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Article by DailyStocks_admin    (02-25-09 05:36 AM)

Filed with the SEC from Feb 12 to Feb 18:

Tollgrade Communications (TLGD)
Ramius Value and Opportunity Master Fund sent a letter to TLGD nominating four candidates for election to its board: Scott Chandler, Jeffrey Libshutz, Edward Meyercord and Jeffrey Solomon. Ramius intends to discuss the nominations with the Pittsburgh-based network-service provider. Ramius holds 1,568,112 shares (11.8% of the total outstanding).

BUSINESS OVERVIEW

CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
The statements contained in this Annual Report on Form 10-K of Tollgrade Communications, Inc. (“Tollgrade,” the “Company,” “us,” or “we”), including, but not limited to those contained in Item 1, “Business,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” along with statements in other reports filed with the Securities and Exchange Commission (the “SEC”), external documents and oral presentations, which are not historical facts are considered to be “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements, which may be expressed in a variety of ways, including the use of forward-looking terminology such as “believe,” “expect,” “intend,” “may,” “will,” “should,” “could,” “potential,” “continue,” “estimate,” “plan,” or “anticipate,” or the negatives thereof, other variations thereon or compatible terminology, relate to, among other things, our strategic focus on our core test and measurement competencies and our ability to realign our resources around growth opportunities in current, adjacent and new markets, our ability to achieve planned cost reductions, new product initiatives, including our DigiTest ICE™ product and our LightHouse™ products targeted at the electric utility market, the inability to complete sales, or possible delays in deployment, of products under international projects due to inability to complete or possible delays in completing the legal and commercial terms for such projects, project delays or cancellations, political instability, inability to obtain proper acceptances or other unforeseen obstacles or delays, projected cash flows which are used in the valuation of intangible assets, the anticipated results of negotiations for purchase orders and other customer purchase agreements, our ability to utilize current deferred and refundable tax assets, service opportunities offered to customers, the potential loss of certain customers, the timing of orders from customers, including the timing of international sales, the effect of consolidations in the markets to which Tollgrade sells, the effects of the economic slowdown in the telecommunications and cable industries, the possibility of future provisions for slow moving inventory, the Company’s expectations with regard to its contract manufacturer, the effect on earnings and cash flows of changes in interest rates, and changes in technology that have impacted our customers’ product needs and spending. We do not undertake any obligation to publicly update any forward-looking statements.
These forward-looking statements, and any forward-looking statements contained in other public disclosures of the Company which make reference to the cautionary factors contained in this Form 10-K, are based on assumptions that involve risks and uncertainties and are subject to change based on the considerations described below. We discuss many of these risks and uncertainties in greater detail in Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors.” These and other risks and uncertainties may cause our actual results, performance or achievements to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements.
The following discussion should be read in conjunction with our “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our financial statements and related notes contained in this Annual Report on Form 10-K.
Item 1. Business.
Tollgrade designs, engineers, markets and supports test system and status monitoring hardware and software products for the telecommunications and cable industries in the United States and international markets. The Company’s telecommunications proprietary test access products enable telecommunications service providers to remotely diagnose problems in Plain Old Telephone Service (“POTS”) lines and Digital Subscriber Lines (“DSL”) in Public Switched Telephone Network (“PSTN”), broadband and next generation Internet Protocol (“IP”) networks.
The Company’s test system products, specifically the LoopCare™, 4TEL®, Celerity®, and LTSC™ centralized test Operation Support Systems (“OSS”), together with the associated remote measurement platforms of DigiTest®, LDU, and N(x)Test™, enable local exchange carriers to conduct a full range of measurement and fault diagnosis for efficient dispatch of field staff to maintain and repair POTS and/or DSL services, along with the ability to pre-qualify and provide broadband DSL services offerings.
The Company’s cable products include the Cheetah™ system, a complete cable status monitoring system that provides a comprehensive testing solution for the Broadband Hybrid Fiber Coax (“HFC”) distribution system. The status monitoring system consists of a host server for user interface, control and configuration; a headend controller for managing network communications; and transponders that are strategically located within the cable network to gather status reports from power supplies, line amplifiers and fiber-optic nodes. Our next generation products can also be upgraded to support Voice over Internet Protocol (“VoIP”) testing capability to enable voice trouble identification in the HFC network.

On August 1, 2007, the Company completed the acquisition of the Broadband Test Division (“BTD”) of Teradyne, Inc. Pursuant to the terms of the acquisition, we acquired substantially all of the assets and assumed certain liabilities of BTD for approximately $11.3 million in cash, and there were approximately $0.6 million in transaction fees for a total acquisition expenditure of $11.9 million. Through this acquisition, we significantly expanded our offering of telecommunication test system products.
Most recently, the Company introduced products targeted at the electric power utility market. Our LightHouse™ centralized remote monitoring system, which is currently available as a beta product for evaluation pilot programs, and is expected to be commercially available during the fourth quarter of 2008, provides the means for electric power utilities to continuously monitor the distribution grid in order to detect faults and help minimize the impact of outages while optimizing the utilization of assets. The new product line will enable monitoring, maintenance and reporting functions in real-time.
We were incorporated in Pennsylvania in 1986, began operations in 1988 and completed our initial public offering in 1995. Our principal offices are located at 493 Nixon Road, Cheswick, Pennsylvania 15024 and our telephone number is (412) 820-1400.
We make available free of charge on our Internet website (www.tollgrade.com) our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or otherwise furnish it to, the SEC.
You may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains our reports, proxy, information statements and other information that we file with the SEC ( www.sec.gov ). Copies of our filings are available free of charge to any shareholder of record upon written request to the Secretary, Tollgrade Communications, Inc., 493 Nixon Road, Cheswick, Pennsylvania 15024.
Products
Telecommunications Test and Measurement Products
Our proprietary telecommunications test and measurement products, which include our Systems Test and MCU â products, enable telephone companies to remotely diagnose problems in POTS lines as well as qualify and troubleshoot broadband DSL and IP services. POTS lines provide traditional voice service as well as connections for communication devices such as computer modems and fax machines. POTS excludes non-switched and private lines, such as data communications service lines, commonly referred to as “special services.” POTS lines still comprise the vast majority of lines in service today throughout the world. Most DSL lines today provide broadband Internet access for residential and business customers, fed from a central or remote office Digital Subscriber Line Access Multiplexer (“DSLAM”) and configured with either a shared POTS voice service or “unbundled” from the voice switch entirely (in the case of a competitive local exchange carriers (“CLECs”) service offering). Our systems can be used to qualify loops for DSL service as well as ongoing maintenance and repair of these “IP” lines. As telecommunications service providers move to all IP networks and services (voice, video and data), Tollgrade’s test systems are positioned to be upgraded to support the testing of these services.
An important aspect of efficiently maintaining a POTS and broadband DSL network is the ability to remotely test, diagnose and locate any service-affecting problems within the network. Tollgrade’s Systems Test Products are made up of a centralized test operating system (LoopCare, 4TEL, Celerity, and LTSC) integrated into the customers’ repair handling database systems, and remote test probes (DigiTest, LDU and N(x)Test) located at telephone companies’ central and remote offices. These systems enable local exchange carriers to conduct a full range of fault diagnostics in the “local loop,” the portion of the telephone network that connects end users to the central office. In addition, line test systems provide the capability to remotely qualify, deploy and maintain services such as DSL and Integrated Services Digital Network (“ISDN”) services which are carried over POTS lines. These test systems reduce the time needed to identify and resolve problems, eliminating or reducing the costs of dispatching a technician to the problem site. Most POTS line test systems, however, were designed only for use over copper wire line; as a result, traditional test systems could not access local loops in which fiber-optic technology had been introduced. Our legacy MCU, which is used primarily by Regional Bell Operating Companies (“RBOCs”), solved this problem, extending LoopCare testing from the central office to the fiber-fed remote Digital Loop Carrier (“DLC”) lines by mimicking a digital bypass pair, which is essentially a telephone circuit that connects central test and measurement devices to the copper circuits close to the customer, i.e. “the last mile.”
We believe our DigiTest® system represents the future of telecommunication network testing, combining our line test system with a next generation test platform to provide a complete test system solution for POTS and DSL local loop prequalification and in-service testing.

