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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _______to_______
Commission file number 1-8191
PORTA SYSTEMS CORP.
(Exact name of registrant as specified in its charter)
Delaware 11-2203988
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
6851 Jericho Turnpike, Syosset, New York 11791
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (516) 364-9300
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ___.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10K or any amendment to this
Form 10K. [X]
Indicate by a check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes__ No X
State aggregate market value of the voting stock held by non-affiliates of
the registrant: $598,767 as of June 30, 2002.
Indicate the number of shares outstanding of each of the registrant's class
of common stock, as of the latest practicable date: 9,972,284 shares of Common
Stock, par value $.01 per share, as of March 19, 2003.
DOCUMENTS INCORPORATED BY REFERENCE
None
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Part I
Item 1. Business
Porta Systems Corp. develops, designs, manufactures and markets a broad
range of standard and proprietary telecommunications equipment and integrated
software applications for sale domestically and internationally. Our core
products, focused on ensuring communications for service providers worldwide,
fall into three categories:
Computer-based operation support systems. Our operations support systems,
which we call our OSS systems, focus on the access loop and are components of
telephone companies' service assurance and service delivery initiatives. The
systems primarily focus on trouble management, line testing, network
provisioning, inventory and assignment, and automatic activation, and most
currently single ended line qualification for the delivery of xDSL high
bandwidth services. We market these systems principally to foreign telephone
operating companies in established and developing countries primarily in Asia,
South and Central America and Europe.
Telecommunications connection and protection equipment. These systems are
used to connect copper-wired telecommunications networks and to protect
telecommunications equipment from voltage surges. We market our copper
connection equipment and systems to telephone operating companies and customer
premise systems providers in the United States and foreign countries.
Signal processing equipment. These products, which we sell principally for
use in defense and aerospace applications, support copper wire-based
communications systems.
Porta Systems Corp. is a Delaware corporation incorporated in 1972 as the
successor to a New York corporation incorporated in 1969. Our principal offices
are located at 6851 Jericho Turnpike, Syosset, New York 11791; telephone number,
516-364-9300. References to "we," "us," "our," and words of like import refer to
Porta Systems Corp. and its subsidiaries, unless the context indicates
otherwise.
Forward-Looking Statements
Statements in this Form 10-K annual report may be "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Forward-looking statements include, but are not limited to, statements
that express our intentions, beliefs, expectations, strategies, predictions or
any other statements relating to our future activities or other future events or
conditions. These statements are based on current expectations, estimates and
projections about our business based, in part, on assumptions made by
management. These statements are not guarantees of future performance and
involve risks, uncertainties and assumptions that are difficult to predict.
Therefore, actual outcomes and results may, and probably will, differ materially
from what is expressed or forecasted in the forward-looking statements due to
numerous factors, including those risks discussed from time to time in this Form
10-K annual report, including the risks described under "Risk Factors" and in
other documents which we file with the Securities and Exchange Commission and
the matters described under "Management's Discussion and Analysis of Financial
Condition and Results of Operations." In addition, such statements could be
affected by risks and uncertainties related to our financial conditions, factors
which affect the telecommunications industry, market and customer acceptance,
competition, government regulations and requirements and pricing, as well as
general industry and market conditions and growth rates, and general economic
conditions. Any forward-looking statements speak only as of the date on which
they are made, and we do not undertake any obligation to update any
forward-looking statement to reflect events or circumstances after the date of
this Form 10-K.
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Risk Factors
We require substantial financing to meet our working capital requirements
and our principal lender has no obligation to provide us with any additional
financing. We had a working capital deficit at December 31, 2002 of $34,199,000.
As of December 31, 2002, our current liabilities included $25,070,000 due to our
senior lender, all of which becomes due on May 15, 2003. We do not have
sufficient resources to pay the senior lender when our obligations to the senior
lender mature on May 15, 2003, or to pay principal and interest of $8,444,000
due at December 31, 2002 on the outstanding subordinated notes that became due
on July 3, 2001, and we do not expect to generate the necessary cash from our
operations to enable us to make those payments. Because our senior lender is no
longer advancing funds to us, at present our only source of funds is from
operations. To the extent that our operations do not generate sufficient funds
to cover our expenses, it may be necessary for us to seek reorganization or
liquidation under the Bankruptcy Code. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
We are incurring losses from our operations, and our losses are continuing.
We incurred a net loss of $4,114,000, or $0.41 per share (basic and diluted), on
sales of $21,417,000 for 2002, following a loss of $14,774,000, or $1.50 per
share (basic and diluted) for 2001. In each of these years, our revenue declined
significantly from the level of the previous year. Our losses are continuing and
we expect that our losses will continue unless we are able both to significantly
increase our revenue and reduce our expenses. We cannot give assurance that we
will be able to operate profitably in the future, and if we are unable to
operate profitably, we may be unable to continue in business.
Because of our decreasing revenues together with problems facing both the
telecommunications industry and the economy, we may not be able to continue in
business. Our sales declined significantly from 2000 to 2001 and again from 2001
to 2002. Unless we are able to stop the downward trend in sales and generate a
significant increase in sales, our reduction in overhead will not be sufficient
to enable us to sustain our operations. We cannot assure you that we will be
able to increase our sales significantly, if at all. As a result of the
deterioration of our operating revenue we are evaluating various options,
including the sale of one or more of our divisions as well as a reorganization
or liquidation under the Bankruptcy Code.
Our independent auditors have included an explanatory paragraph relating to
our ability to continue as a going concern in their report on our financial
statements. Because of our substantial losses in 2002, 2001 and 2000, our
stockholders' deficit of $29,935,000 at December 31, 2002, and our working
capital deficit of $34,199,000 as of December 31, 2002 our auditors included in
their report an explanatory paragraph about our ability to continue as a going
concern.
Because of our financial condition, we have not been able to pay certain of
our creditors on a timely basis, and some of our creditors have obtained
judgments against us. As a result of our continuing financial difficulties, a
number of creditors have engaged attorneys or collection agencies or commenced
legal actions against us, and some of them have obtained judgments against us.
Claimants who have already either commenced litigation or otherwise sought
collection are due approximately $214,000. If we are unable to reach a
settlement with these creditors and others who have not yet brought claims, and
these claimants obtain judgments against us or seek to enforce a judgment
against us, it may be necessary for us, or our senior lender may require us, to
seek protection under the Bankruptcy Code.
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Our largest customer has ceased placing orders for OSS products with us and
has significantly decreased orders for our copper connection/protection
products, which are having a material adverse effect upon our business. Our
largest customers are British Telecommunications and Fujitsu Telecommunications
LTD, which purchases telecommunications equipment from us for sale to British
Telecommunications. Sales to British Telecommunications declined significantly
during the past year. British Telecommunications has informally advised us that
it will not place orders with us for OSS products until we can demonstrate that
we are financially viable. The decline in sales of connection/protection
products for British Telecommunications reflects both our financial condition
and industry conditions generally. We have not been able to replace the sales
made to British Telecommunications and we cannot give any assurance that we will
be able to. The reluctance of British Telecommunications to place orders for OSS
products may affect the willingness of other telecommunications companies to
order new OSS or other products from us. The reduced level of our sales
resulting from the decline in sales to British Telecommunications is continuing
to impair our business, and, if we are not able to replace these sales, or
generate new business from British Telecommunications or Fujitsu, we may not be
able to continue in business.
Since we sell to telecommunications companies, our sales are affected by
economic and other factors that affect that industry, both domestically and
internationally. During the past three years, the telecommunications industry
has been affected by an international slowdown, and many, if not most,
telecommunications companies have scaled back plans for expansion, which has
resulted in a significant drop in the requirements for products including
products such as our OSS products and our connection/protection products. We
cannot assure you that there will be any positive change in the purchasing
patterns of telecommunications companies or that we will benefit from any
positive change which may occur.
Because of our financial condition, we may not be able to perform on our
contracts which may subject us to loss of business and penalties. We are having
and we may continue to have difficulty performing our obligations under our
contracts, which could result in the cancellation of contracts, the loss of
future business and penalties for non-performance.
We are heavily dependent on foreign sales. Approximately 54% of our sales
in 2002 and 2001 and 66% of our sales for 2000, were made to foreign telephone
operating companies. In selling to customers in foreign countries, we are
exposed to inherent risks not normally present in the case of our sales to
United States customers, including extended delays in both completing the
installation and receiving the final payment from our customers for our
Operational Support Systems contracts, as well as further risks relating to
political and economic changes. Furthermore, our financial condition has
impaired our ability to generate new business in the international market as
potential customers express concern about our ability to perform.
We have granted to British Telecommunications rights to our technology.
Under our agreement with British Telecommunications, we gave British
Telecommunications the right to use our connection/protection technology or have
products using our technology manufactured for it by others. As a result,
British Telecommunication may have the right to use our technology and purchase
products based on our technology from others, which has resulted and may
continue to result in a significant decline in our sales to British
Telecommunications.
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We experience difficulties with Operations Support Systems contracts. We
experience delays in purchaser acceptance of the Operations Support Systems and
our receipt of final contract payments in connection with a number of foreign
sales. In addition, we have no steady or predictable flow of orders for
Operations Support Systems and the negotiation of a contract for an operations
support system is an individualized and highly technical process. The
installation, testing and purchaser acceptance phases of these contracts may
last longer than contemplated by the contracts and, accordingly, amounts due
under the contracts may not be collected for extended periods. Furthermore, our
Operation Support Systems contracts typically contain performance guarantees by
us and clauses imposing penalties if we do not meet "in-service" dates. As a
result, it is possible that we may lose money on Operations Support Systems
contracts.
Because of our small size and our financial problems, we may have
difficulty competing for business. We compete directly with a number of large
and small telephone equipment manufacturers in the United States, with Lucent
Technologies, Inc. continuing to be our principal United States competitor. Our
competitors are using our financial difficulties in successfully competing
against us. We anticipate that our loss for 2002, our working capital deficiency
and absence of financing may continue to place us in a competitive disadvantage,
particularly in seeking Operations Support Systems contracts, where we
frequently deal with national telecommunications companies.
We face significant competition for both foreign and domestic sales. In
both foreign and domestic markets, we face considerable competition from other
United States and foreign telephone equipment manufacturers most of which are
larger and have substantially greater financial resources than us. In addition,
if we establish facilities in foreign countries, we face risks associated with
currency devaluation, difficulties in either converting local currency into
dollars or transferring funds to the United States, local tax and currency
regulations and political instability.
We require access to current technological developments. We rely primarily
on the performance and design characteristics of our products and we try to
offer our products at prices and with warranties that will make our products
competitive. Our business could be adversely affected if we cannot obtain
licenses for such updated technology or self develop state-of-the-art
technology. Because of our financial problems, we are not able to devote any
significant effort to research and development, which could increase our
difficulties in making sales of our products.
We rely on certain key employees. We may be dependent upon the continued
employment of certain key employees, including our senior executive officers.
Our failure to retain such employees may have a material adverse effect upon our
business. Because of our financial problems we have experienced key personnel
losses. To the extent that these losses continue or are accelerated, we may be
unable to provide our customers with necessary service, which could result in
the failure to generate new business.
Our stock is subject to the penny stock rules, which may make it difficult
for stockholders to sell our stock. Because our stock is traded on the OTC
Bulletin Board and our stock price is very low, our stock is subject to the
Securities and Exchange Commission's penny stock rules, which impose additional
sales practice requirements on broker-dealers which sell our stock to persons
other than established customers and institutional accredited investors. These
rules may affect the ability of broker-dealers to sell our common stock and may
affect the ability of our stockholders to sell any common stock they may own.
We do not pay dividends on common stock.
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Products
Operations Support Systems. We sell our OSS systems primarily to telephone
operating companies in established and developing countries in Asia, South and
Central America and Europe, and to a lesser extent, in the United States. Our
principal OSS systems are computer-based testing, provisioning, activation and
trouble management products which include software and capital equipment and
typically sell for prices ranging from several hundred thousand to several
million dollars.
The testing products are designed to automatically test for and diagnose
problems in customer telephone lines and to notify telephone company service
personnel of required maintenance. The associated trouble management system
provides automated record keeping (including repair and disposition records) and
analyzes these records to enable the telephone company to identify recurring
problems and equipment deterioration and to fulfill maintenance service level
agreement obligations. The integration of these systems provides a service
assurance function for telephone companies.
A major component of the testing system is the "test head," which provides
the access to, and tests the required telephone line. We have continually
developed our test head capability to meet the changing requirements of the
customer loop, and have recently introduced our latest advanced technology
platform (sixth generation) product, the MKIII. An enhanced version of the
MKIII, the Sherlock, will provide the capability to determine whether customer
lines are xDSL capable, enabling telephone companies to expeditiously
characterize their outside plant, and optimize their responsiveness to market
conditions.
Our other software applications, including the automated assignment of
facilities and activation of service, form part of a telephone company's service
activation function, and can be integrated with the testing and trouble
management systems, to provide a comprehensive access loop capability. In
addition, if requested by customers, We develop software to meet specific
customer requirements, including integration of its systems with telephone
company legacy or third party OSS systems.
Our OSS products are complex and, in most applications, incorporate
features designed to respond to the purchaser's operational requirements and the
particular characteristics of the purchaser's telephone system and operational
processes. As a result, the negotiation of a contract for an OSS system is an
individualized and highly technical process. In addition, contracts for OSS
systems frequently provide for manufacturing, delivery, installation, testing
and purchaser acceptance phases, which take place over periods ranging from
several months to a year or more. These contracts typically contain performance
guarantees by us and clauses imposing penalties if "in-service" dates are not
met. The installation, testing and purchaser acceptance phases of these
contracts may last longer than contemplated by the contracts and, accordingly,
amounts due under the contracts may not be collected for extended periods and,
in some instances, may not be collected. Delays in purchaser acceptance of the
systems and in our receipt of final contract payments have occurred in
connection with a number of foreign sales. In addition, we have not experienced
a steady or predictable flow of orders for OSS systems.
Telecommunications Connection Equipment. Our copper connection/protection
equipment and systems are used by telephone operating companies, by owners of
private telecommunications equipment and by manufacturers and suppliers of
telephone central office and customer premises equipment. Products of the types
comprising our telecommunications connection equipment are included as integral
parts of all domestic and foreign telephone and telecommunications systems. Such
products are sold in a worldwide market, which generally grows in proportion to
increases in the number of telephone subscribers and owners of private
telecommunications equipment, as well as to increases in upgrades to modern
digital switching technology such as DSL, ADSL, and ISDN lines.
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Our connection equipment consists of connector blocks and protection
modules used by telephone companies to interconnect copper-based subscriber
lines to switching equipment lines. The protector modules protect central office
personnel and equipment from electrical surges. The need for protection products
has increased as a result of the worldwide move to digital technology, which is
extremely sensitive to damage by electrical overloads, and because private
owners of telecommunications equipment now have the responsibility to protect
their equipment from damage caused by electrical surges. Line
connecting/protecting equipment usually incorporates protector modules to
safeguard equipment and personnel from injury due to power surges. Currently,
these products include a variety of connector blocks, protector modules and
frames used in telephone central switching offices, PBX installations, multiple
user facilities and customer premise applications.
We also have developed an assortment of frames for use in conjunction with
our traditional line of connecting/protecting products. Frames for the
interconnection of copper circuits are specially designed structures which, when
equipped with connector blocks and protectors, interconnect and protect
telephone lines and distribute them in an orderly fashion allowing access for
repairs and changes in line connections. One of our frame products, the CAM
frame, is designed to produce computer-assisted analysis for the optimum
placement of connections for telephone lines and connector blocks mounted on the
frame.
Our copper connection/protection products are used by many of the Regional
Bell Operating Companies as well as by independent telephone operating companies
in the United States and owners of private telecommunications equipment. These
products are also purchased by other companies for inclusion within their
systems. In addition, our telecommunications connection products have been sold
to telephone operating companies in various foreign countries. This equipment is
compatible with existing telephone systems both within and outside the United
States and can generally be used without modification, although we do custom
design modifications to accommodate the specific needs of our customers.
Signal Processing Products. Our signal processing products include data bus
systems and wideband transformers. Data bus systems, which are the communication
standard for military and aerospace systems, require an extremely high level of
reliability and performance. Wideband transformers are required for ground noise
elimination in video imaging systems and are used in the television and
broadcast, medical imaging and industrial process control industries.
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The table below shows, for the last three fiscal years, the contribution
made to our sales by each of our major categories of the telecommunications
industry:
Sales by Product Category
Years Ended December 31,
-----------------------------------------------------------
2002 2001 2000
---- ---- ----
(Dollars in thousands)
OSS Systems $ 6,414 30% $ 8,874 32% $22,296 44%
Line Connecting
/Protecting
Equipment 9,598 45% 12,756 46% 20,546 40%
Signal Processing 4,523 21% 5,737 20% 7,644 15%
Other 882 4% 695 2% 654 1%
------- ---- ------- ---- ------- ----
Total $21,417 100% $28,062 100% $51,140 100%
======= ==== ======= ==== ======= ====
Markets
We supply equipment and systems to telephone companies which provides
improved services to ensure communication to their customers. In addition, we
provide businesses with systems which improve their internal telecommunication
systems.
