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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, 2003
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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
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.)
6851 Jericho Turnpike, 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: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ___.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10K or any amendment to this
Form 10K. [X]
Indicate by a check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes__ No X
State aggregate market value of the voting stock held by non-affiliates of
the registrant: $199,446 as of June 30, 2003.
Indicate the number of shares outstanding of each of the registrant's
class of common stock, as of the latest practicable date: 9,972,284 shares of
Common Stock, par value $.01 per share, as of March 23, 2004.
DOCUMENTS INCORPORATED BY REFERENCE
None
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Part I
Item 1. Business
Porta Systems Corp. develops, designs, manufactures and markets a 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:
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.
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. In past years, we marketed these systems principally to
foreign telephone operating companies in established and developing countries
primarily in Asia, South and Central America and Europe. We are in the process
of scaling back our OSS operations and limit our activity in this segment to
performing maintenance for existing systems and seeking new business in selected
markets.
Porta Systems Corp. is a Delaware corporation incorporated in 1972 as the
successor to a New York corporation incorporated in 1969. Our principal offices
are located at 6851 Jericho Turnpike, Syosset, New York 11791; telephone number,
516-364-9300. References to "we," "us," "our," and words of like import refer to
Porta Systems Corp. and its subsidiaries, unless the context indicates
otherwise.
Forward-Looking Statements
Statements in this Form 10-K annual report may be "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Forward-looking statements include, but are not limited to, statements
that express our intentions, beliefs, expectations, strategies, predictions or
any other statements relating to our future activities or other future events or
conditions. These statements are based on current expectations, estimates and
projections about our business based, in part, on assumptions made by
management. These statements are not guarantees of future performance and
involve risks, uncertainties and assumptions that are difficult to predict.
Therefore, actual outcomes and results may, and probably will, differ materially
from what is expressed or forecasted in the forward-looking statements due to
numerous factors, including those risks discussed from time to time in this Form
10-K annual report, including the risks described under "Risk Factors" and in
other documents which we file with the Securities and Exchange Commission and
the matters described under "Management's Discussion and Analysis of Financial
Condition and Results of Operations." In addition, such statements could be
affected by risks and uncertainties related to our financial conditions, factors
which affect the telecommunications industry, market and customer acceptance,
competition, government regulations and requirements and pricing, as well as
general industry and market conditions and growth rates, and general
1
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.
Risk Factors
We require substantial financing to meet our working capital requirements
and we have no access to such financing. We had a working capital deficit at
December 31, 2003 of $36,825,000. As of December 31, 2003, our current
liabilities included $25,387,000 due to our senior lender. We do not have
sufficient resources to pay the senior lender or to pay principal and interest
of $9,349,000 due at December 31, 2003 on the outstanding subordinated notes
that became due on July 3, 2001, and we do not expect to generate the necessary
cash from our operations to enable us to make those payments and we have no
other source of outside financing. Because our senior lender is no longer
advancing funds to us, at present our only source of funds is from operations.
To the extent that either our operations do not generate sufficient funds to
cover our expenses or our lenders demand payment which we are unable to make, it
may be necessary for us to seek reorganization or liquidation under the
Bankruptcy Code. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
We are incurring losses from our operations, and our losses are
continuing. We incurred a net loss of $3,357,000, or $0.34 per share (basic and
diluted), on sales of $19,590,000 for 2003, following a loss of $4,114,000, or
$.41 per share (basic and diluted) for 2002. In each of these years, our sales
declined from the level of the previous year, reflecting both a general decline
in sales in the telecommunication industry and our clients' concerns about our
financial condition. 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 sales, we may not be able to continue in
business. Our sales declined significantly (24%) from 2001 to 2002 and again
from 2002 to 2003 by 9%. Unless we are able to stop the downward trend in sales
and generate a significant increase in sales, we will not be able to sustain our
operations since it is unlikely that we will be able to make sufficient
reductions in our overhead to compensate for the decline in sales and gross
profit. We cannot assure you that we will be able to increase our sales
significantly, if at all. As a result of the deterioration of our operating
revenue we are evaluating various options, including the sale of one or more of
our divisions as well as a reorganization or liquidation under the Bankruptcy
Code.
Our independent auditors have included an explanatory paragraph relating
to our ability to continue as a going concern in their report on our financial
statements. Because of our substantial losses in 2003, 2002 and 2001, our
stockholders' deficit of $33,238,000 at December 31, 2003, and our working
capital deficit of $36,825,000 as of December 31, 2003, our auditors included in
their report an explanatory paragraph about our ability to continue as a going
concern.
We are a defendant in material arbitration proceedings which, if adversely
determined, would impair our ability to continue in business. A vendor has
commenced an arbitration proceeding against us seeking $3 million for breach of
contract. If the claimant obtains a significant judgment against us and the
claimant seeks to enforce the judgment, it may be necessary for us, or our
senior lender may require us, to seek protection under the Bankruptcy Code.
2
Because of our financial position, we are subject to claims by creditors
resulting from our failure to make timely payment. A number of creditors have
threatened but not commenced actions against us for goods and services provided
by the creditors. If one or more of these creditors obtain significant judgments
against us and seeks to enforce the judgments, our ability to continue in
business would be impaired and it may be necessary for us, or our senior lender
may require us, to seek protection under the Bankruptcy Code.
If our scaled back OSS operations cannot generate profits, we may
discontinue these operations. We have scaled back our OSS operations
significantly, and we now only perform maintenance services for existing
customers and market our products in a few selected markets. We may not be able
to generate any significant revenue in these markets, and if we are not able to
generate profits from these operations, we may discontinue our OSS operations.
Since we sell to telecommunications companies, our sales are affected by
economic and other factors that affect that industry, both domestically and
internationally. During the past three years, the telecommunications industry
has been affected by an international slowdown, and many, if not most,
telecommunications companies have scaled back plans for expansion, which has
resulted in a significant drop in the requirements for products including
products such as our OSS products and our connection/protection products.
Because of our financial condition, we may not be able to perform on our
contracts which may subject us to loss of business and penalties. We are having
and we may continue to have difficulty performing our obligations under our
contracts, which could result in the cancellation of contracts, the loss of
future business and penalties for non-performance.
We are heavily dependent on foreign sales. Approximately 56% of our sales
in 2003 and 54% of our sales in 2002 and 2001, were made to foreign telephone
operating companies. In selling to customers in foreign countries, we are
exposed to inherent risks not normally present in the case of our sales to
United States customers, including extended delays in both completing the
installation and receiving the final payment from our customers for our
Operational Support Systems contracts, as well as further risks relating to
political and economic changes, including the decline in the value of the dollar
against other major currencies. 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 both purchaser acceptance of the Operations Support Systems
and receipt of final contract payments in connection with a number of foreign
sales. In addition, we have no steady or predictable flow of orders for
Operations Support Systems and the negotiation of a contract for an operations
support system is an individualized and highly technical process. The
installation, testing and purchaser acceptance phases of these contracts may
last longer than contemplated by the contracts and, accordingly, amounts due
under the contracts
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may not be collected for extended periods. Furthermore, our Operation Support
Systems contracts typically contain performance guarantees by us and clauses
imposing penalties if we do not meet "in-service" dates. As a result, it is
possible that we may lose money on Operations Support Systems contracts.
Because of our small size and our financial problems, we may have
difficulty competing for business. We compete directly with a number of large
and small domestic and foreign telephone equipment manufacturers, 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 2003, our working capital deficiency
and absence of financing may continue to place us in a competitive disadvantage.
We require access to current technological developments. We rely primarily
on the performance and design characteristics of our products in marketing our
products, which requires access to state-of-the art technology in order to be
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 and
our technical personnel. Our failure to retain such employees may have a
material adverse effect upon our business. Because of our financial problems, we
have experienced key personnel losses. To the extent that these losses continue
or are accelerated, we may be unable to provide our customers with necessary
service, which could result in the failure to generate new business.
Our stock is subject to the penny stock rules, which may make it difficult
for stockholders to sell our stock. Because our stock is traded on the OTC
Bulletin Board and our stock price is very low, our stock is subject to the
Securities and Exchange Commission's penny stock rules, which impose additional
sales practice requirements on broker-dealers which sell our stock to persons
other than established customers and institutional accredited investors. These
rules may affect the ability of broker-dealers to sell our common stock and may
affect the ability of our stockholders to sell any common stock they may own.
We do not pay dividends on common stock. We presently intend to invest our
earnings, if any, into our operations and the reduction of debt.
Products
Telecommunications Connection Equipment. Our copper connection/protection
equipment and systems are used by domestic and international 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
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
4
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.
Operations Support Systems. We have sold our OSS systems primarily to
telephone operating companies in established and developing countries in Asia,
South and Central America and Europe. As a result of our scaling down of our OSS
operations, we are now only marketing OSS systems in limited areas, and
performing maintenance service on existing installations.
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, provides the capability to
5
determine whether customer lines are xDSL capable, enabling telephone companies
to expeditiously characterize their outside plant, and optimize their
responsiveness to market conditions.
Our other software applications, including the automated assignment of
facilities and activation of service, form part of a telephone company's service
activation function, and can be integrated with the testing and trouble
management systems, to provide a comprehensive access loop capability. In
addition, if requested by customers, we develop software to meet specific
customer requirements, including integration of its systems with telephone
company legacy or third party OSS systems.
Our OSS products are complex and, in most applications, incorporate
features designed to respond to the purchaser's operational requirements and the
particular characteristics of the purchaser's telephone system and operational
processes. As a result, the negotiation of a contract for an OSS system is an
individualized and highly technical process. In addition, contracts for OSS
systems frequently provide for manufacturing, delivery, installation, testing
and purchaser acceptance phases, which take place over periods ranging from
several months to a year or more. These contracts typically contain performance
guarantees by us and clauses imposing penalties if "in-service" dates are not
met. The installation, testing and purchaser acceptance phases of these
contracts may last longer than contemplated by the contracts and, accordingly,
amounts due under the contracts may not be collected for extended periods and,
in some instances, may not be collected. Delays in purchaser acceptance of the
systems and in our receipt of final contract payments have occurred in
connection with a number of foreign sales. In addition, we have not experienced
a steady or predictable flow of orders for OSS systems.
The table below shows, for the last three fiscal years, the contribution
made to our sales by each of our major categories of the telecommunications
industry:
Sales by Product Category
Years Ended December 31,
2003 2002 2001
------------------ ----------------- -----------------
(Dollars in thousands)
Line Connecting
/Protecting
Equipment $11,334 58% 9,598 45% 12,756 46%
Signal Processing 4,253 21% 4,523 21% 5,737 20%
OSS Systems 3,249 17% 6,414 30% 8,874 32%
Other 754 4% 882 4% 695 2%
------- -------- ------- -------- ------- --------
Total $19,590 100% $21,417 100% $28,062 100%
======= ======== ======= ======== ======= ========
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Markets
As a telephone company expands the number of its subscriber lines, it may
require 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.
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 2003, approximately 58% 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. 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. Products are designed to satisfy the specific requirements of each
military or aerospace customer.
During 2003, signal processing equipment accounted for approximately 21%
of our sales.
We supply equipment and systems to telephone companies which provide
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 telecommunications networks have to
7
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 2003, approximately 17% of our sales consisted of OSS products and
services. As a result of the scaling down of our OSS operations, we anticipate
that OSS sales will represent a declining percentage of total sales.
Marketing and Sales
We operate through three business units, which are organized by product
line, and with each having responsibility for the sales and marketing of its
products.
When appropriate to obtain sales in foreign countries, we may enter into
business arrangements and technology transfer agreements covering our products
with local manufacturers and participate in manufacturing and licensing
arrangements with local telephone equipment suppliers.
In the United States and throughout the world, we use independent
distributors in the marketing of all copper based products to the Regional Bell
Operating Companies and the customer premises equipment market. All distributors
marketing copper-based products also market directly competing products. In
addition, we continue to promote the direct marketing relationships we developed
in the past with telephone operating companies.
British Telecommunications purchased line connecting/protecting products
amounting to $867,000 (4% of sales) in 2003, $689,000 (3% of sales) in 2002, and
$3,339,000 (12% of sales) in 2001. During these years, we also sold our products
to unaffiliated suppliers for resale to British Telecommunications. We have a
cross-licensing agreement with British Telecommunications which, in effect,
enables British Telecommunications to use certain of our proprietary information
to modify or enhance products provided to British Telecommunications and permits
British Telecommunications to manufacture or engage others to manufacture those
products.
