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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, 2001
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[ ] 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
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PORTA SYSTEMS CORP.
(Exact name of registrant as specified in its charter)
Delaware 11-2203988
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(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
575 Underhill Boulevard, Syosset, New York 11791
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (516) 364-9300
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Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $.01 American Stock Exchange
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(Title of Class) (Name of Exchange on
which registered)
Securities registered pursuant to Section 12(g) of the Act:
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]
State aggregate market value of the voting stock held by non-affiliates of
the registrant: $997,696 as of March 31, 2002.
Indicate the number of shares outstanding of each of the registrant's
class of common stock, as of the latest practicable date: 9,976,964 shares of
Common Stock, par value $.01 per share, as of March 31, 2002.
DOCUMENTS INCORPORATED BY REFERENCE
None
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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 575 Underhill Boulevard, Syosset, New York 11791; telephone
number, 516-364-9300. References to Porta and 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. 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 are incurring losses from our operations, and our losses are
continuing. We incurred a net loss of $14,774,000, or $1.50 per share (basic and
diluted), on sales of $28,062,000 for 2001, following a loss of $10,176,000, or
$1.04 per share (basic and diluted) for 2000, 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. 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.
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 2001, 2000 and 1999, our
stockholders' deficit of $ 25,849,000 at December 31, 2001, and our working
capital deficit of $31,236,000 as of December 31, 2001 our auditors included in
their report an explanatory paragraph about our ability to continue as a going
concern.
We require substantial financing to meet our working capital requirements
and our principal lender is providing us with financing at its discretion. We
had a working capital deficit at December 31, 2001 of $31,236,000. As of
December 31, 2001, our current liabilities include $22,095,000 due to our senior
lender, all of which is due and payable on December 31, 2002, at which time our
agreement with the senior lender will terminate. In addition, subordinated notes
in the principal amount of $6,144,000 plus accrued interest were outstanding as
of December 31, 2001. These subordinated notes became due on July 3, 2001.
Subsequent to December 31, 2001, the trustee of our subordinated debentures in
the principal amount of $500,000, which will mature on July 1, 2002, served us
with a notice of default for failure to pay interest. Our senior lender has
prohibited us from making any payments on any of the subordinated debt. At
December 31, 2001, we did not have sufficient resources to pay the senior lender
when our obligations to the senior lender mature on December 31, 2002, or the
subordinated notes, and we do not expect to generate the necessary cash from our
operations to enable us to make those payments. Since December 31, 2001, our
senior lender has agreed to advance us up to $1,500,000; however, such advances
are at the discretion of the senior lender and are dependent on, among other
things, the perception of the senior lender that we are either stemming our
losses or effecting a sale of one or more of our divisions. 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. If the senior lender ceases funding our operations,
unless we have obtained alternative financing, we will be unable to continue in
business. Furthermore, unless we obtain funding from another source, including
the sale of one of more of our divisions, we will not be able to pay our senior
lender on December 31, 2002, and we may not be able to continue in business. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Because of our failure to pay our subordinated debt, the holders of the
subordinated debt may seek to obtain and enforce judgments against us, which
could cause a default under our agreement with our senior lender. One holder of
subordinated notes has already commenced an action against us seeking payment of
his note, and, because of our failure to pay the notes when due, other holders
may bring similar actions. If such holders prevail in such actions and seek to
enforce a judgment against us, we may be in default under our agreement with our
senior lender, and we may seek, or our senior lender may seek or require us to
seek, protection under the Bankruptcy Code.
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Because of our financial condition, we have not been able to pay 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,
including a former landlord which has obtained a $400,000 judgment against us.
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 $46,000 was due at December 31, 2001
and an additional $100,000 has become due in 2002. Other claimants who have
already either commenced litigation or otherwise sought collection are due
approximately $600,000. 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.
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 not 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 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 two 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.
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We are heavily dependent on foreign sales. Approximately 54% of our sales
in 2001, 66% of our sales in 2000 and 62% of our sales for 1999, 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, and 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.
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. These
contracts typically contain performance guarantees by us and clauses imposing
penalties on us if we do not meet the contractual in-service dates. 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.
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 2001, our working capital deficiency
and the scheduled expiration of our financing agreement 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.
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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.
We do not meet the continued listing standards of the American Stock Exchange,
and we may be delisted from that exchange. If we are delisted from the American
Stock Exchange, our stock will be traded on the OTC Bulletin Board and will be
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.
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, Porta develops 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.
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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.
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 its major categories of the telecommunications
industry:
Sales by Product Category
Years Ended December 31,
2001 2000 1999
---- ---- ----
(Dollars in thousands)
OSS Systems $ 8,874 32% $22,296 44% $14,254 37%
Line Connecting
/Protecting
Equipment 12,756 46% 20,546 40% 18,189 47%
Signal Processing 5,737 20% 7,644 15% 6,328 16%
Other 695 2% 654 1% 165 0%
------- ------- ------- ------- ------- -------
Total $28,062 100% $51,140 100% $38,936 100%
======= ======= ======= ======= ======= =======
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 2001, approximately 32% 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 2001, approximately 46% 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 2001, signal processing equipment accounted for approximately 20%
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, Porta continues to promote the direct marketing relationships it
developed in the past with telephone operating companies.
We had a non-exclusive supply agreement with British Telecommunications
covering our connecting/protecting products. This agreement, which did not
provide for any purchase commitments by British Telecommunications, expired on
August 31, 2001. British Telecommunications purchased line connecting/protecting
products amounting to $3,339,000 (12% of sales) in 2001, $4,261,000 (8% of
sales) in 2000, and $6,566,000 (17% of sales) in 1999. 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. Although we have been
negotiating with British Telecommunications with respect to a new non-exclusive
supply agreement and British Telecommunications has made modest purchases of
copper connection/protection products from us, as of the date of this report we
have not reached an agreement with British Telecommunications, and we may not be
able to enter into such an agreement. If we do not sell products to British
Telecommunications, whether pursuant to a supply agreement or otherwise, our
business could be impaired.
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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.
During 2000, we entered into a multi-year sales, marketing, and management
co-operative agreement with Fujitsu Telecommunications to market Internet
infrastructure products. Under the agreement, Fujitsu will sell and market
Porta's 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 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,
2001 2000 1999
---- ---- ----
(Dollars in thousands)
North America $13,356 48% $22,795 45% $14,664 38%
United Kingdom 8,060 29% 20,244 40% 15,673 40%
Asia/Pacific 4,552 16% 5,429 10% 4,159 11%
Other Europe 1,761 6% 2,482 5% 3,130 8%
Latin America 288 1% 146 0% 1,257 3%
Other 45 0% 44 0% 53 0%
------- ------- ------- ------- ------- -------
Total Sales $28,062 100% $51,140 100% $38,936 100%
======= ======= ======= ======= ======= =======
(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 23 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 two suppliers. We purchase the majority of our workstations and
servers used in its OSS systems from Compaq Computer Corporation. However, we
could use other computer equipment in our systems if we were unable to purchase
Compaq 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 2001, our five largest customers accounted for sales of
$13,444,000, or approximately 48% of sales, and, during 2000, our five largest
customers accounted for sales of $28,323,000, or approximately 55% of sales. Our
largest customer in 2001 with sales of $3,485,000, or approximately 12% 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 $3,339,000, or 12% of sales, for 2001 and
$5,098,000, or 10% of sales, for 2000. Any significant interruption or decline
in sales to Fujitsu Telecommunications or British Telecommunications may have a
materially adverse effect upon our 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 our sales for either year.
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.
Backlog
At December 31, 2001, our backlog was approximately $6,100,000 compared
with approximately $10,000,000 at December 31, 2000. Of the December 31, 2001
backlog, approximately $5,000,000 represented orders from foreign telephone
operating companies. We expect to ship substantially all of our December 31,
2001 backlog during 2002.
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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.
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
11 of 31
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 $4,400,000 in 2001, $5,800,000 in 2000, and
$6,100,000 in 1999 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 31, 2002, we had 274 employees of which 58 were employed in
the United States, 182 in Mexico, 27 in the United Kingdom, 3 in Poland, 3 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, 2002.
Item 2. Properties
We currently lease approximately 20,400 square feet of executive, sales,
marketing and research and development space in Syosset, New York; and 7,000
square feet of office space located in Charlotte, North Carolina, which has been
vacated. These facilities represent substantially all of our office, plant and
warehouse space in the United States. The Syosset, New York lease expires
December 2005, and the Charlotte, North Carolina lease expires in November 2004.
The annual rental related to the New York property is approximately $350,000.
All rental expense related to the North Carolina facility was accrued in 2000.
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.
Our wholly-owned United Kingdom subsidiary leases approximately 34,300
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 $225,000.
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 31
Item 3. Legal Proceedings
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
recently 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, 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., Index No 600677/01. The complaint asserts 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 have filed an answer and
counterclaim against the plaintiffs. We believe that we have valid defenses to
the claims and intend to defend this action vigorously and to assert
counterclaims against these former executives.
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 has 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.
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Item 4. Submission of Matters to a Vote of Securities Holders
During the fourth quarter of 2001, no matters were submitted to a vote of
security holders of the Company.