Systems Test Products
Our Systems Test product family includes four separate operating systems: LoopCare, 4TEL, Celerity, and LTSC, each having an established installed base. LoopCare is also the primary application for broadband DSL testing and can be architected to overlay 4TEL and LTSC to add this functionality to the existing line test application with the addition of the DigiTest measurement platform.
LoopCare has remained the major OSS utilized by RBOCs for over twenty-five years to test the integrity and quality of their POTS network infrastructure. The LoopCare OSS, which we offer both as part of the DigiTest system and as a stand-alone software product that can interface with other test heads on the market, currently manages testing operations for more than 75% of the copper pairs in the United States, and is the qualification, installation and maintenance tool used to troubleshoot more than 150 million POTS, ISDN and DSL subscribers worldwide.
Also included in our Systems Test products is our DigiTest product family. Our DigiTest product family, which includes LoopCare, DigiTest EDGE®, DigiTest HUB™, and, for 2008, DigiTest ICE™, performs physical and logical measurements to verify the connection performance of copper POTS lines and broadband DSL circuits and reports those measurements to our LoopCare OSS. The LoopCare OSS, in turn, analyzes that measurement data and creates an easy-to-understand fault description. At the same time, the LoopCare system can generate a dispatch to a work center so that a repairman can fix the problem. The DigiTest product family can also serve as a replacement for aging Loop Test System (“LTS”) equipment deployed in current U.S. POTS networks. In addition, LoopCare and the DigiTest product family can be used to pre-qualify, verify installation, and remotely isolate troubles for various DSL services, including testing the logical layers to verify modem synchronization ‘in’ to the DSLAM or ‘out’ to the customer.
DigiTest EDGE provides a global platform for POTS and broadband test applications, by combining a narrowband and wideband metallic testing platform with a multi-layered DSL service assurance platform. These test capabilities, when managed by our LoopCare OSS, enable service providers to accurately isolate a DSL problem between the customer’s premises, the local exchange carrier’s local loop and DSLAM serving network, and the Internet service provider’s data network.
Our DigiTest product family also includes the DigiTest HUB, a central office test platform designed to support multiple testing environments. The DigiTest HUB addresses emerging broadband testing requirements, but also retains interfaces to legacy equipment, allowing for a seamless migration from traditional to packet-based delivery of services and allowing service providers to continue automated, mass-market processes. The DigiTest HUB has been deployed extensively in one of the Company’s large international contracts. Although approved for use with several domestic carriers, sales of the product have been minimal in U.S. markets thus far.
Our most recent addition to the DigiTest product family is the DigiTest ICE, which was introduced on a limited basis internationally in the first quarter of 2008, and is expected to become generally available during the second quarter of 2008. Optimized for deployment at remote DSLAM locations, ICE provides both metallic and multi-layered DSL testing to help service providers install and maintain broadband triple play services within their emerging FTTx networks.
During 2006, we added the N(x)Test/LTSC family of products to our Systems Test product portfolio through an acquisition of certain assets from Emerson; these hardware and software products, along with their accessories and enhancements, electrically measure the characteristics of copper loops and report those results in the form of a fault description which can be used by an operation to direct required repair work on a more focused basis. These products are deployed primarily in the Europe, the Middle East and Africa (“EMEA”) geographical area.
On August 1, 2007, we acquired the BTD business and its family of LDU hardware and 4TEL and Celerity software products from Teradyne, Inc. These products perform many of the same line test functions and test measurements as LoopCare and DigiTest previously discussed, but these products have been optimized for operation in the international markets, and have been deployed extensively in large telephone networks in Europe, covering over 100 million access lines. These products have also been deployed to a lesser scale in North America, as well as targeted deployments in international markets outside of Europe.
We have original equipment manufacturer (“OEM”) agreements in place for the supply of a communications card for our DigiTest EDGE product and for the supply of an access device for that product line. Both of these agreements contain automatic renewal terms, unless earlier terminated. We are also a party to a number of third party software license agreements that allow us to incorporate third party software products and features into our LoopCare and Celerity software.

We have licensing arrangements with Aware, Inc. for certain technology related to our DigiTest products and pay royalties and license fees for the use of such technology on a fixed per unit basis. This license agreement with Aware contains automatic renewal terms, unless earlier terminated.
We market and sell our Systems Test products primarily through our direct sales force as well as through certain reseller and distributor agreements. Sales of the DigiTests product line (including related software sales) accounted for approximately 33%, 33% and 27% of the Company’s revenue for the years ended December 31, 2007, 2006 and 2005, respectively.
We also offer for sale new LoopCare features to existing customers and the base LoopCare OSS as a stand-alone product to CLECs for use with test heads other than our DigiTest hardware. Sales of stand-alone LoopCare software and enhancements accounted for approximately 3%, 3% and 4% of the Company’s revenue for the years ended December 31, 2007, 2006 and 2005, respectively.
MCU
Our legacy MCU products plug into DLC systems, the large network transmission systems used by telephone companies to link the copper and fiber-optic portions of the local loop. MCU products allow our customers to extend their line testing capabilities to all of their POTS lines served by a DLC system regardless of whether the system is fed by a copper or fiber optic link. DLC systems, which are located at telephone companies’ central offices and at remote sites within local user areas, effectively multiplex the services of a single fiber-optic line into multiple copper lines. In many instances, several DLC systems are located at a single remote site to create multiple local loops that serve several thousand different end-user homes and businesses. Generally, for every DLC remote site, customers will deploy at least two MCU line-testing products.
We market and sell our MCU products directly to customers as well as through certain OEM agreements. We also have certain royalty-based license agreements in place to enable us to maintain capability with specific DLC systems. We paid royalties under these agreements in the amounts of $0.6 million, $0.3 million and $0.7 million during the years ended December 31, 2007, 2006 and 2005, respectively.
Sales of MCU products and related hardware accounted for approximately 19%, 18% and 22% of our revenue for the years ended December 31, 2007, 2006 and 2005, respectively.
Cable Testing Products
The Company’s Cheetah performance and status monitoring products provide a broad network assurance solution for the broadband HFC distribution system found in the cable television industry. Our Cheetah products gather status information and report on critical components within the cable network.
Cheetah Cable Monitoring
The Company’s monitoring systems include complete hardware and software solutions that enable efficient HFC plant status monitoring. By providing a constant, proactive view of the health and status of outside plant transmission systems, the products can reduce operating costs and increase subscriber satisfaction.
Our cable offerings consist of CheetahXD™ broadband assurance software, our proprietary CheetahNet™ (formerly NetMentor™) software systems, maintenance, head-end controllers, return path switch hardware, both proprietary and DOCSIS®-based transponders and other equipment which gather status and performance reports from power supplies, line amplifiers and fiber optic nodes.
We have entered into license agreements with C-COR, Alpha Technologies, Inc. (“Alpha”), and General Instrument Corp. d/b/a The Broadband Communications Sector of Motorola, Inc., through which we provide status monitoring transponder technology incorporated into those companies’ cable network management systems. We have a separate agreement with Alpha, the leading supplier of power management products to the cable industry, to serve as a non-exclusive provider of IP-based, DOCSIS-based status monitoring equipment for its power supply systems. This agreement automatically renews on an annual basis unless terminated by either party. We also have a number of third party software license agreements that allow us to incorporate third party software products and features into our Cheetah product offerings.
We have licensing arrangements with Telchemy Incorporated, Wind River Systems, Inc. and AdventNet, Inc. for certain technology related to our cable products and pay royalties and license fees for the use of such technology on a fixed per unit basis.

CheetahIP HFC Service Assurance
Our CheetahIP/HFC service assurance solution allows cable operators to proactively test and monitor VoIP using hardware test probes and software analysis tools. By layering VoIP test point software on to DOCSIS-based transponders, the HFC access network is populated with a Tollgrade test probe that is controlled by the CheetahXD management system, placing active on-demand and batch VoIP test calls point-to-point across the network for remote fault diagnosis.
Our Cheetah IP Service Assurance Products, which were initially announced in June, 2005 have been met with limited market acceptance thus far. In connection with the establishment of a distribution channel for this technology, we have entered into agreements with Brix Networks, Inc. and Tektronix (successor to Minacom), which expire in 2008 and 2009, respectively, and which contain automatic renewal provisions. Sales activity in 2007, both through established third party channels, and on a direct basis, has been minimal; however, we continue to market and offer for sale this suite of products.
Sales of both the Cheetah status monitoring and IP/HFC service assurance product lines (excluding Services) accounted for approximately 19%, 25% and 25% of the Company’s revenue for the years ended December 31, 2007, 2006 and 2005, respectively.
Electric Utility Monitoring Products
The Company’s new product development effort, the LightHouse product line, is being designed to provide power grid monitoring capabilities to electric utilities. Research and investment throughout 2007 enabled a launch of the product line for specific beta customer opportunities in the beginning of 2008. The test system solution currently consists of line mounted sensors, aggregators, and centralized software providing an end to end solution for power providers to efficiently monitor their overhead distribution circuits in real time. A LightHouse sensor, mounted directly on the electrical conductor, will continuously monitor key circuit parameters and transmit data over a wireless network to a central location, reducing time of detecting a problem on the grid, identifying its location and restoring service. LightHouse is intended as an innovative means for electric power utilities to deploy technology to provide real-time grid intelligence to detect faults and help minimize the impact of outages while optimizing the utilization of assets. The ultimate goal of the system is to improve the overall efficiency of energy delivery, improve customer satisfaction and improve the financial performance of the electric utilities. The Company had no revenue in 2007 from these products, which are expected to be generally available in the fourth quarter of 2008.
Services
Our Services offerings include software maintenance as well as our professional services, which are designed to ensure that all of the components of our customers’ test systems operate properly. Including software maintenance, Services revenue accounted for approximately 26%, 21% and 22% of the Company’s revenue for the years ended December 31, 2007, 2006 and 2005, respectively. Our Services business has shifted away from traditional POTS-based testability services toward more contract-based software maintenance services, the revenue from which is more predictable. For 2007, the Services business was comprised primarily of software maintenance agreements, and was expanded considerably with the BTD acquisition. As a result, we expect Services to comprise a larger percentage of our revenue in the future. The primary customers for our Services offerings are the RBOCs, domestically, and international customers.
Operating Segment
We have determined that our business has one operating segment, test assurance. All product sales relate to the business of testing infrastructure and networks for the telecommunications and cable industries. Our products have similar production processes, and are sold through comparable distribution channels and means to similar types and classes of customers already in, or entering into, the telecommunications and cable businesses. Operating results are regularly reviewed by the Company’s chief operating decision maker regarding decisions about the allocation of resources and to assess performance.
Sales and Competition
With our headquarters in Cheswick, Pennsylvania, we market our products and services primarily through our direct sales organization with offices in Cheswick, Pennsylvania. Additionally, we have a channel of OEMs, value-added resellers and distributors, both domestic and international.
Revenue Concentrations
The primary customers for our products and services are the RBOCs (Verizon Communications, Inc., AT&T, Inc. and Qwest Communications International, Inc.), as well as independent international telephone companies and most of the major domestic cable operators. Sales in 2007, 2006, and 2005 to AT&T (including the former BellSouth Corporation) accounted for approximately 25%,

