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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _______to_______
Commission file number 1-8191
PORTA SYSTEMS CORP.
(Exact name of registrant as specified in its charter)
Delaware 11-2203988
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
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: $18,597,424 as of March 12, 1999.
Indicate the number of shares outstanding of each of the registrant's
class of common stock, as of the latest practicable date: 9,298,712 shares of
Common Stock, par value $.01 per share, as of March 12, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant's definitive proxy statement in connection with its 1999 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 standard and proprietary telecommunications equipment
and integrated software applications for sale domestically and internationally.
The Company's core products, focused on ensuring communications for service
providers worldwide, fall into three categories:
Computer-based operation support systems ("OSS"). The Company's OSS
systems focus on the access loop and are components of telephone companies'
Service Assurance, Service Activation and FlowThru initiatives. The Systems
primarily focus on Trouble Management, Line Testing, Network Provisioning,
Inventory and Assignment, and Automatic Activation. These systems are marketed
principally to foreign telephone operating companies in established and
developing countries, primarily in Asia, South and Central America and Europe.
Telecommunications connection and protection equipment. These systems are
used to connect copper-wired telecommunications networks and to protect
telecommunications equipment from voltage surges. The Company's copper
connection equipment and systems are marketed to telephone operating companies
in the United States and foreign countries.
Signal processing equipment. These products support copper wire-based
communications systems and are sold principally for use in defense and aerospace
applications.
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.
Forward-Looking Statements
The statements in this Form 10-K Annual Report that are not descriptions
of historical facts may be forward looking statements that are subject to risks
and uncertainties. In particular, statements in this Form 10-K Annual Report,
including any material incorporated by reference in this Form 10-K, that state
our intentions, beliefs, expectations, strategies, predictions or any other
statements relating to our future activities or other future events or
conditions are forward-looking statements. Forward-looking statements are
subject to risks, uncertainties and other factors, including, but not limited
to, those identified under Risk Factors, which begins on page 9, and those
described in Management's Discussion and Analysis of Financial Conditions and
Results of Operations and in any other filings with the Securities and Exchange
Commission, as well as general economic conditions, any one or more of which
could cause actual results to differ materially from those stated in such
statements.
Products
Operations Support Systems. OSS systems are used primarily by telephone
operating companies. The Company's principal OSS systems are computer-based
testing, provisioning, activation and trouble management products which includes
software and capital equipment and typically sells for prices ranging from
several hundred thousand to several million dollars.
The testing products, introduced in the mid-1970's, were the first
computer-controlled electronic system used to automatically test for and
diagnose problems in customer telephone lines and to notify telephone company
service personnel of required maintenance. The associated Trouble Management
System provides automated record keeping (including repair and disposition
records) and analyzes these records for identification of recurring problems and
equipment deterioration. The integration of these systems provides a service
assurance function for telephone companies. The OSS systems are sold to
telephone operating companies in a number of foreign countries as well as in the
United States.
1
A major component of the testing system is the "test head", which provides
the access to, and actual testing of, the required telephone line. The Company
has continually evolved its test head capability to meet the changing
requirements of the customer loop, and has recently introduced its latest (sixth
generation) product, the MkIII. The MkIII uses an advanced technology platform
and the Mach IV, which will be introduced later in 1999, will provide the
capability to qualify customer lines as xDSL capable, enabling telephone
companies to optimize their responsiveness to market conditions.
The Company's other software applications such as the automated assignment
of facilities and activation of service, form part of a telephone companies
service activation function, and can be packaged and integrated with the testing
and trouble management systems, providing a comprehensive access loop capability
including flow-thru. In addition, pursuant to certain contracts with customers,
the Company develops software to meet specific customer requirements. Including
integration of its systems with telephone company legacy of third party OSS.
The Company's OSS products are complex and, in most applications,
incorporate features designed to respond to the purchaser's operational
requirements and the particular characteristics of the purchaser's telephone
system. 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 not experienced a steady
or predictable flow of orders for OSS systems.
Telecommunications Connection Equipment. The Company's 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 generally grows in proportion to increases in
the number of telephone subscribers and owners of private telecommunications
equipment, as well as to increases in upgrades to modern digital switching
technology.
The Company's connection equipment consists of connector blocks and
protection modules used by telephone companies to interconnect copper-based
subscriber lines to switching equipment lines. The protector modules protect
central office personnel and equipment from electrical surges. The need for
protection products has increased as a result of the worldwide move to digital
technology, which is extremely sensitive to damage by electrical overloads, and
because private owners of telecommunications equipment now have the
responsibility to protect their equipment from damage caused by electrical
surges. Line connecting/protecting equipment usually incorporates protector
modules to safeguard equipment and personnel from injury due to power surges.
Currently, these products include a variety of connector blocks; protector
modules and frames used in telephone central switching offices, PBX
installations 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 produce
computer-assisted analysis and for the optimum placement of connections for
telephone lines on the connector blocks mounted on the frame.
2
The Company's copper connection/protection products are used by several of
the six 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
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 does design
modifications to accommodate the specific needs of its customers.
Signal Processing Products. The Company's signal processing products
include data bus system and wideband transformers. Data bus systems, which are
the communication standard for military and aerospace systems, require an
extremely high level of reliability and performance. Wideband transformers are
required for ground noise elimination in video imaging systems and are used in
the television and broadcast, medical imaging and industrial process control
industries.
The table below shows, for the last three fiscal years, the contribution
made to the Company's sales by each of its major categories of the
telecommunications industry:
Sales by Product Category
Years Ended December 31,
1998 1997 1996
---- ---- ----
(Dollars in thousands)
OSS Systems $27,318 46% $29,561 48% $26,804 46%
Line Connecting
/Protecting
Equipment (*) 24,291 41% 23,753 38% 23,249 40%
Signal Processing 7,539 13% 8,280 13% 7,597 13%
Other 195 0% 636 1% 337 1%
------- ------- ------- ------- ------- -------
Total $59,343 100% $62,230 100% $57,987 100%
======= ======= ======= ======= ======= =======
(*) Includes sales of fiber optics products of $447,000 in 1996. The assets
comprising the fiber optics business unit were sold in March 1996.
Markets for the Company's Products
The Company supplies equipment and systems to telephone companies used to
provide improved services to ensure communication to their customers. In
addition, the Company provides businesses with systems, which improve their
internal telecommunication systems.
3
Typically, 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 which use 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. Countries with emerging telecommunication
networks have 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 changing telephone network. OSS systems facilitate rapid change and
expansion without a comparable increase in the requirement for skilled
technicians, while the computerized line test system insures increased quality
and rapid maintenance and repair of subscriber local loops. The automated
database, which computerizes the inventory and maintenance history of all
subscriber lines in service, helps to keep the rapid change under control.
During 1998, approximately 46% of the Company's sales consisted of OSS
products.
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 line of copper connection equipment for
this purpose. Recent trends towards the transmission of high frequency signals
on copper lines are sustaining this market. Less developed countries, such as
those with emerging networks or those upgrading to digital switching systems,
provide a growing market for copper connection and protection equipment.
The increased sensitivity of the newer digital switches to small amounts
of voltage requires the telephone company which is upgrading its systems to
digital switching systems to also upgrade its central office
connection/protection systems in order to meet these more stringent protection
requirements. The Company supplies central office connection/protection systems
to meet these needs.
During 1998, approximately 41% of the Company's sales were made to
customers in this category.
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's wideband transformers are required for ground noise
elimination in video imaging systems and are used in the television and
broadcast, medical imaging and industrial process control industries. If not
eliminated, ground noise caused by poor electrical system wiring or power
supplies, results in significant deterioration in system performance (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 1998, signal processing equipment accounted for approximately 13%
of the Company's sales.
4
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 November 1996, the Company amended its supply agreement with British
Telecommunications plc ("BT") for the Company's line connecting/protecting
products. The amended agreement will expire on August 31, 2001, and provides,
among other things, that the Company may no longer be the exclusive supplier to
BT for these products. During 1998, 1997, and 1996, BT purchased $11,345,000
(19% of sales), $9,397,000 (15% of sales), and $9,296,000 (16% of sales),
respectively, of the Company's line connecting/protecting 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
amended contract also provides for a 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 by BT or
others for its own purposes.
The Company's OSS systems have primarily been sold to foreign telephone
operating companies (which are sometimes controlled by foreign governments), and
the contracts relating to OSS systems are principally negotiated directly
between the Company and these purchasers.
The Signal Processing line of products is sold primarily to US military
and aerospace prime contractors, and domestic OEMs and end users.
5
The following table sets forth for the last three fiscal years the
Company's sales to customers by geographic region:
Sales to Customers By Geographic Region (1)
Year Ended December 31,
1998 1997 1996
---- ---- ----
(Dollars in thousands)
North America $20,830 35% $19,269 31% $17,644 30%
United Kingdom 20,441 34% 18,640 30% 16,000 28%
Other Europe 3,377 6% 10,587 17% 5,416 9%
Asia/Pacific 7,181 12% 10,278 17% 15,812 27%
Latin America 7,463 13% 2,429 4% 1,738 3%
Middle East 51 0% 879 1% 1,248 2%
Other -- 0% 148 0% 129 1%
------- ------- ------- ------- ------- -------
Total Sales $59,343 100% $62,230 100% $57,987 100%
======= ======= ======= ======= ======= =======
(1) For information regarding the amount of sales, operating profit or loss
and identifiable assets attributable to each of the Company's divisions
and geographic areas, see Note 22 to the Consolidated Financial
Statements.
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
difficulty in 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, local tax regulations and
political instability.
6
Manufacturing
The Company's computer-based testing products include the Company's
proprietary testing circuitry and computer programs, which provide
platform-independent solutions based on UNIX or UNIX compatible operating
systems. The testing products also incorporate disk data storage, data terminals
("CRTs"), teleprinters, minicomputers and personal computers (PC's) purchased by
the Company. These products are installed and tested by the Company on its
customers' premises.
At present, the Company's manufacturing operations are conducted at
facilities located in Glen Cove, New York and Matamoros, Mexico. 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. In addition, the Company has software development sites in
Syosset, New York, Charlotte, North Carolina, and Coventry, United Kingdom.
Source and Availability of Components
The Company generally purchases the standard components used in the
manufacture of its products from a number of suppliers. The Company attempts to
assure itself that the components are available from more than one source. The
Company purchases the majority of its minicomputers used in its OSS systems from
Digital Equipment Corporation ("DEC"). However, 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.
Significant Customers
During the years ended December 31, 1998 and 1997, the Company's five
largest customers accounted for sales of $28,797,000, or approximately 49% of
sales, and $30,633,000, or approximately 49% of sales, respectively. The
Company's largest customer is BT. Sales to BT for the year ended December 31,
1998 and 1997 amounted to $15,349,000 and $13,876,000, respectively, or
approximately 26% and 22%, respectively, of the Company's sales for such years.
Therefore, any significant interruption or decline in sales to BT may have a
materially adverse effect upon the Company's operations. During 1998, sales to a
Chilean telephone company were $6,834,000, or approximately 12% of sales. No
other customers account for 10% or more of the Company's sales for either year.
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 industries. Both catalog and
custom designed products are sold to these customers. Some contracts are
multi-year procurements.
7
Backlog
At December 31, 1998, the Company's backlog was $8,800,000 compared with
approximately $19,558,000 at December 31, 1997. Of the December 31, 1998
backlog, approximately $6,600,000 represented orders from foreign telephone
operating companies, including $1,549,000 attributable to the contract with BT.
See "Marketing and Sales". The Company expects to ship substantially all of its
December 31, 1998 backlog during 1999.
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 or receipt 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 material adverse effect on the
Company's business.
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 Lucent Technologies
("Lucent") continuing to be the Company's principal United States competitor.
Lucent's greater resources, extensive research and development facilities,
long-standing equipment supply relationships with the operating companies of the
regional holding companies and history of manufacturing and marketing products
similar in function to those produced by the Company continue to be significant
factors in the Company's competitive environment.
Currently, Lucent 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, and
endeavors to offer its products at prices and with warranties that will make its
products competitive.
8
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 Lucent, 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, its ability to customize systems and endeavors to offer
such equipment at prices and with warranties that will make them competitive.
Research and Development Activities
During the fiscal years ended December 31, 1998, 1997 and 1996, the
Company spent approximately $6,510,000, $5,361,000, and $3,848,000,
respectively, on its research and development activities. All research and
development was company sponsored and is expensed as incurred.
Employees
As of February 27, 1999, the Company had 446 employees of which 123 were
employed in the United States, 225 in Mexico, 39 in the United Kingdom, 5 in
Poland, 10 in Chile, 11 in China, and 33 in Korea (in connection with the
Company's Korean joint venture). The Company believes that its relations with
its employees are good, and it has never experienced a work stoppage. The
Company's employees are not covered by collective bargaining agreements, except
for its hourly employees in Mexico who are covered by a collective bargaining
agreement that expires on December 31, 1999.
Risk Factors
We recently incurred net losses from our operations. We incurred a net
loss of $6,899,000, or $2.22 per share (basic and diluted), on sales of
$62,230,000 for 1997 after giving effect to a non-cash charge of $11,458,000
related to the exchange of the Company's Zero Coupon Notes for common stock. See
Management's Discussion - Results of Operations. Although we generated net
income of $527,000 and comprehensive net income of $800,000 in 1998, our
year-end results reflect a loss in the fourth quarter of $802,000, and we may
sustain additional losses in the near future.
We have a need to finance our working capital requirements. See
Management's Discussion and Analysis - Liquidity and Capital Resources.
