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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 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, 1995
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from_______to_______
Commission file number 1-8191
PORTA SYSTEMS CORP.
(Exact name of registrant as specified in its charter)
Delaware 11-2203988
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
575 Underhill Boulevard, Syosset, New York 11791
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (516) 364-9300
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $.01 American Stock Exchange
(Title of Class) (Name of Exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10K or any amendment to this
Form 10K. [X]
State aggregate market value of the voting stock held by non-affiliates of
the registrant: $7,564,711 as of March 22, 1996.
Indicate the number of shares outstanding of each of the registrant's class
of common stock, as of the latest practicable date: 10,086,281 shares of Common
Stock, par value $.01 per share, as of March 22, 1996.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant's definitive proxy statement in connection with its 1996 Annual
Meeting of Stockholders to be filed within 120 days of the close of the
registrant's fiscal year is incorporated by reference into Part III of the
Report.
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Item 1. Business
Porta Systems Corp. (the "Company") develops, designs, manufactures and
markets a broad range of proprietary and standard telecommunications equipment
and systems for sale in the United States and abroad. The Company's core
products fall into three categories:
o Computer-based operational support systems ("OSS") which automate the
operational, administrative, maintenance and testing functions within
telephone companies. These systems are marketed principally to foreign
telephone operating companies in developing countries and Europe.
o Telecommunications connection equipment and systems which are used both to
connect copper-wired telecommunications networks and to protect
telecommunications equipment from voltage surges. The copper connection
equipment and systems are marketed to telephone operating companies in the
United States and foreign countries, with the largest customer being
British Telecommunications plc ("BT"), and manufacturers and owners of
telecommunications equipment.
o To a significantly lesser extent, signal processing, which are radio-based
communications systems sold principally for military uses.
In March, 1996 the Company sold its fiber optics connector business. See
"Recent Developments".
Porta Systems Corp. is a Delaware corporation incorporated in 1972 as the
successor to a New York corporation incorporated in 1969. The Company's
principal offices are located at 575 Underhill Boulevard, Syosset, New York
11791; telephone number, 516-364-9300. References to the Company include its
subsidiaries, unless the context indicates otherwise.
Markets for the Company's Products
The Company supplies equipment and systems to telephone companies for use
in providing telecommunications services to their customers and to businesses
for use with their internal telecommunication systems. The markets served by the
Company are described below:
Telecommunications Systems in Emerging Countries. Telephone networks in
certain regions of the world, notably Latin America, Eastern Europe and certain
areas in the Asia/Pacific region, utilize telephone switching systems of older
analog technology. These networks 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.
A country with an emerging telecommunications network may want to rapidly
add access lines in order to increase the availability of telephone service
among its population and to significantly upgrade the quality of the lines
already in service. The Company's OSS systems are designed to meet many of the
needs of a rapidly growing telephone network. These computerized administrative
and provisioning OSS systems facilitate rapid 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
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subscriber local loops. The automated data base which computerizes the inventory
and maintenance history of all subscriber lines in service helps to keep the
rapid growth under control.
As a telephone company expands the number of its subscriber lines, it also
requires connection equipment to interconnect and protect those lines in its
central offices. The Company provides a complete line of copper connection
equipment for this purpose. In the more advanced countries, the movement towards
fiber optic circuits has resulted in a stagnation or decline in the market for
copper connection equipment, while the less developed countries, such as those
with emerging networks or those upgrading to digital switching systems, provide
a growing market for copper connection and protection equipment.
During 1995, approximately 47% of the Company's sales were made to
customers in emerging markets. Such sales include both OSS and copper connection
products.
Digital Systems. In regions such as Western Europe, telephone networks have
achieved an acceptable ratio of available telephone lines to population.
However, the switching systems may utilize analog technology and are more suited
to carrying voice transmissions. These telephone companies are upgrading their
networks by replacing the older analog switching systems with newer digital
systems.
The increased sensitivity of the newer digital switches to small amounts of
voltage requires the telephone company which is upgrading to digital switching
systems to also upgrade its central office connection/protection systems in
order to meet these more stringent protection requirements. The Company is a
major worldwide supplier of central office connection/protection systems.
During 1995, approximately 34% of the Company's sales were made to
customers in this category.
Multi-Media Systems. More advanced telephone companies, such as those in
the United States and Japan, are upgrading their networks to carry not only
voice traffic but also increasing volumes of many different forms of
telecommunications, such as video, facsimile, image and high speed data
transmission. The United States is also experiencing the emergence of
alternative local carriers. This rise in data communications requirements has
been fueled largely by the rapid growth of personal computers and workstations
connected together through local area networks and their need to communicate
both locally and throughout the nation. This rapid rise in the volume and speeds
of data communications in America's business environment requires an upgrade of
the telecommunications distribution wiring systems within buildings and campuses
as well as within the external telephone networks.
The Company offers a broad line of systems and equipment to upgrade a
building's telecommunications distribution system so that it can serve the
increased data communications speeds of today and tomorrow.
During 1995, sales of multi-media systrems accounted for approximately 7%
of the Company's sales.
Fiber Optics Networks. In March 1996, the Company sold its fiber-optics
connector business. See "Recent Developments".
2
During 1995, sales of fiber optics products represented approximately 4% of
the Company's sales.
Signal Processing. The Company's 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, and applications require an extremely high level of
reliability and performance. Products are designed to be application specific to
satisfy the requirements of each military or aerospace program. The Company has
earned a reputation in the aerospace industry for developing and supplying cost
effective products with the highest reliability.
The Company's wideband transformers are required for ground noise
elimination in video imaging systems and are used extensively in television and
broadcast industry, medical imaging and industrial process control. If not
eliminated, ground noise caused by poor electrical system wiring or power
supplies, results in significant deterioration in system performance (poor
picture quality, process failures in instrumentation, etc.). The wideband
transformers provide a cost effective and quick solution to the problem without
the need of redesign of the rest of the system.
During 1995, signal processing equipment accounted for approximately 8% of
the Company's sales.
Products
The first of the Company's two principal telecommunications product
categories is telecommunications connection equipment and systems, which are
used by telephone operating companies, by owners of private telecommunications
equipment and by manufacturers and suppliers of telephone central office and
customer premises equipment. The second of the Company's two principal
telecommunications product categories is operations support systems or OSS
systems, which are used primarily by telephone operating companies. A third line
of the Company's products, sold under the name North Hills Signal Processing, is
high frequency wideband transformers and MIL-STD-1553 data bus couplers.
The table below shows, for the last three fiscal years, the contribution
made to the Company's sales by each of its major segments of the
telecommunications industry (excluding sales from discontinued operations of
$2,979,000 for the period beginning January 1, 1993 and ended May 11, 1993):
3
Sales by Product Category
Years Ended December 31,
1995 1994 1993
---- ---- ----
(Dollars in thousands)
OSS Systems $28,988 47% $21,516 31% $17,709 26%
Line Connect-
ing/Protecting
Equipment (*) 26,867 44% 40,800 59% 42,945 63%
Signal Proses
sing 4,857 8% 5,221 8% 5,485 8%
Other 469 1% 1,448 2% 2,002 3%
------- ------- ------- ------- ------- -------
Total $61,181 100% $68,985 100% $68,141 100%
======= ======= ======= ======= ======= =======
(*) Includes sales of fiber products of $6,513,000 in 1995, $12,150,000 in
1994, and $8,654,000 in 1993.
Operations Support Systems. The Company's OSS systems are used primarily by
telephone operating companies. The Company's principal OSS system is its
computer-based testing system--the Line Condition Report ("LCR")--which is a
major item of capital equipment and typically sells for prices ranging from
several hundred thousand to several million dollars. The Company also
manufactures and sells a number of other products which are used in testing,
maintenance and repair of telephone equipment.
The LCR, introduced in the mid-1970's, was the first computer-controlled
electronic system used to automatically test for and diagnose problems in
customer lines and to notify service personnel of required maintenance. The
associated Mechanized Line Report ("MLR") data base system provides automated
record keeping (including repair and disposition records) and analyzes these
records for identification of recurring problems and equipment deterioration.
The Company has devoted substantial resources to developing and obtaining market
acceptance for its LCR/MLR systems and has continued to modify and enhance its
LCR service features. The Company's LCRs have been sold to telephone operating
companies in a number of foreign countries as well as in the United States.
The Company also develops software-based systems for telephone companies
and provides telephone company line testing products to foreign customers. The
Company's software, which can be packaged and integrated with the LCR, provides
additional OSS functions, such as the automated assignment of telephone company
facilities for the provision of service.
4
The Company's OSS systems are complex systems which, in most applications,
incorporate features designed to respond to the purchaser's operational
requirements and the particular characteristics of the purchaser's telephone
system. 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. Such contracts typically contain performance
guarantees by the Company and clauses imposing penalties on the Company 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. Delays in purchaser acceptance of the systems and in the
Company's receipt of final contract payments have occurred in connection with a
number of foreign sales. In addition, the Company has experienced no steady or
predictable flow of orders for OSS systems.
Telecommunications Connection Equipment. The Company's telecommunications
copper connection/protection equipment and systems are used by telephone
operating companies, by owners of private telecommunications equipment and by
manufacturers and suppliers of telephone central office and customer premises
equipment. Products of the types comprising the Company's line of
telecommunications connection equipment are included as integral parts of all
domestic and foreign telephone and telecommunications systems. Such products are
sold in a worldwide market which grows generally in proportion to increases in
the number of telephone subscribers and owners of private telecommunications
equipment, as well as to increases in upgrades to modern digital switching
technology.
The Company's traditional 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 unwanted electrical surges which
might find their way onto subscriber lines. The need for protection products has
increased as a result of the worldwide move to digital technology, which is
extremely sensitive to damage by electrical overloads, and because private
owners of telecommunications equipment now have the responsibility to protect
their equipment from damage from 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 and multiple user facilities.
The Company also has developed an assortment of frames for use in
conjunction with the Company's 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 the
Company's frame products, the CAM frame, is designed to permit computer-assisted
analysis and recording of the optimum placement of connections for telephone
lines on the connector blocks mounted on the frame.
The Company's telecommunications copper connection/protection equipment,
including its line connecting/protecting products, is used by several of the
operating companies of the seven regional Bell holding 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, the Company's
telecommunications connection products have been sold to telephone operating
5
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 the Company can design
modifications to accommodate the specific needs of its customers.
Marketing and Sales
The Company operates 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, the Company may
enter into arrangements and technology transfer agreements covering its products
with local manufacturers and participate in manufacturing and licensing
arrangements with local telephone equipment suppliers.
In the United States and throughout the world, the Company uses independent
distributors in the marketing of Company products to the customer premises
equipment market. All distributors marketing copper-based products also market
directly competing products. In addition, the Company continues to promote the
direct marketing relationships it forged in the past with telephone operating
companies.
In 1985, the Company signed a three year supply contract with British
Telecommunications plc ("BT") for the Company's line connecting/protecting
products, which contract was renewed for a period of sixteen years in May 1988.
The renewed contract requires no minimum purchases by BT. During 1995, 1994, and
1993, BT purchased $17,252,000, $11,566,000, and $12,713,000, respectively, of
the Company's products. During these years, additional sales of the Company's
products were also made at the direction of BT to certain unaffiliated suppliers
to BT for resale to BT. The contract also provides for a ten year cross license
which, in effect, enables BT to use certain of the Company's proprietary
information to modify or enhance products provided to BT and permits those
products to be manufactured for its own purposes. The Company and BT have
further modified the cross license to provide that such products may be
manufactured by BT for its own purposes only if the Company is unable to supply
such products to BT. Under the cross license, the Company is to be paid a
royalty on any products (including modified or enhanced products) manufactured
under the license, and the Company is obligated to pay BT a royalty on products
the Company manufactures and sells which utilize BT enhancements or
modifications. The Company has engaged in no manufacturing activity under this
cross license to date, although it has received certain royalties, which are not
significant in amount, from BT pursuant to the license in respect of products
manufactured for BT by others.
The Company's OSS systems have primarily been sold to foreign telephone
operating companies, and the contracts relating to OSS systems are principally
negotiated directly between the Company and these purchasers.
The North Hills Signal Processing line of products have been sold primarily
to US military and aerospace prime contractors, and domestic OEMs and End Users.
Approximately 90% of the sales are domestic, with the aerospace and military
accounting for 60%.
The following table sets forth for the last three fiscal years the
Company's sales to customers by geographic region:
6
Sales to Customers By Geographic Region (1) (2)
Year Ended December 31,
----------------------
1995 1994 1993
---- ---- ----
(Dollars in thousands)
United States
and Puerto Rico $16,445 27% $24,150 35% 24,714 36%
United Kingdom 22,230 36% 17,761 26% 26,971 40%
Other Europe 2,831 5% 4,344 6% 2,750 4%
Latin America 4,743 8% 7,917 11% 8,665 13%
Asia/Pacific 13,470 22% 12,909 19% 4,068 6%
Middle East 899 1% 1,009 2% 691 1%
Other 563 1% 895 1% 282 --
------- ------- ------- ------- ------- -------
Total Sales $61,181 100% $68,985 100% $68,141 100%
======= ======= ======= ======= ======= =======
(1) Excludes sales attributable to the Company's discontinued operations of
$2,979,000 during the period beginning January 1, 1993 and ended May 11,
1993.
(2) For information regarding the amount of sales, operating profit or loss and
identifiable assets attributable to each of the Company's geographic areas,
see Note 22 to the Consolidated Financial Statements.
In foreign markets, the Company faces considerable competition from other
United States and foreign telephone equipment manufacturers with substantial
resources. In addition, the Company recognizes that, in selling to customers in
foreign countries, there are 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 the Company's receipt of final payments; and
political and economic change. In addition, to the extent that the Company
establishes facilities in foreign countries, the Company faces risks associated
with currency devaluation, inability to convert local currency into dollars and
political instability.
