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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-K
 þ
    
    Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the fiscal year ended December 31, 2008
 Commission file number 000-27312
 TOLLGRADE COMMUNICATIONS, INC.
  PENNSYLVANIA
    
    25-1537134(State or other jurisdiction of 
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)493 Nixon Road, Cheswick, Pennsylvania
    
    15024(Address of principal executive offices)
    
    (Zip Code)
 412-820-1400
 Securities registered pursuant to Section 12(b) of the Act:
 Common Stock, par value $0.20 per share
    
    The NASDAQ Stock Market LLC(Title of Class)
    
    (Exchange on which registered)
  o þ
  o þ
  þ o
 o þ
  Large accelerated filer oAccelerated filer þNon-accelerated filer o(Do not check if a smaller reporting company)Smaller reporting company o o þ
   DOCUMENTS INCORPORATED BY REFERENCE
 Part of Form 10-K into whichDocument
    
    Document is incorporatedPortions of the Proxy Statement to be
distributed in connection with the 2009
Annual Meeting of Shareholders and to be
filed pursuant to Regulation 14A
    
    III




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TABLE OF CONTENTS
 Part IItem 1.
    
    Business
    
    
    3Item 1A.
    
    Risk Factors
    
    
    12Item 1B.
    
    Unresolved Staff Comments
    
    
    21Item 2.
    
    Properties
    
    
    21Item 3.
    
    Legal Proceedings
    
    
    21Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    21Part IIItem 5.
    
    Market for the Registrants Common Stock, Related Stockholder Matters
and Issuer Purchases of Equity Securities
    
    
    22Item 6.
    
    Selected Financial Data
    
    
    24Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    26Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    48Item 8.
    
    Financial Statements and Supplementary Data
    
    
    48Item 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
    
    
    78Item 9A.
    
    Controls and Procedures
    
    
    78Item 9B.
    
    Other Information
    
    
    78Part IIIItem 10.
    
    Directors, Executive Officers and Corporate Governance
    
    
    79Item 11.
    
    Executive Compensation
    
    
    79Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
    
    
    79Item 13.
    
    Certain Relationships and Related Transactions and Director Independence
    
    
    80Item 14.
    
    Principal Accounting Fees and Services
    
    
    80Part IVItem 15.
    
    Exhibits and Financial Statement Schedules
    
    
    80SIGNATURES
    
    
    83
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PART I
 CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995.
    
 Item 1. Business.
  ® ®
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® ®
    www.sec.gov
 Products
 Telecommunications Test and Measurement Products
 ®
  -4-




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System Test Products
  ®
       -5-




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Services
   MCU
    Cable Testing Products
   ®
 -6-




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®
     Electric Utility Monitoring Products
  Operating Segment
  Sales and Competition
  -7-




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Revenue Concentrations
    Competitive Conditions
    -8-




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Manufacturing
     Product and Technology Development
  -9-




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Proprietary Rights
 ® ® ® ® ® ® ® ® ® ®
   Backlog
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Employees
  Executive Officers of the Company
  Joseph A. Ferrara
    
    Chief Executive Officer, President and Board Member
of Tollgrade since November 2007; Senior Vice
President, Sales and Marketing of Tollgrade from
August 2007 until November 2007; prior thereto
General Manager Data Networks Division of Ericsson,
Inc. from January 2006 until July 2007 following
Ericssons acquisition of Marconis product
divisions; Chief Executive Officer of Marconi
Corporation plcs North American operations from June
2005 until January 2006; Vice President of Business
Operations of Marconis Data Networks Division from
February until June 2005 and July 2000 until April
2004; and Vice President of Marketing of Marconis
Data Networks Division from April 2004 until February
2005; Age 42.Sara M. Antol
    
    General Counsel of the Company since December 2000;
Secretary of the Company since April 1996; Chief
Counsel of the Company from April 1996 until December
2000; prior thereto, attorney at Babst, Calland,
Clements & Zomnir, P.C., a law firm; Age 47.David L. Blakeney
    
    Vice President, Research and Development of the
Company since October 2008; prior thereto consultant
to the Company in the same capacity from March 2008
until October 2008; Vice President, Engineering, for
Altrix Logic from December 2006 until October 2008;
prior thereto, Vice President of Engineering for the
Data Networks Division of Ericsson, Inc., formerly,
Marconi plc from April 1999 to October 2006; Age 47.Gary W. Bogatay, Jr.
    
    Chief Financial Officer of the Company since October
2008; prior thereto Chief Financial Officer,
Secretary and Treasurer of BANKS.com, Inc. from April
2004 until October 2008; Vice President of Finance of
The Pennsylvania Culinary Institute, a subsidiary of
Career Education, from January 2003 to April 2004;
Age 39.Grant Cushny
    
    Vice President of Global Sales and Professional
Services of the Company since August 2007; General
Manager of Broadband Test Division of Teradyne, Inc.
from June 2006 until July 2007; prior thereto
Director of Professional Services from January 2004
until June 2006 and Director of Engineering from
January 2000 until January 2004; Age 45.Robert H. King
    
    Vice President, Sales and Marketing of the Company
since February 2009; Executive Director, Business
Development of the Company from December 2008 until
February 2009; prior thereto President and General
Manager of the Broadband Products Group at Sunrise
Telecom from April 2006 until June 2008; Vice
President, Sales at Sunrise from September 2003 until
April 2006; Age 47.Joseph G. OBrien
    
    Vice President, Human Resources of the Company since
October 1997; Director of Employee Development of the
Company from April 1997 until October 1997; prior
thereto, Coordinator, Elderberry Junction, Goodwill
Industries, a charitable organization, from May 1995
until April 1997; Age 49.Kenneth J. Shebek
    
    Vice President, Operations of the Company since
October 2008; prior thereto, Vice President of Supply
and Logistics for the Data Networks Division of
Ericsson, Inc., formerly, Marconi, plc. From January,
2006 until October 2008; Vice President of Supply
Chain for Marconi, plc, and its Vice President of
North American Operations from January 2003 to
December 2005; Age 46.
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Item 1A. Risk Factors
  Our Services business is subject to a trend of reduced capital spending for our products by our
major customers and possible delays in, or the inability to complete, negotiation and execution of
purchase and service agreements with new or existing customers could significantly impact business
results and possibly result in impairment charges in the future.
  Our future growth depends to a large extent upon our ability to reposition the Company with a
greater focus on our service assurance testing offerings to the telecom market.
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Our cost reduction plans may be ineffective or may limit our ability to compete.
  A continuing downturn in the global economy may adversely affect our revenues, results of
operations and financial condition.
  
    
    poor availability of credit,
    
    continued recession in the United States economy and other countries that we serve,
    
    erosion in the value of the U.S. dollar relative to foreign currencies in jurisdictions
where we transact business,
    
    significant act of terrorism which disrupts global trade or consumer confidence,
    
    geopolitical tensions including war and civil unrest, and
    
    reduced levels of economic activity or disruption of domestic or international
transportation.
   We are dependent upon our ability to attract, retain and motivate our key personnel.
  We depend upon a few major customers for a majority of our revenues, and the loss of any of these
customers, or the substantial reduction in the products or services that they purchase from us,
would significantly reduce our revenues and net income.
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
    
    the conditions of the communications market and the weakening economy in general;
    
    subscriber line loss and related reduced demand for wireline telecommunications
services;
    
    changes or shifts in the technology utilized in the networks;
    
    labor disputes between our customers and their collective bargaining units;
    
    the failure of our customers to meet established purchase forecasts and growth
projections;
    
    competition among the large domestic carriers, competitive exchange carriers and
wireless telecommunications and cable providers; and
    
    reorganizations, including management changes, at one or more of our customers or
potential customers.
  Our operating results may vary from quarter to quarter, causing our stock price to fluctuate.
  We may experience reduced product sales caused by customers transitioning their access network
service assurance solutions.
  We have completed, and may pursue additional acquisitions, which could result in the disruption of
our current business, difficulties related to the integration of acquired businesses, and
substantial expenditures.
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The failure of acquired assets to meet expectations, or a decline in our fair value determined by
market prices of our stock, could indicate impairment of our intangible assets and result in
impairment charges.
  The sale of our products is dependent upon our ability to satisfy the proprietary requirements of
our customers.
  The sale of our products is dependent on our ability to respond to rapid technological change,
including evolving industry-wide standards, and may be adversely affected by the development, and
acceptance by our customers, of new technologies which may compete with or reduce the demand for
our products.
    Our reliance on third parties to manufacture certain aspects of our products involves risks,
including delays in product shipments and reduced control over product quality.
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Our future sales in international markets are subject to numerous risks and uncertainties.
  We face intense competition, which could result in our losing market share or experiencing a
decline in our gross margins.
   Our future results are dependent on our ability to establish, maintain and expand our distribution
channels and our existing third-party distributors.
  The sales cycle for our system products is long, and the delay or failure to complete one or more
large transactions in a quarter could cause our operating results to fall below our expectations.
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We depend on sales of our MCU products for a meaningful portion of our revenues, but this product
is mature and its sales will continue to decline.
   The continued adoption of industry-wide standards in both the telecommunications and cable markets
could have a material adverse effect on our profitability.
  The presence of available open source software could adversely affect our ability to maximize
revenue from software products.
  If our development efforts with respect to our LightHouse system fail to result in products which
meet our customers needs, or if our customers fail to accept our new products, our revenues will
be adversely affected.
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Our customers are subject to an evolving governmental regulatory environment that could
significantly reduce the demand for our products or increase our costs of doing business.
   Our limited ability to protect our proprietary information and technology may adversely affect our
ability to compete, and our products could infringe upon the intellectual property rights of
others, resulting in claims against us the results of which could be costly.
   The success of some of our products is dependent on our ability to maintain licenses to technology
from the manufacturers of systems with which our products must be compatible.
  If we are unable to satisfy our customers specific product quality, certification or network
requirements, our business could be disrupted and our financial condition could be harmed.
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If our accounting controls and procedures are circumvented or otherwise fail to achieve their
intended purposes, our business could be seriously harmed.
  If we ship products that contain defects, the market acceptance of our products and our reputation
will be harmed and our customers could seek to recover their damages from us.
  We may incur significant liabilities if we fail to comply with environmental regulations.
  Consolidations in, or a continued slowdown in, the telecommunications industry could harm our
business.
  Our expenses are relatively fixed in the short term, and we may be unable to adjust spending to
compensate for unexpected revenue shortfalls.
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We rely on software that we license from third-party developers to perform key functions in our
products.
  We are affected by a pattern of product price decline in certain markets, which can harm our
business.
  Our common stock price may be extremely volatile.
  
    
    General market and economic conditions;
    
    Changes in the telecommunications industry;
    
    Actual or anticipated variations in operating results;
    
    Announcements of technological innovations, new products or new services by us or by our
competitors or customers;
    
    The fact that we no longer receive research coverage by sell-side market analysts;
    
    Announcements by us or our competitors of significant acquisitions, strategic
partnerships, joint ventures, capital commitments or other strategic announcements;
    
    Announcements by our customers regarding end market conditions and the status of
existing and future infrastructure network deployments;
    
    Additions or departures of key personnel; and
    
    Future equity or debt offerings or our announcements of these offerings.
  We may be subject from time to time to legal proceedings, and any adverse determinations in these
proceedings could materially harm our business.
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We may have difficulty securing new financing upon the same or substantially similar terms.
  
 Item 1B. Unresolved Staff Comments.
  
 Item 2. Properties.
    
 Item 3. Legal Proceedings.
  