24%, and 28%, respectively, of our total revenue for these years. Sales generated from RBOC customers were 33%, 31% and 37% of our total revenue in 2007, 2006 and 2005, respectively. Although the RBOC customers currently focus their spending in more aggressively in wireless and access technologies, our proportional revenue from RBOCs has remained relatively stable. Meanwhile, our proportional revenues from international sales have increased. Sales to one cable OEM customer, Alpha, were 11% of our total revenue in 2006. Sales to our telecom OEM customer, Lucent Technologies International, Inc., were 12% of total revenue in 2005.
Because of our continued dependency on certain RBOCs and certain significant cable multiple system operators (“MSOs”) and OEMs, the potential loss of one or more of these customers, or the reduction of orders for our products by one or more of these customers, could materially and adversely affect our results.
We distinguish revenue by geographic area based upon customer location. Domestic sales represented approximately 61%, 73%, and 77% of the Company’s total revenue for the years ended December 31, 2007, 2006, and 2005, respectively. International sales represented approximately 39% of the Company’s total revenue for the year ended December 31, 2007, compared with 27% and 23% for the years ended December 31, 2006 and 2005, respectively. This increase is primarily attributable to sales related to the Company’s purchase of BTD acquired from Teradyne, Inc. on August 1, 2007 and the deployment of products into Saudi Arabia, offset, in part, by a decrease in our deployment of products into South Africa and certain European accounts. Our international sales are primarily in three geographic areas: the Americas (excluding the United States of America); Europe, the Middle East and Africa (“EMEA”); and Asia Pacific. Sales for the Americas, excluding the United States of America, were approximately $5.6 million or 22% of international sales, sales for EMEA were $19.8 million or 76% of international sales and sales in Asia Pacific were $0.5 million or 2% of international sales for the year ended December 31, 2007. Sales for the Americas, excluding the United States of America, were approximately $3.9 million or 22% of international sales, sales for EMEA were $11.8 million or 66% of international sales and sales in Asia Pacific were $2.2 million or 12% of international sales for the year ended December 31, 2006. See the discussion in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of this Form 10-K for a further description of our international sales strategies.
Competitive Conditions
The market for telecommunications and cable testing equipment is highly competitive. Primary competitive factors in the Company’s market include price, product features, performance, reliability, service and support, breadth of product line, technical documentation, prompt delivery and the availability of alternative technologies.
The traditional competitors for our POTS telecommunications products include Fluke Corporation (formerly Harris Corporation), and Nortel. Each of these companies provides centralized test and management solutions for POTS networks. Historically, we have successfully positioned ourselves against these offerings by leveraging our patented technologies, entering into partnerships with telecommunications equipment providers, and investing in ongoing research and development for emerging broadband technologies and applications.
Our competitors for broadband technologies and applications include Spirent Communications PLC, Huawei Technologies Co., Ltd., JDS Uniphase, and EXFO Electro-Optical Engineering Inc. Our strategy is to leverage our existing incumbent infrastructure and core competencies to test these broadband next generation networks, in order to position ourselves to compete against these competitors on the basis of lower upfront deployment costs and long-term operational efficiency.
We also face competition as network equipment providers such as Alcatel-Lucent, Occam Networks, Inc. and Tellabs Inc. offer testing technology in the form of a chipset embedded into their products. Where testing was once only available in the form of multi-chip, circuit board-based designs like those found in our remote test system products, integrated testing technology is now available in low-cost chipsets embedded into the products of these network equipment providers. Referred to as “SELT/DELT” (Single Ended Line Test or Double Ended Line Test), the testing technology available in this form has limited functionality and only provides partial views of faults in the network. As such, we continue to believe that more robust testing technology like that offered in our products should be important for network assurance as the next generation network evolves and increased penetration of triple play services occurs. However, we have and will continue to face competition and downward pricing pressure from the availability of these less expensive, less robust alternatives resulting in decreased sales of our system products to certain of our customers, particularly in the CLEC market.
With respect to our cable products, status/performance monitoring competitors include AM Communications, Inc., Cisco Systems Inc. (formerly Scientific Atlanta, Inc.), Alpha and Electroline Equipment Inc. Through the adoption of open, non-proprietary standards for status/performance monitoring systems, such as Hybrid Management Sub-layer (“HMS”) and DOCSIS, this market has become highly competitive. Pricing pressures have increased as all providers of monitoring transponders and associated software have reduced price points to meet customer demands. During 2005, Alpha introduced a DOCSIS-based transponder which competes with the products we supply to the market both directly and through our supply agreement with Alpha. As a result, we have modified our strategies in an attempt to reduce product costs while increasing cooperation with Alpha channel relationships.
As with the telecommunications products, the extension of our cable products to address Internet protocol test applications expands our list of traditional competitors to now include Empirix Inc., JDS Uniphase, Tektronix Canada Inc., Brix Networks, Inc. and Agilent Technologies Inc.
Manufacturing
Our manufacturing operations consist primarily of quality control, functional testing, final assembly, burn-in and shipping. We are ISO 9001:2000 registered with the British Standards Institution, Inc. ISO 9000 is a harmonized set of standards that define quality assurance management. Written by the International Organization for Standardization (“ISO”), ISO 9000 is recognized throughout the United States, Canada, the European Union and Japan. To be registered, the Company develops and maintains internal documentation and processes to support the production of quality products to ensure customer satisfaction.
For our telephony products, we utilize two key independent subcontractors to perform a majority of the circuit board assembly and in-circuit testing work. For our Cheetah hardware, during 2007, we primarily used a single turnkey manufacturer, Bulova Technologies – EMS, LLC (formerly, Dictaphone Corporation’s Electronic Manufacturing Services Division), a wholly-owned subsidiary of Bulova Technologies, LLC, to procure the components and assemble and test the products. The loss of any of these subcontractors or inability of such subcontractors to meet our manufacturing needs could cause delays in our ability to meet our customers’ orders and could have a material adverse effect on our results of operations. In addition, shortages of raw materials delivered to, or production capacity constraints at, the Company’s subcontractors could negatively affect our ability to meet our production obligations and result in increased prices for affected parts. Any such reduction may result in delays in shipments of the Company’s products or increases in the price of components, either of which could have a material adverse impact on us. During 2006, we purchased raw materials from one of our contract manufacturers in order to provide it with temporary liquidity, and, in 2007, we purchased additional raw materials on behalf of this contract manufacturer to help ensure timely product deliveries. We had expected this contract manufacturer to return to full turn key vendor status in 2007, but it did not. The Company will transition to two new contract manufacturers in its place, and we expect this transition to be complete by the end of the second quarter of 2008.
Generally, our products use industry standard components; however, application specific integrated circuits (“ASICs”) are also a key component of some of our products and are custom made to the Company’s specifications. Although we have generally been able to obtain ASICs on a timely basis, a delay in the delivery of these components could have a material adverse impact on the Company.
Product and Technology Development
Our product development personnel are organized into teams dedicated to one or more specific product lines or technologies. We continuously monitor developing technologies in order to introduce new or improved products as defined standards and markets emerge. During 2007, we engaged in limited research and development and product trial activities in the wireless hotspot market; however, based on our strategic focus on our core test and measurement capabilities and expertise, we determined not to further pursue activities in this market. In 2007, we continued to investigate the development of new applications for our telecommunications and cable technologies, as well as to develop enhancements and new features to our LoopCare software product line, DigiTest hardware and other technologies to service the telecommunications and cable industries. Consistent with our strategy, during 2007, we also developed technology for use in power grid monitoring for use by electric utility companies. For the years ended December 31, 2007, 2006 and 2005, research and development expenses were approximately $13.6 million, $13.3 million and $14.1 million, respectively.

