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| TLGD > SEC Filings for TLGD > Form 10-Q on 3-Nov-2009 | All Recent SEC Filings |
3-Nov-2009
Quarterly Report
expense decisions while they wait for the economy to recover and their own
businesses to stabilize. Our quarterly revenue opportunities have declined in
step with the delay in their decision processes. Competitively, our solutions
have historically consisted of hardware and software combinations. Over the past
years, competitors have introduced low-cost hardware solutions, software only
solutions, as well as integrated test capabilities within infrastructure
products. These factors have resulted in increased competition for our
traditional products.
Lastly, there is a trend in the telecommunications market to outsource functions
to companies that specialize in different areas to attain cost reductions and in
some cases, improve service. Our customers have approached this in two ways.
First, a small number have outsourced their entire network operations to large
managed services providers. Second, certain of the larger service providers are
beginning to consolidate vendor relationships to a select group of vendors and
feed smaller suppliers through the larger vendor relationships. While this trend
has not affected us in major accounts to date, certain of our customers now
purchase their Tollgrade maintenance through contracts with larger, third-party
suppliers. This practice can create additional pricing pressure as the
intermediary vendor looks to make a profit by managing the complexity for the
service provider.
In response to these conditions and trends, we have taken decisive action to
reinforce our position with our customers while also exploring new markets for
growth.
We have focused on improving our already strong customer relationships while
aggressively containing costs. We continue to provide excellent customer support
and enhanced capabilities to our customers. Our customer focus also extends to
our proactive efforts to retain and extend our software support and maintenance
contracts. While the service providers actively manage their own capital expense
budgets, we have reduced our cost structure to ensure that the impacts to our
financial results are minimized. We continue to focus on managing and growing
our cash and short term investment balance to enable future investment options.
We have also redirected our spending activities toward new growth initiatives
versus spending on maintenance efforts. Some of these growth areas include new
hardware, software and services offerings for the telecommunications service
assurance market. Our new offerings recently launched and under development
include a software platform, Stratum™, that can be sold stand-alone or as part
of a service assurance system solution, hardware products that integrate into
our service assurance solutions, and OEM products that will be sold and
supported under the Tollgrade brand name. To continue our focused efforts, we
have sold off non-core assets such as our cable product line in the second
quarter 2009, and we are exploring strategic alternatives for our smart grid
power utility product line.
Lastly, through the managed services contract with a large global network
equipment provider executed in April 2009, we have created a new area of
opportunity for the Company. We now have the expertise to provide a new suite of
managed services not only to our service provider customers, but also to
additional network equipment manufacturers, thus expanding our target market. We
believe this new platform will provide new growth opportunities for the Company
in an area that builds upon our expertise and experience in test and
measurement, enabling us to effectively respond to our customers' trend to use
managed services.
We believe that this strategy will enable us to not only weather the economic
downturn, but will position the Company for long-term growth, a return to
profitability, and market leadership.
Products
Services
Our service offerings include software maintenance and support for our operating
support systems ("OSS") offerings and hardware maintenance for the test probes,
and our professional services, which are designed to ensure that all of the
components of our customers' test systems operate properly. The primary
customers for our maintenance and professional services offerings are the large
domestic carriers and international customers. We have a number of large service
agreements with these customers which cover software and, in some cases,
hardware maintenance for our products.
Historically, our services business was comprised of the more traditional
POTS-based testability services, and the revenue stream was largely
project-based and as such, difficult to predict. During the last few years, and
primarily as a result of the Broadband Test Division acquisition, the services
business has moved toward more contract-based software maintenance services, the
revenue from which is more predictable. Because of this trend, our focus on our
software applications as part of our refined strategy, and the decline in
revenues from our other product lines, we expect services to continue to
comprise a larger percentage of our revenue in the future.
In addition, we are party to a managed services contract with a large global
network equipment provider to provide customer support and engineering services.
