<PAGE>   1

                                                                   Exhibit 13.1




                       Know how good your network can be.


                                    [GRAPHIC]


                         Tollgrade Communications, Inc.
                       2000 Annual Report to Shareholders



<PAGE>   2


Tollgrade was into network service assurance before it was popular.

Since the company's founding in 1988, testing has been Tollgrade's primary
focus, developing strategic partnerships with the leading names in tele-
communications equipment and marketing its own products and services to the
leading local exchange carriers and CATV companies in the industry.

Through it all, Tollgrade has evolved from a simple equipment vendor, to a
systems developer and total solutions provider.

In the year 2000, testing became a hot issue in the telecommunications sector as
new entrants, new carriers and the investment community discovered the critical
role cost-effective, automated testing can play in rolling out new services and
improving competitive positioning.

Opportunity was at hand in 2000, and Tollgrade was properly positioned to come
out on top.

And, in the process, we rediscovered our roots. Tollgrade is not simply about
testing or status monitoring. We're not just about service, and we're really no
longer limited simply to providing network assurance solutions for our
customers. We're about all of the above and nothing less.

If you are a local exchange carrier right now, you will find comfort in knowing
that with Tollgrade on your side -- our people and our products -- you can truly

KNOW HOW GOOD YOUR NETWORK CAN BE.

Anything less and it wouldn't be Tollgrade.                         [GRAPHIC]


TABLE OF CONTENTS

1    2000 Financial Highlights
2    Letter to Shareholders
4    2000 Operations Highlights
6    Selected Consolidated Financial Data
7    Management's Discussion and Analysis of Results
       of Operations and Financial Condition
14   Statement of Management's Responsibility for Financial Reporting
15   Report of Independent Accountants
16   Consolidated Financial Statements
20   Notes to Consolidated Financial Statements
28   Shareholder Information
IBC  Board of Directors and Executive Officers


<PAGE>   3

2000 Financial Highlights
                                         (In thousands, except per share data
                                               and number of employees)
                                        December 31, 1999     DECEMBER 31, 2000
OPERATIONS
Total Revenues                            $    61,111           $   114,426
-----------------------------------------------------------------------------

Net Income                                $    10,623           $    27,495
-----------------------------------------------------------------------------

Earnings Per Share-- Diluted              $       .89           $      2.06
-----------------------------------------------------------------------------

Weighted Average Shares of Common
     Stock and Equivalents                 11,958,976            13,359,270
-----------------------------------------------------------------------------

Number of Employees                               282                   411
-----------------------------------------------------------------------------


FINANCIAL POSITION
Total Assets                              $    66,202           $   131,275
-----------------------------------------------------------------------------

Working Capital                           $    49,958           $   111,135
-----------------------------------------------------------------------------

Shareholders' Equity                      $    57,504           $   122,760
-----------------------------------------------------------------------------

REVENUES
(DOLLARS IN THOUSANDS)


   1996         1997        1998        1999        2000
   ----         ----        ----        ----        ----
 $37,490      $45,421*    $46,277*    $61,111     $114,426

* Includes license fees of $250 and $150, respectively


NET INCOME
(DOLLARS IN THOUSANDS)


   1996         1997        1998        1999        2000
   ----         ----        ----        ----        ----
 $5,597       $6,883      $6,967     $10,623      $27,495


DILUTED EARNINGS PER SHARE


   1996         1997        1998        1999        2000
   ----         ----        ----        ----        ----
  $0.47        $0.58       $0.58       $0.89       $2.06


<PAGE>   4


                             LETTER TO SHAREHOLDERS

Tollgrade saw unprecedented growth in revenue and market capitalization in 2000,
yet 2001 will be as challenging as any period in our company's history.



[Photo]

Chris Allison
Chairman and Chief Executive Officer


Dear Shareholder,

Charles Dickens begins his novel A Tale of Two Cities with the words, "It was
the best of times. It was the worst of times." Those thoughts could apply to
today's telecommunications industry and public stock markets just as easily as
they described the days preceding the French Revolution.

Tollgrade saw unprecedented growth in revenue and market capitalization in 2000,
yet 2001 will be as challenging as any period in our company's history. As we
face what amounts to a "perfect storm" of economic uncertainty and a shifting
telecommunications industry, we are comforted by the fact that we have a sturdy
ship with her bow pointed toward stable portions of the telecommunications
equipment sector.

During the first half of 2000, capital expenditures were robust in all
sectors of the telecommunications industry. Competitive Local Exchange Carriers
(CLECs) continued to make huge investments in their networks only to see their
business models begin to fail. Regional Bell Operating Companies (RBOCs) and
Multiple System Operators (MSOs) conducted huge infrastructure build-outs to
compete in the broadband arena, yet rollout of Digital Subscriber Line (DSL) and
cable modem services didn't meet the ambitious expectations the public had set.

Tollgrade, like other telecommunications equipment providers, benefited from
this land rush. Our 2000 revenues were $114.4 million. That's 87.2% higher than
our 1999 revenues of $61.1 million. 2000 net income was 158.8% over 1999 and
earnings per common share increased by 131.5% to $2.06 versus $.89 in 1999.

Despite our great year, we've seen significant changes in the telecommunications
industry during the latter part of 2000. CLECs either went out of business or
dramatically slowed their deployments. MSO hybrid-fiber-coax build-outs in the
CATV industry took longer to complete than previously anticipated. RBOCs began
re-examining all of their network deployments. Fortunately for Tollgrade, our
business emphasis was, and continues to be, aimed at larger carriers. As a
result, our fundamental underpinnings can help us face these tough business
conditions.

We have a solid franchise among RBOC customers for solving Plain Old Telephone
Service (POTS) testability problems through our MCU(R) product line, our POTS
testability consulting business and DigiTest(R). Verizon began deploying
DigiTest during the fourth quarter of 2000 to replace aging POTS test systems so
it could roll out DSL faster. SBC Telecom has made DigiTest a fundamental part
of its POTS and DSL deployment. Our MCU business will continue to be the
flagship of the fleet.

Tollgrade is THE name for POTS testing among the RBOCs. During 2000, we
increased sales of our MCU product line by approximately $32.8 million, or
68.9%.

Also, DigiTest is a great new product for both POTS testing and DSL service
delivery. We're proving its merit with widespread deployment of DigiTest at
Sprint and initial DigiTest deployment at SBC Telecom and other CLECs through
our partners Lucent and Nortel. DigiTest is world-class. Sales of DigiTest
increased by approximately $14.4 million, or 218.4% in 2000.


                                       2
<PAGE>   5

                             LETTER TO SHAREHOLDERS


LIGHTHOUSE is proving to be a player in status monitoring among MSOs such as RCN
and AT&T, and with node vendors such as ANTEC and Motorola. In 2000, the sales
of our LIGHTHOUSE Cable Status Monitoring System increased by approximately
$5.5 million, or 126.9%.

Finally, we are a strong company in delivering innovation and world-class
customer service while running a tight ship.

We posted some great numbers in 2000, which give us a strong foundation for the
tough times we all will see in 2001. So what's our plan going forward?

First, we want to continue our leadership in POTS testability. Our goal is that
no Digital Loop Carrier (DLC) system will be installed without MCU technology.
We also want to focus our Professional Services group like a laser beam on the
RBOCs to make sure that their DLC systems are testable -- which will drive MCU
sales.

Second, we are focusing our DigiTest efforts on Lucent MLT-1 replacement. This
means that, as RBOCs replace older MLT-1 Lucent test hardware, we are there with
our DigiTest system.