 Item 4. Submission of Matters to a Vote of Security Holders.
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PART II
 
 Item 5. Market for the Registrants Common Stock, Related Stockholder Matters and Issuer Purchases
of Equity Securities.
  2008
    
    2007High
    
    Low
    
    High
    
    LowFirst Quarter
    
    $
    8.13
    
    
    $
    5.08
    
    
    $
    12.90
    
    
    $
    9.57Second Quarter
    
    $
    6.07
    
    
    $
    4.24
    
    
    $
    13.55
    
    
    $
    10.35Third Quarter
    
    $
    7.00
    
    
    $
    4.25
    
    
    $
    11.34
    
    
    $
    8.60Fourth Quarter
    
    $
    5.56
    
    
    $
    3.00
    
    
    $
    10.31
    
    
    $
    7.08
    (d) Maximum Number(or Approximate(c) Total number
    
    Dollar Value) ofof shares purchased
    
    Shares that May Yet(a) Total Number of
    
    
    
    
    
    as part of publicly
    
    Be Purchased UnderShares Purchased
    
    (b) Average Price
    
    announced plans or
    
    the Plans orPeriod
    
    (1)
    
    Paid per Share
    
    programs
    
    ProgramsOctober 26  November 22, 2008
    
    
    496,918
    
    
    $
    4.39
    
    
    
    496,918
    
    
    $
    12,800,000
 
 (1)
    
    On October 28, 2008, the Board of Directors approved a share repurchase program, pursuant to
which the Company could repurchase common stock with an aggregate share value of up to $15
million with no expiration date. Such purchases could be made through open market
transactions and privately negotiated transactions at the Companys discretion, subject to
market conditions and other factors. The repurchase program does not obligate the Company to
acquire any particular amount of common stock and, at the Boards discretion, may be
suspended, discontinued or modified at any time. As of December 31, 2008, the Company had
acquired 496,918 shares pursuant to this program at a total cost of $2.2 million. The share
repurchase program currently remains in effect as approved by the Board. -22-




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STOCK PERFORMANCE GRAPH
   
 December 31,
    
    
    December 31,
    
    
    December 31,
    
    
    December 31,
    
    
    December 31,
    
    
    December 31,2003
    
    
    2004
    
    
    2005
    
    
    2006
    
    
    2007
    
    
    2008Tollgrade
    
    
    100
    
    
    
    70
    
    
    
    62
    
    
    
    60
    
    
    
    46
    
    
    
    27NASDAQ Telecomm (IXUT)
    
    
    100
    
    
    
    108
    
    
    
    100
    
    
    
    128
    
    
    
    140
    
    
    
    80S&P 500
    
    
    100
    
    
    
    109
    
    
    
    112
    
    
    
    128
    
    
    
    132
    
    
    
    81
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Item 6. Selected Financial Data.
  (IN THOUSANDS, EXCEPT PER SHARE DATA ANDNUMBER OF EMPLOYEES)YEARS ENDED DECEMBER 31,2008(1)
    
    
    2007(2)
    
    
    2006(3)
    
    
    2005(4)
    
    
    2004(5)Revenues:Products
    
    $
    33,317
    
    
    $
    48,893
    
    
    $
    51,564
    
    
    $
    51,904
    
    
    $
    49,770Services
    
    
    23,907
    
    
    
    17,667
    
    
    
    13,830
    
    
    
    14,415
    
    
    
    13,04857,224
    
    
    
    66,560
    
    
    
    65,394
    
    
    
    66,319
    
    
    
    62,818Cost of sales:Products
    
    
    17,797
    
    
    
    23,501
    
    
    
    25,277
    
    
    
    24,326
    
    
    
    22,191Services
    
    
    7,110
    
    
    
    4,989
    
    
    
    4,543
    
    
    
    3,883
    
    
    
    3,768Amortization
    
    
    3,513
    
    
    
    3,058
    
    
    
    3,419
    
    
    
    3,004
    
    
    
    2,624Impairment of intangible assets
    
    
    3,291
    
    
    
    2,263
    
    
    
    
    
    
    
    
    
    
    
    Write-down of inventory/acquired software
    
    
    759
    
    
    
    
    
    
    
    4,308
    
    
    
    424
    
    
    
    32,470
    
    
    
    33,811
    
    
    
    37,547
    
    
    
    31,637
    
    
    
    28,583Gross profit
    
    
    24,754
    
    
    
    32,749
    
    
    
    27,847
    
    
    
    34,682
    
    
    
    34,235Operating expenses:Selling and marketing
    
    
    8,477
    
    
    
    10,224
    
    
    
    10,552
    
    
    
    8,882
    
    
    
    9,483General and administrative
    
    
    9,615
    
    
    
    9,857
    
    
    
    7,981
    
    
    
    7,486
    
    
    
    7,346Research and development
    
    
    13,099
    
    
    
    13,572
    
    
    
    13,276
    
    
    
    14,079
    
    
    
    15,756Severance/restructuring charges
    
    
    884
    
    
    
    1,838
    
    
    
    1,840
    
    
    
    775
    
    
    
    269Impairment of goodwill
    
    
    
    
    
    
    24,958
    
    
    
    
    
    
    
    
    
    
    
    Total operating expenses
    
    
    32,075
    
    
    
    60,449
    
    
    
    33,649
    
    
    
    31,222
    
    
    
    32,854(Loss) income from operations
    
    
    (7,321
    )
    
    
    (27,700
    )
    
    
    (5,802
    )
    
    
    3,460
    
    
    
    1,381Other income, net
    
    
    1,343
    
    
    
    2,767
    
    
    
    2,755
    
    
    
    1,359
    
    
    
    447(Loss) income before income taxes
    
    
    (5,978
    )
    
    
    (24,933
    )
    
    
    (3,047
    )
    
    
    4,819
    
    
    
    1,828Provision (benefit) for income taxes
    
    
    1,137
    
    
    
    1,220
    
    
    
    (1,213
    )
    
    
    1,301
    
    
    
    914(Loss) net income
    
    $
    (7,115
    )
    
    $
    (26,153
    )
    
    $
    (1,834
    )
    
    $
    3,518
    
    
    $
    914EARNINGS PER SHARE INFORMATION:Net (loss) income per common share:Basic
    
    $
    (0.54
    )
    
    $
    (1.98
    )
    
    $
    (0.14
    )
    
    $
    0.27
    
    
    $
    0.07Diluted
    
    $
    (0.54
    )
    
    $
    (1.98
    )
    
    $
    (0.14
    )
    
    $
    0.27
    
    
    $
    0.07Weighted average shares
of common stock equivalents:Basic
    
    
    13,102
    
    
    
    13,219
    
    
    
    13,239
    
    
    
    13,168
    
    
    
    13,141Diluted
    
    
    13,102
    
    
    
    13,219
    
    
    
    13,239
    
    
    
    13,217
    
    
    
    13,253
 2008
    
    
    2007
    
    
    2006
    
    
    2005
    
    
    2004BALANCE SHEET DATA:Working capital
    
    $
    75,475
    
    
    $
    77,080
    
    
    $
    83,186
    
    
    $
    80,806
    
    
    $
    70,845Total assets
    
    
    124,347
    
    
    
    140,143
    
    
    
    162,352
    
    
    
    163,329
    
    
    
    157,145Pension obligation
    
    
    889
    
    
    
    908
    
    
    
    
    
    
    
    
    
    
    
    Shareholders equity
    
    
    112,454
    
    
    
    123,000
    
    
    
    149,444
    
    
    
    150,261
    
    
    
    146,401
 2008
    
    
    2007
    
    
    2006
    
    
    2005
    
    
    2004OTHER DATA:(unaudited)Number of full-time employees at year-end
    
    
    210
    
    
    
    250
    
    
    
    225
    
    
    
    253
    
    
    
    262
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(1)
    
    During 2008, the Company recorded a $1.2 million restructuring charge
primarily associated with employee severance and the refinement of estimates related to
employee relocation and lease termination costs, a $0.5 million severance charge, a charge of
$3.3 million associated with the impairment of certain intangible assets, and a $0.7 million
inventory restructuring charge.(2)
    
    During 2007, the Company recorded a $0.9 million restructuring charge primarily
associated with employee severance and the refinement of estimates related to employee
relocation and lease termination costs, a $0.9 million severance charge, a charge of $2.3
million associated with the impairment of certain intangible assets, and a $25.0 million
goodwill impairment charge.(3)
    
    During 2006, the Company recorded a $4.3 million inventory restructuring charge
and a $1.8 million restructuring charge for employee related costs.(4)
    
    During 2005, the Company recorded a $0.8 million severance charge related to the
retirement of the Companys former Chief Executive Officer and an impairment charge of $0.4
million related to software that was no longer part of the Companys strategy.(5)
    
    During 2004, the Company recorded a $0.3 million severance charge related to
employee severance from a cost reduction program that was implemented. -25-




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Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations.
  Overview
       
    
    Focus our strategic efforts and resources on the substantial and growing telecom service
assurance market, where we have a significant installed customer base, and use this
position to expand into adjacent markets;
    
    Develop an integrated software platform that will serve multiple applications and
products for the telecom industry including the next-generation IP service assurance
market;
    
    Secure new potential partnerships that we expect will enable us to allow us to expand
our system solutions into adjacent market segments;
    
    Continue to monitor and control costs in all areas of our business;
    
    Look for opportunities to accelerate our business strategy while maintaining our focus
on ongoing current initiatives;
    
    Improve management team capabilities to support the refocused strategy;
    
    Enhance company value through investment, organic growth and potential acquisitions that
promote our strategic objectives; and
    
    Initiate a $15 million share repurchase program.
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Industry and Market Trends
       
    
    our customers are reducing their capital and operating expense budgets as they look
to balance potential lower revenues due to the impact of the recession in the United
States and other international economies;
    
    incumbent telephone carriers continue to lose customers and revenue to cable
competitors, wireless substitution and alternate new media providers;
    
    our traditional customer base of incumbent telephone carriers (especially the large
domestic carriers) have considerably slowed their investments in legacy areas and are
focusing their capital spending on wireless and next-generation wireline projects such
as fiber to the home/curb/premise, IPTV, and DSL services;
    
    triple play service, voice, video and data services competition is fierce and
intensifying;
    
    adoption of open standards for in cable and telecommunications systems is resulting
in increased competition;
    
    increased consolidation among large domestic carriers and others in the
telecommunications industry;
    
    telecommunications customers continue to evaluate the benefits and costs of full
service assurance solutions versus less robust integrated testing solutions, and other
competing software solutions; and
    
    adjacent test and measurement markets continue to evolve and expand in areas that we
did not traditionally pursue, such as the electric power industry.
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Customer Line Loss
  Investment in New Infrastructure and Technologies by our Telecommunications Customers
     Intense Competition Among Telecommunications and Cable Service Providers
   Increased Competition Resulting from Standardization
   -28-




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Consolidation in Telecommunications Market
    Alternative Testing Methods
   Test and Measurement Markets Continue to Expand
  -29-




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Our Responses to These Industry Trends
    Telecommunications Solutions
      -30-




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Cable Solutions
     Expansion into Adjacent and Other Market Segments
    -31-




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Diversification and Acquisitions
    Realignment of Resources
   -32-




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Other Company Trends
    Application of Critical Accounting Policies
  Revenue Recognition
   -33-




---



##### Table of Contents



Goodwill and Intangible Assets
  Sensitivity Analysis
  -34-




---



##### Table of Contents



YearsTwelve-monthRemaining
    
    Carrying
    
    RollingLife at
    
    Value at
    
    ProjectedAsset Description
    
    Life
    
    12/31/08
    
    12/31/08
    
    Amortization(in millions)LoopCareBase Software
    
    
    10
    
    
    
    2.75
    
    
    $
    1.2
    
    
    $
    0.5Post-Warranty
Maintenance Service
Agreements
    
    
    50
    
    
    
    46.75
    
    
    
    29.9
    
    
    
    0.6EmersonProprietary Technology
    
    
    5
    
    
    