Telephone networks in certain regions of the world, notably Latin America,
Eastern Europe and certain areas in the Asia/Pacific region, were designed to
carry voice traffic and are not well suited for high-speed data transmissions or
for other forms of telecommunications that operate more effectively with digital
telecommunications equipment and lines. The telephone networks in these
countries are also characterized by a very low ratio of telephone lines to
population. Countries with emerging telecommunication networks have to rapidly
add access lines in order to increase the availability of telephone service and
to significantly upgrade the quality of the lines already in service.
Our OSS systems are designed to meet many of the needs of a rapidly
changing telephone network. OSS systems facilitate rapid change and expansion
without a comparable increase in the requirement for skilled technicians, while
the computerized line test system insures increased quality and rapid
maintenance and repair of subscriber local loops. The automated database, which
computerizes the inventory and maintenance history of all subscriber lines in
service, helps to keep the rapid change under control.
During 2002, approximately 30% of our sales consisted of OSS products and
services.
As a telephone company expands the number of its subscriber lines, it also
requires additional connection equipment to interconnect and protect those lines
in its central offices. We provide a line of copper connection equipment for
this purpose. Recent trends towards the transmission of high frequency signals
on copper lines are sustaining this market. Less developed countries, such as
those with emerging telecommunications networks or those upgrading to digital
switching systems, provide a growing market for copper connection and protection
equipment.
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The increased sensitivity of the newer digital switches to small amounts of
voltage requires the telephone company which is upgrading its systems to digital
switching systems to also upgrade its central office connection/protection
systems in order to meet these more stringent protection requirements. We supply
central office connection/protection systems to meet these needs.
During 2002, approximately 45% of our sales were made to customers in this
category.
Our line of signal processing products is supplied to customers in the
military and aerospace industry as well as manufacturers of medical equipment
and video systems. The primary communication standard in new military and
aerospace systems is the MIL-STD-1553 Command Response Data Bus, an application
which requires an extremely high level of reliability and performance. Products
are designed to be application specific to satisfy the requirements of each
military or aerospace program.
Our wideband transformers are required for ground noise elimination in
video imaging systems and are used in the television and broadcast, medical
imaging and industrial process control industries. If not eliminated, ground
noise caused by poor electrical system wiring or power supplies, results in
significant deterioration in system performance, including poor picture quality
and process failures in instrumentation. The wideband transformers provide a
cost effective and quick solution to the problem without the need of redesign of
the rest of the system.
During 2002, signal processing equipment accounted for approximately 21% of
our sales.
Marketing and Sales
We operate through three business units, which are organized by product
line, and with each having responsibility for the sales and marketing of its
products.
When appropriate to obtain sales in foreign countries, we may enter into
business arrangements and technology transfer agreements covering our products
with local manufacturers and participate in manufacturing and licensing
arrangements with local telephone equipment suppliers.
In the United States and throughout the world, we use independent
distributors in the marketing of all copper based products to the regional bell
operating companies and the customer premises equipment market. All distributors
marketing copper-based products also market directly competing products. In
addition, We continues to promote the direct marketing relationships it
developed in the past with telephone operating companies.
British Telecommunications purchased line connecting/protecting products
amounting to $689,000 (3% of sales) in 2002, $3,339,000 (12% of sales) in 2001,
and $4,261,000 (8% of sales) in 2000. During these years, we also sold our
products to unaffiliated suppliers for resale to British Telecommunications. We
have a cross-licensing agreement with British Telecommunications which, in
effect, enables British Telecommunications to use certain of our proprietary
information to modify or enhance products provided to British Telecommunications
and permits British Telecommunications to manufacture or engage others to
manufacture those products.
Our OSS systems historically have been sold to foreign telephone operating
companies which are government controlled. Recently, we entered into sales,
marketing and management co-operative agreements and strategic alliances with
various companies.
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During 2000, we entered into a multi-year sales, marketing, and management
co-operative agreement with Fujitsu Telecommunications to market Internet
infrastructure products. This agreement expired during September 2002.Under the
agreement, Fujitsu sold and marketed our advanced Internet infrastructure
technologies, including ADSL Single Ended Line Qualification System for
broadband services and the sixth generation Sherlock remote test unit to telecom
service operators in the United Kingdom, principally British Telecommunications,
and certain other European countries. During 2002, we had no sales pursuant to
this agreement. During 2001 and 2000, we had sales pursuant to this agreement of
$3,200,000 (11% of sales) and $12,051,000 (24% of sales), respectively.
Our signal processing products are sold primarily to US military and
aerospace prime contractors, and domestic original equipment manufacturers and
end users.
The following table sets forth for the last three fiscal years our sales to
customers by geographic region:
Sales to Customers By Geographic Region (1)
Year Ended December 31,
---------------------------------------------------------
2002 2001 2000
---- ---- ----
(Dollars in thousands)
North America $10,442 49% $13,356 48% $22,795 45%
United Kingdom 6,388 30% 8,060 29% 20,244 40%
Asia/Pacific 2,725 13% 4,552 16% 5,429 10%
Other Europe 1,600 7% 1,761 6% 2,482 5%
Latin America 258 1% 288 1% 146 0%
Other 4 0% 45 0% 44 0%
------- ---- ------- ---- ------- ----
Total Sales $21,417 100% $28,062 100% $51,140 100%
======= ==== ======= ==== ======= ====
(1) For information regarding the amount of sales, operating profit or loss and
identifiable assets attributable to each of our divisions and geographic
areas, see Note 22 of Notes to the Consolidated Financial Statements.
In selling to customers in foreign countries, we face inherent risks not
normally present in the case of sales to United States customers, including
increased difficulty in identifying and designing systems compatible with
purchasers' operational requirements; extended delays under OSS systems
contracts in the completion of testing and purchaser acceptance phases and
difficulty in our receipt of final payments and political and economic change.
In addition, to the extent that we establish facilities in foreign countries or
to the extent that payment is denominated in the local currency, we face risks
associated with currency devaluation, inability to convert local currency into
dollars, as well as local tax regulations and political instability.
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Manufacturing
Our computer-based testing products include proprietary testing circuitry
and computer programs, which provide platform-independent solutions based on
UNIX or UNIX compatible operating systems. The testing products also incorporate
disk data storage, teleprinters, file servers and personal computers purchased
by us. These products are installed and tested by us at our customers' premises.
At present, our manufacturing operations are conducted at facilities
located in Syosset, New York and Matamoros, Mexico. From time to time we also
use subcontractors to augment various aspects of our production activities and
periodically explore the feasibility of conducting operations at lower cost
manufacturing facilities located abroad. In selling to foreign telephone
companies, we may be required to provide local manufacturing facilities and, in
conjunction with these facilities, we may grant the facility a license to our
proprietary technology.
Source and Availability of Components
We generally purchase the standard components used in the manufacture of
our products from a number of suppliers. We attempt to assure ourselves that the
components are available from more than one source. We purchase all of our MKIII
test units from one supplier. We purchase the majority of our workstations and
servers used in our OSS systems from Hewlett Packard Corporation. However, we
could use other computer equipment in our systems if we were unable to purchase
Hewlett Packard products. Other components, such as personal computers and line
printers used in connecting with our electronic products, are readily available
from a number of sources.
Significant Customers
During the years ended December 31, 2002, 2001 and 2000, our five largest
customers accounted for sales of $9,784,000, or approximately 46% of sales,
$13,444,000, or approximately 48% of sales, and $28,323,000, or approximately
55% of sales, respectively. Our largest customer in 2002 and 2001 with sales of
$2,725,000 and $3,485,000, or approximately 13% and 12%, respectively, of sales
was Philippine Long Distance Telephone. Our largest customer in 2000 with sales
of $12,051,000, or approximately 24% of sales was Fujitsu Telecommunications.
Our sales to Fujitsu Telecommunications were $3,200,000, or approximately 11% of
sales in 2001. A significant amount of sales of our products for use by British
Telecommunications were sold to Fujitsu Telecommunications, as purchasing agent
for British Telecommunications. As a result, most of the sales to Fujitsu
Telecommunications were for use by British Telecommunications. Direct sales to
British Telecommunications were $2,306,000, or 11% of sales, for 2002,
$3,339,000, or 12% of sales, for 2001 and $5,098,000, or 10% of sales, for 2000.
During 2000, sales to a Mexican telephone company were $5,507,000, or
approximately 11% of sales. No other customers account for 10% or more of our
sales in 2002, 2001 or 2000.
The former Bell operating companies continue to be the ultimate purchasers
of a significant portion of our products sold in the United States, while sales
to foreign telephone operating companies constitute the major portion of our
foreign sales. Our contracts with these customers require no minimum purchases
by such customers. Significant customers for the signal processing products
include major US aerospace companies, the Department of Defense and original
equipment manufacturers in the medical imaging and process control equipment
industries. We sell both catalog and custom designed products to these
customers. Some contracts are multi-year procurements.
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Backlog
At December 31, 2002, our backlog was approximately $4,400,000 compared
with approximately $6,100,000 at December 31, 2001. Of the December 31, 2002
backlog, approximately $3,300,000 represented orders from foreign telephone
operating companies. We expect to ship substantially all of our December 31,
2002 backlog during 2003.
Intellectual Property Rights
We own a number of domestic utility and design patents and have pending
patent applications for these products. In addition, we have foreign patent
protection for a number of our products.
From time to time we enter into licensing and technical information
agreements under which we receive or grant rights to produce certain
subcomponents used in our products. These agreements are for varying terms and
provide for the payment or receipt of royalties or technical license fees.
While we consider patent protection important to the development of our
business, we believe that our success depends primarily upon our engineering,
manufacturing and marketing skills. Accordingly, we do not believe that a denial
of any of our pending patent applications, expiration of any of our patents, a
determination that any of the patents which have been granted to us are invalid
or the cancellation of any of our existing license agreements would have a
material adverse effect on our business.
Competition
The telephone equipment market in which we do business is characterized by
intense competition, rapid technological change and a movement to private
ownership of telecommunications networks. In competing for telephone operating
company business, the purchase price of equipment and associated operating
expenses have become significant factors, along with product design and
long-standing equipment supply relationships. In the customer premises equipment
market, we are functioning in a market characterized by distributors and
installers of equipment and by price competition.
We compete directly with a number of large and small telephone equipment
manufacturers in the United States, with Lucent Technologies continuing to be
our principal United States competitor. Lucent's greater resources, extensive
research and development facilities, long-standing equipment supply
relationships with the operating companies of the regional holding companies and
history of manufacturing and marketing products similar in function to those
produced by us continue to be significant factors in our competitive
environment.
Currently, Lucent and a number of companies with greater financial
resources than us produce, or have the design and manufacturing capabilities to
produce, products competitive with our products. In meeting this competition, we
rely primarily on the engineered performance and design characteristics of our
products to comparable performance or design, and endeavors to offer our
products at prices and with warranties that will make our products compete world
wide.
In connection with overseas sales of our line connecting/protecting
equipment, we have met with significant competition from United States and
foreign manufacturers of comparable equipment and we expect this competition to
continue. In addition to Lucent, a number of our overseas competitors have
significantly greater resources than we do.
11 of 35
We compete directly with a limited number of substantial domestic and
international companies with respect to our sales of OSS systems. In meeting
this competition, we rely primarily on the features of our line testing
equipment, our ability to customize systems and endeavor to offer such equipment
at prices and with warranties that make them competitive.
In addition to the quality and price of the products being offered, the
financial stability of a supplier, especially for OSS contracts, is a crucial
element. Because these contracts require the supplier to spend considerable
funds before the project is completed and require ongoing maintenance service,
potential customers consider the financial stability of the supplier as a major
consideration in awarding a contract. Our financial position, combined with our
recent losses, our working capital deficiency and the scheduled expiration of
our financing agreement with our senior lender, and the decision of British
Telecommunications not to place orders for new OSS products from us and its
reduced level of purchases of copper connection/protection products may place us
at a competitive disadvantage in seeking new business and new orders for
existing customers.
Research and Development Activities
We spent approximately $2,500,000 in 2002, $4,400,000 in 2001, and
$5,800,000 in 2000 on research and development activities. All research and
development was company sponsored and is expensed as incurred. As a result of
our financial difficulties, we have scaled down our research and development
effort, which could hurt our ability to offer competitive products.
Employees
As of March 7, 2003, we had 258 employees of which 56 were employed in the
United States, 176 in Mexico, 18 in the United Kingdom, 3 in Poland, 4 in Chile,
and 1 in China. We believe that our relations with our employees are good, and
we have never experienced a work stoppage. Our employees are not covered by
collective bargaining agreements, except for our hourly employees in Mexico who
are covered by a collective bargaining agreement that expires on December 31,
2003.
Item 2. Properties
We currently lease approximately 14,500 square feet of executive, sales,
marketing and research and development space and 4,200 square feet of
manufacturing space in Syosset, New York. These facilities represent
substantially all of our office, plant and warehouse space in the United States.
The Syosset, New York leases expire February 2008 and May 2007, respectively.
The annual rental related to the New York property is approximately $277,000.
Our wholly-owned United Kingdom subsidiary leases approximately 11,000
square foot facility in Coventry, England, which facility comprises all of our
office, plant and warehouse space. The lease expires in 2019. The aggregate
annual rental is approximately $114,000.
Our wholly-owned Mexican subsidiary owns an approximately 40,000 square
foot manufacturing facility in Matamoros, Mexico.
We believe our properties are adequate for our needs.
12 of 35
Item 3. Legal Proceedings
In July 2001, the holder of a subordinated note in the principal amount of
$500,000 commenced an action against us in the United States District Court for
the Southern District of New York seeking payment of the principal and accrued
interest on their subordinated notes which were payable in July 2001. The
payment of the note is subordinated to payment of our senior debt and we believe
that the subordination provision of the note prohibits payment by us. The
plaintiff's motion for a summary judgment was denied by the court on the grounds
that the terms of the note did not give them permission to obtain a judgment
while we remained in default to the senior debt holder. Our obligations under
the subordinated notes are reflected as current liabilities on our balance
sheet.
In March 2000, we suspended (with pay) Messrs. Ronald Wilkins and Michael
Bahlo, two of our executive officers, from their positions pending completion of
our investigation of certain matters that had come to our attention. Prior to
the completion of this investigation, however, these two executives accepted
positions with another company and thereby voluntarily resigned from their
positions with us. In February 2001, these two executives, together with a third
former executive officer, Mr. Michael Lamb, who similarly resigned from his
position with us, filed suit in the Supreme Court for the State of New York,
County of New York, entitled Ronald Wilkins, Michael Bahlo and Michael Lamb v.
Porta Systems Corp. The complaint asserted various claims against us based on
the allegation that each of these three executives was improperly terminated
from his employment without cause, and seeks compensatory damages, liquidating
damages and attorney's fees. We filed an answer and counterclaim against the
plaintiffs. During 2002, we settled all claims related to this action for
$30,000.
In July 1996, an action was commenced against us and certain present and
former directors in the Supreme Court of the State of New York, New York County
by certain of our stockholders and warrant holders of Porta who acquired their
securities in connection with our acquisition of Aster Corporation. The
complaint alleges breach of contract against us and breach of fiduciary duty
against our directors arising out of an alleged failure to register certain
restricted shares and warrants owned by the plaintiffs. The complaint seeks
damages of $413,000; however, counsel for the plaintiff has advised us that
additional plaintiffs may be added and, as a result, the amount of damages
claimed may be substantially greater than the amount presently claimed. We
believe that we have valid defenses to the claims. Discovery is proceeding,
although there has been no significant activity in this matter subsequent to
December 31, 1999.
In June 2002, BMS Corp. served an arbitration demand on us claiming that we
breached our agreement to market and sell an update to our MLR product which BMS
was to develop. We believe that we have defenses to the claims by BMS and have
filed a counterclaim to recover the $350,000 we advanced to BMS under the
contract. The arbitrators have recently been selected and the proceedings will
move forward over the next several months.
Item 4. Submission of Matters to a Vote of Securities Holders
During the fourth quarter of 2002, no matters were submitted to a vote of
our security holders.
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Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our common stock is traded on the OTC Bulletin Board under the symbol PYTM.
Prior to November 11, 2002, our stock was traded on the American Stock Exchange
under the symbol PSI. The following table sets forth, for 2001 and 2002, the
quarterly high and low sales prices for our common stock on the consolidated
transaction reporting systems for the OTC Bulletin Board and American Stock
Exchange listed issues.