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our common stock is traded on the American Stock Exchange, Inc. under the
symbol PSI. The following table sets forth, for 2000 and 2001, the quarterly
high and low sales prices for our common stock on the consolidated transaction
reporting systems for American Stock Exchange listed issues.
High Low
---- ---
2000 First Quarter $4.88 $0.81
Second Quarter 3.63 1.56
Third Quarter 2.00 0.88
Fourth Quarter 1.00 0.38
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
We did not declare or pay any cash dividends in 2001 or 2000. 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
its common stock in the foreseeable future. In addition, Porta's agreement with
its senior lender prohibits it from paying cash dividends on its common stock.
As of March 12, 2002, we had approximately 983 stockholders of record and
the closing price of our common stock was $0.10.
We did not issue any unregistered securities during 2001.
We do not meet the continued listing standards of the American Stock
Exchange, and we may be delisted from that exchange. If we are delisted from the
American Stock Exchange, our stock will be traded on the OTC Bulletin Board and
will be subject to the Securities and Exchange Commission's penny stock rules.
14 of 31
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,
-----------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(In thousands, except per share data)
Income Statement Data:
Sales $ 28,062 $ 51,140 $ 38,936 $ 59,343 $ 62,230
Operating income (loss) (11,453) (5,153) (9,709) 4,566 6,101
Debt conversion expense -- -- -- (945) (11,458)
Income (loss) before discontinued
operations and extraordinary item (14,774) (10,176) (13,686) 451 (7,021)
Net income (loss) (14,774) (10,176) (13,686) 527 (6,899)
Basic per share amounts:
Continuing operations $ (1.50) $ (1.04) $ (1.44) $ 0.05 $ (2.26)
Net income (loss) $ (1.50) $ (1.04) $ (1.44) $ 0.06 $ (2.22)
Diluted per share amounts:
Continuing operations $ (1.50) $ (1.04) $ (1.44) $ 0.04 $ (2.26)
Net income (loss) $ (1.50) $ (1.04) $ (1.44) $ 0.05 $ (2.22)
Cash dividends declared -- -- -- -- --
Number of shares used in
calculating net income (loss)
per share-basic 9,878 9,763 9,489 9,281 3,111
Number of shares used in
calculating net income (loss)
per share-diluted 9,878 9,763 9,489 9,785 3,111
Balance Sheet Data:
Total assets $ 17,833 $ 34,174 $ 43,448 $ 52,136 $ 51,000
Working capital (deficiency) $(31,236) $(24,152) $ 6,135 $ 14,262 $ 7,286
Long-term debt excluding current
maturities $ -0- $ 376 $ 21,902 $ 17,238 $ 18,858
Stockholders' equity (deficit) $(25,849) $(10,792) $ (1,387) $ 11,984 $ 6,813
15 of 31
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Critical Accounting Policies and Estimates
Financial Reporting Release No. 60, which was recently released by the
Securities and Exchange Commission, requires all companies to include a
discussion of critical accounting policies and methods used in the preparation
of financial statements. 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. We believe the following critical accounting
policies affect the significant judgements and estimates used in the preparation
of our financial statements:
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.
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.
Goodwill
Goodwill represents the difference between the purchase price and the fair
market value of net assets acquired in business combinations treated as
purchases. Goodwill is amortized on a straight-line basis over the estimated
useful life as determined by events and circumstances of the business
combination that gave rise to the goodwill. We assess the recoverability of
unamortized goodwill using the undiscounted projected future cash flows from the
related businesses.
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Our consolidated statements of operations for the three years ended
December 31, 2001, 2000 and 1999, respectively, as a percentage of sales is as
follows:
Years Ended December 31,
2001 2000 1999
---- ---- ----
Sales 100% 100% 100%
Cost of sales 71% 70% 74%
---- ---- ----
Gross Profit 29% 30% 26%
Selling, general and
administrative expenses 33% 28% 35%
Research and development expenses 16% 12% 16%
Goodwill impairment 21% -- --
---- ---- ----
Operating loss (41%) (10%) (25%)
Interest expense (16%) (9%) (9%)
Gain on sale of assets 2% -- --
Other 1% (1%) 1%
----
Loss before income
taxes, equity in net loss of joint
venture and minority interest (54%) (20%) (33%)
Income tax benefit (expense),
equity in net loss of joint venture
and minority interest 1% -- (2%)
---- ---- ----
Net loss (53%) (20%) (35%)
==== ==== ====
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Results of Operations
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. We expect to recognize the balance of the revenue from the in
process OSS contracts during 2002. 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.
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 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 are
presently 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 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.
18 of 31
Results of Operations (continued)
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.
Our losses are continuing into 2002, 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, 2000 and 1999
Our sales for 2000 were $51,140,000 compared to $38,936,000 in 1999, an
increase of $12,204,000 (31%). The increase in revenue is attributed principally
to completion of contracts from our OSS division, although all divisions
achieved increased revenues in 2000 as compared to 1999.
OSS sales for 2000 were $22,296,000, compared to 1999 sales of
$14,254,000, an increase of $8,042,000 (56%). During 2000, OSS sales resulted
primarily from the completion of OSS contracts, which were secured during the
latter part of 1999. We expect to complete revenue recognition from these OSS
contracts in 2001. 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 increased
approximately $2,357,000 (13%) from $18,189,000 in 1999 to $20,546,000 in 2000.
The improved sales level reflected an increase in volume of sales to United
States and Mexican customers, which were offset by a decrease in sales to
customers in the United Kingdom.
Signal processing revenue for 2000 compared to 1999 increased by
$1,316,000 (21%) from $6,328,000 to $7,644,000. The increase in sales primarily
reflects accommodations made to customers where requested delays in deliveries
in 1999 of orders were shipped during 2000.
Gross margin increased from 26% in 1999 to 30% in 2000. The increase in
gross margin is primarily attributed to the higher sales volume in the OSS
division. However, the increase in revenue was still not satisfactory in
completely eliminating the inefficiency resulting from our inability to absorb
our fixed expenses associated with the OSS contracts over our revenue base. This
improvement in gross margin was slightly offset by a lower gross margin in
connection/protection products in 2000 compared to 1999 due to changes in
product mix.
Selling, general and administrative expenses increased by $970,000 (7%)
from $13,603,000 in 1999 to $14,573,000 in 2000. The increase from 1999 to 2000
primarily reflects higher than anticipated professional legal expenses due
primarily to litigation involving us, particularly litigation and settlement of
a dispute with a vendor.
19 of 31
Results of Operations (continued)
Research and development expenses decreased by $260,000 (4%) from
$6,090,000 in 1999 to $5,830,000 in 2000. The decreased expense in 2000 resulted
from the completion during 2000 of certain efforts to develop new products
primarily related to the OSS business.
As a result of the above, we had an operating loss of $5,153,000 in 2000
versus operating loss of $9,709,000 in 1999. The reduced operating loss for 2000
reflects continued profitability in our line connection/protection equipment and
signal processing divisions, and a reduction of the operating loss in our OSS
division from $10,650,000 in 1999 to $6,201,000 in 2000.
Interest expense for 2000 increased by $929,000 from $3,571,000 for 1999
to $4,500,000 in 2000. This change is attributable primarily to increased levels
of borrowing from the Company's senior lender and non cash interest expense
associated with the issuance and re-pricing of warrants held by the senior
lender and subordinated note holders (See Notes 7 and 9 of Notes to Consolidated
Financial Statements).
During 2000, we requested the early termination of our obligations to a
number of current and former executive officers regarding the funding of split
dollar life insurance policies in order to obtain approximately $1,200,000 of
premiums paid by us into the policies. Due to the early termination, we agreed
to forfeit approximately $600,000 of premiums and terminate our interest in the
policies which amount was charged to other expenses during 2000.
As the result of the foregoing, the 2000 net loss was $10,176,000, $1.04
per share (basic and diluted), compared with a net loss of $13,686,000, $1.44
per share (basic and diluted) for 1999.
Liquidity and Capital Resources
At December 31, 2001, we had cash and cash equivalents of $1,204,000
compared with $2,366,000 at December 31, 2000. Our working capital deficit was
$31,236,000 at December 31, 2001 compared to a working capital deficit of
$24,152,000 at December 31, 2000. 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 2001, we used $3,779,000 of cash to support
our operations. Our principal source of funds during 2001 was borrowings from
our senior lender.
As of December 31, 2001, our debt includes $22,095,000 of senior debt
which matured on January 7, 2002, and $6,144,000 of subordinated debt which
became due on July 3, 2001. We were unable to pay the interest payment on the
subordinated notes of approximately $1,358,000 which represents interest from
July 2000 through December 2001. At December 31, 2001, 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, and our
senior lender has precluded us from making payments on the subordinated debt.