Manufacturing
The Company's computer-based testing products include the Company's
proprietary testing circuitry and computer programs, which have been upgraded to
provide platform independent solutions based on UNIX-type operating systems. The
testing products also incorporate disk data storage, data terminals ("CRTs"),
teleprinters and minicomputers purchased by the Company. These products are
installed and tested by the Company on its customers' premises.
7
At present, the Company's manufacturing operations are conducted at
facilities located in Glen Cove, New York; Kingsville, Texas; Matamoros, Mexico
and Korea. The Company from time to time also uses subcontractors to augment
various aspects of its production activities and periodically explores the
feasibility of conducting operations at lower cost manufacturing facilities
located abroad. In pursuing sales opportunities with foreign telephone
companies, the Company may locate its production activities in foreign countries
which require domestic involvement in the production of equipment purchased for
their telephone systems and in foreign countries which, in addition, require
full or partial technology transfers to domestic enterprises.
Source and Availability of Components
The Company purchases the standard components used in the manufacture of
its products from a number of suppliers and generally attempts to assure itself
that the components are available from more than one source. The Company
purchases the minicomputers used in its OSS systems from Digital Equipment
Corporation ("DEC'). However, because the Company's software is now platform
independent, the Company could use other computer equipment in its systems if
the Company were unable to purchase DEC products. Other components, such as CRTs
and teleprinters, used in connecting with the Company's electronic products
could be obtained from alternate sources and readily integrated with the
Company's products.
Backlog
At December 31, 1995, the Company's backlog was $22,569,000 compared with
approximately $25,333,000 at December 31, 1994. Of the December 31, 1995
backlog, approximately $17,091,000 represented orders from foreign telephone
operating companies, including $3,205,000 attributable to the contract with BT.
See "Marketing and Sales". The Company expects to ship substantially all of its
December 31, 1995 backlog during 1996. However, certain of the Company's OSS
contracts provide for deliveries subsequent to December 31, 1996.
Patents
The Company is the owner of a number of utility and design patents and
patent applications. In addition, the Company has sought foreign patent
protection for a number of its products.
From time to time the Company enters into licensing and technical
information agreements under which it receives or grants rights to produce
certain specified subcomponents used in certain of the Company's products or in
connection with products developed by the Company. These agreements are for
varying terms and provide for the payment of royalties or technical license
fees.
While the Company considers patent protection important to the development
of its business, and produces certain subcomponents of its products under
licensing agreements, the Company believes that its success depends primarily
upon its engineering, manufacturing and marketing skills. Accordingly, the
Company does not believe that a denial of any of its pending patent
applications, expiration of any of its patents, a determination that any of the
patents which have been granted to it are invalid or the cancellation of any of
its existing license agreements would have a materially adverse effect on the
Company's business.
8
Competition
The telephone equipment market in which the Company does business is
characterized by intense competition, rapid technological change and a movement
to private ownership of telecommunications equipment. 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, the Company is functioning in a market characterized by
distributors and installers of equipment and by commodity pricing.
The Company competes directly with a number of large and small telephone
equipment manufacturers in the United States, with AT&T continuing to be the
Company's principal United States competitor. AT&T'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 the Company continue to be significant factors in the Company's
competitive environment.
Currently, AT&T and a number of companies with greater financial resources
than the Company produce, or have the design and manufacturing capabilities to
produce, products competitive with the Company's products. In meeting this
competition, the Company relies primarily on the performance and design
characteristics of its products of comparable performance or design, endeavors
to offer its products at prices and with warranties that will make its products
competitive.
In connection with overseas sales of its line connecting/protecting
equipment, the Company has met with significant competition from United States
and foreign manufacturers of comparable equipment and expects this competition
to continue. In addition to AT&T, a number of the Company's overseas competitors
have significantly greater resources than the Company.
The Company competes directly with a limited number of substantial domestic
and international companies with respect to its sales of OSS systems. In meeting
this competition, the Company relies primarily on the features of its line
testing equipment and endeavors to offer such equipment at prices and with
warranties that will make it competitive.
Significant Customers
Sales made to BT amounted to $17,252,000, or approximately 28% of the
Company's 1995 sales. Sales to Korea Telecommunications Authority amounted to
$7,651,000 or 13% in 1995 sales. No other customers account for 5% of the
Company's sales in 1995. In addition, the former Bell operating companies
continue to be the ultimate purchasers of a significant portion of the Company's
products sold in the United States, while sales to foreign telephone operating
companies constitute the major portion of the Company's foreign sales. The
Company's contracts with these customers require no minimum purchases by such
customers. Significant customers for the Signal Processing products include the
major US Aerospace companies, Department of Defense service depots and OEMs in
the medical imaging and process control equipment. Both catalog and custom
designed products are sold to these customers. Some contracts are multi-year
procurements.
9
Research and Development Activities
During the fiscal years ended December 31, 1995, 1994 and 1993, the Company
spent approximately $6,103,000, $3,959,000, and $6,075,000, respectively, on its
research and development activities (excluding the research and development
activities from discontinued operations). All research and development was
Company sponsored.
Employees
As of March 15, 1996, the Company had 354 employees of which 139 were
employed in the United States, 144 were employed in Mexico, 28 were employed in
the United Kingdom, and 43 were employed in Korea. The Company believes that its
relations with its employees have been good, and it has never experienced a work
stoppage. The Company's employees are not covered by contracts with labor
unions, except for its hourly employees in Mexico who are covered by a contract
with the union representing such hourly employees that expires on December 31,
1996.
Recent Developments
Sale of Fiber Optics Business Segment
On March 13, 1996 the Company sold the assets of its fiber optics business
segment to Augat Inc. for $7,893,000 and assumption by the buyer of
approximately $1,400,000 of certain liabilities. The Company received, at
closing, $6,793,000. The balance was escrowed and will be released over the next
12 months based on certain conditions being met. The Company generated
approximately $6,500,000 of revenue in 1995. The sales proceeds were used
primarily to reduce the Company's outstanding senior debt, with the balance used
to provide working capital for the Company's operations.
Amendment and Extension of Loan Agreement
On March 13, 1996 the Company amended and extended its Loan and Security
agreement with its senior lender. The term of this agreement was extended from
November 30, 1996 to November 30, 1998 and provides for waivers of previous
events of defaults. The agreement additionally provides for a $2,000,000
revolving line of credit and a $7,000,000 Letters of Credit and Letters of
Credit Guarantee facility. This facility is limited to a Borrowing Base that is
equal to 80% of eligible accounts receivable and 60% of eligible inventory.
Interest will be charged on all outstanding borrowings (except for undrawn
Letters of Credit and Letters of Credit Guarantees) at 12%. The agreement
requires Facility Fees of $600,000 annually, payable at a rate of $50,000 per
month commencing on November 30, 1996 and continuing to the end of the
agreement.
As part of the agreement, the payment due on a $2,474,000 non-interest
bearing Deferred Funding Fee Note, with originally scheduled payments of
$1,237,000, $618,000 and $619,000 due on November 30, 1995, May 30, 1996 and
November 30, 1996, respectively, were extended to November 30, 1998. In
addition, the annual Facility Fee of $310,000, due November 30, 1995, and a
$300,000 non-interest bearing Net Worth Enhancement Fee Note which was due
during 1995 and 1996 was also extended to November 30, 1998.
This agreement calls for amortization of the principal of the term loan
commencing on June 30, 1997 as follows: $250,000 each June 30, 1997, September
30, 1997, and on December 31, 1997, and $325,000 each on March 31, 1998 and on
the last day of each quarter thereafter during the term of this agreement. There
10
is also a provision that requires the Company to pay this senior lender
additional principal, beginning with the periods stated above, based on an
"Adjusted Cash Flow Amount" formula calculation. In addition, the Agreement
includes an interest coverage ratio measured quarterly beginning with the
quarter to end June 30, 1996 and to be measured each quarter of the agreement.
This credit facility is secured by substantially all of the assets of the
Company.
In connection with this agreement, the senior lender was issued warrants to
purchase 1,000,000 shares of the Company's common stock at $1 per share. These
warrants are in addition to warrants previously issued to this senior lender.
6% Subordinated Debt Exchange Offer
On November 30, 1995, the Company offered holders of its 6% Convertible
Subordinated Debentures due July 1, 2002, to exchange $1,000 principal amount of
such debt for 97 shares of the Company's common stock, par value $.01 per share,
and $767.22 of principal of a new Zero Coupon Senior Subordinated Convertible
Note due January 2, 1998. As of March 22, 1996 approximately 80% of the
outstanding Debentures have been exchanged. The Company issued its new zero
coupon notes and shares of Common Stock. This transaction will improve the
Company's balance sheet and cash flow (see "Management Discussion and
Analysis").
American Stock Exchange
In 1995 the Company reported that it does not presently satisfy all of the
American Stock Exchange's financial guidelines for the continued listing of its
common stock. In the event that this situation is not remedied, there can be no
assurance that the listing of its common stock will continue.
Item 2. Properties
The Company currently leases approximately 20,400 square feet of executive,
sales, marketing and research and development space located in Syosset, New
York; 9,300 square feet of office space used for software development located in
Charlotte, North Carolina; and 48,900 square feet of manufacturing and
warehousing space at two locations in Kingsville, Texas. The Company owns a
31,000 square foot manufacturing and research and develolpment facility located
in Glen Cove, New York. These facilities represent substantially all of the
Company's office, plant and warehouse space in the United States. The Syosset,
New York lease was extended to June 30, 1998; the Charlotte, North Carolina
lease expires in April 1997 and the Kingsville, Texas leases expire in July 1996
and December 1999. The aggregate annual rental is approximately $1,300,000.
The Company's wholly-owned Mexican subsidiary, Porta Systems, S.A. de C.V.,
owns its approximately 40,000 square foot Matamoros, Mexico facility. A
wholly-owned subsidiary of the Company located in the United Kingdom owns a
34,261 square foot facility located in Coventry, England, which facility
comprises all of the Company's office, plant and warehouse space in the United
Kingdom.
The Company believes its properties are adequate for its needs.
11
Item 3. Legal Proceedings
The Company and certain of its present and former officers and directors
are defendants in eight alleged class actions which have been consolidated and
are pending in the United States District Court for the Eastern District of New
York. The actions allege violations of Section 10(b) and 20(a) of the Securities
Exchange Act of 1934 and Rule 10b-5 under such Act. The plaintiffs seek, among
other remedies, unspecified monetary damages.
In March 1996, the Company executed a Stipulation of Settlement to settle
the class action, and an order of preliminary approval of settlement was
approved by the Court. The agreement is subject to certain conditions precedent,
including the maintenance by the Company's common stock of a certain minimum
market value. The settlement, if consummated, will include a cash payment by the
Company's insurers and issuance by the Company of 1,100,000 shares of its common
stock, to be distributed in accordance with a plan to be approved by the Court.
Under the agreement, the Company is not required to contribute any cash towards
the proposed settlement. The Company denies the material allegations and admits
no liability of any sort in connection with the settlement and dismissal of the
action. Notice of the court hearing on the settlement has been sent to class
members, and the hearing is scheduled for June 7, 1996.
The Company and its wholly-owned Mexican subsidiary, Porta Systems, S.A. de
C.V., were named, together with numerous other entities, as defendants in a
multi-plaintiff lawsuit captioned Alvear v. Leonard Electric Products Company,
et al. (Case Nos. 93-03-1354-A and 94-05-2553-A), filed in the District Court
for the State of Texas located in Cameron County, Texas. The material
allegations of the complaint charged that the defendants, including the Company
and its subsidiary, had been negligent in their use and handling of various
hazardous substances and that plaintiffs, or their children, have been severely
injured and have suffered damage in unspecified amounts as a result. Plaintiffs
have also requested an award of exemplary damages. The Company and its
subsidiary agreed to settle such lawsuit with the plaintiffs in return for
payment of a sum of $120,000 and the Partial Final Judgment with respect to such
settlement was executed by Judge Benjamin Euresti, Jr. on November 23, 1994. An
intervention filed by two additional plaintiffs by separate counsel has been
settled with respect to one plaintiff for $2,500. The other plaintiff cannot be
located and a motion has been filed for dismissal as to that plaintiff.
Item 4. Submission of Matters to a Vote of Securities Holders
During the fourth quarter of 1995, there were no matters required to be
submitted to a vote of security holders of the Company.
12
Item Pursuant to Instruction 3 of Item 401 (b) of Regulation S-K:
Executive Officers of the Company as of March 31, 1996
First Elected to
Name and Position Age Position
----- --------
Warren H. Esanu 53 1996
Chairman of the Board
Edward R. Olson 55 1995
President,
Chief Operating Officer
William V. Carney 58 1988, 1989, 1990 and
Vice Chairman, Senior 1970, respectively
Vice President, Chief
Technical Officer and
Secretary
Michael A. Tancredi 66 1984 and 1978,
Vice President respectively
Treasurer
Edward B. Kornfeld 52 1995
Vice President
Chief Financial Officer
John J. Gazzo 53 1984
Vice President
Prem G. Chandran 44 1995
Vice President
All of the Company's officers serve at the pleasure of the Board of
Directors. Of the executive officers listed above, Messrs. Esanu, Carney and
Tancredi are also members of the Board of Directors. There is no family
relationship between any of the executive officers listed above.
Mr. Esanu was elected Chairman of the Board in March 1996. He has been a
director of the Company since 1989. Mr. Esanu will continue to serve as of
counsel to Esanu Katsky Korins & Siger, a position he has held for more than
five years. Esanu Katsky Korins & Siger is general counsel to the Company. 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 real estate
management companies. Mr. Esanu devotes only a portion of his time to the
Company.