High Low
---- ---
2001 First Quarter $1.06 $0.22
Second Quarter 0.40 0.21
Third Quarter 0.30 0.10
Fourth Quarter 0.17 0.05
2002 First Quarter $0.20 $0.07
Second Quarter 0.10 0.06
Third Quarter 0.15 0.03
Fourth Quarter 0.08 0.005
We did not declare or pay any cash dividends in 2002 or 2001. It is our
present policy to retain earnings, if any, to finance the growth and development
of the business, and therefore, we do not anticipate paying cash dividends on
our common stock in the foreseeable future. In addition, our agreement with our
senior lender prohibits it from paying cash dividends on its common stock.
As of March 19, 2003, we had approximately 979 stockholders of record and
the closing price of our common stock was $0.04.
We did not issue any unregistered securities during 2002.
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Equity Compensation Plan Information
The following table summarizes the equity compensation plans under which our
securities may be issued as of December 31, 2002.
Equity Compensation Plan Information as of December 31, 2002
Number of
Number of securities
securities to remaining
be issued upon Weighted-average available for
exercise of exercise price future issuance
outstanding options of outstanding under equity
Plan Category and warrants options and warrants compensation plans
------------- ------------------- -------------------- ------------------
Equity compensation plans
approved by security holders
844,030 $2.25 698,470
Equity compensation plan
not approved by security holders
-0- -0- 95,750
------- ----- -------
844,030 $2.25 794,220
The plan not approved by security holders is a stock bonus plan that permits
issuance of stock on a discretionary basis.
15 of 35
Item 6. Selected Financial Data
The following table sets forth certain selected consolidated financial
information. For further information, see the Consolidated Financial Statements
and other information set forth in Item 8 and Management's Discussion and
Analysis of Financial Condition and Results of Operations set forth in Item 7:
Year Ended December 31,
-----------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(In thousands, except per share data)
Income Statement Data:
Sales $ 21,417 $ 28,062 $ 51,140 $ 38,936 $ 59,343
Operating income (loss) (2,881) (11,453) (5,153) (9,709) 4,566
Debt conversion expense -- -- -- -- (945)
Income (loss) before
extraordinary item (4,114) (14,774) (10,176) (13,686) 451
Net income (loss) (4,114) (14,774) (10,176) (13,686) 527
Basic per share amounts:
Continuing operations $ (0.41) $ (1.50) $ (1.04) $ (1.44) 0.05
Net income (loss) $ (0.41) $ (1.50) $ (1.04) $ (1.44) $ 0.06
Diluted per share amounts:
Continuing operations $ (0.41) $ (1.50) $ (1.04) $ (1.44) $ 0.04
Net income (loss) $ (0.41) $ (1.50) $ (1.04) $ (1.44) $ 0.05
Cash dividends declared -- -- -- -- --
Number of shares used in
calculating net income (loss)
per share-basic 9,994 9,878 9,763 9,489 9,281
Number of shares used in
calculating net income (loss)
per share-diluted 9,994 9,878 9,763 9,489 9,785
Balance Sheet Data:
Total assets $ 14,228 $ 17,833 $ 34,174 $ 43,448 $ 52,136
Working capital (deficiency) $(34,199) $(31,236) $(24,152) $ 6,135 $ 14,262
Current debt maturities $ 31,599 $ 28,621 $ 26,890 $ 2,000 $ 2,000
Long-term debt excluding current
maturities $ -0- $ -0- $ 376 $ 21,902 $ 17,238
Stockholders' equity (deficit) $(29,935) $(25,849) $(10,792) $ (1,387) $ 11,984
16 of 35
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been
prepared in conformity with accounting principles accepted in the United States.
The preparation of these financial statements requires us to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses reported in those financial statements. These judgments can be
complex and consequently actual results could differ from those estimates. Among
the more significant estimates included in these consolidated financial
statements are revenue recognition, allowance for doubtful accounts receivable,
inventory reserves, goodwill valuation and the deferred tax asset valuation
allowance. Note 1 of Notes to Consolidated Financial Statements, included
elsewhere on this annual report on Form 10-K, includes a summary of the
significant accounting policies and methods used in the preparation of our
consolidated financial statements.
Revenue Recognition
Revenue, other than from long-term contracts for specialized products, is
recognized when a product is shipped. Revenues and earnings relating to
long-term contracts for specialized products, principally OSS products, are
recognized on the percentage-of-completion basis primarily measured by the
attainment of milestones. Anticipated losses, if any, are recognized in the
period in which they are identified. The percentage-of-completion method is
based on judgments and estimates that are complex and actual results may differ
from estimates.
Allowance for Doubtful Accounts Receivable
We record an allowance for doubtful accounts receivable based on specifically
identified amounts that we believe to be uncollectible. We also record
additional allowances based on certain percentages of our aged receivables,
which are determined based on historical experience and our assessment of the
general financial conditions affecting our customer base. If our actual
collections experience changes, revisions to our allowance may be required. We
have a limited number of customers with individually large amounts due at any
given balance sheet date. Any unanticipated change in one of those customers'
credit worthiness, or other matters affecting the collectability of amounts due
from such customers, could have a material effect on our results of operations
in the period in which such changes or events occur. After all attempts to
collect a receivable have failed, the receivable is written off against the
allowance.
In the ordinary course of business, we established an allowance for doubtful
accounts receivable in the amount of $1,967,000 and $2,168,000 as of December
31, 2002 and 2001, respectively. Our allowance for doubtful accounts is a
subjective critical estimate that has a direct impact on reported net loss. This
reserve is based upon the evaluation of accounts receivable aging and specific
exposures.
Inventory Reserves
Inventories are stated at the lower of cost (on the average or first-in,
first-out methods) or fair market value. Our stated inventory reflects an
inventory obsolescence reserve that represents the difference between the cost
of the inventory and its estimated market value. This reserve is calculated
based on historical usage and forecasted sales. Actual results may differ from
our estimates.
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Goodwill
Goodwill represents the difference between the purchase price and the fair
market value of net assets acquired in business combinations treated as
purchases. Commencing January 1, 2002, goodwill is an indefinite lived asset and
as such is not amortized. On an annual basis, we test the goodwill for
impairment. We determine the market value of the reporting unit by considering
the projected cash flows generated from the reporting unit to which the goodwill
relates.
Deferred Income Tax Valuation Allowance
Deferred taxes result from temporary differences between the tax bases of
assets and liabilities and their reported amounts in the financial statements.
The temporary differences result from costs required to be capitalized for tax
purposes by the US Internal Revenue Code, and certain items accrued for
financial reporting purposes in the year incurred but not deductible for tax
purposes until paid. Due to our continued losses in 2002 and 2001, a valuation
allowance for the entire deferred tax asset was provided due to the uncertainty
as to future realization.
Results of Operations
Our consolidated statements of operations for the three years ended
December 31, 2002, 2001 and 2000, respectively, as a percentage of sales is as
follows:
Years Ended December 31,
------------------------
2002 2001 2000
---- ---- ----
Sales 100% 100% 100%
Cost of sales 68% 71% 70%
---- ---- ----
Gross profit 32% 29% 30%
Selling, general and
administrative expenses 30% 33% 28%
Research and development expenses 12% 16% 12%
Goodwill impairment 3% 21% --
---- ---- ----
Operating loss (13%) (41%) (10%)
Interest expense (8%) (16%) (9%)
Gain on sale of assets -- 2% --
Gain on sale of investment in joint venture 2% -- --
Equity in net loss of joint venture -- -- --
Other -- 1% (1%)
---- ---- ----
Loss before income
taxes and minority interest (19%) (54%) (20%)
Income tax benefit (expense)
and minority interest -- 1% --
---- ---- ----
Net loss (19%) (53%) (20%)
==== ==== ====
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Results of Operation
Years Ended December 31, 2002 and 2001
Our sales for 2002 were $21,417,000 compared to $28,062,000 in 2001, a
decrease of $6,645,000 (24%). The decrease in revenue is attributed to the
decline in sales from all divisions.
OSS sales for 2002 were $6,414,000, compared to 2001 sales of $8,874,000, a
decrease of $2,460,000 (28%). The decreased sales resulted from the inability to
secure new orders primarily from the slowdown in the telecommunication market
and from lower levels of contract completion compared to the prior year. We
expect to recognize the balance of the revenue from the in process OSS contracts
during 2003. Sales of OSS systems are not made on a recurring basis to
customers, but are the result of extended negotiations that frequently cover
many months and do not always result in a contract. In addition, OSS contracts
may include conditions precedent, such as the customer obtaining financing or
bank approval, and the contracts are not effective until the conditions are
satisfied. Additionally, in April 2002 we disposed of our interest in our Korean
joint venture which generated no sales during 2002 and sales of $1,066,000
during 2001.
Line connection/protection equipment sales for 2002 decreased approximately
$3,158,000 (25%) from $12,756,000 in 2001 to $9,598,000 in 2002. The reduced
sales level reflected a decrease in volume of sales to United States and United
Kingdom customers. The results were adversely affected by the general slowdown
in the telecommunications industry.
Signal processing revenue for 2002 compared to 2001 decreased by $1,214,000
(21%) from $5,737,000 to $4,523,000. The decrease in sales primarily reflects
delays in the receipt of certain anticipated contracts during 2002.
Gross margin increased from 29% in 2001 to 32% in 2002. The margin
improvement resulted from a reduction to the costs associated with certain OSS
contracts reflecting our ability to replace a high cost software vendor with
comparable lower cost software. Offsetting this improvement were lower margins
associated with our Line business that was unable to absorb certain fixed
expenses in relation to lower sales volume, competitive pricing pressures
resulting from the industry's slowdown and additional inventory reserves
required based on reduced turnover.
Selling, general and administrative expenses decreased by $2,933,000 (31%)
from $9,316,000 in 2001 to $6,383,000 in 2002. This decrease relates primarily
to reduced salaries and benefits, consulting services and commissions reflecting
our current level of business and to a lesser extent an occupancy benefit from
the settlement of our North Carolina lease.
Research and development expenses decreased by $1,911,000 (43%) from
$4,427,000 in 2001 to $2,516,000 in 2002. This decrease resulted from our
efforts to reduce expenses in all divisions and most significantly the OSS
business.
At December 31, 2001, our goodwill was $3,761,000, all of which related to
our Signal division. We determined that this goodwill had been impaired as of
June 30, 2002. We engaged in discussions with respect to the sale of that
division during the second quarter of 2002, and based on those discussions we
estimated that the impairment loss was approximately $800,000. This amount was
charged to operations in the quarter ended June 30, 2002. Furthermore, the
negotiations relating to the sale of the Signal division have been discontinued.
We cannot give any assurances that further write-downs will not be necessary in
the future, although management believes that no additional goodwill impairment
charges are necessary at this time.
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Results of Operations (continued)
As a result of the above, we had an operating loss of $2,881,000 in 2002
versus an operating loss of $11,453,000 in 2001.
Interest expense for 2002 decreased by $2,682,000 from $4,480,000 for 2001
to $1,798,000 in 2002. The reduced level of interest expense is attributable to
our amended agreement with our senior lender whereby the old term loan bears no
interest commencing March 1, 2002, until such time as the senior lender, in its
sole discretion, notifies us that interest shall be payable.
In April 2002, we sold our 50% interest in our Korean joint venture for
$450,000 to our joint venture partner. Payment was made by the forgiveness of
commissions, totaling $450,000, which we owed to our sales representation
company owned by our joint venture partner, with respect to sales made by the
Korean joint venture in Korea.
As the result of the foregoing, the 2002 net loss was $4,114,000, $.41 per
share (basic and diluted), compared with a net loss of $14,774,000, $1.50 per
share (basic and diluted) for 2001.
Our losses are continuing into 2003, and we cannot give any assurance that
we will be able to operate profitably in the future. As a result of the
deterioration of our operating revenue resulting from both market conditions and
our financial condition, we are evaluating various options, including the sale
of one or more of our divisions as well as a reorganization under the Bankruptcy
Code.
Years Ended December 31, 2001 and 2000
Our sales for 2001 were $28,062,000 compared to $51,140,000 in 2000, a
decrease of $23,078,000 (45%). The decrease in revenue is attributed to the
decline in sales from all divisions.
OSS sales for 2001 were $8,874,000, compared to 2000 sales of $22,296,000,
a decrease of $13,422,000 (60%). The decline in sales from 2000 to 2001 is
attributed to the completion during 2000 of certain sales contracts secured
during 1999 and failure to secure new contracts as a result of the negative
impact of reduced opportunities in Europe, delays we encountered in obtaining
software from a vendor necessary to complete certain contracts and our financial
difficulties. Sales of OSS systems are not made on a recurring basis to
customers, but are the result of extended negotiations that frequently cover
many months and do not always result in a contract. In addition, OSS contracts
may include conditions precedent, such as the customer obtaining financing or
bank approval, and the contracts are not effective until the conditions are
satisfied.
Line connection/protection equipment sales for 2000 decreased approximately
$7,790,000 (38%) from $20,546,000 in 2000 to $12,756,000 in 2001. The reduced
sales level reflected a decrease in volume of sales to United States, United
Kingdom and Mexican customers. The results were adversely affected by the
general slowdown in the telecommunications industry.
Signal processing revenue for 2001 compared to 2000 decreased by $1,907,000
(25%) from $7,644,000 to $5,737,000. The decrease in sales primarily reflects
delays in the receipt of certain anticipated contracts and a general slowdown in
the order rate from customers during 2001.
Gross margin decreased from 30% in 2000 to 29% in 2001. The decrease in
gross margin is primarily attributed to the lower sales volume in the OSS
division causing inefficiency resulting from our inability to absorb our fixed
expenses associated with the OSS contracts over our revenue base.
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Results of Operations (continued)
Selling, general and administrative expenses decreased by $5,257,000 (36%)
from $14,573,000 in 2000 to $9,316,000 in 2001. The decrease from 2000 to 2001
primarily reflects reduced professional legal expenses and decreased expenses
reflecting our reorganization of our sales and marketing efforts of the OSS
division.
Research and development expenses decreased by $1,403,000 (24%) from
$5,830,000 in 2000 to $4,427,000 in 2001. The decreased expense in 2001 resulted
from our efforts to reduce our expenses primarily related to the OSS business.
In December 2001, we determined that $5,802,000 of goodwill, which
represented all of the goodwill associated with our OSS business unit, was
impaired, and we recorded an impairment loss in that amount. This assessment was
based on the continued decline in sales and losses generated by the business
unit over the past several years and the declining prospects for additional
sales of the products based on the older technology that originally gave rise to
the goodwill. In addition, there were no negotiations in progress for the sale
of the OSS division.
As a result of the above, we had an operating loss of $11,453,000 in 2001
versus an operating loss of $5,153,000 in 2000.
Interest expense for 2001 decreased by $20,000 from $4,500,000 for 2000 to
$4,480,000 in 2001.
During 2001, we sold our Glen Cove, New York facility for $1,850,000 and
recognized a gain on the sale of $684,000, net of expenses of $180,000. Of the
net proceeds of $1,670,000, $474,000 was used to reduce outstanding principal
and $350,000 to reduce outstanding interest obligations to our senior lender. We
retained the remaining proceeds of $846,000 for working capital purposes.
As of December 31, 2001, we had a net income tax benefit of $203,000 which
is comprised of income tax expense of $58,000 and benefit of $261,000. The
benefit reflects the reduction of an accrual for potential tax liability to one
of our subsidiaries that had previously operated in Puerto Rico as a result of
the expiration of the statute of limitations.
As the result of the foregoing, the 2001 net loss was $14,774,000, $1.50
per share (basic and diluted), compared with a net loss of $10,176,000, $1.04
per share (basic and diluted) for 2000.
Liquidity and Capital Resources
At December 31, 2002, we had cash and cash equivalents of $779,000 compared
with $1,204,000 at December 31, 2001. Our working capital deficit was
$34,199,000 at December 31, 2002 compared to a working capital deficit of
$31,236,000 at December 31, 2001. The working capital deficit reflects the
current liabilities to the senior and subordinated lenders together with the
effect of the reduced level of business, which resulted in reduced cash,
receivables and inventory. During 2002, we used $3,238,000 of cash to support
our operations. Our principal source of funds during 2002 was borrowings from
our senior lender. Our senior lender is no longer advancing us any funds. As a
result, our only source of funds is from operations. To the extent that we are
not able to generate sufficient funds to cover our expenses we may have to
consider reorganization or liquidation under the Bankruptcy Code.
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Liquidity and Capital Resources (continued)
As of December 31, 2002, our debt includes $25,070,000 of senior debt which
matures on May 15, 2003, and $6,144,000 principal amount of subordinated debt
which became due on July 3, 2001. We were unable to pay the interest payment on
the subordinated notes of approximately $2,300,000 which represents interest
from July 2000 through December 2002. At December 31, 2002, we did not have
sufficient resources to pay either the senior lender or the subordinated lenders
and it is unlikely that we can generate such cash from our operations. Further,
our senior lender has precluded us from making payments on the subordinated
debt.