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Liquidity and Capital Resources (continued)
On March 1, 2002, our senior lender and we 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. The agreement allows us to draw
monies subject to our senior lender's receipt and approval of a weekly
disbursement budget. Obligations under the new term loan shall bear interest at
12%. Secondly, the agreement establishes all indebtedness prior to March 1, 2002
as an old term loan in the amount of $22,610,000, which includes the balance due
at December 31, 2001 plus accrued interest though March 1, 2002. The old term
loan shall bear no interest until such time as the senior lender in its sole
discretion notifies us that interest shall be payable. Both the new and old term
loans expire on December 31, 2002. As part of this agreement, the senior lender
continues to preclude us from making any payments on indebtedness to any
subordinated creditors except to pay accounts payable in the ordinary course of
business. The $1,500,000 being advanced by our senior lender is being advanced
at the discretion of the senior lender and such advances are dependent on, among
other things, the perception of the senior lender that we are either stemming
our losses or effecting a sale of one or more of our divisions. If the senior
lender ceases funding our operations, unless we have obtained alternative
financing, we will be unable to continue in business. Furthermore, unless we
obtain funding from another source, including the sale of one of more of our
divisions, we will not be able to pay our senior lender on December 31, 2002,
and we may not be able to continue in business.
As of December 31, 2001, we had remaining outstanding $382,000 of 6%
Debentures, net of original issue discount of $3,000, which mature July 2, 2002.
The face amount of the outstanding 6% Debentures was $385,000. 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, 2001 was
$35,000. Additionally, we have been notified by the trustee that the non-payment
of the interest caused an event of default.
As of December 31, 2001, 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 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 recently 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; and
o a number of creditors, including one holder of our subordinated
notes, as discussed above, have engaged attorneys or collection
agencies or commenced legal actions against us, and some of them
have obtained judgments against us, including a former landlord who
has obtained a $400,000 judgment against us.
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 $46,000 was due at December 31, 2001
and an additional $100,000 has become due in 2002. Other claimants who have
already either commenced litigation or otherwise sought collection or who have
obtained judgments against us are due approximately $600,000. 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
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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.
We are seeking to address our need for liquidity by exploring
alternatives, including the possible sale of one or more of our divisions.
During 2000 and 2001 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. Although we are engaged in preliminary
discussions with respect to the sale of one of our divisions, we have not signed
any agreements with respect to such a sale, and we cannot give any assurance
that we will be able to sell any divisions on reasonable terms, if at all.
Furthermore, if we sell a division, we anticipate that a substantial portion of
the net proceeds will be made to our senior lender and we will not receive any
significant amount of working capital from such a sale. During 2001 and early
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. Our senior lender has precluded us from making any payments on
indebtedness to any subordinated creditors. 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. We have been informally advised by British
Telecommunications, which is one of our largest customers that, because of our
financial position, it will not place orders with us for OSS products until we
can demonstrate that we are 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 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
22 of 31
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 65
Michael A. Tancredi Senior vice president, secretary and
treasurer 1970 72
Warren H. Esanu1(1,2) Of counsel to Esanu Katsky Korins &
Siger, LLP, attorneys at law 1997 59
Herbert H. Feldman1(1,2) President, Alpha Risk Management, Inc.,
independent risk management consultants 1989 68
Marco M. Elser Managing director of Elser & Co., an
investment advisory firm 2000 43
- ----------
(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.
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.
23 of 31
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 65
Michael A. Tancredi Senior vice president,
secretary and treasurer 72
Edward B. Kornfeld Senior vice president-operations and
chief financial officer 58
David L. Rawlings Senior vice president 58
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, 58, has been senior vice president-operations since 1996 and
chief financial officer since October 1995. 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.
Mr. Rawlings, 58, has been vice president since March 1996. Mr. Rawlings
was assistant vice president of research and development-copper products from
1992 until March 1996.
Item 11. Executive Compensation
The following table shows the compensation we paid to our chief executive
officer and the four most highly compensated executive officers, other than the
chief executive officer, whose salary and bonus earned exceeded $100,000 for the
year ended December 31, 2001.
24 of 31
SUMMARY COMPENSATION TABLE
Annual Long-Term
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 2001 $240,000 -- -- -- $ 7,981
board and chief executive officer 2000 240,000 -- -- -- 29,556
1999 240,000 -- -- -- 31,996
Edward B. Kornfeld, Senior vice 2001 192,000 -- -- -- 4,872
president - operations and chief 2000 192,000 -- -- -- 4,872
financial officer 1999 192,000 -- -- -- 5,553
David Rawlings, Senior vice president, 2001 146,750 -- -- 5,000 4,343
connector division 2000 142,000 -- -- 10,000 4,287
1999 131,119 -- -- -- 4,953
Prem Chandran, Senior vice president, 2001 135,750 -- -- 5,000 2,666
signal division 2000 131,000 -- -- 10,000 2,562
1999 120,119 -- -- -- 2,808
- ----------
25 of 31
In 2002, Mr. Chandran resigned as an officer.
"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 and 1999), group life insurance in amounts greater than
that available to all employees and special long term disability coverage.
Set forth below is a chart that shows, for 2001, the components of "All
Other Compensation" listed in the Summary Compensation Table.
Mr. Carney Mr. Kornfeld Mr. Rawlings Mr. Chandran
---------- ------------ ------------ ------------
401(k) Match $ 2,550 $ 2,550 $ 2,021 $ 1,856
Supplemental Insurance 5,431 2,322 2,322 810
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.
Employment Agreements. We have entered into employment agreements with
Messrs. Carney and Kornfeld. The agreements continue on a year-to-year basis,
for January 1 of each year, unless terminated on prior notice of not less than
120 days for Mr. Carney and 90 days for Mr. Kornfeld. 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. Carney is entitled to receive his then current salary for 36 months,
and 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 an 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.
Salary Continuation Agreements. We are party to salary continuation
agreements with Messrs. Carney and Kornfeld. The salary continuation agreements
provide 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 36 in the case of Mr. Carney and 24 in the case
of Mr. Kornfeld. For purposes of the salary continuation agreements, 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 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 in each case is currently through December
31, 2001 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.
26 of 31
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 15, 2002 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 Common Percentage of
Stock Beneficially Outstanding
Name Owned Common Stock
---- ----- ------------
William V. Carney 303,021 3.0%
Michael A. Tancredi 114,238 1.1%
Warren H. Esanu 116,500 1.1%
Herbert H. Feldman 71,000 *
Marco M. Elser 360,324 3.6%
Edward B. Kornfeld 114,317 1.1%
David Rawlings 27,820 *
Prem Chandran 25,240 *
All directors and officers
as a group (12 individuals) 1,216,906 12.2%
- ----------
* Less than 1%
The shares for all officers and directors as a group do not include shares
owned by Mr. Chandran, who is no longer an officer.
Except as otherwise indicated each person has the sole power to vote and
dispose of all shares of common stock listed opposite his name.
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 15, 2002 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 51,000
Marco M. Elser 5,000
Edward B. Kornfeld 88,000
David Rawlings 27,820
Prem Chandran 25,240
All officers and directors as a group 564,325
27 of 31
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 2001, Warren H. Esanu, a director, served as a member of our audit
and compensation committees. During 2001, 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 $486,220. Esanu Katsky Korins & Siger, LLP is
continuing to render legal services to us during 2002.
Part IV
Item 14. 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.
28 of 31
(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.
29 of 31
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.
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 December 17, 1990 between the Company and LBA
properties, Inc., incorporated by reference to Exhibit 10 (d) of
the Company's annual report on Form 10-K for the year ended
December 31, 1990.
10.3 Employee Stock Bonus Program filed as Exhibit 4.3 to the Form S-8
dated February 12, 1999 and incorporated herein by reference.
10.4 1999 Stock Option Plan filed as Exhibit A to the Proxy Statement
for the 1999 Annual Meeting to Stockholders and incorporated
herein by reference.
10.5 1996 Stock Option Plan filed as Exhibit A to the Proxy Statement
for the 1996 Annual Meeting to Stockholders and incorporated
herein by reference.
10.6 1998 Stock Option Plan filed as Exhibit 4.2 to the Form S-8 dated
December 3. 1998 and incorporated herein by reference.
10.7 Senior Officers and Directors Stock Purchase Program filed as
Exhibit 4.2 to the Form S-8 dated February 12, 1999 and
incorporated herein by reference.
10.8 Employee Stock Purchase Plan filed as Exhibit 4.1 to the Form S-8
dated February 12, 1999 and incorporated herein by reference.
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 Auditors.
30 of 31
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 April 12, 2002 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, April 12, 2002
---------------------- Chief Executive Officer and Director
William V. Carney (Principal Executive Officer)
/s/ Edward B. Kornfeld Senior Vice President and April 12, 2002
---------------------- Chief Financial Officer
Edward B. Kornfeld (Principal Financial and Accounting Officer)
______________________ Director April 12, 2002
Warren H. Esanu
/s/ Michael A. Tancredi Director April 12, 2002
----------------------
Michael A. Tancredi
/s/ Herbert H. Feldman Director April 12, 2002
----------------------
Herbert H. Feldman
/s/ Marco Elser Director April 12, 2002
----------------------
Marco Elser
31 of 31
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, 2001 and 2000 F-3
Consolidated Statements of Operations and
Comprehensive Loss,
Years Ended December 31, 2001, 2000 and 1999 F-4
Consolidated Statements of Stockholders'
Equity (Deficit), Years Ended
December 31, 2001, 2000 and 1999 F-5
Consolidated Statements of Cash Flows
for the Years Ended December 31, 2001,
2000 and 1999 F-6
Notes to Consolidated Financial Statements F-7
F-1
Report of Independent Certified Public Accountants
The Board of Directors and
Stockholders of Porta Systems Corp.