We are heavily dependent on sales overseas for our revenues. Approximately
60%, 69% and 70% of our sales for 1998, 1997 and 1996, were made to foreign
telephone operating companies. In selling to customers in foreign countries, we
are exposed to inherent risks not normally present in the case of our sales to
United States customers, including extended delays in completing and customer
final payment for our Operational Support Systems contracts, and political and
economic change. In foreign markets, we face considerable competition from other
United States and foreign telephone equipment manufacturers most of which are
larger and have substantially greater financial resources than us. In addition,
if we establish facilities in foreign countries, we face risks associated with
currency devaluation, difficulties in either converting local currency into
dollars or transferring funds to the United States, local tax and currency
regulations and political instability.
We rely heavily on a few customers for most of our sales. See "Significant
Customers" and Note 17 of Notes to the Consolidated Financial Statements.
9
We experience difficulties with Operational Support System contracts. We
experience delays in purchaser acceptance of the Operational Support Systems and
our receipt of final contract payments in connection with a number of foreign
sales. In addition, we have no steady or predictable flow of orders for
Operational Support Systems. The Operational Support System is a complex system
and, in most applications, incorporates features designed to respond to a
purchaser's operational requirements and the particular characteristics of the
purchaser's telephone system. As a result, the negotiation of a contract for an
Operational Support System is an individualized and highly technical process.
Contracts for these systems frequently provide for manufacturing, delivery,
installation, testing and purchaser acceptance to take place over periods of up
to a year or more. These contracts typically contain performance guarantees by
us and clauses imposing penalties on us if we do not meet the contractual
in-service dates. The installation, testing and purchaser acceptance phases of
these contracts may last longer than contemplated by the contracts and,
accordingly, amounts due under the contracts may not be collected for extended
periods.
Many of our competitors are larger and have vastly greater financial
resources. We compete directly with a number of large and small telephone
equipment manufacturers in the United States, with Lucent Technologies, Inc.
continuing to be our principal United States competitor. Lucent's greater
resources, extensive research and development facilities, long-standing
equipment supply relationships with the regional "Baby Bell" companies and
history of manufacturing and marketing products similar in function to those
produced by us continue to be significant factors in our competitive
environment. Furthermore, in the past, competitors have used our financial
difficulties as a sales tool.
Intense competition, rapid technological change and a movement to private
ownership of telecommunications equipment characterize our industry. In
competing for telephone operating company business, the purchase price of
equipment and associated operating expenses have become significant factors,
along with product design and long-standing equipment supply relationships. In
the customer premises equipment market, we operate in a market in which the
products are comparable and the price is the crucial factor in generating sales.
In connection with overseas sales of our line connecting/protecting
equipment, we have met with significant competition from United States and
foreign manufacturers of comparable equipment and expect this competition to
continue. In addition to Lucent, a number of our overseas competitors have
significantly greater resources than us.
We require access to current technological developments. We rely primarily
on the performance and design characteristics of our products and we try to
offer our products at prices and with warranties that will make our products
competitive. Our business could be adversely affected if we cannot obtain
licenses for such updated technology or self develop state of the art
technology.
We rely on certain key employees. We may be dependent upon the continued
employment of certain key employees, including our senior executive officers.
Our failure to retain such employees may have a material adverse effect upon our
business.
We may have problems with the year 2000 issue. See Management's Discussion
and Analysis - "Year 2000 Issue" disclosure.
We do not pay dividends on Common Stock. We have not paid dividends on our
Common Stock and do not anticipate paying dividends in the foreseeable future.
We presently intend to retain future earnings, if any, in order to provide funds
for use in the operation and expansion of our business and, accordingly, do not
anticipate paying cash dividends on our Common Stock in the foreseeable future.
In addition, our agreement with our senior secured lender prohibits payment of
dividends.
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; and 5,300 square feet of office space used for software
development located in Charlotte, North Carolina. The Company also owns a 31,000
square foot manufacturing and research and development 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 expires December 2000, and the Charlotte, North Carolina lease expires in
April 1999. Management is in the process of evaluating its needs at its North
Carolina location and will make a determination regarding the lease prior to the
lease expiration of April 1999. The aggregate annual rental is approximately
$450,000.
The Company's wholly-owned Mexican subsidiary owns an approximately 40,000
square foot manufacturing facility in Matamoros, Mexico. A wholly-owned United
Kingdom subsidiary owns a 34,300 square foot facility in Coventry, England,
which facility comprises all of the Company's office, plant and warehouse space
in the United Kingdom. Subsequent to year end, the Company's United Kingdom
subsidiary entered into a sale lease back agreement whereby the Company sold the
building for approximately $400,000 and entered into a 20 year lease
arrangement.
The Company believes its properties are adequate for its needs.
10
Item 3. Legal Proceedings
In July 1996, an action was commenced against the Company and certain
present and former directors in the Supreme Court of the State of New York, New
York County by certain stockholders and warrant holders of the Company who
acquired their securities in connection with the acquisition by the Company of
Aster Corporation. The complaint alleges breach of contract against the Company
and breach of fiduciary duty against the directors arising out of an alleged
failure to register certain restricted shares and warrants owned by the
plaintiffs. The complaint seeks damages of $413,000; however, counsel for the
plaintiff has advised the Company that additional plaintiffs may be added and,
as a result, the amount of damages claimed may be substantially greater than the
amount presently claimed. The Company believes that the defendants have valid
defenses to the claims. The action is currently in the discovery stage.
In July 1996, the Securities and Exchange Commission (the "SEC") issued an
order (the "Order") directing a private investigation of the Company to
determine whether there has been a violation of Federal securities laws. The SEC
indicated to counsel for the Company that the investigation relates to the
position of the SEC staff that the independence of the Company's auditors for
1995, KPMG Peat Marwick LLP ("Peat Marwick"), was adversely impacted by certain
relationships involving Peat Marwick, on the one hand, and KPMG BayMark
Strategies LLC ("BayMark") and Edward R. Olson, the President of BayMark and the
Company's former interim president and chief operating officer, on the other
hand. Although the Company does not agree with the position of the SEC staff
with respect to the independence of Peat Marwick, the Company is cooperating
with the SEC's investigation. The Company retained BDO Seidman, LLP to reaudit
the Company's 1995 financial statements, which reaudit resulted in no changes to
the Company's 1995 financial statements as audited by Peat Marwick. The Company
does not believe that the investigation will result in any material liability on
the part of the Company. The Company is not aware of any further activity
respecting this investigation since November 1996.
Item 4. Submission of Matters to a Vote of Securities Holders
During the fourth quarter of 1998, there were no matters required to be
submitted to a vote of security holders of the Company.
11
Item Pursuant to Instruction 3 of Item 401 (b) of Regulation S-K:
Executive Officers of the Company
Name and Position Age
- ----------------- ---
William V. Carney 61
Chairman of the Board
Chief Executive Officer
Seymour Joffe 69
President and Chief Operating Officer
Michael A. Tancredi 69
Senior Vice President, and Secretary and Treasurer
Edward B. Kornfeld 55
Senior Vice President - Operations
Chief Financial Officer
Ronald Wilkins 42
Senior Vice President and Managing
Director - OSS
John J. Gazzo 55
Senior Vice President
Michael Bahlo 40
Senior Vice President
Prem G. Chandran 46
Vice President
Edmund Chiodo 44
Vice President
David Rawlings 55
Vice President
William Novelli 67
Vice President
Gerald Hammond 44
Vice President
Michael Lamb 33
Vice President
All of the Company's officers serve at the pleasure of the Board of
Directors. Of the executive officers listed above, Messrs. Carney, Joffe and
Tancredi are also members of the Board of Directors. There is no family
relationship between any of the executive officers listed above.
12
Mr. Carney was elected as Chairman of the Board of Directors and Chief
Executive Officer in 1996 and has served as a director since 1970. Previously,
Mr. Carney had served as Secretary since 1970, 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. Joffe was elected President and Chief Operating Officer in 1996. Mr.
Joffe, who served as director of the Company from 1987 to 1992, has most
recently served the Company as senior consultant to its Operations Support
Systems (OSS) business. Mr. Joffe has been Chairman of JSI International, Inc.
which represents companies in the marketing and positioning of high-tech
products and serves in the Asia Pacific area. Mr. Joffe has also served as an
officer and director of a number of public and private companies involved in the
computer and telecommunications industries.
Mr. Tancredi was elected Senior Vice President and Secretary in 1996. He
has been Treasurer since April 1978 and Director since 1970. He had served as
Vice President between March 1984 to October of 1996. He was Vice President from
April 1978 to February 1984 and Comptroller from April 1971 to March 1978.
Mr. Kornfeld was elected a Senior Vice President-Operations in 1996. He
has served as Vice President-Finance and Chief Financial Officer of the Company
since 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. Wilkins was elected a Senior Vice President and Managing Director, OSS
Division in 1998. Prior to joining Porta Systems Corp. in 1998, Mr. Wilkins was
involved in the wireless telecommunication industry as President and CEO of
Sycom Technologies from November 1997 to August 1998, and Vice President of
Strategic Planning and Alliances at Conxus Communications from December 1995 to
October 1997. Prior to October 1997, Mr. Wilkins held various management
positions with Digital Equipment Corporation.
Mr. Gazzo was elected Senior Vice President in March 1996. He 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. Bahlo was elected Senior Vice President - OSS Sales and Marketing in
January 1999. Prior to joining the Company, Mr. Bahlo was the Vice President,
Marketing and Sales for Daikin U.S. Comtec Laboratories from March 1997 to March
1999, and held various management and marketing positions with Digital Equipment
Corporation from October 1986 to March 1997 most recently as Marketing Group
Manager.
Mr. Chandran was elected Vice President in December 1995. Mr. Chandran has
been with the Company as Assistant Vice President of Engineering since 1991.
Mr. Chiodo was elected Vice President in March 1996. Mr. Chiodo has been
with the Company since 1980. During that time he has held various positions
within the Company, most recently as Assistant Vice President of OSS operations.
Mr. Rawlings was elected Vice President in March 1996. Mr. Rawlings has
been the Assistant Vice President of Research and Development - Copper products
since 1992.
Mr. Novelli was elected Vice President in December 1996. Mr. Novelli has
been the Assistant Vice President of Sale and Marketing - Copper products since
1989.
Mr. Hammond was elected Vice President in March 1997. Mr. Hammond has been
with the Company since 1970. During that time he has held various positions with
the Company, most recently as Assistant Vice President of Research and
Development.
13
Mr. Lamb was elected Vice President - OSS Business Development in January
1999. Prior to joining the Company, Mr. Lamb was most recently Vice President,
Sales and Marketing at audiohighway.com, Inc. Before that he served as Vice
President, Business Development at Sycom Technologies, Inc. from 1993 to 1998,
where he continues to be a member of the board of directors.
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,
1997 through December 31, 1998, 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. Share prices listed below have been
restated to give effect to the one for five reverse stock split which became
effective on August 2, 1996.
High Low
---- ---
1997
First Quarter $2 1/8 $1 3/8
Second Quarter 2 15/16 1 1/4
Third Quarter 5 1/4 2 5/16
Fourth Quarter 4 1/4 3
1998 First Quarter 4 2 7/8
Second Quarter 5 3/8 3 1/2
Third Quarter 4 15/16 1 5/8
Fourth Quarter 2 1/4 1 1/4
The Company did not declare or pay any cash dividends in 1998 or 1997. 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 12, 1999, the Company had approximately 1,036 stockholders of
record.
Item 6. Selected Financial Data
The following table sets forth certain selected consolidated financial
information of the Company. All share and per share data have been restated to
give effect to the one for five reverse stock split which became effective on
August 2, 1996. 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,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In thousands, except per share data)
Income Statement Data:
Sales $ 59,343 $ 62,230 $ 57,987 $ 61,181 $ 68,985
Operating income (loss) 4,566 6,101 3,982 (19,884) (17,541)
Debt conversion expense (945) (11,458) -- -- --
Income (loss) before discontinued
operations and extraordinary item 451 (7,021) 1,252 (29,297) (39,995)
Net income (loss) 527 (6,899) 5,174 (31,041) (39,995)
Basic per share amounts:
Continuing operations $ 0.05 $ (2.26) $ 0.57 $ (20.05) $ (27.51)
Net income (loss) $ 0.06 $ (2.22) $ 2.37 $ (21.25) $ (27.51)
Diluted per share amounts:
Continuing operations $ 0.04 $ (2.26) $ 0.23 $ (20.05) $ (27.51)
Net income (loss) $ 0.05 $ (2.22) $ 0.94 $ (21.25) $ (27.51)
Cash dividends declared -- -- -- -- --
Number of shares used in
calculating net income (loss)
per share-basic 9,281 3,111 2,184 1,461 1,454
Number of shares used in
calculating net income (loss)
per share-diluted 9,785 3,111 5,528 1,461 1,454
Balance Sheet Data:
Total assets $ 52,136 $ 51,000 $ 51,660 $ 60,591 $ 84,963
Long-term debt excluding current
maturities $ 17,238 $ 18,858 $ 45,804 $ 55,389 $ 57,310
Stockholders' equity (deficit) $ 11,984 $ 6,813 $(19,702) $(29,323) $ 1,525
16
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
The Company's consolidated statements of operations for the three years
ended December 31, 1998, 1997 and 1996, respectively, as a percentage of sales
follows:
Years Ended December 31,
1998 1997 1996
---- ---- ----
Sales 100% 100% 100%
Cost of sales 59% 61% 63%
Gross Profit 41% 39% 37%
Selling, general and
administrative expenses 22% 20% 23%
Research and development expenses 11% 9% 7%
---- ---- ----
Operating income 8% 10% 7%
Interest expense (6%) (5%) (9%)
Gain on sale of assets -- -- 4%
Other 2% 2% 1%
Debt conversion expense (2%) (19%) --
---- ---- ----
Income (loss) from continuing
operations before income
taxes and minority interest 2% (12%) 3%
Income tax expense (benefit)
and minority interest 1% (1%) 1%
---- ---- ----
Income (loss) before extraordinary gain 1% (11%) 2%
Extraordinary gain on early
extinguishment of debt -- -- 7%
---- ---- ----
Net income (loss) 1% (11%) 9%
==== ==== ====
17
Results of Operations
Years Ended December 31, 1998 and 1997
The Company's sales for 1998 were $59,343,000 compared to $62,230,000 in
1997, a decrease of $2,887,000 (5%). The decrease in revenue is attributed
principally to shortfalls from the Company's OSS division.