On March 19, 2003, our senior lender and we agreed to an extension to May
15, 2003 of the existing agreement that had expired on December 31, 2002.
As of December 31, 2002, we had $385,000 outstanding of 6% Debentures which
matured July 2, 2002. The interest accrued on the 6% Debentures is payable on
July 1 of each year. Due to the restriction imposed by our senior lender
precluding us from making any payments on indebtedness to any subordinated debt
holder, we were unable to pay the interest due on July 1, 2001. Thus, interest
due at December 31, 2002 was $58,000. Additionally, we have been notified by the
trustee that the non-payment of the interest caused an event of default.
As of December 31, 2002, we had outstanding $6,144,000 of subordinated
notes, all of which became due during 2001. We did not have the resources to
pay, and we did not pay, either the principal or interest on the subordinated
notes totaling $8,444,000, and are restricted by our senior lender from making
such payments. The holder of a subordinated note in the principal amount of
$500,000 has commenced an action seeking payment of the principal and interest
on his note. However, the court denied the holder's motion for a summary
judgment on the grounds that the terms of the note did not give him permission
to obtain a judgment while we remained in default to the senior debt holder.
As a result of our continuing financial difficulties:
o we are having and we may continue to have difficulty performing our
obligations under our contracts, which could result in the
cancellation of contracts or the loss of future business and penalties
for non-performance;
o a number of creditors have engaged attorneys or collection agencies or
commenced legal actions against us, and some of them have obtained
judgments against us; and
o we have continued to suffer a significant decline in revenue in 2002
from 2001 following a significant decline in revenue in 2001 from
2000.
Claimants who have already either commenced litigation or otherwise sought
collection or who have obtained judgments against us are due approximately
$214,000. If we are unable to reach a settlement with these creditors and others
who have not yet brought claims, and these claimants obtain judgments against us
or, in the case of creditors who have already obtained judgments, if the
creditors seek to enforce the judgment, it may be necessary for us, or our
senior lender may require us, to seek protection under the Bankruptcy Code.
The creditors include five former senior executives who have deferred
compensation agreements with us. The total payments due under these agreements
are approximately $1.9 million, of which $133,000 was due at December 31, 2002
and an additional $196,000 becomes due in 2003. The claimants commenced
litigation that has been adjourned pending settlement. We are in the latter
stages of settlement negotiations with these creditors.
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Liquidity and Capital Resources (continued)
We are seeking to address our need for liquidity by exploring alternatives,
including the possible sale of one or more of our divisions. During 2001 and
2002 we were engaged in discussions with respect to the possible sale of our
divisions; however, those negotiations were terminated without an agreement
having been reached, and we may not be able to sell those divisions on
acceptable, if any, terms. Furthermore, if we sell a division, we anticipate
that a substantial portion of the net proceeds will be paid to our senior lender
and we will not receive any significant amount of working capital from such a
sale. During 2001 and 2002, we have taken steps to reduce overhead and
headcount. We will continue to look to reduce costs while we seek additional
business from new and existing customers.
Because of our present stock price, it is highly unlikely that we will be
able to raise funds through the sales of our equity securities, and our
financial condition prevents us from issuing debt securities. In the event that
we are unable to extend our debt obligations and sell one or more of our
divisions, we cannot assure you that we will be able to continue in operations.
Furthermore, we believe that our losses and our financial position are having
and will continue to have an adverse effect upon our ability to develop new
business as competitors and potential customers question our ability both to
perform our obligations under any agreements we may enter and to continue in
business. Because of our financial condition, British Telecommunications, which
is one of our largest customers, is not placing orders with us for OSS products,
and has advised us that it will not place orders for OSS products until we can
demonstrate that we are financially viable. However, British Telecommunication
continues to place orders for OSS maintenance and modest orders for line test
products. The loss of this customer would have a material adverse effect upon
our operations. In addition, our auditors included in their report an
explanatory paragraph about our ability to continue as a going concern.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.
Although we conduct operations outside of the United States, most of our
contracts and sales are dollar denominated. A portion of the revenue from our
United Kingdom operations and the majority of our United Kingdom expenses are
denominated in Sterling. Any Sterling-denominated receipts are promptly
converted into United States dollars. We do not engage in any hedging or other
currency transactions. For 2002, the currency translation adjustment was not
significant in relation to our total revenue.
Item 8. Financial Statements and Supplementary Data.
See Exhibit I
Item 9. Changes In and Disagreements With Accountants On Accounting and
Financial Disclosure.
Not Applicable
23 of 35
Part III
Item 10. Directors and Executive Officers
Set forth below is information concerning our directors:
Name Principal Occupation or Employment Director Since Age
---- ---------------------------------- -------------- ---
William V. Carney(1) Chairman of the board and chief executive officer 1970 66
Michael A. Tancredi Senior vice president, secretary and treasurer 1970 73
Warren H. Esanu(1),(2) Of counsel to Esanu Katsky Korins & Siger, LLP,
attorneys at law 1997 60
Herbert H. Feldman(1),(2) President, Alpha Risk Management, Inc., independent
risk management consultants 1989 69
Marco M. Elser Managing director of Elser & Co., an investment
advisory firm 2000 44
----------
(1) Member of the executive committee.
(2) Member of the audit and compensation committees.
Mr. Carney has been chairman of the board and chief executive officer since
October 1996. He was vice chairman from 1988 to October 1996, senior vice
president from 1989 to October 1996, chief technical officer since 1990 and
secretary from 1977 to October 1996. He also served as senior vice
president-mechanical engineering from 1988 to 1989, senior vice
president-connector products from 1985 to 1988, senior vice
president-manufacturing from 1984 to 1985 and senior vice president-operations
from 1977 to 1984. Since December 2002, Mr. Carney has worked for us on a
part-time basis.
Mr. Tancredi has been senior vice president, secretary and treasurer since
January 1997. He has been vice president-administration since 1995 and treasurer
since 1978, having served as vice president-finance and administration from 1989
to 1995 and vice president-finance from 1984 to 1989.
Mr. Esanu has been a director since April 1997 and also served as a
director from 1989 to 1996. He was also our chairman of the board from March
1996 to October 1996. He has been of counsel to Esanu Katsky Korins & Siger,
LLP, attorneys at law, for more than the past five years. Mr. Esanu is also a
founding partner and chairman of Paul Reed Smith Guitars Limited Partnership
(Maryland), a leading manufacturer of premium-priced electrical guitars. He is
also a senior officer and director of a number of privately held real estate
investment and management companies.
Mr. Elser has been the managing director of Elser & Co., an investment
advisory firm more than the past five years. He has also been associated with
Northeast Securities, a US-based broker dealer and is responsible for the
Italian office, which he founded in 1994.
Mr. Feldman has been president of Alpha Risk Management, Inc., independent
risk management consultants, for more than the past five years.
24 of 35
Set forth is information concerning our executive officers:
Name of Executive Officer Position Age
------------------------- -------- ---
William V. Carney Chairman of the board and chief executive
officer 66
Michael A. Tancredi Senior vice president, secretary and treasurer 73
Edward B. Kornfeld Senior vice president-operations and chief
financial officer 59
All of our officers serve at the pleasure of the board of directors.
Messrs. Carney and Tancredi are also members of the board of directors as stated
above. There is no family relationship between any of the executive officers
listed below.
Mr. Kornfeld, 59, has been senior vice president-operations since 1996 and
chief financial officer since October 1995. Since June 2002, Mr. Kornfeld has
also been a partner of the firm of Tatum CFO Partners, which provides chief
financial officer services to medium and large companies; however, he continues
to devote full time effort to our business. He was vice president-finance from
October 1995 until 1996. For more than five years prior thereto, Mr. Kornfeld
held positions with several companies for more than five years, including Excel
Technology Inc. (Quantronix Corp.) and Anorad Corporation.
Item 11. Executive Compensation
The following table shows the compensation we paid to our chief executive
officer and the only executive officer, other than the chief executive officer,
whose salary and bonus earned exceeded $100,000 for the year ended December 31,
2002.
Summary Compensation Table
Long-Term
Annual Compensation Compensation (Awards)
------------------------------- --------------------------
Restricted Options,
Stock Awards SARs All other
Name and Principal Position Year Salary Bonus (Dollars) (Number) Compensation
--------------------------- ---- ------ ----- --------- -------- ------------
William V. Carney, Chairman of the 2002 $240,000 -- -- -- $ 9,858
board and chief executive officer 2001 240,000 -- -- -- 7,981
2000 240,000 -- -- -- 29,556
Edward B. Kornfeld, Senior vice 2002 192,000 -- -- -- 5,022
president - operations and chief 2001 192,000 -- -- -- 4,872
financial officer 2000 192,000 -- -- -- 4,872
----------
"All Other Compensation" includes a payment to the executive's account
pursuant to our 401(k) Plan, premiums paid with respect to the equity split
dollar program (in 2000), group life insurance in amounts greater than that
available to all employees and special long term disability coverage.
Compensation to Mr. Kornfeld does not include fees of $21,000 paid in 2002 to
Tatum CFO Partners, of which Mr. Kornfeld is a partner.
25 of 35
Set forth below is a chart that shows, for 2002, the components of "All
Other Compensation" listed in the Summary Compensation Table.
Mr. Carney Mr. Kornfeld
---------- ------------
401(k) Match $3,000 $2,700
Supplemental Insurance 6,858 2,322
Certain of our officers named in the summary compensation table or their
affiliates are parties to employment or other agreements providing for
compensation during and after their employment.
During 2002, we did not grant Mr. Carney or Mr. Kornfeld any options, and
neither of them exercised any options to purchase shares of our common stock. As
of December 31, 2002, Mr. Carney held options to purchase 180,000 shares of
common stock and Mr. Kornfeld held options to purchase 88,000 shares of common
stock. All of these options are currently exercisable and, because the exercise
price is less than the market price of the common stock, they were not
in-the-money options and, accordingly, their options had nominal value at
December 31, 2002.
Employment Agreements. We have amended our prior employment agreement with
Mr. Carney whereby he is required to work at a rate of two and one-half days per
week and half of his current base pay is deferred to the termination of his
amended employment agreement of December 31, 2005. No further compensation shall
be paid to Mr. Carney, including the deferral, provided that Mr. Carney's
employment with us does not terminate prior to December 31, 2005.
We have entered into an employment agreement with Mr. Kornfeld. The agreement
continues on a year-to-year basis, from January 1 of each year, unless
terminated on prior notice of not less than 90 days. Salary is determined by the
board, except that the salary may not be reduced except as a part of a salary
reduction program applicable to all executive officers. Upon death or
termination of employment as a result of a disability, the officer or his estate
is to receive a payment equal to three months salary. Upon a termination without
cause Mr. Kornfeld is entitled to receive his then current salary for six months
plus one month for each full year of service up to a maximum aggregate of 24
months. In the event that the executive is covered by an executive severance
agreement, including the salary continuation agreements (as described below),
which provides for payments upon termination subsequent to a "change of
control," the executive would be entitled to the greater of the severance
arrangements as described in this paragraph or the severance payments under the
executive severance agreements. We also have month-to-month agreement with Tatum
CFO Partners of which Mr. Kornfeld is a partner, pursuant to which we pay Tatum
CFO Partners $3,000 per month.
Salary Continuation Agreement. We are party to a salary continuation
agreement with Mr. Kornfeld. The salary continuation agreement provides that, in
the event that a change of control occurs and the executive's employment with us
is subsequently terminated by us other than for cause, death or disability, or
is terminated by the executive as a result of a substantial alteration in the
executive's duties, compensation or other benefits, the executive shall be
entitled to the payment of an amount equal to his monthly salary at the rate in
effect as of the date of his termination (or, if higher, as in effect
immediately prior to the change in control) plus the pro rata monthly amount of
his most recent annual bonus paid immediately before the change of control
multiplied by 24. For purposes of the salary continuation agreement, a change of
control is defined as one which would be required to be reported in response to
the proxy rules under the Securities Exchange Act of 1934, as amended, the
acquisition of beneficial ownership, directly or indirectly, by a person or
group of persons of our securities representing 25% or more of the combined
voting power of our then outstanding securities, or, during any period of two
consecutive years, if individuals who at the beginning of such period
constituted the board cease
26 of 35
for any reason to constitute at least a majority thereof unless the election of
each new director was nominated or ratified by at least two-thirds of the
directors then still in office who were directors at the beginning of the
period. The change of control must occur during the term of the salary
continuation agreement, which is currently through December 31, 2003 and is
renewed automatically unless we give timely notice prior to January 1 of any
year of our election not to renew the agreement. If such a change of control
occurs during the effectiveness of the salary continuation agreement, any
termination of such covered employee during the 18 months following the change
of control will result in the payment of the compensation described above.
Item 12. Principal Holders of Securities and Security Holdings of Management
The following table and discussion provides information as to the shares of
common stock beneficially owned on March 7, 2003 by:
o each director;
o each officer named in the summary compensation table;
o each person owning of record or known by us, based on information
provided to us by the persons named below, to own beneficially at
least 5% of our common stock; and
o all officers and directors as a group.
Shares of Percentage of
Common Stock Outstanding
Name Beneficially Owned Common Stock
---- ------------------ ------------
William V. Carney 303,021 3.0%
Michael A. Tancredi 114,238 1.1%
Warren H. Esanu 116,500 1.2%
Herbert H. Feldman 76,000 *
Marco M. Elser 325,592 3.3%
Edward B. Kornfeld 114,317 1.1%
Ralph DePascale 19,572 *
Christopher Miller 6,796 *
All directors and officers as a group (8
individuals) 1,076,036 10.8%
----------
* Less than 1%
Except as otherwise indicated each person has the sole power to vote and
dispose of all shares of common stock listed opposite his name.
27 of 35
The number of shares owned by our directors and officers named in the
summary compensation table includes shares of common stock which are issuable
upon exercise of options and warrants that are exercisable at March 7, 2003 or
will become exercisable within 60 days after that date. Set forth below is the
number of shares of common stock issuable upon exercise of those options and
warrants for each of these directors and officers.
Name Shares
---- ------
William V. Carney 180,000
Michael A. Tancredi 75,000
Warren H. Esanu 61,500
Herbert H. Feldman 56,000
Marco M. Elser 10,000
Edward B. Kornfeld 88,000
Ralph De Pascale 14,500
Christopher Miller 6,000
All officers and directors as a group 491,000
The shares of common stock issuable upon exercise of Mr. Esanu's options
and warrants include warrants to purchase 12,500 shares of common stock issuable
upon warrants held by Elmira Realty Management Corp. pension and profit sharing
plan. Mr. Esanu has the sole voting and dispositive power with respect to shares
issuable upon exercise of these warrants. All other directors and officers named
in the table hold only options.
Item 13. Certain Relationships and Related Transactions
During 2002, Warren H. Esanu, a director, served as a member of our audit
and compensation committees. During 2002, the law firm of Esanu Katsky Korins &
Siger, LLP, to which Mr. Esanu is of counsel, provided legal services to us, for
which it received fees of $237,591. Esanu Katsky Korins & Siger, LLP is
continuing to render legal services to us during 2003.
Item 14. Controls and Procedures
Our chief executive officer and chief financial officer have supervised and
participated in an evaluation of the effectiveness of our disclosure controls
and procedures as of a date within 90 days of the date of this report, and based
on their evaluations, they believe that our disclosure controls and procedures
(as defined in Rule 13a-14(c) of the Securities Exchange Act of 1934, as
amended) are designed to ensure that information required to be disclosed by us
in the reports that we file or submit under the Securities Exchange Act of 1934
is recorded, processed, summarized and reported, within the time periods
specified in the Commission's rules and forms. As a result of the evaluation,
there were no significant changes in our internal controls or in other factors
that could significantly affect these controls subsequent to the date of their
evaluation.
28 of 35
Part IV
Item 15. Exhibits, Financial Statements Schedules and Reports on Form 8-K.
(a) Document filed as part of this Annual Report on Form 10-K:
(i) Financial Statements.
See Index to Consolidated Financial Statements under Item 8 hereof.
(ii) Financial Statement Schedules.
None
Schedules not listed above have been omitted for the reasons that they were
inapplicable or not required or the information is given elsewhere in the
financial statements.
Separate financial statements of the registrant have been omitted since
restricted net assets of the consolidated subsidiaries do not exceed 25% of
consolidated net assets.
(b) Reports on Form 8-K
None.
29 of 35
(c) Exhibits
Exhibit No. Description of Exhibit
----------
3.1 Certificate of Incorporation of the Company, as amended to date,
incorporated by reference to Exhibit 4 (a) of the Company's
Annual Report on Form 10-K for the year ended December 31, 1991.
3.2 Certificate of Designation of Series B Participating Convertible
Preferred Stock, incorporated by reference to Exhibit 3.2 of the
Company's Annual Report on Form 10-K for the year ended December
31, 1995.