Our goal this year is to deploy DigiTest for POTS test head replacement in
RBOCs, as well as for DSL deployment among RBOCs and blue-chip carriers. While
we need the financial instability of many CLECs to heal, and consolidation to
progress in 2001, we will still pursue stable companies in this market sector.

Third, we want our valued POTS customers to know about the great things that
DigiTest can do for them in DSL testing, particularly leveraging their MCU
investments with low-cost, high-value DigiTest technology.

Fourth, we will focus our DigiTest POTS and DSL technology marketing efforts on
blue-chip, non-RBOC carriers and emerging carriers with solid footing.

Fifth, we want to grow our relationships with Lucent and Nortel and use those
relationships to enter new markets.

Sixth, we want to keep our large MSO customers happy with our LIGHTHOUSE
technology and grow that business, as one-way systems are converted into two-way
transmission, particularly in the area of power supply monitoring.

Seventh, we want to grow our Professional Services business through the
expansion of existing relationships and the creation of new services.

Eighth, we want to continue the development of innovation in our R&D efforts by
the expansion of existing technology and the identification of new technology.

Let me close with the following thoughts:

Five years ago, Tollgrade entered the public market with a little more than $22
million in sales. We ended 2000 with a little more than $114 million in sales.

In between that time, we've seen varying levels of investment in public
communications networks, changes in infrastructure, deregulation, labor strikes
and the emergence of the Internet.

Tollgrade is like a strong ship that has weathered storms in the past with a
bright outlook and her wheel pointed toward a spot on the horizon.

That has not and will not change.


/s/ Chris Allison

Chris Allison
Chairman and Chief Executive Officer


Company
Milestones
in 2000

In addition to Tollgrade's operational performance, four key events transpired
in 2000 that helped to characterize a great year.

March 20

Two-for-one stock split took effect, increasing the number of
Tollgrade's outstanding shares to over 13 million.

April 4

Tollgrade introduced its Digital Wideband Unit (DWU) for DSL testing. The DWU
enables local exchange carriers to conduct the full range of loop qualification
and in-service tests for DSL service.

October 16

Forbes Magazine ranked Tollgrade 31st on its list of "The 200 Best Small
Companies in America." This was the third time in four years Tollgrade was
included on the list.

December 15

Tollgrade celebrated its fifth anniversary on The Nasdaq Stock Market(SM)
by pressing the button to open the day's trading.


                                       3
<PAGE>   6


                           2000 OPERATIONS HIGHLIGHTS

In 2000, Tollgrade achieved growth across each of its three major product lines
and its Professional Services business unit.

[PHOTO]     Tollgrade's MCU Technology continued to serve as the cornerstone of
            the company's growth. MCU technology enables local exchange carriers
            to obtain critical test access in digital loop carrier environments
            and for the deployment of digital subscriber line (DSL) service.

[PHOTO]     Tollgrade's DigiTest System, which tests Plain Old Telephone Service
            (POTS) and is used for DSL loop qualification and in-service
            testing, contributed to Tollgrade's success in a big way in 2000.
            The system is designed to serve as a hardware platform for the
            industry's leading test operations support systems and serves as the
            current hardware standard for next-generation testing of POTS lines
            in North America. Its state-of-the-art DSL loop qualification and
            testing capabilities have given DigiTest its distinct advantage.

[PHOTO]     Tollgrade's LIGHTHOUSE Cable Status Monitoring System, which
            addresses the broadband status monitoring needs of the CATV
            industry, continued to grow in 2000. The system, which consists
            of a headend controller, host software and transponders for power
            supplies, amplifiers and nodes, has become one of the status
            monitoring solutions of choice in the broadband world.

            Tollgrade Professional Services entered its second full year of
            operation in 2000 and exceeded all of its growth expectations. The
            Tollgrade Professional Services team grew from 18 professionals at
            the start of the year, to 26 seasoned experts, serving both the
            telecom and CATV industries by year's end.


                              REVENUES BY PRODUCT
                          (PERCENTAGE OF 2000 REVENUE)

                                   [GRAPHIC]

<TABLE>
<CAPTION>
MCU TECHNOLOGY           DIGITEST SYSTEM                 LIGHTHOUSE                    PROFESSIONAL
FOR TEST EXTENSION       FOR POTS AND DSL TESTING        CABLE STATUS MONITORING       SERVICES          OTHER
------------------       ------------------------        -----------------------       --------          -----
<S>                      <C>                             <C>                           <C>               <C>
     70.2%                      18.4%                           8.6%                      2.2%            0.6%
</TABLE>

                                       4
<PAGE>   7


                           2000 OPERATIONS HIGHLIGHTS

MCU TECHNOLOGY FOR TEST EXTENSION

Key Customers -- BellSouth, Verizon, Qwest, Nortel, Advanced Fibre
Communications, SBC Communications (includes Southwestern Bell, Pacific Bell,
Ameritech and Southern New England Telephone), SBC Telecom - the CLEC subsidiary
of SBC, Sprint North Supply - the procurement division of Sprint USA, Allegiance
Telecom and Choice One Communications

Highlights -- BellSouth increased its purchasing rates
of MCU technology as part of a long-term remediation
program to improve its testability rates system-wide.
SBC Communications incorporated a comprehensive
purchasing program of MCU technology as part of its
Project Pronto initiative to roll out DSL service.                    [GRAPHIC]
Customer demand drove increased sales of Tollgrade's
Telaccord product, which provides test access in a DSL
environment.


DIGITEST SYSTEM FOR POTS AND DSL TESTING

Key Customers -- Nortel Networks, Sprint North Supply, Lucent Technologies,
Choice One, Echelon Communications, SBC Telecom, Verizon and TriVergent.

Highlights -- Tollgrade expanded its customer list to
include large independent carriers and Regional Bell
Operating Companies, along with emerging CLECs through
the rollout of its DigiTest system. The company
introduced its Digital Wideband Unit (DWU) for DSL loop
qualification and in-service testing and demonstrated
the unit's ability to combine a range of measurements
to arrive at accurate DSL rate prediction. In addition,
Tollgrade saw its first sales of DigiTest for the POTS
test-head replacement market. As a result, Tollgrade's
DigiTest is well positioned to serve as the hardware                  [GRAPHIC]
test platform going forward for the replacement of
obsolete test hardware in the North American
network.


LIGHTHOUSE CABLE STATUS MONITORING

Key Customers -- AT&T Broadband, RCN Corporation, ANTEC, C-COR.net and Motorola.

Highlights -- Tollgrade's LIGHTHOUSE Cable Status
Monitoring system continued to penetrate the CATV
marketplace at a time when cable modem shipments
enjoyed a rapid increase throughout the country,
expanding the availability of broadband services over
the HFC network. RCN selected Tollgrade to build out                  [GRAPHIC]
its status monitoring system to proactively monitor the
company's power supplies and nodes.


PROFESSIONAL SERVICES

Key Customers -- SBC Communications, Verizon, BellSouth, Qwest, Sprint
Communications, AT&T Broadband and RCN Corporation.

Highlights -- Tollgrade's Professional Services
business doubled its revenues year-over-year. In the
process, our professionals spent nearly 38,000 hours in
the field, conducting training, troubleshooting and
spearheading testability improvement initiatives that
improved our customers' testability to an average of 90
percent. In addition, Tollgrade Professional Services                 [GRAPHIC]
helped the company build even stronger relationships
with our customers to aid in the sale of new products.


                                       5
<PAGE>   8

                      SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data of the Company as of December 31, 1996,
1997, 1998, 1999, 2000 and for the years then ended is derived from audited
consolidated financial statements of the Company.