OSS sales for 1998 were $27,318,000, compared to 1997 sales of
$29,561,000, a decrease of $2,243,000 (8%). The decreased sales relate primarily
to delays in the installation of certain contracts and delays in the receipt of
new anticipated orders.
Line connection/protection equipment sales for 1998 increased
approximately $538,000 (2%) from $23,753,000 in 1997 to $24,291,000 1998. This
increase relates to improved sales to a customer in Mexico, which were offset by
decreased sales of a certain product line to BT. During 1997, the Company
completed delivery of products to BT under a prior agreement and commenced
delivery of a replacement product. The decline reflected both a decrease in the
number of units sold and a lower selling price per unit for the replacement
product.
Signal processing revenue for 1998 compared to 1997 decreased by $741,000
(9%) from $8,280,000 to $7,539,000. During 1997 revenue was generated from the
earlier than anticipated completion of military orders and non-recurring revenue
from certain engineering services, which was not repeated in 1998. This
represents the decreased revenue from 1997 to 1998.
Cost of sales for the year ended December 31, 1998, as a percentage of
sales compared to 1997, decreased from 61% to 59%. The improvement in gross
margin is attributed to the Company's continuing effort to increase
manufacturing productivity and the decrease of certain fixed expenses associated
with the OSS contracts.
Selling, general and administration expenses increased by $261,000 (2%)
from $12,818,000 to $13,079,000 from December 31, 1998 compared to 1997. The
increase relates primarily to sales commissions on certain line
connection/protection equipment sales for 1998.
Research and development expenses increased by $1,149,000 (21%) from
$5,361,000 in 1997 to $6,510,000 in 1998. The increased expense results from the
Company's efforts to develop new products primarily related to the OSS business
including the MKIII test head.
As a result of the above, the Company had operating income of $4,566,000
in 1998 versus $6,101,000 in 1997, a decrease of 25%. The Company's decreased
operating income for the year ended December 31, 1998, when compared to the year
ended December 31, 1997, was primarily the result of lower levels of revenue
from OSS coupled with increased research and development expenses.
Interest expense for 1998 increased by $371,000 from $3,379,000 for
1997 to $3,750,000 in 1998. The increase in interest expense is attributable
primarily to the issuance of $6,000,000 of 12% subordinated notes, which was
slightly offset by repayments of principal to the Company's senior lender.
18
Results of Operations (continued)
Other income for 1998 included approximately $240,000 from the final
settlement of an insolvency procedure involving the purchaser of the Company's
Israeli operations, which the Company sold in 1992, and $400,000 from the
settlement of a lawsuit against a former vendor.
During 1998 and 1997, the Company recorded debt conversion expenses of
$945,000 and $11,458,000 as a result of the exchange of Zero coupon notes into
common stock. The debt conversion expense represents the difference between the
original conversion price per share of $6.55 and the reduced conversion price
per share of $3.65 (see Notes to Consolidated Financial Statements, Note 6).
During 1998 and 1997, the Company recorded an extraordinary gain from the
early extinguishment of its Debentures of $76,000 and $122,000, respectively
(see Notes to Consolidated Financial Statements, Note 6).
At December 31, 1998, income tax expenses of $606,000 primarily represents
income taxes payable by the Company's UK and Chilean subsidiaries. For 1997, the
Company recorded an income tax benefit of $585,000, reflecting the difference
between a $802,000 deferred tax asset and the Company's tax expenses of
$217,000.
As the result of the foregoing, the 1998 net income was $527,000, $0.06
per basic share and $0.05 per diluted share, compared with a net loss of
$6,899,000, $2.22 per share, for 1997. Basic net income (loss) per share is
based on the weighted average number of shares outstanding. Diluted net income
(loss) per share is based on the weighted average number of shares outstanding
plus dilutive potential shares of common stock. The calculation of the diluted
net income per share for the year ended December 31, 1998, assumes the exercise
of dilutive options and warrants and the conversion of the Debentures. For 1997,
no dilutive potential shares of common stock were added to compute diluted loss
per share because the effect is anti-dilutive.
Years Ended December 31, 1997 and 1996
The Company's sales for 1997 were $62,230,000 compared to $57,987,000 in
1996, an increase of $4,243,000 (7%). The increase in revenue is attributed to
improvement in all of the Company's divisions.
OSS sales for 1997 were $29,561,000, compared to 1996 sales of
$26,804,000, an increase of $2,757,000 (10%). The increased sales relate
primarily to higher volumes generated from the installation of the OSS systems
to the existing customer base.
Line connection/protection equipment sales for 1997 increased
approximately $504,000 (2%) from $23,249,000 in 1996 to $23,753,000 1997. This
increase relates to improved domestic sales, which were offset by decreased
sales of a certain product line to BT. During 1997, the Company completed
delivery of products to BT under a prior agreement and commenced delivery of a
replacement product. The decline reflected both a decline in the number of units
sold and a lower selling price per unit for the replacement product. At December
31, 1997, the orders from BT for this product reflect a continuation of sales at
the reduced level.
Signal processing revenue for 1997 compared to 1996 increased by $683,000
(9%) from $7,597,000 to $8,280,000. The increased revenue was generated from the
earlier than anticipated completion of military orders and non-recurring revenue
from certain engineering services.
19
Results of Operations (continued)
Cost of sales for the year ended December 31, 1997, as a percentage of
sales compared to 1996, decreased from 63% to 61%. The improvement in gross
margin is attributed to the Company's continuing effort to increase
manufacturing productivity and the absorption, over a larger revenue base, of
certain fixed expenses associated with the OSS contracts.
Selling, general and administration expenses decreased by $748,000 (6%)
from $13,566,000 to $12,818,000 from December 31, 1997 compared to 1996. The
decrease reflects the Company's continuing efforts to reduce its costs and
expenses.
Research and development expenses increased by $1,513,000 (39%) from
$3,848,000 in 1996 to $5,361,000 in 1997. The increased expenses results from
the Company's efforts to develop new products, primarily related to the OSS
business.
As a result of the above, the Company had operating income of $6,101,000
in 1997 versus $3,982,000 in 1996, an increase of 53%. The Company's operating
improvement for the year ended December 31, 1997, when compared to the year
ended December 31, 1996, were the results of increased revenue which allowed for
greater manufacturing efficiencies, and the reduced level of selling, general
and administrative expenses.
Interest expense for 1997 decreased by $1,949,000 from $5,328,000 for 1996
to $3,379,000 in 1997. The decrease in interest expense is attributable
primarily to the exchange of the Company's 6% Debentures for the Zero coupon
notes and common stock, which occurred primarily in the first and second
quarters of 1996, and repayment of principal to the Company's senior lender. In
addition, during 1996, the Company incurred additional interest expense
resulting from recognition of certain deferred borrowing costs related to its
loans from its senior lender.
Other income for 1997 included $700,000 from the settlement of an
insolvency procedure involving the purchaser of the Company's Israeli
operations, which the Company sold in 1992.
During 1997, the Company recorded debt conversion expenses of $11,458,000
as a result of the exchange of Notes into common stock. The debt conversion
expense represents the difference between the original conversion price per
share of $6.55 and the reduced conversion price per share of $3.65. In addition,
in connection with this transaction the Company incurred legal expenses of
$234,000 and incurred expenses of $578,000 representing the value of the common
stock and warrants issued (see Notes to Consolidated Financial Statements, Note
6).
During 1997 and 1996, the Company recorded an extraordinary gain from the
early extinguishment of its 6% Debentures of $122,000 and $3,922,000,
respectively (see Notes to Consolidated Financial Statements, Note 6).
At December 31, 1997 the Company recorded an income tax benefit of
$585,000, reflecting the difference between a $802,000 deferred tax asset and
the Company's tax expenses of $217,000, at December 31, 1997.
As the result of the foregoing, the Company incurred a net loss of
$6,899,000, $2.22 per share, for 1997, compared with net income of $5,174,000,
$2.37 per basic share and $0.94 per diluted share, for the year ended December
31, 1996. Basic net income (loss) per share is based on the weighted average
number of shares outstanding. Diluted net income (loss) per share is based on
the weighted average number of shares outstanding plus dilutive potential shares
of common stock. The calculation of the diluted net income per share for the
year ended December 31, 1996, assumes the conversion of the Zero coupon notes
which are dilutive. For 1997, no dilutive potential shares of common stock were
added to compute diluted loss per share because the effect is anti-dilutive.
20
Liquidity and Capital Resources
At December 31, 1998 the Company had cash and cash equivalents of
$3,044,000 compared with $5,091,000 at December 31, 1997. The Company's working
capital at December 31, 1998 was $14,262,000, compared to $7,286,000 at December
31, 1997. The improvement in working capital from December 31, 1997 to December
31, 1998 reflects (i) increased accounts receivable which reflects higher sales
at the end of 1998 of line connection equipment and (ii) the reduced balance of
the Convertible subordinated debentures.
As of December 1, 1998, the Company's loan and security agreement with its
senior secured lender, Foothill Capital Corporation ("Foothill"), was amended,
pursuant to which the loan agreement was extended through January 2, 2001, and
the quarterly loan amortization payment was increased from $325,000 to $400,000
effective for the September 1998 payment. In addition, the revised agreement
requires all principal payments after August 1998 be applied first to the
non-interest bearing notes payable until the notes are paid in full and then to
the term loan. The Company had a revolving line of credit and a letter of credit
facility of $9,000,000 as of December 31, 1998. Availability under this facility
as of that date was approximately $4,000,000. During 1998, the Company repaid
$4,780,000 to Foothill of which $2,950,000 was provided from the proceeds of its
12 % Subordinated Note private placement as described below.
As of December 31, 1998, the Company had remaining outstanding $365,000 of
the 6% Debentures, net of original issue discount of $20,000, which mature July
2, 2002. The face amount of the outstanding 6% Debentures was $385,000. The
interest accrued on the 6% Debentures is payable on July 1 of each year and as
of December 31, 1998 was $12,000. At December 31, 1998, the Company was current
on its interest obligations, which were in arrears in 1997, 1996 and 1995 for
failing to make the interest payments due. Accordingly, the 6% Debentures are no
longer in default.
In January 1998, the Company raised $6,000,000 from the private placement
of 60 units at $100,000 per unit. Each unit consisted of (a) the Company's 12 %
Subordinated Note due January 3, 2000 (a "Subordinated Note"), in the principal
amount of $100,000, and (b) a Series B Common Stock Purchase Warrant (a "Series
B Warrant") to purchase 10,000 shares of Common Stock at $3.00 per share through
December 31, 2002. The proceeds from the sale of the Units was used principally
to pay the remaining $2,796,000 principal amount of Notes which had not been
converted (See Notes to Consolidated Financial Statements, Note 6) and to reduce
the Company's senior debt to Foothill by approximately $2,950,000 (See Notes to
Consolidated Financial Statements, Note 7). The balance of such proceeds was
added to working capital.
The Company believes that its current cash position, internally generated
cash flow and its loan facility will be sufficient to satisfy the Company's
anticipated operating needs for at least the ensuing twelve months. However, as
of December 31, 1998 the Company's long-term debt includes $6,000,000 12%
Subordinated Notes, all of which are due and payable on January 3, 2000. At
December 31, 1998 the Company does not have sufficient resources to pay the
Notes when they mature and it is likely that it cannot generate such cash from
its operations. Although the Company is seeking to refinance or restructure the
Notes and believes it will be able to prior to the maturity date, no assurance
can be given that it will be successful in these efforts. If the Company is
unable to refinance or restructure the Company's business may be materially and
adversely affected.
21
Year 2000 Issue
Many existing computer programs use only two digits to identify a year in
a date field. These programs were designed and developed without considering the
impact of the upcoming change in the century. If not corrected, many computer
applications could fail or create erroneous results by or at the year 2000. This
is referred to as the "Year 2000 Issue." Management has initiated a company-wide
program to prepare the Company's computer systems and applications for year 2000
compliance.
The Company has assigned a team to monitor Year 2000 compliance. With
respect to the products the Company offers for sale, the Company has verified
that the products are Year 2000 compliant. The team is charged with ensuring
Year 2000 compliance for all hardware and software products through its
purchasing process, as well as assessing the Year 2000 readiness and risk to the
Company of its critical vendors and suppliers. The team is also responsible to
coordinate Year 2000 compliance for its internal systems and devices. At
present, Year 2000 compliance of the Company's internal systems and devices is
scheduled to be substantially complete by September 1999.