    2.25
    
    
    
    0.3
    
    
    
    0.1Broadband Test DivisionPost-Warranty
Maintenance Service
Agreements
    
    
    48
    
    
    
    46.60
    
    
    
    1.0
    
    
    
    0.3Post-Warranty
Maintenance Service
Agreements
    
    
    20
    
    
    
    18.60
    
    
    
    2.3
    
    
    
    0.5Post-Warranty
Maintenance Service
Agreements
    
    
    10
    
    
    
    8.60
    
    
    
    0.5
    
    
    
    0.1Post-Warranty
Maintenance Service
Agreements
    
    
    6
    
    
    
    4.60
    
    
    
    0.1
    
    
    
    Technology
    
    
    3-10
    
    
    
    1.60-8.60
    
    
    
    0.6
    
    
    
    0.1Customer Relationships
    
    
    10
    
    
    
    8.60
    
    
    
    0.5
    
    
    
    0.2Other
    
    
    0.5-10
    
    
    
    0.25-9.00
    
    
    
    0.5
    
    
    
    0.3$
    36.9
    
    
    $
    2.7
  Goodwill and Indefinite Lived Assets
   -35-




---



##### Table of Contents



Inventory Valuation
   Allowance for Doubtful Accounts
   Income Taxes
  Warranty
  -36-




---



##### Table of Contents



Long-Lived Assets Held for Sale
     Restructuring Accrual
   Pension Benefits
  -37-




---



##### Table of Contents



Stock-Based Compensation
   Foreign Currency Translation
   Results of Operations for the Year Ended December 31, 2008 Compared to the Year Ended December 31,
2007
 Revenue
     -38-




---



##### Table of Contents



Gross Profit
  Selling and Marketing Expenses
  General and Administrative Expenses
  Research and Development Expenses
  Restructuring Programs
  -39-




---



##### Table of Contents



Balance at
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance atDecember 31,
    
    Restructuring
    
    Cash
    
    Asset write-
    
    December 31,2007
    
    charge/expense
    
    payments
    
    downs
    
    2008Severance
    
    $
    
    
    
    $
    494
    
    
    $
    (494
    )
    
    $
    
    
    
    $
    Inventory write-down
    
    
    
    
    
    
    738
    
    
    
    
    
    
    
    (738
    )
    
    
    Total
    
    $
    
    
    
    $
    1,232
    
    
    $
    (494
    )
    
    $
    (738
    )
    
    $
    
   Balance at
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance atDecember 31,
    
    
    
    
    
    Cash
    
    Asset write-
    
    December 31,2007
    
    Expense
    
    payments
    
    downs
    
    2008Facility
rationalization
including employee
costs
    
    $
    103
    
    
    $
    29
    
    
    $
    (116
    )
    
    $
    (16
    )
    
    $
    Real estate impairment
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    (8
    )
    
    
    Total
    
    $
    103
    
    
    $
    37
    
    
    $
    (116
    )
    
    $
    (24
    )
    
    $
    
    Severance and Related Expenses
    -40-




---



##### Table of Contents



Impairment
   Other Income
  Provisions for Income Taxes
  Net (Loss) Income and Earnings Per Share
  Results of Operations for the Year Ended December 31, 2007 Compared to the Year Ended December 31,
2006
 Revenue
     -41-




---



##### Table of Contents



Gross Profit
  Selling and Marketing Expenses
  General and Administrative Expenses
  Research and Development Expenses
  Restructuring Programs
  -42-




---



##### Table of Contents



Balance at
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance atDecember 31,
    
    
    
    
    
    
    Cash
    
    
    Asset
    
    
    December 31,2006
    
    
    Expense
    
    
    payments
    
    
    write-downs
    
    
    2007Facility
rationalization,
including
employee costs
    
    $
    341
    
    
    $
    914
    
    
    $
    (778
    )
    
    $
    (374
    )
    
    $
    103Real estate impairment
    
    
    
    
    
    
    28
    
    
    
    
    
    
    
    (28
    )
    
    
    Total
    
    $
    341
    
    
    $
    942
    
    
    $
    (778
    )
    
    $
    (402
    )
    
    $
    103
 Severance and Related Expenses
   Impairment
  Other Income
  Provisions for Income Taxes
  Net (Loss) Income and Earnings Per Share
  -43-




---



##### Table of Contents



Liquidity and Capital Resources
           -44-




---



##### Table of Contents



Off-Balance Sheet Arrangements
  Commitments and Contractual Obligations
  -45-




---



##### Table of Contents



Payments due by periodMore than 5Total
    
    
    Less than 1 year
    
    
    1-3 years
    
    
    3-5 years
    
    
    yearsOperating Lease
Obligations
    
    $
    2,010
    
    
    $
    704
    
    
    $
    994
    
    
    $
    312
    
    
    $
    Purchase Obligations
    
    
    138
    
    
    
    75
    
    
    
    42
    
    
    
    21
    
    
    
    FIN 48 Obligations
    
    
    489
    
    
    
    
    
    
    
    489
    
    
    
    
    
    
    
    Pension Obligations
    
    
    914
    
    
    
    25
    
    
    
    
    
    
    
    
    
    
    
    889Total
    
    $
    3,551
    
    
    $
    804
    
    
    $
    1,525
    
    
    $
    333
    
    
    $
    889
   Key Ratios
  Recently Adopted Accounting Pronouncements
    -46-




---



##### Table of Contents




    
    Level 1Unadjusted quoted prices in active markets that are accessible at the
measurement date for identical, unrestricted assets or liabilities.
    
    Level 2Inputs other than quoted prices included within Level 1 that are
observable for the asset or liability, either directly or indirectly, including
quoted prices for similar assets or liabilities in active markets; quoted prices
for identical or similar assets or liabilities in markets that are not active;
inputs other than quoted prices that are observable for the asset or liability
(e.g., interest rates); and inputs that are derived principally from or
corroborated by observable market data by correlation or other means.
    
    Level 3Inputs that are both significant to the fair value measurement and
unobservable.
   Recently Issued Accounting Pronouncements
     -47-




---



##### Table of Contents



Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
  
 Item 8. Financial Statements and Supplementary Data.
 Statements of Operations Data by Fiscal Quarter (Unaudited) (dollars in thousands)
  March 29,
    
    June 28,
    
    September 27,
    
    December 31,2008(2)
    
    2008(3)
    
    2008(4)
    
    2008(5)Revenue(1)
    
    $
    13,184
    
    
    $
    14,597
    
    
    $
    15,206
    
    
    $
    14,237Gross profit(1)
    
    
    2,518
    
    
    
    7,342
    
    
    
    8,196
    
    
    
    6,698Net (loss) income(1)
    
    $
    (6,504
    )
    
    $
    (255
    )
    
    $
    918
    
    
    $
    (1,274
    )Earnings (Loss) Per Share InformationWeighted average sharesBasic
    
    
    13,158
    
    
    
    13,158
    
    
    
    13,173
    
    
    
    12,908Diluted
    
    
    13,158
    
    
    
    13,158
    
    
    
    13,187
    
    
    
    12,908Basic
    
    $
    (0.49
    )
    
    $
    (0.02
    )
    
    $
    0.07
    
    
    $
    (0.10
    )Diluted
    
    $
    (0.49
    )
    
    $
    (0.02
    )
    
    $
    0.07
    
    
    $
    (0.10
    )
 March 31,
    
    June 30,
    
    September 29,
    
    December 31,2007 (6)
    
    2007 (6)
    
    2007 (7)
    
    2007 (8)Revenue(1)
    
    $
    13,042
    
    
    $
    14,181
    
    
    $
    20,578
    
    
    $
    18,752Gross profit(1)
    
    
    7,018
    
    
    
    7,804
    
    
    
    10,946
    
    
    
    6,969Net income (loss)(1)
    
    $
    111
    
    
    $
    450
    
    
    $
    1,426
    
    
    $
    (28,140
    )Earnings (Loss) Per Share InformationWeighted average sharesBasic
    
    
    13,254
    
    
    
    13,260
    
    
    
    13,207
    
    
    
    13,156Diluted
    
    
    13,442
    
    
    
    13,516
    
    
    
    13,440
    
    
    
    13,156Basic
    
    $
    0.01
    
    
    $
    0.03
    
    
    $
    0.11
    
    
    $
    (2.14
    )Diluted
    
    $
    0.01
    
    
    $
    0.03
    
    
    $
    0.11
    
    
    $
    (2.14
    )
 (1)
    
    Revenues, gross profit and net (loss) income are rounded to millions each quarter.
Therefore, the sum of the quarterly amounts may not equal the annual amounts reported.(2)
    
    During the first quarter ended March 29, 2008, the Company recorded a $0.4 million
restructuring charge primarily associated with employee severance and the refinement of estimates
related to employee relocation and lease termination costs. -48-




---



##### Table of Contents



(3)
    
    During the second quarter ended June 28, 2008, the Company recorded a $0.1 million
restructuring charge primarily associated with the refinement of estimates related to employee
relocation and lease termination costs.(4)
    
    During the third quarter ended September 27, 2008, the Company did not record a
restructuring charge during this period.(5)
    
    During the fourth quarter ended December 31, 2008, the Company recorded a charge of
$0.4 million severance charge.(6)
    
    During the first quarter ended March 31, 2007, the Company recorded a $0.4 million
restructuring charge primarily associated with employee severance and the refinement of estimates
related to employee relocation and lease termination costs.(7)
    
    During the second quarter ended June 30, 2007, the Company recorded a $0.2 million
restructuring charge primarily associated with the refinement of estimates related to employee
relocation and lease termination costs.(8)
    
    During the third quarter ended September 29, 2007, the Company recorded a $0.2
million restructuring charge primarily associated with the refinement of estimates related to
employee relocation and lease termination costs.(9)
    
    During the fourth quarter ended December 31, 2007, the Company recorded a charge of
$2.3 million associated with the impairment of certain intangible assets, $0.9 million severance
charge, $0.1 million restructuring charge primarily associated with the refinement of estimates
related to employee relocation, and a $25.0 million goodwill impairment charge. -49-




---



##### 



Financial Statements and Supplementary Data.
 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
  
 Report of Independent Registered Public Accounting Firm
    
    
    51Consolidated Balance Sheets
    
    
    52Consolidated Statements of Operations
    
    
    53Consolidated Statements of Changes in Shareholders Equity
    
    
    55Consolidated Statements of Cash Flows
    
    
    54Notes to Consolidated Financial Statements
    
    
    56Schedule II  Valuation and Qualifying AccountsEX-23.1EX-31.1EX-31.2EX-32
  -50-




---



##### Table of Contents



Report of Independent Registered Public Accounting Firm
  Internal Control -
Integrated Framework
   
 -51-




---



##### Table of Contents



Tollgrade Communications, Inc. and Subsidiaries
Consolidated Balance Sheets
In thousands (except par value)
 December 31, 2008
    
    
    December 31, 2007ASSETSCurrent assets:Cash and cash equivalents
    
    $
    57,976
    
    
    $
    58,222Short-term investments
    
    
    2,419
    
    
    
    632Accounts receivable:Trade, net of allowance for doubtful accounts of $377 in 2008 and $478 in 2007
    
    
    10,560
    
    
    
    14,625Other
    
    
    668
    
    
    
    2,255Inventories
    
    
    10,673
    
    
    
    13,687Prepaid expenses and deposits
    
    
    1,449
    
    
    
    1,120Deferred and refundable income taxes
    
    
    453
    
    
    
    503Assets held for sale
    
    
    
    
    
    
    272Total current assets
    
    
    84,198
    
    
    
    91,316Property and equipment, net
    
    
    2,953
    
    
    
    4,279Intangibles
    
    
    36,853
    
    
    
    44,215Deferred tax asset
    
    
    81
    
    
    