MANAGEMENT DISCUSSION FROM LATEST 10K

This MD&A should be read in conjunction with the other sections of this annual report on Form 10-K, including “Item 1: Business”, “Item 6: Selected Financial Data” and “Item 8: Financial Statements.” Certain statements contained in this MD&A and elsewhere in this report are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended that involve risks and uncertainties. These statements relate to future events or our future financial performance. In some cases, forward-looking statements can be identified by terminology such as “believe,” “expect,” “intend,” “may,” “will,” “should,” “could,” “potential,” “continue,” “estimate,” “plan,” or “anticipate,” or the negatives thereof, other variations thereon or compatible terminology. These statements involve a number of risks and uncertainties. Actual events or results may differ materially from any forward-looking statement as a result of various factors, including those described in Item 1A above under “Risk Factors.”
Overview
Communication services provide people with a means to communicate through diverse channels ranging from cable television to traditional wired telephone service to wireless telephones to electronic means such as e-mail and other Internet-based offerings. As a leading producer of network assurance products for wired networks, our mission is to provide industry-leading, cost-effective service assurance solutions to customers worldwide.
The communications marketplace has evolved rapidly over the last decade, with significant changes in technology, regulation and economic factors affecting our business. Our challenge and opportunity is to leverage our embedded base of customers and strong market position in POTS testing to address the testing and monitoring needs of the next generation network architectures.
Our strategy is to focus on our core test and measurement competencies to grow and develop our position in new and existing markets by:
• Providing innovative products, services, solutions and new technologies to current, adjacent and new markets;

• Realigning our investments to support our core business;

• Improving existing channel partnerships and pursuing new ones;

• Capitalizing on our worldwide customer footprint and relationships;

• Achieving higher levels of execution and performance in all business areas; and

• Enhancing shareholder value through investment, organic growth and potential acquisitions that promote our strategic objectives.
Industry and Market Trends
During the late 1990s and into 2000, we benefited greatly from the increased capital spending of our RBOC and other customers as they built-out or upgraded their digital loop carrier networks during this period. In early 2001, the telecommunications industry experienced a significant downturn, primarily caused by the general slowdown of the U.S. and global economies during the period, network overcapacity, constrained capital markets and financial difficulties among certain telecommunication providers, especially CLECs. During this period, demand for our legacy products either leveled off or declined in the domestic market. This downturn persisted into 2004.
Since that time, and continuing through 2007, telecommunications providers began to increase their capital spending as they began to migrate their networks to next generation technologies. This was a competitive response to other “non-traditional” service providers such as cable and wireless companies seeking to gain market share by adding subscribers once only serviced by traditional fixed wireline carriers.
These events have led to several trends that we expect will continue to impact our business, which are discussed in more detail below:
• incumbent telephone carriers continue to lose customers and revenue to cable providers and smaller, independent local exchange carriers, many of whom are developing their own networks and attempting to compete on price;

• our traditional customer base of incumbent telephone carriers (especially the RBOCs) have considerably slowed their investments in legacy POTS line capacity and instead are focusing their capital spending on wireless and next generation wireline projects such as xDSL services, fiber-to-the-premises or fiber-to-the-node (collectively, “FTTx”) and IPTV;

• due in part to the deregulation of the telecommunications industry that occurred in the late 1990’s, both cable and telephone companies (as well as the providers of satellite, wireless and other information mediums) are embroiled in intense competition over the so-called ‘triple-play’ of voice, data and video broadband services;

• adoption of open, non-proprietary standards for status/performance monitoring systems, such as HMS and DOCSIS, resulting in heightened competition in that market;

• increased consolidation among RBOCs and others in the telecommunications industry;

• certain telecommunications customers who might traditionally have purchased full service assurance solutions from us are evaluating or have chosen less expensive, integrated testing solutions utilizing chip-based technology built into transmission equipment (referred to as “SELT/DELT”) as individual components of an overall turn-key solution; and