Mr. Olson was elected President and Chief Operating Officer of the Company
in November 1995. Mr. Olson is also one of the principals of KPMG BayMark
Strategies LLC. Mr. Olson continues in this position while serving as President
and Chief Operating Officer of the Company. Prior to 1994 Mr. Olson was
president of Ed Olson Consulting Group Ltd. for approximately five years. In
13
addition, Mr. Olson is a member of the Board of Directors and/or officer of
various other corporations. Mr. Olson devotes only a portion of his time to the
Company.
Mr. Carney has been Secretary and director since 1970 and has been Senior
Vice President since November 1989 and Chief Technical Officer from December
1990. He was elected Vice Chairman in January 1988. He was Senior Vice
President-Mechanical Engineering from January 1988 to November 1989 and was
Senior Vice President-Manufacturing from March 1984 to February 1985, Senior
Vice President-Operations from June 1977 to February 1984 and Vice President
from 1970 to June 1977.
Mr. Tancredi has been Vice President since March 1984, Treasurer since
April 1978 and Director since 1970. He was Vice President from April 1978 to
February 1984 and Comptroller from April 1971 to March 1978.
Mr. Kornfeld was elected a Vice President-Finance and Chief Financial
Officer of the Company in October 1995. Prior to his election to this position,
Mr. Kornfeld held positions with several companies for more than five years,
including Excel Technology Inc. (Quantronix Corp.) and Anorad Corporation.
Mr. Gazzo has been Vice President-Marketing of the Company since April 1993
and was general manager of its Porta Electronics Division from November 1989 to
April 1993; he was the Company's Vice President-Research and Development from
March 1984 to November 1989 and was Vice President-Engineering from February
1978 to February 1984. Prior to that time, he was Chief Engineer of the Company.
Mr. Chandran was elected an officer in December 1995. Mr. Chandran had been
with the Company as Assistant Vice President of Engineering since 1991. Prior to
1991, he was Vice President of Engineering of North Hills Electronics, acquired
by the Company in 1991, for more than five years.
14
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters
The Company's Common Stock is traded on the American Stock Exchange, Inc.
under the symbol PSI. The following table sets forth, for the period January 1,
1994 through December 31, 1995, the quarterly high and low sales prices for the
Company's Common Stock on the consolidated transaction reporting systems for
American Stock Exchange listed issues.
High Low
---- ---
1994
First Quarter 12 3/4 9 7/8
Second Quarter 10 7/8 9 3/4
Third Quarter 8 7/8 6
Fourth 6 3/4 4 1/2
1995 First Quarter 6 1/4 3 3/8
Second Quarter 4 5/8 2 5/8
Third Quarter 4 3/8 1
Fourth Quarter 2 1/2 5/8
The Company did not declare or pay any cash dividends in 1995 or 1994. It
is the present policy of the Company to retain earnings to finance the growth
and development of the business and therefore, the Company does not anticipate
paying cash dividends on its Common Stock in the foreseeable future. In
addition, the Company's Amended and Restated Loan and Security Agreement
prohibits the Company from paying cash dividends on its Common Stock.
As of March 15, 1996, the number of holders of record of the Company's
Common Stock was 593.
Item 6. Selected Financial Data
The following table sets forth certain selected consolidated financial
information of the Company. 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:
15
Year Ended December 31,
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
(In thousands, except per share data)
Income Statement
Data:
Sales $ 61,181 $ 68,985 $ 68,141 $ 68,993 $ 81,957
Operating
income (loss) (19,884) (17,541) (3,916) (11,466) 8,971
Income (loss) be-
fore discontin-
ued operations
and extraordinary
item (29,297) (39,995) (7,493) (8,539) 6,930
Net Income
(loss) (31,041) (39,995) (9,545) (14,977) 8,498
Income (loss)
per share from
continuing
operations $ (4.01) $ (5.61) $ (1.08) $ (1.24) $ 1.06
Cash dividends
declared -- -- -- -- --
Number of shares
used in calcu-
lating net in-
come (loss) per
share 7,307 7,133 6,909 6,890 6,555
Balance Sheet
Data:
Total Assets $ 60,591 $ 84,963 $ 109,948 $ 130,345 $ 107,303
Long-term debt
excluding current
maturities $ 55,389 $ 57,310 $ 49,931 $ 34,205 $ 20,430
Stockholders' (deficit)
equity ($ 29,323) $ 1,525 $ 39,841 $ 49,486 $ 65,809
16
Item 7. Management Discussion and Analysis of Financial
Condition and Results of Operations.
The Company's consolidated statements of operations for the three years
ended December 31, 1995 as a percentage of sales follows:
Ended December 31,
1995 1994 1993
---- ---- ----
Sales 100% 100% 100%
Cost of sales 92% 90% 73%
---- ---- ----
Gross Profit 8% 10% 27%
Selling, general and
administrative expenses 27% 29% 24%
Research and development expenses 10% 6% 9%
Litigation settlement 2% -- --
Writedown of net assets sold 1% -- --
Operating loss (33%) (25%) (6%)
Interest expense (14%) (8%) (7%)
Interest income -- -- --
Other (1%) (3%) (4%)
---- ----
Loss from continuing
operations before income
taxes and minority interest (47%) (36%) (17%)
Income tax (benefit) expense -- 22% (6%)
---- ---- ----
Loss before discontinued
operations (48%) (58%) (11%)
Provision for loss on disposal
of discontinued operations 6% -- (3%)
Extraordinary gain on early
extinguishment of debt 3% -- --
---- ---- ----
Net loss (51%) (58%) (14%)
---- ---- ----
17
Financial Condition
The Company's working capital changed from $13,700,000 at December 31, 1994
to a working capital deficit of $8,200,000 at December 31, 1995. At September
30, 1995, the Company had a working capital deficit of $48,900,000. The
improvement in working capital from September 30, 1995 primarily results from
the following transactions regarding the Company's debt:
In March 1996, the Company's loan and security agreement with its senior
secured lender, Foothill Capital Corporation ("Foothill"), was amended. Pursuant
to the amendment, the Company's obligations were extended from November 1996 to
November 1998 and defaults at December 31, 1995 and through the date of the
amendment, were waived by Foothill. As a result, the Company's indebtedness to
Foothill, which was reflected as a current liability of $26,500,000 at September
30, 1995, is treated as a long-term liability of $26,600,000 at December 31,
1995.
In addition, as a result of a default under the interest payment provisions
of the Company's 6% Subordinated Debentures due 2002 (the "Debentures"), the
Company's obligations under the Debentures, which were reflected as a
$32,000,000 current liability at September 30, 1995, would have also been
reflected as a current liability at December 31, 1995. However, as a result of
an exchange offer (the "Exchange Offer") which, as of March 22, 1996, had been
accepted by the holders of approximately 80% of the outstanding Debentures, the
Company issued its new zero coupon notes due January 2, 1998 (Note) and shares
of common stock in exchange for Debentures. The Company is classifying as
current liabilities at December 31, 1995, $6,600,000 of Debentures which have
not been exchanged, and the $25,700,000 of Debentures exchanged as a long-term
liability, consistent with the payment terms of the Notes.
As a result of the Exchange Offer, as of March 22, 1996, the Company issued
its new zero coupon notes in the aggregate principal amount of $22,000,000 and
issued 2,800,000 shares of Common Stock in exchange for Debentures in the
principal amount of $28,700,000. As of such date, the principal amount of
Debentures outstanding was $6,600,000. The Company is in default on payment of
interest on the Debentures which were not exchanged. The Company has no past or
ongoing interest obligation with respect to either the new zero coupon notes or
the Debentures which were exchanged. The aggregate annual interest obligation on
the Debentures which had not been converted at March 22, 1996 is approximately
$440,000, as compared with the $2,200,000 aggregate annual interest obligation
with respect to the Debentures which were outstanding prior to the Exchange
Offer.
On March 13, 1996, the Company consummated an agreement pursuant to which
it sold certain assets and the buyer assumed certain liabilities and severance
obligations related to the operations of the Company's fiber optics management
and component business. Accordingly, at December 31, 1995, the net assets of the
fiber optics business are reflected as "assets held for sale, net" at net
realizable value, based on the terms of the sale. The net assets of the fiber
optics business were sold for a total purchase price of approximately
$8,000,000, of which $1,100,000 is held in escrow, subject to certain
conditions, plus the assumption of approximately $1,400,000 in liabilities. The
proceeds were applied to reduce the Company's obligations to Foothill in
accordance with the March 1996 amendment to the Foothill agreement.
The sale of the fiber optics business benefited the Company in two ways.
First the sale of this business enabled the Company to close two facilities,
with a resultant decrease in personnel and overhead costs, the benefits of which
are expected to be realized commencing with the second quarter of 1996. Second,
18
the sale enabled the Company to amend and extend its agreement with Foothill, as
described above, and make a significant payment to Foothill, which reduces its
ongoing interest costs.
The Company's obligations to Foothill are secured by substantially all of
the assets of the Company and its subsidiaries. The agreement with Foothill was
extended for two years, and the Company is no longer in default under its
agreement with Foothill. The agreement with Foothill requires the Company to
continue to meet certain financial covenants. See Note 11 of Notes to
Consolidated Financial Statements.
Inventory was reduced from $20,100,000 at December 31, 1994 to $9,000,000
at December 31, 1995. This decrease resulted from an inventory reduction program
during 1995 and a $1,800,000 increase in the reserve for slow-moving or obsolete
inventory at December 31, 1995. In addition, as a result of its illiquid
condition, certain vendors ceased shipping to the Company while others required
cash before delivery or cash on delivery. In addition, the inventory relating to
the Company's fiber optics business, amounting to $1,400,000, is included in
"Assets held for sale" at December 31, 1995.
Capital expenditures in 1995 were $1,479,000. The Company does not have any
significant commitments at December 31, 1995 to acquire fixed assets.
The Company's liquidity problems have resulted in increased cost of sales,
resulting in lower gross profits. The gross margin for 1995 is 8%, and the gross
profit of $4,700,000 is significantly less than either selling, general and
administrative expenses of $16,600,000 and research and development expenses of
$6,100,000. Accordingly, without a significant reduction of cost of goods sold,
the Company will not be able to operate profitably. To address this situation,
the Company has consummated the above transactions in 1996 to reduce costs and
is reviewing options to reduce other costs and operating expenses.
The Company continues to require cash for its operations. Foothill has
provided the Company with funds to meet its immediate cash needs. However,
unless the Company can reverse the negative trends in its operations, it may be
unable to obtain cash from any sources, including Foothill. Although the Company
has no plans to sell any of its remaining operations, no assurance can be given
that it will not be necessary for the Company to do so. The failure of the
Company to obtain cash when needed is likely to continue to have an adverse
effect on its business.
Results of Operations
Years Ended December 31, 1995 and 1994
The Company's continued shortage of working capital has had a material
adverse effect upon its operations during 1995. The effects of the working
capital shortage were compounded by the Company's defaults during 1995 under its
agreement with Foothill, which resulted in curtailment of certain advances and
letter of credit facilities. Although the defaults were waived as a result of a
March 1996 amendment to the agreement with Foothill, during most of 1995, the
Company was in default under its agreement with Foothill. Although Foothill
provided the Company with cash to meet its immediate needs, its failure to
provide additional advances and letter of credit facilities adversely affected
the Company's operations. In March 1996, the Company sold its fiber optics
business. Substantially all of the proceeds from the sale were used to reduce
the Company's obligations to Foothill.
19
The Company's sales for 1995 decreased by 11% from 1994 sales, as the
Company experienced continuing liquidity problems which adversely affected the
Company's operations. Sales of OSS products were $29,000,000, a 35% increase
from OSS sales of $21,500,000 in 1994, principally as a result of increased
sales to BT and sales in the Asian market. Sales of copper connection products
decreased by $8,200,000, or 29%, from $28,600,000 in 1994 to $20,400,000 in
1995. The reduction in such sales reflects a reduction in sales to Telefonos de
Mexico, which accounted for sales of $4,600,000 in 1994 and virtually no sales
in 1995, a $1,600,000 reduction in sales of copper connection products to BT, as
well as the effects of reduced production resulting from the Company's working
capital problems. The Company believes that the significantly reduced sales to
Telefonos de Mexico is due in part to the continuing Mexican financial crisis.
However, no assurance can be given that any improvement in the Mexican economy
will result in increased sales of the Company's products.
Sales of fiber optics products declined by $5,700,000, or 47%, from
$12,200,000 in 1994 to $6,500,000 in 1995. The decline reflects the Company's
inability to produce fiber optics products as a result of its financial
problems, as the Company allocated its resources principally to the OSS and
copper connection businesses. This allocation of resources also reflected the
Company's decision late in 1995 to sell the fiber optics business. Sales of
fiber optics products in the fourth quarter of 1995 were less than $1,000,000.
Sales from signal processing products, representing approximately 8% of
1995 sales, were also hampered by the Company's ongoing financial difficulties.
Cost of sales in 1995, as a percentage of sales, increased slightly from
1994, from 90% of sales in 1994 to 92% of sales in 1995. As a result of the high
cost of sales, the gross profit for 1995 was $4,700,000, which was significantly
less than selling, general and administrative expenses and research and
development expenses. The high cost of sales reflected (i) a lower volume of
sales, (ii) the inability of the Company to purchase efficiently and to obtain
materials from certain suppliers, (iii) the under-absorption of overhead costs,
(iv) modification of inventory in order to fulfill customer orders, and (v)
significant writedown of fiber optics inventory reflecting the value of such
inventory in connection with the sale of the fiber optics business in March
1996. In addition, as part of the Company's ongoing evaluation of its inventory
and based on its 1995 level of sales, the Company increased its inventory
reserve by approximately $1,800,000 for slow-moving or obsolete inventory. Steps
taken to reduce manufacturing labor costs by reductions in direct and indirect
manufacturing personnel were not implemented until late in the second quarter of
1995 and are reflected in cost of sales in the third and fourth quarters. The
reduction of facility, personnel and overhead costs from the sale of the fiber
optics business will first be reflected in the second quarter of 1996.
