PERFORMANCE TECHNOLOGIES INC \DE\ - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (No Fee Required)
For the Fiscal Year Ended December 31, 2002
OR
[ ] 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 0-27460

PERFORMANCE TECHNOLOGIES, INCORPORATED
(Exact name of registrant as specified in its charter)
------------------
Delaware 16-1158413
(State or other jurisdiction of incorporation of (I.R.S. Employer
organization) Identification No.)

205 Indigo Creek Drive, Rochester, New York 14626
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (585) 256-0200
---------------------------
Securities registered pursuant to section 12(b) of the Act:
NONE
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Securities registered pursuant to section 12(g) of the Act:
COMMON STOCK, par value $.01 per share
(Title of Class)

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 10-K or any amendment to this
Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [ X ]

The aggregate market value of the voting stock held by non-affiliates of the
registrant as of the close of business on June 28, 2002 was approximately
$64,916,000.

The number of shares outstanding of the registrant's Common Stock, $.01 par
value, was approximately 12,230,000 as of February 28, 2003.

Documents Incorporated by Reference
The information called for by Item 10-13 of Part III is incorporated by
reference to the definitive Proxy Statement for the Annual Meeting of
Stockholders of the Company to be held June 3, 2003, which will be filed with
the Securities and Exchange Commission not later than 120 days after December
31, 2002.

Performance Technologies, Incorporated
Index to Annual Report on Form 10-K

PART I Page

ITEM 1 Business 1
ITEM 2 Properties 11
ITEM 3 Legal Proceedings 11
ITEM 4 Submission of Matters to a Vote of Security Holders 11

PART II

ITEM 5 Market for the Registrant's Common Equity and
Related Stockholder Matters 11
ITEM 6 Selected Financial Data 12
ITEM 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
ITEM 7A Quantitative and Qualitative Disclosures About Market Risk 20
ITEM 8 Financial Statements and Supplementary Data 20
ITEM 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 34

PART III

ITEM 10 Directors and Executive Officers of the Registrant 34
ITEM 11 Executive Compensation 34
ITEM 12 Security Ownership of Certain Beneficial Owners
and Management 35
ITEM 13 Certain Relationships and Related Transactions 35
ITEM 14 Controls and Procedures 35

PART IV

ITEM 15 Exhibits, Financial Statement Schedules and Reports on
Form 8-K 35

PART 1

ITEM 1 - Business

Overview

Performance Technologies (the "Company") is a supplier of embedded computing
products and system-level solutions that can be used in a broad range of
applications and end markets.

Since its founding in 1981 as a Delaware corporation, the Company has
consistently designed innovative embedded products and system solutions that
focus on attributes such as reduced time-to-market for our customers, enhanced
performance, high availability and cost advantages for a user base that includes
communications, military and commercial applications. The Company has a proven
history of successfully adapting its products and services to a constantly
changing, technology-driven marketplace through the course of several business
cycles that have occurred since its founding.

The Company's annual operating performance is subject to various risks and
uncertainties. The following discussion should be read in conjunction with the
Consolidated Financial Statements and related notes included elsewhere herein,
as well as the section appearing in ITEM 1 of this Form 10-K under the heading
"Risk Factors." The Company's future operating results may be affected by
various trends and factors which are beyond the Company's control. These risks
and uncertainties include, among other factors, general business and economic
conditions, rapid or unexpected changes in technologies, cancellations or delays
of customer orders including those associated with "design wins," changes in the
product or customer mix of sales, delays in new product development, customer
acceptance of new products and customer delays in qualification of products.

Important Year 2002 Milestones

2002 was a challenging year with continuing erosion in the general business
environment, as well as the Company's target markets. Management responded to
these demanding market conditions through a series of initiatives that allowed
the Company to maintain profitability.

As the organization entered 2002, it was clear that the traditional users of the
Company's products, primarily telecommunication equipment manufacturing
organizations, were continuing to suffer from a drastic reduction in capital
equipment spending by operators in North America and Europe. It was also clear
that many of the market's forward-looking initiatives related to next-generation
network infrastructure deployment, both in the wireline and wireless areas, had
stalled due to a lack of visibility of an economic recovery. Ongoing
expenditures in the telecommunications industry were generally being limited to
maintenance items, with little attention being paid to network expansion and the
use of new technologies similar to those offered by the Company. Other end
markets for embedded systems also experienced slowdowns in business during 2002.
However, an encouraging perspective is that certain industries that use the
Company's embedded products and systems appear to have shown signs of
stabilization by year-end.

Throughout 2002, most equipment providers that are customers for the Company's
products responded to the economic conditions by implementing cost controls,
reducing workforces and realigning their business models. This restructuring,
which occurred in both 2001 and 2002, has dramatically reduced the engineering
capabilities of many of these companies and is expected to result in a greater
reliance on organizations such as Performance Technologies for "standards-based"
platforms and components to be integrated with their next-generation products.
It is expected that outsourcing of equipment and services, such as those
provided by the Company will result in these companies establishing strategic
relationships with fewer vendors who can supply larger parts of their embedded
system platform requirements.

During 2002, many of the Company's peers that sell products into the embedded
systems marketplace experienced significant revenue declines and operating
losses. Almost all have undergone the same kinds of restructuring as their
customers by consolidating operations and shedding unprofitable operations.

In the face of such a demanding economic climate, management targeted a number
of initiatives and objectives to reposition the Company to operate more
successfully in these conditions and emerge as a strong leader in its markets as
conditions improve. These initiatives included:

1) Selective Reductions in the Company's Cost Structure: This action was carried
out at two different times during 2002 in response to deteriorating conditions
by reducing its workforce by approximately 20% and by consolidating the Raleigh,
North Carolina engineering operations into the Ottawa, Canada Signaling Group.
These reductions allowed the Company to remain viable and profitable. While the
Company's financial performance for 2002 relative to prior years was
disappointing, the Company performed very well compared to its peer group. It
remained profitable and ended the year with a positive revenue growth trend and
a noteworthy improvement in the year-end backlog.

2) Aggressive Use of the Company's Balance Sheet Strength for Acquisitions and
Investments: In the current environment, valuations have been substantially
reduced in comparison to several years ago. This offers the Company an ongoing
opportunity to acquire products, technologies and organizations that were
unavailable during that period. In 2002, the Company successfully carried out
one major acquisition and concluded a strategic minority investment in an early
stage company. These two events were:

Ziatech Acquisition: In October 2002, the Company completed its
acquisition of Intel Corporation's Embedded Communications Platform
Division (formerly Ziatech Corporation). The acquisition more than
doubled the Company's total available market in the embedded systems
space through the addition of highly complementary computing and
systems products. Due to overall industry downsizing, as noted above,
equipment manufacturers and integrators are looking to establish
strategic relationships with fewer vendors. This acquisition allows the
Company to immediately offer a broader range of products to a wider set
of embedded applications in the data communications, tele-
communications, military, industrial automation and transportation
markets. (Details are set forth in the Form 8-K filed with the
Securities and Exchange Commission).

Momentum Computer Investment: In September 2002, the Company completed
an agreement to invest $1.5 million for a 47% interest in Momentum
Computer, Inc., a developer of specialized single board computer
solutions for the data communications, telecommunications, military and
aerospace markets. The Company also loaned Momentum $1.0 million to be
used for working capital requirements. Management believes Momentum
fills an important need in the embedded platform market by offering a
"quick turn" design and delivery capability for custom processor and
high performance I/O embedded products. Momentum's product line is
closely aligned, but does not compete with the Company's existing
embedded switch, access, signaling and Intel-based single board
computer products.

In late 2002, the Board of Directors initiated a review of the specific
alternatives to improve stockholder value in the current business and market
conditions. An area that offered opportunities was a more dedicated effort in
searching for technologies and acquisitions that could be added to the Company
to enhance future growth. In early 2003, the Chairman of the Board of Directors
joined the management staff as Chief Strategic Officer to pursue these
initiatives on a dedicated full-time basis.

3) Broaden Market and Product Focus: In the recent past, the Company targeted
its component and software products at the data communications market. With the
expansion of telecommunications in the late 1990's, many Performance
Technologies products were optimized for use in embedded telecommunications
platforms. As the Company entered 2002, management initiated efforts to broaden
the market and product focus of the organization to become less dependent on
near-term growth in the telecommunications arena. In many instances, this
required minimal product modification, in both hardware and software, and a
redirection of the sales and marketing programs. In addition to redirecting
efforts related to existing products, the acquisition of Ziatech and the
investment in Momentum accomplished an immediate broadening of the Company's
product offering and effective market coverage into end application areas such
as military, industrial automation and transportation.

4) Continued New Product Development: The Company continued an aggressive
posture with respect to funding new product development during 2002, relative to
the soft business conditions. As the business cycle runs its course and in
anticipation of improved conditions, it is management's objective for the
Company to be well positioned with a strong and contemporary product portfolio
that will provide opportunities for accelerated growth. In carrying out this
initiative, the Company continued to develop new and innovative products during
the year, including:

Gigabit Embedded Ethernet Switch: In March 2002, the Company extended
its IPnexus(TM) switching product line to include the first embedded
gigabit Ethernet switch. This product began shipping in the third
quarter and there was a noteworthy backlog of orders for gigabit
switches at year-end. In early 2003, the Company began taking
evaluation orders for a beta version of a new product that offers
network routing capabilities important to enhanced speed and security
in data networks.

Network Processing Modules: In late 2002, the Company introduced the
first in a family of network processor modules as an extension to
Performance Technologies' industry leading IPnexus embedded switching
products. Trade named FlexNAT(TM), (Flexible Network Address
Translation), it is the first and only embedded Ethernet solution to
enable integrated high-speed network data packet processing and gigabit
Ethernet switching. Management expects the network processing products
and the associated software development investment made by the
organization during 2002, will form the base technology for a variety
of products the Company will introduce throughout 2003 and 2004.

Expanded Network Access Products: During 2002, the Company continued to
expand its line of network access products by moving existing designs
to a broader set of standards often found in a variety of enterprise
servers for applications beyond the typical embedded markets. During
2002, the Company focused on expanding its communications software
family marketed under the trade name NexusWare(TM) to improve product
coverage and ease of use. This software family is based on the Linux
operating system, which is rapidly growing in popularity. Management
believes the features provided by NexusWare offer distinct user
advantages unmatched by competitive offerings. This continued
enhancement of the Company's broad and recognized communications and
network software capability generates higher margins than similar
competitive products offered for embedded market applications.

3000 Series Signaling Gateway: Early in 2002, the Company introduced
the 3000 Series Signaling Gateway, a small, full-featured SS7/IP
inter-networking device for use in current telephony applications. The
3000 Gateway is specifically targeted at telecommunications operators
who can use IP networks to reduce the cost of existing wireline and
wireless networks without extensive investments in overhauling the
existing network infrastructure.

Industry Overview

As the economic downturn continued throughout 2002, equipment suppliers that
utilize "standards based" embedded technology (the Company's customer base)
responded by implementing cost controls, cutting engineering workforces and
realigning their business models. Such restructuring has created a more
concentrated supplier landscape for 2003 that is better able to adapt to a
fluctuating market. It is not just the equipment vendors who are readjusting.
Across the technology sector, equipment developers and integrators who have
recently downsized are looking to do more outsourcing of equipment and services
and ultimately establish more strategic relationships with fewer vendors.

The Company supplies technology products that are incorporated into open
standards-based embedded systems. These systems are specifically configured
using various hardware and software, often from multiple suppliers, to meet a
variety of end applications found in market segments such as telecommunications
infrastructure, data communications infrastructure, military, or industrial
systems. The embedded systems market is estimated to be over $3.0 billion in
size, worldwide. Traditionally, a large segment of this market has used
proprietary, purpose-built embedded systems and products. Embedded systems built
on "open standard designs" comprise a smaller segment of this market. While
proprietary systems are expected to continue to dominate this market in the
future, a noteworthy growing share of embedded systems being implemented are
expected to use "open standards." The driving factors behind this changing
paradigm are twofold. First, systems are becoming increasingly more complex,
requiring larger investments and longer lead times to design. Second, as
organizations have downsized, they simply do not have the necessary staff to
carry out extensive new product development while successfully meeting the
competitive pressures of "time to market" found in most technology businesses.
Due to these changes, equipment suppliers are relying on companies such as
Performance Technologies to deliver major building blocks or complete platforms,
allowing the supplier to "layer on" their "value add." This can be software
and/or additional hardware elements directed at specific applications.

In addition, the current environment, which has forced the downsizing of many
engineering and development resources, has also forced reductions in purchasing,
logistics and supply groups. Under these circumstances, many customers are
anxious to limit the number of suppliers, forming more strategic relationships
with organizations that have broader capabilities.

Management believes that the added capability resulting from the acquisition of
Ziatech in late 2002 ideally positions the Company to service these evolving
market needs and opportunities. The acquisition more than doubled the Company's
total available market in the embedded systems space through the addition of key
computing and systems products. This allows the Company to offer a broader range
of products and embedded systems platforms to a customer base that is seeking
fewer suppliers and a higher level of integrated solutions. During 2002, the
Company continued its involvement in promoting and supplying embedded products
based on the contemporary use of networking technology as an integral element of
the system design. This new and forward looking approach to building embedded
systems was created by Performance Technologies engineers and has earned the
Company a leading position in the industry when this innovative concept was
standardized and widely adopted as the next-generation benchmark. This standard
is known in the industry as the PICMG 2.16 specification and applies the
concepts developed for enterprise Ethernet networks to embedded system design.
While the sluggish economy has slowed the deployment of equipment built to this
standard, there is widespread adoption of the concept, and many embedded system
suppliers have incorporated this standard into their next-generation products.
Central to this new system architecture is the use of an embedded Ethernet
switch and Ethernet technology for communication between the blades in a system,
rather than older technologies such as PCI.

In support of this new system concept, the Company has aggressively developed a
comprehensive line of embedded Ethernet switches over the past three years. If
the economic environment had been more stable, management believes that the
demand for these products would have been significantly stronger. Nevertheless,
in the current environment, while most product revenues have been flat or
declining, the Company's Ethernet switches have had noteworthy adoption among
major customers and have actually shown continuing quarter-over-quarter growth.
However, throughout 2002, there were only limited signs that any of the numerous
"design wins" that management attributes to this product have actually reached
full-scale deployment. There are customer indications that this may start to
change over the course of 2003. There is also growing market evidence that some
early competitors have relinquished the space to the Company based on our
comprehensive product offering and aggressive development program in this area.
It is management's belief that the Company is in a leading market position with
its embedded switching technology and that this product family will provide
substantial growth when the economic cycle improves.

Market intelligence organizations, such as the Dell'Oro Group, suggest that
revenues in 2003, in networking switches and routers throughout the industry are
projected to be down 7.5% and 25%, respectively. However, the Ethernet switch
market, which is aligned with the Company's products, is expected to grow 3.0%
this year. According to Dataquest, Ethernet switch revenue totaled $2.9 billion
in the third quarter of 2002, a 1.3% increase from the same period in 2001.
While the use of Ethernet switches in embedded systems is a specialized market
segment, the forecasted growth in this market area validates the viability of
the new embedded system architecture developed by the Company.