Under this agreement, we provide customer support and engineering services
capabilities. The agreement is an important addition to our services business
and is a logical step for us as we offer an expanded portfolio of services to
our current customers as well as new customers.
Telecommunications Test and Measurement Products
Our proprietary telecommunications test and measurement products, which include
our System Test and MCU® products, enable telephone companies to qualify and
troubleshoot broadband DSL and IP services and remotely diagnose problems in
POTS lines. 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 transition
their offerings to IP networks and services (voice, video and data), we are in
the process of upgrading our test systems to support the testing of these
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."
An important aspect of efficiently maintaining a telecommunications network is
the ability to remotely test, diagnose and locate any service-affecting problems
within that network. Our System Test Products are made up of a centralized test
operating system integrated into the customers' repair handling database
systems, and remote test hardware 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 MCU product line, which is used primarily by
large domestic carriers, 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 is well positioned for the present and 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.
During 2008, we determined after a thorough strategic review process to
reposition the Company with a greater focus on its service assurance offerings.
We intend to build upon the strength of our System Test Products, which are at
the center of our service assurance offerings, but with a greater emphasis on
expanding our service assurance software solutions. Our System Test product
software offerings include four separate OSS: 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. We plan to leverage our
incumbencies with our installed base of software customers, and extend testing
coverage to next generation network architectures through a new software
platform called Stratum™. Stratum's initial features are based on both existing
customer requests for enhanced features and our view of the trends in the
market.
With regard to our software development activities during the third quarter, we
launched our next generation service assurance platform, Stratum™, at the
Broadband World Forum in Paris. Stratum is being introduced to telecom providers
to help integrate new IP-based network testing initiatives with existing
platforms, thus providing integrated test analysis across a variety of access
technologies. Stratum will support multiple data inputs from a customer's
network and test resources, including Tollgrade's existing 4TEL®, Celerity® and
LoopCare™ software platforms and test probes, and perform combinational expert
system analysis of faults in the access network to enable more effective
dispatching of field resources. It is able to monitor and collect embedded
performance and measurement data from network equipment, such as DSLAMs, MSANs,
OLTs and ONTs; and from customer premises equipment such as DSL modems, Set Top
Boxes and Remote Gateways. Stratum is currently being deployed in customer
trials in the United States and South America.
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.
One of three patents for our legacy MCU products
will expire during 2010, and we expect that the loss of this patent protection
will permit greater competition within this market segment that could cause our
revenues from this product line to decline.
Electric Utility Monitoring Products
The Company's LightHouse™ product line is designed to provide power grid
monitoring capabilities to electric utilities. Research and investment
throughout 2007 and 2008 enabled the general availability of the first release
of the product line during the first quarter of 2009. 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 to be 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 system is designed to improve the
overall efficiency of energy delivery, improve customer satisfaction and improve
the financial performance of the electric utilities.
As part of our ongoing strategic review that started in fall 2008 and continued
in the third quarter of 2009, we began evaluating the alternatives for this
particular product line to determine the fit with our longer term strategic
focus. We are exploring a number of alternatives including the sale of the
division, possible joint ventures, or a reduction or elimination of the
resources dedicated to the product line. Although a final decision has not been
made in regards to the future of this product line, we intend to reach a final
decision on a path forward by the end of 2009.
Our Customers
Our customers include the top telecom providers and numerous independent telecom
and broadband providers around the world. Our primary customers for our telco
products and services are large domestic and European telecommunications service
providers. We track our telco sales by two large customer groups, the first of
which includes AT&T, Verizon and Qwest (referred to herein as large domestic
carriers), 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").
For the third quarter of 2009, sales to the large domestic customers accounted
for approximately 33% of our total revenue, compared to approximately 46% of
total revenue for the third quarter of 2008. Sales to our largest customer,
AT&T, comprised approximately 17% of our total revenue for the third quarter of
2009, compared to 33% of our total revenue for the third quarter of 2008. Sales
in the third quarter of 2009 and 2008 to the European Telcos accounted for
approximately 17% and 23% respectively, of total revenue.