Syosset, New York
We have audited the accompanying consolidated balance sheets of Porta Systems
Corp. and subsidiaries as of December 31, 2001 and 2000, and the related
consolidated statements of operations and comprehensive loss, stockholders'
equity (deficit), and cash flows for each of the three years in the period ended
December 31, 2001. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated 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, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has suffered substantial losses from
operations in 2001, 2000 and 1999 and, as of December 31, 2001, has a
stockholders' deficit of $25,849,000 and a working capital deficit of
$31,236,000. 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 15, 2002
F-2
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2001 and 2000
(in thousands, except shares and par value)
Assets 2001 2000
------ ---- ----
Current assets:
Cash and cash equivalents $ 1,204 2,366
Accounts receivable - trade, less allowance for doubtful
accounts of $2,168 in 2001 and $2,477 in 2000 4,284 7,425
Inventories 5,206 7,150
Prepaid expenses and other current assets 852 1,130
-------- --------
Total current assets 11,546 18,071
Property, plant and equipment, net 2,328 4,555
Goodwill, net of amortization of $1,501 in 2001 and $5,003 in 2000 3,761 10,357
Other assets 198 1,191
-------- --------
Total assets $ 17,833 34,174
======== ========
Liabilities and Stockholders' Deficit
Current liabilities:
Senior debt $ 22,095 20,746
Subordinated notes 6,144 6,144
6% Convertible subordinated debentures 382 --
Accounts payable 7,023 7,173
Accrued expenses 3,417 5,385
Accrued interest payable 1,593 766
Accrued commissions 1,607 1,553
Accrued deferred compensation 196 196
Income taxes payable 314 259
Short-term loans 11 1
-------- --------
Total current liabilities 42,782 42,223
-------- --------
6% Convertible subordinated debentures -- 376
Deferred compensation 900 987
Income taxes payable -- 154
Other long-term liabilities -- 918
Minority interest -- 308
-------- --------
Total long-term liabilities 900 2,743
-------- --------
Total liabilities 43,682 44,966
-------- --------
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 9,947,421 and 9,817,165 shares in 2001 and 2000, respectively 99 98
Additional paid-in capital 76,056 75,980
Accumulated deficit (95,909) (81,135)
Accumulated other comprehensive loss:
Foreign currency translation adjustment (4,157) (3,797)
-------- --------
(23,911) (8,854)
Treasury stock, at cost, 30,940 shares (1,938) (1,938)
-------- --------
Total stockholders' deficit (25,849) (10,792)
-------- --------
Total liabilities and stockholders' deficit $ 17,833 34,174
======== ========
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, 2001, 2000 and 1999
(in thousands, except per share amounts)
2001 2000 1999
---- ---- ----
Sales $ 28,062 51,140 38,936
Cost of sales 19,970 35,890 28,952
-------- -------- --------
Gross profit 8,092 15,250 9,984
-------- -------- --------
Selling, general and administrative expenses 9,316 14,573 13,603
Research and development expenses 4,427 5,830 6,090
Goodwill impairment 5,802 -- --
-------- -------- --------
Total expenses 19,545 20,403 19,693
-------- -------- --------
Operating loss (11,453) (5,153) (9,709)
Interest expense (4,480) (4,500) (3,571)
Interest income 31 129 188
Gain on sale of assets 684 -- --
Other income (expense), net 191 (813) 218
-------- -------- --------
Loss before income taxes, equity in net loss
of joint venture and minority interest (15,027) (10,337) (12,874)
Income tax benefit (expense) 203 (227) (873)
Equity in net loss of joint venture (175) -- --
Minority interest 225 388 61
-------- -------- --------
Net loss $(14,774) (10,176) (13,686)
======== ======== ========
Other comprehensive income (loss):
Foreign currency translation adjustments (360) 99 (142)
-------- -------- --------
Comprehensive loss $(15,134) (10,077) (13,828)
======== ======== ========
Basic per share amounts:
Net loss per share of common stock $ (1.50) (1.04) (1.44)
======== ======== ========
Weighted average shares of common stock outstanding 9,878 9,763 9,489
======== ======== ========
Diluted per share amounts:
Net loss per share of common stock $ (1.50) (1.04) (1.44)
======== ======== ========
Weighted average shares of common stock outstanding 9,878 9,763 9,489
======== ======== ========
See accompanying notes to consolidated financial statements.
F-4
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity (Deficit)
Years ended December 31, 2001, 2000 and 1999
(In thousands)
Receivable Total
Common Stock Accumulated for Stock-
----------- Additional Other Employee holders'
No. of Par Value Paid-in Comprehensive Accumulated Treasury Stock Equity/
Shares Amount Capital (Loss) Deficit Stock Purchases (Deficit)
---------------------------------------------------------------------------------------------
Balance at December 31, 1998 9,485 $95 $75,135 $(3,754) $(57,273) $(1,938) $(281) $ 11,984
Net loss 1999 -- -- -- -- (13,686) -- -- (13,686)
Common stock issued 154 1 119 -- -- -- -- 120
Warrants re-priced -- -- 56 -- -- -- -- 56
Collection of receivable from
directors and officers
under stock purchase program -- -- -- -- -- 281 281
Foreign currency translation
adjustment -- -- -- (142) -- -- -- (142)
---------------------------------------------------------------------------------------------
Balance at December 31, 1999 9,639 96 75,310 (3,896) (70,959) (1,938) -0- (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) -0- (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) $-0- $(25,849)
======== === ======= ======= ======== ======= ===== ========
See accompanying notes to consolidated financial statements
F-5
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Note 22)
Years ended December 31, 2001, 2000 and 1999
(In thousands)
2001 2000 1999
---- ---- ----
Cash flows from operating activities:
Net loss $(14,774) (10,176) (13,686)
Adjustments to reconcile net loss to net cash
used in operating activities:
Non-cash financing expenses 123 373 18
Gain on sale of assets (684) -- --
Non-cash compensation expense -- -- 8
Depreciation and amortization 1,909 1,911 1,677
Goodwill impairment 5,802 -- --
Amortization of debt discounts 6 56 326
Minority interest (225) (388) (61)
Equity in loss of joint venture 175 -- --
Changes in operating assets and liabilities:
Accounts receivable 3,141 4,712 7,665
Inventories 1,944 1,743 51
Prepaid expenses 278 243 343
Other assets 867 1,427 113
Accounts payable, accrued expenses and other liabilities (2,341) (2,405) 238
-------- -------- --------
Net cash used in operating activities (3,779) (2,504) (3,308)
-------- -------- --------
Cash flows from investing activities:
Repayment of receivables from stock purchase program -- -- 281
Net proceeds from the sale of assets 1,670 -- --
Capital expenditures, net (196) (1,533) (951)
-------- -------- --------
Net cash provided by (used in) investing activities 1,474 (1,533) (670)
-------- -------- --------
Cash flows from financing activities:
Proceeds from senior debt 2,222 5,010 6,150
Repayments of senior debt (873) (1,782) (1,820)
Proceeds from subordinated debentures and warrants -- 80 64
Proceeds from the exercise of options and warrants 38 176 --
Proceeds (repayments) of notes payable/short-term loans 10 (43) (100)
-------- -------- --------
Net cash provided by financing activities 1,397 3,441 4,294
-------- -------- --------
Effect of exchange rate changes on cash (254) (283) (115)
-------- -------- --------
Increase (decrease) in cash and cash equivalents (1,162) (879) 201
Cash and equivalents - beginning of year 2,366 3,245 3,044
-------- -------- --------
Cash and equivalents - end of year $ 1,204 2,366 3,245
======== ======== ========
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 18 and 23, 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.
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.
(Continued)
F-7
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Deferred Computer Software
Software costs incurred for specific customer contracts are charged to cost
of sales at the time revenues on such contracts are recognized. Software
development costs relating to products the Company offers for sale are
deferred in accordance with Statement of Financial Accounting Standards
(SFAS) No. 86 "Accounting for the Costs of Computer Software to Be Sold,
Leased, or Otherwise Marketed." These costs are amortized to cost of sales
over the periods that the related product will be sold, up to a maximum of
four years. Amortization of computer software costs, which all relate to
products the Company offers for sale, amounted to approximately $0, $0,
and $82,000 in 2001, 2000 and 1999, respectively.
Goodwill
Goodwill represents the difference between the purchase price and the fair
market value of net assets acquired in business combinations treated as
purchases. Goodwill is amortized on a straight-line basis over the
estimated useful life as determined by events and circumstances of the
business combination that gave rise to the goodwill. The Company assesses
the recoverability of unamortized goodwill using the undiscounted
projected future cash flows from the related businesses (note 6).
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 15).
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 comprehensive income or loss.
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 2001, 2000 and
1999, no dilutive potential shares of common stock were added to compute
diluted loss per share because the effect was anti-dilutive.
(Continued)
F-8
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Reclassifications
Certain reclassifications have been made to conform prior years' consolidated
financial statements to the 2001 presentation.