Selling, general and administrative expenses decreased by $3,400,000, or
17%, from $20,000,000 in 1994 to $16,600,000 in 1995. The expense decrease
reflects the Company's efforts to reduce personnel costs, as well as a reduced
level of sales and marketing activities. To some extent, the effects of the
personnel reduction were offset by severance costs incurred during 1995.
Research and development expenses increased by $2,100,000, from $4,000,000
in 1994 to $6,100,000 in 1995, or 53%. The increase reflected a reduction in the
amount of software development costs which qualified for capitalization.
In 1995, the Company incurred expenses of $1,100,000, reflecting the value
of the Company's common stock to be issued as a result of the settlement of
20
class actions. See "Item 3. Legal Proceedings." In addition, in 1995, the
Company wrote down the net assets of its fiber optics business to net realizable
value to reflect the price at which the assets were sold in March 1996.
As a result of the foregoing, the Company sustained an operating loss of
$19,900,000, an increase of 14% from the operating loss of $17,500,000 in 1994.
Interest expense increased $2,900,000, or 52%, from $5,600,000 in 1994 to
$8,500,000 in 1995. The increase in interest expense reflects substantially
higher average interest rates and increased borrowings under the Company's
agreement with Foothill as compared with the interest rate and borrowings under
the Company's prior agreement with Chemical Bank. Although most of the increased
borrowings reflect additional borrowings for operations, $2,500,000 of the
additional borrowings result from the purchase by the Company of Debentures
which were purchased from Foothill in connection with the March 1995 amendment
to the Foothill agreement.
Other expenses of approximately $900,000 include costs associated with the
modification of the Company's agreement with Foothill in March 1995. Other
expenses in 1994 related to the restructuring of the Company's secured debt when
Foothill took over Chemical Bank's note from the Company and the terms of the
financing were modified.
Income tax expense for 1995 was nominal, reflecting primarily offshore and
Delaware corporate taxes. The $14,900,000 tax expense in 1994 results from
providing a valuation allowance for deferred income taxes.
The $3,500,000 loss from the sale of discontinued operations reflects a
reduction in the amount of the expected recovery from the sale by the Company in
1993 of its Israeli subsidiaries which were engaged in the manufacture of data
communications connecting equipment. As a result of a receivership and
liquidation proceedings involving the purchaser of the subsidiaries, the
estimated recovery from the sale of such operations was reduced from $4,500,000,
which was the estimated recovery at December 31, 1994, to $1,000,000, which is
the estimated recovery at December 31, 1995.
In connection with the February 1995 amendment to the Company's agreement
with Foothill, the Company repurchased from Foothill and retired $3,900,000
principal amount of Debentures for approximately $2,500,000 through an increase
of $3,000,000 in the term loan to Foothill and the repricing of certain warrants
granted to Foothill. The Company recorded an extraordinary item, a gain of
$1,800,000 million on early extinguishment of this debt, representing the
difference between the book value of the debt and the approximate market value
of the debt on the date of the transaction.
As a result of the foregoing, the Company sustained a loss from continuing
operations in 1995 of $29,300,000, or $4.01 per share, as compared with a loss
from continuing operations in 1994 of $40,000,000, or $5.61 per share. After
giving effect to the loss on sale of discontinued operations and the gain on
early extinguishment of debt, the Company sustained a net loss of $31,000,000,
or $4.25 per share, for 1995, as compared with a net loss of $40,000,000, or
$5.61 per share, in 1994.
In March 1996, the Company sold the net assets of its fiber optics
business, amended its agreement with Foothill and reduced its indebtedness to
Foothill. In addition, through March 22, 1996, the Company issued its zero
coupon notes in the principal amount of $22,000,000 and issued 2,800,000 shares
of Common Stock in exchange for $28,800,000 principal amount of Debentures and
accrued interest of $1,600,000 at December 31, 1995, pursuant to the Exchange
Offer. These transactions enabled the Company to reduce its facilities and
21
personnel expenses, reduce the indebtedness to Foothill and reduce ongoing
interest costs. The effects of these transactions will not be realized until the
second quarter of 1996. However, the benefits to the Company from the reduction
in operating costs, including reductions resulting from the sale of the fiber
optics business, and the reduced interest expense will not enable the Company to
operate profitably unless it is able to significantly reduce its cost of goods
sold or increase its sales margins and reduce its general overhead, as to which
no assurance can be given.
Years Ending December 31, 1994 and 1993
Sales from continuing operations for the full year ended December 31, 1994
compared to 1993 were up 1% primarily due to increased sales in each of the
first three quarters of 1994 compared to the similar periods of 1993. The
Company's sales from continuing operations for the fourth quarter of 1994 were
substantially below expectations, notwithstanding adequate backlog, due to the
continuation of the shipment delays caused by persistent and worsening parts
shortages associated with the reductions in borrowing availability under the
Company's borrowing agreement with its Senior Lender, and a product mix which
resulted in shipment of lower priced and margined products. In addition, the
Company's fourth quarter 1994 OSS sales were generally and adversely impacted by
the intercreditor disagreement which resulted in the Company allocating working
capital toward product manufacture in connection with the contract in order to
fulfill its agreement with its customer and slowing performance on other
contracts in the field due to resulting scarce working capital resources.
Sales of OSS equipment during the year ended December 31, 1994 were
$21,500,000 compared to $17,700,000 in 1993, an increase of 21%, due primarily
to increased sales during 1994 by the Company's Korean joint venture subsidiary.
While sales of fiber optic connection/protection products for the year ended
December 31, 1994 increased to $12,151,000 compared to $8,854,000 in 1993, sales
of fiber optic connection/protection products during the fourth quarter of 1994
were adversely affected by the reductions in working capital availability
discussed above. Sales of copper connection/protection products decreased 16%
during the year ended December 31, 1994 compared to 1993 due in part to shipment
delays caused by persistent parts shortages during the three months ended
September 30, 1994 (which accelerated in the three months ended December 31,
1994) resulting from the reductions in working capital availability under the
Restated Credit Agreement, as well as the inability of a supplier to ship parts
meeting quality standards required by the Company. While shipments to British
Telecommunications plc had fallen during the three months ended September 30,
1994, the Company was able to increase its shipments to this customer during the
fourth quarter of 1994. The Company's backlog for copper products significantly
increased during this period due to increased orders for these products. Also,
the Company's sales to Telefonos de Mexico, which were denominated in Mexican
pesos and which were expected to be approximately the same in 1994 as in 1993
but more evenly distributed over all four quarters of the year, were adversely
affected in early December 1994 by the Mexican economic crisis which caused the
Company to temporarily halt shipments to Telefonos de Mexico pending
negotiations with Telefonos de Mexico to determine the increased pricing
consequences of such economic crisis. Sales of other products, primarily Signal
Processing products, in the year ended December 31, 1994 were slightly higher
than sales during 1993 although sales of other products in the third and fourth
quarters of 1994 were also somewhat affected by the operational inefficiencies
resulting from the reductions in working capital availability.
The dollar amount of cost of sales for the year ended December 31, 1994
increased approximately $13,000,000 or 26% compared to 1993. Cost of sales as a
percentage of sales for the year ended December 31, 1994 compared to 1993
22
increased to 91% from 73%. The dollar amount of cost of sales for the third and
fourth quarters of 1994 compared to the similar periods of 1993 and to the
Company's historical cost of sales experience were particularly high and
negatively impacted the entire year's results due to the unfavorable impact on
the Company's operational costs of the reductions in working capital
availability under the Restated Credit Agreement, the effect of the Company's
concentrated effort to reduce inventories and the sale of lower margin products
in order to generate cash internally to address such reductions in externally
available working capital. In addition, the substantial contribution of the
Company's joint venture in Korea, which sells lower margin OSS products, to OSS
equipment sales tended to increase cost of sales as a percentage of sales. The
Company's operational costs were additionally affected by manufacturing
inefficiencies resulting from materials shortages, smaller productions runs,
higher per unit purchasing and freight costs as well as increased numbers of
employees and idle labor manufacturing time and maintenance of a fixed level of
expenses associated with the support of a higher level of OSS equipment sales
than actually resulted in 1994. While the Company's effort to reduce inventories
resulted in increased cash flow in the third and fourth quarters of 1994, the
consequences of this effort was higher labor costs related to rework of
inventory and reduced margins associated with the sale of certain slow moving
inventory at unfavorable prices. Also, the Company's aggressive inventory
reduction program caused it to conclude, after sales of such inventory, that no
easily accessible and significant market remained for certain of its copper
products in the markets traditionally accessed by the Company or which the
Company would reasonably be able to access in the near term given the
restructuring and cost cutting moves described elsewhere. Accordingly, the
Company determined to make a $2,000,000 provision for such products. In
addition, the Company has made a provision for approximately $2,000,000 of high
density frames which it has in stock due to its discovery that such high density
frames contain defective parts sold to it by a vendor. The Company is presently
considering taking action against such vendor to recoup its losses resulting
from such defective parts.
The dollar amount of selling, general and administrative expenses in the
year ended December 31, 1994, increased by 22% compared to 1993, while selling,
general and administrative expenses as a percentage of sales increased by 20%
during the year ended December 31, 1994 compared to 1993. Selling, general and
administrative expenses were significantly higher during the last quarter of
1994 compared to 1993 due to the costs of servicing its Asia/Pacific marketplace
and selling associated with the European market and commission costs. In
addition, the impact of certain one time costs associated with the pursuit of
substitute financing, the costs of defense of certain lawsuits which the Company
was defending during these periods and the costs of settlement of one of these
lawsuits increased selling, general and administrative expenses during the year
ended December 31, 1994.
Research and development expenses for the year ended December 31, 1994
compared to 1993 decreased significantly, both as a dollar amount and as a
percentage of sales, in part because of a reduction in staff and related costs
due primarily to the consolidation of research and development activities
previously conducted separately by companies acquired in prior periods and in
part because of lower research and development requirements for the Company's
more mature products.
The Company's operating loss for the year ended December 31, 1994 is
primarily attributable to a number of factors, including a shortfall in the
volume of sales, a cost structuring for a much larger level of sales, an
inability to adjust the organization to deal with the sales shortfall, the
reductions in availability of working capital, inventory reduction program, and
transaction costs related to both the Restated Credit Agreement and the New
Credit Agreement.
23
The Company's operating loss for the year ended December 31, 1993 was
$3,916,000 and reflected an improving operational trend during the last six
months of the year. A substantial portion of this operating loss was due to low
volumes of production in comparison to manufacturing capacity, as well as, costs
associated with strategic investments in OSS and fiber optic areas being made by
the Company. In addition, and consistent with the Company's cost of sales, the
mix of product sales contributed to the extent of the loss.
Interest expense for the year ended December 31, 1994 compared to 1993
increased due to higher average interest rates although such higher average
rates were offset by a slightly lower borrowing level during most of 1994
compared to 1993. Interest expenses increased substantially during 1993 compared
to 1992 due to substantially increased debt used to finance the Company's
operating losses and a full year's interest on the 6% Convertible Subordinated
Debentures.
As reported, other expenses for the year ended December 31, 1994 compared
to 1993 decreased. However, such 1994 expenses included various advisory fees
required as a result of the Company's relationship with its lending banks and
fees related to the costs of the Company's financing with both its lending banks
and its new senior lender, which were partially offset by a $ 313,000 gain from
the satisfaction of the bank obligations.
Other expenses for the year ended December 31, 1993 are predominantly
comprised of various advisory fees relating to the negotiation and finalization
of the Restated Credit Agreement as well as fees related to the Company's
unsuccessful efforts to acquire a telecommunications manufacturing business of
another company.
The Company adopted Financial Accounting Standard No. 109 effective January
1, 1992 and, as of December 31, 1993, had recognized a deferred tax asset of
$13,955,000, principally relating to the Company's net operating loss
carryforwards. In the third quarter of 1994, the Company, after reviewing the
deferred tax asset in the context of its results of operations for such third
quarter, recorded a valuation allowance in the entire amount of such deferred
tax asset, which is included in 1994 income tax expense. As a result, the
Company recorded income tax expense of $14,920,000 for the year ended December
31, 1994 compared to income tax benefit of $3,885,000 in 1993, principally
relating to operating losses for United States income tax purposes. The decision
to record such valuation allowance in 1994 was based on the criteria contained
in Financial Accounting Standard No. 109, generally requiring a valuation
allowance when cumulative losses have been experienced and there is a lack of
sufficient objective offsetting evidence to conclude that it is more likely than
not that the deferred tax asset will be utilized.
New Accounting Standards
In October 1995, the Financial Accounting Standards Board (FASB) issued
Statement No. 123, "Accounting for Stock-Based Compensation", which must be
adopted by the Company in 1996. The Company has elected not to implement the
fair value based accounting method for employee stock options, but has elected
to disclose, commencing in 1996, the pro-forma net income and earnings per share
as if such method had been used to account for stock-based compensation cost as
described in the Statement.
In March 1995, The FASB issued Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,"
which must also be adopted by the Company in 1996. The effect of adopting this
standard will be insignificant.