Our 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:
8
Sales to Customers By Geographic Region (1)
Year Ended December 31,
2003 2002 2001
------------------ ----------------- -----------------
(Dollars in thousands)
North America $ 9,647 49% $10,442 49% $13,356 48%
United Kingdom 7,523 38% 6,388 30% 8,060 29%
Asia/Pacific 954 6% 2,729 13% 4,597 16%
Other Europe 1,228 6% 1,600 7% 1,761 6%
Latin America 238 1% 258 1% 288 1%
------- -------- ------- -------- ------- --------
Total Sales $19,590 100% $21,417 100% $28,062 100%
======= ======== ======= ======== ======= ========
(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 21 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.
Manufacturing
Our computer-based testing products include proprietary testing circuitry
and computer programs, which provide platform-independent solutions based on
UNIX or UNIX compatible operating systems. The testing products also incorporate
disk data storage, teleprinters, file servers and personal computers purchased
by us. These products are installed and tested by us at our customers' premises.
At present, our manufacturing operations are conducted at facilities
located in Syosset, New York and Matamoros, Mexico. From time to time we also
use subcontractors to augment various aspects of our production activities and
periodically explore the feasibility of conducting operations at lower cost
manufacturing facilities located abroad. In selling to foreign telephone
companies, we may be required to provide local manufacturing facilities and, in
conjunction with these facilities, we may grant the facility a license to our
proprietary technology.
Source and Availability of Components
We generally purchase the standard components used in the manufacture of
our products from a number of suppliers. We attempt to assure ourselves that the
components are available from more than one source. We purchase all of our MKIII
test units from one supplier. We purchase the majority of our workstations and
servers used in our OSS systems from Hewlett Packard Corporation. However, we
could use other computer equipment in our systems if we were unable to purchase
Hewlett Packard products. Other components, such as personal computers and line
printers used in connecting with our electronic products, are readily available
from a number of sources.
9
Significant Customers
Our five largest customers accounted for sales of $8,507,000, or
approximately 43% of sales, for 2003; $9,784,000, or approximately 46% of sales,
for 2002; and $13,444,000, or approximately 48% of sales, for 2001. Fujitsu
Telecommunications Europe LTD. was our largest customer for 2003, accounting for
sales of $3,150,000, or approximately 16%. Philippine Long Distance Telephone
was our largest customer for 2002 and 2001, accounting for sales of $2,725,000,
or approximately 13%, for 2002 and $3,485,000, or approximately 12%, for 2001. A
significant amount of sales of our products for use by British
Telecommunications were sold to Fujitsu 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 $1,480,000, or 8% of sales, for 2003; $2,306,000, or 11%
of sales, for 2002; and $3,339,000, or 12% of sales, for 2001. No other
customers account for 10% or more of our sales in 2003, 2002 or 2001.
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 U.S. 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, 2003, our backlog was approximately $6,000,000 compared
with approximately $4,400,000 at December 31, 2002. The increase is from the
increased requirement of British Telecommunications. Of the December 31, 2003
backlog, approximately $4,300,000 represented orders from foreign telephone
operating companies. We expect to ship substantially all of our December 31,
2003 backlog during 2004.
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.
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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.
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
worldwide. However, our ability to compete is hampered by our financial
condition.
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. However, because of
our financial condition and our declining OSS business, we have scaled back our
OSS operations and will be only marketing these systems in limited countries.
In addition to the quality and price of the products being offered, the
financial stability of a supplier, especially for OSS contracts, is a crucial
element. Because these contracts require the supplier to spend considerable
funds before the project is completed and require ongoing maintenance service,
potential customers consider the financial stability of the supplier as a major
consideration in awarding a contract. Our financial position, combined with our
recent losses, our working capital deficiency and the scheduled expiration of
our financing agreement with our senior lender, and our decision to scale back
our OSS operations may place us at a competitive disadvantage in seeking new
business and new orders for existing customers in those markets in which we
continue to market these products.
11
Research and Development Activities
We spent approximately $2,100,000 in 2003, $2,500,000 in 2002, and
$4,400,000 in 2001 on research and development activities. These funds were used
to develop a new OSS product and to support improvement to existing OSS,
copper/connect and Signal processing products. 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 December 31, 2003, we had 274 employees of which 48 were employed in
the United States, 193 in Mexico, 18 in the United Kingdom, 3 in Poland, 3 in
Chile, and 9 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, 2004.
Item 2. Properties
We currently lease approximately 14,500 square feet of executive, sales,
marketing and research and development space and 4,200 square feet of
manufacturing space in Syosset, New York. These facilities represent
substantially all of our office, plant and warehouse space in the United States.
The Syosset, New York leases expire February 2008 and May 2007, respectively.
The annual rental related to the New York property is approximately $277,000.
Our wholly-owned United Kingdom subsidiary leases approximately 11,000
square foot facility in Coventry, England, which facility comprises all of our
office, plant and warehouse space. The lease expires in 2019. The aggregate
annual rental is approximately $143,000.
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.
Item 3. Legal Proceedings
In June 2002, BMS Corp. commenced an arbitration proceeding against us in
New York City seeking damages of approximately $3,000,000 and alleging that we
breached our agreement to market and sell an update to our OSS product which BMS
was to develop for us. We believe that we have defenses to the claims by BMS and
we have filed a counterclaim to recover the $350,000 we advanced to BMS under
the contract. The arbitrator has held three days of hearings and hearings are
scheduled to resume in April 2004.
In July 1996, an action was commenced against us and certain present and
former directors in the Supreme Court of the State of New York, New York County
by certain of the Company's stockholders and warrant holders who acquired their
securities in connection with our acquisition of Aster Corporation. The
complaint alleges breach of contract against us and breach of fiduciary duty
against our directors arising out of an alleged failure to register certain
restricted shares and warrants owned by the plaintiffs. The complaint seeks
damages of $413,000; however, counsel for the plaintiff has advised us that
additional plaintiffs may be added and, as a result, the amount of damages
claimed may be substantially greater than the amount presently claimed.
12
We believe that we have valid defenses to the claims. There has been no
significant activity in this matter subsequent to December 31, 1999, and the
case has been administratively dismissed for failure to prosecute.
In July 2001, the holder of a subordinated note in the principal amount of
$500,000 commenced an action against us in the United States District Court for
the Southern District of New York seeking payment of the principal and accrued
interest on their subordinated notes which were payable in July 2001. The
payment of the note is subordinated to payment of our senior debt. The
plaintiff's motion for a summary judgment was denied by the court on the grounds
that the terms of the note did not give them permission to obtain a judgment
while we remained in default to the senior debt holder. Since that time, the
action has remained inactive. Our obligations under the subordinated notes are
reflected as current liabilities on our balance sheet.
Item 4. Submission of Matters to a Vote of Securities Holders
During the fourth quarter of 2003, no matters were submitted to a vote of
our security holders.
13
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our common stock is traded on the OTC Bulletin Board under the symbol
PYTM. Prior to November 11, 2002, our stock was traded on the American Stock
Exchange under the symbol PSI. The following table sets forth, for 2003 and
2002, the quarterly high and low sales prices for our common stock on the
consolidated transaction reporting systems for the OTC Bulletin Board and
American Stock Exchange listed issues.
High Low
---- ---
2003 First Quarter $0.05 $0.01
Second Quarter 0.05 0.02
Third Quarter 0.04 0.01
Fourth Quarter 0.04 0.02
2002 First Quarter $0.20 $0.07
Second Quarter 0.10 0.06
Third Quarter 0.15 0.03
Fourth Quarter 0.08 0.01
We did not declare or pay any cash dividends in 2003 or 2002,and we do not
anticipate paying cash dividends in the foreseeable future. Our agreement with
our senior lender prohibits us from paying cash dividends on our common stock.
As of March 23, 2004, we had approximately 976 stockholders of record and
the closing price of our common stock was $.06.
We did not issue any unregistered securities during 2003.
Equity Compensation Plan Information
The following table summarizes the equity compensation plans under which our
securities may be issued as of December 31, 2003.
14
Equity Compensation Plan Information as of December 31, 2003
Number of securities Weighted-average Number of securities
to be issued upon exercise price remaining available for
exercise of outstanding of outstanding future issuance under
Plan Category options and warrants options and warrants equity compensation plans
------------- -------------------- --------------------- -------------------------
Equity compensation plans
approved by security holders 795,030 $2.13 683,470
Equity compensation plan
not approved by security holders -0- -0- 95,750
------- ----- -------
795,030 $2.13 779,220
The plan not approved by security holders is a stock bonus plan that permits
issuance of stock on a discretionary basis.
15
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,
---------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
(In thousands, except per share data)
Income Statement Data:
Sales $ 19,590 $ 21,417 $ 28,062 $ 51,140 $ 38,936
Operating loss (2,352) (2,881) (11,453) (5,153) (9,709)
Net loss (3,357) (4,114) (14,774) (10,176) (13,686)
Basic and diluted net loss per share $ (0.34) $ (0.41) $ (1.50) $ (1.04) $ (1.44)
Cash dividends declared -- -- -- -- --
Number of shares used in
calculating net loss
per share-basic and diluted 9,972 9,972 9,878 9,763 9,489
Balance Sheet Data:
Total assets $ 12,355 $ 14,228 $ 17,833 $ 34,174 $ 43,448
Working capital (deficiency) $(36,825) $(34,199) $(31,236) $(24,152) $ 6,135
Current debt maturities $ 31,916 $ 31,599 $ 28,621 $ 26,890 $ 2,000
Long-term debt, excluding current
maturities $ -0- $ -0- $ -0- $ 376 $ 21,902
Stockholders' deficit $(33,238) $(29,935) $(25,849) $(10,792) $ (1,387)
16
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been
prepared in conformity with accounting principles accepted in the United States.
The preparation of these financial statements requires us to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses reported in those financial statements. These judgments can be
complex and consequently actual results could differ from those estimates. Among
the more significant estimates included in these consolidated financial
statements are revenue recognition, allowance for doubtful accounts receivable,
inventory reserves, goodwill valuation and the deferred tax asset valuation
allowance. Because of our substantial losses in 2003, 2002 and 2001, and our
stockholders' deficit of $33,238,000 and working capital deficit of $36,825,000
as of December 31, 2003, our auditors included in their report an explanatory
paragraph about our ability to continue as a going concern. Note 1 of Notes to
Consolidated Financial Statements, included elsewhere on this annual report on
Form 10-K, includes a summary of the significant accounting policies and methods
used in the preparation of our consolidated financial statements.
Revenue Recognition
Revenue, other than from long-term contracts for specialized products, is
recognized when a product is shipped. Revenues and earnings relating to
long-term contracts for specialized products, principally OSS products, are
recognized on the percentage-of-completion basis primarily measured by the
attainment of milestones. Anticipated losses, if any, are recognized in the
period in which they are identified. The percentage-of-completion method is
based on judgments and estimates that are complex and actual results may differ
from estimates.
Allowance for Doubtful Accounts Receivable
We record an allowance for doubtful accounts receivable based on
specifically identified amounts that we believe to be uncollectible. We also
record additional allowances based on certain percentages of our aged
receivables, which are determined based on historical experience and our
assessment of the general financial conditions affecting our customer base. If
our actual collections experience changes, revisions to our allowance may be
required. We have a limited number of customers with individually large amounts
due at any given balance sheet date. Any unanticipated change in one of those
customers' creditworthiness, or other matters affecting the collectability of
amounts due from such customers, could have a material effect on our results of
operations in the period in which such changes or events occur. After all
attempts to collect a receivable have failed, the receivable is written off
against the allowance.
We established an allowance for doubtful accounts receivable of $1,091,000
at December 31, 2003 and $1,967,000 at December 31, 2002. Our allowance for
doubtful accounts is a subjective critical estimate that has a direct impact on
reported net loss. This reserve is based upon the evaluation of accounts
receivable aging and specific exposures.
17
Inventory Reserves
Inventories are stated at the lower of cost (on the average or first-in,
first-out methods) or fair market value. Our stated inventory reflects an
inventory obsolescence reserve that represents the difference between the cost
of the inventory and its estimated market value. This reserve is calculated
based on historical usage and forecasted sales. Actual results may differ from
our estimates.
Goodwill
Goodwill represents the difference between the purchase price and the fair
market value of net assets acquired in business combinations treated as
purchases. Commencing January 1, 2002, goodwill is an indefinite lived asset and
as such is not amortized. On an annual basis, we test the goodwill for
impairment. We determine the market value of the reporting unit by considering
the projected cash flows generated from the reporting unit to which the goodwill
relates. As of December 31, 2003, 2002 and 2001, all of our goodwill related to
our signal processing division. In 2002, following the termination of
negotiations to sell that division, we reduced goodwill by $800,000.