The Company expects to incur internal staff costs as well as other
expenses necessary to prepare its systems for the year 2000. The Company expects
to both replace some systems and upgrade others. Maintenance or modification
costs will be expensed as incurred. Management estimates that the cost of this
program will approximate $500,000, with approximately $200,000 representing
incremental costs to the Company. The total cost effort does not include
potential costs related to any customer or other claims or the cost of internal
hardware or software replaced in the normal course of business. Based upon
current information and assessment, the Company does not believe that the Year
2000 issue as discussed above will be material to its financial position or
results of operations or that its business will be adversely affected in any
material respect. Nevertheless, achieving Year 2000 compliance is dependent upon
many factors, some of which are not completely within the Company's control.
Should either the Company's internal systems or one or more of its critical
vendors or suppliers fail due to Year 2000 issues, the Company's business and
its results of operations could be adversely affected.
The Company has evaluated the worst case scenarios in the event that its
products, systems, or business partners are not Year 2000 ready and has
formulated contingency plans to operate. If the Company's investigations suggest
that there is a significant risk that certain products, systems, or business
partners might not be Year 2000 ready, the Company will execute its contingency
plans accordingly.
Statements contained in this Year 2000 disclosure are subject to certain
protection under the Year 2000 Information and Readiness Disclosure Act.
22
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.
Not Applicable.
Item 8. Financial Statements and Supplementary Data.
See Exhibit I
Item 9. Changes In and Disagreements With Accountants On
Accounting and Financial Disclosure.
Not Applicable
Part III
Item 10, 11, 12, and 13.
The information called for by Item 10 (Directors and Executive Officers),
Item 11 (Executive Compensation), Item 12 (Security Ownership of Certain
Beneficial Owners and Management), and Item 13 (Certain Relationships and
Related Transactions) is incorporated herein by reference from the Company's
definitive proxy statement for the Annual Meeting of Shareholders to be filed
with the Securities and Exchange Commission not later than 120 days after the
close of the year ended December 31, 1998.
23
Part IV
Item 14. Exhibits, Financial Statements Schedules and Reports
on Form 8-K.
(a) Document filed as part of this Annual Report on Form 10-K:
(i) Financial Statements.
See Index to Consolidated Financial Statements under Item 8 hereof.
(ii) Financial Statement Schedules.
None
Schedules not listed above have been omitted for the reasons that they
were inapplicable or not required or the information is given elsewhere in the
financial statements.
Separate financial statements of the registrant have been omitted since
restricted net assets of the consolidated subsidiaries do not exceed 25% of
consolidated net assets.
(b) Reports on Form 8-K
None.
(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 10K for the year ended
December 31, 1991.
3.2 Certificate of Designation of Series B Participating
Convertible Preferred Stock, incorporated by reference to
Exhibit 3.2 of the Company's Annual Report on Form 10K for the
year ended December 31, 1995.
3.3 By-laws of the Company, as amended to date, incorporated by
reference to Exhibit 3.3 of the Company's Annual Report on
Form 10K for the year ended December 31, 1995.
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 Amendments, 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.
24
Exhibits (continued)
Exhibit No. Description of Exhibit
4.2.1 Amendment No. 1 to Rights Agreement, dated July 28, 1993
between the Company and The Chase Manhattan Bank (formerly
known as 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.
4.2.2 Amendment No. 2 to Rights Agreement, dated December 24, 1997
between the Company and The Chase Manhattan Bank (formerly
known as Chemical Bank, as successor by merger to
Manufacturers Hanover Trust Company) as Rights Agent.
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,
incorporated by reference to Exhibit 4.7 of the Company's
Annual Report on Form 10K for the year ended December 31,
1995.
4.7.1 Letter Agreement dated as of February 13, 1995, incorporated
by reference to Exhibit 4.7.1 of the Company's Annual Report
on Form 10K for the year ended December 31, 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,
incorporated by reference to Exhibit 4.7.2 of the Company's
Annual Report on Form 10K for the year ended December 31,
1995.
4.8 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, incorporated by reference to Exhibit 4.9 of the
Company's Annual Report on Form 10K for the year ended
December 31, 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, incorporated by reference to
Exhibit 4.11 of the Company's Annual Report on Form 10K for
the year ended December 31, 1995.
25
Exhibits (continued)
Exhibit No. Description of Exhibit
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 favor of Foothill Capital Corporation, incorporated
by reference to Exhibit 4.12.1 of the Company's Annual Report
on Form 10K for the year ended December 31, 1995.
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.
4.19 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 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.
26
Exhibits (continued)
Exhibit No. Description of Exhibit
4.23 Amendment No. Five dated as of November 30, 1997, to Amended
and Restated Loan and Security agreement between Foothill
Capital Corp. ("Foothill") and the Company, including
amendments to the warrants held by Foothill, incorporated by
reference to Exhibit 4.23 of the Company's Form 8-K dated
January 2, 1998.
4.24 Amendment No. Six dated as of August 1, 1998 to Amended and
Restated Loan and Security agreement between Foothill Capital
Corp. ("Foothill") and the Company.
4.25 Amendment No. Seven dated as of December 1, 1998 to Amended
and Restated Loan and Security agreement between Foothill
Capital Corp. ("Foothill") and the Company.
10.1 Form of Split Dollar Agreement--more than ten years,
incorporated by reference to Exhibit 19 (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 10.3 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 19 (cc) of the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1985.
10.6 Agreement dated May 25, 1988 between British
Telecommunications plc and the Company, incorporated by
reference to Exhibit 19 (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.
10.6.1 Amendment to agreement of May 25, 1988, dated September 1,
1996, between British Telecommunications plc and the Company,
incorporated by reference to Exhibit 10.6.1 of the Company's
Annual Report on Form 10-K for the year ended December 31,
1996.
27
Exhibits (continued)
Exhibit No. Description of Exhibit
10.10 Form of Employment Contract dated October 16, 1995 between the
Company and Edward B. Kornfeld, incorporated by reference to
Exhibit 10.10 of the Company's Annual Report on Form 10K for
the year ended December 31, 1995.
10.11 (Deleted)
10.14 1996 Stock Option Plan filed as Exhibit A to the Proxy
Statement for the 1996 Annual Meeting to Stockholders and
incorporated herein by reference.
10.15 Form of subscription agreement for Units, including the form
of 12% Note, Series B Warrant and Series C Warrant,
incorporated by reference to Exhibit 10.15 of the Company's
Form 8-K dated January 2, 1998.
10.16 Agreement dated January 26, 1998, among the Company and Henley
Group, Ltd., Woodstead Associates, L.P., Lake Trust and Smith
Management Company, Inc. incorporated by reference to Exhibit
10.16 of the Company's Form 8-K dated January 2, 1998.
10.17 1998 Stock Option Plan filed as Exhibit 4.2 to the Form S-8
dated December 3. 1998 and incorporated herein by reference.
10.18 Senior Officer and Directors Stock Purchase Program filed as
Exhibit 4.2 to the Form S-8 dated February 12, 1999 and
incorporated herein by reference.
10.19 Employee Stock Purchase Plan filed as Exhibit 4.1 to the Form
S-8 dated February 12, 1999 and incorporated herein by
reference.
10.20 Subsidiaries of the Company, incorporated by reference to
Exhibit 22.1 of the Company's Annual Report on Form 10K for
the year ended December 31, 1995.
23 Consent of Independent Auditors.
28
SIGNATURES
Pursuant to the requirements of Section 13 or 15(b) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
PORTA SYSTEMS CORP.
Dated March 23, 1999 By /s/ William V. Carney
-------------------------
William V. Carney
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the report has been signed by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated. Each person whose
signature appears below hereby authorizes William V. Carney and Edward B.
Kornfeld or either of them acting in the absence of the others, as his true and
lawful attorney-in-fact and agent, with full power of substitution and
resubstitution for him and in his name, place and stead, in any and all
capacities to sign any and all amendments to this report, and to file the same,
with all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission.
Signature Title Date
--------- ----- ----
/s/William V. Carney Chairman of the Board, March 23, 1999
- -------------------------------- Chief Executive Officer and
William V. Carney Director (Principal Executive
Officer)
/s/Edward B. Kornfeld Senior Vice President and March 23, 1999
- -------------------------------- Chief Financial Officer
Edward B. Kornfeld (Principal Financial and
Accounting Officer)
/s/Seymour Joffe Director March 23, 1999
- --------------------------------
Seymour Joffe
/s/Michael A. Tancredi Director March 23, 1999
- --------------------------------
Michael A. Tancredi
/s/Warren H. Esanu Director March 23, 1999
- --------------------------------
Warren H. Esanu
/s/Herbert H. Feldman Director March 23, 1999
- --------------------------------
Herbert H. Feldman
/s/Stanley Kreitman Director March 23, 1999
- --------------------------------
Stanley Kreitman
/s/Lloyd I. Miller, III Director March 23, 1999
- --------------------------------
Lloyd I. Miller, III
/s/Robert Schreiber Director March 23, 1999
- --------------------------------
Robert Schreiber
29
Exhibit I
Item 8. Financial Statements and Supplementary Data
Index Page
- ----- ----
Report of Independent Certified Public Accountants F-2
Consolidated Financial Statements and Notes:
Consolidated Balance Sheets,
December 31, 1998 and 1997 F-3
Consolidated Statements of Operations and
Comprehensive Income (Loss),
Years Ended December 31, 1998, 1997 and 1996 F-4
Consolidated Statements of Stockholders'
Equity (Deficit), Years Ended
December 31, 1998, 1997 and 1996 F-5
Consolidated Statements of Cash Flows
for the Years Ended December 31, 1998,
1997 and 1996 F-6
Notes to Consolidated Financial Statements F-7
F-1
Report of Independent Certified Public Accountants
The Board of Directors and
Stockholders of Porta Systems Corp.:
We have audited the accompanying consolidated balance sheets of Porta Systems
Corp. and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations and comprehensive income (loss),
stockholders' equity (deficit), and cash flows for each of the three years in
the period ended December 31, 1998. 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, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
/s/BDO SEIDMAN, LLP
------------------------
BDO SEIDMAN, LLP
Melville, New York
March 12, 1999
F-2
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1998 and 1997
(Dollars in thousands)
Assets 1998 1997
------ ---- ----
Current assets:
Cash and cash equivalents $ 3,044 5,091
Accounts receivable - trade, less allowance for
doubtful accounts of $915 in 1998 and $1,058
in 1997 19,802 14,891
Inventories 8,944 8,159
Prepaid expenses and other current assets 1,716 1,266
-------- --------
Total current assets 33,506 29,407
-------- --------
Property, plant and equipment, net 4,213 4,667
Deferred computer software, net 82 543
Goodwill, net of amortization of $3,763 in 1998 and
$3,301 in 1997 11,597 12,059
Other assets 2,738 4,324
-------- --------
Total assets $ 52,136 51,000
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of senior debt $ 2,000 1,900
6% Convertible subordinated debentures -- 1,758
Accounts payable 6,893 5,796
Accrued expenses 6,266 8,656
Accrued interest payable 545 398
Accrued commissions 2,438 2,444
Accrued deferred compensation 196 196
Income taxes payable 762 853
Short-term loans 144 120
-------- --------
Total current liabilities 19,244 22,121
-------- --------
Senior debt net of current maturities 11,188 16,062
12% subordinated notes 5,685 --
6% Convertible subordinated debentures 365 --
Zero coupon senior subordinated convertible notes -- 2,796
Deferred compensation 1,021 1,032
Income taxes payable 719 649
Other long-term liabilities 776 487
Minority interest 1,154 1,040
-------- --------
Total long-term liabilities 20,908 22,066
-------- --------
Commitments and contingencies
Stockholders' equity:
Preferred stock, no par value; authorized 1,000,000
shares, none issued -- --
Common stock, par value $.01; authorized 20,000,000
shares, issued 9,484,742 and 8,644,304 shares in
1998 and 1997, respectively 95 86
Additional paid-in capital 75,135 70,926
Accumulated deficit (57,273) (57,799)
Accumulated other comprehensive loss:
Foreign currency translation adjustment (3,754) (4,027)
-------- --------
14,203 9,186
Treasury stock, at cost, 30,940 shares (1,938) (2,066)
Receivable for employee stock purchases (281) (307)
-------- --------
Total stockholders' equity 11,984 6,813
-------- --------
Total liabilities and stockholders'
equity $ 52,136 51,000
======== ========
See accompanying notes to consolidated financial statements.
F-3
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income (Loss)
Years ended December 31, 1998, 1997 and 1996
(in thousands, except per share amounts)
1998 1997 1996
---- ---- ----
Sales $ 59,343 62,230 57,987
Cost of sales 35,188 37,950 36,591
-------- -------- --------
Gross profit 24,155 24,280 21,396
-------- -------- --------
Selling, general and administrative expenses 13,079 12,818 13,566
Research and development expenses 6,510 5,361 3,848
-------- -------- --------
Total expenses 19,589 18,179 17,414
-------- -------- --------
Operating income 4,566 6,101 3,982
Interest expense (3,750) (3,379) (5,328)
Interest income 272 259 136
Gain on sale of assets -- -- 2,264
Other income (expense), net 1,028 1,047 402
Debt conversion expense (945) (11,458) --
-------- -------- --------
Income (loss) before
income taxes and minority interest 1,171 (7,430) 1,456
Income tax expense (benefit) 606 (585) 100
Minority interest 114 176 104
-------- -------- --------
Income (loss) before extraordinary item 451 (7,021) 1,252
Extraordinary gain on early extinguishment of
debt 76 122 3,922
-------- -------- --------
Net income (loss) $ 527 (6,899) 5,174
======== ======== ========
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments 273 (1,015) 1,187
-------- -------- --------
Comprehensive income (loss) $ 800 (7,914) 6,361
======== ======== ========
Basic per share amounts:
Income (loss) before extraordinary item $ 0.05 (2.26) 0.57
Extraordinary item 0.01 0.04 1.80
-------- -------- --------
Net income (loss) per share
of common stock $ 0.06 (2.22) 2.37
======== ======== ========
Weighted average shares of common
stock outstanding 9,281 3,111 2,184
======== ======== ========
Diluted per share amounts:
Income (loss) before extraordinary item $ 0.04 (2.26) 0.23
Extraordinary item 0.01 0.04 0.71
-------- -------- --------
Net income (loss) per share
of common stock $ 0.05 (2.22) 0.94
======== ======== ========
Weighted average shares of common stock
outstanding 9,785 3,111 5,528
======== ======== ========
See accompanying notes to consolidated financial statements.