On a broader but related market observation, management expects the
telecommunications sector to continue to struggle in 2003 and has responded by
adjusting its focus on healthier markets in the near term such as selected
commercial, military and industrial applications. However, there are indications
that certain regions/sectors in the telecommunications market will continue to
be acquiring next-generation equipment this year. For example, the wireless
market is expected to be a sustaining factor in the industry, and Aberdeen is
predicting wireless data services in the form of wireless LAN (WLAN) will be
among the most successful applications for telecommunications in 2003,
addressing three distinct markets: enterprises, residences and public hot spots,
such as airports.

Also, telecommunications as a whole is demonstrating impressive growth in the
Asia-Pacific region. While telecommunications equipment manufacturers and
operators in the United States and Europe continue to report declining revenue
and losses, Asian operators and equipment manufacturers, such as NTT, Huawei,
Samsung, LG and UTStarcom, are continuing to show strength. According to the
International Telecommunication Union (ITU), the number of telephone subscribers
in the Asia-Pacific region in 2002 (both fixed and mobile) accounted for 36
percent of the worldwide total. Ten years earlier, the region accounted for less
than 22 percent. This region has added more than one telephone user every second
for the last decade. Mobile phone growth in the Asia-Pacific region is also
continuing to grow, and future networks in this region will no doubt be IP-based
because of its low price point and ease of implementation. The Company's focus
on products that support IP networks suggests that this is a geographic area
where there will be new opportunities, while the telecommunications markets in
North America and Europe slowly move through a more lengthy recovery process.

Strategy

The Company has a proven history of successfully adapting its products, services
and organization to a constantly changing technology-driven marketplace. This
adaptation has been demonstrated through the course of several business cycles
that have occurred since its founding in 1981. With the Ziatech acquisition in
October 2002, the Company substantially broadened both its product offering and
market coverage to include additional computing and system products that can be
effectively supplied to a market that is twice the size of that which was
available to the Company prior to the acquisition.

Following the acquisition, a new corporate strategy was defined that integrates
the Company's technological innovation and product breadth. The organization's
new business strategy emphasizes its expanded capability to offer a "unified"
solution to the customer base including software, hardware and system platforms
through a single Performance Technologies offering. This new strategy broadens
the Company's market focus to more effectively address embedded system
requirements for communications, military and commercial applications.

The Company's product strategies for 2003 are to effectively expand the
Company's traditional focus of supplying embedded technology components, such as
access and switching products, to supplying "comprehensive" embedded system
platforms incorporating multiple components from the Company's product
portfolio.

Four initiatives have been identified to carry out the 2003 strategy:

Target the Company's Products to a Wider Set of Embedded System
Applications: Appropriate investments are being made to assure the
necessary product features and services that will be required to
broaden the customer base in a variety of promising market segments
outside of the Company's traditional telecommunication focus.

Continue Development of Innovative, Packet-based IP Technology for Use
in Embedded Systems: It is management's intent to leverage the
demonstrated technical innovation of both the traditional Performance
Technologies engineering staff and the newly acquired engineering
talent of the former Ziatech organization. Both have impressive
histories of embedded product and systems innovation.

Extend the Company's Significant Suite of Value-add Software:
Performance Technologies has comprehensive software capability in a
variety of areas. Management's objective during 2003 is to make the
necessary investments to extend this umbrella to include the Ziatech
computing and systems products which traditionally have had lower
margins than the Company's other products.

Increase Market Awareness of the Company's New Capabilities: Leveraging
the Ziatech acquisition, management believes the combined organization
has the fundamental elements to become a premier embedded systems
provider. An aggressive 2003 sales and marketing program is being
carried out to assure awareness of this in the marketplace.

Certainly, there are identifiable risks associated with carrying out the
Company's new corporate and product strategies in the current economic climate.
Since many of the Company's end markets are forecast to show little or no
growth, in order to realize growth in this environment, the Company will have to
take market share from competitors. However, management believes that based on
its review and analysis of the marketplace and the Company's product portfolio
that has numerous strengths, this investment and its associated risk are
worthwhile. If successful, management believes these initiatives will
effectively reposition the organization as an important strategic partner with
many of its customers, thereby increasing their utilization of the Company's
broadened product capabilities. When the business cycle starts to show
improvement, it is further expected that these 2003 initiatives can yield
significant rewards by accelerating revenue growth and profitability.

To effectively implement this growth strategy, management expects to selectively
add to investments in marketing and sales, while sustaining aggressive
engineering development programs during 2003. The Company has a proven track
record of profitable operations, however in the near term, these initiatives
could result in a loss posture for 2003 if revenues do not grow sufficiently
during the year.

The acquisition and initial integration of the Ziatech organization during 2002
has changed the fundamental landscape of opportunity for the Company. In order
to continue this momentum, in January 2003, the Board of Directors expanded the
executive management team by adding a Chief Strategic Officer to identify and
facilitate additional acquisition opportunities, business and technology
investments that can accelerate the Company's growth and associated shareholder
value.

Products

The Company's products and solutions are based on open-system architectures that
include individual system elements, system platforms, single board computers and
software. With embedded solutions for both existing and emerging networks, the
Company serves as a single source vendor for companies involved with industrial,
military, commercial, data communications and telecommunications applications.

The Company markets it embedded products under four general groups. These are:

IPnexus Switching Products
IPnexus Access Products and NexusWare(TM) Software
Ziatech Single Board Computer and Chassis Products
SEGway(TM) SS7/IP Signaling Products

IPnexus Switching Products. The Company's IPnexus Switching products operate in
the new CompactPCI systems architecture referred to as PICMG 2.16. This is an
embedded systems architecture that was developed by the Company and allows the
many techniques, features and advantages that were developed for enterprise
"client-server networks," to be applied to embedded system platforms. This
innovative approach to building these systems uses a specialized Ethernet switch
as the "keystone" of the architecture. This architecture has distinct cost
advantages allowing developers of next-generation systems to reduce design
complexity while increasing overall system reliability and performance. Based on
these clear-cut attributes, the adoption of this standard has occurred at a
record rate among embedded system suppliers and manufacturers to a wide variety
of industries.

As part of the Company's initiative in creating the PICMG 2.16 standard,
engineering undertook an aggressive development program aimed at becoming the
premier supplier of embedded Ethernet switches. The Company's IPnexus switching
products offer a comprehensive family that ranges from low cost, limited speed
to unique higher-end gigabit switches, the latter introduced in 2002. Management
believes that there is substantial pent-up demand for the Company's switching
products based on the number of "design wins" that the Company has realized over
the past twenty-four months. In general, there has been a delay in "design wins"
moving to a production/deployment status based on the soft business conditions.
However, management expects a number of these "design wins" to ultimately
achieve volume order rates as the economy improves and capital spending
rebounds. Based on this scenario, the embedded Ethernet switching product family
could be an important growth driver for the Company.

IPnexus Access Products. The Company's IPnexus Access products are available in
a number of formats that operate in a broad range of data communications and
telecommunications applications. Performance Technologies' access products
provide a connection between a variety of network interfaces and embedded
systems platforms that are used to control the network and/or process
information being transported over networks. This product family includes
stand-alone communication servers and embedded access products that operate as
part of systems based on the PCIbus standard, the CompactPCI (cPCI) standard and
the new PICMG 2.16 standard.

An important element in the Company's access product group is the extensive
communications software products that can be licensed to customers for a variety
of applications. This capability includes: standard communication packages such
as X.25 and Frame Relay, specialized software that supports such applications as
radar protocols used in weather tracking and air traffic control, and SS7
signaling software.

During 2002, the Company introduced its NexusWare software suite. This software
package includes a comprehensive Linux-based development environment and fully
functional runtime software that is supplied with each system. NexusWare is
intended for system engineers using IPnexus Access products to facilitate rapid
integration and development of packet-based embedded systems. NexusWare is
designed to raise the level at which system integration is performed, giving
developers a simplified path to designing comprehensive IPnexus system
solutions. This software package is continually being enhanced and will be
extended to include the newly acquired Ziatech computing products. Management
believes these software tools and products are an important element in assisting
customers to do product integration. This software also generates additional
software license revenue for the Company.

The Company's IPnexus products include embedded Ethernet switches, network
access products and SS7 signaling blades. Announced customers for IPnexus
products include: ADC Telecommunications, Inc., ADLINK Technology, Inc., Agilent
Technologies, Alcatel SA, APW/Electronic Solutions, AudioCodes, Boeing Australia
Limited, Cognitronics Corporation, HP/Compaq Corporation, General Dynamics,
Kaparel, Lucent Technologies, Motorola Corporation, net.com, Nortel Networks,
Northrup Grumman Information Technology, Optibase, Ltd., Raytheon, Siemens AG,
Siemens Carrier Networks LLC, Soma Networks and Sun Microsystems.

Ziatech Computing and Platform Products. The addition of the Ziatech products to
the product line in October 2002 significantly expanded the Company's target
markets, enabling it to offer a more comprehensive solution to an array of
companies in the data communications, telecommunications, industrial automation,
medical and homeland defense.

As the original developer of the widely deployed CompactPCI system standard,
Ziatech has always been a market leader and a driving force behind
standards-based innovation for the embedded market sector. In addition, Ziatech
had developed a range of PICMG 2.16 products that complement the product
offerings already being sold by the Company. The Ziatech computing products
provide a complete range of Intel-based single board computers that can be
applied to a broad range of applications.

In addition to the range of single board computers, the Company now offers a
variety of embedded system chassis and associated chassis management products.
This expanded capability allows Performance Technologies to provide
comprehensive embedded system platforms incorporating multiple components from
the Company's portfolio.

Announced customers for the Ziatech Products include: Analogic, Copper Mountain
Networks, Laurel Networks, Lucent Technologies, Marconi, Nortel Networks and
Soma Networks.

SEGway SS7 IP Signaling Products. The Company's SEGway products are used to
interconnect traditional telephone networks with the growing packet-switched
(IP) network architectures of today. Performance Technologies SEGway signaling
products also reliably transport, concentrate and route SS7 messages between SS7
and IP entities. In 2001, the Company introduced a product that allowed
traditional SS7 messages to be reliably transported over IP networks. One of the
first applications for this technology was the transport of SS7 signals over the
Internet, allowing secondary GSM cellular/mobile markets to be added to the
roaming footprint of a group of European wireless operators. The Company has
since expanded that capability to allow economical replacement/expansion of
traditional SS7 networks over IP networks, at a substantially reduced cost in a
variety of applications. While the reduced capital equipment spending in the
telecommunications markets has slowed deployment of these products, there are
continued market indications that the concept is attractive to
telecommunications operators and will grow as the spending rebounds in this
market.

The Company also provides carrier-grade SS7 and SS7/IP networking solutions for
GSM wireless roaming applications with deployments in over 35 countries
worldwide.

The Company's SEGway products include SS7 network replacement products, SS7/IP
products and the GSM SS7 signaling platform. Announced customers for the SEGway
products include: Alcatel SA, Comfone AG, Ericsson Telecommunications, iBasis
Inc., Motorola Corporation, Nortel Networks, Swisscom AG, Telefonica Moviles
Espana, Teleglobe and TSI Telecommunications Services.

Sales, Marketing and Distribution

The Company markets its products worldwide to a spectrum of customers through
its direct sales force and various channels including Original Equipment
Manufacturers (OEMs), Value Added Resellers (VARs), distributors and systems
integrators. Almost all of the Company's North American business is sold through
the Company's direct sales force.

Due to the highly technical nature of the Company's products, it is essential
that the Company's salespeople are technically oriented and are knowledgeable in
the embedded systems, networking and communications fields. To supplement its
sales force, the Company has field application engineers who assist prospective
customers in determining if the Company's products will meet their requirements.

Currently, 32 sales, marketing and sales support personnel are located in the
Company's Rochester, New York, Connecticut, California (2), Ottawa, Canada and
the United Kingdom offices. In addition, independent sales representatives and
agents cover selected geographic areas nationally and internationally; and
distributors or integrators, handling selected products, supplement the
Company's direct sales team on a worldwide basis.

The Company executes various ongoing marketing strategies designed to attract
new OEM and end-user customers and to stimulate additional purchases from
existing customers. These strategies include direct mail and email campaigns,
direct telemarketing, special pricing programs, active participation in
technical standards groups, participation in national, international and
regional trade shows, selected trade press advertisements and technical
articles, and an active campaign to direct potential customers to the Company's
Web site.

Sales to customers outside of North America represented 25%, 27% and 30% of the
Company's revenue in 2002, 2001 and 2000, respectively. The Company's products
are currently sold by the Company's direct sales force and by international
distributors throughout the more industrialized countries in Europe and in Asia.
International sales are subject to import and export controls, transportation
delays and interruptions, foreign currency exchange rates, and foreign
governmental regulations. Payments for shipments from the United States to
outside the United States are generally made in U.S. dollars and payments for
shipments from Canada to Canada are generally made in Canadian dollars.

Customers

The Company has over 50 active customers worldwide, primarily in the
telecommunications and embedded systems markets. Many of the Company's major
customers are Fortune 500 companies in the United States or of similar stature
in Europe and Asia. In 2002, the largest single customer (Lucent Technologies)
represented 9% of revenue, and the four largest customers (Lucent Technologies,
Teleglobe, HP/Compaq Computer and UTStarcom) represented 28% of the Company's
revenue.

At year-end 2002, approximately 70% of the Company's customers are in the
telecommunications industry and the Company's products are generally integrated
into products for wireline, wireless and next-generation IP network
infrastructure. These products are targeted at customers in the following
sectors: telecommunication equipment manufacturers, telecommunications service
providers and operators, international wireless carriers and platform
manufacturers.

The Company's other customers represent a range of industries utilizing
open-architecture embedded systems. Due to the addition of the Ziatech product
line and the current weakness in the telecommunications industry, the Company is
focusing more marketing and sales emphasis on the overall embedded systems
market than in recent years.

Backlog

At January 31, 2003, the scheduled backlog of orders was $8.4 million, compared
to $3.2 million at February 10, 2002. A substantial portion of the Company's
revenue in each quarter results from orders placed within the quarter and
shipped in the final month of the quarter. Orders are subject to cancellation in
the normal course of business; however, historically, the Company has filled
most of its firm orders. (See Management's Discussion & Analysis included
elsewhere in this report).

Seasonality

The Company's business is not generally subject to large seasonal swings. Much
of the Company's business is project-related, driven by customer demand, which
can cause quarterly fluctuations in revenue.

Environmental Matters

The Company does not believe that compliance with federal, state or local laws
or regulations relating to the protection of the environment have any material
effect on its capital expenditures, earnings or competitive position.

Competition

The acquisition of the Ziatech product line in 2002 enabled the Company to
reposition itself from being an embedded components supplier to supplying
comprehensive embedded systems, incorporating these components. This added
product capability increased the Company's addressable markets and altered the
Company's competitive landscape.

The embedded systems market continues to be characterized by rapid technological
innovations resulting in new product introductions and frequent advances in
price/performance ratios. Competitive factors in this market include product
performance, functionality, product quality and reliability, customer service
and support, marketing capability, corporate reputation and brand recognition,
and changes in relative price/performance ratios.