Deferred Income Tax Valuation Allowance
Deferred taxes result from temporary differences between the tax bases of
assets and liabilities and their reported amounts in the financial statements.
The temporary differences result from costs required to be capitalized for tax
purposes by the US Internal Revenue Code, and certain items accrued for
financial reporting purposes in the year incurred but not deductible for tax
purposes until paid. Due to our continued losses in 2003, 2002 and 2001, a
valuation allowance for the entire deferred tax asset was provided due to the
uncertainty as to future realization.
Other Matters
Senior Debt
Our agreement with our senior lender expires on April 15, 2004. Our senior
lender has granted us extensions in the past. However, at each maturity date,
the senior lender reviews our financial condition, business plan and prospects.
We cannot assure you that the senior lender will continue to extend the loans.
Any adverse event, including declines in business or attempts by creditors,
including judgment creditors, to realize on their claims or judgments could have
an effect on the decision of our senior lender to extend or demand payment on
our notes. In such event, it would be necessary for us to seek protection under
the Bankruptcy Code.
Interest
Pursuant to our agreement with our senior lender, we have not paid or
accrued interest on $22,600,000 of senior debt since March 2002. As a result,
our statement of operations does not reflect any interest charges on the senior
debt for 2003 and the last nine months of 2002. The senior lender has the right
at any time to require us to pay interest; however, our obligation to pay
interest will not require us to pay interest on such senior debt for periods
prior to the date the senior lender requires us to commence interest payments.
We continue to accrue interest on obligations to our senior lender which were
incurred subsequent to March 2002.
18
Continuation of Our Businesses
During the past several years we have, on a number of occasions, engaged
in negotiations with respect to the sale of one or more of our divisions. None
of our discussions resulted in an agreement. We may continue to engage in such
negotiations in the future.
Because of the decline in volume and margins in our OSS business, we have
determined that we cannot operate our OSS business profitably in the same manner
as we operated that business in the past. As a result, we have scaled back our
OSS business, by reducing our personnel and by limiting our operations to the
performance of maintenance service for our existing customer base pursuant to
maintenance contracts and by marketing our OSS services in a limited number of
markets. If we are unable to generate significant business it may be necessary
for us to discontinue the OSS business.
Recent Increase in Copper Sales
We have recently experienced an increase in our copper connection business as a
result of the requirements of British Telecommunications to provide increased
DSL service. We can anticipate that British Telecommunications will continue to
require copper connection products while it is expanding its DSL service. We
cannot predict how long BT will continue to place orders with us.
Results of Operations
The following table sets forth our consolidated statements of operations
for the three years ended December 31, 2003, 2002 and 2001, as a percentage of
sales:
Years Ended December 31,
-------------------------------
2003 2002 2001
---- ---- ----
Sales 100% 100% 100%
Cost of sales 72% 68% 71%
----- ----- -----
Gross profit 28% 32% 29%
Selling, general and
administrative expenses 29% 30% 33%
Research and development expenses 11% 12% 16%
Goodwill impairment 0% 3% 21%
---- ---- ----
Operating loss (12%) (13%) (41%)
Interest expense (6%) (8%) (16%)
Gain on sale of assets -- -- 2%
Gain on sale of investment in joint venture -- 2% --
Other income, net -- -- (1%)
----- ----- -----
Loss before income
taxes and minority interest (18%) (19%) (54%)
Income tax benefit (expense)
and minority interest 1% -- 1%
----- ----- -----
Net loss (17%) (19%) (53%)
19
Results of Operations
Years Ended December 31, 2003 and 2002
Our sales for 2003 were $19,590,000 compared to $21,417,000 in 2002, a
decrease of $1,827,000 (9%). The decrease in revenue is primarily attributed to
the decline in sales of OSS products which more than offset increases in sales
from our Line connection/protection equipment.
Line connection/protection equipment sales for 2003 increased
approximately $1,736,000 (18%) from $9,598,000 in 2002 to $11,334,000 in 2003.
The increased sales level results from an increased level of sales to British
Telecommunications commencing in the third quarter of 2003 as a result of
British Telecommunications increasing the availability of DSL lines. These gains
were offset by a decrease in sales from other customers.
Signal processing revenue for 2003 compared to 2002 decreased by $270,000
(6%) from $4,523,000 to $4,253,000. The decrease in sales primarily reflects
delays in shipments from the backlog due to shortages of materials due to our
tight cash situation.
OSS sales for 2003 were $3,249,000, compared to 2002 sales of $6,414,000,
a decrease of $3,165,000 (49%). The decline in OSS sales in 2003 represented an
accelerated decline in this line of business which had sustained significant
declines in previous years as well. OSS contracts require performance over a
relatively long term, and the customers are generally national telephone
companies in developing markets many of which are operated or regulated by a
government agency. As a result, our ability to maintain OSS business has been
impaired both by our financial condition, since our financial condition may give
customers concern about our ability to perform, and the worldwide slowdown in
this segment of the telecommunications industry. In addition, our failure to
provide a significant component for a major OSS customer has resulted in a
decision by that customer not to give us new OSS contracts. We are currently
engaged in arbitration proceedings with the company that was to have supplied us
with that component. See "Item 3. Legal Proceedings." 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.
Gross margin decreased from 32% in 2002 to 28% in 2003. The line
protection/connection and Signal processing margins increased, but were offset
by lower OSS margins. The gains were the result of better absorption of
manufacturing overhead created by the increased copper/connection level of
business.
Selling, general and administrative expenses decreased by $654,000 (10%)
from $6,383,000 in 2002 to $5,729,000 in 2003. This decrease relates primarily
to reduced salaries and benefits, consulting services and commissions reflecting
our current level of business.
Research and development expenses decreased by $450,000 (18%) from
$2,516,000 in 2002 to $2,066,000 in 2003. This decrease resulted from our
efforts to reduce expenses in all divisions to better match expense level to
sales levels.
At December 31, 2001, our goodwill was $3,761,000, all of which related to
our Signal division. We determined that this goodwill had been impaired as of
June 30, 2002. We engaged in discussions with respect to the sale of that
division during the second quarter of 2002, and based on those discussions we
estimated that the impairment loss was approximately $800,000. This amount was
charged to operations in the quarter ended June 30, 2002. Furthermore, the
negotiations relating to the sale of the Signal division have been discontinued.
There was no impairment adjustment required in 2003. We cannot give any
assurances that further write-downs
20
Results of Operations (continued)
will not be necessary in the future, although management believes that no
additional goodwill impairment charges are necessary at this time.
As a result of the above, we had an operating loss of $2,352,000 in 2003
versus an operating loss of $2,881,000 in 2002.
Interest expense for 2003 decreased by $520,000 from $1,798,000 for 2002
to $1,278,000 in 2003. The reduced level of interest expense is attributable to
our amended agreement with our senior lender whereby the old term loan, in the
principal amount of approximately $23,000,000, bears no interest commencing
March 1, 2002, until such time as the senior lender, in its sole discretion,
notifies us that interest shall be payable.
The tax benefit for 2003 resulted principally from the settlement of an
outstanding tax obligation of $274,000 of one of our subsidiaries for $30,000.
In April 2002, we sold our 50% interest in our Korean joint venture for
$450,000 to our joint venture partner. Payment was made by the forgiveness of
commissions, totaling $450,000, which we owed to our sales representation
company owned by our joint venture partner, with respect to sales made by the
Korean joint venture in Korea. There were no sales in Korea in 2002 or 2003.
As the result of the foregoing, the 2003 net loss was $3,357,000, $0.34
per share (basic and diluted), compared with a net loss of $4,114,000, $0.41 per
share (basic and diluted) for 2002.
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, 2002 and 2001
Our sales for 2002 were $21,417,000 compared to $28,062,000 in 2001, a
decrease of $6,645,000 (24%). The decrease in revenue is attributed to the
decline in sales from OSS and Signal processing divisions.
OSS sales for 2002 were $6,414,000, compared to 2001 sales of $8,874,000,
a decrease of $2,460,000 (28%). The decline in sales from 2001 to 2002 is
attributed to the failure to secure new contracts as a result of the negative
impact of reduced opportunities in Europe, delays we encountered in obtaining
software from a vendor necessary to complete certain contracts and our financial
difficulties. Sales of OSS systems are not made on a recurring basis to
customers, but are the result of extended negotiations that frequently cover
many months and do not always result in a contract. In addition, OSS contracts
may include conditions precedent, such as the customer obtaining financing or
bank approval, and the contracts are not effective until the conditions are
satisfied.
Line connection/protection equipment sales for 2002 decreased
approximately $3,158,000 (25%) from $12,756,000 in 2001 to $9,598,000 in 2002.
The reduced sales level reflected a decrease in volume of sales to United States
and United Kingdom customers due to in part from the weaken telecommunication
market and our weak financial condition.
21
Results of Operations (continued)
Signal processing revenue for 2002 compared to 2001 decreased by
$1,214,000 (21%) from $5,737,000 to $4,523,000. The decrease in sales primarily
reflects delays in the receipt of certain anticipated contracts and a general
slowdown in the order rate from customers during 2002.
Gross margin increased from 29% in 2001 to 32% in 2002. The increase in
gross margin is primarily attributed to decrease in cost associated with certain
OSS contracts reflecting our ability to replace a high cost software vendor with
comparable lower cost software. Offsetting this improvement were lower margins
associated with our Line business that was unable to absorb certain fixed
expenses in relation to lower sales volume, competitive pricing pressures
resulting from the industry's slowdown and additional inventory reserves
required based on reduced turnover.
Selling, general and administrative expenses decreased by $2,933,000 (31%)
from $9,316,000 in 2001 to $6,383,000 in 2002. The decrease from 2002 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 $1,911,000 (43%) from
$4,427,000 in 2001 to $2,516,000 in 2002. The decreased expense in 2002 resulted
from our efforts to reduce our expenses primarily related to the OSS business.
In December 2001, we determined that $5,802,000 of goodwill, which
represented all of the goodwill associated with our OSS business unit, was
impaired, and we recorded an impairment loss in that amount. This assessment was
based on the continued decline in sales and losses generated by the business
unit over the past several years and the declining prospects for additional
sales of the products based on the older technology that originally gave rise to
the goodwill. In addition, there were no negotiations in progress for the sale
of the OSS division.
As a result of the above, we had an operating loss of $2,881,000 in 2002
versus an operating loss of $11,453,000 in 2001.
Interest expense for 2002 decreased by $2,682,000 from $4,480,000 for 2001
to $1,798,000 in 2002. The decrease in interest expense is due to an agreement
with our senior lender which 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.
In April 2002, we sold our 50% interest in our Korean joint venture for
$450,000 to our joint venture partner. Payment was made by the forgiveness of
commissions, totaling $450,000, which we owed to our sales representation
company owned by our joint venture partner, with respect to sales made by the
Korean joint venture in Korea.
As the result of the foregoing, the 2002 net loss was $4,114,000, $.41 per
share (basic and diluted), compared with a net loss of $14,774,000, $1.50 per
share (basic and diluted) for 2001.
22
Liquidity and Capital Resources
At December 31, 2003, we had cash and cash equivalents of $469,000
compared with $779,000 at December 31, 2002. Our working capital deficit was
$36,825,000 at December 31, 2003 compared to a working capital deficit of
$34,199,000 at December 31, 2002. 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 2003, our senior lender refused to advance us
any funds. As a result, our only source of funds was from operations. To the
extent that we are not able to generate sufficient funds to cover our expenses,
we may have to consider reorganization or liquidation under the Bankruptcy Code.
As of December 31, 2003, our debt includes $25,387,000 of senior debt
which matures on April 15, 2004, and $6,144,000 principal amount of subordinated
debt which became due on July 3, 2001. We were unable to pay the interest
payment on the subordinated notes of approximately $3,205,000 which represents
interest from July 2000 through December 2003. As of December 31, 2003, we also
had $385,000 outstanding of 6% Debentures which matured July 2, 2002. The
interest accrued at December 31, 2003 was $85,000. We have also been notified by
the trustee that the non-payment of the principal and interest caused an event
of default. At December 31, 2003, we did not have sufficient resources to pay
either the senior lender or the subordinated lenders and it is unlikely that we
can generate such cash from our operations. Further, our senior lender has
precluded us from making payments on the subordinated debt.
On January 14, 2004, our senior lender and we agreed to an extension to
April 15, 2004. As of December 31, 2003, we did not have resources to pay our
senior lender.
As a result of our continuing financial difficulties:
o Although we have scaled back our OSS operations we are having and
may continue to have difficulty performing our obligations under our
OSS contracts, which could result in the cancellation of contracts
or the loss of future business and penalties for non-performance;
o a number of creditors have engaged collection agencies; and
o we have continued to suffer a decline in sales in 2003 from 2002
which was partially offset by additional products sold to British
Telecommunications, following a significant decline in sales in 2002
from 2001.