24
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
(Registrant)
By Warren H. Esanu
---------------
Warren H. Esanu
Chairman of the Board
Date: April 1, 1996
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date
----
Warren H. Esanu April 1, 1996
- ----------------
Warren H. Esanu
Chairman of the Board
and Director
Edward R. Olson April 1, 1996
- ---------------
Edward R. Olson
President
Edward B. Kornfeld April 1, 1996
- ------------------
Edward B. Kornfeld
Vice President and
Chief Financial and
Accounting Officer
Howard D. Brous April 1, 1996
- ---------------
Howard D. Brous
Director
William V. Carney April 1, 1996
- -----------------
William V. Carney
Director
25
Date
----
Herbert H. Feldman April 1, 1996
- ------------------
Herbert H. Feldman
Director
Stanley Kreitman April 1, 1996
- ----------------
Stanley Kreitman
Director
Michael A. Tancredi April 1, 1996
- -------------------
Michael A. Tancredi
Director
26
Item 8. Financial Statements and Supplement Data
Index Page
Independent Auditor's Report ............................................ F-1
Consolidated Financial Statements and Notes:
Consolidated Balance Sheets,
December 31, 1995 and 1994 ....................................... F-2
Consolidated Statement of Operations for the Years Ended
December 31, 1995, 1994 and 1993 ................................. F-3
Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 1995, 1994 and 1993 ..................... F-4
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1995, 1994 and 1993 ................................. F-5
Notes to Consolidated Financial Statements ......................... F-6
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
27
PART III
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K.
(a) Documents 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 consolidated subsidiaries do not exceed 25% of
consolidated net assets.
(b) Reports on Form 8-K.
A current report on Form 8-K dated November 30, 1994 was filed.
28
(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.
3.3 By-laws of the Company, as amended to date.
4.1 Amendment dated as of December 16, 1993 to the Warrant Agreement among
the Company, Aster Corporation and Chemical Bank as successor to
Manufacturers Hanover Trust Company as Warrant Agent, incorporated by
reference to Exhibit 4.2 of the Company's Annual Report on Form 10-K
for the year ended December 31, 1993.
4.2 Form of Rights Agreement, dated as of March 22, 1989 between the
Company and Manufacturers Hanover Trust Company, as Rights Agent,
incorporated by reference to the Company's Registration Statement on
Form 8-A dated April 3, 1989.
4.2.1 Amendment No. 1 to Rights Agreement, dated July 28, 1993 between the
Company and Chemical Bank (as successor by merger to Manufacturers
Hanover Trust Company), as Rights Agent, incorporated by reference to
the Company's Registration Statement on Form 8-A/A filed August 4,
1993.
4.3 Warrant issued to Aspen Grove Financial Corporation to Purchase 87,500
Shares of Common Stock dated as of June 13, 1994, incorporated by
reference to Exhibit 4(d) to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1994.
4.4 Warrant issued to Banque Scandinave en Suisse to Purchase 100,000
shares of Common Stock dated as of June 13, 1994, incorporated by
reference to Exhibit 4(f) to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1994.
4.5 Stock Option Agreement dated as of May 15, 1994 between the Company
and Stanley Kreitman, incorporated by reference to Exhibit 4(a) to the
Company's Quarterly Report on Form 10-Q for the
29
quarter ended September 30, 1994.
4.6 Amended and Restated Loan and Security Agreement dated as of November
28, 1994, between the Company and Foothill Capital Corporation,
incorporated by reference to Exhibit 2 to the Company's Current Report
on Form 8-K dated November 30, 1994.
4.7 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 Capital Corporation.
4.7.1 Letter Agreement dated as of February 13, 1995.
4.7.2 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 Capital Corporation.
4.7.3 Waiver of Default dated March 30, 1995.
4.8 Secured Promissory Note dated November 28, 1994 made by the Company in
favor of Foothill Capital Corporation, incorporated by reference to
Exhibit 4 to the Company's Current Report on Form 8-K dated November
30, 1994.
4.9 Amended and Restated Secured Promissory Note dated February 13, 1995.
4.10 Deferred Funding Fee Note dated November 28, 1994 made by the Company
in favor of Foothill Capital Corporation, incorporated by reference to
Exhibit 5 to the Company's Current Report on Form 8-K dated November
30, 1994.
4.11 Amendment Number Three to Amended and Restated Loan and Security
Agreement dated March 12, 1996, between the Company and Foothill
Capital Corporation.
4.12 Warrant to Purchase Common Stock of the Company dated November 28,
1994 executed by the Company in favor of Foothill Capital Corporation,
incorporated by reference to Exhibit 6 to the Company's Current Report
on Form 8-K dated November 30, 1994.
4.12.1 Amendment Number One to Warrant to Purchase Common Stock of the
Company dated as of February 13, 1995 executed by the Company in
30
favor of Foothill Capital Corporation.
4.13 Assignment of Loans, Liens and Loan Documents dated November 28, 1994
between Chemical Bank, The Bank of New York, Foothill Capital
Corporation, the Company and certain of the subsidiaries of the
Company, incorporated by reference to Exhibit 3 to the Company's
Current Report on Form 8-K dated November 30, 1994.
4.14 Warrant to Purchase Common Stock of the Company dated November 28,
1994 executed by the Company in favor of Chemical Bank, incorporated
by reference to Exhibit 12 to the Company's Current Report on Form 8-K
dated November 30, 1994.
4.15 Warrant to Purchase Common Stock of the Company dated November 28,
1994 executed by the Company in favor of The Bank of New York,
incorporated by reference to Exhibit 13 to the Company's Current
Report on Form 8-K dated November 30, 1994.
4.16 Indenture dated as of July 1, 1992 between the Company and the Bank of
New York as trustee, incorporated by reference to Exhibit 4(a) of the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30,
1992.
4.17 Form of Warrant to Purchase Common Stock of the Company dated as of
June 1, 1993 between the Company and Mallory Factor, incorporated by
reference to Exhibit 4(f) of the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1993.
4.18 Form of Warrant Agreement dated as of August 12, 1993 between the
Company and Berenson Minella & Company, incorporated by reference to
Exhibit 4(e) of the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1993.
4.19 Lockbox Operating Procedural Agreement dated as of November 28, 1994
among Chemical Bank, the Company and Foothill Capital Corporation,
incorporated by reference to Exhibit 7 to the Company's Current Report
on Form 8-K dated November 30, 1994.
4.20 Security Agreement, dated as of July 16, 1993, made by Woo Shin
Electro-Systems Company to
31
Chemical Bank, incorporated by reference to Exhibit 4(b) (iv) of the
Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1993.
4.21 Indenture dated as of November 30, 1995, between the Company and
American Stock Transfer & Trust Company.
10.1 Form of Split Dollar Agreement -- more than ten years, incorporated by
reference to Exhibit l9(d) of the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1985.
10.2 Form of Split Dollar Agreement -- less than ten years, incorporated by
reference to Exhibit 19 (e) of The Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1985.
10.3 Form of Amendment No. 1 to Split Dollar Agreement -- less than ten
years -- Acceleration upon change of control, incorporated by
reference to Exhibit 10(i)(i) of the Company's Annual Report on Form
10-K for the year ended December 31, 1988.
10.4 Form of Executive Salary Continuation Agreement, incorporated by
reference to Exhibit l9(cc) of the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1985.
10.5 Agreement dated as of January 1, 1990 between the Company and Alpha
Risk Management, Inc., incorporated by reference to Exhibit 10(k) of
the Company's Annual Report on Form 10-K for the year ended December
31, 1990.
10.6 Agreement dated May 25, 1988 between British Telecommunications plc
and the Company, incorporated by reference to Exhibit l9(a) of the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30,
1988. Confidential Treatment granted document filed separately with
the SEC.
10.7 Lease dated December 17, 1990 between the Company and LBA Properties,
Inc., incorporated by reference to Exhibit 10 (d) of the Company's
annual report on Form 10-K for the year ended December 31, 1990.
10.8 Asset Purchase Agreement dated as of March 6, 1996 by and among Augat
Inc., Porta Systems Corp. and
32
certain of its Subsidiaries.
10.9 Form of Employment Contract dated October 2, 1995 between the Company
and KPMG BayMark Strategies LLC's Crisis Management Group.
10.10 Form of Employment Contract dated October 16, 1995 between the Company
and Edward B. Kornfeld.
10.11 Form of Employment Contract dated March 28, 1996 between the Company
and Warren H. Esanu.
10.12 Form of Executive Salary Continuation Agreement dated October 16, 1995
between the Company and Edward B. Kornfeld.
22.1 Subsidiaries of the Company.
23 Consent of Independent Auditors
33
Independent Auditors' Report
The Board of Directors and
Stockholders of Porta Systems Corp.:
We have audited the accompanying consolidated balance sheets of Porta Systems
Corp. and subsidiaries as of December 31, 1995 and 1994, and the related
statements of operations, stockholders' (deficit) equity, and cash flows for
each of the years in the three-year period ended December 31, 1995. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, 1995 and 1994, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1995, in conformity with generally accepted accounting
principles.
The accompanying consolidated 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's recurring losses from
operations and working capital and net capital deficiencies raise substantial
doubt about its ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 2. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
KPMG PEAT MARWICK LLP
Jericho, New York
March 22, 1996
F-1
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1995 and 1994
(Dollars in thousands)
Assets 1995 1994
------ ---- ----
Current assets:
Cash and cash equivalents $ 1,109 2,332
Accounts receivable - trade, less allowance for doubtful
accounts of $1,251 in 1995 and $585 in 1994 12,626 13,964
Inventories 8,979 20,146
Prepaid expenses 659 1,020
Receivable from sale of discontinued operations 1,000 --
-------- --------
Total current assets 24,373 37,462
-------- --------
Assets held for sale, net 7,893 --
Property, plant and equipment, net 6,911 11,139
Receivable from sale of discontinued operations -- 4,500
Deferred computer software, net 3,188 6,257
Goodwill, net of amortization of $2,265 in 1995 and $2,192 in 1994 11,793 19,032
Other assets 6,433 6,573
-------- --------
Total assets $ 60,591 84,963
======== ========
Liabilities and Stockholders' (Deficit) Equity
Current liabilities:
Convertible subordinated debentures $ 6,564 --
Accounts payable 8,302 9,690
Accrued expenses 10,502 6,065
Accrued interest payable 3,534 1,414
Accrued commissions 2,016 2,180
Income taxes payable 780 478
Customer advances 504 2,525
Notes payable -- 1,237
Short-term loans 368 152
-------- --------
Total current liabilities 32,570 23,741
-------- --------
Long-term debt 26,645 21,000
Convertible subordinated debentures 25,660 35,073
Notes payable net of current maturities 3,084 1,237
Income taxes payable 811 1,330
Other long-term liabilities 385 400
Minority interest 759 657
-------- --------
Total long-term liabilities 57,344 59,697
-------- --------
Commitments and contingencies
Stockholders' (deficit) equity:
Preferred stock, no par value; authorized 1,000,000 shares, none issued -- --
Common stock, par value $.01; authorized 20,000,000 shares,
issued 7,461,806 shares in 1995 and 1994 75 75
Additional paid-in capital 33,248 32,888
Foreign currency translation adjustment (4,199) (4,031)
Accumulated deficit (56,074) (25,033)
-------- --------
(26,950) 3,899
Treasury stock, at cost, 166,700 and 154,700
shares in 1995 and 1994, respectively (2,066) (1,938)
Receivable for employee stock purchases (307) (436)
-------- --------
Total stockholders' (deficit) equity (29,323) 1,525
-------- --------
Total liabilities and stockholders' (deficit) equity $ 60,591 84,963
======== ========
See accompanying notes to consolidated financial statements.
F-2
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 1995, 1994 and 1993
(in thousands, except per share amounts)
1995 1994 1993
---- ---- ----
Sales $ 61,181 68,985 68,141
Cost of sales 56,444 62,530 49,539
-------- -------- --------
Gross profit 4,737 6,455 18,602
-------- -------- --------
Selling, general and administrative expenses 16,556 20,037 16,443
Research and development expenses 6,103 3,959 6,075
Litigation settlement 1,100 -- --
Write-down of net assets held for sale to net realizable value 862 -- --
-------- -------- --------
Total expenses 24,621 23,996 22,518
-------- -------- --------
Operating loss (19,884) (17,541) (3,916)
Interest expense (8,484) (5,617) (4,813)
Interest income 87 251 357
Other, net (884) (2,022) (2,985)
-------- -------- --------
Loss from continuing operations before
income taxes and minority interest (29,165) (24,929) (11,357)
Income tax expense (benefit) 30 14,920 (3,885)
Minority interest (102) (146) (21)
-------- -------- --------
Loss before discontinued operations (29,297) (39,995) (7,493)
Provision for loss on disposal of discontinued operations (3,500) -- (2,052)
-------- -------- --------
Loss before extraordinary item (32,797) (39,995) (9,545)
Extraordinary gain on early extinguishment of debt 1,756 -- --
-------- -------- --------
Net loss $(31,041) (39,995) (9,545)
======== ======== ========
Per share amounts:
Continuing operations $ (4.01) (5.61) (1.08)
Discontinued operations (.48) -- (.30)
Extraordinary item .24 -- --
-------- -------- --------
Net loss per share $ (4.25) (5.61) (1.38)
======== ======== ========
Weighted average shares outstanding 7,307 7,133 6,909
======== ======== ========
See accompanying notes to consolidated financial statements.