3.3 By-laws of the Company, as amended to date, incorporated by
reference to Exhibit 3.3 of the Company's Annual Report on Form
10-K for the year ended December 31, 1995.
4.1 Amended and Restated Loan and Security Agreement dated as of
November 28, 1994, between the Company and Foothill ("Foothill")
Capital Corporation, incorporated by reference to Exhibit 2 to
the Company's Current Report on Form 8-K dated November 30,
1994.
4.2 Amendment Number One dated February 13, 1995 to the Amended and
Restated Loan and Security Agreement dated as of November 28,
1994 between the Company and Foothill, incorporated by reference
to Exhibit 4.7 of the Company's Annual Report on Form 10K for
the year ended December 31, 1995.
4.3 Amendment Number Two dated March 30, 1995 to the Amended and
Restated Loan and Security Agreement dated as of November 28,
1994 between the Company and Foothill, incorporated by reference
to Exhibit 4.7.2 of the Company's Annual Report on Form 10K for
the year ended December 31, 1995.
4.4 Amended and Restated Secured Promissory Note dated February 13,
1995, incorporated by reference to Exhibit 4.9 of the Company's
Annual Report on Form 10K for the year ended December 31, 1995.
4.5 Amendment Number Three to Amended and Restated Loan and Security
Agreement dated March 12, 1996, between the Company and
Foothill, incorporated by reference to Exhibit 4.11 of the
Company's Annual Report on Form 10K for the year ended December
31, 1995.
4.6 Warrant to Purchase Common Stock of the Company dated November
28, 1994 executed by the Company in favor of Foothill,
incorporated by reference to Exhibit 6 to the Company's Current
Report on Form 8-K dated November 30, 1994.
4.7 Lockbox Operating Procedural Agreement dated as of November 28,
1994 among Chemical Bank, the Company and Foothill, incorporated
by reference to Exhibit 7 to the Company's Current Report on
Form 8-K dated November 30, 1994.
30 of 35
Exhibits (continued)
Exhibit No. Description of Exhibit
-----------
4.8 Combined Amendment No. Four dated as of March 1, 2002 to Amended
and Restated Loan and Security agreement between Foothill and
the Company.
4.9 Combined Amendment No. Five dated as of May 10, 2002 to Amended
and Restated Loan and Security agreement between Foothill and
the Company.
4.10 Combined Amendment No. Six dated as of March 19, 2003 to Amended
and Restated Loan and Security agreement between Foothill and
the Company.
10.1 Form of Executive Salary Continuation Agreement, incorporated by
reference to Exhibit 19 (cc) of the Company's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1985.
10.2 Lease dated November 6, 2002 between the Company and Long Island
Industrial Group LLC.
10.3 Lease dated May 1, 2002 between the Company and Long Island
Industrial Group LLC.
22 Subsidiaries of the Company, incorporated by reference to
Exhibit 22.1 of the Company's Annual Report on Form 10K for the
year ended December 31, 1995.
23 Consent of Independent Certified Public Accountants.
31 of 35
SIGNATURES
Pursuant to the requirements of Section 13 or 15(b) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
PORTA SYSTEMS CORP.
Dated March 31, 2003 By /s/ William V. Carney
` ----------------------------
William V. Carney
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the report has been signed by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated. Each person whose
signature appears below hereby authorizes William V. Carney and Edward B.
Kornfeld or either of them acting in the absence of the others, as his true and
lawful attorney-in-fact and agent, with full power of substitution and
resubstitution for him and in his name, place and stead, in any and all
capacities to sign any and all amendments to this report, and to file the same,
with all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission.
Signature Title Date
------------------------------- ----------------------- ---------------
/s/William V. Carney Chairman of the Board, March 31, 2003
------------------------------- Chief Executive Officer
William V. Carney and Director Principal
(Executive Officer)
/s/Edward B. Kornfeld Senior Vice President and March 31, 2003
------------------------------- Chief Financial Officer
Edward B. Kornfeld (Principal Financial
and Accounting Officer)
/s/Warren H. Esanu Director March 31, 2003
-------------------------------
Warren H. Esanu
/s/Michael A. Tancredi Director March 31, 2003
-------------------------------
Michael A. Tancredi
/s/Herbert H. Feldman Director March 31, 2003
-------------------------------
Herbert H. Feldman
/s/Marco Elser Director March 31, 2003
-------------------------------
Marco Elser
32 of 35
CERTIFICATION OF CHIEF EXECUTIVE AND FINANCIAL OFFICERS
The undersigned chief executive officer and chief financial officer of
the Registrant do hereby certify that this Annual Report on Form 10-K fully
complies with the requirements of Section 13(a) or 15(d) of the Securities Act
of 1934, as amended, and that the information contained in this report fairly
presents, in all material respects, the financial condition and results of
operations of the Registrant at the dates and for the periods shown in such
report.
Dated March 31, 2003 By /s/William V. Carney
--------------------------------
William V. Carney
Chairman of the Board
and Chief Executive Officer
Dated March 31, 2003 By /s/Edward B. Kornfeld
--------------------------------
Edward B. Kornfeld
Senior Vice President
and Chief Financial Officer
33 of 35
William V. Carney does hereby certify that he is the duly elected and incumbent
chief executive officerof Porta Systems Corp ("the issuer") and he does hereby
certify, with respect to the issuer's Form 10-K for the year ended December 31,
2002 (the "report") as follows:
1. He has reviewed the report;
2. Based on his knowledge, the report does not contain any untrue statement of
a material fact or omit to state a material fact necessary in order to make
the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
the report;
3. Based on his knowledge, the financial statements, and other financial
information included in the report, fairly present in all material respects
the financial condition, results of operations and cash flows of the issuer
as of, and for, the periods presented in the report;
4. He and the other certifying officer are responsible for establishing and
maintaining disclosure controls and procedures, as defined in Rule
13a-14(c) of the Securities Exchange Act of 1934, as amended, for the
issuer and have:
i. Designed such disclosure controls and procedures to ensure that
material information relating to the issuer, including its
consolidated subsidiaries, is made known to them by others within
those entities, particularly during the period in which the periodic
reports are being prepared;
ii. Evaluated the effectiveness of the issuer's disclosure controls and
procedures as of a date within 90 days prior to the filing date of the
report (the "Evaluation Date"); and
iii. Presented in the report their conclusions about the effectiveness of
the disclosure controls and procedures based on the required
evaluation as of the Evaluation Date
5. He and the other certifying officer have disclosed to the issuer's auditors
and to the audit committee of the board of directors (or persons fulfilling
the equivalent function):
i. All significant deficiencies in the design or operation of internal
controls which could adversely affect the issuer's ability to record,
process, summarize and report financial data and have identified for
the issuer's auditors any material weaknesses in internal controls;
and
ii. Any fraud, whether or not material, that involves management or other
employees who have a significant role in the issuer's internal
controls; and
6. He and the other certifying officer have indicated in the report whether or
not there were significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent to the date of
their most recent evaluation, including any corrective actions with regard
to significant deficiencies and material weaknesses.
By /s/ William V. Carney
--------------------------------
William V. Carney
Chief Executive Officer
Edward B. Kornfeld does hereby certify that he is the duly elected and incumbent
chief financial officer of Porta Systems Corp. (the "issuer") and he does hereby
certify, with respect to the issuer's Form 10-K for the year ended December 31,
2002 (the "report") as follows:
1. He has reviewed the report;
2. Based on his knowledge, the report does not contain any untrue statement of
a material fact or omit to state a material fact necessary in order to make
the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
the report;
34 of 35
3. Based on his knowledge, the financial statements, and other financial
information included in the report, fairly present in all material respects
the financial condition, results of operations and cash flows of the issuer
as of, and for, the periods presented in the report;
4. He and the other certifying officer are responsible for establishing and
maintaining disclosure controls and procedures, as defined in Rule
13a-14(c) of the Securities Exchange Act of 1934, as amended, for the
issuer and have:
i. Designed such disclosure controls and procedures to ensure that
material information relating to the issuer, including its
consolidated subsidiaries, is made known to them by others within
those entities, particularly during the period in which the periodic
reports are being prepared;
ii. Evaluated the effectiveness of the issuer's disclosure controls and
procedures as of a date within 90 days prior to the filing date of the
report (the "Evaluation Date"); and
iii. Presented in the report their conclusions about the effectiveness of
the disclosure controls and procedures based on the required
evaluation as of the Evaluation Date
5. He and the other certifying officer have disclosed to the issuer's auditors
and to the audit committee of the board of directors (or persons fulfilling
the equivalent function):
i. All significant deficiencies in the design or operation of internal
controls which could adversely affect the issuer's ability to record,
process, summarize and report financial data and have identified for
the issuer's auditors any material weaknesses in internal controls;
and
ii. Any fraud, whether or not material, that involves management or other
employees who have a significant role in the issuer's internal
controls; and
6. He and the other certifying officer have indicated in the report whether or
not there were significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent to the date of
their most recent evaluation, including any corrective actions with regard
to significant deficiencies and material weaknesses.
By /s/Edward B. Kornfeld
-----------------------------
Edward B. Kornfeld
Chief Financial Officer
35 of 35
Exhibit I
Item 8. Financial Statements and Supplementary Data
Index Page
Report of Independent Certified Public Accountants F-2
Consolidated Financial Statements and Notes:
Consolidated Balance Sheets,
December 31, 2002 and 2001 F-3
Consolidated Statements of Operations and
Comprehensive Loss,
Years Ended December 31, 2002, 2001 and 2000 F-4
Consolidated Statements of Stockholders'
Deficit, Years Ended
December 31, 2002, 2001 and 2000 F-5
Consolidated Statements of Cash Flows
for the Years Ended December 31, 2002,
2001 and 2000 F-6
Notes to Consolidated Financial Statements F-7
F-1
Report of Independent Certified Public Accountants
The Board of Directors and Stockholders
Porta Systems Corp.
Syosset, New York
We have audited the accompanying consolidated balance sheets of Porta Systems
Corp. and subsidiaries as of December 31, 2002 and 2001, and the related
consolidated statements of operations and comprehensive loss, stockholders'
deficit, and cash flows for each of the three years in the period ended December
31, 2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Porta Systems Corp.
and subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States of America.
As discussed in Notes 1 and 6 to the consolidated financial statements,
effective January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets."
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company has suffered substantial losses
from operations in 2002, 2001, and 2000 and, as of December 31, 2002, has a
stockholders' deficit of $29,935,000 and a working capital deficit of
$34,199,000. These factors raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans in regard to these matters
are also described in Note 2. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/BDO SEIDMAN, LLP
---------------------
BDO SEIDMAN, LLP
Melville, New York
March 13, 2003
F-2
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2002 and 2001
(in thousands, except shares and par value)
Assets 2002 2001
------ ---- ----
Current assets:
Cash and cash equivalents $ 779 1,204
Accounts receivable - trade, less allowance
for doubtful accounts of $1,967 in 2002 and
$2,168 in 2001 4,654 4,284
Inventories 3,363 5,206
Prepaid expenses and other current assets 329 852
--------- ------
Total current assets 9,125 11,546
Property, plant and equipment, net 1,802 2,328
Goodwill, net 2,961 3,761
Other assets 340 198
--------- ------
Total assets $ 14,228 17,833
========= ======
Liabilities and Stockholders' Deficit
Current liabilities:
Senior debt $ 25,070 22,095
Subordinated notes 6,144 6,144
6% Convertible subordinated debentures 385 382
Accounts payable 5,241 7,023
Accrued expenses 2,640 3,417
Accrued interest payable 2,639 1,593
Accrued commissions 566 1,607
Deferred compensation 329 196
Income taxes payable 302 314
Short-term loans 8 11
--------- ------
Total current liabilities 43,324 42,782
--------- ------
Deferred compensation 839 900
--------- ------
Total long-term liabilities 839 900
--------- ------
Total liabilities 44,163 43,682
--------- ------
Commitments and contingencies
Stockholders' deficit:
Preferred stock, no par value;
authorized 1,000,000 shares,
none issued -- --
Common stock, par value $.01;
authorized 20,000,000 shares,
issued 10,003,224 and 9,947,421
shares in 2002 and 2001, respectively 100 99
Additional paid-in capital 76,059 76,056
Accumulated deficit (100,023) (95,909)
Accumulated other comprehensive loss:
Foreign currency translation adjustment (4,133) (4,157)
--------- ------
(27,997) (23,911)
Treasury stock, at cost, 30,940 shares (1,938) (1,938)
--------- ------
Total stockholders' deficit (29,935) (25,849)
--------- ------
Total liabilities and stockholders' deficit $ 14,228 17,833
========= ======
See accompanying notes to consolidated financial statements.
F-3
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Operations and
Comprehensive Loss Years ended
December 31, 2002, 2001 and 2000
(in thousands, except per share amounts)
2002 2001 2000
---- ---- ----
Sales $ 21,417 28,062 51,140
Cost of sales 14,599 19,970 35,890
-------- ------ ------
Gross profit 6,818 8,092 15,250
-------- ------ ------
Selling, general and administrative expenses 6,383 9,316 14,573
Research and development expenses 2,516 4,427 5,830
Goodwill impairment 800 5,802 --
-------- ------ ------
Total expenses 9,699 19,545 20,403
-------- ------ ------
Operating loss (2,881) (11,453) (5,153)
Interest expense (1,798) (4,480) (4,500)
Interest income 7 31 129
Gain on sale of assets -- 684 --
Gain on sale of investment in joint venture 450 -- --
Equity in net loss of joint venture -- (175) --
Other income (expense), net 119 191 (813)
-------- ------ ------
Loss before income taxes and minority
interest (4,103) (15,202) (10,337)
Income tax benefit (expense) (11) 203 (227)
Minority interest -- 225 388
-------- ------ ------
Net loss $ (4,114) (14,774) (10,176)
======== ====== ======
Other comprehensive income (loss):
Foreign currency translation adjustments 24 (360) 99
Comprehensive loss $ (4,090) (15,134) (10,077)
======== ====== ======
Basic per share amounts:
Net loss per share of common stock $ (0.41) (1.50) (1.04)
======== ====== ======
Weighted average shares of common stock
outstanding 9,994 9,878 9,763
======== ====== ======
Diluted per share amounts:
Net loss per share of common stock $ (0.41) (1.50) (1.04)
======== ====== ======
Weighted average shares of common stock
outstanding 9,994 9,878 9,763
======== ====== ======
See accompanying notes to consolidated financial statements.
F-4
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Deficit
Years ended December 31, 2002, 2001 and 2000
(In thousands)
Common Stock Accumulated Total
------------------ Additional Other Stock-
No. of Par Value Paid-in Comprehensive Accumulated Treasury holders'
Shares Amount Capital (Loss) Deficit Stock Deficit
------ ------ ------- ------ ------- ----- -------
Balance at December 31, 1999 9,639 $ 96 $ 75,310 $ (3,896) $ (70,959) $ (1,938) $ (1,387)
Net loss 2000 -- -- -- -- (10,176) -- (10,176)
Common stock issued 178 2 174 -- -- -- 176
Warrants issued or re-priced -- -- 496 -- -- -- 496
Foreign currency translation
adjustment -- -- -- 99 -- -- 99
------ ---- --------- --------- --------- --------- ---------
Balance at December 31, 2000 9,817 98 75,980 (3,797) (81,135) (1,938) (10,792)
Net loss 2001 -- -- -- -- (14,774) -- (14,774)
Common stock issued 130 1 37 -- -- -- 38
Warrants re-priced -- -- 39 -- -- -- 39
Foreign currency translation
adjustment -- -- -- (360) -- -- (360)
------ ---- --------- --------- --------- --------- ---------
Balance at December 31, 2001 9,947 99 76,056 (4,157) (95,909) (1,938) (25,849)
Net loss 2002 -- -- -- -- (4,114) -- (4,114)
Common stock issued 56 1 3 -- -- -- 4
Foreign currency translation
adjustment -- -- -- 24 -- -- 24
------ ---- --------- --------- --------- --------- ---------
Balance at December 31, 2002 10,003 $100 $ 76,059 $ (4,133) $(100,023) $ (1,938) $ (29,935)
====== ==== ========= ========= ========= ========= =========
See accompanying notes to consolidated financial statements
F-5
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Note 21) Years ended December 31,
2002, 2001 and 2000
(In thousands)
2002 2001 2000
---- ---- ----
Cash flows from operating activities:
Net loss $(4,114) (14,774) (10,176)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 713 1,909 1,911
Goodwill impairment 800 5,802 --
Amortization of debt discounts 3 6 56
Gain on sale of investment in joint venture (450) -- --
Non-cash financing expenses -- 123 373
Gain on sale of assets -- (684) --
Minority interest -- (225) (388)
Equity in loss of joint venture -- 175 --
Changes in operating assets and liabilities:
Accounts receivable (370) 3,141 4,712
Inventories 1,843 1,944 1,743
Prepaid expenses 523 278 243
Other assets (142) 867 1,427
Accounts payable, accrued expenses and other liabilities (2,044) (2,341) (2,405)
------- ----- -----
Net cash used in operating activities (3,238) (3,779) (2,504)
------- ----- -----
Cash flows from investing activities:
Net proceeds from the sale of assets -- 1,670 --
Capital expenditures, net (124) (196) (1,533)
------- ----- -----
Net cash provided by (used in) investing activities (124) 1,474 (1,533)
------- ----- -----
Cash flows from financing activities:
Proceeds from senior debt 2,975 2,222 5,010
Repayments of senior debt -- (873) (1,782)
Proceeds from subordinated debentures and warrants -- -- 80
Proceeds from the issuance of common stock 4 38 176
Proceeds (repayments) of notes payable/short-term loans (3) 10 (43)
------- ----- -----
Net cash provided by financing activities 2,976 1,397 3,441
------- ----- -----
Effect of exchange rate changes on cash and cash equivalents (39) (254) (283)
------- ----- -----
Decrease in cash and cash equivalents (425) (1,162) (879)
Cash and equivalents - beginning of year 1,204 2,366 3,245
------- ----- -----
Cash and equivalents - end of year $ 779 1,204 2,366
======= ===== =====
See accompanying notes to consolidated financial statements.