<TABLE>
<CAPTION>
                                                              (In thousands, except per share data)
                                                                    Years Ended December 31,
                                               1996           1997          1998           1999         2000
-------------------------------------------------------------------------------------------------------------------
<S>                                          <C>            <C>           <C>           <C>            <C>
STATEMENTS OF OPERATIONS DATA:
Revenues(1)                                  $  37,490      $  45,421     $  46,277     $  61,111      $114,426
Cost of product sales                           18,322         20,104        19,620        25,014        42,638
 ...................................................................................................................
Gross profit                                    19,168         25,317        26,657        36,097        71,788
Operating expenses:
     Selling and marketing                       4,767          5,446         5,704         7,006        12,289
     General and administrative                  2,552          3,768         4,128         4,723         6,216
     Research and development                    3,921          5,945         6,880         8,757        12,456
 ...................................................................................................................
Total operating expenses                        11,240         15,159        16,712        20,486        30,961
-------------------------------------------------------------------------------------------------------------------
Income from operations                           7,928         10,158         9,945        15,611        40,827
Other income, net                                  845            899         1,062           949         2,525
 ...................................................................................................................
Income before income taxes                       8,773         11,057        11,007        16,560        43,352

Provision for income taxes                       3,176          4,174         4,040         5,937        15,857
-------------------------------------------------------------------------------------------------------------------
Net income                                   $   5,597      $   6,883     $   6,967     $  10,623      $ 27,495
-------------------------------------------------------------------------------------------------------------------
Earnings per share: (2)
     Basic                                   $     .51      $     .61     $     .60     $     .92      $   2.18
     Diluted                                       .47            .58           .58           .89          2.06
-------------------------------------------------------------------------------------------------------------------
Weighted average shares
     of common stock and equivalents:
     Basic                                      11,002         11,372        11,683        11,574        12,636
     Diluted                                    11,879         11,923        11,933        11,959        13,359
-------------------------------------------------------------------------------------------------------------------
</TABLE>


<TABLE>
<CAPTION>
                                                                       As of December 31,
                                                 1996          1997           1998         1999           2000
-------------------------------------------------------------------------------------------------------------------
<S>                                          <C>            <C>           <C>           <C>            <C>
BALANCE SHEET DATA:
Working capital                              $  27,232      $  34,570     $  40,539     $  49,958      $111,135
Total assets                                    34,626         43,713        49,865        66,202       131,275
Shareholders' equity                            30,006         38,101        45,696        57,504       122,760
-------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
                                                 1996          1997           1998         1999           2000
-------------------------------------------------------------------------------------------------------------------
<S>                                          <C>            <C>           <C>           <C>            <C>
OTHER DATA: (3)
Number of employees at year end                    184            205           230           282           411
Average revenue per employee                 $     204      $     222     $     201     $     217      $    278
-------------------------------------------------------------------------------------------------------------------
</TABLE>

(1)      Includes license fees of $250 and $150 for 1997 and 1998, respectively.

(2)      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.

(3)      Data not derived from Company's audited financial statements.


                                       6
<PAGE>   9

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:


o        Customers' ability to meet established purchase forecasts and their own
         growth projections;

o        The ability of certain customers to maintain financial strength and
         access to capital;

o        The ability for sales and marketing partners to meet their own
         performance objectives and provide vendor financing to certain local
         exchange carriers;

o        Customers' seasonal buying patterns and the risk of order
         cancellations;

o        Risk of shortage of key components and possibility of limited source of
         supply;

o        Manufacturing delays and availability of manufacturing capacity;

o        Intense competition in the market for the Company's products;

o        Rapid technological change along with the need to continually develop
         new products and gain customer acceptance and approval;

o        The Company's dependence on a relatively narrow range of products;

o        Competition;

o        The Company's dependence on key employees;

o        Difficulties in managing the Company's growth;

o        The Company's dependence upon a small number of large customers and
         certain suppliers;

o        The Company's dependence upon proprietary rights;

o        Risks of third party claims of infringement; and

o        Possibility of product defects; and

o        Government regulation.

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.
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 70% of the
Company's revenue for the year ended December 31, 2000 and will continue to
account for a majority of the Company's revenues for the foreseeable future.

         The Company's DigiTest(R) centralized network test system platform
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 complete hardware testing for POTS and local loop
prequalification for DSL services. The system currently consists of three
integrated pieces of hardware, the Digital Measurement Node ("DMN"), the Digital
Measurement Unit ("DMU"), and the Digital



                                       7
<PAGE>   10


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

Wideband Unit ("DWU"). 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, bridge tap detection, data
rate prediction, and in-service wideband testing. Sales of the DigiTest product
line accounted for approximately 18% of the Company's revenue for the year ended
December 31, 2000.

         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 9% of the Company's revenue for the
year ended December 31, 2000.

         Through 2000, 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. By making improvements in the customers'
digital loop carrier ("DLC") testability levels, 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 test and diagnose line problems. The
Professional Services business levels continued to increase in 2000, but are not
yet considered material to the Company's revenue for the year ended December 31,
2000.

         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 DLC equipment
manufacturers. For the year ended December 31, 2000, approximately 64% of the
Company's total revenue was generated from sales to these four RBOCs, the two
largest of which comprised approximately 43% of total revenues. The Company
markets and sells its products directly, as well as through various Original
Equipment Manufacturer ("OEM") 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
and shipments to the RBOCs. This timing is particularly sensitive to various
business factors within each of the RBOCs including the RBOCs relationships with
their various organized labor groups. In addition, the markets for the Com-
pany's new products, specifically DigiTest and LIGHTHOUSE, 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, the Company experienced certain customer demands to consolidate
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 status monitoring industry 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, if adopted by the standards setting body, are
expected to become final in the year 2001 and may affect the Company's revenues
from such products in subsequent periods. 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.
However, the international telephony markets differ from those found
domestically due to the different types and configurations of equipment used by
those international communica-



                                       8
<PAGE>   11

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


tion companies to provide services. In addition, certain competitive elements
also 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.
However, the Company continues to evaluate opportunities for its other products
in international markets. 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 11% for the year ended December 31, 2000.

         The Company believes that the near-term economic climate could be one
of challenge and uncertainty. In addition, the Company believes that future
growth may be affected as a result of an overall near-term economic slowdown
whereby customers may become more conservative in their ordering patterns and
quantities, or that certain emerging carriers become financially unstable. Due
to this uncertainty, the Company will evaluate its investments in marketing and
research and development expenses and monitor, control or decrease expense
levels, as appropriate.


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 is 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 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 the current year revenues. 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.

         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,
they are not necessarily indicative of long-term trends in sales of the
Company's products. Management believes that there is a continuing 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



                                       9
<PAGE>   12

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

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 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 expense 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%, is 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%, is 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%,
is 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.

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 is 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.


YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998

REVENUES

Revenues for the year ended December 31, 1999 were $61.1 million, and were $14.8
million, or 32.1%, higher than the revenues of $46.3 million for the year ended


                                       10
<PAGE>   13

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


December 31, 1998. The increases in revenues were primarily associated with the
sale of new products, as well as increased sales of core MCU products. During
1999, the Company generated revenues of approximately $9.4 million associated
with new product introductions including the Company's DigiTest product line,
while same product and services sales between periods increased $5.4 million, or
11.8%. Contributing to the increase in same product and services sales in 1999
was continued strong purchasing by Qwest (formerly US West) associated with that
company's continued effort to improve testability in selected states, offset by
the lower sales to certain Verizon (formerly Bell Atlantic) regions. The Company
believes the decreased sales within the Verizon region during 1999 was the
result of higher than expected inventories as a result of slower than expected
deployment of MCU products within certain regions. Verizon's testability
improvement initiatives migrated to more complex embedded DLC architectures that
require the provisioning of additional equipment and increased installation
time. The Company implemented certain strategies, including providing
professional services which provide comprehensive technical training and other
testability improvement initiatives services which were designed to return
product usage to historical levels. The effectiveness of these programs resulted
in some increased deployment of the Company's MCU technology, which in turn
began to reduce existing inventory levels within Verizon. There were no
assurances as to the ultimate effectiveness of these programs in returning
product deployment to historical levels.