Accounting for Stock-Based Compensation
The Company follows the Statement of Financial Accounting Standard No. 123,
"Accounting for Stock-Based Compensation". Porta has elected not to
implement the fair value based accounting method for employee stock
options, but has elected to disclose the pro-forma net income and earnings
per share as if such method had been used to account for stock-based
compensation cost as described in the Statement.
Accounting for the Impairment of Long-Lived Assets
The Company follows the Statement of Financial Accounting Standard No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of". Porta believes that there is no impairment of
its long-lived assets except for goodwill as discussed in note 6.
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 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"),
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets" effective for fiscal years beginning after December 15, 2001. It
also issued SFAS No. 143, "Accounting for Obligations Associated with the
Retirement of Long-Lived Assets" in August 2001 and SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" in
October 2001.
SFAS141 requires the use of the purchase method of accounting and prohibits
the use of the pooling-of-interests method of accounting for business
combinations initiated after June 30, 2001. SFAS 141 also requires that
the Company recognize acquired intangible assets apart from goodwill if
the acquired intangible assets meet certain criteria. SFAS 141 applies to
all business combinations initiated after June 30, 2001 and for purchase
business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the
carrying amounts of intangible assets and goodwill based on the criteria
in SFAS 141.
(Continued)
F-9
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
SFAS142 requires, among other things, that companies no longer amortize
goodwill, but instead, test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for
the purposes of assessing potential future impairments of goodwill,
reassess the useful lives of other existing recognized intangible assets,
and cease amortization of intangible assets with an indefinite useful
life. An intangible asset with an indefinite useful life should be tested
for impairment in accordance with the guidance in SFAS 142. SFAS 142 is
required to be applied in fiscal years beginning after December 15, 2001
to all goodwill and other intangible assets recognized at that date,
regardless of when those assets were initially recognized. SFAS 142
requires the Company to complete a transitional goodwill impairment test
six months from the date of adoption. The Company is also required to
reassess the useful lives of other intangible assets within the first
interim quarter after adoption of SFAS 142. The Company's previous
business combinations were accounted for using the purchase method. As of
December 31, 2001, the net carrying amount of goodwill is $3,761,000.
Currently, the Company is assessing, but has not yet determined, how the
adoption of SFAS 141 and SFAS 142 will impact its financial position and
results of operations.
SFAS143 establishes standards for the reporting of obligations associated
with the retirement of tangible long-lived assets and the associated asset
retirement costs. It also provides accounting guidance for legal
obligations associated with the retirement of tangible long-lived assets.
SFAS 143 is effective for fiscal years beginning after June 15, 2002 with
early adoption permitted. The Company expects that the provisions of SFAS
143 will not have a material effect on its consolidated results of
operations.
SFAS144 establishes a single accounting model for the impairment or disposal
of long-lived assets and new standards for reporting discontinued
operations. The provisions of SFAS 144 are effective in fiscal years
beginning after December 15, 2001 and in general are to be applied
prospectively. The Company is currently evaluating the provisions of SFAS
144 but does not expect they will have a material effect on its
consolidated results of operations upon adoption.
(2) Liquidity
As of December 31, 2001, Porta's debt included $22,095,000 of senior debt,
which matured on January 7, 2002, and $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 ($1,358,000) on the subordinated notes. The
amount of interest represents interest from July 2000 through December
2001. At December 31, 2001, 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.
(Continued)
F-10
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
On March 1, 2002, the Company and its 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. The agreement
allows the Company to draw monies subject to the senior lender's receipt
and approval of a weekly disbursement budget. However, the advances are at
the discretion of the senior lender. Obligations under the new term loan
bear interest at 12% per annum. The amended agreement establishes all
indebtedness prior to March 1, 2002 as an old term loan in the amount of
$22,610,000, which includes the balance due at December 31, 2001 plus
accrued interest through March 1, 2002. The old term loan shall bear no
interest until such time as the senior lender in its sole discretion
notifies the Company that interest shall be payable. Both the new and old
term loans are payable on December 31, 2002. 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. The agreement also requires the Company to diligently pursue the
sale of one or more of its divisions and pay the net proceeds from such
sale to the senior lender, which may not leave the Company with sufficient
capital for its operations.
The $1,500,000 being advanced by the Company's senior lender is being
advanced at the discretion of the senior lender and such advances are
dependent on, among other things, the perception of the senior lender that
the Company is either stemming its losses or effecting a sale of one or
more of its divisions. If the senior lender ceases funding Porta's
operations, unless it has obtained alternative financing, the Company will
be unable to continue in business. Furthermore, unless the Company obtains
funding from another source, including the sale of one of more of its
divisions, Porta will not be able to pay its senior lender on December 31,
2002, and Porta may not be able to continue in business.
As of December 31, 2001, the Company had remaining outstanding $382,000 of 6%
Debentures, net of original issue discount of $3,000, which mature July 2,
2002. The face amount of the outstanding 6% Debentures was $385,000. The
interest accrued on the 6% Debentures is payable on July 1 of each year.
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 on July 1, 2001.
Thus, interest due at December 31, 2001 was $35,000. Additionally, the
trustee has notified the Company that the non-payment of the interest
caused an event of default.
As of December 31, 2001, the Company had outstanding $6,144,000 of
subordinated notes, all of which became due during 2001. The Company did
not have the resources to pay, and it did not pay, either the principal or
interest on the subordinated notes and is restricted by its 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 recently 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 the
Company remained in default to the senior debt holder.
(Continued)
F-11
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
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; and
o a number of creditors, including one holder of Porta's subordinated
notes, as discussed above, have engaged attorneys or collection
agencies or commenced legal actions against the Company, and some of
them have obtained judgments against the Company, including a former
landlord who has obtained a $400,000 judgment against the Company.
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 $46,000 was due
at December 31, 2001 and an additional $100,000 has become due in 2002.
Other claimants who have already either commenced litigation or otherwise
sought collection or have obtained a judgment against the Company are due
approximately $600,000. 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 Company is seeking to address its need for liquidity by exploring
alternatives, including the possible sale of one or more of its divisions.
During 2000 and 2001, 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. Although the Company
is engaged in preliminary discussions with respect to a sale of one of its
divisions, the Company has not signed any agreements with respect to such
a sale, and it may not be able to sell any of its divisions on reasonable
terms. 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 early 2002, the Company has taken steps to reduce
overhead and headcount. 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 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.
F-12
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.
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Accounts Receivable
Accounts receivable included approximately $500,000 and $0 at December 31,
2001 and 2000, respectively, of revenues earned but not yet contractually
billable relating to long-term contracts for specialized products. All
such amounts at December 31, 2001 are expected to be billed in 2002. In
addition, accounts receivable included approximately $311,000 and
$1,197,000 at December 31, 2001 and 2000, respectively, of retainage
balances due on various long-term contracts. All such amounts, net of
reserves, at December 31, 2001 are expected to be collected in 2002 and
all such amounts, net of reserves, at December 31, 2000, were collected in
2001. The allowance for doubtful accounts receivable was $2,168,000 and
$2,477,000 as of December 31, 2001 and 2000, respectively. The allowance
for doubtful accounts was increased by provisions of $0, $730,000, and
$1,070,000 and decreased by write-offs of $309,000, $132,000, and $106,000
for the years ended December 31, 2001, 2000, and 1999, respectively.
(4) Inventories
Inventories consist of the following: December 31,
2001 2000
---- ----
Parts and components $3,217,000 4,973,000
Work-in-process 192,000 543,000
Finished goods 1,797,000 1,634,000
---------- ----------
$5,206,000 7,150,000
========== ==========
(5) Property, Plant and Equipment
Property, plant and equipment consists of the following:
December 31
----------------- Estimated
2001 2000 useful lives
---- ---- ------------
Land $ 132,000 246,000 --
Buildings 1,060,000 2,284,000 30 years
Machinery and equipment 7,221,000 8,870,000 3-10 years
Furniture and fixtures 2,557,000 2,700,000 8 years
Transportation equipment 84,000 133,000 4 years
Tools and molds 4,108,000 4,124,000 8 years
Leasehold improvements 822,000 858,000 Term of lease
---------- ----------
15,984,000 19,215,000
Less accumulated depreciation
and amortization 13,656,000 14,660,000
---------- ----------
$2,328,000 4,555,000
========== ==========
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.
(Continued)
F-13
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Goodwill
As of December 31, 2001 and 2000, unamortized goodwill was $3,761,000 and
$10,357,000, respectively. 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. Additionally, there are presently no ongoing negotiations
regarding the sale of the OSS division.
During 2000 and 1999, in view of recent competitive developments in the
telecommunications market place and Porta's changing business model in
response, management reassessed the useful life of certain of its
goodwill. At that time, in management's opinion, there was no impairment
in the carrying value of this long-lived intangible asset (based upon an
analysis of undiscounted future cash flows), and management determined
that the useful life of the goodwill should be shortened to be more
reflective of the current rate of technology change and competitive
conditions. Accordingly, management changed the estimated useful life of
certain goodwill from an original life of 40 years to a remaining life of
13 years in 1999 and 10 years in 2000, which changes were applied
prospectively from the fourth quarters of 1999 and 2000. These changes in
accounting estimate increased amortization expense in 2000 and in 1999 by
approximately $25,000 and $58,000, respectively.