For computing and platform products, the Company faces a group of competitors
including Motorola Computer Group, Force Computers, Radisys Corporation and SBS
Technologies. These competitors are split into two categories: the full systems
suppliers noted above, and technology component suppliers offering either
computing components or platforms. Management believes that computing products
is the cornerstone of the embedded systems market, and product functionality and
quality, time-to-market and price/performance are key factors to winning new
accounts.

The Company's first embedded IP Ethernet switch products were introduced to the
embedded systems market in 2000 and the first PICMG 2.16 compliant models were
introduced in the fall of 2001. Initially, there were several small and large
competitors offering one or two different models of IP switches to the market.
Today, some of these competitors are withdrawing products from the market,
without introducing new products. Management believes this has occurred because
the technological requirements, both hardware and software, were underestimated.
Current competitors include Zynx and Ramix, small private companies. The size of
this market is small compared to the enterprise switch market and larger
companies in that market are not expected to enter this segment due to the
customization requirements and relatively low volumes, as compared to the
enterprise market.

In the network access market, the Company believes its key differentiations from
its competitors are its depth of market experience and suite of communication
software, known as NexusWare. The Company's products compete with products from
Adax Incorporated, Audiocodes Ltd., Artesyn Technologies, Interphase Corporation
and NMS Communications.

In the signaling market, the Company generally focuses its engineering on
products that use Internet Protocol (IP) to carry signaling traffic. Since this
is a newer area in the signaling market, the Company believes it has an
advantage over competitors' products. Companies such as Ulticom, Inc., Tekelec,
NMS Communications and several larger companies that have proprietary SS7
technology or products could develop and sell products more directly competitive
with the Company's signaling products.

Research and Development

The Company's research and development expenses were approximately $6.9 million,
$7.9 million and $8.9 million for 2002, 2001 and 2000, respectively. These
expenses consist primarily of employee costs, material consumed in developing
and designing new products, and amounts expended for software license/tools. The
Company expects to continue to invest heavily in research and development in
order to create innovative new products for the embedded systems market.

The Company has developed significant core competencies applicable to computing
platforms, single board computers, voice and data communications, high
availability, hot swap, redundant technologies and signaling communications. The
Company also has significant software expertise that it expects to apply to
embedded systems and platforms.

Proprietary Technology

The Company's success depends upon retaining and maximizing the Company's
proprietary technologies. To date, the Company has relied principally upon
trademark, copyright and trade secret laws to protect its proprietary
technology. The Company generally enters into confidentiality or license
agreements with its customers, distributors and potential customers that contain
confidentiality provisions, and limits access to, and distribution of, the
source code to its software and other proprietary information. All of the
Company's employees are subject to the Company's employment policy regarding
confidentiality. The Company's software products are provided to customers under
license, generally in the form of object code, which provides a high degree of
confidentiality with respect to the intellectual property value.

Suppliers

In the fast paced technology environment, manufacturers frequently "obsolete"
electronic components. Furthermore, more situations are arising where the
Company is utilizing sole or limited source components on its products. The
Company has generally been able to obtain adequate supplies of components or has
redesigned specific products when adequate components are not available. The
Company obtains components on a purchase order basis and does not generally have
long-term contracts with any of its suppliers.

Manufacturing

The Company maintains a state-of-the-art manufacturing facility in Rochester,
New York where it manufactures its network access, switching and signaling
products. The Computing Products Group (formerly Ziatech) manufactures its
products under contract and performs system level manufacturing and integration
in-house. Management intends to transition the higher volume, contemporary
computing products to its Rochester manufacturing operation during 2003.

Rochester manufacturing operates under an integrated MRP system that assists in
managing inventory levels and facilitates demand forecast. The Rochester surface
mount manufacturing facility and quality management systems are currently
certified to ISO 9002 standards. Many of the Company's products have high
software content and are generally produced in low volumes. By utilizing an
in-house manufacturing capability, management believes that the Company has
achieved some safety from the risks inherent in utilizing contract
manufacturing. These risks typically include the sub-contractor's inability to
meet flexible manufacturing requirements, inventory control and cost
containment. In addition, use of in-house manufacturing enables the Company to
maintain a high quality level for its products and greater responsiveness to
customer's delivery requirements. Management expects these attributes to be
applied to the Ziatech products as selected products are transitioned from
contract manufacturing to the Company's in-house facility.

The Company has limited alternative capabilities through third parties, however,
to perform such manufacturing activities. In the event of an interruption of
production at its manufacturing facility, the Company's ability to deliver
products in a timely fashion would be compromised, which would have a material
adverse effect on the Company's results of operations.

Employees

During 2002, the Company improved its cost structure primarily through
reductions in the Company's staff and by consolidating the engineering
operations from its Raleigh, North Carolina facility into its Ottawa, Canada
Signaling Group. The programs were performed during the first and third quarters
of 2002 as the continuing decline in capital spending in the Company's target
markets resulted in lower demand for the Company's products and lower than
anticipated Company revenue. These reductions involved approximately forty
employees and were initiated throughout the organization.

In October 2002, the Company added approximately seventy employees with the
acquisition of the new Computing Products Group (formerly Ziatech Corporation).

As of January 31, 2003, the Company had 220 full-time employees, five part-time
and contract employees and five Engineering Cooperative student employees.
Management believes its relations with its employees are good. The Company's
employees are not subject to collective bargaining agreements.

The Company's fulltime employees work in the following areas:

Research and Development 95
Marketing and Sales 32
Manufacturing 67
General and Administrative 26

Management believes that the Company's future success will depend on its ability
to continue to attract and retain qualified personnel.

Risk Factors

Technological Change and New Product Introductions. The market for the Company's
products is characterized by rapid technological change and frequent
introduction of products based on new technologies. As new products are
introduced, the industry standards change. Additionally, the overall embedded
systems market, particularly the telecommunications industry, is volatile as the
effects of new technologies, new standards, new products and short life cycles
contribute to changes in the market and the performance of industry
participants. The Company's future revenue will depend upon the Company's
ability to anticipate technological changes and to develop and introduce
enhanced products of its own on a timely basis that comply with new industry
standards. New product introductions, or the delays thereof, could contribute to
quarterly fluctuations in operating results as orders for new products commence
and orders for existing products decline. Moreover, significant delays can occur
between a product introduction and commencement of volume production. The
inability to develop and manufacture new products in a timely manner, the
existence of reliability, quality or availability problems in its products or
their component parts, or the failure to achieve market acceptance for its
products would have a material adverse effect on the Company's revenue and
operating results. Further, in a poor economic climate, such as today, current
technologies may become obsolete before being replaced by new technologies.

Competition. The embedded systems market, particularly the telecommunications
industry, is extremely competitive and the Company faces a number of large and
small competitors. Many of the Company's principal competitors have established
brand name recognition and market positions and have substantially greater
experience and financial resources to deploy on promotion, advertising, research
and product development than the Company. In addition, as the Company broadens
its product offerings, it expects to face competition from new competitors.
Companies in related markets could offer products with functionality similar or
superior to that offered by the Company's products. Increased competition could
result in price reductions, reduced margins and loss of market share, all of
which would materially and adversely affect the Company's revenue and operating
results. Large companies have recently acquired several of the Company's
competitors. These acquisitions are likely to permit the Company's competition
to devote significantly greater resources to the development and marketing of
new competitive products and the marketing of existing competitive products to
their larger installed bases. The Company expects that competition will increase
substantially as a result of these and other industry consolidations and
alliances, as well as the emergence of new competitors. There can be no
assurance that the Company will be able to compete successfully with its
existing or new competitors or that competitive pressures faced by the Company
will not have a material adverse effect on the Company's revenue and operating
results.

Dependence on Key Customers. There can be no assurance that the Company's
principal customers will continue to purchase products from the Company at
current levels. Customers typically do not enter into long-term volume purchase
contracts with the Company, and customers have certain rights to extend or delay
the shipment of their orders. The loss of one or more of the Company's major
customers, and the reduction, delay or cancellation of orders, or a delay in
shipment of the Company's products to such customers, would have a material
adverse effect on the Company's revenue and operating results. (See Management's
Discussion and Analysis included elsewhere in this report).

Design Wins. A design win is when a customer or prospective customer notifies
the Company that its product has been selected to be integrated with their
product. Ordinarily, there are a number of steps between the design win and when
customers initiate production shipments. Typically, design wins reach production
volumes at varying rates. Historically, this gestation period prior to volume
orders has been twelve to eighteen months or more after the design win occurs. A
variety of risks such as schedule delays, cancellations, and changes in customer
markets and economic conditions can adversely affect a design win before
production is reached or during deployment. While management still believes that
design wins continue to be an important metric in evaluating the market
acceptance of the Company's products, unfortunately in the current economic
climate, fewer customers are doing new design activity and a smaller number of
these design wins are moving into production than in the past.

Potential Fluctuations in Annual and Quarterly Results. The Company's future
annual and quarterly operating results can vary significantly depending on
factors such as the timing and shipment of significant orders, new product
introductions by the Company and its competitors, market acceptance of new and
enhanced versions of the Company's products, changes in pricing policies by the
Company and its competitors, the mix of distribution channels through which the
Company's products are sold, inability to obtain sufficient supplies of sole or
limited source components for the Company's products, and seasonal and general
economic conditions. The Company's expense levels are based, in part, on the
Company's expectations as to future revenue. Since a substantial portion of the
Company's revenue in each quarter results from orders placed within the quarter
and often shipped in the final weeks of that quarter, revenue levels are
extremely difficult to predict. If revenue levels are below expectations,
revenue and operating results will be adversely affected. Net income would be
disproportionately affected by a reduction in revenue because only a small
portion of the Company's net expenses varies with its revenue. (See Management's
Discussion and Analysis included elsewhere in this report).

Dependence on Third Party Component Suppliers. Certain components used in the
Company's products are currently available to the Company from one or a limited
number of sources. There can be no assurance that future supplies will be
adequate for the Company's needs or will be available on prices and terms
acceptable to the Company. The Company's inability in the future to obtain
sufficient limited-source components, or to develop alternative sources, could
result in delays in product introduction or shipments, and increased component
prices could negatively affect the Company's gross margins, either of which will
have a material adverse effect on the Company's revenue and operating results.

Dependence on Internal Manufacturing. In order to avoid relying on outside
contract manufacturers, the Company manufactures its network access, switch and
signaling products at its Rochester, New York facility. The Company's newly
acquired Ziatech computing and platform products have been manufactured at
contract manufacturers. The Company does not have alternative manufacturing
capabilities, either internally or through third parties, to perform its
manufacturing functions except it expects to begin manufacturing certain of the
Ziatech computing products in its Rochester manufacturing facility during 2003.
Even if the Company were able to identify alternative third-party contract
manufacturers, there can be no assurance that the Company would be able to
retain their services on terms and conditions acceptable to the Company. In the
event of an interruption in production, the Company would not be able to deliver
products on a timely basis, which would have a material adverse effect on the
Company's revenue and operating results. Although the Company currently has
business interruption insurance, no assurances can be given that such insurance
will adequately cover the Company's lost business as a result of such an
interruption.

Dependence on Proprietary Technology. The Company's success depends upon the
Company's proprietary technologies. To date, the Company has relied principally
upon trademark, copyright and trade secret laws to protect its proprietary
technologies. The Company generally enters into confidentiality or license
agreements with its customers, distributors and potential customers and limits
access to and distribution of the source code to its software and other
proprietary information. The Company's employees are subject to the Company's
employment policy regarding confidentiality. There can be no assurance that the
steps taken by the Company in this regard will be adequate to prevent
misappropriation of its technologies or to provide an effective remedy in the
event of a misappropriation by others.

Although management believes that the Company's products do not infringe on the
proprietary rights of third parties, there can be no assurance that infringement
claims will not be asserted, resulting in costly litigation in which the Company
may not ultimately prevail. Adverse determinations in such litigation could
result in the loss of the Company's proprietary rights, subject the Company to
significant liabilities, require the Company to seek licenses from third parties
or prevent the Company from manufacturing or selling its products, any of which
will have a material adverse effect on the Company's revenue and operating
results.

Because of the existence of a large number of patents in the computer networking
industry and the rapid rate of new patents granted or new standards developed,
or new technology, it may be necessary for the Company to enter into technology
licenses from others. There can be no assurance that these third party
technology licenses will be available to the Company on commercially reasonable
terms. The loss of, or inability to obtain, any of these technology licenses
could result in delays or reductions in product shipments. Any such delays or
reductions in product shipments will have a material adverse effect on the
Company's revenue and operating results.

Dependence on Personnel. The Company's success depends on the continued
contributions of its personnel, many of whom would be difficult to replace. Over
the past several years, one of the incentives used to retain key personnel has
been the issuance of stock options. Unfortunately, in the current market, the
Company's stock price has declined such that almost all of those stock options
are below the grant price, thereby negating the retention attributes of those
instruments.

Through mid-2001, competition for engineering personnel in the Company's
marketplace was intense. Since mid-2001, engineering personnel seem to be more
readily available. Although the Company's employees are subject to the Company's
employment policy regarding confidentiality and ownership of inventions,
employees are generally not subject to employment agreements or non-competition
covenants. Changes in personnel could adversely affect the Company's operating
results.

Notes: IPnexus, NexusWare, FlexNat, Ziatech, and SEGway are trademarks of
Performance Technologies, Inc.

ITEM 2 - Properties

The Company's corporate headquarters are located in 57,000 square feet of office
and manufacturing space in Rochester, New York. Corporate headquarters include
the executive offices, along with sales, marketing, engineering and
manufacturing operations. The Company relocated these operations to this leased
facility in April 2002. This lease expires in 2012. There is sufficient room for
growth in the intermediate term in this facility and it is capable of
accommodating a variety of expansion options. In 2001, the Company purchased
land adjacent to this facility to accommodate future expansion.

The Company's Computing Products Group (formerly Ziatech Corporation) is located
in 61,000 square feet of office and manufacturing space leased in San Luis
Obispo, California. This lease expires in 2008. This facility includes sales and
marketing personnel, and engineering and manufacturing operations for the
computing products. Approximately 12,000 square feet of this facility is
currently sublet to a tenant and there is sufficient room for this group's
intermediate-term growth in this facility.

The Company has sales and marketing personnel, and signaling engineering staff
located in 13,000 square feet of office space leased in a building located in
downtown Ottawa, Canada. The office lease agreements in this building expire in
May 2003. The Company has the option to renew these leases for a future period
of one or two years. The Company expects to exercise its renewal options under
these leases. The Signaling Group also had 7,000 square feet of office space in
downtown Raleigh, North Carolina. In September 2002, the engineering functions
at this facility were consolidated into the Ottawa, Canada signaling operations.
The Company is attempting to sublet this space, however, the commercial office
space market in downtown Raleigh is very soft. This office lease expires in
February 2005.

The Company also leases sales and engineering offices in San Diego, California
and sales offices in Connecticut and the United Kingdom.

ITEM 3 - Legal Proceedings

From time to time, the Company is involved in litigation relating to claims
arising out of its operations in the normal course of business. With the
exception of the following items, the Company is not a party to any such legal
proceedings, the adverse outcome of which, individually or in the aggregate,
would have a material adverse effect on the Company's results of operations,
financial condition or cash flows.