In addition, a vendor has commenced arbitration proceedings against us
alleging breach of contract.
We have sought to address our need for liquidity by exploring
alternatives, including the possible sale of one or more of our divisions.
During 2002 and 2003, we were engaged in discussions with respect to the
possible sale of our divisions; however, those negotiations were terminated
without an agreement having been reached, and we may not be able to sell those
divisions on acceptable, if any, terms. Furthermore, if we sell a division, we
anticipate that a substantial portion, if not all, of the net proceeds will be
paid to our senior lender and we will not receive any significant amount of
working capital from such a sale. During 2002 and 2003, we have taken steps to
reduce overhead by relocating the executive, sales/marketing, accounting and
research and development departments to less expensive offices in Syosset, NY
and further reduced the OSS personnel as part of the scaling down effort. We
will continue to look to reduce costs while we seek additional business from new
and existing customers.
23
Because of our present stock price, we cannot 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.
As of December 31, 2003, we did not have any material off-balance sheet
arrangements that have or are reasonably likely to have a material effect on our
current or future financial condition, results of operations, liquidity, or
capital resources.
The following table summarizes our principal contractual obligations as of
December 31, 2003 and the effects such obligations are expected to have on our
liquidity and cash flow in future periods.
Payments Due by Period
Contractual
Obligations 2004 2005-2006 2007-2008 Thereafter
- ----------- ---- --------- --------- ----------
(in thousands)
Long-term $35,479 -- -- --
Debt
Operating 628 1,136 860 2,996
Leases
Deferred Compensation
Obligations 58 102 116 707
Purchase
Obligations 951 -- -- --
------- ------- ------- -------
Total $37,116 $ 1,238 $ 976 $ 3,703
======= ======= ======= =======
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 2003, the currency translation adjustment was not
significant in relation to our total revenue.
Item 8. Financial Statements and Supplementary Data.
See Exhibit I
24
Item 9. Changes In and Disagreements With Accountants On
Accounting and Financial Disclosure.
Not Applicable
Item 9A. Controls and Procedures.
Disclosure Controls and Procedures
As of the end of the period covered by this report, our Chief Executive
Officer and Chief Financial Officer evaluated the effectiveness of our
disclosure controls and procedures. Based on their evaluation, the Chief
Executive Officer and the Chief Financial Officer have concluded that our
disclosure controls and procedures are effective in alerting them to material
information that is required to be included in the reports that we file or
submit under the Securities Exchange Act of 1934.
Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting
that occurred during our last fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
25
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 67
Michael A. Tancredi(1) Senior vice president, secretary and treasurer 1970 74
Warren H. Esanu(1),(2) Of counsel to Esanu Katsky Korins & Siger, LLP,
attorneys at law 1997 61
Herbert H. Feldman(1),(2) President, Alpha Risk Management, Inc., independent
risk management consultants 1989 70
Marco M. Elser(2) Managing director of Elser & Co., an investment
advisory firm 2000 45
- ----------
(1) Member of the executive committee.
(2) Member of the audit and compensation committees.
Mr. Carney has been chairman of the board and chief executive officer
since October 1996. He was vice chairman from 1988 to October 1996, senior vice
president from 1989 to October 1996, chief technical officer since 1990 and
secretary from 1977 to October 1996. He also served as senior vice
president-mechanical engineering from 1988 to 1989, senior vice
president-connector products from 1985 to 1988, senior vice
president-manufacturing from 1984 to 1985 and senior vice president-operations
from 1977 to 1984. Since December 2002, Mr. Carney has worked for us on a
part-time basis.
Mr. Tancredi has been senior vice president, secretary and treasurer since
January 1997. He has been vice president-administration since 1995 and treasurer
since 1978, having served as vice president-finance and administration from 1989
to 1995 and vice president-finance from 1984 to 1989.
Mr. Esanu has been a director since April 1997 and also served as a
director from 1989 to 1996. He was also our chairman of the board from March
1996 to October 1996. He has been of counsel to Esanu Katsky Korins & Siger,
LLP, attorneys at law, for more than the past five years. Mr. Esanu is also a
founding partner and chairman of Paul Reed Smith Guitars Limited Partnership
(Maryland), a leading manufacturer of premium-priced electrical guitars. He is
also a senior officer and director of a number of privately held real estate
investment and management companies.
Mr. Elser has been the managing director of Elser & Co., an investment
advisory firm, for 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.
26
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 67
Michael A. Tancredi Senior vice president, secretary and treasurer 74
Edward B. Kornfeld Senior vice president-operations and chief 60
financial officer; and effective April 1, 2004,
president, chief operating officer and chief
financial officer
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, 60, has been senior vice president-operations since 1996 and
chief financial officer since October 1995. Effective April 1, 2004, he will be
president, chief operating officer and chief financial officer. Since June 2002,
Mr. Kornfeld has also been a partner of the firm of Tatum CFO Partners, which
provides chief financial officer services to medium and large companies;
however, he continues to devote full time effort to our business. He was vice
president-finance from October 1995 until 1996. For more than five years prior
thereto, Mr. Kornfeld held positions with several companies for more than five
years, including Excel Technology Inc. (Quantronix Corp.) and Anorad
Corporation.
We maintain a code of ethics that applies to our principal executive
officer, principal financial officer, controller, or persons performing similar
functions. Any waiver of the code must be approved by the Audit Committee and
must be disclosed in accordance with SEC rules. During the second quarter of
2004, we expect to adopt and have publicly available a code of conduct
applicable to directors, officers and employees.
Our board of directors has determined that Mr. Marco Elser, based on his
experience as a financial investment advisor, is an audit committee financial
expert, as defined in Item 402(h) of Regulation S-K.
27
Item 11. Executive Compensation
The following table shows the compensation we paid to our chief executive
officer and the only executive officer, other than the chief executive officer,
whose salary and bonus earned exceeded $100,000 for the year ended December 31,
2003.
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 2003 $133,000 -- -- -- $7,734
board and chief executive officer 2002 240,000 -- -- -- 9,858
2001 240,000 -- -- -- 7,981
Edward B. Kornfeld, Senior vice 2003 192,000 -- -- -- 5,022
president - operations and chief 2002 192,000 -- -- -- 5,022
financial officer 2001 192,000 -- -- -- 4,872
- -----------
"All Other Compensation" includes a payment to the executive's account
pursuant to our 401(k) Plan, group life insurance in amounts greater than that
available to all employees and special long term disability coverage.
Compensation to Mr. Kornfeld does not include fees of $36,000 paid in 2003
to Tatum CFO Partners, of which Mr. Kornfeld is a partner.
Set forth below is a chart that shows, for 2003, the components of "All
Other Compensation" listed in the Summary Compensation Table.
Mr. Carney Mr. Kornfeld
---------- ------------
401(k) Match $ 1,350 $ 2,700
Supplemental Insurance 6,384 2,322
During 2003, we did not grant Mr. Carney or Mr. Kornfeld any options, and
neither of them exercised any options to purchase shares of our common stock. As
of December 31, 2003, Mr. Carney held options to purchase 176,250 shares of
common stock and Mr. Kornfeld held options to purchase 63,000 shares of common
stock. All of these options are currently exercisable and, because the exercise
price is less than the market price of the common stock, they were not
in-the-money options and, accordingly, their options had nominal value at
December 31, 2003.
28
Employment Agreements. We have amended our employment agreement with Mr.
Carney whereby he is required to work at a rate of two and one-half days per
week, and half of his current base pay is deferred until the termination of his
amended employment agreement on December 31, 2005. No further compensation shall
be paid to Mr. Carney, including the deferred amount, if we do not terminate Mr.
Carney's employment prior to December 31, 2005.
We have entered into an employment agreement with Mr. Kornfeld. The
agreement continues on a year-to-year basis, from January 1 of each year, unless
terminated on prior notice of not less than 90 days. Salary is determined by the
board, except that the salary may not be reduced except as a part of a salary
reduction program applicable to all executive officers. Upon death or
termination of employment as a result of a disability, Mr. Kornfeld or his
estate is to receive a payment equal to three months salary. Upon a termination
without cause Mr. Kornfeld is entitled to receive his then current salary for
six months plus one month for each full year of service up to a maximum
aggregate of 24 months. In the event that Mr. Kornfeld is covered by an
executive severance agreement, including the salary continuation agreements (as
described below), which provides for payments upon termination subsequent to a
"change of control," the executive would be entitled to the greater of the
severance arrangements as described in this paragraph or the severance payments
under the executive severance agreements. We also have month-to-month agreement
with Tatum CFO Partners of which Mr. Kornfeld is a partner, pursuant to which we
pay Tatum CFO Partners $3,000 per month.
Salary Continuation Agreement. We are party to a salary continuation
agreement with Mr. Kornfeld. The salary continuation agreement provides that, in
the event that a change of control occurs and Mr. Kornfeld's employment with us
is subsequently terminated by us other than for cause, death or disability, or
is terminated by Mr. Kornfeld as a result of a substantial alteration in his
duties, compensation or other benefits, the executive shall be entitled to the
payment of an amount equal to his monthly salary at the rate in effect as of the
date of his termination (or, if higher, as in effect immediately prior to the
change in control) plus the pro rata monthly amount of his most recent annual
bonus paid immediately before the change of control multiplied by 24. For
purposes of the salary continuation agreement, a change of control is defined as
one which would be required to be reported in response to the proxy rules under
the Securities Exchange Act of 1934, as amended, the acquisition of beneficial
ownership, directly or indirectly, by a person or group of persons of our
securities representing 25% or more of the combined voting power of our then
outstanding securities, or, during any period of two consecutive years, if
individuals who at the beginning of such period constituted the board cease for
any reason to constitute at least a majority thereof unless the election of each
new director was nominated or ratified by at least two-thirds of the directors
then still in office who were directors at the beginning of the period. The
change of control must occur during the term of the salary continuation
agreement, which is currently through December 31, 2004 and is renewed
automatically unless we give timely notice prior to January 1 of any year of our
election not to renew the agreement. If such a change of control occurs during
the effectiveness of the salary continuation agreement, any termination of such
covered employee during the 18 months following the change of control will
result in the payment of the compensation described above.
Item 12. Principal Holders of Securities and Security Holdings of Management
The following table and discussion provides information as to the shares
of common stock beneficially owned on March 15, 2004 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.
29
Shares of Common
Stock Beneficially Percentage of Outstanding
Name Owned Common Stock
----- ------------------ -------------------------
William V. Carney 303,021 3.0%
Michael A. Tancredi 114,238 1.1%
Warren H. Esanu 116,500 1.2%
Herbert H. Feldman 76,000 *
Marco M. Elser 325,592 3.3%
Edward B. Kornfeld 114,317 1.1%
All directors and officers
as a group (8 individuals) 1,076,036 10.8%
* Less than 1%
Except as otherwise indicated each person has the sole power to vote and
dispose of all shares of common stock listed opposite his name.
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, 2004 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 176,250
Michael A. Tancredi 72,530
Warren H. Esanu 71,500
Herbert H. Feldman 61,000
Marco M. Elser 15,000
Edward B. Kornfeld 63,000
All officers and directors as a group 479,780
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 exercise of 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.
30
Item 13. Certain Relationships and Related Transactions
During 2003, Warren H. Esanu, a director, served as a member of our audit
and compensation committees. During 2003, 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 $283,616. Esanu Katsky Korins & Siger, LLP is
continuing to render legal services to us during 2004.
Item 14. Principal Accountant Fees and Services.
The following is a summary of the fees for professional services rendered by our
independent accountants, BDO Seidman, LLP, for the fiscal years ended December
31, 2003 and December 31, 2002:
Fees
------------------------------
Fee Category Fiscal 2003 Fiscal 2002
------------ ----------- -----------
Audit fees $ 170,200 $193,700
Audit-related fees 10,000 9,500
Tax fees 5,500 5,500
--------- --------
Total Fees $ 185,700 $208,700
========= ========
Audit fees. Audit fees represent fees for professional services performed
by BDO Seidman, LLP for the audit of our annual financial statements and the
review of our quarterly financial statements, as well as services that are
normally provided in connection with statutory and regulatory filings or
engagements.
Audit-related fees. Audit-related fees represent fees for assurance and
related services performed by BDO Seidman, LLP that are reasonably related to
the performance of the audit or review of our financial statements. The specific
service was the audit of our retirement plan.
Tax Fees. Tax fees represent fees for tax compliance services performed by
BDO Seidman, LLP.
All other fees. BDO Seidman, LLP did not perform any services other than
the services described above.
Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit
Services of Independent Auditors
The Audit Committee's policy is to pre-approve all audit and permissible
non-audit services provided by the independent auditors. These services may
include audit services, audit-related services, tax services and other services.
The independent auditors and management are required to periodically report to
the Audit Committee regarding the extent of services provided by the independent
auditors in accordance with this pre-approval, and the fees for the services
performed to date. The Audit Committee may also pre-approve particular services
on a case-by-case basis. All services were pre-approved by the Audit Committee.
31
Part IV
Item 15. Exhibits, Financial Statements Schedules and Reports
on Form 8-K.
(a) Document filed as part of this Annual Report on Form 10-K:
(i) Financial Statements.
See Index to Consolidated Financial Statements under Item 8 hereof.
(ii) Financial Statement Schedules.
None
Schedules not listed above have been omitted for the reasons that they
were inapplicable or not required or the information is given elsewhere in the
financial statements.
Separate financial statements of the registrant have been omitted since
restricted net assets of the consolidated subsidiaries do not exceed 25% of
consolidated net assets.
(b) Reports on Form 8-K
On November 18, 2003, we filed a Form 8-K under Item 12, to furnish our press
release reporting our results of operations for the third quarter and nine
months of 2003.
(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.
32
Exhibits (continued)
Exhibit
No. Description of Exhibit
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.
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, incorporated by reference to Exhibit 4.8 of the
Company's Annual Report on Form 10K for the year ended December
31, 2001.
4.9 Combined Amendment No. Five dated as of May 10, 2002 to Amended
and Restated Loan and Security agreement between Foothill and
the Company, incorporated by reference to Exhibit 4.9 of the
Company's Annual Report on Form 10K for the year ended December
31, 2002.
4.10 Combined Amendment No. Six dated as of March 19, 2003 to Amended
and Restated Loan and Security agreement between Foothill and
the Company, incorporated by reference to Exhibit 4.10 of the
Company's Annual Report on Form 10K for the year ended December
31, 2002.
33
Exhibits (continued)
Exhibit
No. Description of Exhibit
10.1 Form of Executive Salary Continuation Agreement, incorporated by
reference to Exhibit 19 (cc) of the Company's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1985.
10.2 Lease dated November 6, 2002 between the Company and Long Island
Industrial Group LLC., incorporated by reference to Exhibit 10.2
of the Company's Annual Report on Form 10K for the year ended
December 31, 2002.
10.3 Lease dated May 1, 2002 between the Company and Long Island
Industrial Group LLC., incorporated by reference to Exhibit 10.3
of the Company's Annual Report on Form 10K for the year ended
December 31, 2002.
14.1 Code of Ethics of the Company dated March 23, 2004.
22 Subsidiaries of the Company, incorporated by reference to
Exhibit 22.1 of the Company's Annual Report on Form 10K for the
year ended December 31, 1995.
23 Consent of Independent Certified Public Accountants.
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
34
SIGNATURES
Pursuant to the requirements of Section 13 or 15(b) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
PORTA SYSTEMS CORP.
Dated March 26, 2004 By /s/ William V. Carney
--------------------------------
William V. Carney
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the report has been signed by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated. Each person whose
signature appears below hereby authorizes William V. Carney and Edward B.
Kornfeld or either of them acting in the absence of the others, as his true and
lawful attorney-in-fact and agent, with full power of substitution and
resubstitution for him and in his name, place and stead, in any and all
capacities to sign any and all amendments to this report, and to file the same,
with all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission.
Signature Title Date
--------- ----- ----
/s/ William V. Carney Chairman of the Board, March 26, 2004
------------------- Chief Executive Officer and Director
William V. Carney (Principal Executive Officer)
/s/ Edward B. Kornfeld Senior Vice President and March 26, 2004
------------------- Chief Financial Officer
Edward B. Kornfeld (Principal Financial and
Accounting Officer)
/s/ Warren H. Esanu Director March 26, 2004
-------------------
Warren H. Esanu
/s/ Michael A. Tancredi Director March 26, 2004
-------------------
Michael A. Tancredi
/s/ Herbert H. Feldman Director March 26, 2004
-------------------
Herbert H. Feldman
/s/ Marco Elser Director March 26, 2004
-------------------
Marco Elser
35
Exhibit I
Item 8. Financial Statements and Supplementary Data
Index Page
- ----- ----
Report of Independent Certified Public Accountants F-2
Consolidated Financial Statements and Notes:
Consolidated Balance Sheets,
December 31, 2003 and 2002 F-3
Consolidated Statements of Operations and Comprehensive Loss,
Years Ended December 31, 2003, 2002 and 2001 F-4
Consolidated Statements of Stockholders' Deficit, Years Ended
December 31, 2003, 2002 and 2001 F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2003, 2002 and 2001 F-6
Notes to Consolidated Financial Statements F-7
F-1
Report of Independent Certified Public Accountants
The Board of Directors and Stockholders
Porta Systems Corp.
Syosset, New York
We have audited the accompanying consolidated balance sheets of Porta Systems
Corp. and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of operations and comprehensive loss, stockholders'
deficit, and cash flows for each of the three years in the period ended December
31, 2003. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Porta Systems Corp.
and subsidiaries as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted
in the United States of America.
As discussed in Notes 1 and 6 to the consolidated financial statements,
effective January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets."
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company has suffered substantial
recurring losses from operations and, as of December 31, 2003, has a
stockholders' deficit of $33,238,000 and a working capital deficit of
$36,825,000. 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 24, 2004
F-2
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2003 and 2002
(in thousands, except shares and par value)
Assets 2003 2002
---- ----
Current assets:
Cash and cash equivalents $ 469 779
Accounts receivable - trade, less allowance for
doubtful accounts of $1,091 in 2003 and
$1,967 in 2002 3,898 4,654
Inventories 3,004 3,363
Prepaid expenses and other current assets 472 329
--------- ---------
Total current assets 7,843 9,125
Property, plant and equipment, net 1,466 1,802
Goodwill 2,961 2,961
Other assets 85 340
--------- ---------
Total assets $ 12,355 14,228
========= =========
Liabilities and Stockholders' Deficit
Current liabilities:
Senior debt $ 25,387 $ 25,070
Subordinated notes 6,144 6,144
6% Convertible subordinated debentures 385 385
Accounts payable 5,635 5,241
Accrued expenses 3,117 2,640
Accrued interest payable 3,563 2,639
Accrued commissions 284 566
Deferred compensation 58 329
Income taxes payable 95 302
Short-term loans -- 8
--------- ---------
Total current liabilities 44,668 43,324
--------- ---------
Deferred compensation 925 839
--------- ---------
Total long-term liabilities 925 839
--------- ---------
Total liabilities 45,593 44,163
--------- ---------
Commitments and contingencies
Stockholders' deficit:
Preferred stock, no par value; authorized 1,000,000
shares, none issued -- --
Common stock, par value $.01; authorized 20,000,000
shares, issued 10,003,224 shares in both 2003 and 2002 100 100
Additional paid-in capital 76,059 76,059
Accumulated deficit (103,380) (100,023)
Accumulated other comprehensive loss:
Foreign currency translation adjustment (4,079) (4,133)
--------- ---------
(31,300) (27,997)
Treasury stock, at cost, 30,940 shares (1,938) (1,938)
--------- ---------
Total stockholders' deficit (33,238) (29,935)
--------- ---------
Total liabilities and stockholders' deficit $ 12,355 $ 14,228
========= =========
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, 2003, 2002 and 2001
(in thousands, except per share amounts)
2003 2002 2001
---- ---- ----
Sales $ 19,590 21,417 28,062
Cost of sales 14,147 14,599 19,970
-------- -------- --------
Gross profit 5,443 6,818 8,092
-------- -------- --------
Selling, general and administrative expenses 5,729 6,383 9,316
Research and development expenses 2,066 2,516 4,427
Goodwill impairment -- 800 5,802
-------- -------- --------
Total expenses 7,795 9,699 19,545
-------- -------- --------
Operating loss (2,352) (2,881) (11,453)
Interest expense (1,278) (1,798) (4,480)
Interest income 1 7 31
Gain on sale of assets -- -- 684
Gain on sale of investment in joint venture -- 450 --
Equity in net loss of joint venture -- -- (175)
Other income, net -- 119 191
-------- -------- --------
Loss before income taxes and minority interest (3,629) (4,103) (15,202)
Income tax benefit (expense) 272 (11) 203
Minority interest -- -- 225
-------- -------- --------
Net loss $ (3,357) (4,114) (14,774)
======== ======== ========
Other comprehensive income (loss):
Foreign currency translation adjustments 54 24 (360)
-------- -------- --------
Comprehensive loss $ (3,303) (4,090) (15,134)
======== ======== ========
Basic and diluted per share amounts:
Net loss per share of common stock $ (0.34) (0.41) (1.50)
======== ======== ========
Weighted average shares of common stock outstanding 9,972 9,972 9,878
======== ======== ========
See accompanying notes to consolidated financial statements.
F-4
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Deficit
Years ended December 31, 2003, 2002 and 2001
(In thousands)
Common Stock Accumulated Total
-------------------- Additional Other Stock-
No. of Par Value Paid-in Comprehensive Accumulated Treasury holders'
Shares Amount Capital Loss) Deficit Stock Deficit
------ ------ ------- ----- ------- ----- -------
Balance at December 31, 2000 9,817 $ 98 $ 75,980 $ (3,797) $ (81,135) $ (1,938) $ (10,792)
Net loss 2001 -- -- -- -- (14,774) -- (14,774)
Common stock issued 130 1 37 -- -- -- 38
Warrants re-priced -- -- 39 -- -- -- 39
Foreign currency translation
adjustment -- -- -- (360) -- -- (360)
------ --------- --------- --------- --------- --------- ---------
Balance at December 31, 2001 9,947 99 76,056 (4,157) (95,909) (1,938) (25,849)
Net loss 2002 -- -- -- -- (4,114) -- (4,114)
Common stock issued 56 1 3 -- -- -- 4
Foreign currency translation
adjustment -- -- -- 24 -- -- 24
------ --------- --------- --------- --------- --------- ---------
Balance at December 31, 2002 10,003 100 76,059 (4,133) (100,023) (1,938) (29,935)
Net loss 2003 -- -- -- -- (3,357) -- (3,357)
Foreign currency translation
adjustment -- -- -- 54 -- -- 54
------ --------- --------- --------- --------- --------- ---------
Balance at December 31, 2003 10,003 $ 100 $ 76,059 $ (4,079) $(103,380) $ (1,938) $ (33,238)
====== ========= ========= ========= ========= ========= =========
See accompanying notes to consolidated financial statements
F-5
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Note 20) Years ended December 31,
2003, 2002 and 2001
(In thousands)
2003 2002 2001
---- ---- ----
Cash flows from operating activities:
Net loss $(3,357) (4,114) (14,774)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 483 713 1,909
Goodwill impairment -- 800 5,802
Amortization of debt discounts -- 3 6
Gain on sale of investment in joint venture -- (450) --
Non-cash financing expenses -- -- 123
Gain on sale of assets -- -- (684)
Minority interest -- -- (225)
Equity in loss of joint venture -- -- 175
Changes in operating assets and liabilities:
Accounts receivable 756 (370) 3,141
Inventories 359 1,843 1,944
Prepaid expenses (143) 523 278
Other assets 255 (142) 867
Accounts payable, accrued expenses and other liabilities 1,122 (2,044) (2,341)
------- ------- -------
Net cash used in operating activities (525) (3,238) (3,779)
------- ------- -------
Cash flows from investing activities:
Net proceeds from the sale of assets -- -- 1,670
Capital expenditures, net (72) (124) (196)
------- ------- -------
Net cash used in investing activities (72) (124) (1,474)
------- ------- -------
Cash flows from financing activities:
Proceeds from senior debt 317 2,975 2,222
Repayments of senior debt -- -- (873)
Proceeds from the issuance of common stock -- 4 38
Proceeds (repayments) of notes payable/short-term loans (8) (3) 10
------- ------- -------
Net cash provided by financing activities 309 2,976 1,397
------- ------- -------
Effect of exchange rate changes on cash and cash equivalents (22) (39) (254)
------- ------- -------
Decrease in cash and cash equivalents (310) (425) (1,162)
Cash and equivalents - beginning of year 779 1,204 2,366
------- ------- -------
Cash and equivalents - end of year $ 469 779 1,204
======= ======= =======
See accompanying notes to consolidated financial statements.
F-6
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(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. The Company engages solely in
development of software products for specific customer contracts and
as such costs are charged to cost of sales at the time revenues on
such contracts are recognized.