    Other assets
    
    
    262
    
    
    
    333Total assets
    
    $
    124,347
    
    
    $
    140,143LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,265
    
    
    $
    4,214Accrued warranty
    
    
    1,590
    
    
    
    1,937Accrued expenses
    
    
    1,655
    
    
    
    3,148Accrued salaries and wages
    
    
    363
    
    
    
    891Accrued royalties payable
    
    
    299
    
    
    
    707Income taxes payable
    
    
    268
    
    
    
    572Deferred revenue
    
    
    3,283
    
    
    
    2,767Total current liabilities
    
    
    8,723
    
    
    
    14,236Pension obligation
    
    
    889
    
    
    
    908Deferred tax liabilities
    
    
    1,792
    
    
    
    1,727Other tax liabilities
    
    
    489
    
    
    
    272Total liabilities
    
    
    11,893
    
    
    
    17,143Commitments and contingenciesShareholders equity:Common stock, $0.20 par value, 50,000 authorized shares,
issued shares, 13,733 in 2008 and 13,731 in 2007
    
    
    2,744
    
    
    
    2,744Additional paid-in capital
    
    
    73,923
    
    
    
    73,389Treasury stock, at cost, 1,072 shares in 2008 and 575 shares in 2007
    
    
    (8,081
    )
    
    
    (5,900
    )Retained earnings
    
    
    45,748
    
    
    
    52,863Accumulated other comprehensive loss
    
    
    (1,880
    )
    
    
    (96
    )Total shareholders equity
    
    
    112,454
    
    
    
    123,000Total liabilities and shareholders equity
    
    $
    124,347
    
    
    $
    140,143
  -52-




---



##### Table of Contents



Tollgrade Communications, Inc. and Subsidiaries
Consolidated Statements of Operations
In thousands (except per share data)
 Years Ended December 31,2008
    
    
    2007
    
    
    2006Revenues:Products
    
    $
    33,317
    
    
    $
    48,893
    
    
    $
    51,564Services
    
    
    23,907
    
    
    
    17,667
    
    
    
    13,83057,224
    
    
    
    66,560
    
    
    
    65,394Cost of sales:Products
    
    
    17,797
    
    
    
    23,501
    
    
    
    25,277Services
    
    
    7,110
    
    
    
    4,989
    
    
    
    4,543Amortization
    
    
    3,513
    
    
    
    3,058
    
    
    
    3,419Severance expense/inventory write-down
    
    
    759
    
    
    
    
    
    
    
    4,308Impairment of intangible assets
    
    
    3,291
    
    
    
    2,263
    
    
    
    32,470
    
    
    
    33,811
    
    
    
    37,547Gross profit
    
    
    24,754
    
    
    
    32,749
    
    
    
    27,847Operating expenses:Selling and marketing
    
    
    8,477
    
    
    
    10,224
    
    
    
    10,552General and administrative
    
    
    9,615
    
    
    
    9,857
    
    
    
    7,981Research and development
    
    
    13,099
    
    
    
    13,572
    
    
    
    13,276Restructuring expense
    
    
    37
    
    
    
    942
    
    
    
    1,840Severance expense
    
    
    847
    
    
    
    896
    
    
    
    Impairment of goodwill
    
    
    
    
    
    
    24,958
    
    
    
    Total operating expense
    
    
    32,075
    
    
    
    60,449
    
    
    
    33,649Loss from operations
    
    
    (7,321
    )
    
    
    (27,700
    )
    
    
    (5,802
    )Other income:Interest income
    
    
    1,343
    
    
    
    2,767
    
    
    
    2,755Total other income
    
    
    1,343
    
    
    
    2,767
    
    
    
    2,755Loss before income taxes
    
    
    (5,978
    )
    
    
    (24,933
    )
    
    
    (3,047
    )Provision (benefit) for income taxes
    
    
    1,137
    
    
    
    1,220
    
    
    
    (1,213
    )Net loss
    
    $
    (7,115
    )
    
    $
    (26,153
    )
    
    $
    (1,834
    )PER SHARE INFORMATION:Weighted average shares of common
stock and equivalents:Basic
    
    
    13,102
    
    
    
    13,219
    
    
    
    13,239Diluted
    
    
    13,102
    
    
    
    13,219
    
    
    
    13,239Net loss per common share:Basic
    
    $
    (0.54
    )
    
    $
    (1.98
    )
    
    $
    (0.14
    )Diluted
    
    $
    (0.54
    )
    
    $
    (1.98
    )
    
    $
    (0.14
    )
  -53-




---



##### Table of Contents



Tollgrade Communications, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
 Years Ended December 31,2008
    
    
    2007
    
    
    2006Cash flows from operating activities:Net loss
    
    $
    (7,115
    )
    
    $
    (26,153
    )
    
    $
    (1,834
    )Adjustments to reconcile net loss to net cash provided by operating activities:Depreciation and amortization
    
    
    5,192
    
    
    
    4,755
    
    
    
    5,499Impairment of goodwill and intangible assets
    
    
    3,291
    
    
    
    27,221
    
    
    
    Valuation allowance
    
    
    123
    
    
    
    9,922
    
    
    
    Compensation expense related to stock plans
    
    
    534
    
    
    
    815
    
    
    
    517Deferred income taxes
    
    
    246
    
    
    
    (9,435
    )
    
    
    (441
    )Excess tax benefits from share based compensation
    
    
    
    
    
    
    (10
    )
    
    
    (94
    )Restructuring and asset impairment
    
    
    775
    
    
    
    473
    
    
    
    5,309Provision for losses on inventories
    
    
    953
    
    
    
    402
    
    
    
    (90
    )Provision for allowance for doubtful accounts
    
    
    100
    
    
    
    86
    
    
    
    86Changes in assets and liabilities, net of acquisitions:Accounts receivable  trade
    
    
    5,026
    
    
    
    4,197
    
    
    
    (3,952
    )Accounts receivable  other
    
    
    1,204
    
    
    
    562
    
    
    
    (512
    )Inventories
    
    
    1,316
    
    
    
    (4,106
    )
    
    
    (1,727
    )Refundable income taxes
    
    
    (64)
    
    
    
    897
    
    
    
    (231
    )Prepaid expenses deposits and other assets
    
    
    (302
    )
    
    
    (150
    )
    
    
    565Accounts payable
    
    
    (4,513
    )
    
    
    1,959
    
    
    
    (318
    )Accrued warranty
    
    
    (343
    )
    
    
    (198
    )
    
    
    (85
    )Accrued expenses, deferred revenue and salaries and wages
    
    
    (1,122
    )
    
    
    (1,902
    )
    
    
    40Accrued royalties payable
    
    
    (407
    )
    
    
    500
    
    
    
    (381
    )Income taxes payable
    
    
    (287
    )
    
    
    557
    
    
    
    (678
    )Net cash provided by operating activities:
    
    
    4,607
    
    
    
    10,392
    
    
    
    1,673Cash flows from investing activities:Purchase of Emerson test business
    
    
    
    
    
    
    
    
    
    
    (5,501
    )Purchase of BTD from Teradyne
    
    
    
    
    
    
    (11,855
    )
    
    
    Purchase of investments
    
    
    (4,266
    )
    
    
    (12,194
    )
    
    
    (9,646
    )Redemption/maturity of investments
    
    
    2,479
    
    
    
    16,885
    
    
    
    22,333Capital expenditures, including capitalized software
    
    
    (507
    )
    
    
    (2,324
    )
    
    
    (1,247
    )Investments in other assets
    
    
    
    
    
    
    
    
    
    
    (155
    )Sale of assets held for sale
    
    
    265
    
    
    
    892
    
    
    
    Net cash (used in) provided by investing activities:
    
    
    (2,029
    )
    
    
    (8,596
    )
    
    
    5,784Cash flows from financing activities:Repurchase of treasury shares
    
    
    (2,181
    )
    
    
    (1,109
    )
    
    
    Proceeds from the exercise of stock options
    
    
    
    
    
    
    89
    
    
    
    406Excess tax benefit from share based compensation
    
    
    
    
    
    
    10
    
    
    
    94Net cash (used in) provided by financing activities:
    
    
    (2,181
    )
    
    
    (1,010
    )
    
    
    500Net increase in cash and cash equivalents
    
    
    397
    
    
    
    786
    
    
    
    7,957Effect of exchange rate change on cash and cash equivalents
    
    
    (643
    )
    
    
    58
    
    
    
    Cash and cash equivalents at beginning of year
    
    
    58,222
    
    
    
    57,378
    
    
    
    49,421Cash and cash equivalents at end of year
    
    $
    57,976
    
    
    $
    58,222
    
    
    $
    57,378Supplemental disclosure of cash flow information:Cash paid during the year for income taxes
    
    $
    14
    
    
    $
    3
    
    
    $
    811
  -54-




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##### Table of Contents



Tollgrade Communications, Inc. and Subsidiaries
Condensed Consolidated Statements of Changes in Shareholders Equity
(In thousands) (Unaudited)
 AccumulatedOther
    
    
    
    
    
    
    OtherCommon Stock
    
    
    Additional
    
    
    Treasury
    
    
    Retained
    
    
    Comprehensive
    
    
    
    
    
    
    ComprehensiveShares
    
    
    Amount
    
    
    Paid-In
    
    
    Stock
    
    
    Earnings
    
    
    Loss
    
    
    Total
    
    
    LossBalance at December 31, 2005
    
    
    13,664
    
    
    $
    2,733
    
    
    $
    71,469
    
    
    $
    (4,791
    )
    
    $
    80,850
    
    
    
    
    
    
    $
    150,261Exercise of common stock
options
    
    
    45
    
    
    
    9
    
    
    
    397
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    406Tax benefit from exercise
of stock options
    
    
    
    
    
    
    
    
    
    
    94
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    94Compensation expense for
options and restricted
stock, net
    
    
    
    
    
    
    
    
    
    
    517
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    517Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,834
    )
    
    
    
    
    
    
    (1,834
    )
    
    $
    (1,834
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (1,834
    )Balance at December 31, 2006
    
    
    13,709
    
    
    
    2,742
    
    
    
    72,477
    
    
    
    (4,791
    )
    
    
    79,016
    
    
    
    
    
    
    
    149,444Exercise of common stock
options
    
    
    10
    
    
    
    2
    
    
    
    87
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    89Tax benefit from exercise
of stock options
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,109
    )
    
    
    
    
    
    
    
    
    
    
    (1,109
    )Compensation expense for options and restricted stock, net
    
    
    12
    
    
    
    
    
    
    
    815
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    815Actuarial gain, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32
    
    
    
    32
    
    
    $
    32Foreign currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (128
    )
    
    
    (128
    )
    
    
    (128
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (26,153
    )
    
    
    
    
    
    
    (26,153
    )
    
    
    (26,153
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (26,249
    )Balance at December 31, 2007
    
    
    13,731
    
    
    
    2,744
    
    
    
    73,389
    
    
    
    (5,900
    )
    
    
    52,863
    
    
    
    (96
    )
    
    
    123,000
    
    
    
    Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,181
    )
    
    
    
    
    
    
    
    
    
    
    (2,181
    )
    
    
    Compensation expense for
options and restricted
stock, net
    
    
    2
    
    
    
    
    
    
    
    534
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    534Actuarial gain, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    87
    
    
    
    87
    
    
    $
    87Foreign currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,871
    )
    
    
    (1,871
    )
    
    
    (1,871
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,115
    )
    
    
    
    
    
    
    (7,115
    )
    
    
    (7,115
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (8,899
    )Balance at December 31, 2008
    
    
    13,733
    
    
    $
    2,744
    
    
    $
    73,923
    
    
    $
    (8,081
    )
    
    $
    45,748
    
    
    $
    (1,880
    )
    
    $
    112,454
  -55-




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##### Table of Contents



TOLLGRADE COMMUNICATIONS, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 ORGANIZATION, BUSINESS AND BASIS OF PRESENTATION
   USE OF ESTIMATES
  PRINCIPLES OF CONSOLIDATION
  CASH AND CASH EQUIVALENTS
  INVESTMENTS
  ALLOWANCE FOR DOUBTFUL ACCOUNTS
  INVENTORIES
  PROPERTY AND EQUIPMENT
  VALUATION OF LONG-LIVED ASSETS
  -56-




---



##### Table of Contents



PRODUCT WARRANTY
  REVENUE RECOGNITION
      COST OF SALES
  SHIPPING AND HANDLING COSTS
  GOODWILL AND INTANGIBLE ASSETS
  -57-




---



##### Table of Contents



RESEARCH AND DEVELOPMENT COSTS
  CAPITALIZED SOFTWARE COSTS
  INCOME TAXES
    SEGMENT INFORMATION
  RECLASSIFICATIONS
  -58-




---



##### Table of Contents



RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
    
    
    Level 1Unadjusted quoted prices in active markets that are accessible at the
measurement date for identical, unrestricted assets or liabilities.
    