Goodwill associated with one of Porta's other business units of $3,761,000 is
amortized on a straight-line basis over a remaining life of 29 years. The
Company has determined that there is no impairment of this asset.
(7) Senior Debt
On December 31, 2001 and 2000, Porta's senior debt consisted of debt under
its credit facility in the amount of $22,095,000 and $20,596,000,
respectively, and a non-interest bearing deferred funding fee note payable
to the senior lender in the amounts of $0 and $150,000, respectively. As
of December 31, 2001, the total outstanding principal balance was due
on January 7, 2002, and has been classified as a current liability. (See
Note 2)
(Continued)
F-14
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
During 2000, the Company and its senior lender agreed to extend the loan and
security agreement to July 3, 2001. As part of the agreement, Porta agreed
to reduce the exercise price of outstanding warrants to purchase 471,000
shares of common stock held by its senior lender to $2.00 per share. The
value of the reduction of the warrant price was $169,000 which was
recorded as deferred financing expense and additional paid in capital in
2000. In addition, during 2000, the Company and its senior lender agreed
to increase the revolving line maximum by $2,000,000 from $9,000,000 to
$11,000,000 through January 1, 2001. As of December 31, 2000, the Company
had borrowed $1,160,000 under the increased revolving line. As
consideration, the Company issued to its senior lender a five-year warrant
to purchase 100,000 shares of common stock at $2.00 per share. The value
of the warrants issued was $129,000 which was recorded as deferred
financing expense and additional paid in capital in 2000. The balance of
the facility is comprised of a term loan. The credit facility is secured
by substantially all of Porta's assets. All obligations, except undrawn
letters of credit, letter of credit guarantees and the deferred fee notes,
bear interest at 12%. The Company incurs a fee of 2% per annum on the
average balance of letter of credit guarantees outstanding. In connection
with the senior lender's waiver of non-compliance during 2000, the Company
reduced from $2.00 per share to $1.00 per share, the exercise price of
warrants to purchase 571,000 shares of common stock which are held by the
lender. The value of the reduction in exercise price was $59,000 and
recorded as deferred financing expense and additional paid in capital.
Based upon the warrant transactions during 2000, additional non-cash
interest expense of $289,000 was recognized. The agreement also provided
for loan principal payments of $400,000 on the last day of each quarter
during the term of the agreement. As part of the agreement, the loan
amortization shall first be applied to the non-interest bearing notes
payable until these notes are paid in full and then to the term loan. The
agreement also requires the Company to pay additional principal payments
if its cash flow exceeds certain amounts. A monthly facility fee payment
of $50,000 continuing to the end of the agreement is also required.
On January 2, 2001, Porta did not have the resources to repay the $1,160,000
of principal due. In March 2001, the senior lender agreed to allow the
Company to defer the repayment of borrowings related to the increased
maximum, defer all monthly facility fees and the April 1, 2001 principal
payment to the earlier of the termination of the agreement of July 3, 2001
or the sale of one or more of the divisions of the Company. The agreement
also precluded the Company from making any payments on indebtedness to any
subordinated creditors, although it permits payment of accounts payable in
the ordinary course of business.
In April 2001, the Company and its senior lender agreed to add all current
and future interest due, which will be computed at 14%, to the principal
balance through the loan expiration date. As consideration, 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.
On the July 3, 2001, the loan expiration date, the Company did not have the
resources to repay the loan, at which time the senior lender and the
Company executed an extension agreement for approximately a one month
period, which extensions continued monthly though February 2002.
(Continued)
F-15
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Subsequent to December 31, 2001, 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. The agreement
allows the Company to draw monies subject to the senior lender's receipt
and approval of a weekly disbursement budget. Any advances under this
agreement are subject to the discretion of the senior lender. Obligations
under the new term loan bear interest at 12%, which interest shall accrue
monthly and be applied to the principal until September 1, 2002 when
interest for the month of August 2002 shall be paid and interest shall
continue to be paid each subsequent month. 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. Both the
new and old term loans are due on December 31, 2002. Additionally, the
senior lender has 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 allows for standby letters of credit not
to exceed a maximum of $573,000.
(8) 6% Convertible Subordinated Debentures
As of December 31, 2001 and 2000 Porta had outstanding $382,000 and $376,000
of its 6% convertible subordinated debentures due July 1, 2002 (the
"Debentures"), net of original issue discount of $3,000 and $9,000,
respectively. The face amount of the outstanding Debentures was $385,000
at both December 31, 2001 and 2000. The Debentures are convertible at any
time prior to maturity into Common Stock of the Company at a conversion
rate of 8.333 shares for each $1,000 face amount of Debentures, subject to
adjustment under certain circumstances. 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, 2001 and 2000, accrued interest on the debentures was $35,000 and
$12,000, respectively. Subsequent to December 31, 2001, the trustee of the
Debentures gave notice to the Company that it was in default under the
indenture and the Debentures.
(9) Subordinated Notes
As of December 31, 2001 and 2000, $6,144,000 of Subordinated Notes were
outstanding. As of December 31, 2001, $6,144,000 of principal and
$1,358,000 of accrued interest were due and payable. However, Porta did
not have the resources to pay the $6,144,000 principal and $1,358,000 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 21).
(Continued)
F-16
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
During December 1999, Porta (a) extended its maturity date of the $6,000,000
outstanding principal amount of Subordinated Notes to January 3, 2001 with
the right to extend the maturity date to July 3, 2001 if Porta achieves
certain financial results, (b) increased the interest rate of the
Subordinated Notes to 14% per annum during the initial term and to 15%
during the extended term, (c) reduced the exercise price of the previously
issued Series B and C Warrants to $1.00 per share, (d) granted the holders
of the Subordinated Notes the right to a payment in kind option, whereby
the note holder has the right to receive interest in the form of a new
subordinated note in the principal amount equal to 125% of the interest
then due, with the new subordinated note bearing interest at the rate of
125% of the then current interest rate of the Subordinated Notes, and (e)
agreed that, if Porta extends the maturity date of the Subordinated Notes
to July 3, 2001, it will issue to the noteholders New Warrants to purchase
a total of 300,000 shares of Common Stock at the average closing price of
the Common Stock for five trading days preceding January 3, 2001. As a
result of the amendment to the Subordinated Notes, Porta recorded a
discount of approximately $56,000 relating to the re-pricing of the
warrants and additional interest expense for Noteholders who elected the
paid in kind option at December 31, 1999 of approximately $13,000.
In connection with a further amendment of the Subordinated Notes in April
2000, the Company agreed to issue to the noteholders New Warrants to
purchase an aggregate of 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 was recorded during 2000
in connection with this transaction.
(10) Joint Venture
The Company has a 50% interest in a joint venture agreement with a Korean
partner. Unless otherwise terminated in accordance with the joint venture
agreement, the joint venture will terminate on December 31, 2010. The
Company's option to acquire an additional 1% interest of the joint
venture, for approximately $190,000 expired during 2001. 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 sells and receives 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, Porta's share of the
losses on its investment have been recorded on the equity method effective
October 1, 2001. As such losses are in excess of Porta's investment, and
Porta does not guaranty such excess losses, the investment in the joint
venture is carried at $0 as of December 31, 2001.
(11) Stockholders' Equity
Porta had outstanding warrants to its senior lender to purchase 571,152
shares of common stock, which are immediately exercisable at $0.25 per
share and for which 471,152 expire on November 30, 2002 and 100,000 expire
on June 6, 2005.
Porta had outstanding to an investment banker warrants to purchase 400,000
shares of common stock at $1.56 per share which expire April 2002.
(Continued)
F-17
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
See Note 9 in connection with the issuance of the Series B and C Warrants as
part of the private placement of the subordinated Notes and the amendment
of the terms of the Subordinated Notes and Series B and C Warrants.
As of December 31, 2001, Porta had stock purchase warrants outstanding to
purchase 15,000 shares of common stock at an exercise price of $1.8125 per
share until May 2005 of which warrants to purchase 10,000 shares of common
stock are immediately exercisable.
Under a 1984 Employee Incentive Plan, Porta provided an opportunity for
certain employees of the Company and its subsidiaries to acquire
subordinated convertible debentures. As a result, as of December 31, 1998,
there was $13,000 of employee promissory notes receivable outstanding, of
which the maturity date has been extended to April 1999. During 1998, the
Board of Directors approved a reduction in the original issue price of the
debentures to the then current market rate of the common stock,
approximately $1.38 per share, which common stock was held by Porta as
collateral for the notes. Accordingly, the related receivable from
employees was reduced from $307,000 to $13,000 to reflect the new
valuation. The reduction on the original issue resulted in a non-cash
compensation charge in 1998 of $298,000. During 1999, all of the
receivables from employees were paid.
(12) Stockholder Rights Plan
Porta has a Stockholder Rights Plan in which preferred stock purchase rights
were distributed to stockholders as a dividend at the rate of one right
for each common share. This plan has expired.