GROSS PROFIT

Gross profit for 1999 was $36.1 million compared to $26.7 million for 1998,
representing an increase of $9.4 million, or 35.4%. Gross profit as a percentage
of revenues increased to 59.1% for 1999 compared to 57.6% for 1998.
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.

SELLING AND MARKETING EXPENSE

Selling and marketing expense consist primarily of personnel costs as well as
commissions and travel expenses of direct sales and marketing personnel, and
costs associated with marketing programs. Selling and marketing expense for 1999
was $7.0 million, or 11.5% of revenues, compared to $5.7 million, or 12.3% of
revenues for 1998. This increase of $1.3 million, or 22.8%, was primarily
related to increased costs associated with certain performance-based
compensation programs, as well as an increase in spending on general
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 1999 was $4.7
million, or 7.7%, of revenues, compared to $4.1 million, or 8.9%, of revenues
for 1998. This increase of $0.6 million, or 14.4%, was primarily attributable to
an increase in professional service consulting fees, as well as an increase in
expense for the Company's management incentive compensation program associated
with the Company's financial performance for the year ended December 31, 1999.

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 1999 was $8.8 million, or 14.3%, of revenues,
compared to $6.9 million, or 14.9%, of revenues for 1998. This increase of $1.9
million, or 27.3%, was principally due to costs associated with new product
development and the addition of personnel to support these new product
development activities. In addition, research and development expenses reflect
an increase in expense associated with the Company's management incentive
compensation program as mentioned above. 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 $1.0 million for
1999 compared to $1.1 million for 1998. The decrease of $0.1 million, or 10.6%,
was primarily the result of the prior year period including approximately $0.2
million of net key man life insurance proceeds associated with the death of the
Company's former Chairman R. Craig Allison.

PROVISIONS FOR INCOME TAXES

The Company's effective tax rate for 1999 was 35.9% of income before income
taxes, compared to the 36.7% rate in 1998. The decrease in the effective income
tax rate reflects the effect of certain permanent differences comprising a
larger percentage of pre-tax book income.


                                       11
<PAGE>   14

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


NET INCOME AND EARNINGS PER SHARE

For the year ended December 31, 1999, net income was $10.6 million compared to
$7.0 million for the year ended December 31, 1998, representing an increase of
$3.7 million, or 52.5%. Diluted earnings per common share of $.89 for 1999
increased by 53.4%, or $.31, from the $.58 earned in 1998. Fiscal year 1998
includes approximately $0.2 million, or $.02 per share, related to the after-tax
effect of net key man life insurance as previously discussed above. Excluding
the effect of net key man life insurance proceeds, net income increased $3.9
million, or 55.7%, while diluted earnings per share for 1999 increased 58.9%, or
$0.33 per share. Diluted weighted average shares of common stock and equivalents
outstanding were 11,958,976 in 1999 compared to 11,933,102 in 1998. As a
percentage of revenues, net income for 1999 increased to 17.4% from 15.1% in
1998.

LIQUIDITY AND CAPITAL RESOURCES

The Company had working capital of $111.1 million as of December 31, 2000
compared to the working capital of $50.0 million as of December 31, 1999. The
increase of $61.2 million, or 122.5%, can be attributed to operating cash flow
(income from operations before depreciation and amortization) and proceeds from
the exercise of stock options exceeding requirements for purchases of property
and equipment. Significant components of the Company's change in working capital
include an increase in cash and cash equivalents which include the effect of
additional operating cash flow, as well as cash received as a result of stock
option exercises, an increase in raw materials and work-in-process inventories
to support the new product introductions of the Company's DigiTest and
LIGHTHOUSE cable status monitoring system as well as an increase in MCU-related
inventory to support certain project-related customer programs, and an increase
in accounts receivable-trade as a result of the increased sales levels during
the latter part of 2000. In addition, the Company's current deferred and
refundable tax assets as of December 31, 2000 includes a current tax benefit of
approximately $9.0 million resulting from the exercise of certain nonstatutory
stock options under the Company's various stock option programs during 2000. The
Company is entitled to a tax deduction in the current tax year 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 nonstatutory stock options.
The Company anticipates that these tax deductions will be utilized either
through a refund of prior year taxes paid or through the elimination of income
taxes payable in 2001. As of December 31, 2000, the Company had $61.6 million of
cash and cash equivalents, short-term and long-term investments, which are
unrestricted and available for corporate purposes including acquisitions, and
other general working capital requirements.

         The Company made capital expenditures of $4.1 million in 2000,
primarily related to production test equipment and fixtures, computer hardware
to support new hires and to upgrade and expand the IT infrastructure, as well as
various leasehold expansion and improvements made to the Company's facilities.
Capital expenditures were $2.3 million and $1.7 million for 1999 and 1998,
respectively, and were primarily related to upgrades to the IT infrastructure,
office equipment, test fixtures and development systems, tooling and leasehold
improvements. The Company has recently completed a facility occupancy and
planning study to determine the various alternatives available for facility
expansion that may be necessary to accommodate potential future growth. The
Company is currently evaluating these alternatives that include the solicitation
and potential procurement of certain land parcels that surround the current
lease facility for the possible expansion of parking and or new building
structures. This purchase of properties is approximately $1.8 million and will
most likely occur during the first half of 2001. Planned capital expenditures
for 2001 are anticipated to total approximately $6.0 million. These planned
capital projects include test fixtures and development systems, computer and
office equipment and leasehold improvements to the Company's facilities.

         On April 22, 1997, the Company's Board of Directors authorized a
program to purchase up to 400,000 shares of its common stock over the next two
years. The program intended that the shares would be utilized to provide stock
under certain employee benefit programs. As of April 22, 1999, the expiration of
this initial program, the Company had purchased 382,400 shares of common stock
under this program. The Company used existing cash and short-term investments to
finance these purchases. On May 6, 1999, the Company's Board of Directors
authorized a new program to purchase up to 400,000 shares of its common stock
over a two-year period. As of December 31, 2000, the Company had not initiated
any purchases of common stock under this program. The number of shares that the
Company intends to purchase and the time of such purchases will be determined by
the Company, at its discretion.


                                       12
<PAGE>   15


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

The Company plans to 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 2001 results. The Company's financial position enables it to meet cash
requirements for operations and capital expansion programs.

         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 rights will be exercisable only if a person or group
acquires or announces a tender or exchange offer for 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.

         If after a person or group acquires 20% or more of the outstanding
common stock, 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%.

         The rights were not distributed in response to any specific effort to
acquire control of the Company, nor is the Company presently aware of any such
effort. The distribution of the rights will not affect the Company's reported
earnings and is not taxable to shareholders or to the Company. Shareholders will
not receive any documents evidencing their rights unless and until the rights
become exercisable. Until that time, the rights will not trade separately from
the common stock. The rights will expire on August 15, 2006.