F-6
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2001 and 2000
(1) Summary of Significant Accounting Policies
Nature of Operations and Principles of Consolidation
Porta Systems Corp. ("Porta" or the "Company") designs, manufactures and
markets systems for the connection, protection, testing and
administration of public and private telecommunications lines and
networks. The Company has various patents for copper and software based
products and systems that support voice, data, image and video
transmission. Porta's principal customers are the U.S. regional telephone
operating companies and foreign telephone companies.
The accompanying consolidated financial statements include the accounts of
Porta and its majority-owned or controlled subsidiaries. All significant
intercompany transactions and balances have been eliminated in
consolidation.
Revenue Recognition
Revenue, other than from long-term contracts for specialized products, is
recognized when a product is shipped. Revenues and earnings relating to
long-term contracts for specialized products are recognized on the
percentage-of-completion basis primarily measured by the attainment of
milestones. Anticipated losses, if any, are recognized in the period in
which they are identified.
Concentration of Credit Risk
Financial instruments, which potentially subject Porta to concentrations of
credit risk, consist principally of cash and accounts receivable. At
times such cash in banks exceeds the FDIC insurance limit.
As discussed in notes 17 and 22, substantial portions of Porta's sales are
to customers in foreign countries. The Company's credit risk with respect
to new foreign customers is reduced by obtaining letters of credit for a
substantial portion of the contract price, and by monitoring credit
exposure related to each customer.
Cash Equivalents
The Company considers investments with original maturities of three months
or less at the time of purchase to be cash equivalents. Cash equivalents
consist of commercial paper.
Accounts Receivable
Accounts receivable are customer obligations due under normal trade terms.
The Company sells its products directly to customers, to distributors and
original equipment manufacturers involved in a variety of industries
including, telecommunications and military/aerospace. The Company
performs continuing credit evaluations of its customers' financial
condition and although it generally does not require collateral, letters
of credit may be required from customers in certain circumstances.
(Continued)
F-7
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The Company records an allowance for doubtful accounts receivable based on
specifically identified amounts that it believes to be uncollectible. The
Company also records additional allowances based on certain percentages
of its aged receivables, which are determined based on historical
experience and its assessment of the general financial conditions
affecting its customer base. If the Company's actual collection
experience changes, revisions to its allowance may be required. The
Company has a limited number of customers with individually large amounts
due at any given balance sheet date.
Inventories
Inventories are stated at the lower of cost (on the average or first-in,
first-out methods) or market.
Property, Plant and Equipment
Property, plant and equipment are carried at cost. Leasehold improvements
are amortized over the term of the lease. Depreciation is computed using
the straight-line method over the related assets' estimated lives.
Deferred Computer Software
The Company engages solely in development of software products for specific
customer contracts and as such costs are charged to cost of sales at the
time revenues on such contracts are recognized.
Goodwill
Goodwill represents the difference between the purchase price and the fair
market value of net assets acquired in business combinations treated as
purchases. Commencing January 1, 2002, goodwill is an indefinite lived
asset and as such is not amortized. On an annual basis, or more
frequently if certain events occur, the Company tests the goodwill for
impairment. The Company determines the market value of the reporting unit
by considering the projected cash flows generated from the reporting unit
to which the goodwill relates.
Income Taxes
Deferred income taxes are recognized based on the differences between the
tax bases of assets and liabilities and their reported amounts in the
financial statements that will result in taxable or deductible amounts in
future years. Further, the effects of tax law or rate changes are
included in income as part of deferred tax expense or benefit for the
period that includes the enactment date (note 14).
Foreign Currency Translation
Assets and liabilities of foreign subsidiaries are translated at year-end
rates of exchange, and revenues and expenses are translated at the
average rates of exchange for the year. Gains and losses resulting from
translation are accumulated in a separate component of stockholders'
equity. Gains and losses resulting from foreign currency transactions
(transactions denominated in a currency other than the functional
currency) are included in operations.
(Continued)
F-8
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Net Loss Per Share
Basic net loss per share is based on the weighted average number of shares
outstanding. Diluted net loss per share is based on the weighted average
number of shares outstanding plus the dilutive effect of potential shares
of common stock, as if such shares had been issued. For 2002, 2001 and
2000, no dilutive potential shares of common stock were added to compute
diluted loss per share because the effect would be anti-dilutive.
Reclassifications
Certain reclassifications have been made to conform prior years'
consolidated financial statements to the 2002 presentation.
Accounting for Stock-Based Compensation
The Company applies the intrinsic value method as outlined in APB Opinion
No. 25, "Accounting for Stock Issued to Employees", and related
Interpretations in accounting for stock options. Under the intrinsic
value method, no compensation expense is recognized if the exercise price
of the Company's employee stock options equals the market price of the
underlying stock on the date of the grant. Accordingly, no compensation
cost has been recognized. SFAS No. 123, "Accounting for Stock-Based
Compensation", requires the Company to provide pro forma information
regarding net loss and net loss per common share as if compensation cost
for the Company's stock option programs had been determined in accordance
with the fair value method prescribed therein. The following table
illustrates the effect on net loss and loss per common share as if the
fair value method had been applied to all outstanding and unvested awards
in each period presented.
Year Ended December 31
------------------------------
2002 2001 2000
---- ---- ----
(In millions, except per share data)
Net loss, as reported .................. $(4,114) $(14,774) $(10,176)
Deduct: Total stock-based employee
compensation expense determined
under fair value method for all awards (1) (13) (217)
------- -------- --------
Pro forma net loss ..................... $(4,115) $(14,787) $(10,393)
======= ======== ========
Loss per common share:
Basic - as reported .................. $ (0.41) $ (1.50) $ (1.04)
======= ======== ========
Basic - pro forma .................... $ (0.41) $ (1.50) $ (1.06)
======= ======== ========
Diluted - as reported ................ $ (0.41) $ (1.50) $ (1.04)
======= ======== ========
Diluted - pro forma .................. $ (0.41) $ (1.50) $ (1.06)
======= ======== ========
(Continued)
F-9
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Accounting for the Impairment of Long-Lived Assets
The Company follows the Statement of Financial Accounting Standard No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets".
Long-lived assets other than goodwill are evaluated for impairment when
events or changes in circumstances indicate the carrying amount of the
assets may not be recoverable through the estimated undiscounted future
cash flows from the use of these assets.
Use of Estimates
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Among the more significant estimates
included in these consolidated financial statements are the estimated
allowance for doubtful accounts receivable, inventory reserves,
percentage of completion for long-term contracts, goodwill valuation and
the deferred tax asset valuation allowance. Actual results could differ
from those and other estimates.
New Accounting Pronouncements
In June 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146 ("SFAS 146"), "Accounting for
Costs Associated with Exit or Disposal Activities". This statement covers
restructuring type activities beginning with plans initiated after
December 31, 2002. Should the Company enter into activities covered by
this standard after that date, the provisions of SFAS 146 would be
applied. As a result of this standard, there is no impact on the
Company's consolidated financial position or results of operations for
the periods presented.
In December 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS 148"). SFAS 148 provides
alternative methods of transition for a voluntary change to the fair
value method of accounting for stock-based employee compensation as
originally provided by SFAS No. 123 "Accounting for Stock-Based
Compensation". Additionally, SFAS 148 amends the disclosure requirements
of SFAS 123 to require prominent disclosure in both the annual and
interim financial statements about the method of accounting for
stock-based compensation and the effect of the method used on reported
results. The transitional requirements of SFAS 148 will be effective for
all financial statements for fiscal years ending after December 15, 2002.
The disclosure requirements shall be effective for financial reports
containing condensed financial statements for interim periods beginning
after December 31, 2002. The Company has adopted the disclosure portion
of this statement for the fiscal year ended December 31, 2002. The
application of this standard will have no impact on the Company's
consolidated financial position or results of operations. The Company
expects to continue to utilize the intrinsic value method of accounting
for stock-based employee compensation.
(Continued)
F-10
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(2) Liquidity
As of December 31, 2002, the Company's debt included $25,070,000 of senior
debt including principal and interest, which, as a result of a March 2003
extension, matures on May 15, 2003, and principle amount $6,144,000 of
subordinated debt, which matured on July 3, 2001. The Company was unable
to pay the principal ($6,144,000) or interest ($2,300,000) on the
subordinated notes. The amount of interest represents interest from July
2000 through December 2002. At December 31, 2002, the Company did not
have sufficient resources to pay either the senior lender or the
subordinated lenders and it is likely that it cannot generate such cash
from its operations, and the senior lender had precluded the Company from
making payments on the subordinated debt. Accordingly, all senior and
subordinated debt are classified as current liabilities at December 31,
2002 (note 7).
In March 2003, the Company and its senior lender agreed to an amended and
restated loan and security agreement extending the due date of the
indebtedness to May 15, 2003. As part of this agreement, the senior
lender continues to preclude the Company from making any payments on
indebtedness to any subordinated creditors, but the Company is not
prohibited from paying accounts payable in the normal course of business.
As of December 31, 2002, the Company had remaining outstanding $385,000 of
6% Debentures which matured on July 2, 2002. Due to the restriction
imposed by the Company's senior lender precluding it from making any
payments on indebtedness to any subordinated debt holder, the Company was
unable to pay the interest due of $23,000 which was due on each of July
1, 2001 and 2002, and it was unable to pay the principal of $385,000
which was due on July 2, 2002. Additionally, the Company has been
notified by the trustee that the non-payment caused an event of default.
As a result of its continuing financial difficulties:
o the Company is having and may continue to have difficulty performing
its obligations under its contracts, which could result in the
cancellation of contracts or the loss of future business and penalties
for non-performance;
o a number of creditors have engaged attorneys or collection agencies or
commenced legal actions against the Company, and some of them have
obtained judgments against the Company; and
o the Company continued to suffer a significant decline in revenue in
2002 from 2001 following a significant decline in revenue in 2001 from
2000.
(Continued)
F-11
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Claimants who have already either commenced litigation or otherwise sought
collection or have obtained a judgment against the Company are due
approximately $214,000. If Porta is unable to reach a settlement with
these creditors and others who have not yet brought claims, and these
claimants obtain judgments against the Company or seek to enforce
judgments against the Company, it may be necessary for it, or its senior
lender may require it, to seek protection under the Bankruptcy Code.
The creditors include five former senior executives who have deferred
compensation agreements with the Company. The total payments due under
these agreements are approximately $1.9 million, of which $133,000 was
due at December 31, 2002 and an additional $196,000 becomes due in 2003.
The claimants commenced litigation that has been adjourned pending
settlement. The Company is in the latter stages of settlement
negotiations with these creditors.
The Company is seeking to address its need for liquidity by exploring
alternatives, including the possible sale of one or more of its
divisions. During 2001 and 2002, the Company was engaged in discussions
with respect to the possible sale of its divisions; however, those
negotiations were terminated without an agreement having been reached.
Furthermore, if the Company sells a division, the agreement with the
Company's senior lender requires it to pay the net proceeds to the senior
lender. As a result of this provision and the Company's obligations to
the holders of subordinated debt, unless the lenders consent to the
Company retaining a portion of the net proceeds from any sale for its
operations, the Company will not receive any significant amount, and may
not receive any, of the net proceeds from any such sale for working
capital.
During 2001 and 2002, the Company has taken steps to reduce overhead,
including a reduction in personnel. The Company will continue to look to
reduce costs while it seeks additional business from new and existing
customers. Because of its present stock price, it is highly unlikely that
the Company will be able to raise funds through the sales of its equity
securities, and Porta's financial condition prevents it from issuing debt
securities. In the event that the Company is unable to extend its debt
obligations and sell one or more of its divisions, it cannot be assured
that the Company will be able to continue in operations. Furthermore, the
Company believes that its losses and its financial position, together
with the continuing economic climate affecting the telecommunications
industry generally, are having and will continue to have an adverse
effect upon its ability to develop new business as competitors and
potential customers question its ability both to perform its obligations
under any agreements it may enter and to continue in business. The
Company has been informally advised by British Telecommunications, which
is one of its largest customers that, because of Porta's financial
position, this customer will not place orders with the Company for its
OSS products until it can demonstrate that it is financially viable.
However, this customer continues to place orders for OSS maintenance and
modest orders for line test products. The loss of this customer would
have a material adverse effect upon the Company's operations.
These financial statements have been prepared assuming that the Company
will continue as a going concern and, accordingly, do not include any
adjustments that might result from the outcome of the uncertainties
described above.
(Continued)
F-12
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Accounts Receivable
Accounts receivable are customer obligations due under normal trade terms.
The Company sells its products directly to customers, to distributors and
original equipment manufacturers involved in a variety of industries
including, telecommunications and military/aerospace. The Company
performs continuing credit evaluations of its customers' financial
condition and although it generally does not require collateral, letters
of credit may be required from customers in certain circumstances. Senior
management reviews accounts receivable on a monthly basis to determine if
any receivables will potentially be uncollectible. Included are any
accounts receivable balances that are determined to be uncollectible,
along with a general reserve, in the overall allowance for doubtful
accounts. After all attempts to collect a receivable have failed, the
receivable is written off against the allowance. Based on the information
available to the Company, it believes the allowance for doubtful accounts
as of December 31, 2002 is adequate. However, actual write-offs might
exceed the recorded allowance.
Accounts receivable included approximately $873,000 and $500,000 at
December 31, 2002 and 2001, respectively, of revenues earned but not yet
contractually billable relating to long-term contracts for specialized
products. All such amounts at December 31, 2002 are expected to be billed
in 2003. In addition, accounts receivable included approximately $300,000
and $311,000 at December 31, 2002 and 2001, respectively, of retainage
balances due on various long-term contracts. All such amounts, net of
reserves, at December 31, 2002 are expected to be collected in 2003 and
all such amounts, net of reserves, at December 31, 2001, were collected
in 2002. The allowance for doubtful accounts receivable was $1,967,000
and $2,168,000 as of December 31, 2002 and 2001, respectively. The
allowance for doubtful accounts was increased by provisions of $23,000,
$0, and $730,000 and decreased by write-offs of $224,000, $309,000, and
$132,000 for the years ended December 31, 2002, 2001, and 2000,
respectively.
(4) Inventories
Inventories consist of the following:
December 31,
------------------------------
2002 2001
---- ----
Parts and components $1,767,000 3,217,000
Work-in-process 208,000 192,000
Finished goods 1,388,000 1,797,000
---------- ---------
$3,363,000 5,206,000
========== =========
(Continued)
F-13
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Property, Plant and Equipment
Property, plant and equipment consists of the following:
December 31
-------------------------- Estimated
2002 2001 useful lives
---- ---- ------------
Land $ 132,000 132,000 --
Buildings 1,110,000 1,060,000 20-50 years
Machinery and equipment 7,821,000 7,221,000 3-8 years
Furniture and fixtures 2,551,000 2,557,000 5-10 years
Transportation equipment 74,000 84,000 4 years
Tools and molds 3,774,000 4,108,000 8 years
Leasehold improvements 858,000 822,000 Term of lease
----------- ---------
16,320,000 15,984,000
Less accumulated depreciation
and amortization 14,518,000 13,656,000
----------- ---------
$ 1,802,000 2,328,000
=========== =========
During 2001, the Company sold its Glen Cove, New York facility for
$1,850,000 and recognized a gain on the sale of $684,000, net of expenses
of $180,000. Of the net proceeds of $1,670,000, $474,000 was used to
reduce outstanding principal and $350,000 to reduce outstanding interest
obligations to the Company's senior lender. The Company retained the
remaining proceeds of $846,000 for working capital purposes.