Concentration of Credit Risk
Financial instruments, which potentially subject Porta to concentrations
of credit risk, consist principally of cash and accounts receivable.
At times such cash in banks exceeds the FDIC insurance limit.
As discussed in notes 17 and 21, 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 when possible 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.
(Continued)
F-7
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Accounts Receivable
Accounts receivable are customer obligations due under normal trade terms.
The Company sells its products directly to customers, to distributors
and original equipment manufacturers involved in a variety of
industries, principally telecommunications and military/aerospace. The
Company performs continuing credit evaluations of its customers'
financial condition and although it generally does not require
collateral, letters of credit may be required from customers in
certain circumstances.
The Company records an allowance for doubtful accounts receivable based on
specifically identified amounts that it believes to be uncollectible.
The Company also records additional allowances based on certain
percentages of its aged receivables, which are determined based on
historical experience and its assessment of the general financial
conditions affecting its customer base. If the Company's actual
collection experience changes, revisions to its allowance may be
required. The Company has a limited number of customers with
individually large amounts due at any given balance sheet date.
Inventories
Inventories are stated at the lower of cost (on the average or first-in,
first-out methods) or market.
Property, Plant and Equipment
Property, plant and equipment are carried at cost. Leasehold improvements
are amortized over the shorter of the term of the lease or the
estimated lives of the related assets. Depreciation is computed using
the straight-line method over the related assets' estimated lives.
Goodwill
Goodwill represents the difference between the purchase price and the fair
market value of net assets acquired in business combinations.
Commencing January 1, 2002, goodwill is an indefinite lived asset and
as such is not amortized. On an annual basis, or more frequently if
certain events occur, the Company tests the goodwill for impairment.
The Company determines the market value of the reporting unit by
considering the projected cash flows generated from the reporting unit
to which the goodwill relate. Goodwill at December 31, 2003 and 2002,
related only to the Company's signal processing division.
(Continued)
F-8
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
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, and tax benefits of net operating loss carryforwards.
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. A valuation allowance is recorded to
reduce net deferred tax assets to amounts that are more likely than
not to be realized (note 14).
Foreign Currency Translation
Assets and liabilities of foreign subsidiaries are translated at year-end
rates of exchange, and revenues and expenses are translated at the
average rates of exchange for the year. Gains and losses resulting
from translation are accumulated in a separate component of
stockholders' equity. Gains and losses resulting from foreign currency
transactions (transactions denominated in a currency other than the
functional currency) are included in operations.
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 2003, 2002 and 2001, no dilutive potential shares of common stock
were added to compute diluted loss per share because the effect would
be anti-dilutive.
Reclassifications
Certain reclassifications have been made to conform prior years'
consolidated financial statements to the 2003 presentation.
(Continued)
F-9
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Accounting for Stock-Based Compensation
The Company applies the intrinsic value method as outlined in Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees," and related Interpretations in accounting for stock
options. Under the intrinsic value method, no compensation expense is
recognized if the exercise price of the Company's employee stock
options equals the market price of the underlying stock on the date
of the grant. Accordingly, no compensation cost has been recognized.
Statement of Financial Accounting Standard ("SFAS") No. 123,
"Accounting for Stock-Based Compensation," requires the Company to
provide pro forma information regarding net loss and net loss per
common share as if compensation cost for the Company's stock option
programs had been determined in accordance with the fair value method
prescribed therein. The following table illustrates the effect on net
loss and loss per share of common stock as if the fair value method
had been applied to all outstanding and unvested awards in each
period presented.
Year Ended
December 31
-----------------------------------
2003 2002 2001
---- ---- ----
(In thousands, except per share data)
Net loss, as reported $ (3,357) $ (4,114) $(14,774)
Deduct: Total stock-based employee compensation expense
determined under fair value method for all awards (1) (1) (13)
-------- -------- --------
Pro forma net loss $ (3,358) $ (4,115) $(14,787)
======== ======== ========
Loss per share of common stock:
Basic and diluted - as reported $ (0.34) $ (0.41) $ (1.50)
======== ======== ========
Basic and diluted - pro forma $ (0.34) $ (0.41) $ (1.50)
======== ======== ========
Accounting for the Impairment of Long-Lived Assets
The Company follows SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." Long-lived assets other than goodwill
are evaluated for impairment when events or changes in circumstances
indicate the carrying amount of the assets may not be recoverable
through the estimated undiscounted future cash flows from the use of
these assets.
(Continued)
F-10
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
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, accrued expenses,
goodwill valuation and the deferred tax asset valuation allowance.
Actual results could differ from those and other estimates.
New Accounting Pronouncements
In May 2003, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 150. "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." SFAS No. 150
clarifies the definition of a liability as currently defined in FASB
Concepts Statement No. 6, "Elements of Financial Statements," as well
as other planned revisions. This statement requires a financial
instrument that embodies an obligation of an issuer to be classified
as a liability. In addition, the statement establishes standards for
the initial and subsequent measurement of these financial instruments
and disclosure requirements. SFAS 150 was effective for financial
instruments entered into or modified after May 31, 2003. For all
instruments entered into or last modified prior to May 31, 2003, SFAS
150 was effective at the beginning of the Company's third quarter of
2003. The adoption of SFAS 150 did not have a material effect on the
Company's financial position or results of operations.
In January 2003, the FASB issued interpretation ("FIN") No. 46,
"Consolidation of Variable Interest Entities" and in December 2003, a
revised interpretation was issued (FIN No. 46(R)). In general, a
variable interest entity ("VIE") is a corporation, partnership, trust,
or any other legal structure used for business purposes that either
does not have equity investors with voting rights or has equity
investors that do not provide sufficient financial resources for the
entity to support its activities. FIN 46 requires a VIE to be
consolidated by a company if that company is designated as the primary
beneficiary. Application of FIN 46 is required in financial statements
of public entities that have an interest in structures that are
commonly referred to as special-purpose entities, or SPEs, for periods
ending after December 15, 2003. Application by public entities, other
than small business issuers, for all other types of VIEs (i.e.
non-SPEs) is required in financial statements for periods ending after
March 15, 2004. The adoption of FIN 46 did not have a material effect
on the Company's financial position or results of operations.
(Continued)
F-11
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
In December 2002, the FASB issued FAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure." This statement
amends FAS No. 123, "Accounting for Stock-Based Compensation," to
provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee
compensation. In addition, FAS 148 amends the disclosure requirements
of FAS 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported
results. The Company adopted the disclosure provisions of this
standard.
In November 2002, the FASB reached a consensus regarding Emerging Issues
Task Force ("EITF") Issue No. 00-21, "Revenue Arrangements with
Multiple Deliverables." EITF 00-21 addresses accounting for
arrangements that may involve the delivery or performance of multiple
products, services, and/or rights to use assets. The guidance provided
by EITF 00-21 is effective for contracts entered into on or after July
1, 2003. The adoption of EITF 00-21 did not have a material effect on
the Company's financial position or results of operations.
In November 2002, the FASB issued FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees
of Indebtedness of Others." FIN 45 addresses the disclosures to be
made by a guarantor in its interim and annual financial statements
about its obligations under certain guarantees. FIN 45 also clarifies
that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken
in issuing the guarantee. The disclosure requirements in this
Interpretation are effective for financial statements of interim or
annual periods ending after December 15, 2002. The adoption of FIN 45
did not have a material effect on the Company's financial position or
results of operations.
In June 2002, the FASB issued FAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities". This Statement addresses financial
accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)". The
principal difference between this Statement and EITF 94-3 relates to
the Statement's requirements for recognition of a liability for a cost
associated with an exit or disposal activity. This Statement requires
that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred, whereas under
EITF 94-3, a liability was recognized at the date of an entity's
commitment to an exit plan. This Statement is effective for exit or
disposal activities that are initiated after December 31, 2002. The
adoption of FAS 146 did not have a material effect on the Company's
financial position or results of operations.
(Continued)
F-12
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(2) Liquidity
As of December 31, 2003, the Company's debt included (a) $25,387,000 of
senior debt including principal and interest, which, as a result of a
January 14, 2004 extension, matures on April 15, 2004, (b) $6,144,000
principal amount of subordinated debt, which matured on July 3, 2001,
and (c) $385,000 of 6% Debentures which matured on July 2, 2002. The
Company was unable to pay the principal ($6,144,000) or interest
($3,205,000) on the subordinated notes or the principal ($385,000) or
interest ($81,000) on the 6% Debenture. At December 31, 2003, 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 any subordinated
indebtedness, other than accounts payable in the normal course of
business. Accordingly, all senior and subordinated debt are classified
as current liabilities (note 7).
The Company has suffered substantial recurring losses from operations and,
as of December 31, 2003, has a working capital deficit of $36,825,000.
In addition, the Company continued to suffer a decline in sales in
2003 from 2002 following a significant decline in sales in 2002 from
2001.
As a result of its continuing financial difficulties:
o the Company is having and may continue to have difficulty
performing its obligations under its contracts, which could result
in the cancellation of contracts or the loss of future business
and penalties for non-performance;
o a number of creditors have engaged collection agencies; and
o the Company has significantly scaled back its Operating Support
Systems ("OSS") operations.
A vendor has commenced an arbitration proceeding against us seeking $3
million for breach of contract (see note 19). If the claimant obtains
a significant judgment against the Company and the claimant seeks to
enforce the judgment, or if one or more of the Company's other
creditors obtain significant judgments against it and seeks to enforce
the judgments, the Company's ability to continue in business would be
impaired and it may be necessary for the Company, or its senior lender
may require the Company, 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. If the Company sells any or all of its divisions, 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 2003, 2002 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.
F-13
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
During 2002 and 2003, the Company has taken steps to reduce overhead,
including a reduction in personnel. The Company will continue to look
to reduce costs while it seeks additional business from new and
existing customers. Because of its present stock price, the Company
cannot 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 or restructure its
debt obligations and sell one or more of its divisions, it cannot be
assured that the Company will be able to continue in operations.
Furthermore, the Company believes that its losses and its financial
position, together with the continuing economic climate affecting the
telecommunications industry generally, are having 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
was informally advised, in 2001, 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 is placing orders for line test products. The loss of this
customer would have a material adverse effect upon the Company's
operations.
The Company's obligations to its senior lender mature on April 15, 2004,
at which time, unless extended, all of the principal and interest on
the senior debt becomes due and payable. The senior lender has granted
the Company extensions in the past. However, at each maturity date,
the senior lender reviews the Company's financial condition, business
plan and prospects. The Company cannot determine whether the senior
lender will continue to extend the loans. Any adverse event, including
continuing declines in business or attempts by creditors, including
judgment creditors, to realize on their claims or judgments could have
an effect on the decision of the senior lender to extend or demand
payment on the notes. In such event, it would be necessary for the
Company to seek protection under the Bankruptcy Code.
These financial statements have been prepared assuming that the Company
will continue as a going concern and, accordingly, do not include any
adjustments that might result from the outcome of the uncertainties
described above.
(Continued)
F-14
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Accounts Receivable
Accounts receivable are customer obligations due under normal trade terms.
The Company sells its products directly to customers, to distributors
and original equipment manufacturers involved in a variety of
industries, principally telecommunications and military/aerospace. The
Company performs continuing credit evaluations of its customers'
financial condition and although it generally does not require
collateral, letters of credit may be required from customers in
certain circumstances. Senior management reviews accounts receivable
on a monthly basis to determine if any receivables will potentially be
uncollectible. Included are any accounts receivable balances that are
determined to be uncollectible, along with a general reserve, in the
overall allowance for doubtful accounts. After all attempts to collect
a receivable have failed, the receivable is written off against the
allowance. Based on the information available to the Company, it
believes the allowance for doubtful accounts as of December 31, 2003
is adequate. However, actual write-offs might exceed the recorded
allowance.
Accounts receivable included approximately $1,213,000 and $873,000 at
December 31, 2003 and 2002, respectively, of revenues earned but not
yet contractually billable pursuant to long-term contracts for
specialized products. All such amounts at December 31, 2003 are
expected to be billed in 2004. In addition, accounts receivable
included approximately $224,000 and $300,000 at December 31, 2003 and
2002, respectively, of retainage balances, representing amounts held
back by customers to insure performance by the Company of its
obligations under various long-term contracts. All such amounts, at
December 31, 2003 are expected to be collected in 2004. The allowance
for doubtful accounts receivable was $1,091,000 and $1,967,000 as of
December 31, 2003 and 2002, respectively. The allowance for doubtful
accounts was increased by provisions of $210,000, $23,000, and $0 and
decreased by write-offs of $1,086,000, $224,000, and $309,000 for the
years ended December 31, 2003, 2002, and 2001, respectively.