BACKLOG

As of December 31, 2000, the Company's backlog was $8.2 million compared to the
backlog at December 31, 1999 of $12.1 million. The Company's backlog consists of
firm customer purchase orders for the Company's various products. Backlog at
December 31, 2000 also includes approximately $1.3 million related to the
one-time order from Qwest for the Company's Broadcast Program Channel Unit
destined for use at the Salt Lake City Winter Olympic Games. 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 the impact did not have a
material effect on its business, results of operations and financial condition.


                                       13
<PAGE>   16

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 judgements. 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 2000
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 19, 2001


                                       14
<PAGE>   17

REPORT OF INDEPENDENT ACCOUNTANTS


January 19, 2001


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, 2000 and
1999, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2000 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 the opinion expressed above.


PRICEWATERHOUSECOOPERS LLP

/s/ PricewaterhouseCoopers LLP


Pittsburgh, Pennsylvania
January 19, 2001



                                       15
<PAGE>   18

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
ASSETS                                                               December 31, 1999          DECEMBER 31, 2000
-------------------------------------------------------------------------------------------------------------------
<S>                                                                  <C>                        <C>
Current assets:
     Cash and cash equivalents                                         $  15,555,810             $  30,423,783
     Short-term investments                                               13,516,676                28,405,655
     Accounts receivable:
         Trade                                                            10,865,244                18,775,643
         Other                                                               335,155                   813,809
     Inventories                                                          17,335,747                30,499,482
     Prepaid expenses and deposits                                           461,934                   787,098
     Refundable taxes due                                                         --                 8,950,672
  Deferred tax assets                                                        575,251                   983,246
         Total current assets                                             58,645,817               119,639,388
Long-term investments                                                      2,850,000                 2,750,000
Property and equipment, net                                                4,337,115                 6,503,923
Deferred tax assets                                                          367,626                 2,380,828
Patents                                                                        1,396                       417
 ...................................................................................................................
         Total assets                                                  $  66,201,954             $ 131,274,556
-------------------------------------------------------------------------------------------------------------------

LIABILITIES AND SHAREHOLDERS' EQUITY
-------------------------------------------------------------------------------------------------------------------
Current liabilities:
     Accounts payable                                                  $     911,769             $   1,874,328
     Accrued expenses                                                      1,222,866                 1,937,589
     Accrued salaries and wages                                            2,209,473                 2,813,433
     Royalties payable                                                       793,689                 1,142,478
     Income taxes payable                                                  2,443,609                   636,938
     Deferred income                                                       1,106,483                   100,000
 ...................................................................................................................
         Total current liabilities                                         8,687,889                 8,504,766
Deferred tax liabilities                                                       9,950                     9,950
 ...................................................................................................................
         Total liabilities                                                 8,697,839                 8,514,716
Commitments
Shareholders' equity:
     Preferred stock, $1.00 par value; authorized shares,
         10,000,000; issued shares, -0- in 1999 and 2000, respectively            --                        --
     Common stock, $.20 par value; authorized shares, 50,000,000;
         issued shares, 12,102,280 in 1999 and 13,329,264 in 2000          2,420,456                 2,665,853
     Additional paid-in capital                                           28,828,568                66,343,728
     Treasury stock, at cost, 386,800 shares in 1999
         and 2000, respectively                                           (3,164,975)               (3,164,975)
     Retained earnings                                                    29,420,066                56,915,234
 ...................................................................................................................
         Total shareholders' equity                                       57,504,115               122,759,840
 ...................................................................................................................
              Total liabilities and shareholders' equity               $  66,201,954             $ 131,274,556
-------------------------------------------------------------------------------------------------------------------
</TABLE>


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


                                       16
<PAGE>   19

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                       Years Ended December 31,
                                                           1998                  1999                 2000
-------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>                   <C>                   <C>
Revenues                                             $  46,277,409         $  61,111,103         $ 114,426,097
Cost of product sales                                   19,620,226            25,014,418            42,637,979
 ...................................................................................................................
Gross profit                                            26,657,183            36,096,685            71,788,118
Operating expenses:
     Selling and marketing                               5,704,323             7,006,118            12,288,646
     General and administrative                          4,127,580             4,722,970             6,216,427
     Research and development                            6,880,015             8,756,551            12,456,337
 ...................................................................................................................
         Total operating expenses                       16,711,918            20,485,639            30,961,410
Income from operations                                   9,945,265            15,611,046            40,826,708
Other income (expense):
     Interest expense                                     (107,694)               (1,549)                   --
     Interest and other income                           1,169,531               950,380             2,525,460
 ...................................................................................................................
         Total other income (expense)                    1,061,837               948,831             2,525,460
Income before income taxes                              11,007,102            16,559,877            43,352,168
Provision for income taxes                               4,039,800             5,937,000            15,857,000
 ...................................................................................................................
         Net income                                  $   6,967,302         $  10,622,877         $  27,495,168
-------------------------------------------------------------------------------------------------------------------
</TABLE>


<TABLE>
<CAPTION>
EARNINGS PER SHARE INFORMATION:
-------------------------------------------------------------------------------------------------------------------
<S>                                                     <C>                   <C>                   <C>
Weighted average shares of common stock and equivalents:
   Basic                                                11,682,694            11,573,580            12,636,284
   Diluted                                              11,933,102            11,958,976            13,359,270
 ...................................................................................................................
Net income per common share:
   Basic                                             $         .60         $         .92         $        2.18
   Diluted                                           $         .58         $         .89         $        2.06
-------------------------------------------------------------------------------------------------------------------
</TABLE>


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


                                       17
<PAGE>   20

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                 Additional
                      Preferred Stock        Common Stock          Paid-in      Treasury     Unearned      Retained
                       Shares  Amount    Shares       Amount       Capital       Stock     Compensation    Earnings        Total
------------------------------------------------------------------------------------------------------------------------------------
<S>                    <C>     <C>     <C>          <C>          <C>           <C>           <C>         <C>           <C>
Balance at
   December 31, 1997     --     $--    11,454,700   $2,290,939   $24,086,846   $   (70,355)  $(35,934)   $11,829,887   $ 38,101,383

Exercise of common
   stock options         --      --       387,628       77,527     1,076,112            --         --             --      1,153,639
Tax benefit from
   exercise of
   stock options         --      --            --           --     1,163,441            --         --             --      1,163,441
Restricted stock -
   compensation
   charged to
   expense, net          --      --            --           --            --            --     28,934             --         28,934
Shares forfeited         --      --        (1,400)        (280)       (6,720)           --      7,000             --             --
Purchase of
   treasury stock        --      --            --           --            --    (1,718,932)        --             --     (1,718,932)
Net income               --      --            --           --            --            --         --      6,967,302      6,967,302
 ...................................................................................................................................
Balance at
   December 31, 1998     --      --    11,840,928    2,368,186    26,319,679    (1,789,287)        --     18,797,189     45,695,767

Exercise of common
   stock options         --      --       261,352       52,270     2,123,652            --         --             --      2,175,922
Tax benefit from
   exercise of
   stock options         --      --            --           --       385,237            --         --             --        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     --      --    12,102,280    2,420,456    28,828,568    (3,164,975)        --    $29,420,066     57,504,115

EXERCISE OF COMMON
   STOCK OPTIONS         --      --     1,226,984      245,397    11,580,460            --         --             --     11,825,857
TAX BENEFIT FROM
   EXERCISE OF
   STOCK OPTIONS         --      --            --           --    25,934,700            --         --             --     25,934,700
NET INCOME               --      --            --           --            --            --         --     27,495,168     27,495,168
 ...................................................................................................................................
BALANCE AT
   DECEMBER 31, 2000     --    $ --        13,329   $2,665,853   $66,343,728   $(3,164,975)  $     --    $56,915,234   $122,759,840
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>