F-4
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity (Deficit)
Years ended December 31, 1998, 1997 and 1996
(In thousands)
Accumulated Receivable Total
Common Stock Other Retained for Stock-
------------------- Additional Comprehensive Earnings Employee holders'
No. of Par Value Paid-in Income (Accumulated Treasury Stock Equity/
Shares Amount Capital (Loss) Deficit) Stock Purchases (Deficit)
------ ------ ------- ---------- -------- ----- --------- ---------
Balance at December 31, 1995 1,492 $15 $33,308 $(4,199) $(56,074) $(2,066) $(307) $(29,323)
Net income 1996 - - - - 5,174 - - 5,174
Common stock issued 732 7 2,873 - - - - 2,880
Warrants issued - - 380 - - - - 380
Foreign currency translation
adjustment - - - 1,187 - - - 1,187
----- --- ------- ------- -------- ------- ----- -------
Balance at December 31, 1996 2,224 22 36,561 (3,012) (50,900) (2,066) (307) (19,702)
Net loss 1997 - - - - (6,899) - - (6,899)
Common stock issued 6,420 64 34,001 - - - - 34,065
Warrants issued - - 364 - - - - 364
Foreign currency translation
adjustment - - - (1,015) - - - (1,015)
----- --- ------- ------- -------- ------- ----- -------
Balance at December 31, 1997 8,644 86 70,926 (4,027) (57,799) (2,066) (307) 6,813
Net income 1998 - - - - 527 - - 527
Common stock issued 841 9 3,702 - - - - 3,711
Warrants issued - - 630 - - - - 630
Restructure of receivable for
employee stock purchases - - (123) - (1) 128 294 298
Receivable from directors and
officers stock purchase program - - - - - (268) (268)
Foreign currency translation
adjustment - - - 273 - - - 273
----- --- ------- ------- -------- ------- ----- -------
Balance at December 31, 1998 9,485 $95 $75,135 $(3,754) $(57,273) $(1,938) $(281) $11,984
===== === ======= ======= ======== ======= ===== =======
See accompanying notes to consolidated financial statements
F-5
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Note 21)
Years ended December 31, 1998, 1997 and 1996
(Dollars in thousands)
1998 1997 1996
---- ---- ----
Cash flows from operating activities:
Net income (loss) $ 527 (6,899) 5,174
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Gain on sale of assets -- -- (2,264)
Extraordinary gain (76) (122) (3,922)
Non-cash debt conversion expense 945 10,646 --
Non-cash financing expenses 473 274 2,280
Non-cash compensation expense 298 -- --
Realized gain on litigation settlement -- (229) (174)
Depreciation and amortization 2,195 3,040 3,941
Amortization of debt discounts 323 40 104
Minority interest 114 (176) 104
Changes in operating assets and liabilities:
Accounts receivable (4,911) 1,143 (3,408)
Inventories (785) (735) 1,555
Prepaid expenses (450) (484) (123)
Other receivables -- 31 --
Other assets 962 (122) (743)
Accounts payable, accrued expenses and other liabilities 276 (999) (1,788)
------- ------- -------
Net cash provided by (used in) operating activities (109) 5,408 736
------- ------- -------
Cash flows from investing activities:
Proceeds from disposal of assets held for sale, net -- 500 7,393
Proceeds from sale of assets -- -- 3,456
Capital expenditures, net (665) (409) (125)
------- ------- -------
Net cash provided by (used in) investing activities (665) 91 10,724
------- ------- -------
Cash flows from financing activities:
Proceeds from senior debt 6 306 1,343
Repayments of senior debt (4,780) (3,013) (10,403)
Proceeds from 12% subordinated debentures and warrants 6,000 -- --
Repayment of Zero coupon senior subordinated convertible notes (2,796) -- --
Proceeds (repayments) of notes payable/short-term loans 24 89 (337)
------- ------- -------
Net cash used in financing activities (1,546) (2,618) (9,397)
------- ------- -------
Effect of exchange rate changes on cash 273 (374) (588)
------- ------- -------
Increase (decrease) in cash and cash equivalents (2,047) 2,507 1,475
Cash and equivalents - beginning of year 5,091 2,584 1,109
------- ------- -------
Cash and equivalents - end of year $ 3,044 5,091 2,584
======= ======= =======
See accompanying notes to consolidated financial statements.
F-6
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(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
in which they are identified.
Concentration of Credit Risk
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist principally of cash and
accounts receivable. At times such cash in banks exceeds the FDIC
insurance limit.
As discussed in notes 17 and 22, substantial portions of the Company's
sales are to customers in foreign countries. The Company's credit risk
with respect to new foreign customers is reduced by obtaining letters
of credit for a substantial portion of the contract price, and by
monitoring credit exposure with each customer.
Cash Equivalents
The Company considers investments with original maturities of three months
or less at the time of purchase to be cash equivalents. Cash
equivalents consist of commercial paper.
Inventories
Inventories are stated at the lower of cost (on the average or first-in,
first-out methods) or market.
(Continued)
F-7
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
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 $461,000, $1,133,000 and $1,551,000 in 1998,
1997, and 1996, respectively.
Goodwill
Goodwill represents the difference between the purchase price and the fair
market value of net assets acquired in business combinations treated
as purchases. Goodwill is amortized on a straight-line basis over 20
to 40 years. At December 31, 1998, $9,587,000 of the goodwill is being
amortized over approximately 20 years and $2,010,000 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 tax law or rate changes are
included in income as part of deferred tax expense or benefit for the
period that includes the enactment date (note 13).
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.
(Continued)
F-8
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Net Income (Loss) Per Share
Basic net income (loss) per share is based on the weighted average number
of shares outstanding. Diluted net income (loss) per share is based on
the weighted average number of shares outstanding plus dilutive
potential shares of common stock, if such shares had been issued. The
calculation of the diluted net income per share for the year ended
December 31, 1998, assumes the exercise of dilutive options and
warrants and the conversion of the 6% Subordinated Debentures. For
1997 no dilutive potential common shares were added to compute diluted
loss per share because the effect was anti-dilutive. The calculation
of diluted net income per share for the year ended December 31, 1996,
assumes the conversion of the Zero coupon senior subordinated
convertible notes which were dilutive.
All share and per share information give effect to the one for five
reverse stock split effective August 2, 1996.
Reclassifications
Certain reclassifications have been made to conform prior years'
consolidated financial statements to the 1998 presentation.
Accounting for Stock-Based Compensation
The Company follows the Statement of Financial Accounting Standard No.
123, "Accounting for Stock-Based Compensation". The Company has
elected not to implement the fair value based accounting method for
employee stock options, but has elected to disclose the pro-forma net
income and earnings per share as if such method had been used to
account for stock-based compensation cost as described in the
Statement.
Accounting for the Impairment of Long-Lived Assets
The Company follows the Statement of Financial Accounting Standard No.
121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of". The Company believes that there
is no impairment of its long-lived assets.
Use of Estimates
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates
and assumptions that affect reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Among the more significant estimates
included in these consolidated financial statements are the estimated
allowance for doubtful accounts receivable, inventory reserves,
percentage of completion for long-term contracts, and the deferred tax
asset valuation allowance. Actual results could differ from those and
other estimates.
(Continued)
F-9
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
New Accounting Standards
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities".
SFAS No. 133 requires companies to recognize all derivative contracts
at their fair market values, as either assets or liabilities on the
balance sheet. If certain conditions are met, a derivative may be
specifically designated as a hedge, the objective of which is to match
the timing of gain or loss recognition on the hedging derivative with
recognition of (1) the changes in the fair value of the hedged asset
or liability that are attributable to the hedge risk, or (2) the
earnings effect of the hedged forecast transaction. For a derivative
not designated as a hedging instrument, the gain or loss is recognized
in income in the period of change. SFAS No. 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. The
Company believes the adoption of this statement will not have a
material effect on the Company's consolidated financial position,
results of operations or cash flows.
The Company has adopted the following standards for the current financial
statement periods and any required comparative information for earlier
years has been restated. Results of operations and financial position
have been unaffected by the implementation of these new standards.
Statement of Financial Standards (SFAS) No. 130, "Reporting Comprehensive
Income", establishes standards for reporting and display of
comprehensive income, its components and accumulated balances.
Comprehensive income is defined to include all changes in equity
except those resulting from investments by owners and distributions to
owners. Other comprehensive income (loss) consists of foreign currency
translation adjustments.
SFASNo. 131, "Disclosures About Segments of an Enterprise and Related
Information", which supersedes SFAS No. 14, "Financial Reporting for
Segments of a Business Enterprise", establishes standards for the way
that public enterprises report information about operating segments in
financial statements issued to the public. It also establishes
standards regarding products and services, geographic areas and major
customers. SFAS No. 131 defines operating segments as components of an
enterprise about which separate financial information is available
that is evaluated regularly by the chief operating decision maker in
deciding how to allocate resources and in assessing performance.
(2) Accounts Receivable
Accounts receivable included approximately $5,657,000 and $0 at December
31, 1998 and 1997, respectively, of revenues earned but not yet
contractually billable relating to long-term contracts for specialized
products. All such amounts at December 31, 1998 are expected to be
billed in the subsequent year. In addition, accounts receivable
included approximately $2,860,000 and $3,820,000 at December 31, 1998
and 1997, respectively, of retainage balances due on various long-term
contracts. All such amounts are expected to be collected during the
subsequent year. The allowance for doubtful accounts receivable was
$915,000 and $1,058,000 as of December 31, 1998 and 1997,
respectively. The allowance for doubtful accounts was increased by
provisions of $210,000, $107,000, and $553,000 and decreased by
write-offs of $353,000, $599,000, and $254,000 for the years ended
December 31, 1998, 1997, and 1996, respectively.
(Continued)
F-10
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Inventories
Inventories consist of the following:
December 31,
------------------------------
1998 1997
---- ----
Parts and components $4,959,000 5,349,000
Work-in-process 743,000 1,079,000
Finished goods 3,242,000 1,731,000
---------- ----------
$8,944,000 8,159,000
========== ==========
(4) Property, Plant and Equipment
Property, plant and equipment consists of the following:
December 31
------------------ Estimated
1998 1997 useful lives
---- ---- ------------
Land $ 246,000 246,000 --
Buildings 2,585,000 2,525,000 20-50 years
Machinery and equipment 7,947,000 7,385,000 3-8 years
Furniture and fixtures 3,566,000 3,424,000 5-10 years
Transportation equipment 129,000 126,000 4 years
Tools and molds 3,124,000 3,067,000 8 years
Leasehold improvements 805,000 793,000 Term of lease
---------- ----------
18,402,000 17,566,000
Less accumulated depreciation
and amortization 14,189,000 12,899,000
---------- ----------
$ 4,213,000 4,667,000
=========== ==========
Total depreciation and amortization expense for 1998, 1997 and 1996, related to
property, plant and equipment amounted to approximately $1,197,000,
$1,468,000 and $1,746,000, respectively.
(Continued)
F-11
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Senior Debt
On December 31, 1998 and 1997, the Company's long-term debt consisted of
senior debt under its credit facility in the amount of $10,682,000 and
$14,878,000, respectively, and $2,512,000 and $3,084,000 of
non-interest bearing deferred funding fee notes payable, respectively.
Of these amounts outstanding $2,000,000 and $1,900,000 are classified
as the current portion of senior debt as of December 31, 1998 and
1997, respectively. The credit facility consists of a combined
revolving line of credit and letter of credit availability of
$9,000,000. The balance of the facility is comprised of a term loan.
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 bear interest at 12%. The
Company incurs a fee of 2% on the average balance of letter of credit
guarantees outstanding.
During 1998 the Company extended its Loan and Security Agreement with its
senior lender from August 31, 1999 to January 2, 2001.
The agreement (as revised) provides for loan principal payments $400,000
on the last day of each quarter during the term of the agreement. As
part of the revised agreement, the loan amortization shall first be
applied to the non-interest bearing notes payable until these notes
are paid in full and then to the term loan. Commencing June 30, 1997,
the agreement also requires the Company to pay additional principal
payments if its cash flow exceeds certain amounts.
Through December 31, 1998, 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. The Company incurred a
$300,000 fee on February 13, 1995, evidenced by a non-interest bearing
note 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. The original aggregate balance of the non-interest
bearing notes was $3,084,000. As noted above, pursuant to an amendment
to the loan agreement the loan amortization payments are being applied
against these non-interest bearing notes. As of December 31, 1998 the
balance of the notes is $2,512,000 of which $2,000,000 has been
classified as the current portion of long term debt. The agreement
requires a monthly facility fee payment of $50,000, commencing
November 30, 1996, and continuing to the end of the agreement.