    Level 2Inputs other than quoted prices included within Level 1 that are
observable for the asset or liability, either directly or indirectly, including
quoted prices for similar assets or liabilities in active markets; quoted prices
for identical or similar assets or liabilities in markets that are not active;
inputs other than quoted prices that are observable for the asset or liability
(e.g., interest rates); and inputs that are derived principally from or
corroborated by observable market data by correlation or other means.
    
    Level 3Inputs that are both significant to the fair value measurement and
unobservable.
   RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
  -59-




---



##### Table of Contents



2. ACCOUNTING FOR STOCK-BASED COMPENSATION
     -60-




---



##### Table of Contents



Stock-Based Compensation Expense
      Stock OptionsYear Ended
    
    Year Ended
    
    Year EndedDecember 31, 2008
    
    December 31, 2007
    
    December 31, 2006Weighted average grant
date fair values
    
    $
    2.68
    
    
    $
    3.69
    
    
    $
    4.84Expected life (in years)
    
    
    5.0
    
    
    
    5.0
    
    
    
    5.0Risk free interest rate
    
    
    2.8
    %
    
    
    3.6
    %
    
    
    4.7
    %Volatility
    
    
    48.1
    %
    
    
    48.6
    %
    
    
    56.1
    %
  -61-




---



##### Table of Contents



Weighted AverageNumber of Shares
    
    
    Range of Exercise Price
    
    
    Exercise PriceOutstanding, December 31, 2005
    
    
    1,780,037
    
    
    $
    7.28  $159.19
    
    
    $
    26.87Granted
    
    
    30,000
    
    
    
    9.00  9.19
    
    
    
    9.13Exercised (A)
    
    
    (44,984
    )
    
    
    7.56  12.55
    
    
    
    9.02Cancelled/Forfeited/Expired
    
    
    (406,668
    )
    
    
    7.28  117.34
    
    
    
    16.28Outstanding, December 31, 2006
    
    
    1,358,385
    
    
    
    7.28  159.19
    
    
    
    30.24Granted
    
    
    160,000
    
    
    
    7.78  9.84
    
    
    
    7.91Exercised (A)
    
    
    (10,500
    )
    
    
    7.56  9.49
    
    
    
    8.49Cancelled/Forfeited/Expired
    
    
    (67,323
    )
    
    
    8.49  159.19
    
    
    
    43.74Outstanding, December 31, 2007
    
    
    1,440,562
    
    
    
    7.28  159.19
    
    
    
    27.28Granted
    
    
    684,400
    
    
    
    3.27  6.57
    
    
    
    5.97Exercised (A)
    
    
    
    
    
    
    
    
    
    
    -Cancelled/Forfeited/Expired
    
    
    (519,472
    )
    
    
    6.57  55.90
    
    
    
    12.16Outstanding, December 31, 2008
    
    
    1,605,490
    
    
    $
    3.27  159.19
    
    
    $
    23.08Number of SharesOptions exercisable at:December 31, 2006
    
    
    1,258,092
    
    
    
    
    
    
    $
    31.96December 31, 2007
    
    
    1,280,563
    
    
    
    
    
    
    $
    29.70December 31, 2008
    
    
    937,757
    
    
    
    
    
    
    $
    35.14
 
 (A)
    
    The intrinsic value associated with exercised options which represent the difference between
the strike price and the market value of Tollgrade stock at the time of exercise was less then $0.1
million in 2008 and 2007, respectively.  Stock Options Outstanding
    
    Stock Options ExercisableNumber
    
    Weighted
    
    Weighted
    
    
    
    
    
    Number
    
Weighted Average

    WeightedOutstanding as of
    
    Average
    
    Average
    
    Aggregate
    
    Exercisable
    
Remaining

    Average
    
    AggregateRange of Exercise
    
    December 31,
    
    Remaining
    
    Exercise
    
    Intrinsic
    
    as of December 31,
    
Contractual

    Exercise
    
    IntrinsicPrices
    
    2008
    
    Contractual Life
    
    Price ($)
    
    Value ($)
    
    2008
    
Life

    Price ($)
    
    Value (B)($)$3.27  4.39
    
    
    128,000
    
    
    
    9.81
    
    
    $
    3.34
    
    
    $
    181,200
    
    
    
    
    
    




    $
    
    
    
    $
    4.40  6.57
    
    
    466,400
    
    
    
    9.08
    
    
    
    6.57
    
    
    
    
    
    
    
    30,000
    
    

9.08


    
    6.576.58  8.49
    
    
    295,425
    
    
    
    7.88
    
    
    
    8.13
    
    
    
    
    
    
    
    195,425
    
    

7.34


    
    8.318.50  13.63
    
    
    179,415
    
    
    
    4.41
    
    
    
    11.30
    
    
    
    
    
    
    
    176,082
    
    

4.34


    
    11.3313.64  28.40
    
    
    247,000
    
    
    
    2.88
    
    
    
    23.65
    
    
    
    
    
    
    
    247,000
    
    

2.88


    
    23.6528.41  55.90
    
    
    152,750
    
    
    
    2.32
    
    
    
    45.29
    
    
    
    
    
    
    
    152,750
    
    

2.32


    
    45.2955.91  71.88
    
    
    2,000
    
    
    
    1.34
    
    
    
    71.88
    
    
    
    
    
    
    
    2,000
    
    

1.34


    
    71.8871.89  103.59
    
    
    8,000
    
    
    
    1.80
    
    
    
    103.59
    
    
    
    
    
    
    
    8,000
    
    

1.80


    
    103.59103.60  117.34
    
    
    113,000
    
    
    
    1.62
    
    
    
    117.34
    
    
    
    
    
    
    
    113,000
    
    

1.62


    
    117.34117.35  159.19
    
    
    13,500
    
    
    
    1.53
    
    
    
    159.19
    
    
    
    
    
    
    
    13,500
    
    

1.53


    
    159.19Total $3.27  159.19
    
    
    1,605,490
    
    
    
    6.16
    
    
    $
    23.08
    
    
    $
    181,200
    
    
    
    937,757
    
    

4.04


    $
    35.14
    
    
    $
    
 
 (B)
    
    The aggregate intrinsic value in the preceding table represents the difference between the
strike price and the market value of Tollgrade stock on December 31, 2008. The market value of Tollgrades
stock was $6.33 on December 31, 2008. The total number of shares in-the-money options exercisable was
zero and 131,000 shares on December 31, 2008 and  2007, respectively. -62-




---



##### Table of Contents



Weighted Average
    
    
    Aggregate IntrinsicWeighted Average
    
    
    Remaining
    
    
    ValueNo. of Shares
    
    
    Exercise Price
    
    
    Contractual Term
    
    
    (1)Vested
    
    
    937,757
    
    
    $
    35.14
    
    
    
    4.0
    
    
    $
    Expected to Vest
    
    
    667,733
    
    
    $
    5.97
    
    
    
    9.2
    
    
    $
    181,200Total
    
    
    1,605,490
    
    
    $
    23.08
    
    
    
    6.2
    
    
    $
    181,200
 
 (1)
    
    The aggregate intrinsic value in the preceding table represents the difference between the
exercise price and the value of Tollgrade stock $6.33 and $8.02 on December 31, 2008 and December
31, 2007 respectively.  3. RESTRUCTURING
   Balance at
    
    Restructuring
    
    
    
    
    
    
    
    
    
    Balance atDecember 31, 2007
    
    charge/expense
    
    Cash payments
    
    Asset write-downs
    
    December 31, 2008Severance
    
    $
    
    
    
    $
    494
    
    
    $
    (494
    )
    
    $
    
    
    
    $
    Inventory write-down
    
    
    
    
    
    
    738
    
    
    
    
    
    
    
    (738
    )
    
    
    Total
    
    $
    
    
    
    $
    1,232
    
    
    $
    (494
    )
    
    $
    (738
    )
    
    $
    
   Balance at
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance atDecember 31, 2007
    
    Expense
    
    Cash payments
    
    Asset write-downs
    
    December 31, 2008Facility
rationalization
including employee
costs
    
    $
    103
    
    
    $
    29
    
    
    $
    (116
    )
    
    $
    (16
    )
    
    $
    Real estate impairment
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    (8
    )
    
    
    Total
    
    $
    103
    
    
    $
    37
    
    
    $
    (116
    )
    
    $
    (24
    )
    
    $
    
  -63-




---



##### Table of Contents



4. ACQUISITION
   Accounts Receivable
    
    $
    4,579Inventories
    
    
    1,428Property and equipment
    
    
    454Intangible assets
    
    
    7,937Goodwill
    
    
    1,122Other
    
    
    26Total assets acquired
    
    
    15,546Deferred income
    
    
    1,588Accounts payable
    
    
    709Pension obligation
    
    
    870Relocation and lease termination accrual
    
    
    524Total liabilities
    
    
    3,691Net assets acquired
    
    $
    11,855
  (In Thousands,
    
    (In Thousands,Except Per Share
    
    Except Per ShareData)
    
    Data)Unaudited Pro Forma
    
    Unaudited Pro FormaYear Ended
    
    Year EndedDecember 31, 2007
    
    December 31, 2006Revenues
    
    $
    77,714
    
    
    $
    85,962Loss from operations
    
    $
    (27,632
    )
    
    $
    (11,192
    )Net loss
    
    $
    (26,082
    )
    
    $
    (5,078
    )Pro forma basic and diluted loss per share
    
    $
    (1.97
    )
    
    $
    (0.38
    )Actual basis and diluted loss per share
    
    $
    (1.98
    )
    
    $
    (0.14
    )
  -64-




---



##### Table of Contents



Accounts receivable
    
    $
    1,827Inventories
    
    
    1,113Property and equipment
    
    
    112Intangible assets
    
    
    1,113Goodwill
    
    
    2,274Total assets acquired
    
    
    6,439Deferred income
    
    
    175Accounts payable
    
    
    636Restructuring
    
    
    127Total liabilities
    
    
    938Net assets acquired
    
    $
    5,501
  (In Thousands, Except Per Share Data)UnauditedYear endPro FormaDecember 31, 2006Revenues
    
    $
    66,960Loss from operations
    
    $
    (5,792
    )Net loss
    
    $
    (1,822
    )Pro forma basic and diluted loss per share
    
    $
    (0.14
    )Actual diluted loss per share
    
    $
    (0.14
    )
 -65-




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##### Table of Contents



5. INTANGIBLE ASSETS
  Useful
    
    
    December 31, 2008Life
    
    
    
    
    
    
    Accumulated(Years)
    