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


                                       18
<PAGE>   21

TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                         Years Ended December 31,
                                                                1998               1999               2000
-------------------------------------------------------------------------------------------------------------------
<S>                                                         <C>               <C>                <C>
Cash flows from operating activities:
Net income                                                  $  6,967,302      $ 10,622,877       $ 27,495,168
Adjustments to reconcile net income
     to net cash provided by operating activities:
         Depreciation and amortization                         1,387,598         1,252,743          1,910,245
         Deferred income taxes                                  (545,420)         (253,512)          (481,541)
         Provision for losses on inventory                        88,000           393,000            743,129
         Provision for allowance for doubtful accounts            50,000           100,000             22,189
         Compensation expense for restricted stock                28,934                --                 --
Changes in assets and liabilities:
     Increase in accounts receivable-trade                       (53,377)       (3,077,184)        (7,932,588)
     (Increase) decrease in accounts receivable-other            216,410           (34,475)          (478,654)
     Increase in inventories                                  (1,188,657)       (4,526,976)       (13,906,864)
     (Increase) decrease in prepaid expenses and deposits         56,839          (109,521)          (325,164)
     Increase (decrease) in accounts payable                    (272,106)          224,690            962,559
     Increase (decrease) in accrued expenses, salaries
         and wages, royalties payable and deferred income       (816,995)        2,649,211            660,989
     Increase (decrease) in income taxes payable                (157,754)        1,655,130         (1,806,671)
 ...................................................................................................................
         Net cash provided by operating activities             5,760,774         8,895,983          6,862,797
 ...................................................................................................................
Cash flows from investing activities:
     Purchase of investments                                 (17,380,104)      (15,183,124)       (38,637,741)
     Redemption/maturity of investments                       17,844,566        14,618,612         23,848,762
     Capital expenditures                                     (1,695,975)       (2,272,485)        (4,076,074)
     Purchase of treasury stock                               (1,718,932)       (1,375,688)                --
 ...................................................................................................................
         Net cash used in investing activities                (2,950,445)       (4,212,685)       (18,865,053)
 ...................................................................................................................
Cash flows from financing activities:
     Proceeds from the exercise of stock options
         including related tax benefits                        2,317,080         2,561,159         26,870,229
 ...................................................................................................................
         Net cash provided by financing activities             2,317,080         2,561,159         26,870,229
 ...................................................................................................................
Net increase in cash and cash equivalents                      5,127,409         7,244,457         14,867,973
Cash and cash equivalents at beginning of year                 3,183,944         8,311,353         15,555,810
 ...................................................................................................................
Cash and cash equivalents at end of year                    $  8,311,353      $ 15,555,810       $ 30,423,783
-------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
     Cash paid during the year for interest                 $    107,694      $      1,549                 --
     Cash paid during the year for income taxes             $  3,596,079      $  4,078,830       $  3,145,422
-------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of non-cash financing activity:
     Tax benefit from the exercise of stock options         $         --      $         --       $ 10,890,328
-------------------------------------------------------------------------------------------------------------------
</TABLE>


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


                                       19
<PAGE>   22

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

1.  ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND BASIS OF PRESENTATION

Tollgrade Communications, Inc. (the Company) designs, engineers, markets and
supports test system, test access and status monitoring products 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 DigiTest, 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.

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, 1999 and 2000 consist of a treasury note
and/or individual municipal bonds stated at cost, which approximates market
value. These securities have a maturity of one year or less at date of purchase
and/or contain a callable provision in which the bonds can be called within one
year from date of purchase. Long-term investments are individual municipal bonds
with a maturity of more than one year but less than eighteen months. The primary
investment purposes are to provide a reserve for future business purposes,
including possible 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" 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. Property and equipment is depreciated
on a straight-line method over their estimated useful lives ranging from 3 to 7
years. 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.

PATENTS

The costs of patents are being amortized on a straight-line method over a period
of five years.


                                       20
<PAGE>   23


PRODUCT WARRANTY

The Company records estimated warranty costs on the accrual basis of accounting.
These reserves are based on applying historical returns and cost experience to
the current level of product shipments.

REVENUE RECOGNITION

Revenue from product sales is recognized at the time of shipment. Revenue from
Professional Services is recognized upon services being rendered. 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.

RESEARCH AND DEVELOPMENT COSTS

Research and development costs are charged to operations in the year incurred.

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.

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 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.

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,
                                                         1998                1999               2000
-------------------------------------------------------------------------------------------------------------
<S>                                                  <C>                 <C>                 <C>
Net Income                                           $ 6,967,302         $10,622,877         $27,495,168
-------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding            11,682,694          11,573,580          12,636,284
 .............................................................................................................
Effect of dilutive securities - stock options            250,408             385,396             722,986
 .............................................................................................................
                                                      11,933,102          11,958,976          13,359,270
-------------------------------------------------------------------------------------------------------------
Earnings per share:
  Basic                                              $       .60         $       .92         $      2.18
-------------------------------------------------------------------------------------------------------------
  Diluted                                            $       .58         $       .89         $      2.06
-------------------------------------------------------------------------------------------------------------
</TABLE>

                                       21
<PAGE>   24

2.  INVENTORIES

Inventories consisted of the following:

                               December 31, 1999           DECEMBER 31, 2000
------------------------------------------------------------------------------
Raw materials                     $ 8,173,299                 $13,800,196
Work in process                     7,410,203                  12,981,052
Finished goods                      1,752,245                   3,718,234
 ..............................................................................
                                  $17,335,747                 $30,499,482
------------------------------------------------------------------------------


3.  PROPERTY AND EQUIPMENT

Property and equipment consisted of the following:

<TABLE>
<CAPTION>
                                                  December 31, 1999     DECEMBER 31, 2000
-------------------------------------------------------------------------------------------
<S>                                                 <C>                    <C>
Test equipment and tooling                          $4,217,189             $ 5,900,085
Office equipment and fixtures                        3,269,761               4,735,551
Leasehold improvements                               1,590,704               2,059,764
 ...........................................................................................
                                                     9,077,654              12,695,400
Less accumulated depreciation and amortization       4,740,539               6,191,477
 ...........................................................................................
                                                    $4,337,115             $ 6,503,923
-------------------------------------------------------------------------------------------
</TABLE>


4.  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, 1999 and 2000, there were 12,102,280 and 13,329,264
issued shares, respectively.

STOCK REPURCHASE PROGRAM

On April 22, 1997, the Company's Board of Directors authorized a program to
purchase up to 400,000 shares of its common stock over a two-year period. The
program intended that the shares would be utilized to provide stock under
certain employee benefit programs. As of April 22, 1999, the expiration of this
initial program, the Company had purchased 382,400 shares of common stock under
this program. The Company has used existing cash and short-term investments to
finance these purchases. On May 6, 1999, the Company's Board of Directors
authorized a new program to purchase up to 400,000 shares of its common stock
over a two-year period. As of December 31, 2000, the Company had not initiated
any purchases of common stock under this new program. The number of shares that
the Company intends to purchase and the time of such purchases will be
determined by the Company at its discretion. The Company plans to use existing
cash and short-term investments to finance any such purchases.