In connection with the credit facility, in November 1994 the Company
issued warrants to its senior lender to purchase 82,500 shares of
common stock, exercisable at $17.20 per share and expiring in November
1999. In connection with the extended agreement in March 1996, the
Company granted additional warrants to the lender to purchase 200,000
shares of common stock at $5 per share that expire in March 2001. The
value of the warrants, as issued in March 1996 of $380,000 was
recorded as deferred financing expense and additional paid in capital
in 1996.
(Continued)
F-12
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Pursuant to the November 30, 1997 extension of the credit facility, the
Company agreed to amend the terms of the warrants previously issued to
its senior lender. The 82,500 and 200,000 warrants, after adjustment
for the antidilution provisions contained in the warrant agreement,
provides for the purchase of 164,627 and 295,441 shares of common
stock, respectively and are immediately exercisable at $3.00 per share
and expire on November 30, 2002. The value of the change in warrant
terms is estimated to be $45,000 and was recorded as a deferred
financing expense and additional paid in capital in 1997.
Financial debt covenants include an interest coverage ratio measured
quarterly with 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. As of December 31, 1998, the Company was in compliance with the
above covenants.
Maturities of the Company's long-term debt, including convertible
subordinated debentures and 12% subordinated notes (notes 6 and 7),
are as follows:
1999 $ 2,000,000
2000 7,685,000
2001 9,188,000
2002 365,000
-----------
$19,238,000
===========
(Continued)
F-13
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) 6% Convertible Subordinated Debentures and
Zero Coupon Senior Subordinated Convertible Notes
As of December 31, 1998 and 1997 the Company had outstanding $365,000 and
$1,758,000 of its 6% convertible Subordinated Debentures due July 1,
2002 (the "Debentures"), net of original issue discount of $20,000 and
$137,000, respectively. The face amount of the outstanding Debentures
was $385,000 and $1,895,000 at December 31, 1998 and 1997,
respectively. The Debentures are convertible at any time prior to
maturity into Common Stock of the Company at a conversion rate of
8.333 shares for each $1,000 face amount of Debentures, subject to
adjustment under certain circumstances.
The Debentures are redeemable at the option of the Company, (a) in whole
or in part, at redemption prices ranging from 89.626% of face amount
beginning July 1, 1995 to 100% of face amount 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, 1998 and 1997 amounted to $12,000 and
$398,000, respectively. As of December 31, 1998 the Company remedied
its prior default by paying the interest due through July 1, 1998.
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 was 19.4 shares of common stock and $767.22 of
principal of Notes in exchange for each $1,000 principal amount of
Debentures converted. Accrued interest on the Debentures, which were
exchanged, was eliminated.
The Notes were unsecured and did not bear interest. There were no sinking
fund requirements for the Notes. Each Note was convertible into common
stock at a conversion price of $6.55 prior to the amendment as
discussed below. Accordingly, in addition to the 699,855 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 were exchanged, is 4,225,600. The Notes were
redeemable at the option of the Company at 90.32% of the principal
balance increasing periodically to 100% of the principal balance on
November 1, 1997.
As of December 31, 1996, the Company had exchanged approximately
$33,770,000 principal amount of the Debentures, net of related
unamortized discount and accrued interest expense, for 655,000 shares
of stock and $25,909,000 of Notes. This represented 94% of the
outstanding balance of the 6% Debentures prior to any conversion to
the Notes. In addition, as of December 31, 1996, $24,000 of Notes had
been converted into 3,600 shares of stock. As of December 31, 1996,
$25,885,000 Notes were outstanding.
(Continued)
F-14
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
During 1997, the Company exchanged approximately $410,000 principal amount
of the Debentures, net of related unamortized discount and accrued
interest expense, for 8,000 shares of common stock and $315,000 of
Notes.
Effective November 13, 1997, the Company amended the terms of the Notes.
Under the amended terms, the conversion price of the Notes was reduced
to $3.65 from $6.55. As of December 31, 1997, approximately
$23,400,000 of principal amount of Notes were converted into
approximately 6,412,000 shares of common stock. The conversion of the
Notes for common stock reduced debt by $23,400,000, increased equity
by $34,049,000 and resulted in a primarily non-cash charge of
$11,458,000. The non-cash charge was based on the difference between
the value of the shares issuable under the original terms and the
value of the shares issued with respect to the Notes under the amended
terms. In connection with the conversion of the debt, the Company
issued to its investment banking firm 120,000 shares of common stock.
As of December 31, 1997, $2,796,000 of the Notes remained outstanding.
During 1998, the Company (i) repaid the remaining balance of the Notes
from the proceeds of the 12% Subordinated Notes (note 7) (ii)
exchanged $250,000 additional principal amount of the Debentures for
5,000 shares of common stock and $192,000 of Notes which were then
converted to 53,000 shares of common stock based on the amended terms
of the Notes as described above and (iii) issued approximately 330,000
shares of common stock in exchange for $1,260,000 principal amount of
its Debentures and accrued interest. The Company recorded a debt
conversion expense of approximately $945,000, net of interest
forgiven, in the first quarter of 1998. After giving effect to these
transactions, as of December 31, 1998 the Company has no Notes
outstanding and $385,000 principal amount of Debentures outstanding.
The exchange of the Debentures for the Notes and common stock was
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 were recorded for the
amount of the future cash payments, and not discounted, the common
stock issued was recorded at the market value at the time of issuance,
and an extraordinary gain on restructuring was recorded of
approximately $76,000, $122,000, and $3,922,000 in 1998, 1997 and
1996, respectively. Accordingly, no future interest expense was
recorded on the Notes, subsequent to the time of issuance.
(Continued)
F-15
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(7) 12% Subordinated Notes
In January 1998, the Company raised $6,000,000 from the private placement
of 60 units at $100,000 per unit which mature on January 3, 2000. Each
unit consisted of (a) the Company's 12 % Subordinated Note due January
3, 2000 (a "12% Note"), in the principal amount of $100,000, and (b) a
Series B Common Stock Purchase Warrant (a "Series B Warrant") to
purchase 10,000 shares of Common Stock at $3.00 per share through
December 31, 2002. In the event that any 12% Note is outstanding one
year from the date on which such 12% Note is issued (the "Anniversary
Date of the Note"), the Company shall issue to the holder of such 12%
Note on the Anniversary Date of the Note a Series C Warrant to
purchase 25 shares of Common Stock for each $1,000 principal amount of
12% Notes outstanding on the Anniversary Date of the Note. The Series
C Warrant will have an exercise price equal to the average closing
prices of the Common Stock on each of the five trading days preceding
the Anniversary Date of the Note with respect to which the Series C
Warrant is being issued and will expire on December 31, 2003. The
proceeds from the sale of the Units was used principally to pay the
remaining principal amount of Zero Coupon Notes which had not been
converted of approximately $2,800,000 (note 6) and to reduce the
Company's senior debt by approximately $2,950,000 (note 5). The
balance of such proceeds was added to working capital.
The Series B and Series C Warrants were valued at $630,000 and were
recorded as part of additional paid in capital. Accordingly, the
Company recorded the net 12% Notes at a value of $5,370,000. As of
December 31, 1998, the Company had 12% Notes outstanding of
$5,685,000, net of original issue discount of $315,000. Subsequent to
December 31, 1998, pursuant to the terms of the Notes, the Company
issued 150,000 Series C Warrants to the holders of the Notes. The
Series C Warrants were issued at an average exercise price of $1.94
pursuant to the terms of the Notes.
(8) Joint Venture
The Company entered into a joint venture agreement as of April 24, 1986
with a Korean partner whereby each owns a 50% interest in the joint
venture. 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 $190,000, to purchase an additional 1%
interest in the joint venture, which would increase the Company's
ownership percentage to 51%. The Company consolidates the operations
of the joint venture since the Company can obtain a controlling
interest at its election and the joint venture 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.
(Continued)
F-16
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(9) Stockholders' Equity
On June 6, 1996, the stockholders of the Company approved a one-for-five
reverse split (the "Reverse Split") of the Company's common stock. As
a result of the Reverse Split, each share of common stock outstanding
at the effective date of the Reverse Split, without any action on the
part of the holder thereof, became one-fifth share of common stock.
The par value of the common stock was not affected by the Reverse
Split. In conjunction with the Reverse Split, the Company reclassified
approximately $84,000 from common stock to additional paid-in capital.
All share and per share data have been restated to give effect to the
Reverse Split.
During 1996, the Company settled a class action lawsuit. The settlement
included a cash payment by the Company's insurers and issuance by the
Company of 220,000 shares of its common stock. As of December 31,
1998, all shares have been issued pursuant to such settlement.
During 1994, the Company issued warrants to purchase 82,500 shares of
common stock at an exercise price of $17.20 per share to its senior
lender that expire in November 1999. In March 1996, the Company, in
connection with an agreement to amend and extend certain senior debt,
issued warrants to purchase 200,000 shares of common stock at an
exercise price of $5.00 per share that expire March 2001. In
consideration of the November 30, 1997 extension of the credit
facility, the Company agreed to amend the terms of the warrants
previously issued to its senior lender. The 82,500 and 200,000
warrants, after adjustment for the antidilution provisions contained
in the warrant agreement, allow for the purchase of 164,627 and
295,441 shares of common stock, respectively and are immediately
exercisable at $3.00 per share and expire on November 30, 2002. In
connection with the change of the warrant terms, the Company recorded
deferred financing costs of $45,000 (note 5).
In 1997, as remuneration for advisory services by an investment banking
firm, the Company issued warrants to purchase 400,000 shares of common
stock which are exercisable at $1.56 per share, and expire in April
2002. In addition, as remuneration for the advisory services related
to the debt conversion, the Company issued to its investment banking
firm 120,000 shares of common stock (note 6). In 1997, in connection
with these services, the Company recorded deferred consulting and debt
conversion expense of approximately $80,000 and $580,000,
respectively.
During 1998, pursuant to the private placement of $6,000,000 of 12%
Subordinated Notes (note 7) the Company issued Series B Common Stock
Purchase Warrants to purchase 600,000 shares of common stock at $3.00
per share. The Series B Warrants expire on December 31, 2002.
Subsequent to December 31, 1998, pursuant to the terms of the Notes,
the Company issued Series C Common Stock Purchase Warrants to purchase
150,000 shares of common stock to the holders of the Notes. The Series
C Warrants were issued at an average exercise price of $1.94 pursuant
to the terms of the Notes and expire December 31, 2003. The Series B
and Series C Warrants were valued at $630,000 and were recorded as
part of additional paid in capital in 1998.
(Continued)
F-17
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
As of December 31, 1998, the Company also had stock purchase warrants
outstanding to purchase 53,000 shares of common stock at an exercise
price of $17.50 per share expiring in November 2001 to its former
lenders in return for a discount with respect to the repayment of its
debt in 1994.
Under a 1984 Employee Incentive Plan, the Company provided an opportunity
for certain employees of the Company and its subsidiaries to acquire
subordinated convertible debentures. As a result , as of December 31,
1998, there is $13,000 of employee promissory notes receivable
outstanding, of which the maturity date has been extended to April
1999. During 1998, the Board of Directors approved a reduction in the
original issue price of the debentures to the current market rate of
the common stock, approximately $1.38 per share, which common stock is
held by the Company as collateral for the notes. Accordingly, the
related receivable from employees was reduced from $307,000 to $13,000
to reflect the new valuation. The reduction on the original issue
resulted in a non-cash compensation charge in 1998 of $298,000.
During 1998, the Board of Directors implemented a Stock Purchase Program
(the "program") for senior executive officers and directors of the
Company. The program was established to increase the direct equity
investment in the Corporation of the senior executives and directors.
The program sets forth that each participant shall purchase common
stock equal to ten percent of the participant's salary for those who
are officers and $30,000 with respect to those who are outside
directors. The number of shares purchased is based on the fair market
value per share of Common stock of $1.50. The stock purchase for each
officer is payable to the Company on an installment basis. The Company
is holding the shares as security against the outstanding obligation
until it is paid in full. The maximum number of shares to be issued
pursuant to the program is 186,000. The initial receivable related to
the program was $279,000. As of December 31, 1998 the receivable
balance was $268,000.
(10) Stockholder Rights Plan
The Company has a Stockholder Rights Plan in which preferred stock
purchase rights were distributed to stockholders as a dividend at the
rate of one right for each common share. 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 $175.00 per right.
The rights will be exercisable only if a person or group acquires
beneficial ownership of 22.5 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 22.5 percent or more
of the common stock.
(Continued)
F-18
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
If any person becomes the beneficial owner of 22.5 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.
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 22.5 percent position has been acquired.
(11) 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 for a period of fifteen years following the earlier of
attainment of age 65 or death. During 1998, 1997 and 1996, the Company
accrued approximately $185,000, $203,000 and $180,000, respectively,
under these agreements.
In 1986, the Company established the Porta Systems Corp. 401(k) Savings
Plan for the benefit of eligible employees, as defined in the Savings
Plan. Participants contribute a specified percentage of their base
salary up to a maximum of 15%. The Company will match a participant's
contribution by an amount equal to 25% 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, 1998, 1997 and
1996, the Company's contribution amounted to $96,000, $96,000 and
$90,000, respectively.
The Company does not provide any other post-retirement benefits to any of
its employees.
(12) Incentive Plans
The Company's 1986 Stock Incentive Plan ("1986 Plan"), expired in March
1996, although options granted prior to the expiration date remain in
effect in accordance with their terms. Options granted under the 1986
Plan may be incentive stock options, as defined in the Internal
Revenue Code, or options that are not incentive stock options. The
exercise price for all options granted were equal to the fair market
value at the date of grant.