(4) Inventories
Inventories consist of the following:
December 31,
-------------------------------
2003 2002
---- ----
Parts and components $1,673,000 1,767,000
Work-in-process 427,000 208,000
Finished goods 904,000 1,388,000
---------- ---------
$3,004,000 3,363,000
========== =========
(Continued)
F-15
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Property, Plant and Equipment
Property, plant and equipment consists of the following:
December 31
-----------------------------
2003 2002 useful lives
---- ---- ------------
Land $ 132,000 132,000 --
Buildings 1,110,000 1,110,000 20 years
Machinery and equipment 7,991,000 7,821,000 3-8 years
Furniture and fixtures 2,295,000 2,551,000 5-10 years
Transportation equipment 74,000 74,000 4 years
Tools and molds 3,833,000 3,774,000 8 years
Leasehold improvements 882,000 858,000 Lesser of term of lease
----------- --------- or estimated life of asset
16,317,000 16,320,000
Less accumulated depreciation
and amortization 14,851,000 14,518,000
----------- ---------
$ 1,466,000 1,802,000
=========== =========
(6) Goodwill
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets". This statement established financial accounting and reporting
standards for acquired goodwill and other intangible assets.
Specifically, the standard addresses how acquired intangible assets
should be accounted for after they have been recognized in the
financial statements. In accordance with SFAS No. 142, intangible
assets, including purchased goodwill, must be evaluated for
impairment. Those intangible assets that will continue to be
classified as goodwill or as other intangibles with indefinite lives
are no longer amortized.
Effective January 1, 2002, the Company ceased amortization of goodwill
resulting in a decrease of $795,000 in amortization for the year
ended December 31, 2002 compared to the same period in 2001. Instead
of amortizing goodwill over a fixed period of time, the Company will
measure the fair value of the acquired business at least annually to
determine if goodwill has been impaired. In addition, the Company
completed the first step of the goodwill transitional impairment
test, which required determining the fair value of the reporting
units as of January 1, 2003 and comparing it to the carrying value of
the reporting unit net assets. The Company determined that there was
no impairment loss resulting from the transitional impairment test as
of January 1, 2003.
(Continued)
F-16
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
As of December 31, 2003 and 2002, goodwill totaled $2,961,000. At such
dates, all of the goodwill related to the Company's Signal division.
During the second quarter of 2002, the Company was engaged in
discussions with respect to the sale of the Signal division. Based on
those discussions the Company determined that goodwill was impaired
and it estimated that the amount of the impairment was $800,000. This
amount was charged to operations in the quarter ended June 30, 2002.
Furthermore, the Company cannot give assurances that further
write-downs will not be necessary, although management believes that
no additional goodwill impairment charges are necessary at this time.
In December 2001, the Company determined that $5,802,000 of goodwill
associated with its OSS business unit was impaired and as such
recorded an impairment loss. This assessment was based on the
continued decline in sales and losses generated by the business unit
over the past several years and the declining prospects for additional
sales of the products based on the older technology that originally
gave rise to the goodwill.
The following schedule presents adjusted net loss, basic net loss per
share and diluted net loss per share, exclusive of goodwill
amortization expense, had the standard been adopted for those periods.
Year Ended December 31
------------------------------------------
2003 2002 2001
---- ---- ----
(In thousands, except per share data)
Reported net loss $(3,357) $(4,114) $(14,774)
Add back:
Goodwill amortization -- -- 795
------- ------- --------
Adjusted net loss $(3,357) $(4,114) $(13,979)
======= ======= ========
Basic and Diluted net loss
per share of common stock:
Reported net loss $ (0.34) $ (0.41) $ (1.50)
Goodwill amortization -- -- .08
------- ------- --------
Adjusted net loss $ (0.34) $(0.41) $ (1.42)
======= ======= ========
(Continued)
F-17
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(7) Senior Debt
On December 31, 2003 and 2002, Porta's senior debt consisted of debt
under its credit facility in the amount of $25,387,000 and
$25,070,000, respectively. Substantially all of the Company's assets
are pledged as collateral for the senior debt. The current agreement
with the senior lender, as amended in January 2004 and described
below, will expire on April 15, 2004 and, accordingly, the senior debt
has been classified as a current liability (see note 2).
In March 2002, the senior lender agreed to an amended and restated loan
and security agreement whereby a new term loan was established with a
maximum principal amount of $1,500,000 and subsequently increased in
May 2002 to $2,250,000. The agreement allowed the Company to draw
monies subject to the senior lender's receipt and approval of a weekly
disbursement budget. Any advances under this agreement were at the
discretion of the senior lender. Obligations under the new term loan
bear interest at 12%, which interest shall accrue monthly and be added
to the principal until September 1, 2002 when interest for the month
of August 2002 became payable and current interest became payable. The
agreement provides that all indebtedness prior to March 1, 2002 is
reflected as an old term loan in the amount of $22,610,000, which
includes the principal balance due at December 31, 2001 plus accrued
interest though March 1, 2002. The old term loan bears no interest
until such time as the senior lender in its sole discretion notifies
the Company that interest shall be payable. Additionally, the senior
lender prohibited the Company from making any payments on indebtedness
to any subordinated creditors, but the Company is not prohibited from
paying accounts payable in the ordinary course of business. Finally,
the agreement allowed for standby letters of credit not to exceed a
maximum of $573,000. As of December 31, 2003, the Company did not have
any standby letters of credit outstanding. As of December 31, 2003,
the Company had borrowed $2,250,000, the maximum principal amount
under the new term loan, and the total principal and interest on the
new term loan was $2,777,000.
As consideration for an April 2001 loan amendment, the Company agreed to
reduce the exercise price of the outstanding warrants to purchase
approximately 570,000 shares of common stock held by its senior lender
to $0.25 per share. The value of the reduction in exercise price was
$39,000, which was recorded as interest expense and additional paid in
capital. As of December 31, 2003, 100,000 of these warrants remain
outstanding.
(8) 6% Convertible Subordinated Debentures
As of December 31, 2003 and 2002, the Company had outstanding $385,000 of
its 6% convertible subordinated debentures due July 1, 2002 (the
"Debentures"). 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, 2003 and
2002, accrued interest on the debentures was $81,000 and $58,000,
respectively. The trustee of the Debentures gave notice to the Company
that the non-payment caused an event of default.
(Continued)
F-18
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(9) Subordinated Notes
As of December 31, 2003 and 2002, $6,144,000 of Subordinated Notes were
outstanding. As of December 31, 2003, $6,144,000 of principal and
$3,205,000 of accrued interest were due and payable. However, the
Company did not have the resources to pay the $6,144,000 principal and
$3,205,000 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).
(10) Joint Venture
In April 2002, the Company sold its 50% interest in its Korean joint
venture company, for $450,000 to its joint venture partner. Payment
was made by the forgiveness of commissions, totaling $450,000, which
were owed by the Company to its sales representation company (which is
owned by the Company's joint venture partner) with respect to sales
made by the joint venture in Korea. The investment in the joint
venture had previously been written down to zero as the Company's
share of the losses of the joint venture exceeded its investment.
Therefore, the transaction was reflected as a $450,000 reduction in
accrued commissions and a non-cash gain on sale of investment in joint
venture.
(11) Stockholders' Equity
At December 31, 2003, the Company had outstanding (a) warrants issued to
its senior lender to purchase 100,000 shares of common stock, which
are currently exercisable at $0.25 per share and expire on June 6,
2005, (b) warrants issued to a vendor to purchase 15,000 shares of
common stock, which are currently exercisable at $1.8125 per share and
expire in May 2005 (c) warrants issued to the holders of subordinated
notes to purchase 127,500 shares of Common Stock which are exercisable
at $3.00 per share and expire on January 2, 2005.
(12) Employee Benefit Plans
The Company 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 modified agreements will be made for a period ranging from
approximately 15 to approximately 25 years. In 2003, under the
modified requirements, the accrued liability was reduced by
approximately $137,000. During 2002 and 2001, the Company accrued
approximately $122,000 and $166,000, respectively, under the original
agreements.
The Company maintains 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, 2003, 2002 and 2001, the Company's
contribution amounted to $37,000, $47,000 and $54,000, respectively.
(Continued)
F-19
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The Company maintains the Employee Stock Purchase Plan for the benefit of
eligible employees, as defined in the Purchase Plan, which permits
employees to purchase the Company's common stock at discounts up to
10%. The Company has reserved 1,000,000 shares of the Company's stock
for issuance under the plan. During 2002, and 2001, 55,803, and
130,250 shares, respectively, were issued pursuant to the Purchase
Plan. No shares were issued in 2003 pursuant to the Plan.
The Company does not provide any other post-retirement benefits to any
of its employees.
(13) Incentive Plans
During 1999, the Company established an Employee Stock Bonus Plan whereby
stock may be given to employees who are not officers or directors to
recognize their contributions. A maximum of 95,750 shares of common
stock is reserved for issuance pursuant to the Bonus Plan. No shares
of common stock were issued pursuant to the Bonus Plan during 2003,
2002 and 2001.
The Company's 1996 Stock Incentive Plan ("1996 Plan") covers 450,000
shares of common stock. Incentive stock options cannot be issued
subsequent to ten years from the date the 1996 Plan was approved.
Options under the 1996 Plan may be granted to key employees, including
officers and directors of the Company and its subsidiaries, except
that members and alternate members of the stock option committee are
not eligible for options under the 1996 Plan. The exercise prices for
all options granted were equal to the fair market value at the date of
grant and vest as determined by the board of directors. In addition,
the 1996 Plan provides for the automatic grant to non-management
directors of non-qualified options to purchase 2,000 shares on May 1st
of each year commencing May 1, 1996, with an exercise price equal to
the average closing price of the last ten trading days of April of
each year.
The Company'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.
The Company'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-20
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The weighted-average fair values of options granted were $0.02, $0.05 and
$0.23 per share for options granted in 2003, 2002 and 2001,
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 2003, 2002 and 2001:
2003 2002 2001
---- ---- ----
Dividends: $0.00 per share $0.00 per share $0.00 per share
Volatility: 50% 100% 100%
Risk-free interest: 4.22%-5.48% 4.22%-5.48% 4.22%-5.48%
Expected term: 5 - 9.6 years 5 - 9.6years 5 - 9.6years
A summary of the status of the Company's stock option plans as of December
31, 2003, 2002, and 2001, and changes during the years ending on those
dates is presented below:
2003 2002 2001
------------------------ ------------------------- -----------------------
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 601,530 $2.43 801,705 $3.96 949,713 $2.55
Granted 15,000 0.02 15,000 0.07 55,000 0.29
Exercised -- -- --
Forfeited (64,000) 3.21 (215,175) 2.11 (203,008) 2.58
------- ------- -------
Outstanding end of year 552,530 $2.27 601,530 $2.43 801,705 $3.96
======= ======= =======
Options exercisable
at year-end 542,530 567,647 698,105
======= ======= =======
The following table summarizes information about stock options outstanding
under the stock option plans at December 31, 2003:
Options Outstanding Options Exercisable
------------------------------------------------------- -------------------------------
Weighted-average
Range of Outstanding Remaining Weighted-average Exercisable Weighted-Average
Exercise Prices at 12/31/03 Contractual Life Exercise Price at 12/31/03 Exercise Price
<$1.00 50,000 7.8 years $0.15 48,000 $0.15
$1.00 - 1.99 215,780 3.4 years $1.51 215,780 $1.51
$2.00 - 2.99 11,500 5.5 years $2.26 11,500 $2.26
$3.00 - 3.85 275,250 .4 years $3.27 267,250 $3.26
------- -------
552,530 542,530
======= =======
(Continued)
F-21
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(14) Income Taxes
The provision (benefit) for income taxes consists of the following:
2003 2002 2001
--------------------- --------------------- -----------------------
Current Deferred Current Deferred Current Deferred
------- -------- ------- -------- ------- --------
Federal $ -- -- -- -- -- --
State and foreign (272,000) -- 11,000 -- (203,000) --
---------- ---------- -------- ----------- ----------- -----------
Total $(272,000) -- 11,000 -- 203,000 --
========== ========== ======== =========== ========== ===========
The domestic and foreign components of loss before provision (benefit) for
income taxes were as follows:
2003 2002 2001
---- ---- ----
United States $(2,989,000) (3,726,000) (11,578,000)
Foreign (640,000) (376,000) (3,399,000)
----------- ---------- -----------
Loss before provision
(benefit) for income taxes $(3,629,000) (4,102,000) (14,977,000)
=========== ========== ===========
A reconciliation of the Company's income tax provision and the amount
computed by applying the statutory U.S. federal income tax rate of 34%
to loss before income taxes is as follows:
2003 2002 2001
---- ---- ----
Tax benefit at statutory rate $(1,234,000) (1,395,000) (5,092,000)
Increase (decrease) in income tax benefit resulting from:
Increase in valuation allowance 1,379,000 1,094,000 3,057,000
State and foreign taxes, less applicable federal benefits (114,000) (98,000) (211,000)
Non-deductible goodwill impairment -- 272,000 1,973,000
Other expenses not deductible for tax purposes 8,000 13,000 333,000
Foreign income taxed at rates
different from U.S. statutory rate (16,000) (78,000) (19,000)
Estimated NOL adjustments, including Section 382 limitation - -- --
Reversal and adjustments of prior year's accrual (275,000) 203,000 (262,000)
Other (20,000) -- 18,000
----------- ----------- -----------
$ (272,000) 11,000 203,000
=========== =========== ===========
Porta has unused United States tax net operating loss (NOL) carryforwards
of approximately $52,357,000 expiring at various dates between 2009
and 2023. Due to the 1997 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 with respect
to approximately $23.9 million of the NOL, representing the portion
that arose prior to the change in control. The carryforward amounts
are subject to review by the Internal Revenue Service (IRS). In
addition, Porta has foreign NOL carryforwards of approximately
$6,734,000 with indefinite expiration dates.