    
    Gross
    
    
    Amortization
    
    
    Impairments
    
    
    NetAmortizing Intangible Assets:Post Warranty Service Agreements
    
    
    6-50
    
    
    $
    37,563
    
    
    $
    3,752
    
    
    $
    
    
    
    $
    33,811Technology
    
    
    2-10
    
    
    
    18,762
    
    
    
    14,979
    
    
    
    1,396
    
    
    
    2,387Customer Relationships
    
    
    5-15
    
    
    
    3,554
    
    
    
    1,420
    
    
    
    1,676
    
    
    
    458Tradenames and other
    
    
    0.5-10
    
    
    
    809
    
    
    
    393
    
    
    
    219
    
    
    
    197Total Intangible Assets
    
    
    
    
    
    $
    60,688
    
    
    $
    20,544
    
    
    $
    3,291
    
    
    $
    36,853
 Useful
    
    
    December 31, 2007Life
    
    
    
    
    
    
    Accumulated(Years)
    
    
    Gross
    
    
    Amortization
    
    
    Impairments
    
    
    NetAmortizing Intangible Assets:Post Warranty Service Agreements
    
    
    6-50
    
    
    $
    38,204
    
    
    $
    2,019
    
    
    $
    
    
    
    $
    36,185Technology
    
    
    3-10
    
    
    
    19,249
    
    
    
    13,858
    
    
    
    448
    
    
    
    4,943Customer Relationships
    
    
    5-15
    
    
    
    3,626
    
    
    
    1,190
    
    
    
    
    
    
    
    2,436Tradenames and other
    
    
    0.5-10
    
    
    
    2,635
    
    
    
    169
    
    
    
    1,815
    
    
    
    651Total Intangible Assets
    
    
    
    
    
    $
    63,714
    
    
    $
    17,236
    
    
    $
    2,263
    
    
    $
    44,215
 Goodwill
    
    December 31, 2008
    
    December 31, 2007Balance at beginning of the year
    
    $
    
    
    
    $
    23,836Acquisitions
    
    
    
    
    
    
    1,122Impairments
    
    
    
    
    
    
    (24,958
    )Balance at end of the year
    
    $
    
    
    
    $
    
 Impairments
 Long-Lived Assets
   Indefinite-Lived Assets Including Goodwill
   -66-




---



##### Table of Contents



Useful Life
    
    
    ValuePost-Warranty Service Agreements
    
    6  48 years
    
    $
    6,090Technology
    
    3  10 years
    
    $
    800Customer Relationships
    
    10 years
    
    $
    776Other
    
    0.5  10 years
    
    $
    174Goodwill
    
    
    
    
    
    $
    1,122
  Useful Life
    
    
    ValueCustomer Relationship
    
    5 years
    
    $
    193Technology
    
    5 years
    
    $
    761Tradename
    
    3 years
    
    $
    62Backlog
    
    6 months
    
    $
    97Goodwill
    
    
    
    
    
    $
    2,274
   6. INVENTORIES
  December 31, 2008
    
    December 31, 2007Raw materials
    
    $
    6,225
    
    
    $
    8,393Work in process
    
    
    3,296
    
    
    
    3,582Finished goods
    
    
    3,492
    
    
    
    4,32113,013
    
    
    
    16,296Reserves for slow moving and obsolete inventory
    
    
    (2,340
    )
    
    
    (2,609
    )$
    10,673
    
    
    $
    13,687
 -67-




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##### Table of Contents



7. PROPERTY AND EQUIPMENT
  Years
    
    December 31, 2008
    
    December 31, 2007Test equipment and tooling
    
    
    3-5
    
    
    $
    11,547
    
    
    $
    11,246Office equipment and fixtures
    
    
    5-7
    
    
    
    9,663
    
    
    
    9,724Leasehold improvements
    
    
    1-6
    
    
    
    2,723
    
    
    
    2,86023,933
    
    
    
    23,830Less accumulated depreciation and amortization
    
    
    
    
    
    
    (20,980
    )
    
    
    (19,551
    )$
    2,953
    
    
    $
    4,279
  8. ASSETS HELD FOR SALE
  9. PRODUCT WARRANTY
  December 31, 2008
    
    December 31, 2007Balance at the beginning of the year
    
    $
    1,937
    
    
    $
    2,135Accruals for warranties issued during the year
    
    
    1,789
    
    
    
    1,680Settlements during the year
    
    
    (2,136
    )
    
    
    (1,878
    )Balance at the end of the year
    
    $
    1,590
    
    
    $
    1,937
  10. PENSIONS
    -68-




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##### Table of Contents



Pension Benefits
    
    Pension Benefits(in thousands)
    
    2008
    
    2007Change in projected benefit obligation:Projected benefit obligation at January 1,
    
    $
    1,260
    
    
    $
    Acquisition of BTD
    
    
    
    
    
    
    1,226Service cost
    
    
    83
    
    
    
    37Interest cost
    
    
    65
    
    
    
    27Plan participants contributions
    
    
    5
    
    
    
    2Actuarial gains
    
    
    (96
    )
    
    
    (32
    )Effect of foreign currency
    
    
    (60
    )
    
    
    Projected benefit obligation at December 31,
    
    $
    1,257
    
    
    $
    1,260
 2008
    
    2007Change in fair value of plan assets:January 1,
    
    $
    352
    
    
    $
    Acquisition of BTD
    
    
    
    
    
    
    332Employer contribution
    
    
    23
    
    
    
    9Plan participants contributions
    
    
    5
    
    
    
    2Actual return on plan assets (net of cost)
    
    
    5
    
    
    
    9Effect of foreign currency
    
    
    (17
    )
    
    
    Fair value of plan assets at December 31,
    
    $
    368
    
    
    $
    352Unfunded status of plans at December 31,
    
    $
    889
    
    
    $
    908
 2008
    
    2007Amounts recognized in accumulated other comprehensive
income:Prior service cost
    
    
    
    
    
    
    Actuarial gains, net
    
    $
    87
    
    
    $
    32Total
    
    $
    87
    
    
    $
    32
  Pension Benefits
    
    Pension Benefits(in thousands)
    
    2008
    
    2007Noncurrent assets
    
    $
    
    
    
    $
    Noncurrent liabilities
    
    
    889
    
    
    
    908Net amount recognized at December 31,
    
    $
    889
    
    
    $
    908
  Pension Benefits
    
    Pension Benefits(in thousands)
    
    2008
    
    2007Projected benefit obligation in excess of plan assets:Projected benefit obligation
    
    $
    1,257
    
    
    $
    1,260Fair value of plan assets
    
    $
    368
    
    
    $
    352Accumulated benefit obligation in excess of plan assets:Accumulated benefit obligation
    
    $
    933
    
    
    $
    959
 -69-




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##### Table of Contents



Pension Benefits
    
    Pension Benefits(in thousands)
    
    2008
    
    2007Components of net periodic benefit cost:Service cost
    
    $
    83
    
    
    $
    37Interest cost
    
    
    65
    
    
    
    27Expected return on plan assets
    
    
    (15
    )
    
    
    (6
    )Net periodic benefit cost
    
    $
    133
    
    
    $
    58
  (in thousands)Expected benefit payments:2009  2012
    
    
    2013  2017
    
    $
    229
  2008
    
    2007Weighted-average assumptions used to determine the
benefit obligationDiscount rate
    
    
    6.00
    %
    
    
    5.39
    %Rate of compensation increase
    
    
    3.00
    %
    
    
    2.78
    %Weighted-average assumptions used to determine the net
benefit costsDiscount rate
    
    
    5.37
    %
    
    
    5.39
    %Rate of compensation increase
    
    
    3.00
    %
    
    
    2.78
    %Expected annual return on plan assets
    
    
    4.0
    %
    
    
    4.0
    %
 11. LICENSE AND ROYALTY FEES
  -70-




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##### Table of Contents



12. INCOME TAXES
  2008
    
    2007
    
    2006Current:Federal
    
    $
    (16
    )
    
    $
    (19
    )
    
    $
    (781
    )Foreign
    
    
    777
    
    
    
    742
    
    
    
    State
    
    
    7
    
    
    
    10
    
    
    
    9768
    
    
    
    733
    
    
    
    (772
    )Deferred:Federal
    
    
    
    
    
    
    648
    
    
    
    (530
    )Foreign
    
    
    369
    
    
    
    (180
    )
    
    
    State
    
    
    
    
    
    
    19
    
    
    
    89369
    
    
    
    487
    
    
    
    (441
    )$
    1,137
    
    
    $
    1,220
    
    
    $
    (1,213
    )
   Years Ended December 31,2008
    
    2007
    
    2006Federal statutory tax rate
    
    
    (34
    %)
    
    
    (34
    %)
    
    
    (34
    %)Foreign income taxes
    
    
    (1
    %)
    
    
    
    
    
    
    State income taxes
    
    
    
    
    
    
    
    
    
    
    Valuation allowance
    
    
    49
    %
    
    
    38
    %
    
    
    3
    %Tax contingency reserve
    
    
    5
    %
    
    
    1
    %
    
    
    (2
    %)Export sales benefit
    
    
    
    
    
    
    
    
    
    
    (4
    %)Tax exempt interest
    
    
    
    
    
    
    
    
    
    
    (6
    %)Other
    
    
    
    
    
    
    
    
    
    
    3
    %Effective tax rate
    
    
    19
    %
    
    
    5
    %
    
    
    (40
    %)
 -71-




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##### Table of Contents



2008
    
    2007Deferred Tax Assets:Excess of tax basis over book basis for:Property and equipment
    
    $
    328
    
    
    $
    416Goodwill and intangible assets
    
    
    9,331
    
    
    
    8,831Inventory
    
    
    634
    
    
    
    380Reserves recorded for:Warranty
    
    
    602
    
    
    
    734Inventory
    
    
    819
    
    
    
    849Allowance for doubtful accounts
    
    
    132
    
    
    
    170Severance
    
    
    34
    
    
    
    60Federal net operating loss carryforwards
    
    
    3,660
    
    
    
    1,103State net operating loss carryforwards
    
    
    3,409
    
    
    
    3,063Stock based compensation
    
    
    595
    
    
    
    417Pension benefit obligation
    
    
    39
    
    
    
    12Other
    
    
    31
    
    
    
    120Gross deferred tax assets
    
    $
    19,614
    
    
    $
    16,155Valuation allowance
    
    
    (15,848
    )
    
    
    (12,655
    )Deferred tax assets
    
    $
    3,766
    
    
    $
    3,500Deferred Tax Liabilities:Excess of book basis over tax basis for:Intangible assets
    
    $
    (4,984
    )
    
    $
    (4,511
    )Property and equipment
    
    
    (14
    )
    
    
    (93
    )Other
    
    
    (90
    )
    
    
    (120
    )Total deferred tax liability
    
    
    (5,088
    )
    
    
    (4,724
    )Net deferred tax liabilities
    
    $
    (1,322
    )
    
    $
    (1,224
    )Reconciliation to the consolidated
balance sheets:Deferred tax asset current
    
    $
    389
    
    
    $
    503Deferred tax assets non-current
    
    $
    81
    
    
    
    Deferred tax liabilities non-current
    
    
    (1,792
    )
    
    
    (1,727
    )Net deferred tax liability
    
    $
    (1,322
    )
    
    $
    (1,224
    )
    -72-




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##### Table of Contents



Unrecognized Tax Benefits Tabular Reconciliation (in thousands)
 2008
    
    
    2007Beginning balance  January 1,
    
    $
    272
    
    
    $
    96Additional uncertain tax positions
    
    
    244
    
    
    
    201Reductions due to expirations of statute of limitations
    
    
    (27
    )
    