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 December 14, 2000, the Board of Directors of the Company approved a
proposal to increase the number of shares available under the 1998 Employee
Incentive Compensation Plan (the "1998 Plan") by 200,000 shares, from 740,000 to
940,000 shares. The aggregate number of shares of the Company's Common Stock
which may be issued under the 1995 Long-Term Incentive Compensation Plan (the
"1995 Plan") and the 1998 Plan is 2,210,000 and 940,000 shares respectively,
subject to proportionate adjustment in the event of stock splits and similar
events. 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 shares
authorized but not granted under these plans at December 31, 1999 and 2000 were
as follows:

<TABLE>
<CAPTION>
                                                            Shares Authorized But Not Granted
                                                    December 31, 1999                DECEMBER 31, 2000
-------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>                              <C>
1995 Long-Term Incentive Compensation Plan               510,016                          193,373
1998 Employee Incentive Compensation Plan                 67,988                          188,626
 ...................................................................................................................
Total                                                    578,004                          381,999
-------------------------------------------------------------------------------------------------------------------
</TABLE>


                                       22
<PAGE>   25

     Certain employees and directors of the Company were granted stock options
under the 1995 Plan and the 1998 Plan and various other agreements. 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 1998, 1999 and
2000 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,
                                                        1998                 1999                 2000
---------------------------------------------------------------------------------------------------------------
<S>                              <C>                <C>                 <C>                  <C>
Net income                       As reported        $6,967,302          $10,622,877          $27,495,168
                                 Pro forma          $5,159,610          $ 8,889,233          $23,019,191

 ...............................................................................................................
Diluted earnings per share       As reported        $      .58          $       .89          $      2.06
                                 Pro forma          $      .43          $       .74          $      1.72
---------------------------------------------------------------------------------------------------------------
</TABLE>


     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 1998, 1999 and 2000: expected volatility of 50.8% in 1998, 51.9%
in 1999 and 77.0% in 2000; a risk-free interest rate of 4.82% in 1998, 4.97% in
1999, and 5.83% in 2000; and an expected holding period of 4 years. The weighted
average fair value of stock options, calculated using the Black-Scholes
option-pricing model, granted during 1998, 1999 and 2000, is $3.84, $4.76 and
$58.36, 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, 1997              1,506,534         $   .47850  -  $ 12.87500         $ 7.92
Granted                                     1,084,000            7.28125  -    13.56250           8.59
Exercised                                    (387,428)            .48000  -    11.75000           2.98
Cancelled                                     (80,667)           6.00000  -    13.56250          10.33
--------------------------------------------------------------------------------------------------------------
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
--------------------------------------------------------------------------------------------------------------
</TABLE>


                                                             Weighted Average
Options exercisable at:          Number of Shares             Exercise Price
-------------------------------------------------------------------------------
December 31, 1998                   1,423,316                    $ 9.20
December 31, 1999                   1,660,425                      9.49
DECEMBER 31, 2000                     997,680                     21.92
-------------------------------------------------------------------------------


                                       23
<PAGE>   26

     The following table summarizes the status of the stock options, outstanding
and exercisable, at December 31, 2000:

<TABLE>
<CAPTION>
                                                 Stock Options Outstanding             Stock Options Exercisable
-------------------------------------------------------------------------------------------------------------------
                                           Weighted Average        Weighted                           Weighted
    Range of Exercise                          Remaining             Average                            Average
         Prices                Shares       Contractual Life    Exercise Price        Shares       Exercise Price
-------------------------------------------------------------------------------------------------------------------
<S>                         <C>            <C>                  <C>                  <C>           <C>
 $  6.00000  - $  7.28125     265,433            6.68             $  6.74            265,433          $  6.74
 ...................................................................................................................
 $  7.50000  - $  7.68750     227,944            7.66                7.56            216,611             7.55
 ...................................................................................................................
 $  8.75000  - $ 10.31250     269,476            7.54                9.70            179,509             9.92
 ...................................................................................................................
 $ 11.03125  - $ 55.89850     350,211            8.35               32.84            251,779            25.38
 ...................................................................................................................
 $ 71.87500  - $117.34400     213,834            9.64              115.26             71,855           115.27
 ...................................................................................................................
 $159.18750  - $159.18750      36,342            9.53              159.19             12,493           159.19
 ...................................................................................................................
      TOTAL                 1,363,240            7.98             $ 35.25            997,680          $ 21.92
-------------------------------------------------------------------------------------------------------------------
</TABLE>


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%.

5.  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. Royalty
fees of $1,903,701, $2,011,930 and $2,910,803 were incurred in 1998, 1999 and
2000, respectively, and are included in cost of product sales in the
accompanying consolidated statements of operations.


                                       24
<PAGE>   27

6.  INCOME TAXES

The provision for income taxes consisted of the following:

                                      Years Ended December 31,
                            1998                1999              2000
-------------------------------------------------------------------------------
Current:
     Federal             $4,030,841          $5,478,412        $14,212,441
     State                  554,379             712,100          2,126,100
 ...............................................................................
                          4,585,220           6,190,512         16,338,541
-------------------------------------------------------------------------------
Deferred:
     Federal               (475,494)           (221,011)          (434,521)
     State                  (69,926)            (32,501)           (47,020)
 ...............................................................................
                           (545,420)           (253,512)          (481,541)
 ...............................................................................
                         $4,039,800          $5,937,000        $15,857,000
-------------------------------------------------------------------------------

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

                                                 Years Ended December 31,
                                                1998       1999       2000
------------------------------------------------------------------------------
Federal statutory tax rate                       34%        34%        35%
     Research and development tax credit         (1)        --         --
     State income taxes                           3          3          5
     Foreign sales corporation tax benefit       --         (1)        --
     Other                                        1         --        (3)
 ..............................................................................
     Effective tax rate                          37%        36%        37%
------------------------------------------------------------------------------

     The components of and changes in the deferred tax assets and liabilities
recorded in the accompanying balance sheets at December 31, 1999 and 2000 were
as follows:

<TABLE>
<CAPTION>
                                                          Deferred                     Deferred
                                           December 31,   Expense       December 31,   Expense                        DECEMBER 31,
                                              1998        (Credit)         1999        (Credit)        Other             2000
------------------------------------------------------------------------------------------------------------------------------------
<S>                                        <C>           <C>           <C>            <C>            <C>             <C>
DEFERRED TAX ASSETS:
Excess of tax basis over book
     basis for:
         Property and equipment             $149,797     $  27,989     $  121,808     $ (63,082)     $       --      $  184,890
         Inventory                           204,778       (42,404)       247,182       (74,621)             --         321,803

Reserves recorded for:
         Warranty                            169,650       (64,350)       234,000      (173,550)             --         407,550
         Inventory                           104,130      (153,270)       257,400      (165,750)             --         423,150
         Allowance for doubtful
              accounts                        39,000       (31,670)        70,670        (7,330)             --          78,000
Net operating loss carryforward                   --            --             --            --       1,939,656       1,939,656
Other                                         22,010        10,193         11,817         2,792              --           9,025
 ....................................................                   ..........                                    ..........
Total deferred tax assets                    689,365                      942,877                                     3,364,074
----------------------------------------------------                   ----------                                    ----------

DEFERRED TAX LIABILITIES:
Excess of book basis over tax
     basis for:
         Other                                (9,950)           --         (9,950)           --                          (9,950)
 ....................................................                   ..........                                    ..........
Total deferred tax liabilities                (9,950)                      (9,950)                                       (9,950)
----------------------------------------------------                   ----------                                    ----------

------------------------------------------------------------------------------------------------------------------------------------
Net deferred taxes                          $679,415     $(253,512)    $  932,927     $(481,541)     $1,939,656      $3,354,124
Reconciliation to the balance sheet:
         Current portion of
              deferred tax assets            354,891                      575,251                                       983,246
         Long-term portion of
              deferred tax liabilities        (9,950)                      (9,950)                                       (9,950)
 ....................................................................................................................................
Long-term deferred taxes                    $334,474                    $ 367,626                                    $2,380,828
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                       25
<PAGE>   28


7.  LEASE COMMITMENTS

The Company leases office space and equipment under agreements which are
accounted for as operating leases. The office lease expires December 31, 2002
and may be extended up to an additional 3 years. The equipment lease expires in
August 2005. The Company is also involved in various month-to-month leases for
research and development equipment. In addition, the office lease includes
provisions for possible adjustments in annual future rental commitments relating
to excess taxes and excess maintenance costs that may occur. The Company made
additional rental payments of $4,827, $0 and $9,198 in 1998, 1999 and 2000,
respectively.