(13) 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 2001, 2000 and 1999,
Porta accrued approximately $166,000, $180,000 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, 2001, 2000 and 1999, Porta's contribution amounted to
$54,000, $72,000 and $93,000, 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 2001 and 2000, 130,256 and 84,804 shares, respectively, were issued
pursuant to the Purchase Plan. Subsequent to December 31, 2001, Porta
issued approximately 29,500 shares of stock to the participants of the
Purchase Plan.
Porta does not provide any other post-retirement benefits to any of its
employees.
(Continued)
F-18
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(14) 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 100,000 shares of common stock is reserved for
issuance pursuant to the Bonus Plan. During 1999 Porta issued 4,250 shares
of common stock pursuant to the Bonus Plan and recorded a charge of
approximately $8,000. No shares of common stock were issued pursuant to
the Bonus Plan during 2001 and 2000.
Porta's 1986 Stock Incentive Plan ("1986 Plan"), expired in March 1996,
although options granted prior to the expiration date remain in effect in
accordance with their terms. Options granted under the 1986 Plan may be
incentive stock options, as defined in the Internal Revenue Code, or
options that are not incentive stock options. The exercise prices for all
options granted were equal to the fair market value at the date of grant.
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, based upon
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.
(Continued)
F-19
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
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, 2001, 10,000 of the options
are vested.
Porta applies APB Opinion 25, "Accounting for Stock Issued to Employees"
("APB 25") and related Interpretations in accounting for the 1999, 1998,
1996 and 1986 Plans. Under APB 25, no compensation cost is recognized for
options granted to employees at exercise prices greater than or equal to
fair market value of the underlying common stock at the date of grant.
Porta has adopted the disclosure only provisions of Statement of Financial
Accounting Standard No. 123, "Accounting for Stock-Based Compensation"
("SFAS No.123") which requires the Company to provide, beginning with 1995
grants, pro forma information regarding net income (loss) and net income
(loss) per common share (basic and diluted) as if compensation costs for
Porta's stock option plans had been determined in accordance with the fair
value method prescribed in SFAS No.123. If Porta had elected to recognize
compensation costs based on fair value of the options granted at grant
date as prescribed by SFAS No. 123, net loss and net loss per share (basic
and diluted) would have been increased to the pro forma amounts indicated
below:
(Dollars in thousands, except per share data)
2001 2000 1999
---- ---- ----
Pro forma net loss $(14,787) $(10,393) $(14,280)
Pro forma net loss per share (basic
and diluted) $ (1.50) $ (1.06) $ (1.50)
The weighted-average fair values of options granted were $0.23, $ 1.62 and
$1.36 per share in 2001, 2000 and 1999, 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
2001, 2000 and 1999:
2001 2000 1999
---- ---- ----
Dividends: $0.00 per share $0.00 per share $0.00 per share
Volatility: 100% 57.64%-68.70% 45.80%-80.00%
Risk-free interest: 4.22%-5.48% 5.54%-6.53% 4.50%-6.40%
Expected term: 5 - 9.6 years 5 years 5 years
(Continued)
F-20
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
A summary of the status of Porta's stock option plans as of December 31,
2001, 2000, and 1999, and changes during the years ending on those dates
is presented below:
2001 2000 1999
------------------------- ----------------------- ---------------------------
Shares Weighted Shares Weighted Shares Weighted
Under Average Under Average Under Average
Option Exercise Price Option Exercise Price Option Exercise Price
------ -------------- ------ -------------- ------ --------------
Outstanding beginning of year 949,713 $2.55 870,538 $2.51 907,965 $3.42
Granted 55,000 0.29 108,500 3.12 27,700 1.74
Exercised -- (6,000) 1.50 --
Forfeited (203,008) 2.58 (23,325) 2.80 (65,127) 15.04
------- ------- -------
Outstanding end of year 801,705 $3.96 949,713 $2.55 870,538 $2.51
======= ======= =======
Options exercisable at year-end 698,105 807,780 799,238
======= ======= =======
The following table summarizes information about stock options outstanding
under the stock option plans at December 31, 2001:
Options Outstanding Options Exercisable
-------------------------------------------------- ----------------------------------
Range of Outstanding Remaining Weighted-average Exercisable Weighted-Average
Exercise Prices at 12/31/01 Contractual Life Exercise Price at 12/31/01 Exercise Price
--------------- ----------- ---------------- -------------- ----------- --------------
<$1.00 55,000 6.7 years $0.29 31,000 $0.31
$1.00 - 1.99 280,780 5.5 years $1.51 280,613 $1.51
$2.00 - 2.99 51,175 3.8 years $2.25 50,375 $2.26
$3.00 - 3.99 411,750 2.6 years $3.24 333,117 $3.26
$4.00 - 5.00 3,000 0.8 years $5.00 3,000 $5.00
(15) Income Taxes
The provision (benefit) for income taxes consists of the following:
2001 2000 1999
-------------------- -------------------- ---------------------
Current Deferred Current Deferred Current Deferred
------- -------- ------- -------- ------- --------
Federal $ -- -- -- -- -- 716,000
State and foreign (203,000) -- 227,000 -- 62,000 95,000
--------- -- --------- -- --------- ---------
Total $(203,000) -- 227,000 -- 62,000 811,000
========= == ========= == ========= =========
The domestic and foreign components of loss before provision for income taxes
were as follows:
2001 2000 1999
---- ---- ----
United States $(11,578,000) (7,519,000) (7,516,000)
Foreign (3,399,000) (2,430,000) (5,297,000)
------------ ---------- -----------
Loss before provision for
income taxes $(14,977,000) (9,949,000) (12,813,000)
============ ========== ===========
(Continued)
F-21
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
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 from
continuing operations before income taxes is as follows:
2001 2000 1999
---- ---- ----
Tax expense (benefit) at statutory rate $(5,092,000) (3,383,000) (4,356,000)
Increase (decrease) in income tax benefit resulting from:
Increase (decrease) in valuation allowance 3,057,000 2,776,000 5,486,000
State and foreign taxes, less applicable federal benefits (211,000) (127,000) (368,000)
Non-deductible goodwill impairment 1,973,000 -- --
Other expenses not deductible for tax 333,000 345,000 152,000
Foreign income taxed at rates
Different from U.S. statutory rate (19,000) 25,000 (5,000)
Estimated NOL adjustments, including Section 382 limitation -- 594,000 --
Reversal of prior year's accrual (262,000)
Other 18,000 (3,000) (36,000)
----------- ----------- -----------
$ (203,000) 227,000 873,000
=========== =========== ===========
Porta has unused United States tax net operating loss (NOL) carryforwards of
approximately $89,000,000 expiring at various dates between 2009 and 2021.
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 $5,700,000 with indefinite
expiration dates.
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 3,961,000
-----------
$43,855,000
===========
The components of the deferred tax assets, the net balance of which zero
after the valuation allowance, as of December 31, 2001 and 2000 are as
follows:
2001 2000
---- ----
Deferred tax assets:
Inventory $ 1,370,000 1,211,000
Allowance for doubtful accounts receivable 835,000 828,000
Benefits of tax loss carryforwards 18,734,000 16,622,000
Benefit plans 633,000 845,000
Accrued commissions 619,000 581,000
Other 917,000 390,000
Depreciation 818,000 392,000
------------ ------------
23,926,000 20,869,000
Valuation allowance (23,926,000) (20,869,000)
------------ ------------
$ -- --
============ ============
(Continued)
F-22
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
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.
Because of Porta's losses in 2001 and 2000, 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. The aggregate annual
amounts payable by Porta, including interest on the unpaid amounts at a
current rate of 7%, is $240,000 in 2001. As of December 31, 2001, 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, 2001, $274,000 remains outstanding.
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, 2001, undistributed earnings of the foreign subsidiaries amounted to
approximately $1,186,000. It is not practicable to determine the amount of
income or withholding tax that would be payable upon the remittance of
those earnings.
(16) Leases
At December 31, 2001, 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
2001, 2000, and 1999 amounted to approximately $793,000, $1,357,000 and
$874,000, respectively. All rental expense related to the Company's North
Carolina facility, which has been vacated, were accrued in 2000. The
landlord of the North Carolina facility has obtained a $400,000 judgment
against the Company. Minimum rental commitments, exclusive of future
escalation charges, for each of the next five years are as follows:
2002 $1,005,000
2003 774,000
2004 720,000
2005 555,000
2006 222,000
Thereafter 2,914,000
----------
$6,190,000
==========
(Continued)
F-23
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(17) Contingencies
At December 31, 2001, Porta was contingently liable for outstanding letters
of credit aggregating approximately $573,000 as security for the
performance of certain long-term contracts.
Porta is a party to 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 21).
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, including a former landlord of the North Carolina
facility, which has obtained a $400,000 judgment against the Company (note
15). 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 $46,000 was due
at December 31, 2001 and an additional $100,000 has become due in 2002.
Other claimants who have already either commenced litigation or otherwise
sought collection or have obtained a judgment against the Company are due
approximately $600,000.