• as a result of challenges in our traditional markets, we are seeking new opportunities in adjacent markets such as the electric power industry; the utilities are at a critical point with managing their infrastructure, and are looking to next generation network architectures to improve the performance and reliability of the nation’s power grid.
Customer Line Loss
The most evident market trend to affect our results in the years from 2001 through 2007 was the general slowdown in the build-out of POTS networks by incumbent telephone carriers such as the RBOCs and other independent local exchange carriers. Beginning in 2001, the declining demand for wired telephone service, known as “line loss,” caused our customers to lose more wired customer lines than they are adding. This primarily resulted from competition from wireless telephone and cable VoIP telephone providers and the reduction in the need for multiple telephone lines due to the increased popularity of DSL (which is normally accessed though a household’s primary hardwire telephone line) and broadband access to the Internet. Although we do not believe that wireless or VoIP service will entirely replace the need for wired telephone service, we do expect that wireless and VoIP telephones will continue to erode the demand for POTS service. As will be discussed, this has and will continue to reduce demand for some of our legacy POTS testing products but also presents opportunities for our new solutions and technologies. The extent and continued pace of such reduced demand, however, is difficult to predict at this time.
Investment in New Infrastructure and Technologies by our Telecommunications Customers
Our telecommunications customers have considerably slowed their investments in POTS line capacity relative to their spending patterns in the late 1990s through 2001. Instead, these providers, from which we derive a large percentage of our revenue, are focusing their capital spending on wireless and next generation wireline projects such as DSL services and FTTx projects.
During 2007, telecommunications service providers continued the migration of their networks to these next generation technologies. A majority of the RBOCs have, at present, announced capital budgets for 2008 which are at or only slightly below 2007 expenditure levels. Rather than investing in POTS, however, increasing portions of these capital budgets continue to be allocated to other projects, such as wireless, DSL rollouts, and network improvements, new switching technology and FTTx projects. As a result, we continue to see delays in centralized test system deployments.
AT&T and Qwest have indicated they will continue to use their current hybrid fiber/copper networks utilizing DSL technology for the foreseeable future to provide a vast array of competitively priced voice, data and ultimately video services to the market (the so-called ‘triple play’). Verizon is taking a different strategic direction by implementing a deep fiber to the premises (“FTTP”) network that in some cases will reach directly into the consumers’ home (known as the “FiOS” program).
If implemented on a large scale, FTTP projects, such as Verizon FiOS, will continue to reduce demand for our MCU and legacy DigiTest products with those customers. Unlike traditional hybrid networks in which our MCU products are deployed, fiber-optic systems can be tested and managed with appropriate software (including variations of our LoopCare software). Although there is an increased rate of deployment of FTTP networks worldwide, it is likely to take many years before there is sufficient penetration to displace the “last mile” copper network.
As opposed to FTTP, others are developing fiber to the node (“FTTN”) projects, pursuant to which, the fiber link will extend only to the nodes in the network rather than to the customer premises. This will leave a portion of the copper network intact. Given the size and breadth of the present hybrid networks, including the billions of dollars invested in them, coupled with the billions of dollars required to replace them with all fiber-optic lines, we believe that the copper portion of the network will remain an important part of the telecommunications system in the United States for the foreseeable future. As long as that copper portion remains, some need for traditional testing methods should continue.
As a result of these trends, we continue to expect that sales of our legacy MCU products will continue to decline on an annual basis. These declines are likely to accelerate as the RBOCs complete their respective FTTx expansion programs.
The Company’s strategy to respond to these trends is outlined in the section of this MD&A entitled “Our Reponses to These Industry Trends” that follows. A review of the impact of these network trends on certain of the Company’s intangible assets is contained in the Critical Accounting Policies section of this Item 7.
Intense Competition Among Telecommunications and Cable Service Providers
The continuing evolution of the communications marketplace has resulted, and will continue to result, in intense competition among telecommunications and cable service providers. The deregulation of the industry over the past eight years has allowed cable service providers as well as new competitors such as wireless service providers and VoIP service providers to enter the market to offer consumers increasing choice among a variety of communication services, including voice, data, and video services. Wireless service providers offer the consumer the ability to place calls from nearly any location in the United States, and from most parts of the world. VoIP service providers allow a person to place phone calls from a VoIP phone either to other VoIP customers or to hardwired or wireless telephone numbers. As a result, competition among telecommunications providers has greatly increased and the industry has transformed from a highly regulated monopolistic model to a free market model.
These factors have adversely affected our business to varying degrees over the past three years. Our products have historically been sold primarily to telephone and cable television companies. Because there are still a relatively limited number of such companies, the loss of any of our traditional customers may translate into reduced demand for our offerings, especially our test system and test access hardware products.
Conversely, increased competition into the marketplace has further driven our traditional customers to invest in their access networks leading to new test system opportunities. Telephone companies, especially the RBOCs, have also been attempting to meet the demand for broadband services, with the build-out of their DSL networks, which in some instances has resulted in increased demand for our MCU products. However, as discussed above, the expansion of the broadband market will likely continue to reduce the demand for POTS service, potentially depressing overall sales of copper based testing products including MCU products.
Increased Competition in Cable Markets Resulting from Standardization
Through the adoption of open, non-proprietary standards for status/performance monitoring systems, such as HMS and DOCSIS, the market for our cable products has become highly competitive. We have experienced significant pricing pressures as all providers of monitoring transponders and associated software have reduced price points to meet customer demands. During 2005, Alpha introduced a DOCSIS-based transponder which competes with the products we supply to the market both directly and through our supply agreement with Alpha.
Unlike most of the existing telephone networks, the HFC networks maintained by the cable television companies are capable of providing broadband services with little additional capital investments. In general, cable companies have been quite successful with their deployments of high bandwidth Internet services. The adoption of the DOCSIS standard for cable modems by several cable companies has eliminated the demand for certain of our proprietary Cheetah head-end hardware products, and has reduced demand for other associated proprietary Cheetah offerings.
In the cable marketplace, cable providers continue to drive the adoption of broadband and expand services beyond just traditional cable television service to high speed data and voice services. They are also aggressively attacking competitors with offerings targeted at business customers.
Consolidation in Telecommunications Market
Competition in the telecommunications market has had the secondary effect of resulting in the consolidation of many of the telecommunications service providers. Just a few years ago, there were six RBOCs. That number has now been reduced to three. In some ways, we have benefited from the increased competition in the industry; because such competition has brought more and new providers into the market that may need our products to provide consistent and quality telecommunications services. However, to the extent competition drives further industry consolidations, we have experienced and could continue to experience disruption of our existing customer relationships, delays or loss of customer orders and pricing pressures caused by the reduction in the number of customers desiring our products. These trends cause decreased revenues and lower net income. As stated above, however, we believe that it is too early to predict the course that industry consolidations will take in the future, or how such consolidations might affect our future revenues. Further, our major customers are currently actively pursuing acquisitions to add to their product offerings, such as the RBOCs acquiring wireless capabilities. We do not currently sell products to wireless carriers; accordingly, these acquisitions will likely cause our customers to decrease spending in traditional areas as they divert funding to these acquisitions and integrations.
Alternative Embedded Testing Methods
We have begun to face increased competition from certain network equipment providers that offer testing technology in the form of a chipset embedded into their products. Where testing was once only available in the form of multi-chip, circuit board-based designs like those found in our remote test system products, integrated testing technology is now available in low-cost chipsets embedded into the products of these network equipment providers. Known as “SELT/DELT”, the testing technology available in this form has limited functionality and only provides partial views of faults in the network. As such, we continue to believe that more robust testing technology like that offered in our products should be important for network assurance as the next generation network evolves and increased penetration of triple play services occurs. However, we have and will continue to face competition and downward pricing pressure from the availability of these less expensive, less robust alternatives resulting in decreased sales of our system products to certain of our customers, particularly in the CLEC market. Due in part to their adoption of the SELT/DELT technology, revenues from these customers have decreased dramatically.
Electric Power Utility Market
With the development and limited introduction of our new LightHouse product line, we are targeting our service assurance products into a new market, the electric utility industry. This industry is in a tremendous period of change. There has been minimal to no improvement in the delivery efficiency in decades and minimal infrastructure investment in years. There are estimates that greater than half of today’s utility infrastructure will need to be replaced in the next ten years. Simultaneously, we believe that regulatory changes for improved reliability cannot be met without new hardware and software, and that the reporting requirements alone will require new capabilities. Moreover, climate change issues are driving investment in renewable energy sources and demand response capabilities that add significant complexity to the distribution grid. As a result of these factors, many of the major electric utilities are looking to next generation network architectures and new technology to improve the performance and reliability of the nation’s power grid. We believe that smart grid sensors and software to remotely monitor expensive equipment can enable electric utilities to meet demands for improved grid reliability, faster response to disturbances, increased energy efficiency and better, more cost-effective management of assets. We are developing a sensor technology that will provide utilities with a snapshot of the grid’s current status for fault and equipment problem location and historical data to enable better economic decisions about asset operations and maintenance, plus more accurate load research and forecasting.
Our Responses to These Industry Trends
The evolution of the telecommunication and cable networks requires us to constantly evaluate our core business strategy and product offerings. We have taken a number of steps to position the Company to take advantage of our strengths, as follows:
Development and Marketing of Solutions
Given the increasing interest of the RBOCs in FTTx projects and the importance of software products to cable monitoring systems, we have increased our emphasis on developing and marketing new product solutions for network assurance. We continue to engage in research and development of new and expanded telecommunications and cable products and to aggressively market and sell our products both domestically and internationally.
Telecommunications Solutions
Our LoopCare and 4TEL/Celerity solutions are already the primary OSS software for copper line networks. Because fiber-only networks require new and unique software and hardware solutions for network testing, we have actively promoted our ability to adapt our existing OSS systems to serve FTTN systems. In addition, we are actively engaged in research and development of new hardware solutions for hybrid fiber networks.
Since its introduction, our DigiTest test head has undergone several significant developmental changes. With the LoopCare software in combination with the DigiTest hardware, we offer a complete integrated testing system to smaller customers such as CLECs and international customers. Furthermore, as a result of past extensive research and development efforts, we offer our DigiTest EDGE product, which combines the reliability of our DigiTest POTS testing system with our new Broadband Services Unit (“BSU”) test capability and T-1 Special Services test capability, under certain applications. Our DigiTest HUB product was designed to support multiple testing environments, including broadband testing, while retaining interfaces to legacy equipment. The DigiTest ICE was designed to provide both metallic and multi-layered DSL testing to help service providers install and maintain broadband triple play services within traditional and hybrid fiber copper networks. Although these products have seen some success in certain international customers, and have been approved in certain domestic networks, we have not had success selling them into the domestic service providers. Furthermore, it is not clear whether the international customers who have deployed these products will continue to do so, as the original projects driving these product sales are substantially complete. However, we continue to actively market and attempt to sell these products into both domestic and international markets. As the DSL subscriber base of the RBOCs’ network reaches a level of maturity that should support higher measures of centralized testing, certain portions of the DigiTest product family, including DigiTest ICE, should compete favorably with similar offerings in that market.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

The following discussion should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and Notes thereto appearing elsewhere in this report.
CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
This MD&A should be read in conjunction with our annual report on Form 10-K for the year ended December 31, 2007. Certain statements contained in this MD&A and elsewhere in this report are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended that involve risks and uncertainties. These statements relate to future events or our future financial performance. In some cases, forward-looking statements can be identified by terminology such as “believe,” “expect,” “intend,” “may,” “will,” “should,” “could,” “potential,” “continue,” “estimate,” “plan,” or “anticipate,” or the negatives thereof, other variations thereon or compatible terminology. These statements involve a number of risks and uncertainties. Actual events or results may differ materially from any forward-looking statement as a result of various factors, including those described in Part II, Item 1A below under “Risk Factors.”
Overview
On October 22, 2008, we announced the results of our strategic review process that began in April, 2008. As a result of that review, we determined that the appropriate strategy for the Company at the current time is to seek to enhance shareholder value through a refocusing of our core business by emphasizing our service assurance offerings to the telecom markets. Our strategy is to focus on our core test system software platforms by:
• Focusing our efforts on the substantial and growing telco service assurance market, where we have a significant installed customer base, by leveraging our current position and expanding into adjacent markets.

• Leveraging new potential partnerships to allow us to expand our system solutions into adjacent market segments.

• Continuing to actively manage the performance and results in all areas of our business.

• Continuing our internal review process to look for opportunities to accelerate our business strategy and focus our efforts along the way.

• Enhancing the management team capabilities to support the refocused strategy.
The Board of Directors has also approved a program for the repurchase of up to $15 million of our common stock through open market and privately negotiated transactions.