Following the Company's announcement on May 19, 2000 regarding its preliminary
results of operations for the second quarter, several class action lawsuits were
filed in the United States District Court for the Western District of New York
against the Company, as well as several of its officers and directors, alleging
violations of federal securities laws. On September 25, 2002, the Company
announced it had signed a Memorandum of Understanding for the settlement of the
class action litigation. The Company recorded a charge of $143,000 in the third
quarter of 2002 in connection with the settlement of the litigation. The terms
of the settlement outlined in the memorandum between the Company and the class
action plaintiffs have been submitted to the Court in the form of a settlement
agreement. This proposed settlement will be subject to Court acceptance and
approval.

ITEM 4 - Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders during the fourth
quarter 2002.

PART II

ITEM 5 - Market for the Registrant's Common Equity and Related Stockholder
Matters

The Company's common stock is traded on the Nasdaq National Market System under
the trading symbol "PTIX." The following table sets forth the high and the low
quarterly closing prices of the common stock during the two most recent years,
as reported on the Nasdaq National Market System. These prices represent
quotations among securities dealers without adjustments for retail markups,
markdowns or commissions and may not represent actual transactions.

2002 High Low
-----------------------------------------------------------------------
First Quarter $13.57 $ 7.65
Second Quarter 8.60 6.25
Third Quarter 6.31 3.43
Fourth Quarter $ 4.74 $ 3.20

2001 High Low
-----------------------------------------------------------------------
First Quarter $15.75 $10.06
Second Quarter 16.49 10.00
Third Quarter 17.40 8.22
Fourth Quarter $13.55 $ 8.00

As of February 28, 2003, there were 189 stockholders of record of the Company's
common stock.

To date, the Company has not paid cash dividends on its common stock and has no
intention to do so for the foreseeable future.

Equity Plan Information:

The Performance Technologies, Incorporated 2001 Stock Option Plan was approved
by the Company's stockholders at the 2001 Annual Meeting.

The following table provides certain information regarding the Company's equity
compensation plan.

(a) (b) (c)
Number of
securities to be
issued upon Weighted average Number of
Plan Category exercise of exercise price of securities
outstanding outstanding remaining
options, warrants options, warrants available for
and rights and rights future issuance
------------------- ------------------- --------------------
Equity compensation plans
approved by security holders 2,146,680 $10.46 875,050

Equity compensation plans not
approved by security holders
------------------- ------------------- --------------------
Total 2,146,680 $10.46 875,050
=================== =================== ====================

The Company has no equity compensation plans that have not been approved by its
stockholders.

ITEM 6 - Selected Financial Data
-----------------------
(in thousands, except per share amounts)

For the Years Ended December 31: 2002 2001 2000 1999 1998
- ----------------------------------------------- ----------- -- ----------- --- ----------- -- ----------- -- ------------

Sales $27,014 $36,517 $38,963 $44,494 $34,118
Income from operations 326 5,186 7,050 6,226 6,047
Basic earnings per share:
Net income from operations (1) $ .03 $ .42 $ .54 $ .47 $ .46
Weighted average common shares 12,263 12,282 13,106 13,165 13,077
Diluted earnings per share:
Net income from operations (1) $ .03 $ .41 $ .51 $ .45 $ .45
Weight average common and
common equivalent shares 12,373 12,708 13,769 13,789 13,517

Excluding non-recurring expenses (2) (3)
Income from operations $ 1,186 $ 5,186 $ 7,050 $ 7,970 $ 6,047
Basic earnings per share $ .10 $ .42 $ .54 $ .61 $ .46
Diluted earnings per share $ .10 $ .41 $ .51 $ .58 $ .45

At December 31: 2002 2001 2000 1999 1998
- ----------------------------------------------- ----------- -- ----------- --- ----------- -- ----------- -- ------------
Working capital $32,130 $34,728 $36,975 $39,009 $32,221
Total assets 45,204 42,954 44,758 49,142 40,122
Long-term debt, less current portion 6
Total stockholders' equity $38,809 $38,342 $39,468 $40,828 $34,180

(1) All per share amounts have been adjusted where appropriate, for the
three-for-two stock split effected in September 1999.

(2) In 2002, using an effective tax rate of 31%, amounts exclude
non-recurring expenses amounting to $.9 million, or $.07 per share.
In 1999, amounts exclude a $1.7 million charge for acquisition
expenses.

(3) This data is a non-GAAP measure that should be read in conjunction
with GAAP disclosures herein.

ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results
of Operations

The Company's annual operating performance is subject to various risks and
uncertainties. The following discussion should be read in conjunction with the
Consolidated Financial Statements and related notes, included elsewhere herein,
as well as the section appearing in ITEM 1 of this Form 10-K under the heading
"Risk Factors." The Company's future operating results may be affected by
various trends and factors which are beyond the Company's control. These
include, among other factors, general business and economic conditions, rapid or
unexpected changes in technologies, cancellation or delay of customer orders
including those relating to design wins, changes in the product or customer mix
of sales, delays in new product development, customer acceptance of new products
and customer delays in qualification of products. In addition, during difficult
economic periods, customer's visibility deteriorates causing delays in their
placement of orders. These factors often result in a substantial portion of the
Company's revenue being derived from orders placed within the quarter and
shipped in the final month of the quarter.

Matters discussed in Management's Discussion and Analysis of Financial Condition
and Results of Operations and elsewhere in this Form 10-K include
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, and are subject to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. The Company's actual results could
differ materially from those discussed in the forward-looking statements.

Overview

Industry: 2002 was a challenging year with continuing erosion in the general
business environment, as well as the Company's target markets. In these markets,
the telecommunications industry is the largest sector which was burdened with
overcapacity and a slowing economy that resulted in reduced prices, stifled
competition and severely limited capital expenditures. Other end markets for
embedded systems also experienced business slowdowns during 2002, but not as
severe as the telecommunications industry. Management responded to these
demanding market conditions through a series of initiatives that allowed the
Company to maintain profitability while many comparable organizations suffered
large financial losses that, in some cases, threatened their continued
operations. Please refer to PART 1, Item 1, under the caption "Business", for a
discussion of the industry, economic environment and the Company's initiatives
during 2002.

Traditionally, "design wins" have been an important metric for management to
judge the Company's product acceptance in its marketplace. Typically, design
wins reach production volumes at varying rates, generally beginning
twelve-to-eighteen months after the design win occurs. A variety of risks such
as schedule delays, cancellations, and changes in customer markets and economic
conditions can adversely affect a design win before production is reached or
during deployment. While management still believes that design wins continue to
be an important metric in evaluating the market acceptance of the Company's
products, unfortunately in the current economic climate, fewer customers are
doing new design activity and a smaller number of these design wins are moving
into production than in the past. During 2002, the Company received notification
for twenty-four new design wins for its IPnexus Switching (8), IPnexus Access
(12), Ziatech Computing and Platform (2), and SEGway SS7 IP Signaling products
(2), compared to thirty-five new design wins during 2001. Not all design wins
are expected to result in production orders.

Financial: On October 2, 2002, the Company acquired a portion of Intel
Corporation's Embedded Communications Platform Division (formerly Ziatech
Corporation). Beginning in the fourth quarter, the Company's revenue and
expenses reflect the Ziatech operations.

In 2002, the following non-recurring items affected the comparability of income
between years:

o restructuring charges ($.6 million pre-tax, or $.03 per share);
o in-process research and development expense ($.4 million after-tax, or
$.03 per share); and
o class action settlement costs ($.1 million pre-tax, or $.01 per share).

Revenue for 2002 amounted to $27.0 million, compared to $36.5 million in 2001.
The continuing decline in capital spending in the communications and
telecommunications markets dramatically impacted the Company's network access
and signaling product revenue in 2002. The newly acquired Ziatech operations
contributed $5.0 million to revenue in 2002. Sales outside of North America
amounted to $6.9 million and $9.7 million in 2002 and 2001, respectively.

Net income in 2002 amounted to $.3 million, or $.03 per share, including
non-recurring expenses, and amounted to $1.2 million, or $.10 per share,
excluding non-recurring expenses, based on 12.4 million shares outstanding.
Using an effective income tax rate of 31%, non-recurring expenses during 2002
amounted to $.9 million after tax, or $.07 per share. Net income in 2001
amounted to $5.2 million, or $.41 per share, based on 12.7 million shares
outstanding.

Cash, cash equivalents and marketable securities amounted to $24.1 million and
$26.9 million at December 31, 2002 and 2001, respectively, and no long-term debt
existed at either date. During 2002 and 2001, the Company generated $5.5 million
and $9.0 million of cash from operating activities, respectively. During 2002
and 2001, the Company expended $.1 million and $6.9 million, respectively, to
buy back its shares in the open market. In September 2002, the Company invested
$1.5 million for a 47% minority interest in Momentum Computer, Inc. and loaned
Momentum an additional $1.0 million to be used for working capital. In October
2002, the Company acquired a portion of Intel Corporation's Embedded
Communications Platform Division (formerly Ziatech Corporation) for $3.0 million
in cash.

Results of Operations

The following table sets forth for the years indicated certain consolidated
financial data expressed as a percentage of sales and is included as an aid to
understanding the Company's results and should be read in conjunction with the
selected financial data and Consolidated Financial Statements (including the
notes thereto) appearing elsewhere in this report. The table includes the
results of operations of the new Computing Products Group (formerly Ziatech
Corporation), since it was acquired on October 2, 2002.

Percentage of Sales
Year Ended December 31,
2002 2001 2000
----------- ---------- ----------

Sales 100.0% 100.0% 100.0%
Cost of goods sold 47.6 36.5 35.3
----------- ---------- ----------

Gross profit 52.4 63.5 64.7

Operating expenses:
Selling and marketing 16.2 15.2 12.6
Research and development 25.6 21.7 22.9
General and administrative 10.1 8.1 6.4
Restructuring charges 2.1
In-process research and development 1.4
Class action legal settlement .5
----------- ---------- ----------

Total operating expenses 55.9 45.0 41.9
----------- ---------- ----------

(Loss) income from operations (3.5) 18.5 22.8

Other income, net 2.0 2.7 5.0
----------- ---------- ----------

(Loss) income before income taxes and equity in
loss of unconsolidated company (1.5) 21.2 27.8

Income tax (benefit) provision (3.0) 7.0 9.7
----------- ---------- ----------

Income before equity in loss of unconsolidated company 1.5 14.2 18.1

Equity in loss of unconsolidated company, net of tax (.3)
----------- ---------- ----------

Net income 1.2% 14.2% 18.1%
=========== ========== ==========

Excluding non-recurring expenses (1) (2)

Income before income taxes and equity in
loss of unconsolidated company 2.5% 21.2% 27.8%

Income tax (benefit) provision (2.2) 7.0 9.7
----------- ---------- ----------

Income before equity in loss of unconsolidated company 4.7 14.2 18.1

Equity in loss of unconsolidated company, net of tax (.3)
----------- ---------- ----------

Net income, including non-recurring expenses 4.4% 14.2% 18.1%
=========== ========== ==========

(1) Based on an effective tax rate of 31%, excludes non-recurring expenses in
2002 for restructuring charges, in-process research and development costs, and
class action settlement costs totaling $.9 million after-tax, or 3.2% of sales.

(2) This data is a non-GAAP measure that should be read in conjunction with GAAP
disclosures herein.

Year Ended December 31, 2002, compared with the Year Ended December 31, 2001

Sales. Total revenue for 2002 was $27.0 million, compared to $36.5 million for
2001. The newly acquired Ziatech operations contributed $5.0 million to revenue
in 2002. For the years indicated, the Company's products are grouped into four
distinct categories in one market segment: Signaling and network access
products, Ziatech computing products, IPnexus switching products, and other
products. Revenue from each product category, expressed as a percentage of sales
for 2002 and 2001, are as follows:

2002 2001
-------------- ---------------

Signaling and network access products 70% 87%
Ziatech computing products 18% 0%
IPnexus switching products 9% 5%
Other 3% 8%
-------------- ---------------

Total 100% 100%
============== ===============

Signaling and network access products: Revenue from this product category
amounted to $18.8 million and $31.8 million in 2002 and 2001, respectively. The
continuing decline in capital expenditure investments by customers in the
Company's target markets significantly reduced signaling and network access
product revenue in 2002.

Ziatech computing products: Revenue from this product category amounted to $5.0
million in 2002. This product revenue was generated in the fourth quarter 2002
by the newly acquired Ziatech operations.

IPnexus switching products: Revenue from this category grew 44% to $2.4 million
in 2002, compared to $1.7 million for 2001. The Company's IPnexus switch product
family has been designed for the embedded systems market and is based on the
PICMG 2.16 systems architecture, which was ratified in September 2001. While
still a modest percentage of the Company's revenue, IPnexus switch product
revenue is expected to grow when customers move their new products into
production.

Other products: Revenue from other products amounted to $.8 million and $3.0
million in 2002 and 2001, respectively. This revenue is related to legacy
products. Customer demand for these products has declined significantly over the
past twelve months as customers move to newer technology. Many of these products
are project oriented and shipments can fluctuate on a quarterly basis.

Gross Profit. Gross profit consists of sales, less cost of goods sold including
material costs, manufacturing expenses, amortization of software development
costs, expenses associated with engineering contracts and technical support
function expenses. Gross margin was 52.4% and 63.5% of sales in 2002 and 2001,
respectively. Fixed expenses such as certain manufacturing labor and overhead
costs, technical support costs, and amortization of capitalized software
development spread over lower sales volumes impacted gross margin as a
percentage of sales during 2002, compared to 2001. The decrease in gross margin
in 2002 is also attributable to the write off of certain software capitalization
projects of $.3 million, an increase in inventory obsolescence expense of $.3
million, and lower gross margins on the newly acquired computing products.

Total Operating Expenses. Total operating expenses amounted to $15.1 million and
$16.4 million in 2002 and 2001, respectively, and include expenses associated
with the new Computing Products Group (formerly Ziatech Corporation) during the
fourth quarter 2002. During January and September 2002, the Company took actions
to improve its cost structure by more closely aligning expenses with current
revenue levels. These expense reductions amounted to $2.6 million annually and
were attained by reducing staffing levels by approximately 20% and by
consolidating one remote office location to more efficiently provide engineering
and product support. Despite these efforts, when total operating expenses are
spread over lower sales volumes, total operating expenses increased to 55.9% of
sales in 2002, compared to 45.0% in 2001.

Selling and marketing expenses amounted to $4.4 million and $5.5 million in 2002
and 2001, respectively. This decrease in expense is primarily the result of
lower personnel and commission expenses, and reductions in advertising, travel
and trade show participation. This decrease was partially offset by expenses
associated with the new Computing Products Group during the fourth quarter 2002.

Research and development expenses amounted to $6.9 million and $7.9 million in
2002 and 2001, respectively. This decrease in expense is primarily attributable
to lower engineering staff levels. This decrease was partially offset by
expenses associated with the new Computing Products Group during the fourth
quarter 2002. Despite the net reduction in expense, management continues to
commit significant resources to the development of new products. In addition,
the Company capitalizes certain software development costs, which reduce the
amount of software development costs charged to operating expense. Amounts
capitalized were $1.2 million and $1.7 million for 2002 and 2001, respectively.
Gross expenditures for engineering and software development were $8.1 million
and $9.6 million for 2002 and 2001, respectively.