In the second quarter of 2009, we entered into a multi-year managed services
contract with a large global network equipment provider to provide customer
support and engineering services. For the third quarter of 2009, sales to this
customer were $1.9 million, or approximately 17% of total revenue.
As of September 26, 2009, the Company had approximately $4.5 million of accounts
receivable with four customers, each of which individually exceeded 10% of our
September 26, 2009 receivable balances. As of December 31, 2008, the Company had
approximately $4.5 million of accounts receivable with three customers, each of
which individually exceeded 10% of our December 31, 2008 receivable balances.
For the nine months ended September 26, 2009 and September 27, 2008, sales to
the large domestic customers accounted for approximately 40% and 36%,
respectively, of our total revenue. Sales to AT&T comprised approximately 22%
and 24% of our total revenue for the nine months ended September 26, 2009 and
September 27, 2008, respectively. Sales for the nine months ended September 26,
2009 and September 27, 2008 to the European Telcos accounted for approximately
21% and 44% of total revenue, respectively. For the nine months ended
September 26, 2009, managed service sales to a large global network equipment
provider were $3.5 million accounting for approximately 11% of total revenue.
Backlog
Our order backlog for firm customer purchase orders, software maintenance
contracts and managed services contracts was $16.3 million as of September 26,
2009, compared to a backlog of $15.1 million as of December 31, 2008. The
backlog at September 26, 2009 and December 31, 2008 included approximately
$7.2 million and $12.0 million, respectively, related to software maintenance
contracts, which is primarily earned and recognized as income on a straight-line
basis during the remaining terms of these agreements. The decline in software
maintenance backlog is associated with three individual customer contracts.
Because two of the contracts are up for renewal at the end of 2009, the backlog
at September 26, 2009 only includes one quarter from each of these contracts in
the total amount. The third customer contract expired in June of 2009 and,
although this contract was renewed shortly after the end of the third quarter
2009 for an additional one year period, backlog at September 26, 2009 does not
include revenue from this contract. On a sequential basis, backlog decreased to
$16.3 million at September 26, 2009 from $17.7 million at June 27, 2009. We
expect that approximately 28% of the current total backlog will be recognized as
revenue in the fourth quarter 2009. We are currently in discussions with certain
large domestic and international customers to finalize agreements to renew their
expiring multi-year software maintenance contracts, and we are also pursuing
opportunities to bolster our managed service revenues.
RESULTS OF OPERATIONS FROM CONTINUING OPERATIONS
THREE MONTHS ENDED SEPTEMBER 26, 2009 COMPARED TO THREE MONTHS ENDED SEPTEMBER
27, 2008
Revenues
Our revenues for the third quarter of 2009 were $11.3 million compared to
revenues of $12.9 million for the third quarter of 2008.
Product revenue consists of sales of our system test products as well as sales
of our traditional MCU product line. Product revenues were approximately
$5.0 million or 44.2% of total third quarter revenues compared to $7.4 million
or 57.5% of the total third quarter revenue for 2008. Overall, our
third quarter 2009 product revenues decreased by approximately $2.4 million or
32.4% compared to the same period in the prior year. The decrease is primarily
attributable to our legacy MCU product line which had sales of approximately
$1.1 million during the third quarter of 2009, a decrease of $2.1 million
compared to sales of $3.2 million in the same prior period. Although we expect
continued sales of this product line into the foreseeable future, this is a
mature product line with sales that do fluctuate based on an unpredictable
demand, but we believe this product lines sales will continue to decline over
time. In addition to the decline of our MCU revenue, sales of the our system
test products were down slightly to $3.9 million in the third quarter of 2009, a
decrease of $0.3 million, compared to sales of $4.2 million in the third quarter
of 2008. System test products revenue includes sales of DigiTest products
including DigiTest ICE™, LDU™ and N(x)Test™ test probe hardware products as well
as custom software applications and licenses. Third quarter 2009 sales of system
test hardware products were lower largely as a result of declines in software
applications revenue.