General Business Trends
During the third quarter of 2008, revenues from Services were approximately 39.2% of total revenue, compared to approximately 24.5% of total revenue in the third quarter of 2007. The increase in revenues from Services in the third quarter of 2008 is attributed to revenues generated from our Broadband Test Division acquisition, which had largely a service-oriented revenue base, and the fact that because the acquisition closed in August, 2007, the comparable quarter in the earlier year only included two months of revenues from Services. We expect that including Broadband Test Division revenues for the entire year in our consolidated revenues will cause the percentage of Services revenue as a portion of total revenue for 2008 to increase as compared to 2007 and that this trend will continue in the near future due to a decrease in revenue from certain existing products as discussed below. In addition, since our Services revenue is typically associated with existing purchase orders, contracts or a combination of both, we expect this portion of the business to help improve the predictability of overall Company revenues. During the third quarter of 2008, the remainder of our revenue, or 60.8% of the consolidated total, was comprised of sales of software and hardware products to new or existing customers.
During the third quarter of 2008, we saw our first domestic DigiTest® ICE™ sales with a new customer, Integra Telecom, and also reached general availability for all three versions of our DigiTest ICE product line. Overall, sales of our System test products declined significantly from $9.2 million during the third quarter 2007 to $4.1 million during the third quarter 2008. This decline was primarily due to the completion of two large international projects in 2007 that did not repeat in 2008. These declines were partially offset by our first domestic sale of our DigiTest ICE product and higher sales of custom software applications. In addition, we did not have significant hardware shipments in the third quarter 2008 for a large BTD European project from 2007. At the present time, we have not entered into new project or frame agreements for future revenues of similar size to those that contributed to the revenues in 2007.
International sales decreased during the third quarter 2008 as compared to third quarter, 2007, both in total revenue and as a percentage of sales. International sales decreased to approximately $4.9 million or 32.2% of the Company’s total revenue for the quarter ended September 27, 2008, compared to $10.0 million or 48.6% for the third quarter ended September 29, 2007. Again, this decrease is attributable primarily to the completion of the two international projects that contributed to 2007 results and the lack of contribution from the large project in Europe during the third quarter 2008. As our international business is largely project-based, these results may continue to fluctuate significantly on a quarterly basis depending upon project timing and other factors.
Declines in older legacy product lines continued to impact results in the third quarter of 2008, as we have seen throughout 2008. Sales of cable legacy products, MCU® and older DigiTest product lines declined in the third quarter 2008 when compared year over year to last year’s results. We saw a sequential increase from the second quarter of 2008 to the third quarter of 2008 in MCU sales, due to a large copper reclamation project with a Former RBOC. However, although we may periodically enjoy increased revenues from the MCU product line on a project-by-project basis, we continue to expect declines for both MCU and cable products over the long term.

As a result of these factors, we expect revenues from our core test System products to continue to be challenged in the near term. Management presently expects that the year over year revenue decline can be offset to some extent for the remainder of 2008 by the addition of services revenue from the Broadband Test Division acquisition and the addition of new product revenue, but it is unlikely that these revenues will offset the entire decline, or that the decline might not accelerate more quickly than expected. However, revenues from non-project related sources are difficult to predict from quarter to quarter, and could possibly result in swings or declines in revenue levels on a quarterly basis, and such swings or declines may be material.
Due to our lower than expected operating results for the first quarter of 2008, subsequent to quarter-end, management undertook a review of our revenue and earnings expectations for the remainder of the year. As a result of this review, in April 2008, management made significant revisions to its 2008 financial outlook. These revisions were based on lower than expected second quarter results and deepening concerns about the impact of further deteriorations in general economic conditions and the resulting effect on our markets.
Recently, general worldwide economic conditions have experienced an even more severe downturn, and these conditions make it extremely difficult for us and our customers and vendors to accurately forecast and plan future business activities. Further, these challenging conditions could cause our domestic and international customers to further slow spending on our products and services, which could extend our sales cycles or reduce revenues. Also, during these difficult conditions, our customers may face issues gaining timely access to credit, which could negatively affect their ability to make timely payments to us. If that were to occur we may be required to increase our allowance for doubtful accounts and our days sales outstanding would be adversely affected. We cannot predict the timing, extent or duration of any economic slowdown or recovery, but if the economic slowdown continues or worsens, our business, financial condition and results of operation will likely be adversely affected.
Our Customers
The Company’s customers range from the top telecom and cable providers, to numerous independent telecom, cable and broadband providers around the world. Our primary customers for our telco products and services are large domestic and European telecommunications service providers. The Company tracks its telco sales by two large customer groups, the first of which includes Qwest, AT&T and Verizon (formerly referred to as RBOCs and collectively referred to herein as the “Former RBOCs”), and the second of which includes certain large international telephone service providers in Europe, namely British Telecom, Royal KPN N.V., Belgacom S.A., Deutsche Telecom AG (T-Com) and Telefónica O2 Czech Republic, a.s. (collectively referred to herein as the “European Telcos”). European Telco revenue increased in total and as a percentage of sales primarily based on the inclusion of customer revenue associated with the acquisition of the Broadband Test Division beginning during the third quarter of 2007. For the third quarter ended September 27, 2008, sales to the Former RBOCs accounted for approximately 38.8% of the Company’s total revenue, compared to approximately 30.3% of total revenue for the third quarter of 2007. Sales to AT&T comprised approximately 27.9% of the Company’s total revenue for the third quarter of 2008, compared to approximately 21.7% of total revenue for the third quarter of 2007. Sales in the third quarter of 2008 and 2007 to the European Telcos accounted for approximately 19.4% and 16.1% respectively, of total revenue.

For the nine months ended September 27, 2008 and September 29, 2007, sales to the RBOCs accounted for approximately 30.3% and 35.2%, respectively, of the Company’s total revenue. Sales to AT&T comprised approximately 20.1% and 26.9% of the Company’s total revenue for the nine months ended September 27, 2008 and September 29, 2007, respectively. Sales for the nine months ended September 27, 2008 and September 29, 2007 to the European Telcos accounted for approximately 25.1% and 7.0% of total revenue. Sales to one European Telco individually exceeded 10% of the Company’s total revenue for the nine months ended September 27, 2008.
Our Solutions
Telecommunications Solutions
The Company’s telecommunications System Test products, specifically the LoopCare™, 4TEL®, Celerity®, and LTSC™ centralized test Operation Support Systems (“OSS”), together with the associated remote test and measurement platforms of DigiTest, LDU, and N(x)Test™, enable local exchange carriers to conduct a full range of measurement and fault diagnosis for efficient dispatch of field staff to maintain and repair POTS and/or DSL services, along with the ability to pre-qualify and provide broadband DSL services offerings. Although these solutions remain the primary test solutions for copper line networks, we are actively engaged in research and development of new software and hardware for new network solutions that expand coverage to hybrid and next generation networks.
With the LoopCare software in combination with the DigiTest hardware, including the EDGE®, HUB™ and the recent introduction of DigiTest ICE, we offer a complete integrated testing system to customers. DigiTest ICE is designed to provide both metallic and multi-layered DSL testing to help service providers install and maintain broadband triple play services within traditional and hybrid fiber copper networks.
Although the DigiTest EDGE and DigiTest HUB have been deployed by certain domestic and international customers, we have only had limited success expanding these deployments. It is not clear whether the international customers who have deployed these products will continue to do so at the same or similar volumes, as the original projects driving these product sales have been completed. We continue to see opportunities to position DigiTest EDGE and HUB products within customer networks while DigiTest ICE opportunities are being driven by next generation network decentralization to smaller remote sites. We continue to actively market and attempt to sell these products into both domestic and international markets.
As the DSL subscriber base of the telecom carrier’s networks reach a size that would support higher measures of centralized testing, certain portions of the DigiTest product family, including DigiTest ICE, are positioned to compete favorably with similar offerings in that market.
Similarly, we offer integrated testing through our 4TEL and Celerity software, sold in conjunction with the LDU hardware. Contributions from sales of LDU hardware and 4TEL and Celerity software have helped, on a year to date basis, offset some of the declines experienced in sales of some of the Company’s other product lines, although the contribution of those products in the third quarter, 2008 was less on a sequential basis than the second quarter, 2008 due to the lack of revenues from the large European frame contract mentioned above. We expect to see this trend continue at least for the near term, but new product solutions, including the DigiTest ICE product, need to rapidly gain market share in order to continue to offset these declines.