(6) Goodwill
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets". This statement established financial accounting and reporting
standards for acquired goodwill and other intangible assets.
Specifically, the standard addresses how acquired intangible assets
should be accounted for after they have been recognized in the financial
statements. In accordance with SFAS No. 142, intangible assets, including
purchased goodwill, must be evaluated for impairment. Those intangible
assets that will continue to be classified as goodwill or as other
intangibles with indefinite lives are no longer amortized.
Effective January 1, 2002, the Company ceased amortization of goodwill
resulting in a decrease of $795,000 in amortization for the year ended
December 31, 2002 compared to the same period in 2001. Instead of
amortizing goodwill over a fixed period of time, the Company will measure
the fair value of the acquired business at least annually to determine if
goodwill has been impaired. In addition, the Company completed the first
step of the goodwill transitional impairment test, which requires
determining the fair value of the reporting units as of January 1, 2002
and comparing it to the carrying value of the reporting units net assets.
The Company determined that there was no impairment loss resulting from
the transitional impairment test as of January 1, 2002.
(Continued)
F-14
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
As of December 31, 2002 and 2001, unamortized goodwill was $2,961,000 and
$3,761,000, respectively. During the second quarter of 2002, the Company
was engaged in discussions with respect to the sale of the Signal
division. Based on those discussions the Company determined that goodwill
was impaired and it estimated that the amount of the impairment was
$800,000. This amount was charged to operations in the quarter ended June
30, 2002. Furthermore, the Company cannot give assurances that further
write-downs will not be necessary.
In December 2001, the Company determined that $5,802,000 of goodwill
associated with its OSS business unit was impaired and as such recorded
an impairment loss. This assessment was based on the continued decline in
sales and losses generated by the business unit over the past several
years and the declining prospects for additional sales of the products
based on the older technology that originally gave rise to the goodwill.
The following schedule presents adjusted net loss, basic net loss per share
and diluted net loss per share, exclusive of goodwill amortization
expense, had the standard been adopted for those periods.
Year Ended June 30
-------------------------------
2002 2001 2000
---- ---- ----
(In thousands, except per share data)
Reported net loss ..................... $(4,114) $(14,774) $(10,176)
Add back:
Goodwill amortization ............. -- 795 719
------- -------- ----------
Adjusted net loss ..................... $(4,114) $(13,979) $ (9,457)
======= ======== ==========
Basic net loss per common share:
Reported net loss ................. $ (0.41) $ (1.50) $ (1.04)
Goodwill amortization ............. -- .08 .07
------- -------- ----------
Adjusted net loss ................. $ (0.41) $ (1.42) $ (0.97)
======= ======== ==========
Diluted net earnings per common share:
Reported net loss ................. $ (0.41) $ (1.50) $ (1.04)
Goodwill amortization ............. -- .08 .07
------- -------- ----------
Adjusted net loss ................. $ (0.41) $ (1.42) $ (0.97)
======= ======== ==========
(Continued)
F-15
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(7) Senior Debt
On December 31, 2002 and 2001, Porta's senior debt consisted of debt under
its credit facility in the amount of $25,070,000 and $22,095,000,
respectively. The current agreement with the senior lender, as amended in
March 2002 and March 2003 and described below, expires on May 15, 2003
and, accordingly, the senior debt has been classified as a current
liability. (See Note 2)
In March 2003, the Company's senior lender agreed to an extension to May
15, 2003 of the existing agreement that had expired on December 31, 2002.
In March 2002, the senior lender agreed to an amended and restated loan and
security agreement whereby a new term loan was established with a maximum
principal amount of $1,500,000 and subsequently increased in May 2002 to
$2,250,000. The agreement allowed the Company to draw monies subject to
the senior lender's receipt and approval of a weekly disbursement budget.
Any advances under this agreement were at the discretion of the senior
lender. Obligations under the new term loan bear interest at 12%, which
interest shall accrue monthly and be added to the principal until
September 1, 2002 when interest for the month of August 2002 became
payable and current interest became payable. The agreement provides that
all indebtedness prior to March 1, 2002 is reflected as an old term loan
in the amount of $22,610,000, which includes the principal balance due at
December 31, 2001 plus accrued interest though March 1, 2002. The old
term loan bears no interest until such time as the senior lender in its
sole discretion notifies the Company that interest shall be payable.
Additionally, the senior lender prohibited the Company from making any
payments on indebtedness to any subordinated creditors, but the Company
is not prohibited from paying accounts payable in the ordinary course of
business. Finally, the agreement allowed for standby letters of credit
not to exceed a maximum of $573,000. As of December 31, 2002, the Company
did not have any standby letters of credit outstanding. As of December
31, 2002, the Company has borrowed $2,250,000, the maximum principal
amount under the new term loan, and the total principal and interest on
the new term loan was $2,460,000.
As consideration for an April 2001 loan amendment, the Company agreed to
reduce the exercise price of the outstanding warrants to purchase
approximately 570,000 shares of common stock held by its senior lender to
$0.25 per share. The value of the reduction in exercise price was
$39,000, which was recorded as interest expense and additional paid in
capital. As of December 31, 2002, 100,000 of these warrants remain
outstanding.
(8) 6% Convertible Subordinated Debentures
As of December 31, 2002 and 2001, the Company had outstanding $385,000 and
$382,000 of its 6% convertible subordinated debentures due July 1, 2002
(the "Debentures"), net of original issue discount of $0 and $3,000,
respectively. The face amount of the outstanding Debentures was $385,000
at both December 31, 2002 and 2001. The Company has not paid interest on
these Debentures since July 2000, and its senior lender prohibits it from
making any payments of principal and interest (note 7). At December 31,
2002 and 2001, accrued interest on the debentures was $58,000 and
$35,000, respectively. The trustee of the Debentures gave notice to the
Company that the non-payment caused an event of default.
(Continued)
F-16
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(9) Subordinated Notes
As of December 31, 2002 and 2001, $6,144,000 of Subordinated Notes were
outstanding. As of December 31, 2002, $6,144,000 of principal and
$2,300,000 of accrued interest were due and payable. However, Porta did
not have the resources to pay the $6,144,000 principal and $2,300,000 of
interest due on the subordinated debt. In addition, the senior lender had
precluded the Company from making payments on the subordinated debt (note
7). During 2001, one of the noteholders unsuccessfully attempted to
obtain a judgment compelling the Company to pay the past due Notes and
related interest (note 20).
(10) Joint Venture
In April 2002, the Company sold its 50% interest in its Korean joint
venture company, for $450,000 to its joint venture partner. Payment was
made by the forgiveness of commissions, totaling $450,000, which were
owed to its sales representation company owned by the Company's joint
venture partner, with respect to sales made by the joint venture in
Korea. The investment in the joint venture had previously been written
down to zero as the Company's share of the losses of the joint venture
exceeded its investment. Therefore, the transaction was reflected as a
$450,000 reduction in accrued commissions and a non-cash gain on sale of
investment in joint venture.
Prior to October 1, 2001, the Company consolidated the operations of the
joint venture since the Company could obtain a controlling interest at
its election and the joint venture was entirely dependent on the Company
for the products it sold and the receipt of management assistance from
the Company. The joint venture partner's interest is shown as a minority
interest through September 30, 2001. Based on the expiration of the
option agreement, the reduced volume of products sold to the joint
venture and reduced level of management assistance provided to the joint
venture, the Company's share of the losses on its investment were
recorded on the equity method effective October 1, 2001. As such losses
are in excess of Porta's investment, and the Company does not guaranty
such excess losses, the investment in the joint venture was carried at $0
as of December 31, 2001.
(11) Stockholders' Equity
At December 31, 2002 ,the Company had outstanding (a) warrants issued to
its senior lender to purchase 100,000 shares of common stock, which are
currently exercisable at $0.25 per share and expire on June 6, 2005, and
(b) warrants issued to a vendor to purchase 15,000 shares of common
stock, which are currently exerciseable at $1.8125 per share and expire
in May, 2005.
In connection with an amendment of the Subordinated Notes in April 2000,
the Company agreed to issue to the noteholders New Warrants to purchase
an aggregate 127,500 shares of Common Stock at $3.00 per share, the value
of which was determined to be $140,000 and recorded as deferred financing
expenses and additional paid in capital in 2000. Additional non-cash
interest expense of $84,000 and $56,000 was recorded during 2000 and
2001, respectively, in connection with this transaction.
(Continued)
F-17
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(12) Employee Benefit Plans
Porta has deferred compensation agreements with certain present and former
officers and employees, with benefits commencing at retirement equal to
50% of the employee's base salary, as defined. Payments under the
agreements will be made for a period of fifteen years following the
earlier of attainment of age 65 or death. During 2002, 2001 and 2000,
Porta accrued approximately $122,000, $166,000 and $180,000,
respectively, under these agreements.
In 1986, Porta established the Porta Systems Corp. 401(k) Savings Plan for
the benefit of eligible employees, as defined in the Savings Plan.
Participants contribute a specified percentage of their base salary up to
a maximum of 15%. Porta will match a participant's contribution by an
amount equal to 25% of the first 6% contributed by the participant. A
participant is 100% vested in the balance to his credit. For the years
ended December 31, 2002, 2001 and 2000, Porta's contribution amounted to
$47,000, $54,000 and $72,000, respectively.
In 1999, Porta established the Employee Stock Purchase Plan for the benefit
of eligible employees, as defined in the Purchase Plan, which permits
employees to purchase Porta's common stock at discounts up to 10%. Porta
has reserved 1,000,000 shares of Porta stock for issuance under the plan.
During 2002 and 2001, 55,803 and 130,256 shares, respectively, were
issued pursuant to the Purchase Plan.
Porta does not provide any other post-retirement benefits to any of its
employees.
(13) Incentive Plans
During 1999, Porta established an Employee Stock Bonus Plan whereby stock
may be given to non-officers or directors to recognize the contributions
of employees. A maximum of 95,750 shares of common stock is reserved for
issuance pursuant to the Bonus Plan. No shares of common stock were
issued pursuant to the Bonus Plan during 2002, 2001 and 2000.
(Continued)
F-18
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Porta's 1996 Stock Incentive Plan ("1996 Plan") covers 450,000 shares of
common stock. Incentive stock options cannot be issued subsequent to ten
years from the date the 1996 Plan was approved. Options under the 1996
Plan may be granted to key employees, including officers and directors of
the Company and its subsidiaries, except that members and alternate
members of the stock option committee are not eligible for options under
the 1996 Plan. The exercise prices for all options granted were equal to
the fair market value at the date of grant and vest as determined by the
board of directors. In addition, the 1996 Plan provides for the automatic
grant to non-management directors of non-qualified options to purchase
2,000 shares on May 1st of each year commencing May 1, 1996, with an
exercise price equal to the average closing price of the last ten trading
days of April of each year.
Porta's 1998 Non-Qualified Stock Option Plan ("1998 Plan") covers 450,000
shares of common stock. Options under the 1998 Plan may be granted to key
employees, including officers and directors of the Company and its
subsidiaries. The exercise prices for all options granted were equal to
the fair market value at the date of grant and vest as determined by the
board of directors.
Porta's 1999 Incentive and Non-Qualified Stock Option Plan ("1999 Plan")
covers 400,000 shares of common stock. Incentive stock options cannot be
issued subsequent to ten years from the date the 1999 Plan was approved.
Options under the 1999 Plan may be granted to key employees, including
officers and directors of the Company and its subsidiaries, except that
members and alternate members of the stock option committee are not
eligible for options under the 1999 Plan. The exercise prices for all
options granted were equal to the fair market value at the date of grant
and vest as determined by the board of directors. In addition, the 1999
Plan provides for the automatic grant to non-management directors of
non-qualified options to purchase 5,000 shares on May 1st of each year
commencing May 1, 1999, based upon the average closing price of the last
ten trading days of April of each year; provided, however, that the
non-management directors will not be granted non-qualified options
pursuant to the 1999 Plan for any year to the extent options are granted
under the 1996 Plan for such year.
During 1999, pursuant to an employment contract with an officer, Porta
issued options to purchase 15,000 shares of common stock at $1.75 per
share. The exercise prices approximated market value on the date of
issuance. The options expire in May 2005. As of December 31, 2002, all of
these options have been forfeited.
(Continued)
F-19
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The weighted-average fair values of options granted were $0.05, $0.23 and
$1.62 per share for options granted in 2002, 2001 and 2000, respectively.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions for
2002, 2001 and 2000:
2002 2001 2000
--------------- -------------- ---------------
Dividends: $0.00 per share $0.00 per share $0.00 per share
Volatility: 100% 100% 57.64%-68.70%
Risk-free interest: 4.22%-5.48% 4.22%-5.48% 5.54%-6.53%
Expected term: 5 - 9.6 years 5 -9.6years 5 years
A summary of the status of Porta's stock option plans as of December 31,
2002, 2001, and 2000, and changes during the years ending on those dates is
presented below:
2002 2001 2000
-------------------- -------------------- ----------------------
Weighted Weighted Weighted
Shares Average Shares Average Shares Average
Under Exercise Under Exercise Under Exercise
Option Price Option Price Option Price
------ -------- ------ -------- ------ --------
Outstanding beginning
of year 801,705 $3.96 949,713 $2.55 870,538 $2.51
Granted 15,000 0.07 55,000 0.29 108,500 3.12
Exercised -- -- (6,000) 1.50
Forfeited (215,175) 2.11 (203,008) 2.58 (23,325) 2.80
------- ------- -------
Outstanding end of year 601,530 $3.96 801,705 $3.96 949,713 $2.55
======= ======= =======
Options exercisable
at year-end 567,647 698,105 807,780
======= ======= =======
The following table summarizes information about stock options outstanding
under the stock option plans at December 31, 2002:
Options Outstanding Options Exercisable
------------------------------------------------ --------------------------------
Range of Outstanding Remaining Weighted-average Exercisable Weighted-Average
Exercise Prices at 12/31/02 Contractual Life Exercise Price at 12/31/02 Exercise Price
--------------- ----------- ---------------- -------------- ----------- --------------
<$1.00 35,000 8.1 years $0.21 32,000 $0.20
$1.00 - 1.99 217,780 4.4 years $1.51 217,780 $1.51
$2.00 - 2.99 11,500 6.5 years $2.26 11,200 $2.26
$3.00 - 3.85 337,250 1.4 years $3.26 306,667 $3.26
------- -------
601,530 567,647
======= =======
(Continued)
F-20
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(14) Income Taxes
The provision (benefit) for income taxes consists of the following:
2002 2001 2000
------------------ ------------------- -----------------
Current Deferred Current Deferred Current Deferred
------- -------- ------- -------- ------- --------
Federal $ -- -- -- -- -- --
State and foreign 11,000 -- (203,000) -- 227,000 --
------- ----- ------- ----- ------- -----
Total $11,000 -- (203,000) -- 227,000 --
======= ===== ======= ===== ======= =====
The domestic and foreign components of loss before provision (benefit) for
income taxes were as follows:
2002 2001 2000
---- ---- ----
United States $(3,726,000) (11,578,000) (7,519,000)
Foreign (376,000) (3,399,000) (2,430,000)
----------- ----------- ----------
Loss before provision (benefit)
for income taxes $(4,102,000) (14,977,000) (9,949,000)
=========== =========== ==========
A reconciliation of Porta's income tax provision and the amount computed by
applying the statutory U.S. federal income tax rate of 34% to loss before
income taxes is as follows:
2002 2001 2000
---- ---- ----
Tax benefit at statutory rate $(1,395,000) (5,092,000) (3,383,000)
Increase (decrease) in income tax benefit
resulting from:
Increase in valuation allowance 1,094,000 3,057,000 2,776,000
State and foreign taxes, less applicable
federal benefits (98,000) (211,000) (127,000)
Non-deductible goodwill impairment 272,000 1,973,000 --
Other expenses not deductible for tax 13,000 333,000 345,000
Foreign income taxed at rates
Different from U.S. statutory rate (78,000) (19,000) 25,000
Estimated NOL adjustments, including
Section 382 limitation -- -- 594,000
Reversal of prior year's accrual 203,000 (262,000) --
Other -- 18,000 (3,000)
----------- -------- -------
$ 11,000 (203,000) 227,000
=========== ======== =======
Porta has unused United States tax net operating loss (NOL) carryforwards
of approximately $48,409,000 expiring at various dates between 2009 and
2022. Due to the change in ownership which resulted from the conversion
of Porta's Zero coupon subordinated convertible notes to common stock,
Porta's usage of its NOL will be limited in accordance with Internal
Revenue Code section 382. Porta's carryforward utilization of the NOL is
limited to $1,767,000 per year. The carryforward amounts are subject to
review by the Internal Revenue Service (IRS). In addition, Porta has
foreign NOL carryforwards of approximately $6,037,000 with indefinite
expiration dates.