Services revenue consists of software maintenance and managed services
agreements and installation oversight and product management services provided
to customers. Services revenue was approximately $6.3 million or 55.7% of total
third quarter of 2009 revenues compared to $5.5 million or 42.5% of the total
third quarter revenue for 2008 Overall, our third quarter 2009 service revenue
increased by approximately $0.8 million or 15.1% compared to the same period in
the prior year. The increase was primarily attributable to a multi-year managed
services agreement that we completed during the second quarter 2009 that added
approximately $1.9 million in new revenue during the third quarter of 2009. The
increase was offset, in part, by the lack of a signed software maintenance
agreement with a large international customer, lower repairs revenue and the
effect of changes in foreign exchange rates.
Gross Profit
Gross profit for the third quarter of 2009 was $2.2 million compared to
$7.1 million in the third quarter of 2008. As a percentage of sales, our third
quarter 2009 gross margin was 49.4% for our product sales and 66.1% for our
service sales compared to 61.9% for our product sales and 59.7% of our service
sales during the same 2008 period. The decrease in our product sales margins
relates to a change in product mix from higher margin hardware units sold during
the third quarter of 2008 as well as lower volumes of software applications
revenue. Additionally, lower overall product sales volumes contributed to the
decline in product sales margins as there was less volume to absorb fixed
overhead costs. The increase in our services sales margins relates primarily to
the reduction in workforce that occurred during the first quarter of 2009.
As a percentage of sales, gross profit for the third quarter of 2009 was 19.7%
versus 55.0% for the third quarter of 2008. Included in 2009 gross profit is a
$3.1 million reserve for obsolete and slow-moving inventory, a $0.5 million
severance charge related to our planned workforce reduction, and an intangible
asset impairment charge that was related, in part, to the write-down of certain
inventory items that were included as part of our overall inventory write-down.
Selling and Marketing Expense
Selling and marketing expense was $1.6 million in the third quarter of 2009
which is consistent with the third quarter of 2008. This expense consists
primarily of payroll and employee benefit related costs, consulting, advertising
and promotional expenses as well as travel related costs. As a percentage
of revenues, selling and marketing expenses increased to 13.8% in the third
quarter of 2009 from 12.4% in the third quarter of 2008.
General and Administrative Expense
General and administrative expenses for the third quarter of 2009 were
$4.1 million compared to $2.2 million in the third quarter of 2008, an increase
of $1.9 million or 86.4%. General and administrative expenses normally consist
of payroll and employee benefit related costs, insurance expense and
professional services and legal fees. However, during the third quarter of 2009,
these expenses also included a $1.1 million bad debt expense related to one of
our large international contracts whose collectability management has deemed to
be uncertain, proxy contest expenses related to the election of directors that
approximated $0.4 million, $0.1 million in additional professional and legal
fees related to a potential acquisition that was not pursued beyond the due
diligence stage and $0.1 million related to an employee relocation. As a
percentage of revenues, general and administrative expenses increased to 36.3%
in the third quarter of 2009 from 17.1% in the third quarter of 2008 primarily
as a result of the charges mentioned above.
Research and Development Expense
Research and development expense, which consists primarily of payroll and
benefit related costs, associated with ongoing customer support, decreased
$0.2 million, or 6.4%, to $2.4 million in the third quarter of 2009. The third
quarter 2009 decline is primarily attributable to cost control efforts and the
effect of changes in foreign currency exchange rates. As a percentage of
revenues, research and development expense for the third quarter of 2009
increased slightly to 20.8% compared to 19.5% for the third quarter of 2008.
Severance Expense
During the third quarter of 2009, we developed a plan to reduce and restructure
our workforce across all levels of the organization in an effort to reduce costs
and to better align our human resources to match our ongoing revenue streams.
. . .
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