As the life cycle for MCU products continues to mature, and our telecommunications customers focus their capital spending on new network initiatives, we expect demand for our MCU and legacy testing products will continue to diminish over time. During the third quarter of 2008, we experienced a slight decline in MCU sales from the third quarter of 2007. However, we did experience a significant increase in the third quarter of 2008 in comparison to both the first and second quarters of 2008. This sequential increase was primarily due to sales from a sizeable copper reclamation project with a large domestic telco customer.
We have historically provided financial information for sales of our stand-alone LoopCare software features on the basis that these sales were previously significant and differed from those LoopCare license arrangements made in conjunction with the DigiTest hardware sales. However, as this product has continued to mature, and as we have continued to experience declines in sales of these stand-alone LoopCare software features, we determined that beginning with the first quarter 2008 report and in future reports and filings, the LoopCare stand-alone software feature results will only be discussed in conjunction with our System Test products. This is consistent with the manner in which we have treated custom software feature sales for our other software platforms, 4TEL and Celerity, since our acquisition of the Broadband Test Division. The declines in sales of LoopCare features are driven in large part by service providers continuing to carefully evaluate expenditures in this area as they focus their capital expenditures on new network elements, and the level of sales of these features is not expected to recover in the foreseeable future.
We continue with our strategic emphasis on new product development and obtaining new customers in an attempt to replace the declining revenue from our legacy product lines.
Cable Solutions
The Company’s Cheetah™ performance and status monitoring products provide a broad network assurance solution for the broadband HFC distribution system found in the cable television industry. Our Cheetah products gather status information and report on critical components within the cable network.
During the third quarter of 2008, we experienced significant declines year over year sales of our Cheetah products, primarily from lower market demand through our OEM distribution agreement with Alpha Technologies, Inc., as well as from our direct sales customers. Although we expected to see declines in sales during the quarter, we believe that the greater decline of sales of cable products to these customers was at least partially due to the continuing difficult economic environment. We also continue to face competition from Alpha, as they introduced their own DOCSIS ® -based transponder in 2005, which has adversely impacted our sales of our Cheetah products. We do not expect to see significant recovery in this market, at least in the near future.
Consolidations within the cable industry and the adoption of the DOCSIS standards have caused and will continue to cause pricing and margin pressure as competitors continue to reduce pricing. In response, we continued to further reduce our costs for this product line through a restructuring and realignment effort implemented in the first quarter of 2008. Some of these new products are in adjacent markets from our traditional cable products thereby diversifying our product offerings. As a result, our revenues and net income have been and may continue to be adversely affected. We continue to develop strategies to offset these lower margins by lowering manufacturing costs while offering additional feature sets to our DOCSIS-based products, such as our downloadable software modules for VoIP and IP testing, that are intended to build upon an embedded base of core technology. We are also actively developing new products for introduction through the remainder of the year. We continue to explore opportunities for our cable products, in an attempt to improve performance by strengthening our cost position in this very competitive market. There is no guarantee that we will be successful and it is possible that our cable products and related costs may continue to adversely affect overall revenue and net income results.
Services
Our Services offerings include software maintenance as well as our professional services, which are designed to ensure that all of the components of our customers’ test systems operate properly. Our Services offerings also include hardware maintenance services, for both our mature and acquired product lines.
During the third quarter of 2008, our Services revenues increased from the prior year period, primarily due to the additional service agreements acquired as part of the Broadband Test Division acquisition. These service agreements, some of which are with the European Telcos described earlier, cover both hardware and software maintenance for products sold by the Broadband Test Division prior to the acquisition. These service agreements are similar to those entered into with the Company’s Former RBOC customers as it relates to software maintenance. The revenue contributions from these service agreements have helped to offset some of the declines in the Company’s mature product lines in other areas.
During the remainder of calendar year 2008, there are a number of service agreements with Former RBOCs and European Telcos which will expire unless renewed. As such, the expiring agreements are subject to possible negotiation for pricing and other terms. Although we continue to emphasize our significant knowledge, long-term relationships and customer value for our maintenance offerings, given the difficult economic environment, we may face pricing pressure from customers during these negotiations. If the negotiations are not successful, the agreements may not be renewed at all or may be renewed on terms that are not as favorable to the Company as the current arrangements. In either event, the revenue and profitability of our Services offerings could be materially adversely affected, which could result in an impairment to the corresponding intangible assets on our balance sheet.
BACKLOG
Our backlog consists of firm customer purchase orders and signed software maintenance agreements. As of September 27, 2008, the Company had backlog of approximately $18.4 million compared to $19.2 million as of December 31, 2007 and $23.0 million as of September 29, 2007. The decrease in the backlog from September 29, 2007 to September 27, 2008 is primarily attributable to the effect of shipments under the large European telecom project as well as hardware orders associated with a large international project at September 29, 2007 that did not recur. The backlog at September 27, 2008,

December 31, 2007 and September 29, 2007 include approximately $14.4 million, $13.6 million, and $11.8 million, respectively, related to software maintenance contracts, which are earned and recognized as income on a straight-line basis during the remaining term of the underlying agreements. The Company’s policy is to include a maximum of twelve months revenue from multi-year maintenance agreements in reported backlog.
We currently have software maintenance agreements with all of the Former RBOCs and with many European Telcos. Most of these agreements are multi-year, with expiration dates ranging from December 31, 2008 through 2011. We also have several maintenance arrangements in place for our cable software products.
Management expects that approximately 40% of the current backlog will be recognized as revenue in the fourth quarter of 2008. Periodic fluctuations in customer orders and backlog result from a variety of factors, including but not limited to the timing of significant orders and shipments. These fluctuations are most evident as it relates to revenue streams from sales of products other than our software maintenance agreements, which tend to be more predictable. Although these fluctuations could impact short-term results, they are not necessarily indicative of long-term trends in sales of our products.
OPERATING SEGMENT
We have determined that our business has one operating segment, test assurance. All product sales relate to the business of testing infrastructure and networks for the telecommunications and cable industries. Our products have similar production processes, and are sold through comparable distribution channels and means to similar types and classes of customers already in, or entering into, the telecommunications and cable businesses. Operating results as a whole are regularly reviewed by the Company’s Chief Operating decision maker regarding decisions about the allocation of resources and to assess performance.
INTERNATIONAL SALES
International sales represented approximately $4.9 million, or 32.2% of the Company’s total revenue for the quarter ended September 27, 2008, compared to $10.0 million, or 48.6%, for the quarter ended September 29, 2007. The decline in international sales is primarily due to the completion of one of the two large international projects that contributed to 2007 revenues. Our international sales were primarily in three geographic areas based upon customer location for the quarter ended September 27, 2008: the Americas (excluding the United States); Europe, the Middle East and Africa (EMEA); and Asia. Sales for the Americas were approximately $0.9 million and $1.5 million, sales in EMEA were approximately $3.9 million and $8.4 million, and sales in Asia were approximately $0.1 million for each of the quarters ended September 27, 2008 and September 29, 2007, respectively.
International sales represented approximately $18.1 million, or 42.1% of the Company’s total revenue for the nine months ended September 27, 2008, compared to $17.2 million, or 36.0%, for the nine months ended September 29, 2007. Our international sales were primarily in three geographic areas based upon customer location for the nine months ended September 27, 2008: the Americas (excluding the United States); Europe, the Middle East and Africa (EMEA); and Asia. Sales in the Americas were approximately $2.8 million and $3.8 million, sales in EMEA were approximately $14.3 million and $13.1 million, and sales in Asia were approximately $1.0 million and $0.3 million for the nine months ended September 27, 2008 and the nine months ended September 29, 2007, respectively.

CONF CALL

Joe Ferrara

Thanks Andrew. Good morning and thank you for joining us to review Tollgrade's second quarter 2008 results. This morning, I'll share with you the highlights of our second quarter and, as well as our revenue outlook for the third quarter of 2008, and then we'll take any questions you may have. With me today are Sam Knoch, our CFO and Grant Cushny, our Vice President of Sales and Professional Services. They would join me and answer any questions you may have. Also with us is Christie Tillapaugh, one of our staff attorneys. Christie will provide us with forward-looking statements before we start. Christie.

Christie Tillapaugh

Good morning. During this conference call, we will be making some statements regarding future events to resolve including our revenue guidelines for the third quarter of 2008 which are forward-looking statements within the meeting of section 27A of the Securities Act of 1933, as amended and section 21E of the Securities and Exchange Act of 1934, as amended. Such statements are based on assumptions that involved risks and uncertainties and actual events or results may differ materially from the forward-looking statements that we are making.

In addition to the factors that we mentioned today, additional risk factors that could cause actual events or results to differ materially are included in our filings with the SEC specifically in our annual report on Form 10-K for the year ended December 31, 2007 and in our reports from Form10Q. We expressly disclaim any intention to update our forward-looking statements and the estimates and assumptions associated with them at any time or for any reasons. Thank you.

Joe Ferrara

Thanks, Christie, and again, good morning. I am going to jump right in and start with the review of some of the highlights since our last conference call. We made some significant progress across our business in the –.

Operator

Just one moment there has been an interruption in the call, just one moment please.

Joe Ferrara

Andrew?

Operator

Thank you, we can now hear you please continue.

Joe Ferrara

Okay. So I'm going to jump right in and start with the review of the highlights since our last conference call. We made some significant progress across our business in the past few months which we are very proud of. First, we reached general availability of the first release of our DigiTest ICE product line in June. We also planned additional releases of the product to be generally available by the end of Q3. Second, for the second consecutive year, we received an award from AT&T for being one of it's outstanding suppliers in the area of products and service performance. Third, our operational expenses have significantly declined as compared to the previous quarters based on the restructuring activities in Q1 and actively controlling cost across the business. We have seen declines of 14% in operating expenses in Q2 versus Q1. Lastly, we had a $3.4 million in cash and short-term investments through our balance sheet during the second quarter and now I have over 59 million in cash and short-term investments.

In our last earnings conference call in May 1, I commented about our strategic review process as part of our commitment to take the actions necessary to enhance the value of Tollgrade for our shareholders. We continue to work through the potential opportunities and I have already begun to realize some of the benefits from implementing the internal programs to address the challenges in our business.

Results from our second quarter of 2008 underscored the current condition of our business. We saw increases in revenue year-over-year from our most recent acquisition but the increase is only served to offset declines in other products in our portfolio. This is a challenge that we are striving to address with the introduction of new products throughout the year. Specifically, the first release of the Digitest ICE became commercially available to customers in June.

In addition, other products are expected to become generally available later in the year including our LightHouse power utility solution [ph] and our cable [ph] end-of-line monitoring solution. These few introductions will help begin to address this issue. We are making all attempts to ensure that these new product introductions will be successful but in the meantime we need to manage between declining revenue on some of our older product lines while the new products are introduced to the market. While we saw the continuing effects of the general weakness in the economy and its impact on customer budgets and timing of the equipment purchases during the second quarter. We did see a small increase in our sales from Q1.