F-3
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Stockholders' (Deficit) Equity
Years ended December 31, 1995, 1994 and 1993
(In thousands)
Receivable Total
Foreign Retained for Stock-
Common Stock Additional Currency Earnings Employee holders'
No. of Par Value Paid-in Translation (Accumulated Treasury Stock (Deficit)/
Shares Amount Capital Adjustment Deficit) Stock Purchases Equity
------------------------------------------------------------------------------------------
Balance at December 31, 1992 7,054 $71 $29,457 $(2,102) $24,507 $(1,938) $(509) $49,486
Net loss 1993 - - - - (9,545) - - (9,545)
Stock issued 28 - 92 - - - - 92
Repayments of receivable - - - - - - 11 11
Warrants issued - - 604 - - - - 604
Foreign currency translation
adjustment - - - (807) - - - (807)
-----------------------------------------------------------------------------------------
Balance at December 31, 1993 7,082 71 30,153 (2,909) 14,962 (1,938) (498) 39,841
Net loss 1994 - - - - (39,995) - - (39,995)
Stock issued 380 4 2,135 - - - - 2,139
Warrants issued - - 600 - - - - 600
Write off of receivable for
employee stock purchases - - - - - - 62 62
Foreign currency translation
adjustment - - - (1,122) - - - (1,122)
-----------------------------------------------------------------------------------------
Balance at December 31, 1994 7,462 75 32,888 (4,031) (25,033) (1,938) (436) 1,525
Net loss 1995 - - - - (31,041) - - (31,041)
Warrants issued - - 360 - - - - 360
Write off of receivable for
employee stock purchases - - - - - (128) 129 1
Foreign currency translation
adjustment - - - (168) - - - (168)
-----------------------------------------------------------------------------------------
Balance at December 31, 1995 7,462 $75 $33,248 $(4,199) $(56,074) $(2,066) $(307) $(29,323)
=========================================================================================
See accompanying notes to consolidated financial statements
F-4
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1995, 1994 and 1993
(Dollars in thousands)
1995 1994 1993
---- ---- ----
Cash flows from operating activities:
Net loss $(31,041) (39,995) (9,545)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Loss on disposal of discontinued operations 3,500 -- 2,052
Gain on extinguishment or refinancing of indebtedness (1,756) (913) --
Non-cash financing costs 2,698 600 202
Deferred income taxes -- 13,955 (4,841)
Depreciation and amortization 7,015 5,580 5,416
Write off of employee notes receivable 1 62 --
Amortization of discount on convertible subordinated debentures 603 442 426
Minority interest 102 163 21
Changes in assets and liabilities:
Accounts receivable 1,338 2,598 4,640
Inventories 9,700 8,047 1,613
Prepaid expenses (773) (328) 178
Other assets 1,916 (330) (1,857)
Accounts payable, accrued expenses and other liabilities 4,167 10,414 (4,621)
-------- -------- --------
Net cash (used in) provided by operating activities (2,530) 295 (6,316)
-------- -------- --------
Cash flows from investing activities:
Capital additions, net of minor disposals (1,749) (1,107) (1,559)
Repayment of employee loans -- -- 11
-------- -------- --------
Net cash used in investing activities (1,749) (1,107) (1,548)
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of debt 5,781 24,212 22,897
Repayments of debt (2,500) (22,299) (19,397)
Proceeds from issuance of common stock -- 2,139 92
Repayments of notes payable/short-term loans -- (1,162) (9,942)
-------- -------- --------
Net cash provided by (used in) financing activities 3,281 2,890 (6,350)
-------- -------- --------
Effect of exchange rates on cash (225) (1,473) (807)
(Decrease) increase in cash and cash equivalents (1,223) 605 (15,021)
Cash and equivalents - beginning of year 2,332 1,727 16,748
-------- -------- --------
Cash and equivalents - end of year $ 1,109 2,332 1,727
======== ======== ========
Supplemental cash flow information:
Cash paid for interest $ 2,915 4,196 4,135
======== ======== ========
Cash paid for income taxes $ 73 128 80
======== ======== ========
See accompanying notes to consolidated financial statements.
F-5
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1995 and 1994
(1) Summary of Significant Accounting Policies
Nature of Operations and Principles of Consolidation
Porta Systems Corp. (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. The Company'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 Systems Corp. (the "Company") and its majority-owned or controlled
subsidiaries. All significant intercompany transactions and balances
have been eliminated in consolidation.
Revenue Recognition
Revenue, from other than 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
determined.
Cash Equivalents
The Company considers investments with original maturities of three months
or less at the time of purchase to be cash equivalents. Cash equivalents
consist of commercial paper.
Inventories
Inventories are stated at the lower of cost (on the average or first-in,
first-out methods) or market.
Property, Plant and Equipment
Property, plant and equipment are carried at cost. Leasehold improvements
are amortized over the term of the lease. Depreciation is computed using
the straight-line method over the related assets' estimated lives.
Deferred Computer Software
Software costs incurred for specific customer contracts are charged to cost
of sales at the time revenues on such contracts are recognized. Software
development costs relating to products the Company offers for sale are
deferred in accordance with Statement of Financial Accounting Standards
(SFAS) No. 86 "Accounting for the Costs of Computer Software to Be Sold,
Leased, or Otherwise Marketed". These costs are amortized to cost of
sales over the periods that the related product will be sold, up to a
maximum of four years. Amortization of computer software costs, which
all relate to products the Company offers for sale, amounted to
approximately $3,171,000, $1,847,000 and $1,414,000 in 1995, 1994, and
1993, respectively.
(Continued)
F-6
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Goodwill
Goodwill represents the difference between the purchase price and the fair
market value of net assets acquired in business combinations treated as
purchases. Goodwill is amortized on a straight-line basis over 18 to 40
years. At December 31, 1995, $7,242,000 of the goodwill is being
amortized over approximately 18 years and $4,551,000 is being amortized
over 40 years. The Company assesses the recoverability of unamortized
goodwill using the undiscounted projected future cash flows from the
related businesses.
Income Taxes
Deferred income taxes are recognized based on the differences between the
tax bases of assets and liabilities and their reported amounts in the
financial statements that will result in taxable or deductible amounts
in future years. Further, the effects of enacted 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.
Puerto Rico income taxes were accrued prior to September 30, 1993 on income
earned by a subsidiary of the Company which had operated in Puerto Rico
based on a ten year 90% industrial tax exemption effective for periods
subsequent to May 28, 1987. The Company's subsidiary operating in Puerto
Rico was liquidated by merger on September 30, 1993 (see note 9).
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 net income or loss.
Earnings (Loss) Per Share
Earnings per share are based on the weighted average number of shares
outstanding and common equivalent shares arising from dilutive
unexercised stock options. Loss per share is based on the weighted
average number of shares outstanding. Fully diluted earnings per share
information is not presented as it is anti-dilutive.
Reclassifications
Certain reclassifications have been made to conform prior years'
consolidated financial statements to the 1995 presentation.
(Continued)
F-7
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, and the
deferred tax asset valuation allowance. Actual results could differ from
those and other estimates.
(2) Liquidity
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. In 1995 and
1994, the Company experienced a lack of liquidity. In addition, the
Company's recurring losses from operations and working capital and net
capital deficiencies raise substantial doubt about the Company's ability
to continue as a going concern. The consolidated financial statements do
not include any adjustments that might arise from the outcome of this
uncertainty.
The Company, to enhance its liquidity, sold the net assets related to its
fiber optics business in March 1996 (note 4). This sale raised
approximately $8 million of cash and the acquiring company assumed
approximately $1,400,000 of liabilities. The sale of this business,
which in 1995 and prior years sustained significant losses, eliminated a
considerable operating cash drain. A majority of the proceeds from the
sale were used to pay down a portion of the Company's debt, which in
turn will reduce ongoing interest costs and provide the Company with
working capital through the ability to then restructure its senior debt.
In addition, through March 22, 1996, the Company exchanged approximately
80% of its 6% subordinated convertible debt for non-interest bearing
notes. This will reduce interest expense by approximately $1,700,000 per
year. In addition, the Company is reviewing various options in which it
can streamline operations or further reduce operating expenses to
enhance the Company's ability to attain profitable operations.
(Continued)
F-8
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Discontinued Operations
In 1992, the Company recorded the sale of its network communications
business, for which it received $3,750,000 in cash and cash equivalents
plus promissory notes, which after an additional provision for loss on
disposal of discontinued operations of $2,052,000 in 1993, had a balance
of $4,500,000.
As a result of liquidation and receivership proceedings involving the
indirect parent of the buyer of the business, the estimated recovery
from the sale of such operations was reduced in the second quarter of
1995 to $1,000,000 which resulted in an additional provision for loss on
disposal of discontinued operations of $3,500,000 in 1995. The remaining
receivable at December 31, 1995 is collateralized, at the option of the
Company, by either a $750,000 standby letter of credit or approximately
54,000 shares of common stock of the entity which acquired the business
from receivership. Such shares are held in escrow and have a fair value
of $1,387,000 at December 31, 1995 based on quoted market prices. As
part of an agreement with the Company's primary lender, the remaining
proceeds from the sale of the network communications business must be
applied to reduce the outstanding principal balance of the Company's
term loan (note 11).
(4) Assets Held for Sale
On March 13, 1996, the Company consummated an agreement pursuant to which
it sold certain assets and the buyer assumed certain liabilities and
severance obligations related to the operations of the Company's fiber
optics management and component business for $7,893,000, subject to
certain adjustments. The Company continues to be liable for certain
liabilities amounting to approximately $700,000, related to its fiber
optics facilities in Ireland. The Company received $6,793,000 at closing
and the remainder was placed into two escrow funds to be released over
the next year, subject to certain conditions, including a final
valuation of the net assets transferred. The proceeds were primarily
used to repay long-term debt (note 11). As a result of the transaction,
the Company recorded a charge to operations in 1995 of $862,000 to write
down the net assets sold to net realizable value. Net sales of the fiber
optics business approximated $6,513,000, $12,150,000, and $8,654,000 for
1995, 1994 and 1993, respectively.
Net assets held for sale at net realizable value as of December 31, 1995
consists of the following:
Inventory $ 1,467,000
Fixed assets 1,510,000
Deferred computer software 319,000
Goodwill 5,897,000
Other assets 115,000
Accounts payable and accrued liabilities (1,415,000)
----------
$ 7,893,000
============
(Continued)
F-9
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Joint Venture
The Company entered into a joint venture agreement as of April 24, 1986
with a Korean partner. Unless otherwise terminated in accordance with
the joint venture agreement, the joint venture will terminate on
December 31, 2010. In addition, the Company has entered into an
agreement with its joint venture partner whereby the Company has
obtained an option, exercisable for approximately $2,300, to purchase an
additional 1% interest in Woo Shin Electro-Systems Co. (Woo Shin), which
would increase the Company's ownership percentage to 51%. The Company
consolidates the operations of Woo Shin since the Company can obtain a
controlling interest at its election for a nominal sum and Woo Shin is
entirely dependent on the Company for the products it sells as well as
receiving management assistance from the Company. The interest in the
joint venture not owned by the Company is shown as a minority interest.
(6) Inventories
Inventories consist of the following:
December 31,
------------
1995 1994
---- ----
Parts and components $ 5,370,000 11,838,000
Work-in-process 849,000 1,854,000
Finished goods 2,760,000 6,454,000
---------- ----------
$ 8,979,000 20,146,000
========== ==========
(7) Property, Plant and Equipment
Property, plant and equipment consists of the following:
December 31 Estimated
1995 1994 useful lives
---- ---- ------------
Land $ 246,000 246,000 -
Buildings 2,358,000 2,288,000 20 years
Machinery and equipment 8,426,000 15,149,000 5-8 years
Furniture and fixtures 3,379,000 5,057,000 5-10 years
Transportation equipment 240,000 372,000 4 years
Tools and molds 4,233,000 5,501,000 8 years
Leasehold improvements 827,000 3,539,000 Term of lease
Construction in progress - 35,000
-------------- ---------------
19,709,000 32,187,000
Less accumulated depreciation
and amortization 12,798,000 21,048,000
-------------- ---------------
$ 6,911,000 11,139,000
============== ===============
Total depreciation and amortization expense for 1995, 1994 and 1993
amounted to approximately $3,610,000, $3,242,000 and $2,996,000,
respectively.
(Continued)
F-10
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(8) Accounts Receivable
Accounts receivable included approximately $1,146,000 and $2,246,000 at
December 31, 1995, and 1994, of revenues earned but not yet
contractually billable relating to long-term contracts for specialized
products. All such amounts at December 31, 1995, are expected to be
billed in the subsequent year. The allowance for doubtful accounts
receivable was $1,251,000 and $585,000 as of December 31, 1995 and 1994
respectively. The allowance for doubtful accounts was increased by
provisions of $864,000, $318,000, and $434,000 and decreased by
writeoffs of $198,000, $144,000, and $187,000 for the years ended
December 31, 1995, 1994, and 1993, respectively.
(9) Income Taxes
Included in loss from continuing operations is income (loss) from foreign
operations of $1,272,000, $(920,000) and $2,253,000, for 1995, 1994 and
1993, respectively.
The provision for income taxes consists of the following:
1995 1994 1993
---- ---- ----
Current Deferred Current Deferred Current Deferred
Federal $ (98,000) - 800,000 12,670,000 - (4,598,000)
State and foreign 128,000 - 165,000 1,285,000 956,000 (243,000)
---------- ---------- -------- ----------- ---------- -----------
Total $ 30,000 - 965,000 13,955,000 956,000 (4,841,000)
========== ========== ======== =========== ========== ===========
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:
1995 1994 1993
---- ---- ----
Tax benefit at statutory rate $ (10,554,000) (8,526,000) (3,861,000)
Increase (decrease) in income tax
benefit resulting from:
Increase in valuation allowance 10,741,000 22,219,000 -
Benefit of Puerto Rico industrial
tax exemption - 813,000 (152,000)
State and foreign taxes, less
applicable federal benefits 132,000 147,000 645,000
Other (289,000) 267,000 (517,000)
------------- -------------- -------------
$ 30,000 14,920,000 (3,885,000)
============ ============== =============
(Continued)
F-11
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The per common share effect of the income tax savings from the Puerto Rico
industrial tax exemption for 1993 was $.02. The Company has unused
United States tax net operating loss carryforwards of approximately
$72,000,000 expiring at various dates between 2003 and 2010. In
addition, the Company has net operating loss carryforwards arising from
acquired companies of approximately $9,878,000. The carryforward amounts
are subject to review by the Internal Revenue Service (IRS). As a result
of the sale of the Company's fiber optics business (note 4) in March,
1996, the above net operating loss carryforwards and acquired net
operating loss carryforwards will be reduced by $1,969,000 and
$6,592,000, respectively. In addition, there are investment, research
and development and job tax credit carryforwards of approximately
$1,300,000 expiring at various dates between 1996 and 2001.