    
    (25
    )Ending balance  December 31,
    
    $
    489
    
    
    $
    272
     13. LINE OF CREDIT
  14. COMMITMENTS AND CONTINGENCIES
   At December 31, 20082009
    
    $
    7692010
    
    
    5802011
    
    
    5462012
    
    
    3772013
    
    
    Thereafter
    
    
    $
    2,272
 -73-




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15. MAJOR CUSTOMERS, REVENUE CONCENTRATION AND DEPENDENCE ON CERTAIN SUPPLIERS
       -74-




---



##### Table of Contents



16. SHORT-TERM INVESTMENTS
  December 31, 2008
    
    
    December 31, 2007Carrying Amount
    
    
    Fair Value
    
    
    Carrying Amount
    
    
    Fair ValueFinancial assets:Cash and cash equivalents
    
    $
    57,976
    
    
    $
    57,976
    
    
    $
    58,222
    
    
    $
    58,222Short-term investments
    
    $
    2,419
    
    
    $
    2,419
    
    
    $
    632
    
    
    $
    632
 17. PER SHARE INFORMATION
    December 31, 2008
    
    
    December 31, 2007
    
    
    December 31, 2006Net loss
    
    $
    (7,115
    )
    
    $
    (26,153
    )
    
    $
    (1,834
    )Weighted average common shares outstanding
    
    
    13,102
    
    
    
    13,219
    
    
    
    13,239Effect of dilutive securities  stock options
    
    
    
    
    
    
    
    
    
    
    13,102
    
    
    
    13,219
    
    
    
    13,239Loss per share:Basic
    
    $
    (0.54
    )
    
    $
    (1.98
    )
    
    $
    (0.14
    )Diluted
    
    $
    (0.54
    )
    
    $
    (1.98
    )
    
    $
    (0.14
    )
 18. EMPLOYEE DEFINED CONTRIBUTION PLANS
  19. SEVERANCE AND RELATED EXPENSE
  -75-




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##### Table of Contents



20. SUBSEQUENT EVENTS
  -76-




---



##### Table of Contents



Col. B
    
    Col C.
    
    
    
    
    
    Col. EBalance at
    
    Additions
    
    
    
    
    
    Balance atBeginning
    
    
    
    
    
    Charged to
    
    Col. D
    
    EndCol. A
    
    of Year
    
    Charged to Expense
    
    Other Accounts
    
    Deductions
    
    of YearAllowance for doubtful accounts:Year ended December 31, 2008
    
    $
    478
    
    
    
    100
    
    
    
    
    
    
    
    (201
    )
    
    $
    377Year ended December 31, 2007
    
    $
    535
    
    
    
    86
    
    
    
    
    
    
    
    (143
    )
    
    $
    478Year ended December 31, 2006
    
    $
    465
    
    
    
    86
    
    
    
    
    
    
    
    (16
    )
    
    $
    535Inventory reserve:Year ended December 31, 2008
    
    $
    2,609
    
    
    
    953
    
    
    
    
    
    
    
    (1,222
    )
    
    $
    2,340Year ended December 31, 2007
    
    $
    2,425
    
    
    
    402
    
    
    
    
    
    
    
    (218
    )
    
    $
    2,609Year ended December 31, 2006
    
    $
    2,095
    
    
    
    (90
    )
    
    
    420
    
    
    
    
    
    
    $
    2,425Warranty reserve:Year ended December 31, 2008
    
    $
    1,937
    
    
    
    1,789
    
    
    
    
    
    
    
    (2,136
    )
    
    $
    1,590Year ended December 31, 2007
    
    $
    2,135
    
    
    
    1,680
    
    
    
    
    
    
    
    (1,878
    )
    
    $
    1,937Year ended December 31, 2006
    
    $
    2,220
    
    
    
    1,595
    
    
    
    
    
    
    
    (1,680
    )
    
    $
    2,135Valuation allowance on net
deferred tax assets:Year ended December 31, 2008
    
    $
    12,655
    
    
    
    123
    
    
    
    3,070
    
    
    
    
    
    
    $
    15,848Year ended December 31, 2007
    
    $
    2,733
    
    
    
    9,922
    
    
    
    
    
    
    
    
    
    
    $
    12,655Year ended December 31, 2006
    
    $
    2,004
    
    
    
    729
    
    
    
    
    
    
    
    
    
    
    $
    2,733
 -77-




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##### Table of Contents



Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
  
 Item 9A. Controls and Procedures.
 Evaluation of Disclosure Controls and Procedures
  Managements Report on Internal Control over Financial Reporting
     Evaluation of Changes in Internal Controls over Financial Reporting
  
 Item 9B. Other Information.
  -78-




---



##### Table of Contents



PART III
 
 Item 10. Directors, Executive Officers and Corporate Governance.
   
 Item 11. Executive Compensation.
  
 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.
  Securities Authorized for Issuance Under Equity Compensation Plans
  No. of securities remainingavailable for futureissuance under equityNo. of securities
    
    
    
    
    
    compensation plansto be issued upon
    
    Weighted average
    
    (excluding securities to beexercise of
    
    exercise price of
    
    issued upon exercise ofoutstanding options
    
    outstanding options
    
    outstanding options)Equity compensation
plans approved by
security holders1995 Long-Term
Incentive
Compensation Plan (1)
    
    
    642,325
    
    
    $
    41.97
    
    
    
    2006 Long-Term
Incentive
Compensation Plan
    
    
    761,067
    
    
    $
    6.33
    
    
    
    459,039Equity compensation
plans not approved
by security holders1998 Employee
Incentive
Compensation Plan (1)
    
    
    202,098
    
    
    $
    26.15
    
    
    
    Total:
    
    
    1,605,490
    
    
    
    
    
    
    
    459,039
 
 (1)
    
    No further grants may be made under these plans.  -79-




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##### Table of Contents



Item 13. Certain Relationships and Related Transactions and Director Independence.
  
 Item 14. Principal Accounting Fees and Services.
  
 PART IV
 
 Item 15. Exhibits and Financial Statement Schedules.
 (a)
    
    The following documents have been filed as part of this report or, where noted, incorporated by
reference:
 (1)
    
    Financial StatementsThe financial statements of the Company are listed in the Index to Consolidated Financial
Statements on Page 56.(2)
    
    Financial Statement ScheduleThe financial statement schedule filed in response to Item 8 and Item 15(d) of Form
10-K, Schedule II (Valuation and Qualifying Accounts), is listed in the Index to
Consolidated Financial Statements on Page 56.(3)
    
    The following exhibits are included herewith and made a part hereof:
 ExhibitNumber
    
    Description3.1
    
    Amended and Restated Articles of Incorporation of the Company (the Articles) as amended
through May 6, 1998 (conformed copy), incorporated herein by reference to Exhibit 3.1 to the
Annual Report of Tollgrade Communications, Inc. (the Company) on Form 10-K, filed with the
Securities and Exchange Commission (the SEC) on March 24, 1999 (the 1998 Form 10-K).3.1a
    
    Statement with Respect to Shares dated July 23, 1996 (conformed copy), incorporated herein by
reference to Exhibit 3.1a to the 1998 Form 10-K.3.1b
    
    Amendment to Articles incorporated herein by reference, filed on the Companys Current Report
on Form 8-K filed with the SEC on May 21, 2007.3.2
    
    Amended and Restated Bylaws of the Company filed as Exhibit 3.2 to the Companys Current
Report on Form 8-K filed with the SEC on May 21, 2007.10.1*
    
    1995 Long-Term Incentive Compensation Plan, amended and restated as of January 24, 2002,
incorporated herein by reference to Exhibit B to the 2002 Proxy Statement of the Company,
filed with the SEC on March 22, 2002.10.2*
    
    Form of Stock Option Agreement dated December 14, 1995 and December 29, 1995 for
Non-Statutory Stock Options granted under the 1995 Long-Term Incentive Compensation Plan,
incorporated herein by reference to Exhibit 10.15 to the Companys Form 10-K, filed with the
SEC on March 19, 1997 (the 1996 Form 10-K).10.3*
    
    Form of Stock Option Agreement for Non-Statutory Stock Options granted under the 1995
Long-Term Incentive Compensation Plan, incorporated herein by reference to Exhibit 10.2 to the
Companys Form 10-Q, filed with the SEC on November 12, 1996.10.4*
    
    Form of Non-employee Director Stock Option Agreement with respect to the Companys 1995
Long-Term Incentive Compensation Plan, incorporated herein by reference to Exhibit 10.25 to
the Companys Form 10-K filed with the SEC on March 25, 1998 (the 1997 Form 10-K).10.5*
    
    Form of Change in Control Agreement, together with a schedule listing the name of each
Executive with whom the Company has entered into an agreement in substantially identical form
and in each case the date of such agreement, filed herewith.10.6*
    
    1998 Employee Incentive Compensation Plan, amended and restated as of January 24, 2002,
incorporated herein by reference to Exhibit 10.25 to the Companys Form 10-K, filed with the
SEC on March 22, 2002 (the 2001 Form 10-K).10.7
    
    Asset Purchase Agreement by and between Lucent Technologies, Inc. and Tollgrade
Communications, Inc. dated September 28, 2001, incorporated herein by reference to Exhibit 2.1
to the Companys Current Report on Form 8-K filed with the SEC on October 15, 2001.
 -80-




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##### Table of Contents



ExhibitNumber
    
    Description10.8
    
    Purchase and Sale Agreement, entered into February 13, 2003, between the Company and Acterna,
LLC, incorporated herein by reference to Exhibit 2.1 to the Companys Current Report on Form
8-K filed with the SEC on February 27, 2003.10.9
    
    Lease and License for Alterations dated October 18, 2007 among Tollgrade UK Limited,
Tollgrade Communications, Inc., Bedell Corporate Trustees Limited and Atrium Trustees (as
Trustees of the Park One Unit Trust), filed as Exhibit 10.2 to the Companys Form 10-Q filed
with the SEC on November 8, 2007.10.10
    
    Agreement dated November 27, 2006 by and between Knightsbridge Realty L.L.C. and Tollgrade
Communications, Inc., filed as Exhibit 10.1 to the Companys Current Report of Form 8-K filed
with the SEC on November 30, 2006.10.11
    
    Lease Agreement, dated as of August 31, 2005, between Regional Industrial Development
Corporation of Southwestern Pennsylvania and the Company, incorporated herein by reference to
Exhibit 10.1 to the Companys Current Report on Form 8-K filed with the SEC on September 7,
2005.10.12
    
    Asset Purchase Agreement dated February 7, 2006 by and among Emerson Electric Co., Emerson
Network Power, Energy Systems, North America, Inc. and Tollgrade Communications, Inc., filed
as Exhibit 10.25 to the 2006 Form 10-K.10.13*
    
    Management Incentive Compensation Plan, as amended, filed as Exhibit 10.1 to the Companys
Form 10-Q filed with the SEC on April 27, 2007.10.14*
    
    Tollgrade Communications, Inc. 2006 Long-Term Incentive Compensation Plan filed as Exhibit
10.1 to the Companys Current Report on Form 8-K filed with the SEC on May 11, 2006.10.15*
    
    Form of Stock Option Agreement for Non-Statutory Stock Options granted under the 2006
Long-Term Incentive Compensation Plan, filed as Exhibit 10.1 to the Companys Form 10-Q filed
with the SEC on October 27, 2006.10.16
    
    Asset Purchase Agreement dated May 31, 2007 between Tollgrade Communications, Inc. and
Teradyne, Inc., filed as Exhibit 10.1 to the Companys Form 10-Q filed with the SEC on July
27, 2007.10.17*
    
    Form of Employee Restricted Share Agreement for restricted share grants pursuant to the 2006
Long-Term Incentive Compensation Plan, filed as Exhibit 10.37 to the Companys Form 10-K filed
with the SEC on March 17, 2008 (the 2007 Form 10-K).10.18*
    