Yesterday, we reported second quarter 2008 revenue of 14.6 million which on a sequential basis was up by more than 10% compared to the first quarter of 2008 which was 13.2 million. Our Q2 revenue was also higher than the second quarter of 2007 which was 14.2 million. We exceeded our revenue expectations for the second quarter of this year which ranged from 11 million to 14 million, largely [ph] due to the contribution from our most recent acquisition. For the first half of 2008, revenue was 27.8 million compared to revenue of 27.2 million for the first half of 2007. A small year-over-year increase but clearly we need to do better, given the addition of acquisition revenues. The declines and demands for some of our core products has been challenging for our top line revenue.

In our earnings release, we report a loss per share of $0.02 on a GAAP basis for the second quarter of 2008 which included the effects of non-cash charges for restructuring and stock-based compensation expenses which amounted to $0.02. Excluding these non-cash charges are non-GAAP earnings performance in the quarter was break-even.

On a GAAP basis, earnings per share results for the second quarter of 2007 were $0.03 per share while a non-GAAP earnings per share on the second quarter of 2007 was $0.06 per share. That’s a brief summary of our second quarter 2008 results.

Now I want to share with you a few key trends from the second quarter. Our services results have become a significant source of revenue since the BTD acquisition last year which has a large service oriented revenue base. In the second quarter of 2008, revenue from our services offerings comprised 42% of overall revenue for the quarter. This compares to the 23% contribution from the quarter a year ago. Also, product sales from the BTD acquisition represented approximately 16% of second quarter of 2008 revenue, primarily driven by shipments to European telecom customers.

International sales, in general, made up nearly one-half of the quarter’s overall revenue contribution. That’s an increased of almost 70% international revenue compared to the quarter a year ago. Our traditional product lines, MCUs, DigiTest, and Cheetah, have all expense double-digit declines in revenues since the second quarter of this year compared to the second quarter of 2007. However, on a sequential basis versus the first quarter of 2008, MCU and Cheetah products made reasonable recoveries from multiyear loss [ph] in Q1. And again, our balance sheet remains very healthy. Since Q1, we have returned to our year-end levels of cash and short-term investments.

That’s a review of general business trends. Now I’ll provide a more detailed financial review of the quarter and a brief review by product line. Margins for the second quarter on a non-GAAP basis were 50.3%, slightly better on the sequential basis but down compared to the second quarter of 2007 results with gross margin with nearly 55%. The year-over-year of decline is primarily due to three factors. First, a change in product mix, shifting to a larger mix of lower margin products. Second, lower manufacturing volumes which is impacting overhead absorption rates. And finally, higher certification fees and other cost related to our new product introductions.

We continue to work on reducing our overall cost structure during the second quarter of this year on a sequential basis compared to the first quarter of this year with lowered expenses and selling and marketing, G&A and R&D by approximately 11%, 13%, and 11%, respectively. These cost reductions are the results of the restructuring efforts that begun during the first quarter of this year. The completion of the BTD acquisition integration cost that carried into 2008 and our continued efforts to reduce spending in company wide.

On a year-over-year basis, only R&D costs were up slightly reflecting the additional engineering cost from the BTD acquisition which took place in last year’s third quarter.

Overall, expenses for the second quarter of 2008 were down on both the sequential and year-over-year basis. Expenses for the second quarter of 2008 on a non-GAAP basis excluding special charges were 7.6 million compared to 7.7 million in the quarter a year ago. On a GAAP basis, overall operating expenses were 7.7 million in the second quarter compared to 7.9 million in the second quarter of 2007.

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We will continue to balance our spending with long-term opportunities as we move forward. Our backlog for a firm customer purchase orders and signs up for a maintenance contracts was 18.5 million at the end of the second quarter of this year compared to the backlog of 19.2 million at the end of 2007. A majority of these backlogs amounts 75% and 71%, respectively, as related to software maintenance contracts. We expect approximately 38% of the current backlog to be recognized as revenue in the third quarter of 2008. Review in our performance by product line our top code test [ph] systems business which includes the product families of DigiTest, LDU, and N(x) Test were evident from this group of products for the second quarter of this year was 5.2million compared to 4.5million in the quarter a year ago, an increase of approximately 15%. This increase is largely due to the addition of the LDU products to our portfolio on Q3 of last year, which offset lower sales of our DigiTest products, specifically the DigiTest DMU products. LDU shipments were strong in both the first and second quarter of 2008 with these significant shipments to European customers.

With regard to DigiTest ICE, our compact service assurance offering, while it has been standardize with one of our large international customers, deployments have been slow a year to date. The initial release of DigiTest ICE became generally available in June. We expect to see initial shipments of ICE into the domestic telecom market during the third quarter of 2008. We remain encouraged by the initial interest in ICE and are hopeful for its success as a lower cost service assurance solution for remote sites and broadband networks.

Revenue from LoopCare software license fees was roughly 550,000 in the second quarter of 2008, compared to 486,000 in Q2 of 2007. Sales of cable hardware and software products during the second quarter of 2008 were 2.1million, which is down from 3.5million in sales on the second quarter of 2007. This decline is primarily due to reduced market demand through OEM channels and two major MSOs. We expect this condition to continue for a number of quarters, but are attempting to replace the revenue through other customer accounts and new product offerings. We believe lower cable operator spending is impacting many other vendors in this market as well.

MCU sales were roughly 1.2million in the second quarter of 2008 compared to 2.9million in a quarter a year ago. Roughly one half of this decline is due to the completion of a major customer testability project in 2007, and the rest can be attributed to overall reduce market demand for MCUs.

Customer budget releases for MCUs early on the year, began to ease and we experienced some recovery in MCU sales in the second quarter, Sales increased by 40% from the Q1 revenue of $850,000 for MCUs. Revenue from services continues to be strong. The addition of recently acquired software maintenance agreements nearly doubled services revenue in the second quarter of 2008, achieving revenue of 6.1million compared to 3.3 million in a quarter a year ago.

As discussed previously, many of these agreements are multi-year commitments with major domestic and international telecom companies.

We continue to invest in our new power utility product line, LightHouse, which is in the midst of important customer trials and also on a development path to general availability. We hope these trials will validate our capabilities in long-term opportunity in this new market segment. Anticipate conducting additional pilots [ph] throughout the bounds of 2008, and also expect the LightHouse solution to be commercially available later in the year.

Looking ahead to the third quarter of 2008, we expect revenue to range from 12 million to 15million, which is slightly higher than the revenue guidance provided for the second quarter of 2008. Included in this revenue is the expectation of a meaningful contribution from initial domestic market shipments of DigiTest ICE, our new low-cost IP Service Assurance Probe to promote (inaudible). This revenue range also reflects our continuing caution about global economic conditions and a general impact on customer capital expenditures.

As I briefly mentioned earlier and as you know, during the second quarter, we expanded our strategic review process by engaging outside the advisers to work with us to undertake a full review of strategic opportunities to leverage Tollgrade’s expertise and reputation in service assurance test and measurement solutions. We’re in the midst of this evaluation process and to date, have not reached any specific conclusions. No deadline has been set for completing the process, but our objective remains to ensure that we've preserved an enhance share holder value.

We continue to challenge ourselves to execute on our plans and drive for a sustainable and dependable position in the market that can provide long term profitable growth. The market for our traditional products continues to be challenging, which means that we have to execute on our new product introduction activities to impact the results of our top line revenue. This is a key activity for the Tollgrade team while we examine potential opportunities to enhance short-share holder value in our strategic review process. We remained actively engage with customers and prospects.

During the second quarter, we are pleased with our activities at two trade show industry events. Last month, our sales and marketing teams were busy at our two largest trade shows of the year. At MAXCOM in Las Vegas, we featured the recently released DigiTest ICE solution to telecom customers, and the LDU 50 made its debut as part of Tollgrade’s product offering. The following week in Philadelphia was the SCTE Cable Tech Expo where we featured our Cheetah End-of-Line Monitoring Solution and our Call Quality Manager, IP Test Element. Also, we have several trade show events on the near term horizon.

Our LightHouse team will be exhibiting next week in Ohio at a national power utility conference on advanced distribution automation. And later in the third quarter, we will exhibit at Broadband World Forum in Brussels, as we continue to target international telecom customers.

Lastly, as I mentioned earlier, we are very pleased that for the second consecutive year, AT&T honored Tollgrade as one of its outstanding suppliers in the area of product and service performance. We are only one of 27 suppliers named by AT&T as a tribute to the people in our organization and the interaction with customers like AT&T.

Thanks must go out to our AT&T sales and services team, and the engineering team supporting them. This is a tremendous recognition from a long-standing industry-leading customer.

Another, some of you may have questions for Sam Knoch, Grant Cushny, or myself, so this time I’ll turn the call over our conference coordinator, Andrew, who will remind you how to signal for any questions or comments you may have for us.

Andrew?

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