The Company's net operating loss carryforwards expire in the following
years:
2003 $ 187,000
2007 13,062,000
2008 17,291,000
2009 18,125,000
2010 23,335,000
-----------
$72,000,000
===========
The components of the deferred tax assets and liabilities as of December
31, 1995 and 1994 were as follows:
1995 1994
---- ----
Deferred tax assets:
Inventory allowances $ 4,157,000 3,508,000
Allowance for doubtful accounts receivable 359,000 102,000
Benefits of tax loss carryforwards 27,755,000 19,226,000
Benefit plans 1,593,000 968,000
Alternative minimum taxes 293,000 293,000
Depreciation 122,000 --
Other 30,000 458,000
Benefits of tax loss carryforwards of
acquired businesses 3,479,000 3,479,000
Differences between tax basis and book basis
of net assets of businesses acquired 3,165,000 3,165,000
------------ ------------
40,953,000 31,199,000
Valuation allowance (39,604,000) (28,863,000)
------------ ------------
1,349,000 2,336,000
------------ ------------
Deferred tax liabilities:
Capitalized software costs (1,349,000) (1,821,000)
Depreciation -- (515,000)
(1,349,000) (2,336,000)
$ -- $ --
=========== ===========
(Continued)
F-12
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
In the third quarter of 1994, the Company, after reviewing the deferred tax
asset in the context of its results of operations for such third
quarter, recorded a valuation allowance in the entire amount of its then
existing deferred tax asset, which is included in income tax expense.
This decision was based on the criteria contained in SFAS No. 109,
generally requiring a valuation allowance when cumulative losses have
been experienced and there is a lack of sufficient objective offsetting
evidence to conclude that it is more likely than not that the deferred
tax asset will be utilized.
During 1993, the Company repatriated all undistributed accumulated earnings
of its subsidiary operating in Puerto Rico through a liquidation of such
subsidiary by means of a merger into the Company. No United States
income taxes were payable upon remittance of these earnings. Repatriated
earnings accumulated prior to May 28, 1987 are not subject to tax by the
Commonwealth of Puerto Rico; earnings accumulated subsequent to May 28,
1987 are subject to a maximum 10% tax at repatriation. In 1993 as part
of the liquidation, the Company repatriated $24,279,000 in earnings
accumulated prior to May 28, 1987 and $2,482,000 of earnings accumulated
subsequent to May 28, 1987.
The income tax returns of the Company and its subsidiary operating in
Puerto Rico were examined by the IRS for the tax years ended December
31, 1989 and 1988. 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 the Company's net
operating losses. The settlement amounted to approximately $953,000. The
Company has entered into a structured settlement with the IRS whereby
monthly payments will be made along with certain scheduled balloon
payments through February 1997. Aggregate annual amounts payable by the
Company, including interest on the unpaid amounts at a current rate of
7%, is $514,000 in 1996 and $223,000 in 1997. As of December 31, 1995,
the Company has not made all the required payments under the settlement.
The income tax returns of the Company and its subsidiary operating in
Puerto Rico were examined by the IRS for the tax years ended December
31, 1991 and 1990. 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 the Company's net
operating losses. In settlement of this examination, the Company revoked
its Section 936 election and included its subsidiary in the Company's
tax return. Accordingly, the adjustments were offset resulting in no
deficiency.
(10) Notes Payable and Short-Term Loans
The Company has outstanding $3,084,000 and $2,474,000 of non-interest
bearing deferred funding fee notes payable with its senior lender,
included in notes payable at December 31, 1995 and 1994, respectively.
As of December 31, 1995 these deferred funding fees are due on November
30, 1998 (note 11). The Company's Korean subsidiary also has short-term
borrowings with banks at December 31, 1995 and 1994 of $368,000 and
$152,000, respectively, bearing interest at 11%
(Continued)
F-13
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(11) Long-Term Debt
On December 31, 1995 and 1994, the Company's long-term debt consisted of
senior debt under its credit facility in the amount of $26,645,000 and
$21,000,000, respectively.
On November 28, 1994, and as amended on February 13, 1995, the Company
consummated a financing arrangement with a senior lender whereby the
senior lender provided the Company advances under a revolving line of
credit up to the lesser of $10 million or a borrowing base equal to 80%
of eligible accounts receivable and 50% of eligible inventory, less the
amount of letters of credit and letter of credit guarantees outstanding,
and a $13,502,188 term loan. If the Company sells its Glen Cove real
property, the first $1 million of proceeds must be used to reduce the
term loan. In addition, on February 13, 1995 the senior lender provided
the Company with an advance under a net worth enhancement (NWE) line of
credit of $3 million. The senior lender agreed to issue standby letters
of credit or guarantees of payment in an amount not to exceed the lesser
of $8 million or the borrowing base less the amount outstanding on the
revolving line of credit. If the senior lender must make an advance
under a letter of credit or letter of credit guarantee, such amount will
be deemed outstanding under the revolving line of credit. The credit
facility is secured by substantially all of the Company's assets. All
obligations except undrawn letters of credit, letter of credit
guarantees and the deferred fee notes will bear interest at 12%. The
Company will incur a fee of 2% on the average balance of undrawn letters
of credit and letter of credit guarantees outstanding.
As of December 31, 1995, the Company violated certain financial covenants
and was in default of its agreement with its senior lender. On March 13,
1996, the Company entered into an agreement to extend its Loan and
Security Agreement with its senior lender from November 30, 1996 to
November 30, 1998, which also provided for a waiver of all previous
events of default. The agreement provides for loan principal payments of
$250,000 on each of June 30, 1997, September 30, 1997 and December 31,
1997, and $325,000 commencing March 31, 1998 and on the last day of each
quarter thereafter during the term of the agreement. Commencing June 30,
1997, the agreement requires the Company to pay additional principal
payments if certain "adjusted cash flow amounts", as defined, are
attained. The March, 1996 amendment also requires that certain proceeds
from the Company's sale of its fiber optics business (note 4), including
$6,793,000 received at closing, the first $100,000 disbursed from escrow
to the Company and 50% of any additional amounts disbursed to the
Company, must be paid directly to the senior lender. The $6,793,000
received at closing was used to pay accrued interest through March 31,
1996, repay the $3,000,000 NWE line of credit and the remainder
partially repaid the principal balance of the term loan. Upon the
payment on March 13, 1996, the lender made available to the Company a
$2,000,000 revolving line of credit. Simultaneously, and in accordance
with the amended agreement, the revolving line of credit maximum amount
was reduced from $10,000,000 to $2,000,000 and the maximum available for
letters of credit or guarantees was reduced from $8,000,000 to
$7,000,000. The outstanding balance of the term loan and revolving line
of credit was approximately $20 million and approximately $900,000,
respectively, after all the above transactions.
(Continued)
F-14
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Through March 22, 1996, the Company incurred the following fees, in
connection with this credit facility: In 1994, a one-time $2,474,000
deferred funding fee for the revolving line and term loan evidenced by a
non-interest bearing promissory note due and payable on November 30,
1998, (as of December 31, 1994, $1,237,000 was due in 1995 before the
March, 1996 amendment to the agreement). The Company incurred a $300,000
NWE fee on February 13, 1995, evidenced by a non-interest bearing note
due November 30, 1998 and a $310,000 facility fee on November 30, 1995,
which amount has been added to the outstanding principal balance of the
deferred funding fee note and is also due November 30, 1998. In
consideration of the extension of the facility term to November 30,
1998, the agreement requires a monthly facility fee payment of $50,000,
commencing November 30, 1996, and continuing to the end of the
agreement. In addition to the fees, the Company incurred a $550,000
investment banking fee and attorney and filing fees amounting to
$319,000 included in other nonoperating expenses in 1994.
In connection with the credit facility, in November, 1994 the Company
issued warrants to its senior lender to purchase 275,000 shares of
common stock, immediately exercisable at $3.44 per share and expiring in
November 1999, together with warrants to purchase 137,500 shares of the
Company's common stock on the same economic terms that became
exercisable on March 13, 1996. In connection with the extended agreement
in March 1996, the Company granted additional warrants to the lender to
purchase 1,000,000 shares of common stock at $1 per share that expire in
March 2001. All such warrants provide the senior lender demand and
"piggyback" registration rights.
Financial debt covenants include an interest coverage ratio measured
quarterly commencing with the quarter ending June 30, 1996, limitations
on the incurrence of indebtedness, limitations on capital expenditures,
and prohibitions on declarations of any cash or stock dividends or the
repurchase of the Company's stock.
In connection with the amendment to the agreement on February 13, 1995, the
Company purchased from the senior lender $3.9 million principal amount
of its 6% Subordinated Debentures for approximately $2.5 million,
including accrued interest. Such payment was financed with funds
received from the increase in the term loan. The Company recorded an
extraordinary gain on the early extinguishment of the debt of
$1,756,000. Such gain represented the excess of the book value over the
market value of the debt with the premium paid in excess of the market
value of the debt of $782,000 reflected as additional borrowing costs
over the remaining term of the facility.
Maturities of the Company's long-term debt, including convertible
subordinated debentures (exclusive of $6,564,000 which are in default
and have not been exchanged as described in note 12 and are classified
as a current liability) and notes payable net of current maturities, are
as follows:
1997 $ 750,000
1998 54,639,000
----------
$55,389,000
===========
Of the amount due in 1998, $6,793,000 was repaid on March 13, 1996.
(Continued)
F-15
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(12) 6% Convertible Subordinated Debentures
As of December 31, 1995 and 1994 the Company had outstanding $32,224,000
and $35,073,000 of its 6% convertible Subordinated Debentures due July
1, 2002 (the Debentures), net of original issue discounts amortized to
principal over the term of the debt using the effective interest rate
method, of $3,851,000 and $4,927,000, respectively. The face amount of
the outstanding Debentures was $36,075,000 and $40,000,000 at December
31, 1995 and 1994, respectively. The Debentures are convertible at any
time prior to maturity, unless previously redeemed, into Common Stock of
the Company at a conversion rate of 41.667 shares for each $1,000
principal amount at maturity of Debentures, subject to adjustment under
certain circumstances.
The Debentures are redeemable at the option of the Company, (a) in whole
or in part, at redemption prices ranging from 89.626% of principal
amount at maturity beginning July 1, 1995 to 100% of principal amount
at maturity beginning July 1, 2001 and thereafter, together with
accrued and unpaid interest to the Redemption Date, and (b) in whole
at any time, at a redemption price equal to the issue price plus
interest and that portion of the original issue discount and interest
accrued to the redemption date, in the event of certain changes in
United States taxation or the imposition of certain certification,
information or other reporting requirements.
Interest on the Debentures is payable on July 1 of each year. The interest
accrued as of December 31, 1995 and 1994 amounted to $3,244,000 and
$1,200,000, respectively. As of December 31, 1995 the Company is in
default under the interest payment provisions of the Debentures.
On November 30, 1995, the Company offered the holders of its Debentures an
exchange of such debt for common stock and zero coupon senior
subordinated convertible notes (the Notes) due January 2, 1998. The
exchange ratio is 97 shares of common stock and $767.22 of principal of
Notes in exchange for $1,000 principal amount of Debentures. Accrued
interest on the Debentures would also be eliminated. The Company may be
required to file a registration statement for the common stock and Notes
issued in the exchange. In addition, the Board of Directors of the
Company, subject to shareholder approval, approved an amendment to the
Company's certificate of incorporation increasing the authorized common
stock from 20 million to 40 million shares.
(Continued)
F-16
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The unsecured Notes will not bear interest and there are no sinking fund
requirements. Each Note is convertible into common stock at a conversion
price of $1.85 per share until May 1, 1996 and then at decreasing prices
to $1.31 per share on November 1, 1996 and thereafter. Accordingly, in
addition to the 3,499,275 maximum common shares issuable from the
exchange of the Debentures, the maximum number of common shares that
could be issued upon conversion, if all Debentures are exchanged, is
21,128,000. In the event that the number of outstanding common shares
will exceed 19,000,000, in lieu of issuing common stock for converted
Notes, the Company will issue one share of Series B Participating
Convertible Preferred Stock for each 50 shares of common stock otherwise
issuable upon conversion of the Notes. Such preferred stock will have 50
votes per share and, upon the filing of a certificate of amendment to
increase the number of authorized common shares to 40,000,000, each
share will automatically be converted into 50 shares of common stock.
The Notes are redeemable at the option of the Company at 79.48% of the
principal balance increasing periodically to 100% of the principal
balance on November 1, 1997.
Subsequent to December 31, 1995 and through March 22, 1996, the Company
exchanged approximately $28,725,000 principal amount of the Debentures,
net of unamortized discount of $3,065,000, for 2,786,325 shares of the
Company's common stock and $22,038,000 principal amount of Notes
pursuant to the Exchange Offer. Accordingly, the Debentures exchanged,
which were outstanding at December 31, 1995, have been classified as a
long-term liability, consistent with the payment terms of the Notes.
Since the remaining principal amount of $7,350,000 with a carrying value
of $6,564,000 of Debentures not exchanged are in default, such debt has
been classified as a current liability at December 31, 1995.
The exchange of the Debentures for the Notes and common stock will be
accounted for as a troubled debt restructuring in accordance with
Statement of Financial Accounting Standards No. 15. Since the future
principal and interest payments under the Notes is less than the
carrying value of the Debentures, The Notes will be recorded for the
amount of the future cash payments, and not discounted, and an
extraordinary gain on restructuring of approximately $3 million will be
recorded. Accordingly, no future interest expense will be recorded on
the Notes.