(Continued)
F-21
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Porta's United States net operating loss carryforwards (after limitations
as described above) expire in the following years:
2009 $ 4,106,000
2010 18,880,000
2011 884,000
2018 37,000
2019 7,546,000
2020 8,441,000
2021 4,259,000
2022 4,256,000
-----------
$48,409,000
===========
The components of the deferred tax assets, the net balance of which total
zero after the valuation allowance, as of December 31, 2002 and 2001 are
as follows:
2002 2001
---- ----
Deferred tax assets:
Inventory $ 1,313,000 1,370,000
Allowance for doubtful accounts receivable 757,000 835,000
Benefits of tax loss carryforwards 20,690,000 18,734,000
Benefit plans 591,000 633,000
Accrued commissions 218,000 619,000
Other 1,093,000 917,000
Depreciation 358,000 818,000
------------ ----------
25,020,000 23,926,000
Valuation allowance (25,020,000) (23,926,000)
------------ ----------
$ -- --
============ ==========
Because of Porta's losses in 2002 and 2001, a valuation allowance for the
entire deferred tax asset was provided due to the uncertainty as to
future realization.
The income tax returns of Porta and its subsidiary operating in Puerto Rico
were examined by the IRS for the tax year ended December 31, 1989. As a
result of this examination, the IRS increased the Puerto Rico
subsidiary's taxable income resulting from intercompany transactions,
with a corresponding increase in Porta's net operating losses. The
settlement amounted to approximately $953,000. Porta is currently in a
structured settlement with the IRS, which is reviewed annually, whereby
monthly payments will be made to liquidate the settlement. As of December
31, 2002, Porta has not made all the required payments through that date
under the settlement and has been in correspondence with the IRS to
obtain an offer in compromise. As of December 31, 2002, $274,000 remains
outstanding.
(Continued)
F-22
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
No provision was made for U.S. income taxes on the undistributed earnings
of Porta's foreign subsidiaries as it is management's intention to
utilize those earnings in the foreign operations for an indefinite period
of time or repatriate such earnings only when tax effective to do so. At
December 31, 2002, undistributed earnings of the foreign subsidiaries
amounted to approximately $1,417,000. It is not practicable to determine
the amount of income or withholding tax that would be payable upon the
remittance of those earnings.
(15) Leases
At December 31, 2002, Porta and its subsidiaries leased manufacturing and
administrative facilities, equipment and automobiles under a number of
operating leases. Porta is required to pay increases in real estate taxes
on the facilities in addition to minimum rents. Total rent expense for
2002, 2001, and 2000 amounted to approximately $499,000, $793,000 and
$1,375,000, respectively. With respect to the Company's lease in North
Carolina, rent expense in 2002 was reduced by approximately $280,000, the
difference between the total lease obligation at the time the facility
was vacated in 2000 of approximately $400,000 and the final settlement
approximating $120,000. Rent expense in 2000 reflected the accrual of the
remaining lease obligation. Minimum rental commitments, exclusive of
future escalation charges, for each of the next five years are as
follows:
2003 $ 614,000
2004 527,000
2005 517,000
2006 526,000
2007 496,000
Thereafter 2,723,000
----------
$5,403,000
==========
(16) Contingencies
Porta is a defendant in legal actions arising out of the ordinary conduct
of its business. Management believes that the settlement of these matters
will not have a materially adverse effect on the financial position of
the Company (note 20).
As a result of the Company's continuing financial difficulties, a number of
creditors have engaged attorneys or collection agencies or commenced
legal actions against the Company, and some of them have obtained
judgments against the Company. Claimants who have already either
commenced litigation or otherwise sought collection or have obtained a
judgment against the Company are due approximately $214,000.
(Continued)
F-23
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(17) Major Customers
During the years ended December 31, 2002, 2001 and 2000, Porta's five
largest customers accounted for sales of $9,784,000, or approximately 46%
of sales, $13,444,000, or approximately 48% of sales, and $28,323,000, or
approximately 55% of sales, respectively. Porta's largest customer in
2002 and 2001 with sales of $2,725,000 and $3,485,000, or approximately
13% and 12%, respectively, of sales, was Philippines Long Distance
Telephone (PLDT). However, in 2001 Porta's sales to British
Telecommunications plc ("BT") directly of $3,339,000, approximately 12%
of sales, and through Fujitsu Telecommunications Europe LTD ("FTEL") as
purchasing agent to BT of $3,200,000, approximately 11% of sales in 2001,
combined for sales of $6,539,000, approximately 23% of sales, in 2001.
Porta's largest customer in 2000 with sales of $12,051,000, or
approximately 24% of sales, was Fujitsu Telecommunications Europe LTD
("FTEL"). A significant amount of sales of the Company's products for use
by British Telecommunications plc ("BT") were sold to FTEL as purchasing
agent to BT. Direct sales to BT for the year ended December 31, 2002,
2001 and 2000 amounted to $2,306,000, $3,339,000 and $5,098,000,
respectively, or approximately 11%, 12% and 10%, respectively, of Porta's
sales for such years. Direct sales to FTEL for the year ended December
31, 2001 and 2000 amounted to $3,200,000, and $12,051,000, respectively,
or approximately 11% and 24%, respectively, of Porta's sales for such
years. Therefore, any significant interruption or decline in sales to
FTEL or BT may have a materially adverse effect upon Porta's operations.
During 2000, sales to a Mexican telephone company were $5,507,000, or
approximately 11% of sales. No other customers account for 10% or more of
Porta's sales for any year. Approximately 53% and 19%, respectively, of
Porta's accounts receivable are due from the five largest customers as of
December 31, 2002 and 2001, respectively.
(18) Fair Values of Financial Instruments
Cash equivalents, accounts receivable and accounts payable are reflected in
the consolidated financial statements at fair value because of the short
term maturity of these instruments.
The fair value of Porta's senior and subordinated debt and related interest
cannot be reasonably estimated due to the lack of marketability of such
instruments. However, management believes that the fair value of these
instruments is significantly less than their aggregate carrying amount.
(Continued)
F-24
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(19) Net Loss Per Share
Options to purchase 601,530, 806,705 and 649,733 shares of common stock for
2002, 2001 and 2000, respectively, with exercise prices ranging from
$0.07 to $3.85, $0.22 to $5.00 and $1.69 to $5.00 for 2002, 2001 and
2000, respectively, were outstanding but not included in the computation
of diluted net loss per share because the exercise prices were greater
than the average market price of common stock during such years, and the
effect of doing so would be anti-dilutive.
Warrants to purchase 242,500, 1,776,152 and 195,000 shares of common stock
for 2002, 2001 and 2000, respectively, with exercise prices ranging from
$0.25 to $1.81, $0.25 to $3.00 and $1.81 to $17.50 for 2002, 2001 and
2000, respectively, were outstanding but not included in the computation
of diluted net loss per share because the exercise prices were greater
than the average market price of common stock during such years, and the
effect of doing so would be anti-dilutive.
(Continued)
F-25
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(20) Legal Matters
In July 2001, the holder of a subordinated note in the principal amount of
$500,000 commenced an action against the Company in the United States
District Court for the Southern District of New York seeking payment of
the principal and accrued interest on their subordinated notes which were
payable in July 2001. The payment of the note is subordinated to payment
of the Company's senior debt and the Company believes that the
subordination provision of the note prohibits payment by the Company. The
plaintiffs' motion for a summary judgment was denied by the court on the
grounds that the terms of the note did not give them permission to obtain
a judgment while Porta remained in default to the senior debt holder. The
Company's obligations under the subordinated notes are reflected as
current liabilities on the Company's balance sheet.
In March 2000, the Company suspended (with pay) Messrs. Ronald Wilkins and
Michael Bahlo, two of its executive officers, from their positions
pending completion of the Company's investigation of certain matters that
had come to its attention. Prior to the completion of this investigation,
however, these two executives accepted positions with another company and
thereby voluntarily resigned from their positions with the Company. In
February 2001, these two executives, together with a third former
executive officer, Mr. Michael Lamb, who similarly resigned from his
position with the Company, filed suit in the Supreme Court for the State
of New York, County of New York. The complaint asserted various claims
against the Company based on the allegation that each of these three
executives was improperly terminated from his employment without cause,
and seeks compensatory damages, liquidating damages and attorney's fees.
The Company filed an answer and counterclaim against the plaintiffs.
During 2002, the Company settled all claims related to this action for
$30,000.
In July 1996, an action was commenced against Porta and certain present and
former directors in the Supreme Court of the State of New York, New York
County by certain stockholders and warrant holders of Porta who acquired
their securities in connection with the acquisition by Porta of Aster
Corporation. The complaint alleges breach of contract against Porta and
breach of fiduciary duty against the directors arising out of an alleged
failure to register certain restricted shares and warrants owned by the
plaintiffs. The complaint seeks damages of $413,000; however, counsel for
the plaintiff have advised Porta that additional plaintiffs may be added
and, as a result, the amount of damages claimed may be substantially
greater than the amount presently claimed. Porta believes that the
defendants have valid defenses to the claims. Discovery is proceeding,
although there has been no significant activity in this matter subsequent
to December 31, 1999.
In June 2002, BMS Corp. served an arbitration demand on the Company
claiming that it breached an agreement to market and sell an update to
the Company's MLR product which BMS was to develop. The Company believes
that it has defenses to the claims by BMS and has filed a counterclaim to
recovery the $350,000 the Company advanced to BMS under the contract. The
arbitrators have recently been selected and the proceedings will move
forward over the next several months.
See Note 16, in connection with claims against the Company by creditors.
(Continued)
F-26
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(21) Cash Flow Information
(1) Supplemental cash flow information for the years ended December 31, is
as follows:
2002 2001 2000
---- ---- ----
Cash paid for interest $10 933 3,763
Cash paid for income taxes $ 2 131 183
(2) Non-cash transactions:
(i) In 2000 and 2001, Porta incurred non-cash charges totaling
$140,000 as a result of the issuance New Warrants (note 11).
(ii) In 2000, Porta incurred a non-cash charge of $169,000 as a result
of the reduction in the exercise price of the Warrants issued to its
senior lender.
(iii) In 2000, Porta incurred a non-cash charge of $129,000 as a
result of Warrants issued to its senior lender in connection with an
increase in its revolving line of credit to its senior lender .
(iv) In 2000, Porta incurred a non-cash charge of $59,000 as a result
of the reduction in the exercise price of the Warrants issued to its
senior lender in connection with a waiver of default .
(v) In 2001, Porta incurred a non-cash charge of $39,000 as a result
of the reduction in the exercise price of the Warrants issued to its
senior lender in connection with an agreement to add all current and
future interest due to the principal balance through the loan
expiration date (note 7).
(Continued)
F-27
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(22) Segment and Geographic Data
Porta has three reportable segments: Line Connection and Protection
Equipment ("Line") whose products interconnect copper telephone lines to
switching equipment and provides fuse elements that protect telephone
equipment and personnel from electrical surges; Operating Support Systems
("OSS") whose products automate the testing, provisioning, maintenance
and administration of communication networks and the management of
support personnel and equipment; and Signal Processing ("Signal") whose
products are used in data communication devices that employ high
frequency transformer technology.
The factors used to determine the above segments focused primarily on the
types of products and services provided, and the type of customer served.
Each of these segments is managed separately from the others, and
management evaluates segment performance based on operating income.
2002 2001 2000
---- ---- ----
Revenue:
Line $ 9,598,000 12,756,000 20,546,000
OSS 6,414,000 8,874,000 22,296,000
Signal 4,523,000 5,737,000 7,644,000
----------- ---------- ----------
$20,535,000 27,367,000 50,486,000
=========== ========== ==========
Segment profit (loss):
Line $ (565,000) 1,275,000 3,665,000
OSS 226,000 (10,518,000) (6,201,000)
Signal 286,000 1,449,000 2,088,000
----------- ---------- ----------
$ (53,000) (7,794,000) (448,000)
=========== ========== ==========
Depreciation and amortization:
Line $ 245,000 374,000 424,000
OSS 350,000 1,262,000 1,262,000
Signal 25,000 166,000 162,000
----------- ---------- ----------
$ 620,000 1,802,000 1,848,000
=========== ========== ==========
Total identifiable assets:
Line $ 3,975,000 5,990,000 8,508,000
OSS 4,538,000 4,268,000 14,942,000
Signal 4,319,000 5,557,000 6,591,000
----------- ---------- ----------
$12,832,000 15,815,000 30,041,000
=========== ========== ==========
Capital expenditures:
Line $ 37,000 132,000 340,000
OSS 58,000 55,000 1,132,000
Signal 9,000 0 45,000
----------- ---------- ----------
$ 104,000 187,000 1,517,000
=========== ========== ==========
(Continued)
F-28
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The following table reconciles segment totals to consolidated totals:
2002 2001 2000
---- ---- ----
Revenue:
Total revenue for reportable segments $ 20,535,000 27,367,000 50,486,000
Other revenue 882,000 695,000 654,000
------------ ---------- ----------
Consolidated total revenue $ 21,417,000 28,062,000 51,140,000
============ ========== ==========
Operating loss:
Total segment loss for reportable segments $ (53,000) (7,794,000) (448,000)
Corporate and unallocated (2,828,000) (3,659,000) (4,705,000)
------------ ---------- ----------
Consolidated total operating loss $ (2,881,000) (11,453,000) (5,153,000)
============ ========== ==========
Depreciation and amortization:
Total for reportable segments $ 620,000 1,802,000 1,848,000
Corporate and unallocated 93,000 107,000 63,000
------------ ---------- ----------
Consolidated total deprecation and amortization $ 713,000 1,909,000 1,911,000
============ ========== ==========
Total assets:
Total for reportable segments $ 12,832,000 15,815,000 30,041,000
Corporate and unallocated 1,396,000 2,018,000 4,133,000
------------ ---------- ----------
Consolidated total assets $ 14,228,000 17,833,000 34,174,000
============ ========== ==========
Capital expenditures:
Total for reportable segments $ 104,000 187,000 1,517,000
Corporate and unallocated 20,000 9,000 16,000
------------ ---------- ----------
Consolidated total capital expenditures $ 124,000 196,000 1,533,000
============ ========== ==========
The following table presents information about the Company by geographic
area:
2002 2001 2000
---- ---- ----
Revenue:
United States $ 9,877,000 12,999,000 17,225,000
United Kingdom 6,388,000 8,060,000 20,244,000
Asia/Pacific 2,725,000 4,552,000 5,429,000
Other Europe 1,600,000 1,761,000 2,482,000
Latin America 258,000 288,000 146,000
Other North America 565,000 357,000 5,570,000
Other 4,000 45,000 44,000
----------- ---------- ----------
Consolidated total revenue $21,417,000 28,062,000 51,140,000
=========== ========== ==========
Consolidated long-lived assets:
United States $ 4,274,000 5,301,000 12,115,000
United Kingdom 364,000 583,000 1,107,000
Other North America 455,000 523,000 568,000
Asia/Pacific 0 0 612,000
Latin America 7,000 8,000 14,000
Other 3,000 2,000 3,000
----------- ---------- ----------
5,103,000 6,417,000 14,419,000
Current and other assets 9,125,000 11,416,000 19,755,000
----------- ---------- ----------
Consolidated total assets $14,228,000 17,833,000 34,174,000
=========== ========== ==========
(Continued)
F-29
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(23) Quarterly Information (Unaudited)
The following presents certain unaudited quarterly financial data:
Quarter Ended
-------------------------------------------------------
March 31, June 30, September 30, December 31,
2002 2002 2002 2002
--------- -------- ------------- ------------
Net sales $ 4,744,000 $ 6,492,000 $ 5,093,000 $ 5,088,000
Gross profit 878,000 2,117,000 2,025,000 1,798,000
Net income (loss) (2,637,000) (887,000) (696,000) 106,000
Net income (loss)
per share:
Basic $(0.26) $(0.09) $(0.07) $0.01
Diluted $(0.26) $(0.09) $(0.07) $0.01
Quarter Ended
-------------------------------------------------------
March 31, June 30, September 30, December 31,
2001 2001 2001 2001
--------- -------- ------------- ------------
Net sales $ 7,042,000 $ 8,915,000 $ 6,039,000 $ 6,066,000
Gross profit 1,414,000 2,925,000 1,503,000 2,250,000
Net loss (3,233,000) (2,511,000) (1,898,000) (7,132,000)
Net loss per share:
Basic $(0.33) $(0.25) $(0.19) $(0.73)
Diluted $(0.33) $(0.25) $(0.19) $(0.73)
Net income for the quarter ended December 31, 2002 reflects the benefit
associated with the reversal of certain reserves for potential claims
established in prior years and a settlement of a lease obligation,
approximating $400,000. In addition, the Company reduced certain expense
estimates recorded in earlier quarters in 2002, approximating $400,000.
Net loss for the quarter ended December 31, 2001 reflects an impairment
loss on goodwill of $5,802,000 associated with OSS operations (note 6).
F-30