General and administrative expenses amounted to $2.7 million and $2.9 million in
2002 and 2001, respectively. This decrease in expense is the result of tightened
control over general and administrative expenses and lower personnel related
expenses. This decrease was partially offset by expenses associated with the new
Computing Products Group during the fourth quarter 2002.

Restructuring charges amounted to $.6 million in 2002. These non-recurring
expenses were associated with actions the Company took to improve its cost
structure. They include severance related to staffing reductions and expenses
associated with closing the Raleigh, North Carolina engineering facility.

In-process research and development expenses were $.4 million in 2002. This is a
one-time charge for in-process research and development costs associated with
the Ziatech acquisition that were expensed in accordance with FASB
Interpretation No. 4, "Applicability of SFAS No. 2 to Business Combinations
Accounted for by the Purchase Method." This charge relates to research and
development projects that had not reached technological feasibility and had no
alternative use.

Class action legal settlement charges were $.1 million in 2002. In September
2002, the Company signed a Memorandum of Understanding for settlement of the
class action litigation outstanding since May 2000.

Other Income, net. Other income consists primarily of interest income from
marketable securities and cash equivalents. The funds are primarily invested in
high quality Municipal and U.S. Treasury securities with maturities of less than
one year. Over the past twelve months, interest rates have declined reducing
interest income by $.4 million in 2002.

Income Taxes. The income tax benefit of $.8 million during 2002 reflects tax
credits due the Company relating to its international operations, as well as
benefits derived from its research activities, foreign sales and tax-exempt
interest. The income tax provision for 2001 is based on the combined federal,
state and foreign effective tax rate of 33%.

Equity in Loss of Unconsolidated Company, net of tax. In September 2002, the
Company completed a 47% minority interest investment in Momentum Computer Inc.,
a developer of specialized single board computer solutions located in Carlsbad,
California. During 2002, a loss of $.1 million was recorded reflecting the
allocation of Momentum's net loss to the Company, based on the Company's
ownership percentage.

Year Ended December 31, 2001, compared with the Year Ended December 31, 2000

Sales. Total revenue for 2001 was $36.5 million, compared to $39.0 million for
2000. For the years indicated, the Company's products are grouped into four
distinct categories in one market segment: Signaling and network access
products, IP Switching products, U.S. Government/LAN interface products, and
Other products. Revenue from each product category expressed as a percentage of
sales for 2001 and 2000 is as follows:

2001 2000
-------------- ---------------

Signaling and network access products 87% 82%
IP Switching products 5% 1%
U.S. Government/LAN interface products 0% 3%
Other 8% 14%
-------------- ---------------

Total 100% 100%
============== ===============

Signaling and Network Access Products: Revenue from this category amounted to
$31.8 million and $32.1 million in 2001 and 2000, respectively. The Company
broadened its signaling product line and developed several new cPCI network
access products during 2001.

IP Switching Products: Revenue from this category increased over 300% to $1.7
million in 2001, compared to $.4 million for 2000. The first member of the IP
switch family, the CPC4400 was introduced in September 2000. Three new IPnexus
Ethernet switch models (CPC3400, CPC4401 and CPC4406) began shipping to
customers in September 2001 and two new IPnexus Gigabit Ethernet switch models
(CPC5400 and CPC6400) are scheduled for delivery in the first half of 2002.

U.S. Government/LAN Interface Products: Revenue from these U.S. Government
projects amounted to zero and $1.1 million in 2001 and 2000, respectively. This
sub-contract ended in June 2000.

Other product revenue: Revenue from other products amounted to $3.0 million and
$5.4 million in 2001 and 2000, respectively. This revenue is related to legacy
products. Many of these products are project oriented and shipments can
fluctuate on a quarterly basis.

Gross Profit. Gross profit consists of sales, less cost of goods sold including
material costs, manufacturing expenses, amortization of software development
costs, expenses associated with engineering contracts and technical support
function expenses. Gross margin was 63.5% and 64.7% of sales in 2001 and 2000,
respectively. Fixed expenses spread over lower sales volumes in 2001 as compared
to 2000 impacted gross margin as a percentage of sales.

Total Operating Expenses. Total operating expenses amounted to $16.4 million and
$16.3 million in 2001 and 2000, respectively. As a percentage of sales, total
operating expenses increased to 45.0% in 2001, from 41.9% in 2000. At the
beginning of 2001, the Company increased sales and marketing expense levels to
garner greater market share. Beginning in the second quarter through the
remainder of the year, the Company reduced expense levels due to deteriorating
economic conditions.

Selling and marketing expenses amounted to $5.5 million and $4.9 million in 2001
and 2000, respectively. Expenditures for advertising, travel and trade show
participation were increased at the beginning of 2001 and then began declining
in the second quarter as the economy deteriorated.

Research and development expenses amounted to $7.9 million and $8.9 million in
2001 and 2000, respectively. During 2001, the Company focused its engineering
efforts on the development of the IPnexus embedded switch and network access
products and broadening its signaling product line. In addition, the Company
capitalized certain software development costs. Amounts capitalized were $1.7
million and $.8 million for 2001 and 2000, respectively. Gross expenditures for
engineering and software development were $9.6 million and $9.7 million for 2001
and 2000, respectively.

General and administrative expenses amounted to $2.9 million and $2.5 million in
2001 and 2000, respectively. An incentive related expense amounting to $.2
million was recorded to reflect the attainment of certain corporate goals in
2001. The remaining year-over-year expense increase is primarily attributable to
an increase in corporate insurance costs.

Other Income, net. Other income consists primarily of interest income from
marketable securities and cash equivalents. The funds are primarily invested in
high quality Municipal and U.S. Treasury securities with maturities of less than
one year.

Income Taxes. The provision for income taxes for 2001 is based on the combined
federal, state and foreign effective tax rate of 33%, compared to 35% in 2000.
Based on operational decisions implemented during 2000, the Company was able to
utilize Canadian tax incentives to lower its net effective tax rate in 2001.

Business Strategy

Performance Technologies has a proven history of successfully adapting its
products, services and organization to a constantly changing technology-driven
marketplace. This adaptation has been demonstrated through the course of several
business cycles that have occurred since its founding in 1981. With the Ziatech
acquisition in October 2002, the Company substantially broadened both its
product offering and market coverage to include additional computing and system
products that can be effectively supplied to a market that is twice the size of
that which was available to the Company prior to the acquisition. Following the
acquisition, a new corporate strategy was defined that integrates the Company's
technological innovation and product breadth. Please refer to PART 1, Item 1,
under the caption "Business", for a discussion of the Company's new corporate
and product strategies for 2003.

Liquidity and Capital Resources

At December 31, 2002, the Company's primary source of liquidity included cash,
cash equivalents and marketable securities of $24.1 million and available
borrowings of $5.0 million under a bank revolving credit facility. No amounts
were outstanding under this credit facility as of December 31, 2002. The Company
had working capital of $32.1 million and $34.7 million at December 31, 2002 and
2001, respectively.

Cash generated by operating activities was $5.5 million, $9.0 million and $5.9
million in 2002, 2001 and 2000, respectively.

During 2002, cash used by investing activities was $10.4 million. Capital
equipment purchases were $1.1 million, $1.3 million and $1.3 million in 2002,
2001 and 2000, respectively. In addition, the Company capitalizes certain
software development costs. Amounts capitalized and included within investing
activities were $1.2 million, $1.7 million and $.8 million in 2002, 2001 and
2000, respectively.

In October 2002, the Company acquired a portion of Intel Corporation's Embedded
Communications Platform Division (formerly Ziatech Corporation) for a cash
purchase price of $3.0 million, plus $.6 million of acquisition related
expenses.

In September 2002, the Company completed a minority interest investment of $1.5
million in Momentum Computer, Inc. and loaned Momentum an additional $1 million
to be used for working capital.

In August 2002, the Board of Directors authorized a plan to repurchase up to one
million shares of the Company's common stock. During 2002, the Company
repurchased a total of 35,000 shares at a total cost of $.1 million under this
program.

In March 2001, the Board of Directors authorized a one-year plan to repurchase
up to an additional 500,000 shares of the Company's common stock. The Company
did not repurchase any shares under this program in 2002, compared to 206,000
shares repurchased at a total cost of $2.2 million under this program in 2001.

In August 2000, the Board of Directors authorized the repurchase of up to one
million shares of the Company's common stock and the Company repurchased 342,000
and 658,000 of its common shares in 2001 and 2000, respectively. The total cost
of repurchasing such shares was $4.7 million and $8.8 million in 2001 and 2000,
respectively. This program was completed in March 2001.

As a result of the net loss in the third quarter 2002, the Company was in
violation of one of the covenants under the bank revolving credit facility.
Subsequent to the end of the quarter, the default on the covenant violation was
waived. The Company was in compliance with such covenants at December 31, 2002
and the revolving credit facility was amended and extended through April 15,
2003. The Company is currently negotiating a new bank revolving credit facility
which may result in a less favorable credit arrangement.

The Company leases facilities under operating leases. Under the terms of the
facility lease in Rochester, New York, which expires in March 2012, the Company
agreed to pay an annual rental of $740,000 in the first full year, with
pre-established adjustments for each year thereafter. Under the terms of the
facility lease in San Luis Obispo, California, which expires in December 2008,
the Company agreed to pay an annual rental of $422,000 with an annual adjustment
based on the Consumer Price Index. For both lease agreements, the Company is
also required to pay the pro rata share of the real property taxes and
assessments, expenses and other charges associated with these facilities. The
Company has leased facilities in its other operating locations in North America
that expire between 2003 through 2005.

Future minimum lease payments for all operating leases having a remaining term
in excess of one year at December 31, 2002 are as follows:

2003 $ 1,429,000
2004 1,443,000
2005 1,296,000
2006 1,295,000
2007 1,321,000
Thereafter 3,867,000
------------
Total minimum lease payments $10,651,000
============

Assuming there is no significant change in the Company's business, management
believes that its current cash, cash equivalents and marketable securities
together with cash generated from operations will be sufficient to meet the
Company's anticipated needs, including working capital and capital expenditure
requirements, for at least the next twelve months. However, management is
continuing its strategic acquisition program to further accelerate its new
product and market penetration efforts. This program could have an impact on the
Company's working capital, liquidity or capital resources.

Recently Issued Accounting Pronouncements

FAS 141 - In June 2001, the FASB issued SFAS No. 141, "Business Combinations."
SFAS No. 141 addresses financial accounting and reporting for business
combinations. All business combinations in the scope of this Statement are
accounted for using one method, purchase accounting. On October 2, 2002, the
Company adopted SFAS No. 141. The purchase of a portion of Intel Corporation's
Communications Platform Division (formerly Ziatech Corporation) was accounted
for and reported in accordance with this Statement.

FAS 144 - In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets to
be held and used, to be disposed of other than by sale, and to be disposed of by
sale. On January 1, 2002, the Company adopted SFAS No. 144. Adoption of this
statement did not have a material impact on the results of operations or the
financial position of the Company.

FAS 146 - In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 requires that a
liability for costs associated with an exit or disposal activity be recognized
when it is incurred and measured initially at fair value. On July 1, 2002, the
Company adopted SFAS No. 146. Adoption of this statement did not have a material
impact on the results of operations or the financial position of the Company.

FAS 148 - In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS
No. 123, "Accounting for Stock Based Compensation," to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The Company has previously adopted the disclosure only
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation."
Accordingly, no compensation cost has been recognized for the stock option plan.
On December 31, 2002, the Company adopted the disclosure requirements of SFAS
No. 148. Adoption of this statement did not have a material impact on the
results of operations or the financial position of the Company.

FIN 45 - In November 2002, the FASB issued Interpretation No. 45. "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." Interpretation No. 45 required that at
the time a company issues a guarantee, the company must recognize an initial
liability for the fair value, or market value, of the obligations it assumes
under that guarantee. This interpretation is applicable on a prospective basis
to guarantees issued or modified after December 31, 2002. The Company does not
currently provide significant guarantees on a routine basis. As a result, the
Company does not currently believe this interpretation will have a material
impact on the results of operations or the financial position of the Company.

FIN 46 - In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities." Interpretation No. 46 requires companies with a
variable interest entity to apply this guidance to that entity as of the
beginning of the first interim period beginning after June 15, 2003 for existing
interests and immediately for new interests. The application of the guidance
could result in the consolidation of a variable interest entity. The only
variable interest entity of the Company is its investment in Momentum Computer,
Inc. disclosed in Note F. The Company is evaluating the impact of this
interpretation on financial results.

Critical Accounting Estimates and Assumptions

In preparing the financial statements in accordance with GAAP, management is
required to make estimates and assumptions that have an impact on the assets,
liabilities, revenue and expense amounts reported. These estimates can also
affect supplemental information disclosures by the Company, including
information about contingencies, risk and financial condition. The Company
believes, given current facts and circumstances, its estimates and assumptions
are reasonable, adhere to GAAP, and are consistently applied. Inherent in the
nature of an estimate or assumption is the fact that actual results may differ
from estimates, and estimates may vary as new facts and circumstances arise. The
critical accounting policies, judgments and estimates, which management believes
have the most significant effect on the financial statements are set forth
below:

o Revenue Recognition
o Software Development Costs
o Valuation of Inventory

Revenue Recognition: The Company recognizes revenue in accordance with the SEC
Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." The Company recognizes revenue when persuasive evidence of an
arrangement exists, delivery has occurred or services have been provided, the
sale price is fixed or determinable, and collectability is reasonably assured.
Additionally, the Company sells its products on terms, which transfer title and
risk of loss at a specified location, typically shipping point. Accordingly,
revenue recognition from product sales occurs when all factors are met,
including transfer of title and risk of loss, which generally occurs upon
shipment by the Company. Revenue earned from arrangements for software systems
requiring significant production, modification, or customization of software is
recognized over the contract period as performance milestones are fulfilled. If
all conditions of revenue recognition are not met, the Company defers revenue
recognition. Revenue from consulting and other services is recognized at the
time the services are rendered. Any anticipated losses on contracts are charged
to operations as soon as such losses are determined. Revenue from software
maintenance contracts is recognized ratably over the contractual period. The
Company believes that the accounting estimate related to revenue recognition is
a "critical accounting estimate" because the Company's terms of sale can vary,
and management exercises judgment in determining whether to defer revenue
recognition. Such judgments may materially affect net sales for any period.
Management exercises judgment within the parameters of GAAP in determining when
contractual obligations are met, title and risk of loss are transferred, sales
price is fixed or determinable and collectability is reasonably assured.

Software Development Costs: All software development costs incurred in
establishing the technological feasibility of computer software products to be
sold are research and development costs. Software development costs incurred
subsequent to the establishment of technological feasibility of a computer
software product to be sold and prior to general release of that product are
capitalized. Amounts capitalized are amortized commencing after general release
of that product over the estimated remaining economic life of that product,
generally three years, or using the ratio of current revenues to current and
anticipated revenues from such product, whichever provides greater amortization.
If in the judgment of management, technological feasibility for a particular
project has not been met or recoverability of amounts capitalized is in doubt,
project costs are expensed as research and development or charged to costs of
goods sold, as applicable. The Company believes that the accounting estimate
related to software development costs is a "critical accounting estimate"
because the Company's management exercises judgment in determining whether
project costs are expensed as research and development. Such judgments may
materially affect expense amounts for any period. Management exercises judgment
within the parameters of GAAP in determining when technological feasibility has
been met and recoverability of software development costs is reasonably assured.