    Form of Director Restricted Share Agreement for restricted share grants pursuant to the 2006
Long-Term Incentive Compensation Plan, filed as Exhibit 10.38 to the 2007 Form 10-K.10.19*
    
    Amendment dated December 13, 2007 to the Management Incentive Compensation Plan, filed as
Exhibit 10.39 to the 2007 Form 10-K.10.20*
    
    Amendment dated December 13, 2007 to the 1995 Long-Term Incentive Compensation Plan, filed
as Exhibit 10.40 to the 2007 Form 10-K.10.21*
    
    Amendment dated December 13, 2007 to the 1998 Long-Term Incentive Compensation Plan, filed
as Exhibit 10.41 to the 2007 Form 10-K.10.22*
    
    Separation and Mutual Release Agreement dated January 7, 2008 between the Company and Carol
M. Franklin, filed as Exhibit 10.1 to the Current Report on Form 8-K/A filed with the SEC on
January 10, 2008.10.23*
    
    Severance Policy, filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC
on January 31, 2008.10.24*
    
    Employment Agreement, dated April 10, 2008 between the Company and Joseph A. Ferrara, filed
as Exhibit 10.1 to the Current Report on Form 8-K/A filed with the SEC on April 16, 2008.10.25*
    
    Severance and Retention Agreement dated October 14, 2008 between the Company and Kenneth J.
Shebek, filed as Exhibit 10.3 to the Current Report on Form 8-K filed with the SEC on October
22, 2008.10.26*
    
    Severance Agreement dated October 14, 2008 between the Company and David L. Blakeney, filed
as Exhibit 10.2 to the Current Report on Form 8-K filed with the SEC on October 22, 2008.10.27*
    
    Severance Agreement dated October 14, 2008 between the Company and Gary W. Bogatay, Jr.,
filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on October 22,
2008.10.28*
    
    Agreement dated November 21, 2008 between the Company and Samuel C. Knoch, filed as Exhibit
10.1 to the Current Report on Form 8-K/A filed with the SEC on November 26, 2008.10.29*
    
    Agreement dated November 28, 2008 between the Company and Matthew J. Rosgone, filed as
Exhibit 10.1 to the Current Report on Form 8-K/A filed with the SEC on December 3, 2008.10.30*
    
    Summary of Compensatory Arrangement with Robert H. King, as described in the Current Report
on Form 8-K filed with the SEC on February 20, 2009.
 
 *
    
    Management contract or compensatory plan, contract or arrangement required to be filed by Item
601(b)(10)(iii) of Regulation S-K. -81-




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®  ®  ®  ®  ®  ®  ®
 -82-




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SIGNATURES
  TOLLGRADE COMMUNICATIONS, INC.By

/s/ Joseph A. FerraraJoseph A. FerraraChief Executive Officer and President  Signature
    
    Title/s/ Joseph A. Ferrara

Joseph A. Ferrara
    
    Chief Executive Officer, President and Director
(Principal Executive Officer)/s/ James J. Barnes

James J. Barnes
    
    Director/s/ Daniel P. Barry

Daniel P. Barry
    
    Director/s/ David S. Egan

David S. Egan
    
    Director/s/ Richard H. Heibel, M.D.

Richard H. Heibel, M.D.
    
    Director/s/ Robert W. Kampmeinert

Robert W. Kampmeinert
    
    Director/s/ Brian C. Mullins

Brian C. Mullin
    
    Director/s/ Gary W. Bogatay, Jr.

Gary W. Bogatay, Jr.
    
    Chief Financial Officer and Treasurer
(Principal Financial Officer)/s/ R. Joseph Fink

R. Joseph Fink
    
    Controller
(Principal Accounting Officer)
 
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##### Table of Contents



EXHIBIT INDEX
 ExhibitNumber
    
    Description3.1
    
    Amended and Restated Articles of Incorporation of the Company (the Articles) as amended
through May 6, 1998 (conformed copy), incorporated herein by reference to Exhibit 3.1 to the
Annual Report of Tollgrade Communications, Inc. (the Company) on Form 10-K, filed with the
Securities and Exchange Commission (the SEC) on March 24, 1999 (the 1998 Form 10-K).3.1a
    
    Statement with Respect to Shares dated July 23, 1996 (conformed copy), incorporated herein by
reference to Exhibit 3.1a to the 1998 Form 10-K.3.1b
    
    Amendment to Articles incorporated herein by reference, filed on the Companys Current Report
on Form 8-K filed with the SEC on May 21, 2007.3.2
    
    Amended and Restated Bylaws of the Company filed as Exhibit 3.2 to the Companys Current
Report on Form 8-K filed with the SEC on May 21, 2007.10.1
    
    1995 Long-Term Incentive Compensation Plan, amended and restated as of January 24, 2002,
incorporated herein by reference to Exhibit B to the 2002 Proxy Statement of the Company,
filed with the SEC on March 22, 2002.10.2
    
    Form of Stock Option Agreement dated December 14, 1995 and December 29, 1995 for
Non-Statutory Stock Options granted under the 1995 Long-Term Incentive Compensation Plan,
incorporated herein by reference to Exhibit 10.15 to the Companys Form 10-K, filed with the
SEC on March 19, 1997 (the 1996 Form 10-K).10.3
    
    Form of Stock Option Agreement for Non-Statutory Stock Options granted under the 1995
Long-Term Incentive Compensation Plan, incorporated herein by reference to Exhibit 10.2 to the
Companys Form 10-Q, filed with the SEC on November 12, 1996.10.4
    
    Form of Non-employee Director Stock Option Agreement with respect to the Companys 1995
Long-Term Incentive Compensation Plan, incorporated herein by reference to Exhibit 10.25 to
the Companys Form 10-K filed with the SEC on March 25, 1998 (the 1997 Form 10-K).10.5
    
    Form of Change in Control Agreement, together with a schedule listing the name of each
Executive with whom the Company has entered into an agreement in substantially identical form
and in each case the date of such agreement, filed herewith.10.6
    
    1998 Employee Incentive Compensation Plan, amended and restated as of January 24, 2002,
incorporated herein by reference to Exhibit 10.25 to the Companys Form 10-K, filed with the
SEC on March 22, 2002 (the 2001 Form 10-K).10.7
    
    Asset Purchase Agreement by and between Lucent Technologies, Inc. and Tollgrade
Communications, Inc. dated September 28, 2001, incorporated herein by reference to Exhibit 2.1
to the Companys Current Report on Form 8-K filed with the SEC on October 15, 2001.10.8
    
    Purchase and Sale Agreement, entered into February 13, 2003, between the Company and Acterna,
LLC, incorporated herein by reference to Exhibit 2.1 to the Companys Current Report on Form
8-K filed with the SEC on February 27, 2003.10.9
    
    Lease and License for Alterations dated October 18, 2007 among Tollgrade UK Limited,
Tollgrade Communications, Inc., Bedell Corporate Trustees Limited and Atrium Trustees (as
Trustees of the Park One Unit Trust), filed as Exhibit 10.2 to the Companys Form 10-Q filed
with the SEC on November 8, 2007.10.10
    
    Agreement dated November 27, 2006 by and between Knightsbridge Realty L.L.C. and Tollgrade
Communications, Inc., filed as Exhibit 10.1 to the Companys Current Report of Form 8-K filed
with the SEC on November 30, 2006.10.11
    
    Lease Agreement, dated as of August 31, 2005, between Regional Industrial Development
Corporation of Southwestern Pennsylvania and the Company, incorporated herein by reference to
Exhibit 10.1 to the Companys Current Report on Form 8-K filed with the SEC on September 7,
2005.10.12
    
    Asset Purchase Agreement dated February 7, 2006 by and among Emerson Electric Co., Emerson
Network Power, Energy Systems, North America, Inc. and Tollgrade Communications, Inc., filed
as Exhibit 10.25 to the 2006 Form 10-K.10.13
    
    Management Incentive Compensation Plan, as amended, filed as Exhibit 10.1 to the Companys
Form 10-Q filed with the SEC on April 27, 2007.10.14
    
    Tollgrade Communications, Inc. 2006 Long-Term Incentive Compensation Plan filed as Exhibit
10.1 to the Companys Current Report on Form 8-K filed with the SEC on May 11, 2006.
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##### Table of Contents



ExhibitNumber
    
    Description10.15
    
    Form of Stock Option Agreement for Non-Statutory Stock Options granted under the 2006
Long-Term Incentive Compensation Plan, filed as Exhibit 10.1 to the Companys Form 10-Q filed
with the SEC on October 27, 2006.10.16
    
    Asset Purchase Agreement dated May 31, 2007 between Tollgrade Communications, Inc. and
Teradyne, Inc., filed as Exhibit 10.1 to the Companys Form 10-Q filed with the SEC on July
27, 2007.10.17
    
    Form of Employee Restricted Share Agreement for restricted share grants pursuant to the 2006
Long-Term Incentive Compensation Plan, filed as Exhibit 10.37 to the Companys Form 10-K filed
with the SEC on March 17, 2008 (the 2007 Form 10-K).10.18
    
    Form of Director Restricted Share Agreement for restricted share grants pursuant to the 2006
Long-Term Incentive Compensation Plan, filed as Exhibit 10.38 to the 2007 Form 10-K.10.19
    
    Amendment dated December 13, 2007 to the Management Incentive Compensation Plan, filed as
Exhibit 10.39 to the 2007 Form 10-K.10.20
    
    Amendment dated December 13, 2007 to the 1995 Long-Term Incentive Compensation Plan, filed
as Exhibit 10.40 to the 2007 Form 10-K.10.21
    
    Amendment dated December 13, 2007 to the 1998 Long-Term Incentive Compensation Plan, filed
as Exhibit 10.41 to the 2007 Form 10-K.10.22
    
    Separation and Mutual Release Agreement dated January 7, 2008 between the Company and Carol
M. Franklin, filed as Exhibit 10.1 to the Current Report on Form 8-K/A filed with the SEC on
January 10, 2008.10.23
    
    Severance Policy, filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC
on January 31, 2008.10.24
    
    Employment Agreement, dated April 10, 2008 between the Company and Joseph A. Ferrara, filed
as Exhibit 10.1 to the Current Report on Form 8-K/A filed with the SEC on April 16, 2008.10.25
    
    Severance and Retention Agreement dated October 14, 2008 between the Company and Kenneth J.
Shebek, filed as Exhibit 10.3 to the Current Report on Form 8-K filed with the SEC on October
22, 2008.10.26
    
    Severance Agreement dated October 14, 2008 between the Company and David L. Blakeney, filed
as Exhibit 10.2 to the Current Report on Form 8-K filed with the SEC on October 22, 2008.10.27
    
    Severance Agreement dated October 14, 2008 between the Company and Gary W. Bogatay, Jr.,
filed as Exhibit 10.1 to the Current Report on Form 8-K filed with the SEC on October 22,
2008.10.28
    
    Agreement dated November 21, 2008 between the Company and Samuel C. Knoch, filed as Exhibit
10.1 to the Current Report on Form 8-K/A filed with the SEC on November 26, 2008.10.29
    
    Agreement dated November 28, 2008 between the Company and Matthew J. Rosgone, filed as
Exhibit 10.1 to the Current Report on Form 8-K/A filed with the SEC on December 3, 2008.10.30
    
    Summary of Compensatory Arrangement with Robert H. King, as described in the Current Report
on Form 8-K filed with the SEC on February 20, 2009.21.1
    
    List of subsidiaries of the Company, filed as Exhibit 21.1 to the 2007 Form 10-K.23.1
    
    Consent of PricewaterhouseCoopers LLP, filed herewith.31.1
    
    Certification of Chief Executive Officer, filed herewith.31.2
    
    Certification of Chief Financial Officer, filed herewith.32
    
    Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.
Section 350, filed herewith.
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