice President, Technology

STEPHANIE M. WEDGE
Vice President, Professional Services



<PAGE>

(R) TOLLGRADE, MCU, DigiTest and
LIGHTHOUSE are registered trademarks
of Tollgrade Communications, Inc.

TM LoopCare and TELACCORD are
trademarks of Tollgrade Communications, Inc.

All other trademarks are the property
of their respective owners.

(C) 2002 Tollgrade Communications, Inc.
All rights reserved.



                                [TOLLGRADE LOGO]

                             CORPORATE HEADQUARTERS
    493 Nixon Road, Cheswick, PA 15024 - 1-800-878-3399 - www.tollgrade.com