(18) Major Customers
During the years ended December 31, 2001, 2000 and 1999, Porta's five largest
customers accounted for sales of $13,444,000, or approximately 48% of
sales, $28,323,000, or approximately 55% of sales, and $19,700,000, or
approximately 51% of sales, respectively. Porta's largest customer in 2001
with sales of $3,485,000, or approximately 12% of sales, was Philippines
Long Distance Telephone (PLDT). However, 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. Porta's largest customer in 1999 was BT. Direct sales to BT
for the year ended December 31, 2001, 2000 and 1999 amounted to
$3,339,000, $5,098,000 and $7,825,000, respectively, or approximately 12%,
10% and 20%, 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 19% and 26%, respectively, of Porta's accounts receivable
are due from the five largest customers as of December 31, 2001 and 2000,
respectively.
(Continued)
F-24
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(19) Fair Values of Financial Instruments
Cash equivalents, accounts receivable, accounts and notes payable, and
short-term loans 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 long-term debt cannot be reasonably estimated due
to the lack of marketability of such instruments.
(20) Net Loss Per Share
The following table sets forth the computation of basic and diluted net loss
per share:
2001 2000 1999
---- ---- ----
Numerator-Basic and diluted
Net loss per share:
Net loss $(14,774,000) $(10,176,000) $(13,686,000)
============ ============ ============
Denominator:
Denominator for basic and diluted net loss
per share -weighted-average shares 9,878,000 9,763,000 9,489,000
============ ============ ============
Basic per share amounts:
Net loss per share of common stock $ (1.50) $ (1.04) $ (1.44)
============ ============ ============
Diluted per share amounts:
Net loss per share of common stock $ (1.50) $ (1.04) $ (1.44)
============ ============ ============
Options to purchase 806,705, 649,733 and 638,508 shares of common stock for
2001, 2000 and 1999, respectively, with exercise prices ranging from $0.22
to $5.00, $1.69 to $5.00 and $1.69 to $5.00 for 2001, 2000 and 1999,
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.
Warrants to purchase 1,776,152, 195,500 and 913,000 shares of common stock
for 2001, 2000 and 1999, respectively, with exercise prices ranging from
$0.25 to $1.81, $1.81 to $17.50 and $1.56 to $17.50 for 2001, 2000 and
1999, 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.
(Continued)
F-25
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(21) 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 recently 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 asserts 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
has filed an answer and counterclaim against the plaintiffs. The Company
believes that it has valid defenses to the claims and intends to defend
this action vigorously and to assert counterclaims against these former
executives.
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.
See Note 16, in connection with a judgment by a former landlord, and Note 17,
in connection with claims against the Company by creditors.
(Continued)
F-26
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(22) Cash Flow Information
(1) Supplemental cash flow information for the years ended December 31, is as
follows:
2001 2000 1999
---- ---- ----
Cash paid for interest $ 933 3,763 3,117
===== ===== =====
Cash paid for income taxes $ 131 183 379
===== ===== =====
(2) Non-cash transactions:
(i) In 1999, in connection with advisory services provided by an
investment banking firm, the Company issued 150,000 shares of common
stock valued at approximately $113,000 (notes 7 and 10).
(ii) In 1999, Porta incurred a non-cash charge of $56,000 as a
result of the reduction in the exercise price of the Series B and
Series C Warrants (note 9).
(iii) In 2000, Porta incurred a non-cash charge of $140,000 as a
result of the issuance New Warrants (note 9).
(iv) 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 (note 7).
(v) 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 (note
7).
(vi) 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 (note
7).
(vii) 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
(23) 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.
2001 2000 1999
---- ---- ----
Revenue:
Line $ 12,756,000 20,546,000 18,189,000
OSS 8,874,000 22,296,000 14,254,000
Signal 5,737,000 7,644,000 6,328,000
------------ ---------- -----------
$ 27,367,000 50,486,000 38,771,000
============ ========== ===========
Segment profit:
Line $ 1,275,000 3,665,000 3,582,000
OSS (10,518,000) (6,201,000) (10,650,000)
Signal 1,449,000 2,088,000 1,884,000
------------ ---------- -----------
$ (7,794,000) (448,000) (5,184,000)
============ ========== ===========
Depreciation and amortization:
Line $ 374,000 424,000 505,000
OSS 1,262,000 1,262,000 881,000
Signal 166,000 162,000 199,000
------------ ---------- -----------
$ 1,802,000 1,848,000 1,585,000
============ ========== ===========
Total identifiable assets:
Line $ 5,990,000 8,508,000 7,921,000
OSS 4,268,000 14,942,000 21,637,000
Signal 5,557,000 6,591,000 7,965,000
------------ ---------- -----------
$ 15,815,000 30,041,000 37,523,000
============ ========== ===========
Capital expenditures:
Line $ 132,000 340,000 415,000
OSS 55,000 1,132,000 670,000
Signal 0 45,000 27,000
------------ ---------- -----------
$ 187,000 1,517,000 1,112,000
============ ========== ===========
(Continued)
F-28
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The following table reconciles segment totals to consolidated totals:
2001 2000 1999
---- ---- ----
Revenue:
Total revenue for reportable segments $ 27,367,000 50,486,000 38,771,000
Other revenue 695,000 654,000 165,000
------------ ------------ ------------
Consolidated total revenue $ 28,062,000 51,140,000 38,936,000
============ ============ ============
Operating loss:
Total segment loss for reportable segments $ (7,794,000) (448,000) (5,184,000)
Corporate and unallocated (3,659,000) (4,705,000) (4,525,000)
------------ ------------ ------------
Consolidated total operating loss $(11,453,000) (5,153,000) (9,709,000)
============ ============ ============
Depreciation and amortization:
Total for reportable segments $ 1,802,000 1,848,000 1,585,000
Corporate and unallocated 107,000 63,000 92,000
------------ ------------ ------------
Consolidated total deprecation and amortization $ 1,909,000 1,911,000 1,677,000
============ ============ ============
Total assets:
Total for reportable segments $ 15,815,000 30,041,000 37,523,000
Corporate and unallocated 2,018,000 4,133,000 5,925,000
------------ ------------ ------------
Consolidated total assets $ 17,833,000 34,174,000 43,448,000
============ ============ ============
Capital expenditures:
Total for reportable segments $ 187,000 1,517,000 1,112,000
Corporate and unallocated 9,000 16,000 79,000
------------ ------------ ------------
Consolidated total capital expenditures $ 196,000 1,533,000 1,191,000
============ ============ ============
The following table presents information about the Company by geographic
area:
2001 2000 1999
---- ---- ----
Revenue:
United States $12,999,000 17,225,000 14,368,000
United Kingdom 8,060,000 20,244,000 15,673,000
Asia/Pacific 4,552,000 5,429,000 4,159,000
Other Europe 1,761,000 2,482,000 3,130,000
Latin America 288,000 146,000 1,257,000
Other North America 357,000 5,570,000 296,000
Other 45,000 44,000 53,000
----------- ----------- -----------
Consolidated total revenue $28,062,000 51,140,000 38,936,000
=========== =========== ===========
Consolidated long-lived assets:
United States $ 5,301,000 12,115,000 12,011,000
United Kingdom 583,000 1,107,000 2,398,000
Other North America 523,000 568,000 618,000
Asia/Pacific 0 612,000 200,000
Latin America 8,000 14,000 35,000
Other 2,000 3,000 8,000
----------- ----------- -----------
6,417,000 14,419,000 15,270,000
Current and other assets 11,416,000 19,755,000 28,178,000
----------- ----------- -----------
Consolidated total assets $17,833,000 34,174,000 43,448,000
=========== =========== ===========
(Continued)
F-29
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(24) Quarterly Information (Unaudited)
The following presents certain unaudited quarterly financial data:
Quarter Ended
--------------------------------------------------------------------
March 31, 2001 June 30, 2001 September 30, 2001 December 31, 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 income (loss) (3,233,000) (2,511,000) (1,898,000) (7,132,000)
Net income (loss) per share:
Basic $(0.33) $(0.25) $(0.19) $(0.73)
Diluted $(0.33) $(0.25) $(0.19) $(0.73)
Quarter Ended
--------------------------------------------------------------------
March 31, 2000 June 30, 2000 September 30, 2000 December 31, 2000
-------------- ------------- ------------------ -----------------
Net sales $15,928,000 $13,828,000 $11,195,000 $10,189,000
Gross profit 5,716,000 3,570,000 2,852,000 3,112,000
Net income (loss) 306,000 (2,887,000) (3,156,000) (4,439,000)
Net income (loss) per share:
Basic $0.03 $(0.30) $(0.32) $(0.45)
Diluted $0.03 $(0.30) $(0.32) $(0.45)
Quarter Ended
--------------------------------------------------------------------
March 31, 1999 June 30, 1999 September 30, 1999 December 31, 1999
-------------- ------------- ------------------ -----------------
Net sales $ 9,526,000 $ 9,109,000 $ 8,397,000 $11,904,000
Gross profit 2,811,000 2,639,000 1,878,000 2,656,000
Net loss (1,744,000) (2,940,000) (3,999,000) (5,003,000)
Net loss per share:
Basic $(0.18) $(0.31) $(0.42) $(0.53)
Diluted $(0.18) $(0.31) $(0.42) $(0.53)
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).
Net loss for the quarter ended December 31, 2000 reflects an accrual
associated with the reduction of overhead and headcount, and consolidation
of OSS operations of approximately $900,000.
F-30