Valuation of inventories: Inventories are stated at the lower of cost or market,
using the first-in, first-out method. The Company's inventory includes purchased
parts and components, work in process and finished goods. The Company provides
inventory reserves for excess, obsolete or slow moving inventory after periodic
evaluation of historical sales, current economic trends, forecasted sales,
estimated product lifecycles and estimated inventory levels. The factors that
contribute to inventory valuation risks are the Company's purchasing practices,
electronic component obsolescence, accuracy of sales and production forecasts,
introduction of new products, product lifecycles and the associated product
support. The Company manages its exposure to inventory valuation risks by
maintaining safety stocks, minimum purchase lots, managing product end-of-life
issues brought on by aging components or new product introductions, and by
utilizing certain inventory minimization strategies such as vendor-managed
inventories. The Company believes that the accounting estimate related to
valuation of inventories is a "critical accounting estimate" because it is
susceptible to changes from period-to-period due to the requirement for
management to make estimates relative to each of the underlying factors ranging
from purchasing, to sales, to production, to after-sale support. If actual
demand, market conditions or product lifecycles are adversely different from
those estimated by management, inventory adjustments to lower market values
would result in a reduction to the carrying value of inventory, an increase in
inventory write-offs and a decrease to gross margins.

ITEM 7A - Quantitative and Qualitative Disclosures About Market Risk

The Company is exposed to various market risks in the normal course of business,
primarily interest rate risk, Canadian currency fluctuation risk and changes in
the market value of its investments, and believes its exposure to such risk is
minimal. The Company's investments are made in accordance with the Company's
investment policy and primarily consist of U.S. Treasury securities, municipal
securities and corporate obligations. The Company does not participate in the
investment of derivative financial instruments.

ITEM 8 - Financial Statements and Supplementary Data

Index to Financial Statements: Page
----

Report of Independent Accountants 21
Consolidated Balance Sheets at December 31, 2002 and 2001 22
Consolidated Statements of Income for the Years Ended
December 31, 2002, 2001 and 2000 23
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 2002, 2001 and 2000 24
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2002, 2001 and 2000 25
Notes to Consolidated Financial Statements 26

Index to Financial Statement Schedules:

Schedule II - Valuation and qualifying accounts
Schedule II a - Allowance for doubtful accounts 35
Schedule II b - Reserve for inventory obsolescence 36

All other schedules have been omitted because they are not applicable or the
required information is shown in the Consolidated Financial Statements or notes
thereto.

Report of Independent Accountants

To the Board of Directors and Stockholders of
Performance Technologies, Incorporated:

In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
Performance Technologies, Incorporated and its subsidiaries at December 31, 2002
and 2001, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 2002 in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

Rochester, New York
February 5, 2003

PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

ASSETS

December 31,
2002 2001
---- ----

Current assets:
Cash and cash equivalents $22,077,000 $26,913,000
Marketable securities 2,006,000
Accounts receivable, net 6,622,000 6,905,000
Inventories, net 4,550,000 3,756,000
Prepaid expenses and other assets 942,000 359,000
Deferred taxes 1,574,000 608,000
--------------- ---------------
Total current assets 37,771,000 38,541,000

Property, equipment and improvements, net 3,012,000 2,465,000
Software development costs, net 2,068,000 1,948,000
Note receivable from unconsolidated company 1,000,000
Investment in unconsolidated company 1,353,000
--------------- ---------------
Total assets $45,204,000 $42,954,000
=============== ===============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable $ 1,926,000 $ 417,000
Income taxes payable 502,000 350,000
Accrued expenses 3,213,000 3,046,000
--------------- ---------------
Total current liabilities 5,641,000 3,813,000

Deferred taxes 754,000 799,000
--------------- ---------------
Total liabilities 6,395,000 4,612,000
--------------- ---------------

Commitments and contingencies (Notes I and P)

Stockholders' equity:
Preferred stock - $.01 par value; 1,000,000 shares
authorized; none issued
Common stock - $.01 par value; 50,000,000 shares
authorized; 13,260,038 shares issued 133,000 133,000
Additional paid-in capital 10,961,000 11,305,000
Retained earnings 40,565,000 40,239,000
Treasury stock - at cost, 1,013,696 and 1,024,547 shares
held at December 31, 2002 and 2001, respectively (12,782,000) (13,284,000)
Accumulated other comprehensive loss (68,000) (51,000)
--------------- ---------------

Total stockholders' equity 38,809,000 38,342,000
--------------- ---------------

Total liabilities and stockholders' equity $45,204,000 $42,954,000
=============== ===============

The accompanying notes are an integral part of these consolidated financial
statements.

PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

Year Ended December 31,
2002 2001 2000
---- ---- ----

Sales $27,014,000 $36,517,000 $38,963,000
Cost of goods sold 12,846,000 13,327,000 13,768,000
--------------- --------------- ---------------
Gross profit 14,168,000 23,190,000 25,195,000
--------------- --------------- ---------------

Operating expenses:
Selling and marketing 4,385,000 5,534,000 4,889,000
Research and development 6,914,000 7,941,000 8,926,000
General and administrative 2,735,000 2,946,000 2,497,000
Restructuring charges 573,000
In-process research and development 366,000
Class action legal settlement 143,000
--------------- --------------- ---------------
Total operating expenses 15,116,000 16,421,000 16,312,000
--------------- --------------- ---------------
(Loss) income from operations (948,000) 6,769,000 8,883,000

Other income, net 550,000 971,000 1,947,000
--------------- --------------- ---------------
(Loss) income before income taxes and equity in
loss of unconsolidated company (398,000) 7,740,000 10,830,000

Income tax (benefit) provision (819,000) 2,554,000 3,780,000
--------------- --------------- ---------------
Income before equity in loss of unconsolidated company 421,000 5,186,000 7,050,000

Equity in loss of unconsolidated company, net of tax (95,000)
--------------- --------------- ---------------
Net income $ 326,000 $ 5,186,000 $ 7,050,000
=============== =============== ===============

Basic earnings per share $ .03 $ .42 $ .54
=============== =============== ===============

Diluted earnings per share $ .03 $ .41 $ .51
=============== =============== ===============

Weighted average number of common shares used in
basic earnings per share 12,263,351 12,282,400 13,105,953
Potential common shares 109,721 425,661 663,080
--------------- --------------- ---------------
Weighted average number of common shares used in
diluted earnings per share 12,373,072 12,708,061 13,769,033
=============== =============== ===============

The accompanying notes are an integral part of these consolidated financial
statements.

PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

Accumulated
Additional Other
Common Stock Paid-in Retained Treasury Comprehensive
Shares Amount Capital Earnings Stock Income (loss) Total
------------ ----------- ------------- ------------ ------------- ------------- ------------
Balance -
January 1, 2000 13,186,526 $ 132,000 $12,665,000 $28,003,000 $ 28,000 $40,828,000

2000 net income 7,050,000 7,050,000
Currency translation
adjustment (79,000) (79,000)
Exercise of options
and warrants 73,512 1,000 (304,000) $ 783,000 480,000
Tax benefit-option plan 14,000 14,000
Purchase of treasury
stock-658,200 shares (8,825,000) (8,825,000)
------------ ----------- ------------- ------------ ------------- ------------- ------------
Balance -
December 31, 2000 13,260,038 133,000 12,375,000 35,053,000 (8,042,000) (51,000) 39,468,000

2001 net income 5,186,000 5,186,000
Currency translation
adjustment
Exercise of options
and warrants (1,089,000) 1,630,000 541,000
Tax benefit-option plan 19,000 19,000
Purchase of treasury
stock-547,334 shares (6,872,000) (6,872,000)
------------ ----------- ------------- ------------ ------------- ------------- ------------
Balance -
December 31, 2001 13,260,038 133,000 11,305,000 40,239,000 (13,284,000) (51,000) 38,342,000

2002 net income 326,000 326,000
Currency translation
adjustment (17,000) (17,000)
Exercise of options (371,000) 621,000 250,000
Tax benefit-option plan 27,000 27,000
Purchase of treasury
stock-34,511 shares (119,000) (119,000)
------------ ----------- ------------- ------------ ------------- ------------- ------------

Balance -
December 31, 2002 13,260,038 $ 133,000 $10,961,000 $40,565,000 $(12,782,000) $(68,000) $38,809,000
============ =========== ============= ============ ============= ============= ============

The accompanying notes are an integral part of these consolidated financial
statements.

PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

Year Ended December 31,
2002 2001 2000
---- ---- ----
Cash flows from operating activities:
Net income $ 326,000 $ 5,186,000 $ 7,050,000
Non-cash adjustments:
Depreciation and amortization 2,124,000 1,537,000 1,313,000
Provision for bad debts 200,000 152,000 (70,000)
Reserve for inventory obsolescence 980,000 708,000 1,027,000
Non-cash restructuring charges 209,000
Deferred income taxes 32,000 392,000 595,000
In-process research and development 366,000
Equity in loss of unconsolidated company, net of tax 95,000
Changes in operating assets and liabilities, net of effects
of acquisition:
Accounts receivable 80,000 336,000 2,131,000
Inventories (104,000) 1,324,000 (2,915,000)
Prepaid expenses and other (226,000) 386,000 (63,000)
Accounts payable and accrued expenses 1,221,000 (1,130,000) (1,407,000)
Income taxes payable 177,000 150,000 (1,760,000)
---------------- ---------------- ----------------
Net cash provided by operating activities 5,480,000 9,041,000 5,901,000
---------------- ---------------- ----------------

Cash flows from investing activities:
Purchases of property, equipment and improvements (1,110,000) (1,325,000) (1,348,000)
Capitalized software development costs (1,188,000) (1,654,000) (819,000)
Purchase of marketable securities (2,006,000) (5,000) (17,988,000)
Maturities of marketable securities 10,000,000 30,000,000
Business acquisition (3,643,000)
Investment in unconsolidated company (1,500,000)
Note receivable from unconsolidated company (1,000,000)
---------------- ---------------- ----------------
Net cash (used) provided by investing activities (10,447,000) 7,016,000 9,845,000
---------------- ---------------- ----------------

Cash flows from financing activities:
Repayment of debt (6,000)
Exercise of stock options and warrants 250,000 541,000 480,000
Purchase of treasury stock (119,000) (6,872,000) (8,825,000)
---------------- ---------------- ---------------
Net cash provided (used) by financing activities 131,000 (6,331,000) (8,351,000)
---------------- ---------------- ----------------

Net (decrease) increase in cash and cash equivalents (4,836,000) 9,726,000 7,395,000
Cash and cash equivalents at beginning of year 26,913,000 17,187,000 9,792,000
---------------- ---------------- ---------------
Cash and cash equivalents at end of year $22,077,000 $26,913,000 $17,187,000
================ ================ ================

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid, net of (refunds) $(1,050,000) $ 2,033,000 $ 5,050,000

Non-cash financing activity:
Exercise of stock options using 800 and 100 shares
of common stock in 2001 and 2000, respectively $ $ 10,000 $ 4,000

The accompanying notes are an integral part of these consolidated financial
statements.

PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note A - Nature of Business and Summary of Significant Accounting Policies

The Company: Performance Technologies, Incorporated (the Company) was formed in
1981 under the laws of the State of Delaware and maintains its corporate offices
in Rochester, New York. The Company is a leading developer of embedded computing
products and system-level solutions for equipment manufacturers and service
providers worldwide with competencies in compute platforms, IP/Ethernet
switching, communications software, wide area networking, SS7/IP interworking
and high availability.

Segment Data, Geographic Information and Significant Customers: The Company
operates in one industry segment. Export sales to customers outside North
America represented 25%, 27% and 30% of sales for the years ended December 31,
2002, 2001 and 2000, respectively. For 2002, 2001 and 2000, four customers
accounted for approximately 28%, 30% and 32%, respectively, of sales, with no
single customer representing greater than 9%, 9% and 12%, respectively, of
sales.

Principles of Consolidation: The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. Investments in which
the Company owns 20% to 50% of the voting stock or exercises significant
influence over operating and financial policies are accounted for using the
equity method of accounting. In addition, the consolidated financial statements
include the operating results of Ziatech Corporation from the date of the
acquisition (Note B). All significant inter-company transactions have been
eliminated.

Foreign Currency Translation: The Canadian dollar is the functional currency of
the Company's Canadian subsidiary. Assets and liabilities of foreign operations
are translated to U.S. dollars at current rates of exchange, and revenue and
expenses are translated using average rates. Gains and losses from foreign
currency translation are included in "Accumulated other comprehensive income
(loss)" as a separate component of stockholders' equity. Translation adjustments
are not tax-effected as they relate to investments considered permanent in
nature. Foreign currency transaction gains and losses are included in the
Consolidated Statements of Income.

Use of Estimates: The preparation of the consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at year-end and
the reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates.

Concentration of Credit Risk: Financial instruments that potentially expose the
Company to significant concentrations of credit risk consist principally of bank
deposits, marketable securities and accounts receivable. Marketable securities
consist of high quality, short-term interest-bearing financial instruments. The
Company performs ongoing credit evaluations of its customers' financial
condition and maintains an allowance for uncollectable accounts receivable based
upon the expected collectability of all accounts receivable. UTStarcom
represented 23% of accounts receivable at December 31, 2002, and Telefonica
Moviles Espana and Bell Canada represented 19% and 15% of accounts receivable,
respectively, at December 31, 2001.

Fair Value of Financial Instruments: The carrying amounts of the Company's
financial instruments, including cash and cash equivalents, marketable
securities, accounts receivable and accounts payable approximate fair values at
December 31, 2002 and 2001, as the maturity of these instruments are generally
short term.

Note A - Nature of Business and Summary of Significant Accounting Policies
(continued)

Cash Equivalents: The Company considers all highly liquid investments purchased
with an original maturity of three months or less to be cash equivalents.

Marketable Securities: The Company has classified all of its marketable debt
securities as held to maturity and has accounted for these investments at
amortized cost. Marketable securities classified as held to maturity are high
credit quality securities in accordance with the Company's investment policy.

Inventories: Inventories are valued at the lower of cost or market using the
first-in, first-out method. The Company provides inventory reserves for excess,
obsolete or slow moving inventory based on changes in customer demand,
technology developments or other economic factors.

Revenue Recognition: The Company recognizes revenue in accordance with the SEC
Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." Revenue is recognized upon receipt of a signed purchase order or
contract, product shipment, provided the sales price is fixed or determinable,
and collectability is reasonably assured. Revenue from arrangements for software
systems requiring significant production, modification, or customization of
software is recognized over the contract period as performance milestones are
fulfilled. Revenue from consulting and other services is recognized at the time
the services are rendered. Any anticipated losses on contracts are charged to
operations as soon as such losses are determined. Revenue from software
maintenance contracts is recognized ratably over the contractual period.