       Minimum annual future rental commitments under noncancelable leases
       as of December 31 are:
       2001 ......................................................  $ 701,230
       2002 ......................................................    741,550
       2003 ......................................................     76,270
       2004 ......................................................     76,270
       2005 ......................................................     54,024

     The rent expense for all lease commitments was $425,714, $599,615 and
$731,320 in 1998, 1999 and 2000, respectively.

8.  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 more than 70% of the Company's net product sales for 2000.
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 2000.

     Sales to the RBOCs accounted for approximately 82%, 61% and 64% of the
Company's net product sales for fiscal years 1998, 1999 and 2000, respectively.
During fiscal year 1998, sales to three RBOCs individually exceeded 10% of
consolidated revenues and on a combined basis, comprised 76% of the Company's
net product sales. During fiscal years 1999 and 2000, sales to four RBOCs
individually exceeded 10% of consolidated revenues and on a combined basis,
comprised 61% and 64%, respectively, of the Company's net product sales. In
addition, sales to an Original Equipment Manufacturer accounted for
approximately 3%, 11% and 4% of the Company's net product sales for fiscal years
1998, 1999 and 2000, 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 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.

9.  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 or not to exceed the
regulatory imposed limit, as defined. The Company does not make any matching
contributions to the plan.

10.  DEFERRED AND REFUNDABLE TAX ASSETS

The Company's current refundable tax assets as of December 31, 2000 include a
tax benefit of $8,950,672 resulting from the exercising of certain nonstatutory
stock options by various directors, officers and other employees under the
Company's various stock option programs during 2000. The Company is entitled to
a tax deduction in the current tax year ended December 31, 2000 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 nonsatutory stock options.
It is anticipated that these deductions will be utilized either through a refund
of prior year taxes paid or through the elimination of income taxes payable in
2001.


                                       26
<PAGE>   29

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.


<TABLE>
<CAPTION>
                                                       (In thousands, except per share data)
                                                             Quarter Ended (Unaudited)
                                March 31,  June 30,  Sept. 30,  Dec. 31,   MARCH 31, JUNE 30,   SEPT. 30, DEC. 31,
                                  1999       1999      1999       1999       2000      2000       2000      2000
-------------------------------------------------------------------------------------------------------------------
<S>                             <C>        <C>       <C>        <C>       <C>        <C>        <C>       <C>
Revenues                        $ 11,120   $ 14,270  $  13,403  $ 22,318  $  22,418  $ 29,667   $ 29,788  $ 32,554
Cost of product sales              4,752      5,903      6,040     8,320      8,372    11,414     10,841    12,012
 ...................................................................................................................
Gross profit                       6,368      8,367      7,363    13,998     14,046    18,253     18,947    20,542
Operating expenses:
     Selling and marketing         1,398      1,767      1,561     2,280      2,384     3,028      3,440     3,438
     General and administrative    1,048        965        980     1,729      1,378     1,495      1,591     1,752
     Research and development      1,876      2,158      2,126     2,597      2,590     3,098      3,178     3,589
 ...................................................................................................................
Total operating expenses           4,322      4,890      4,667     6,606      6,352     7,621      8,209     8,779
 ...................................................................................................................
Income from operations             2,046      3,477      2,696     7,392      7,694    10,632     10,738    11,763
Other income, net                    271        236        334       107        470       546        662       848
 ...................................................................................................................
Income before income taxes         2,317      3,713      3,030     7,499      8,164    11,178     11,400    12,611
Provision for income taxes           831      1,340      1,092     2,674      2,939     4,024      4,104     4,790
 ...................................................................................................................
Net income                      $  1,486   $  2,373  $   1,938  $  4,825  $   5,225  $  7,154   $  7,296  $  7,821
-------------------------------------------------------------------------------------------------------------------
Net income per common share
     Basic                      $    .13   $    .21  $     .17  $    .41  $     .43  $    .57   $    .57  $    .60
     Diluted                    $    .13   $    .20  $     .16  $    .39  $     .39  $    .54   $    .54  $    .58
Weighted average shares of
     common stock and equivalents:)
     Basic                        11,576     11,538     11,548    11,631     12,219    12,563     12,821    12,940
     Diluted                      11,759     11,612     12,017    12,397     13,546    13,318     13,460    13,434
-------------------------------------------------------------------------------------------------------------------
</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:

                                          High                    Low
--------------------------------------------------------------------------------
1999:
     First Quarter                     $  9-13/16               $ 7-1/2
     Second Quarter                       8-7/16                  7-1/16
     Third Quarter                       13-7/16                  7-1/2
     Fourth Quarter                      19-11/16                10-1/2
2000:
     First Quarter                     $ 84                     $16-1/16
     Second Quarter                     147-3/16                 31-1/2
     Third Quarter                      168-7/8                  78-5/8
     Fourth Quarter                     148                      25-3/4
--------------------------------------------------------------------------------

     At January 31, 2001, the Company had 175 holders of record of its Common
Stock and 13,340,246 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.


                                       27
<PAGE>   30

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 Thursday,
May 3, 2001, at 3:00 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
   TDD for Hearing Impaired:
     1-800-231-5469
   Foreign Shareholders:
     201-329-8660
   TDD Foreign 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 2000, which will be
filed with the Securities and Exchange Commission during the first quarter of
2001, 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.


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

TM TELACCORD is a trademark of Tollgrade Communications, Inc.

All other trademarks are the property of their respective owners.

(C)2001 Tollgrade Communications, Inc. All rights reserved.


                                       28
<PAGE>   31

Board of Directors

[PHOTO]                    CHRIS ALLISON
                           Chairman and
                           Chief Executive Officer

[PHOTO]                    JAMES J. BARNES
                           Attorney at Law,
                           Buchanan Ingersoll P.C.

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

[PHOTO]                    DAVID S. EGAN
                           President, ClubCom, Inc.

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

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

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



EXECUTIVE OFFICERS

[PHOTO]                    CHRIS ALLISON
                           Chairman and
                           Chief Executive Officer

[PHOTO]                    SARA M. ANTOL
                           General Counsel and Secretary

[PHOTO]                    RICHARD A. BAIR, JR.
                           Executive
                           Vice President,
                           Engineering

[PHOTO]                    ROBERT L. CORNELIA
                           Executive
                           Vice President,
                           Operations

[PHOTO]                    BRADLEY N. DINGER
                           Controller

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

[PHOTO]                    MARK C. FREY
                           Senior
                           Vice President,
                           Test Access Division

[PHOTO]                    SAMUEL C. KNOCH
                           Chief Financial Officer and Treasurer

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

[PHOTO]                    TIMOTHY D. O'BRIEN
                           Director of
                           Corporate Communications

[PHOTO]                    MARK B. PETERSON
                           President

[PHOTO]                    MATTHEW J. ROSGONE
                           Senior
                           Vice President, Purchasing, Manufacturing
                           and Documentation

[PHOTO]                    ROGER A. SMITH
                           Executive
                           Vice President, Technology




<PAGE>   32


                                [TOLLGRADE LOGO]

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