(Continued)
F-19
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The Company's 1996 Stock Incentive Plan ("1996 Plan"), is authorized to
issue 450,000 shares of Common Stock. Incentive stock options cannot
be issued subsequent to ten years from the date the 1996 Plan was
approved. Options under the 1996 Plan may be granted to key employees,
including officers and directors of the Company and its subsidiaries,
except that members and alternate members of the stock option
committee are not eligible for options under the 1996 Plan. The
exercise price for all options granted were equal to the fair market
value at the date of grant and vest as determined by the board of
directors. In addition, the 1996 Plan provides for the automatic grant
to non-management directors of non-qualified options to purchase 2,000
shares on May 1st of each year commencing May 1, 1996, based upon the
average closing price of the last ten trading days of April of each
year.
The Company's 1998 Stock Non-Qualified Stock Option Plan ("1998 Plan"), is
authorized to issue 450,000 shares of common stock. Options under the
1998 Plan may be granted to key employees, including officers and
directors of the Company and its subsidiaries. The exercise price for
all options granted were equal to the fair market value at the date of
grant and vest as determined by the board of directors.
During 1998, pursuant to a certain employment contract, the Company issued
30,000 options to purchase common stock of the Company. Under this
agreement, the options are exercisable at $1.25, which approximated
market value on the date of issuance and expire on August 31, 2004. As
of December 31, 1998 none of the options are vested.
The Company applies APB Opinion 25, "Accounting for Stock Issued to
Employees" ("APB 25") and related Interpretations in accounting for
the 1998, 1996 and 1986 Plans. Under APB 25, no compensation cost is
recognized for options granted to employees at exercise prices greater
than or equal to fair market value of the underlying common stock at
the date of grant.
The Company has adopted the disclosure only provisions of Statement of
Financial Accounting Standard No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No.123") which requires the Company to provide,
beginning with 1995 grants, pro forma information regarding net income
and net income per common share (basic and diluted) as if compensation
costs for the Company's stock option plans had been determined in
accordance with the fair value method prescribed in SFAS No.123. If
the Company had elected to recognize compensation costs based on fair
value of the options granted at grant date as prescribed by SFAS No.
123, net income (loss) and net income (loss) per share (basic and
diluted) would have been reduced to the pro forma amounts indicated
below:
(Dollars in thousands, except per share data)
1998 1997
---- ----
Pro forma net income (loss) $ 237 $(7,026)
Pro forma net income (loss) per
share (basic and diluted) $0.03 $ (2.26)
The weighted-average fair value of options granted was $ 1.47 and $0.35
per share in 1998 and 1997.
(Continued)
F-20
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following
assumptions for 1998 and 1997:
Dividends: $0.00 per share
Volatility: 46.10%-80.00%
Risk-free interest: 4.80%- 6.40%
Expected term: 5 years
Such pro forma information has not been presented for 1996 because
management has determined that the compensation costs associated with
options granted in 1996 are not material to net income (loss) or net
income (loss) per share.
A summary of the status of the Company's 1986 stock option plan as of
December 31, 1998, 1997, and 1996, and changes during the years ending
on those dates is presented below:
1998 1997 1996
---------------------- ---------------------- -----------------------
Shares Weighted Shares Weighted Shares Weighted
Under Average Under Average Under Average
Option Exercise Price Option Exercise Price Option Exercise Price
------ -------------- ------ -------------- ------ --------------
Outstanding beginning of year 16,392 $ 57 16,397 $ 57 56,360 $58
Granted -- -- --
Exercised -- -- --
Forfeited (865) 63 (5) 38 (39,963) 58
------ ------ ------
Outstanding end of year 15,527 $ 57 16,392 $ 57 16,397 $57
====== ====== ======
Options exercisable at year-end 15,527 16,392 16,397
====== ====== ======
The following table summarizes information about stock options outstanding
under the 1986 Plan at December 31, 1998:
Options Outstanding Options Exercisable
------------------------------------------------- -----------------------------
Range of Outstanding Remaining Weighted-average Exercisable Weighted-Average
Exercise Prices at 12/31/98 Contractual Life Exercise Price at 12/31/98 Exercise Price
- --------------- ----------- ---------------- ---------------- ----------- ----------------
$ 5 to 25 3,000 3.7 years $ 5 3,000 $ 5
25 to 75 9,970 0.8 65 9,970 65
75 to 100 2,557 0.3 86 2,557 86
------ ------
$ 5 to 100 15,527 1.3 $57 15,527 $57
====== ======
A summary of the status of the Company's 1996 stock option plan as of
December 31, 1998, 1997 and 1996, and changes during the year is
presented below:
(Continued)
F-21
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
1998 1997 1996
----------------------- ----------------------- -----------------------
Shares Weighted Shares Weighted Shares Weighted
Under Average Under Average Under Average
Option Exercise Price Option Exercise Price Option Exercise Price
------ -------------- ------ -------------- ------ --------------
Outstanding beginning
of year 437,988 $1.67 79,448 $2.45 -0- $0.00
Granted 12,000 3.85 358,780 1.50 79,448 2.45
Exercised -- -- -- -- -- --
Forfeited (2,050) 1.51 (240) 2.00 -- --
------- ------- ------
Outstanding end of year 447,938 $1.73 437,988 $1.67 79,448 $2.45
======= ======= ======
Options exercisable at
year-end 447,938 333,488 63,050
======= ======= ======
The following table summarizes information about stock options outstanding
under the 1996 Plan at December 31, 1998:
Options Outstanding Options Exercisable
------------------------------------------------- -------------------------------
Range of Outstanding Remaining Weighted-average Exercisable Weighted-Average
Exercise Prices at 12/31/98 Contractual Life Exercise Price at 12/31/98 Exercise Price
- --------------- ----------- ---------------- ---------------- ----------- ----------------
$ 1 to 5 447,938 7.5 years $ 1.73 447,938 $ 1.73
======= =======
A summary of the status of the Company's 1998 stock option plan as of
December 31, 1998, and changes during the year is presented below:
1998
--------------------------------
Shares Weighted
Under Average
Option Exercise Price
------ --------------
Outstanding beginning of year 0 $ 0.00
Granted 448,000 3.25
Exercised -- --
Forfeited (3,500) 3.25
-------
Outstanding end of year 444,500 $ 3.25
=======
Options exercisable at year-end -0-
=======
The following table summarizes information about stock options outstanding
under the 1998 Plan at December 31, 1998:
Options Outstanding Options Exercisable
----------------------------------------------- -----------------------------
Range of Outstanding Remaining Weighted-average Exercisable Weighted-Average
Exercise Prices at 12/31/98 Contractual Life Exercise Price at 12/31/98 Exercise Price
- --------------- ----------- ---------------- ---------------- ----------- ----------------
$ 1 to 5 444,500 5.1 years $ 3.25 -0- $ 0.00
======= =====
(Continued)
F-22
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(13) Income Taxes
The provision for income taxes consists of the following:
1998 1997 1996
---- ---- ----
Current Deferred Current Deferred Current Deferred
------- -------- ------- -------- ------- --------
Federal $ -- (8,000) 40,000 (708,000) -- --
State and foreign 615,000 (1,000) 177,000 (94,000) 100,000 --
--------- ------ ------- -------- ------- --------
Total $ 615,000 (9,000) 217,000 (802,000) 100,000 --
========= ====== ======= ======== ======= ========
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 income (loss) from continuing operations before income taxes is as
follows:
1998 1997 1996
---- ---- ----
Tax expense (benefit) at statutory
rate $ 398,000 (2,526,000) 495,000
Increase (decrease) in income tax
benefit resulting from:
Decrease in valuation allowance (4,097,000) (22,740,000) (495,000)
State and foreign taxes, less
applicable federal benefits 615,000 83,000 100,000
Debt conversion expense not
deductible for tax 411,000 3,620,000 --
Other expenses not deductible
for tax 136,000 206,000 --
Foreign income taxed at rates
lower than U.S. statutory rate (239,000) (730,000) --
Utilization of net operating loss
carryforward (118,000) (669,000) --
Expiration of capital loss and
investment tax credit
carryforwards 4,387,000 642,000 --
Estimated NOL in excess of
382 limitation (719,000) 21,500,000 --
Other (168,000) 29,000 --
----------- ----------- --------
$ 606,000 (585,000) 100,000
=========== =========== ========
The Company has unused United States tax net operating loss (NOL)
carryforwards of approximately $66,682,000 expiring at various dates
between 2007 and 2011. No tax benefit or expense was apportioned to
the extraordinary gains, as such amounts are immaterial. Due to the
change in ownership which resulted from the conversion of the
Company's Zero coupon subordinated convertible notes to common stock,
the Company's usage of its NOL will be limited in accordance with
Internal Revenue Code section 382. The Company's carryforward
utilization of the NOL is limited to $1,767,000 per year. The
carryforward amounts are subject to review by the Internal Revenue
Service (IRS). The capital loss carryforwards expired during 1998 and,
as a result of the section 382 limitation, no benefit from tax credit
carryforwards will be available.
The Company's net operating loss carryforwards, limited by section 382,
expire in the following years:
2009 $ 3,757,000
2010 18,880,000
2011 884,000
-----------
$23,521,000
===========
(Continued)
F-23
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The components of the deferred tax assets and liabilities, the net balance
of which is included in prepaid and other current assets, as of
December 31, 1998 and 1997 are as follows:
1998 1997
---- ----
Deferred tax assets:
Inventory $ 1,488,000 1,634,000
Allowance for doubtful accounts
receivable 345,000 307,000
Benefits of tax loss carryforwards 9,056,000 8,455,000
Benefit plans 871,000 1,007,000
Accrued Commissions 913,000 941,000
Other 290,000 422,000
Depreciation 487,000 --
Benefit of investment tax credit
carryforwards -- 658,000
Benefit of capital loss carryforwards -- 4,387,000
------------ ------------
13,450,000 17,811,000
Valuation allowance (12,607,000) (16,704,000)
------------ ------------
843,000 1,107,000
------------ ------------
Deferred tax liabilities:
Capitalized software costs (32,000) (240,000)
Depreciation -- (65,000)
------------ ------------
(32,000) (305,000)
------------ ------------
$ 811,000 802,000
============ ============
Deferred taxes result from temporary differences between the tax bases of
assets and liabilities and their reported amounts in the financial
statements. The temporary differences result from costs required to be
capitalized for tax purposes by the US Internal Revenue Code, and
certain items accrued for financial reporting purposes in the year
incurred but not deductible for tax purposes until paid.
Because of the Company's US tax losses in 1996, a valuation allowance for
the deferred tax asset was provided due to the uncertainty as to
future realization. During the years ended December 31, 1998 and 1997,
the valuation allowance was reduced to reflect a net deferred tax
asset equal to the anticipated tax benefit of the temporary
differences which are expected to be realized within one year based on
the Company's 1999 and 1998 projected US taxable income, respectively.
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 is currently in a structured
settlement with the IRS, which is reviewed annually, whereby monthly
payments will be made to liquidate the settlement. Aggregate annual
amounts payable by the Company, including interest on the unpaid
amounts at a current rate of 7%, is $240,000 in 1998. As of December
31, 1998, the Company has made all the required payments through that
date under the settlement and approximately $770,000 remains
outstanding.
(Continued)
F-24
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
No provision was made for U.S. income taxes on the undistributed earnings
of the Company's foreign subsidiaries as it is management's intention
to utilize those earnings in the foreign operations for an indefinite
period of time or repatriate such earnings only when tax effective to
do so. At December 31, 1998, undistributed earnings of the foreign
subsidiaries amounted to approximately $5,980,000. It is not
practicable to determine the amount of income or withholding tax that
would be payable upon the remittance of those earnings.
(14) Sale of Israeli Subsidiary
In 1992 the Company sold its Israeli network communications business. As
a result of an insolvency procedure involving the purchaser of this
business and pursuant to the sale of the business out of receivership,
the Company's receivable was represented by shares of common stock of
the entity which acquired the discontinued operation. In 1996, the
Company sold such shares for $3,456,000 and recorded a gain of
$2,264,000. The gain represented an adjustment in the estimated value
of the shares previously received and accordingly was reflected in
continuing operations. As part of an agreement with the Company's
senior lender, the net proceeds from the sale were applied to reduce
the outstanding principal balance of the Company's term loan. In 1998
and 1997, the Company received $241,000 and $700,000, respectively,
representing final payments resulting from the insolvency procedure.
Such payments are included in other income.
(15) Leases
At December 31, 1998, 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 1998, 1997, and 1996 amounted to
approximately $716,000, $827,000 and $871,000, respectively. Minimum
rental commitments, exclusive of future escalation charges, for each
of the next five years are as follows:
1999 $ 469,000
2000 383,000
2001 64,000
2002 55,000
2003 29,000
Thereafter 10,000
----------
$1,010,000
==========
(16) Contingencies
At December 31, 1998, the Company was contingently liable for outstanding
letters of credit aggregating approximately $5,340,000 as security for
the performance of certain long-term contracts.
The Company is a party to legal actions arising out of the ordinary
conduct of its business. Management believes that the settlement of
these matters will not have a materially adverse effect on the
financial position of the Company (note 20).
(Continued)
F-25
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(17) Major Customers
During the years ended December 31, 1998, 1997 and 1996, the Company's
five largest customers accounted for sales of $28,797,000, or
approximately 49% of sales, $30,633,000, or approximately 49% of
sales, and $ 27,807,000, or approximately 48% of sales, respectively.