Property, Equipment and Improvements: Property, equipment and improvements are
stated at cost. Depreciation of equipment and improvements is provided for using
the straight-line method over the following estimated useful lives:

Engineering equipment and software 3-5 years
Manufacturing equipment 3-5 years
Furniture and equipment 3-5 years
Leasehold improvements the lesser of 10 years or the lease term

Upon retirement or disposal of an asset, the asset and the related accumulated
depreciation are eliminated from the accounts with gains or losses included as a
component of "Other income" in the Consolidated Statements of Income.

Long-Lived Assets: The Company regularly assesses all of its long-lived assets
for impairment when events or circumstances indicate their carrying amounts may
not be recoverable, in accordance with Statement of Financial Accounting
Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets."

Research and Development: Research and development costs are expensed as
incurred.

Advertising: Advertising costs are expensed as incurred and recorded in "Selling
and marketing" in the Consolidated Statements of Income. Advertising expense
amounted to $69,000, $249,000 and $244,000 for 2002, 2001 and 2000,
respectively.

Software Development Costs: On a product-by-product basis, software development
costs incurred subsequent to the establishment of technological feasibility and
prior to general release of the product are capitalized and amortized commencing
after general release over its estimated remaining economic life, generally
three years, or using the ratio of current revenues to current and anticipated
revenues from such software, whichever provides greater amortization.

Note A - Nature of Business and Summary of Significant Accounting Policies
(continued)

Income Taxes: The Company accounts for income taxes using the asset and
liability approach which requires recognition of deferred tax liabilities and
assets for the expected future tax consequences of temporary differences between
the carrying amounts and the tax basis of such assets and liabilities. This
method utilizes enacted statutory tax rates in effect for the year in which the
temporary differences are expected to reverse and gives immediate effect to
changes in income tax rates upon enactment. Deferred tax assets are recognized,
net of any valuation allowance, for deductible temporary differences and tax
credit carryforwards. Deferred income tax expense (benefit) represents the
change in net deferred tax asset and liability balances.

Stock Based Employee Compensation: At December 31, 2002, the Company had one
stock-based employee compensation plan. The Company accounts for this plan under
the recognition and measurement principles of APB Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations. Accordingly, no
stock-based employee compensation cost has been recognized in net income for the
stock option plan. Had compensation cost for the stock option plan been
determined based on the fair value recognition provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," the Company's net income (loss) and
earnings (loss) per share would have been as follows:

Year Ended December 31,
2002 2001 2000
--------------- --------------- ---------------

Net income, as reported $ 326,000 $5,186,000 $7,050,000

Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (2,285,000) (1,699,000) (2,480,000)
--------------- --------------- ---------------
Pro forma net income (loss) $(1,959,000) $3,487,000 $4,570,000
=============== =============== ===============

Earnings (loss) per share:
Basic - as reported $ .03 $ .42 $ .54
=============== =============== ===============
Basic - pro forma $ (.16) $ .28 $ .35
=============== =============== ===============

Diluted - as reported $ .03 $ .41 $ .51
=============== =============== ===============
Diluted - pro forma $ (.16) $ .27 $ .33
=============== =============== ===============

The assumptions regarding the annual vesting of stock options were 25% per year
for options granted in 2002 and 2001, and 33% per year for options granted in
2000. The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 2002, 2001 and 2000: Dividend yield of 0%;
expected volatility of 68%, 64% and 63%; risk-free interest rate of 3.7%, 4.7%
and 6.2%; and expected lives of four years in 2002 and 2001, and three years in
2000, respectively.

Earnings Per Share: Basic earnings per share is computed by dividing net income
by the weighted average number of common shares outstanding for the period.
Diluted earnings per share calculations reflect the assumed exercise of dilutive
employee stock options and warrants, applying the treasury stock method.
Dilutive earnings per share calculations exclude the effect of approximately
1,740,000, 864,000 and 236,000 options for 2002, 2001 and 2000, respectively,
since such options have an exercise price in excess of the average market price
of the Company's common stock for the respective periods.

Recent Accounting Pronouncements: FAS 141 - In June 2001, the FASB issued SFAS
No. 141, "Business Combinations." SFAS No. 141 addresses financial accounting
and reporting for business combinations. All business combinations in the scope
of this Statement are accounted for using one method, purchase accounting. On
October 2, 2002, the Company adopted SFAS No. 141. The purchase of a portion of
Intel Corporation's Communications Platform Division (formerly Ziatech
Corporation) was accounted for and reported in accordance with this Statement.

FAS 144 - In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets to
be held and used, to be disposed of other than by sale, and to be disposed of by
sale. On January 1, 2002, the Company adopted SFAS No. 144. Adoption of this
statement did not have a material impact on the results of operations or the
financial position of the Company.

FAS 146 - In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 requires that a
liability for costs associated with an exit or disposal activity be recognized
when it is incurred and measured initially at fair value. On July 1, 2002, the
Company adopted SFAS No. 146. Adoption of this statement did not have a material
impact on the results of operations or the financial position of the Company.

FAS 148 - In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS
No. 123, "Accounting for Stock Based Compensation," to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The Company has previously adopted the disclosure only
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation."
Accordingly, no compensation cost has been recognized for the stock option plan.
On December 31, 2002, the Company adopted the disclosure requirements of SFAS
No. 148. Adoption of this statement did not have a material impact on the
results of operations or the financial position of the Company.

FIN 45 - In November 2002, the FASB issued Interpretation No. 45. "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." Interpretation No. 45 required that at
the time a company issues a guarantee, the company must recognize an initial
liability for the fair value, or market value, of the obligations it assumes
under that guarantee. This interpretation is applicable on a prospective basis
to guarantees issued or modified after December 31, 2002. The Company does not
currently provide significant guarantees on a routine basis. As a result, the
Company does not currently believe this interpretation will have a material
impact on the results of operations or the financial position of the Company.

FIN 46 - In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities." Interpretation No. 46 requires companies with a
variable interest entity to apply this guidance to that entity as of the
beginning of the first interim period beginning after June 15, 2003 for existing
interests and immediately for new interests. The application of the guidance
could result in the consolidation of a variable interest entity. The only
variable interest entity of the Company is its investment in Momentum Computer,
Inc. disclosed in Note F. The Company is evaluating the impact of this
interpretation on financial results.

Note B - Acquisition

On October 2, 2002, the Company acquired a portion of Intel Corporation's
Embedded Communications Platform Division (Ziatech Corporation). The acquisition
of all outstanding shares of Ziatech Corporation (Ziatech) was completed at a
cash purchase price of $2,967,000. The results of Ziatech have been included in
the consolidated financial statements from the date of acquisition. The Ziatech
single board computer and chassis products will enable the Company to serve a
broader range of customers in the Company's target markets. The purchase price
allocation was prepared in accordance with the application of SFAS No. 141,
"Business Combinations." Following is a summary of the estimated fair values of
the assets acquired and liabilities assumed as of the date of the acquisition:

Inventories, net $ 1,670,000
All other current assets 1,343,000
Property, equipment and improvements 554,000
Acquired in-process research and development 366,000
----------------
Total assets acquired 3,933,000
----------------

Current liabilities 290,000
Acquisition costs incurred 676,000
----------------
Total liabilities acquired and acquisition costs 966,000
----------------

Purchase price $ 2,967,000
================

The value of $366,000 assigned to acquired in-process research and development
(IPR&D) was expensed upon acquisition because the technological feasibility of
all acquired projects under development had not been established and had no
alternative future use. The IPR&D relates to certain single board computer and
chassis products for use in embedded systems. Certain amounts reflected in the
purchase price allocation are preliminary; however, the Company does not expect
material changes.

Note C - Accounts Receivable, net

Accounts receivable consisted of the following: At December 31,
2002 2001
------------- -------------
Accounts receivable $ 6,923,000 $ 7,189,000
Less: allowance for doubtful accounts (301,000) (284,000)
------------- -------------
Net $ 6,622,000 $ 6,905,000
============= =============

Note D - Inventories, net

Inventories consisted of the following: At December 31,
2002 2001
------------- -------------

Purchased parts and components $ 3,967,000 $ 1,329,000
Work in process 2,046,000 2,778,000
Finished goods 2,088,000 468,000
------------- -------------
8,101,000 4,575,000
Less: reserve for inventory obsolescence (3,551,000) (819,000)
------------- -------------
Net $ 4,550,000 $ 3,756,000
============= =============

The reserve for inventory obsolescence includes $2,666,000 at December 31, 2002
for the newly acquired Ziatech Corporation.

Note E - Property, Equipment and Improvements, net

Property, equipment and improvements consisted of the following:
At December 31,
2002 2001
------------- -------------
Land $ 407,000 $ 407,000
Engineering equipment and software 4,180,000 3,876,000
Manufacturing equipment 1,955,000 1,313,000
Furniture and equipment 1,655,000 1,364,000
Leasehold improvements 271,000 166,000
------------- -------------
8,468,000 7,126,000
Less: accumulated depreciation and amortization (5,456,000) (4,661,000)
------------- -------------
Net $3,012,000 $2,465,000
============= =============

Total depreciation and amortization expense for equipment and improvements for
2002, 2001 and 2000 was $1,070,000, $975,000 and $894,000, respectively.

Note F - Investment in Unconsolidated Company

In September 2002, the Company completed an agreement to invest $1,500,000 for a
47% ownership interest in Momentum Computer, Inc. (Momentum), a developer of
specialized single board computer solutions for the data communications,
telecom, military and aerospace markets. This investment is accounted for under
the equity method. The Company has an option to acquire the remaining ownership
of Momentum during a specified future period for additional consideration based
on a formula calculation. As part of the investment agreement, the Company also
loaned $1,000,000 to Momentum to be used for its working capital requirements.
This loan is due and payable September, 2006, is guaranteed by the majority
stockholder, and carries an interest rate at the prime rate or prime plus two
percent. The Company records its investment in Momentum on the Consolidated
Balance Sheets as "Investment in unconsolidated company" and its share of
Momentum's earnings or loss as "Equity in loss of unconsolidated company, net of
tax" on the Consolidated Statements of Income.

Note G - Accrued Expenses

Accrued expenses consisted of the following: At December 31,
2002 2001
------------- -------------

Accrued compensation $ 1,642,000 $ 1,294,000
Accrued professional services 453,000 329,000
Deferred revenue 470,000 917,000
Accrued restructuring charges 163,000
Other accrued expenses 485,000 506,000
------------- -------------
Total $ 3,213,000 $ 3,046,000
============= =============

Note H - Credit Agreements

At December 31, 2002, the Company had a revolving credit loan agreement with a
bank under which it can borrow up to $5 million, which expires on April 15,
2003. Borrowings bear interest either at the bank's prime rate or the one-month
LIBOR rate plus applicable basis points as outlined in the agreement. Borrowings
are collateralized by trade accounts receivable, inventory, equipment, contract
rights and intangibles. The agreement requires the Company to meet certain
financial and non-financial covenants. As a result of the net loss in the third
quarter 2002, the Company was in violation of one of the covenants under the
revolving credit facility. Subsequent to the end of the quarter, the default on
the covenant violation was waived. The Company was in compliance with such
covenants at December 31, 2002. There were no balances outstanding under this
agreement at December 31, 2002 and 2001. The annual fee on the credit loan
agreement is immaterial.

Note I - Commitments

The Company leases facilities under operating leases. Under the terms of the
facility lease in Rochester, New York, which expires in March 2012, the Company
agreed to pay an annual rental of $740,000 in the first full year, with
pre-established adjustments for each year thereafter. Under the terms of the
facility lease in San Luis Obispo, California, which expires in December 2008,
the Company agreed to pay an annual rental of $422,000 with an annual adjustment
based on the Consumer Price Index. For both lease agreements, the Company is
also required to pay the pro rata share of the real property taxes and
assessments, expenses and other charges associated with these facilities. The
Company has leased facilities in its other operating locations in North America
that expire between 2003 through 2005.

Future minimum lease payments for all operating leases having a remaining term
in excess of one year at December 31, 2002 are as follows:

2003 $ 1,429,000
2004 1,443,000
2005 1,296,000
2006 1,295,000
2007 1,321,000
Thereafter 3,867,000
-----------
Total minimum lease payments $10,651,000
===========

Rental expense amounted to $1,218,000, $908,000 and $830,000 for 2002, 2001 and
2000, respectively.

Note J - Stockholders' Equity

On February 9, 2000, the stockholders approved an amendment to the Restated
Certificate of Incorporation to increase the number of authorized common shares,
from 15 million shares to 50 million shares.

In August 2000, the Board of Directors authorized the repurchase of up to one
million shares of the Company's common stock and the Company repurchased 341,800
and 658,200 of its common shares in 2001 and 2000, respectively. The total cost
of repurchasing such shares was $4,699,000 and $8,825,000 in 2001 and 2000,
respectively. This program was completed in March 2001.

In March 2001, the Board of Directors authorized the repurchase of an additional
five hundred thousand shares of the Company's common stock. The Company did not
repurchase any shares under this program in 2002. During 2001, the Company
repurchased a total of 205,534 shares at a total cost of $2,173,000. This
program expired in March 2002.

In August 2002, the Board of Directors authorized the repurchase of an
additional one million shares of the Company's common stock. During 2002, the
Company repurchased a total of 34,511 shares at a total cost of $119,000 under
this program.

Note K - Stock Option Plan

In 1986, the Company established the 1986 Incentive Stock Option Plan pursuant
to which the Board of Directors reserved 2,700,000 shares of common stock for
grant. On February 9, 2000, the stockholders approved an amendment to the Stock
Option Plan to increase, by 500,000 shares, the number of authorized shares that
may be issued pursuant to this Plan. On May 31, 2001, the stockholders approved
the 2001 Stock Option Plan pursuant to which 1,500,000 shares of common stock
were reserved for grant. The 2001 Stock Option Plan replaced the 1986 plan,
which expired on December 31, 2001. Options for the purchase of 276,000 shares
available for issuance under the 1986 plan were cancelled upon adoption of the
2001 plan. Options may be granted to any officer or employee at not less than
the fair market value at the date of grant (not less than 110% of the fair
market value in the case of holders of more than 10% of the Company's common
stock). Options granted under the plans generally expire five or six years from
the date of grant and generally vest over three, four or five years.

With respect to non-qualified options, the Company recognizes a tax benefit upon
exercise in an amount equal to the tax effect of the difference between the
option price and the fair market value of the common stock at the exercise date.
Tax benefits related to such non-qualified stock options are credited to
additional paid-in capital.