(Continued)
F-22
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The components of the deferred tax assets, the net balance of which total
zero after the valuation allowance, as of December 31, 2003 and 2002
are as follows:
2003 2002
---- ----
Deferred tax assets:
Inventory $ 1,018,000 1,313,000
Allowance for doubtful accounts
receivable 420,000 757,000
Benefits of tax loss carryforwards 22,447,000 20,690,000
Benefit plans 468,000 591,000
Accrued commissions 109,000 218,000
Other 1,579,000 1,093,000
Depreciation 358,000 358,000
------------ ------------
26,399,000 25,020,000
Valuation allowance (26,399,000) (25,020,000)
------------ ------------
$ -- $ --
Because of Porta's losses in 2003 and 2002, 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 was
in a structured settlement with the IRS, which was reviewed annually,
whereby monthly payments to be made to liquidate the settlement. As of
December 31, 2002, Porta had not made all the required payments
through that date under the settlement and had been in correspondence
with the IRS to obtain an offer in compromise. As of December 31,
2002, $274,000 remained outstanding. In January 2003, Porta accepted
an offer to pay $30,000 in full settlement of this liability;
accordingly the related tax and accrued interest liability was
reversed in 2003.
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, 2003, undistributed earnings of the foreign
subsidiaries amounted to approximately $1,472,000. It is not
practicable to determine the amount of income or withholding tax that
would be payable upon the remittance of those earnings.
(Continued)
F-23
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(15) Leases
At December 31, 2003, 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 2003, 2002, and 2001 amounted to approximately $537,000,
$499,000 and $793,000, respectively. Minimum rental commitments,
exclusive of future escalation charges, for each of the next five
years are as follows:
2004 $ 628,000
2005 583,000
2006 585,000
2007 553,000
2008 307,000
Thereafter 2,996,000
----------
$5,652,000
(16) Major Customers
Porta's five largest customers accounted for sales of $8,507,000, or
approximately 43% of sales, for 2003, $9,784,000, or approximately 46%
of sales, for 2002 and $13,444,000, or approximately 48% of sales, for
2001. Fujitsu Telecommunications Europe LTD was Porta's largest
customer for 2003, accounting for sales of $3,150,000, or
approximately 16%. Philippine Long Distance Telephone was Porta's
largest customer for 2002 and 2001, accounting for sales of
$2,725,000, or approximately 13%, and $3,485,000, or approximately
12%, respectively. A significant amount of sales of our products for
use by British Telecommunications were sold to Fujitsu 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
$1,480,000, or 8% of sales, for 2003, $2,306,000, or 11% of sales, for
2002 and $3,339,000, or 12% of sales, for 2001. No other customers
account for 10% or more of the Company's sales in 2003, 2002 or 2001.
(17) Fair Values of Financial Instruments
Cash equivalents, accounts receivable and accounts payable are reflected
in the consolidated financial statements at fair value because of the
short term maturity of these instruments.
The fair value of Porta's senior and subordinated debt and related
interest cannot be reasonably estimated due to the lack of
marketability of such instruments. However, management believes that
the fair value of these instruments is significantly less than their
aggregate carrying amount.
(Continued)
F-24
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(18) Net Loss Per Share
Options to purchase 552,530, 601,530 and 806,705 shares of common stock
for 2003, 2002 and 2001, respectively, with exercise prices ranging
from $0.02 to $3.85, $0.07 to $3.85 and $0.22 to $5.00 for 2003, 2002
and 2001, respectively, were outstanding but not included in the
computation of diluted net loss per share because the exercise prices
were greater than the average market price of common stock during such
years, and the effect of doing so would be anti-dilutive due to losses
incurred.
Warrants to purchase 242,500, 242,500 and 1,776,152 shares of common stock
for 2003, 2002 and 2001, respectively, with exercise prices ranging
from $0.25 to $3.00, $0.25 to $1.81 and $0.25 to $3.00 for 2003, 2002
and 2001, respectively, were outstanding but not included in the
computation of diluted net loss per share because the exercise prices
were greater than the average market price of common stock during such
years, and the effect of doing so would be anti-dilutive due to losses
incurred.
(19) Legal Matters
In June 2002, BMS Corp. commenced an arbitration proceeding against the
Company in New York City seeking damages of approximately $3,000,000
and alleging that Porta breached its agreement to market and sell an
update to an OSS product which BMS was to develop for the Company.
Porta believes that it has defenses to the claims by BMS and has filed
a counterclaim to recover the $350,000 the Company advanced to BMS
under the contract. The arbitrator has held three days of hearings and
hearings are scheduled to resume in April 2004. If BMS obtains a
significant judgment against the Company in this proceeding and seeks
to enforce the judgment, the Company's ability to continue in business
would be impaired.
In July 1996, an action was commenced against the Company and certain
present and former directors in the Supreme Court of the State of New
York, New York County by certain of the Company's stockholders and
warrant holders who acquired their securities in connection with the
Company's acquisition of Aster Corporation. The complaint alleges
breach of contract against Porta and breach of fiduciary duty against
the Company's 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 it has valid defenses
to the claims. There has been no significant activity in this matter
subsequent to December 31, 1999, and the case has been administratively
dismissed for failure to prosecute.
(Continued)
F-25
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
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 Porta's senior debt. The plaintiff's motion
for a summary judgment was denied by the court on the grounds that the
terms of the note did not give them permission to obtain a judgment
while the Company remained in default to the senior debt holder. Since
that time, the action has remained inactive.
(20) Cash Flow Information
(1) Supplemental cash flow information for the years ended December 31, is
as follows:
2003 2002 2001
---- ---- ----
Cash paid for interest $ 6 10 933
==== ==== ====
Cash paid for income taxes $ 11 2 131
==== ==== ====
(2) Non-cash transactions:
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.
(21) 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.
(Continued)
F-26
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
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.
2003 2002 2001
---- ---- ----
Revenue:
Line $11,334,000 9,598,000 12,756,000
OSS 3,249,000 6,414,000 8,874,000
Signal 4,253,000 4,523,000 5,737,000
----------- ---------- ----------
$18,836,000 20,535,000 27,367,000
=========== ========== ==========
Segment profit (loss):
Line $ 1,634,000 (565,000) 1,275,000
OSS (3,072,000) 226,000 10,518,000)
Signal 1,393,000 286,000 1,449,000
----------- ---------- ----------
$ (45,000) (53,000) (7,794,000)
=========== ========== ==========
Depreciation and amortization:
Line $ 253,000 245,000 374,000
OSS 136,000 350,000 1,262,000
Signal 22,000 25,000 166,000
----------- ---------- ----------
$ 411,000 620,000 1,802,000
=========== ========== ==========
Total identifiable assets:
Line $ 4,099,000 3,975,000 5,990,000
OSS 2,932,000 4,538,000 4,268,000
Signal 4,293,000 4,319,000 5,557,000
----------- ---------- ----------
$11,324,000 12,832,000 15,815,000
=========== ========== ==========
Capital expenditures:
Line $ 46,000 37,000 132,000
OSS 0 58,000 55,000
Signal 4,000 9,000 0
----------- ---------- ----------
$ 50,000 104,000 187,000
=========== ========== ==========
(Continued)
F-27
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The following table reconciles segment totals to consolidated totals:
2003 2002 2001
---- ---- ----
Revenue:
Total revenue for reportable segments $ 18,836,000 20,535,000 27,367,000
Other revenue 754,000 882,000 695,000
------------ ------------ ------------
Consolidated total revenue $ 19,590,000 21,417,000 28,062,000
============ ============ ============
Operating loss:
Total segment loss for reportable segments $ 45,000) (53,000) (7,794,000)
Corporate and unallocated (2,307,000) (2,828,000) (3,659,000)
------------ ------------ ------------
Consolidated total operating loss $ (2,352,000) (2,881,000) (11,453,000)
============ ============ ============
Depreciation and amortization:
Total for reportable segments $ 411,000 620,000 1,802,000
Corporate and unallocated 72,000 93,000 107,000
------------ ------------ ------------
Consolidated total deprecation and amortization $ 483,000 713,000 1,909,000
============ ============ ============
Total assets:
Total for reportable segments $ 11,324,000 12,832,000 15,815,000
Corporate and unallocated 1,031,000 1,396,000 2,018,000
------------ ------------ ------------
Consolidated total assets $ 12,355,000 14,228,000 17,833,000
============ ============ ============
Capital expenditures:
Total for reportable segments $ 50,000 104,000 187,000
Corporate and unallocated 22,000 20,000 9,000
------------ ------------ ------------
Consolidated total capital expenditures $ 72,000 124,000 196,000
============ ============ ============
The following table presents information about the Company by geographic
area:
2003 2002 2001
---- ---- ----
Revenue:
United States $ 8,610,000 9,877,000 12,999,000
United Kingdom 7,523,000 6,388,000 8,060,000
Asia/Pacific 428,000 2,725,000 4,552,000
Other Europe 1,228,000 1,600,000 1,761,000
Latin America 238,000 258,000 288,000
Other North America 1,037,000 565,000 357,000
Other 526 4,000 45,000
----------- ----------- -----------
Consolidated total revenue $19,590,000 21,417,000 28,062,000
=========== =========== ===========
Consolidated long-lived assets:
United States $ 3,859,000 4,274,000 5,301,000
United Kingdom 255,000 364,000 583,000
Other North America 393,000 455,000 523,000
Asia/Pacific 0 0 0
Latin America 5,000 7,000 8,000
Other 0 3,000 2,000
----------- ----------- -----------
4,512,000 5,103,000 6,417,000
Current and other assets 7,843,000 9,125,000 11,416,000
----------- ----------- -----------
Consolidated total assets $12,355,000 14,228,000 17,833,000
=========== =========== ===========
(Continued)
F-28
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(22) Quarterly Information (Unaudited)
The following presents certain unaudited quarterly financial data:
Quarter Ended
-------------------------------------------------------------------------
March 31, 2003 June 30, 2003 September 30, 2003 December 31, 2003
-------------- ------------- ------------------ -----------------
Net sales $ 4,374,000 $ 3,964,000 $5,787,000 $5,465,000
Gross profit 993,000 1,068,000 2,059,000 1,324,000
Net loss (1,426,000) (1,041,000) (214,000) (676,000)
Basic and diluted
net loss per share: $(0.14) $(0.10) $(0.02) $(0.07)
Quarter Ended
-------------------------------------------------------------------------
March 31, 2002 June 30, 2002 September 30, 2002 December 31, 2002
-------------- ------------- ------------------ -----------------
Net sales $ 4,744,000 $ 6,492,000 $ 5,093,000 $ 5,088,000
Gross profit 878,000 2,117,000 2,025,000 1,798,000
Net income (loss) (2,637,000) (887,000) (696,000) 106,000
Basic and diluted net
income (loss) per share: $(0.26) $(0.09) $(0.07) $0.01
The net loss for the quarter ended December 31, 2003 reflects a benefit
associated with a modification of deferred compensation agreements of
approximately $214,000. In addition, the Company recorded additional
estimated costs to complete long - term contracts in progress of
$600,000.
Net income for the quarter ended December 31, 2002 reflects the benefit
associated with the reversal of certain reserves for potential claims
established in prior years and a settlement of a lease obligation,
approximating $400,000. In addition, the Company reduced certain
expense estimates recorded in earlier quarters in 2002, approximating
$400,000.
F-29