The Company's largest customer is British Telecommunications plc
("BT"). Sales to BT for the year ended December 31, 1998, 1997 and
1996 amounted to $15,349,000, $13,876,000 and $11,308,000,
respectively, or approximately 26%, 22% and 20%, respectively, of the
Company's sales for such years. Therefore, any significant
interruption or decline in sales to BT may have a materially adverse
effect upon the Company's operations. During 1998, sales to a Chilean
telephone company were $6,834,000, or approximately 12% of sales.
During 1996, sales to a Philippines telephone company were $7,034,000,
or approximately 12% of sales. No other customers account for 10% or
more of the Company's sales for any year. Approximately 64% of the
Company's accounts receivable are due from the five largest customers
as of December 31, 1998 and 1997.
(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 senior long-term debt approximates
fair value as the extension of the Loan and Security Agreement was
re-negotiated on December 1, 1998.
The carrying amount and estimated fair value of the Company's additional
financial instruments are summarized as follows:
December 31, 1998 December 31, 1997
----------------- -----------------
Carrying Estimated Carrying Estimated
amount fair value amount fair value
------ ---------- ------ ----------
6% Convertible
Subordinated Debentures $ 365,000 108,000 1,758,000 1,471,000
========== ========== ========== ==========
Zero Coupon Subordinated
Convertible Notes $ -- -- 2,796,000 2,796,000
========== ========== ========== =========
12% Subordinated Notes $5,685,000 5,685,000 -- --
========== ========== ========== =========
Management's estimated fair value of the Debentures as of December 31,
1998 is estimated based on the conversion features on the Debentures
at the market value of the Company's common stock at December 31,
1998. Management's estimated fair value of the Debentures as of
December 31, 1997 is based on market prices of the Company's common
stock price, which were issued in January 1998 for the conversion of
$1,260,000 of principal amount of the Debentures.
Management estimates that the fair value of the 12% Subordinated Notes as
of December 31, 1998 approximates the carrying value of the debt due
to stability of interest rates from the date of the debt origination
of January 1998 as compared to December 31, 1998.
(Continued)
F-26
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(19) Net Income (Loss) Per Share
The following table sets forth the computation of basic and diluted net
income (loss) per share:
Numerator-Basic and diluted
net income (loss) per share: 1998 1997 1996
----------- ----------- -----------
Income (loss) from continuing
operations $ 451,000 $(7,021,000) $ 1,252,000
Extraordinary item 76,000 122,000 3,922,000
----------- ----------- -----------
Net income (loss) 527,000 $(6,899,000) $ 5,174,000
=========== =========== ===========
Denominator:
Denominator for basic net income
(loss) per share - weighted-
average shares 9,281,000 3,111,000 2,184,000
Effect of dilutive securities:
Options and Warrants 452,000 -- --
6% Convertible Subordinated
Notes 52,000 -- --
Zero Coupon Senior
Subordinated Convertible
Notes -- -- 3,344,000
----------- ----------- -----------
Denominator for diluted net
income (loss) per share-
adjusted weighted-average
shares and assumed conversions 9,785,000 3,111,000 5,528,000
=========== =========== ===========
Basic per share amounts:
Continuing operations $ 0.05 $ (2.26) $ 0.57
Extraordinary item 0.01 0.04 1.80
----------- ----------- -----------
Net income (loss) per
share of common stock $ 0.06 $ (2.22) $ 2.37
=========== =========== ===========
Diluted per share amounts:
Continuing operations $ 0.04 $ (2.26) $ 0.23
Extraordinary item 0.01 0.04 0.71
----------- ----------- -----------
Net income (loss) per share
of common stock $ 0.05 $ (2.22) $ 0.94
=========== =========== ===========
For additional disclosure regarding the Zero Coupon Senior Subordinated
Notes see note 6.
In November 1997, the Company converted approximately $23,400,000 of the
Notes to approximately 6,412,000 shares of common stock. Had this
conversion taken place as of January 1, 1997, the denominator for the
basic net income (loss) per share (the weighted-average shares) and
the diluted net income (loss) per share (adjusted weighted-average
shares and assumed conversion) would have been 8,639,000 for 1997.
(Continued)
F-27
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Options to purchase 486,577, 25,442 and 25,447 shares of common stock for
1998, 1997 and 1996, respectively, with exercise prices ranging from
$3.25 to $86.25, $3.69 to $86.25 and $3.69 to $8.25 for 1998, 1997 and
1996, respectively, were outstanding but not included in the
computation of diluted net income (loss) per share because the
exercise prices were greater than the average market price of common
stock during such years.
Warrants to purchase 53,000, 548,668 and 360,500 shares of common stock
for 1998, 1997 and 1996, respectively, with exercise prices ranging
from $17.50, $3.00 to $50.00 and $5.00 to $33.10 for 1998, 1997 and
1996, respectively, were outstanding but not included in the
computation of diluted net income (loss) per share because the
exercise prices were greater than the average market price of common
stock during such years.
(20) Legal Matters
In July 1996, an action was commenced against the Company and certain
present and former directors in the Supreme Court of the State of New
York, New York County by certain stockholders and warrant holders of
the Company who acquired their securities in connection with the
acquisition by the Company of Aster Corporation. The complaint alleges
breach of contract against the Company and breach of fiduciary duty
against the directors arising out of an alleged failure to register
certain restricted shares and warrants owned by the plaintiffs. The
complaint seeks damages of $413,000; however, counsel for the
plaintiff have advised the Company that additional plaintiffs may be
added and, as a result, the amount of damages claimed may be
substantially greater than the amount presently claimed. The Company
believes that the defendants have valid defenses to the claims.
Discovery is proceeding.
In July 1996, the Securities and Exchange Commission (the "SEC") issued
an order (the "Order") directing a private investigation of the
Company to determine whether there has been a violation of Federal
securities laws. The SEC indicated to counsel for the Company that the
investigation relates to the position of the SEC staff that the
independence of the Company's auditors for 1995, KPMG Peat Marwick LLP
("Peat Marwick"), was adversely impacted by certain relationships
involving Peat Marwick, on one hand, and KPMG BayMark Strategies LLC
("BayMark") and Edward R. Olson, the President of BayMark and the
Company's former interim president and chief operating officer, on the
other hand. Although the Company does not agree with the position of
the SEC staff with respect to the independence of Peat Marwick, the
Company is cooperating with the SEC's investigation. The Company
retained BDO Seidman, LLP to reaudit the Company's 1995 financial
statements, which reaudit resulted in no changes to the Company's 1995
financial statements as audited by Peat Marwick. The Company does not
believe that the investigation will result in any material liability
on the part of the Company. There has been no further activity
respecting this investigation since November 1996.
(Continued)
F-28
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(21) Cash Flow Information
(1) Supplemental cash flow information for the years ended December 31, is
as follows:
1998 1997 1996
---- ---- ----
Cash paid for interest $2,411 2,844 2,751
====== ===== =====
Cash paid for income taxes $ 223 117 105
====== ===== =====
(2) Non-cash transactions:
(i) During 1998, 1997 and 1996, the Company exchanged approximately
$250,000, $410,000 and $33,770,000 principal amount of its Debentures,
net of unamortized discount and accrued interest, for 5,000, 8,000 and
655,000 shares of Common stock, and $192,000, $315,000 and $25,909,000
of Notes, respectively (note 6).
(ii) During 1996, the Company issued 3,600 shares of common stock as a
result of the conversion of Notes under the original terms (note 6).
(iii) During 1998 and 1997, the Company issued 53,000 and 6,412,000
shares of common stock, respectively, upon the conversion of Notes
(note 6).
(iv) During 1998, the Company issued 330,000 shares of common stock
upon the conversion of $1,260,000 of Debentures (note 6)
(v) During 1998 and 1996, the Company issued 147,000 and 73,000 shares
of common stock to satisfy a portion of the final settlement of a
class action lawsuit (note 9).
(vi) In connection with the Company's March 1996 amendment to its
credit facility, the Company granted its senior lender warrants to
purchase 200,000 shares of common stock (note 5). The value of the
warrants was recorded as deferred financing expense and additional
paid in capital.
(vii) In connection with the November 1997 extension of the Company's
credit facility with its senior lender, the Company amended the terms
of previously issued warrants to purchase common stock. The value of
the amendment, approximately $45,000 was recorded as deferred
financing and additional paid in capital.
(viii) In connection with advisory services provided in 1997 by an
investment banking firm, the Company issued 120,000 shares of common
stock in 1998 and warrants to purchase 400,000 shares of common stock
were issued in 1997 (notes 6 and 9).
(ix) In 1998, in connection with the 12% subordinated notes, the
Company issued Series B and Series C Warrants, which were valued at
$630,000 and were recorded as part of additional paid in capital and
original issue discount (note 7).
(Continued)
F-29
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(22) Segment and Geographic Data
The Company has three reportable segments: Line Connection and Protection
Equipment ("Line") whose products interconnect copper telephone lines
to switching equipment and provides fuse elements that protect
telephone equipment and personnel from electrical surges; Operating
Support Systems ("OSS") whose products automate the testing,
provisioning, maintenance and administration of communication networks
and the management of support personnel and equipment; and Signal
Processing ("Signal") whose products are used in data communication
devices that employ high frequency transformer technology.
The factors used to determine the above segments focused primarily on the
types of products and services provided, and the type of customer
served. Each of these segments is managed separately from the others,
and management evaluates segment performance based on operating
income.
1998 1997 1996
---- ---- ----
Revenue:
Line $24,291,000 23,753,000 23,249,000
OSS 27,318,000 29,561,000 26,804,000
Signal 7,539,000 8,280,000 7,597,000
----------- ---------- ----------
$59,148,000 61,594,000 57,650,000
=========== ========== ==========
Segment profit:
Line $ 6,580,000 7,091,000 6,329,000
OSS (365,000) 634,000 1,078,000
Signal 1,953,000 2,325,000 2,222,000
----------- ---------- ----------
$ 8,168,000 10,050,000 9,629,000
=========== ========== ==========
Depreciation and amortization:
Line $ 722,000 831,000 906,000
OSS 1,170,000 1,850,000 2,526,000
Signal 200,000 215,000 359,000
----------- ---------- ----------
$ 2,092,000 2,896,000 3,791,000
=========== ========== ==========
Total identifiable assets:
Line $10,330,000 9,329,000 9,182,000
OSS 28,283,000 25,018,000 28,197,000
Signal 8,176,000 8,273,000 7,330,000
----------- ---------- ----------
$46,789,000 42,620,000 44,709,000
=========== ========== ==========
Capital expenditures:
Line $ 280,000 277,000 33,000
OSS 283,000 97,000 45,000
Signal 93,000 12,000 40,000
----------- ---------- ----------
$ 656,000 386,000 118,000
=========== ========== ==========
(Continued)
F-30
PORTA SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The following table reconciles segment totals to consolidated totals:
1998 1997 1996
---- ---- ----
Revenue:
Total revenue for reportable
segments $59,148,000 61,594,000 57,650,000
Other revenue 195,000 636,000 337,000
----------- ---------- ----------
Consolidated total revenue $59,343,000 62,230,000 57,987,000
=========== ========== ==========
Operating income:
Total segment profit for
reportable segments $ 8,168,000 10,050,000 9,629,000
Corporate and unallocated (3,602,000) (3,949,000) (5,647,000)
----------- ---------- ----------
Consolidated total operating
income $ 4,566,000 6,101,000 3,982,000
=========== ========== ==========
Depreciation and amortization:
Total for reportable segments $ 2,092,000 2,896,000 3,791,000
Corporate and unallocated 103,000 144,000 150,000
----------- ---------- ----------
Consolidated total deprecation
and amortization $ 2,195,000 3,040,000 3,941,000
=========== ========== ==========
Total assets:
Total for reportable segments $46,789,000 42,620,000 44,709,000
Corporate and unallocated 5,347,000 8,380,000 5,949,000
----------- ---------- ----------
Consolidated total assets $52,136,000 51,000,000 50,658,000
=========== ========== ==========
Capital expenditures:
Total for reportable segments $ 656,000 386,000 118,000
Corporate and unallocated 9,000 23,000 7,000
----------- ---------- ----------
Consolidated total capital
expenditures $ 665,000 409,000 125,000
=========== ========== ==========
The following table presents information about the Company by geographic
area:
1998 1997 1996
---- ---- ----
Revenue:
United States $18,951,000 17,980,000 17,644,000
Other North America 1,879,000 1,289,000 0
United Kingdom 20,441,000 18,640,000 16,000,000
Asia/Pacific 7,181,000 10,278,000 15,812,000
Latin America 7,463,000 2,429,000 1,738,000
Other Europe 3,377,000 10,587,000 5,416,000
Other 51,000 1,027,000 1,377,000
----------- ----------- -----------
Consolidated total revenue $59,343,000 62,230,000 57,987,000
=========== =========== ===========
Consolidated long-lived assets:
United States $12,317,000 13,044,000 13,943,000
Other North America 663,000 650,000 504,000
United Kingdom 2,520,000 2,776,000 2,706,000
Asia/Pacific 273,000 245,000 590,000
Latin America 26,000 0 0
Other 11,000 11,000 4,000
----------- ----------- -----------
15,810,000 16,726,000 17,747,000
Current and other assets 36,326,000 34,274,000 32,911,000
----------- ----------- -----------
Consolidated total assets $52,136,000 51,000,000 50,658,000
=========== =========== ===========
F-31