(13) Leases
At December 31, 1995, the Company and its subsidiaries leased manufacturing
and administrative facilities, equipment and automobiles under a number
of operating leases. The Company is required to pay increases in real
estate taxes on the facilities in addition to minimum rents. Total rent
expense for 1995, 1994, and 1993 amounted to approximately $1,277,000,
$1,397,000 and $1,468,000, respectively. Minimum rental commitments,
exclusive of future escalation charges, for each of the next five years
are as follows:
1996 $ 547,000
1997 399,000
1998 328,000
1999 312,000
2000 273,000
(Continued)
F-17
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(14) Incentive Plans
Under the Company's 1984 Employee Incentive Plan, the Company provided an
opportunity to acquire subordinated convertible debentures to certain
employees of the Company and its subsidiaries. The debentures bore
interest at 1% over the prime rate. These debentures on issuance were
convertible into a specified number of shares of Common Stock. The
conversion price was the fair market value on the date of purchase of
the debentures. Under the 1984 Plan, if requested, the Company loaned a
purchaser of a debenture all or part of the cash necessary to make such
a purchase. Any such loan was evidenced by a full recourse
interest-bearing promissory note payable to the Company for the amount
borrowed. This plan was suspended when the Company's stockholders
approved the Company's 1986 Stock Option Plan.
As of December 31, 1995, there is $307,000 of employee promissory notes
receivable outstanding related to debentures that were converted to
common stock. The maturity date of the notes was extended to April 1996.
At December 31, 1995, the majority of such notes receivable have had the
payment of interest forgiven. During 1993, $48,600 principal amount of
debentures was converted into 5,400 shares of Common Stock and $378,000
principal amount of debentures and $378,000 of loans incurred therewith
matured in accordance with their terms and were repaid by the Company
and employees, respectively. During 1995, the Company wrote off $128,000
of notes receivable and took possession of the related shares held as
collateral. Accordingly, the balance of the note has been recorded as an
addition to treasury stock.
In 1986, the stockholders of the Company approved the Company's 1986 Stock
Incentive Plan (1986 Plan), subsequently amending it to permit the
granting of options to purchase up to 850,000 shares of Common Stock to
employees of the Company and its 50% or more owned subsidiaries whom the
Company's Compensation Committee (Committee) determines are eligible for
such grants.
Options granted under the 1986 Plan may be incentive stock options, as
defined in the Internal Revenue Code, or options which are not incentive
stock options. If options granted are incentive stock options, the
option price payable upon exercise is determined by the Committee at the
time the option is granted but will not be less than 100% of the fair
market value of the Common Stock on the date of grant and will be 110%
of such fair market value on the date of grant if the individual who
receives such option is the owner of 10% or more of the Company's Common
Stock. Incentive stock options are not exercisable more than ten years
from the date of grant, except that, in the case of an incentive stock
option granted to an individual who owns 10% or more of the Company's
Common Stock, such option must be exercised within 5 years of the date
of grant. If options which are not incentive stock options are granted,
the option price at the time of exercise may not be less than 50% of the
fair market value at the time the option is granted. Options under the
1986 Plan may be subject to exercise in such installments as determined
by the Committee. The exercise price for all options granted was equal
to the fair market value at the date of grant.
(Continued)
F-18
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Information regarding the 1986 Plan is as follows:
Shares Option
under option price
Balance, December 31, 1992 615,910 7.5625 - 22.00
Exercised (2,500) 7.5625 - 10.875
Canceled (211,760) 7.5625 - 22.00
-------- ---------------
Balance, December 31, 1993 401,650 7.5625 - 17.50
Granted 10,000 9.875
Exercised (1,000) 7.5625
Canceled (6,775) 13.125 - 17.25
------- ---------------
Balance, December 31, 1994 403,875 7.5625 - 17.50
Granted 30,000 1.00
Canceled (152,075) 7.5625-17.50
-------- ------ -----
Balance, December 31, 1995 281,800 1.00-17.50
======= ============
At December 31, 1995, options to purchase 251,800 shares were exercisable
and there were 525,575 options available for grant under the 1986 plan.
(15) Employee Benefit Plans
The Company has deferred compensation agreements with certain officers and
employees, with benefits commencing at retirement equal to 50% of the
employee's base salary, as defined. Payments under the agreements will
be made only after a participant's employment with the Company
terminates and then for a period of fifteen years following the earlier
of attainment of age 65 or death. During 1995, 1994 and 1993, the
Company accrued approximately $203,000, $191,000 and $162,000,
respectively, under these agreements.
In 1986, the Company established the Porta Systems Corp. 401(k) Savings
Plan (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%. The Company will match a
participant's contribution by an amount equal to 75% (subsequently
changed to 25% as of January 1, 1996) of the first six percent
contributed by the participant. A participant is 100% vested in the
balance to his credit. For the years ended December 31, 1995, 1994 and
1993, the Company's contribution amounted to $379,000, $417,000 and
$475,000, respectively.
The Company does not provide any other post-retirement benefits to any of
its employees.
(Continued)
F-19
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(16) Stockholders' Equity
During 1993, the Company issued warrants to purchase 155,000 shares of
Common Stock to certain consultants as partial remuneration for services
provided. Warrants to purchase 135,000 shares were issued at an exercise
price approximating the fair market value at the date of grant and
warrants to purchase the remaining 20,000 shares of Common Stock were
issued at an exercise price of $1.00 per share. In connection with the
issuance of these warrants, the Company recorded an expense of $202,000.
Also, during 1993, warrants to purchase 20,000 shares of Common Stock at
$1.00 per share were exercised.
During 1994, the Company issued warrants to purchase 412,500 shares of
common stock at an exercise price of $3.44 per share to its senior
lender that expire in November, 1999, and warrants to purchase 265,000
shares of common stock at an exercise price of $3.50 per share to its
former lenders in return for a discount with respect to the repayment of
its debt. In connection with the issuance of these warrants, the Company
recorded deferred financing costs of $360,000 and an expense of
$600,000, respectively. In March 1996, the Company, in connection with
an agreement to amend and extend certain long-term debt, issued warrants
to purchase 1,000,000 shares of common stock at an exercise price of
$1.00 per share that expire March, 2001 (note 11). As of March 22, 1996,
all warrants issued to lenders are exercisable.
In June 1994, pursuant to a private placement to certain offshore
investors, the Company sold an aggregate of 375,000 shares of
unregistered common stock and two-year warrants to acquire 187,500
shares of common stock at an exercise price of $11 per share. The
Company received proceeds of $2,131,750 net of expenses.
(17) Shareholder Rights Plan
The Company has adopted a Shareholder Rights Plan in which preferred stock
purchase rights were distributed to stockholders as a dividend at the
rate of one right for each common share. Each right entitles the holder
to buy from the Company one one-hundredth of a newly issued share of
Series A junior participating preferred stock at an exercise price of
$35.00 per right.
The rights will be exercisable only if a person or group acquires
beneficial ownership of 20 percent or more of the Company's Common Stock
or commences a tender or exchange offer upon consummation of which such
person or group would beneficially own 20 percent or more of the Common
Stock.
If any person becomes the beneficial owner of 20 percent or more of the
Company's Common Stock other than pursuant to an offer for all shares
which is fair to and otherwise in the best interests of the Company and
its stockholders, each right not owned by such person or related parties
will enable its holders to purchase, at the right's then current
exercise price, shares of Common Stock of the Company (or, in certain
circumstances as determined by the Board of Directors, a combination of
cash, property, common stock or other securities) having a value of
twice the right's exercise price. In addition, if the Company is
involved in a merger or other business combination transaction with
another person in which its shares are changed or converted, or sells
more than 50 percent of its assets to another person or persons, each
right that has not previously been exercised will entitle its holder to
purchase, at the right's then current exercise price, common shares of
such other person having a value of twice the right's exercise price.
(Continued)
F-20
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The Company will generally be entitled to redeem the rights, by action of a
majority of the continuing directors of the Company, at $.01 per right
at any time until the tenth business day following public announcement
that a 20 percent position has been acquired.
(18) Fair Values of Financial Instruments
Cash equivalents, accounts receivable, accounts and notes payable, accrued
expenses and short-term loans are reflected in the consolidated
financial statements at fair value because of the short term maturity of
these instruments.
The carrying amount of the Company's long-term debt approximates fair
value as the extension of the Loan and Security Agreement was
renegotiated on March 13, 1995 with similar terms to those that existed
at December 31, 1995.
The carrying amount and estimated fair value of the Company's additional
financial instruments are summarized as follows:
December 31, 1995
Carrying Estimated
amount fair value
------ ----------
Receivable from sale of discontinued operations$ 1,000,000 1,370,000
========== =========
Convertible subordinated debentures $ 32,224,000 12,626,000
========== ==========
The estimated fair value of the receivable from the sale of discontinued
operations is based upon the quoted market price of the shares of common
stock collateralizing the receivable. Management's estimated fair value
of the convertible subordinated debentures is based on market prices
obtained from dealers of such debt.
(19) Major Customers
Consolidated sales made to a Korean telephone company amounted to
$7,651,000, $9,599,000 and $3,330,000 in 1995, 1994 and 1993,
respectively. Sales made to a United Kingdom telephone company in 1995,
1994 and 1993 amounted to $17,252,000, $11,566,000 and $12,713,000,
respectively. Sales made to a Mexican telephone company in 1995, 1994
and 1993 amounted to $41,000, $4,987,000 and $7,257,000, respectively.
(20) Contingencies
At December 31, 1995, the Company was contingently liable for outstanding
letters of credit aggregating approximately $5,323,000 as security for
the performance of certain long-term contracts and the borrowing from a
bank of its Korean subsidiary.
The Company is a party to various lawsuits arising out of the ordinary
conduct of its business. Management believes that the settlement of
these matters will not have a materially adverse effect on the financial
position of the Company.
(Continued)
F-21
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(21) Legal Matters
The Company and certain of its present and former officers and directors
are defendants in eight alleged class actions which have been
consolidated and are pending in the United States District Court for the
Eastern District of New York. The actions allege violations of Section
10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5
under such Act. The plaintiffs seek, among other remedies, unspecified
monetary damages.
In March 1996, the Company executed a Stipulation of Settlement to settle
the class actions, and an order of preliminary approval of settlement
was approved by the Court. The agreement is subject to certain
conditions precedent, including the maintenance by the Company's common
stock of a certain minimum market value. The settlement, if consummated,
will include a cash payment by the Company's insurers and issuance by
the Company of 1,100,000 shares of its common stock, to be distributed
in accordance with a plan to be approved by the Court. Under the
agreement, the Company is not required to contribute any cash towards
the proposed settlement. In connection with the settlement, the Company
recorded a charge to income of $1,100,000 in the fourth quarter of 1995,
based upon the market value of the shares to be issued.
The Companydenies the material allegations and admits no liability of any
sort in connection with the settlement and dismissal of the action.
Notice of the court hearing on the settlement has been sent to class
members, and the hearing is scheduled for June 7, 1996. The settlement
is subject to the final approval of the court.
(22) Segment Disclosure
The Company operates exclusively in the telecommunications industry.
Customers include telephone operating companies and others within and
outside the United States and its possessions.
In the following table, intercompany sales are accounted for at cost plus a
reasonable profit. Identifiable assets for the geographic areas are
those assets identified with the operations in each area. Corporate
assets consist principally of cash and cash equivalents, debt issuance
costs, employee loans for debentures and patents. The Company does not
allocate costs for product development, marketing or management to each
segment. Thus, the information may not be indicative of the extent to
which geographic areas contributed to the Company's consolidated results
of operations.
(Continued)
F-22
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Geographic area data for the years ended December 31, 1995, 1994 and
1993 are as follows:
1995 1994 1993
---- ---- ----
Sales made from:
United States and Puerto Rico to:
U.S. customers $ 16,445,000 23,831,000 24,718,000
Foreign customers 12,875,000 11,069,000 5,828,000
Intercompany 14,849,000 25,102,000 27,068,000
------------ ------------ ------------
44,169,000 60,002,000 57,614,000
------------ ------------ ------------
Korea-to customers 7,651,000 9,599,000 3,330,000
------------ ------------ ------------
Europe-to customers 24,174,000 19,847,000 27,264,000
Intercompany 3,735,000 690,000 1,299,000
------------ ------------ ------------
27,909,000 20,537,000 28,563,000
Other-to customers 36,000 4,639,000 7,001,000
Intercompany 2,410,000 3,796,000 2,716,000
------------ ------------ ------------
2,446,000 8,435,000 9,717,000
------------ ------------ ------------
Intercompany eliminations (20,994,000) (29,588,000) (31,083,000)
------------ ------------ ------------
Consolidated sales $ 61,181,000 68,985,000 68,141,000
============ ============ ============
Operating income loss
United States and Puerto Rico (22,549,000) (16,621,000) (6,383,000)
Europe 2,279,000 (1,465,000) 2,341,000
Korea 288,000 387,000 (113,000)
Other 98,000 158,000 239,000
------------ ------------ ------------
Consolidated operating (loss) $(19,884,000) (17,541,000) (3,916,000)
============ ============ ============
Identifiable assets:
United States and Puerto Rico 39,600,000 63,200,000 91,915,000
Europe 11,414,000 10,505,000 8,578,000
Korea 2,540,000 2,491,000 2,459,000
Other 623,000 1,248,000 1,112,000
------------ ------------ ------------
Consolidated identifiable assets 54,177,000 77,444,000 104,064,000
Corporate assets 6,414,000 7,519,000 5,884,000
------------ ------------ ------------
Consolidated total assets $ 60,591,000 84,963,000 109,948,000
============ ============ ============
F-23