The following table summarizes stock option activity under these plans:

Weighted-Average Option
Number of Shares Exercise Price Price Range

Outstanding at January 1, 2000 1,115,418 $8.72 $1.22 - $18.75
Granted 526,375 $15.14 $9.00 - $28.75
Exercised (77,249) $5.38 $1.22 - $9.75
Expired (64,013) $14.09 $5.94 - $28.75
-----------
Outstanding at December 31, 2000 1,500,531 $10.91 $4.44 - $28.75
Granted 572,950 $13.85 $8.00 - $14.50
Exercised (65,650) $7.36 $4.44 - $10.25
Expired (189,001) $15.05 $6.17 - $28.75
-----------
Outstanding at December 31, 2001 1,818,830 $11.54 $4.83 - $28.75
Granted 615,250 $7.72 $3.40 - $8.60
Exercised (45,362) $5.51 $4.83 - $9.88
Expired (242,038) $12.55 $7.82 - $28.75
----------
Outstanding at December 31, 2002 2,146,680 $10.46 $3.40 - $28.75
===========

The following table summarizes information about stock options at December 31,
2002:

Options outstanding Options exercisable

Weighted Weighted Weighted
average average average
Range of remaining exercise exercise
exercise price Options life (yrs) price Options price
- --------------------- --------------- ------------ ------------- -------------- -------------
$ 3.40-$ 6.14 508,355 4.0 $ 4.88 404,105 $ 5.15
$ 6.15-$ 8.89 511,100 4.7 $ 8.43 58,650 $ 7.75
$ 8.90-$11.64 387,475 1.3 $ 9.49 326,970 $ 9.43
$11.65-$14.39 510,250 5.1 $13.84 289,995 $13.88
$14.40-$28.75 229,500 2.1 $21.44 150,033 $20.80
- --------------------- --------------- ------------ ------------- -------------- -------------
2,146,680 3.7 $10.46 1,229,753 $10.38
=============== ============ ============= ============== =============

At December 31, 2002, 875,050 options were available for future grant under the
stock option plan. During 2001 and 2000, warrants for 56,250 shares for each
year, issued at fair market value in 1995, were exercised at a price of $1.22
per share. At December 31, 2002, there are no warrants outstanding.

Note L - Stockholder Rights Plan

On October 27, 2000, the Company's Board of Directors adopted a Stockholder
Rights Plan. Under this plan, one preferred stock Purchase Right was distributed
as a dividend for each share of common stock held by the stockholders of record
as of the close of business of November 8, 2000. Until the occurrence of certain
events, the Rights are traded as a unit with the common stock. Each Right will
separate and entitle stockholders to buy stock upon the occurrence of certain
events generally related to the change of control of the Company as defined in
the Plan. The Rights become exercisable ten days after either: (1) an "Acquiring
Person" acquires or commences a tender offer to acquire 15% or more of the
Company's common stock, or (2) an "Adverse Person" has acquired 10% or more of
the Company's common stock and the Board determines this person is likely to
cause pressure on the Company to enter into a transaction that is not in the
Company's best long-term interest. All Rights not held by an Acquiring Person or
an Adverse Person become rights to purchase from the Company one one-thousandth
of one share of preferred stock at an initial exercise price of $110 per Right.
Each Right entitles the holder of that Right to purchase the equivalent of $220
worth of the Company's common stock for $110. If after such an event the Company
merges, consolidates or engages in a similar transaction in which it does not
survive, each holder has a "flip over" right to buy discounted stock in the
surviving entity. The Company may redeem the Rights for $.001 each. The Rights
Plan expires on November 1, 2010 or can be modified or terminated, at the option
of the Board of Directors.

Note M - Income Taxes

Pre-tax earnings and provision for income taxes consisted of the following for
the years ended December 31, 2002, 2001 and 2000:

2002 2001 2000
------------- ------------- ------------

Pre-tax earnings (loss):
United States $(1,125,000) $ 6,265,000 $ 9,784,000
Outside United States 727,000 1,475,000 1,046,000
------------- ------------- ------------
Total pre-tax earnings (loss) $ (398,000) $ 7,740,000 $10,830,000
============= ============= ============

The provisions (benefit) for income taxes were as follows:
2002 2001 2000
-------------- ------------- ------------
Current income tax provision (benefit):
Federal $ (827,000) $ 1,551,000 $ 2,874,000
State (102,000) 198,000 288,000
Foreign 76,000 401,000 99,000
------------- ------------- ------------
(853,000) 2,150,000 3,261,000
Deferred provision 34,000 404,000 519,000
------------- ------------- ------------
Total provision (benefit) $ (819,000) $ 2,554,000 $ 3,780,000
============ ============= ============

Reconciliation of the statutory U.S. federal income tax rate to effective rates were as follows:
2002 2001 2000
---- ---- ----
Federal income tax at statutory rate 34.0% 34.0% 34.0%
State tax provision, net of federal benefit 17.0 1.7 1.8
Tax credits 90.9 (4.5) (2.0)
Foreign sales exemption 46.8 (3.4) (2.8)
Acquired in-process research and development (31.3)
Other 48.4 5.2 3.9
------ ------ ------
Effective tax rate 205.8% 33.0% 34.9%
====== ====== ======

The deferred income tax assets and liabilities consisted of the following:

At December 31,
Assets 2002 2001
- ------- --------------- -------------
Accrued vacation, payroll and other accrued expenses $ 181,000 $ 111,000
Inventory obsolescence reserve and other inventory related items 1,272,000 320,000
Bad debt reserve 105,000 87,000
Loss in investment in unconsolidated company 51,000
Research tax credits 16,000
Other (35,000) 74,000
--------------- -------------
Total deferred tax assets $ 1,574,000 $ 608,000
--------------- -------------

Liabilities
- -----------
Capitalized software development cost, net $ (724,000) $ (682,000)
Difference in tax basis of assets 37,000 (22,000)
Investment tax credit (67,000) (95,000)
--------------- -------------
Total deferred tax liabilities (754,000) (799,000)
--------------- -------------
Net deferred tax asset (liability) $ 820,000 $ (191,000)
=============== =============

The deferred income tax asset for inventory obsolescence reserve and other
inventory related items includes $941,000 at December 31, 2002 for the newly
acquired Ziatech Corporation.

As of December 31, 2002, no deferred taxes have been provided on the
undistributed earnings of its Canadian subsidiary, as the Company does not plan
to initiate any action that would require the payment of income taxes. It is not
practicable to estimate the amount of additional tax that might be payable on
these undistributed earnings.

Note N - Research and Software Development Costs

The Corporation incurred research and software development costs relating to the
development of new products as follows:
2002 2001 2000
------------- ------------ ------------

Gross expenditures for engineering and
software development $8,102,000 $9,595,000 $9,745,000
Less: amounts capitalized (1,188,000) (1,654,000) (819,000)
------------- ------------ ------------
Net charged to operating expenses $6,914,000 $7,941,000 $8,926,000
============= ============ ============

Software development costs consisted of the following:
At December 31,
2002 2001
------------ ------------

Capitalized software development costs $4,167,000 $5,202,000
Less: accumulated amortization (2,099,000) (3,254,000)
------------ ------------
Net $2,068,000 $1,948,000
============ ============

Amortization of software development costs included in cost of goods sold was
$1,068,000, $558,000 and $419,000 for 2002, 2001 and 2000, respectively.

Note O - Employee Benefit Plans

For the Company's operations in the United States, the Company's Retirement
Savings Plans qualify under Section 401(k) of the Internal Revenue Code.
Discretionary matching contributions by the Company to the plans were $15,000,
$99,000 and $133,000 for 2002, 2001 and 2000, respectively. In conjunction with
its Flexible Benefits plans, the Company made additional discretionary qualified
contributions to employee accounts which vest immediately amounting to $82,000,
$119,000 and $139,000 for 2002, 2001 and 2000, respectively.

For its operations in Canada, contributions were made to a Registered Retirement
Savings Plan (RRSP) that is administered by the Canadian government.
Discretionary matching contributions to the Plan were $28,000, $186,000 and
$190,000 for 2002, 2001 and 2000, respectively.

Note P - Litigation

Following the Company's announcement on May 19, 2000 regarding its preliminary
results of operations for the second quarter, several class action lawsuits were
filed in the United States District Court for the Western District of New York
against the Company, as well as several of its officers and directors, alleging
violations of federal securities laws. On September 25, 2002, the Company
announced it had signed a Memorandum of Understanding for the settlement of the
class action litigation. The Company recorded a charge of $143,000 in the third
quarter of 2002 in connection with the litigation. The terms of the settlement
outlined in the memorandum between the Company and the class action plaintiffs
have been submitted to the Court in the form of a settlement agreement. This
proposed settlement will be subject to Court acceptance and approval.

The Company is subject to various other legal proceedings and claims that arise
in the ordinary course of business. In the opinion of management, the amount of
any ultimate liability with respect to these actions will not materially affect
the financial position of the Company.

Note Q - Transactions with Related Parties

Prior to the Company relocating to its current corporate headquarters and
manufacturing facility in April 2002, the Company leased its primary facility in
Rochester, New York from an entity controlled by two directors of the Company.
During 2002, 2001 and 2000, the Company paid rent of $117,000, $347,000 and
$335,000, respectively, for the use of this location. This lease expired in
April 2002.

Note R - Restructuring Programs

During 2002, the Company recorded restructuring charges of $573,000 as the
Company improved its cost structure primarily through reductions in the
Company's staff and by consolidating the engineering operations of its Raleigh,
North Carolina facility into its Ottawa, Canada Signaling Group. The programs
were completed during the first and third quarters of 2002 as the continuing
decline in capital spending in the Company's target markets resulted in lower
than anticipated Company revenue. The restructuring charges were comprised of
$341,000 for employee severance and related costs, $177,000 related to lease
commitments for the closure of the Raleigh, North Carolina facility and $55,000
for the disposal of equipment and leasehold improvements. The severance charges
were for approximately 40 employees and were initiated throughout the
organization. Substantially, all actions under these programs were completed in
2002, although lease commitments will continue through 2005. A summary of the
activity with respect to the restructuring accrual is as follows:

Severance
and related Leasehold Asset
costs commitments impairment Total
---------------- ---------------- -------------- --------------
2002 charge $341,000 $177,000 $55,000 $573,000
2002 utilization (332,000) (23,000) (55,000) (410,000)
---------------- ---------------- -------------- --------------
Balance at
December 31, 2002 $ 9,000 $154,000 $163,000
================ ================ ============== ==============

Note S - Quarterly Results (unaudited)

The following is a summary of unaudited quarterly results of operations for the
years ended December 31, 2002 and 2001.

2002
---------------------------------------------------------

(in thousands, except per share data)
Mar. 31 Jun. 30 Sep. 30 Dec. 31
----------- ------------ ----------- -----------
Sales $6,407 $6,619 $3,955 $10,033
Gross profit 3,755 3,943 1,739 4,731
Income (loss) from operations 454 468 (1,803) (67)
Net income (loss) 393 407 (1,191) 717

Basic earnings per share $ 0.03 $ 0.03 $(0.10) $ 0.06

Diluted earnings per share $ 0.03 $ 0.03 $(0.10) $ 0.06

2001
---------------------------------------------------------
(in thousands, except per share data)
Mar. 31 Jun. 30 Sep. 30 Dec. 31
----------- ------------ ----------- -----------
Sales $9,700 $9,444 $9,871 $ 7,502
Gross profit 5,891 5,833 6,493 4,973
Income from operations 1,364 1,638 2,456 1,311
Net income 1,152 1,259 1,770 1,005

Basic earnings per share $ 0.09 $ 0.10 $ 0.14 $ 0.08

Diluted earnings per share $ 0.09 $ 0.10 $ 0.14 $ 0.08

Due to rounding, the sum of the quarters in 2002 and 2001 does not equal the
total earnings per share for the year.

ITEM 9 - Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

None.

PART III

The information required by Part III, Items 10 - 13, is omitted from this Report
and presented in the Company's definitive proxy statement to be filed, pursuant
to Regulation 14A not later than 120 days after the end of the fiscal year
covered by this Report, in connection with the Company's Annual Meeting of
Stockholders to be held on June 3, 2003, which information included therein is
incorporated herein by reference.

ITEM 10 - Directors and Executive Officers of the Registrant

The section entitled "Election of Directors" appearing in the Company's proxy
statement for the Annual Meeting of Stockholders to be held on June 3, 2003,
sets forth certain information with respect to the directors and executive
officers of the Company and is incorporated herein by reference.

ITEM 11 - Executive Compensation

The section entitled "Executive Compensation" appearing in the Company's proxy
statement for the Annual Meeting of Stockholders to be held on June 3, 2003,
sets forth certain information with respect to the compensation of management of
the Company and is incorporated herein by reference.

ITEM 12 - Security Ownership of Certain Beneficial Owners and Management

The section entitled "Security Ownership of Certain Beneficial Owners and
Management" appearing in the Company's proxy statement for the Annual Meeting of
Stockholders to be held on June 3, 2003, sets forth certain information with
respect to the ownership of the Company's Common Stock and is incorporated
herein by reference. Information required by this item concerning securities
authorized for issuance under equity compensation plans is included in Part II,
Item 5 under the caption "Equity Plan Information."

ITEM 13 - Certain Relationships and Related Transactions

The section entitled "Certain Transactions" appearing in the Company's proxy
statement for the Annual Meeting of Stockholders to be held on June 3, 2003,
sets forth certain information with respect to certain business relationships
and transactions between the Company and its directors and officers and is
incorporated herein by reference.

ITEM 14 - Controls and Procedures

a. Evaluation of Disclosure Controls and Procedures

In accordance with Rule 13a-15(b) of the Securities Exchange Act of
1934 (the "Exchange Act"), within 90 days prior to the filing date of
this Annual Report on Form 10-K, an evaluation was carried out under
the supervision and with the participation of the Company's management,
including the certifying officers of the effectiveness of the design
and operation of the Company's disclosure controls and procedures (as
defined in Rule 13a-14(c) under the Exchange Act). Based upon their
evaluation of these disclosure controls and procedures, the certifying
officers concluded that the disclosure controls and procedures were
effective as of the date of such evaluation to ensure that material
information relating to the Company, including its consolidated
subsidiaries, was made known to them by others within those entities,
particularly during the period in which this Annual Report on Form 10-K
was being prepared.

b. Changes in Internal Controls

There were no significant changes in the Company's internal controls or
other factors that could significantly affect these controls subsequent
to the date of their evaluation.

PART IV

ITEM 15 - Exhibits, Financial Statement Schedules and Reports on Form 8-K

(1) Financial Statements
The financial statements filed as part of this report are included in
the response to Item 8 of Part III of this 10-K report.

(2) Financial Statement Schedules

Schedule II - Valuation and Qualifying Accounts

Schedule II a - Allowance for Doubtful Accounts

Additions
(reversals) Deductions
Balance at ----------- ----------- Balance at
beginning charged to amounts end of
of period earnings written off period
------------ ------------- ------------- ------------

Year Ended December 31, 2002
Deducted in the Consolidated Balance Sheet
from Accounts Receivable

Allowance for doubtful accounts $284,000 $200,000 $183,000 $301,000
============ ============= ============= ============
Year Ended December 31, 2001
Deducted in the Consolidated Balance Sheet
from Accounts Receivable

Allowance for doubtful accounts $186,000 $152,000 $54,000 $284,000
============ ============= ============= ============

Year Ended December 31, 2000
Deducted in the Consolidated Balance Sheet
from Accounts Receivable

Allowance for doubtful accounts $795,000 $ (70,000) $539,000 $186,000
============ ============= ============= ============

Schedule II b - Reserve for Inventory Obsolescence

Additions Deductions
Balance at ----------------------------- ------------ Balance at
beginning charged to Amounts end of
of period earnings Other (1) written off period
------------- ------------ ------------- ------------ -------------

Year ended December 31, 2002
Deducted in the Consolidated
Balance Sheet from Inventories

Reserve for inventory obsolescence $ 819,000 $ 980,000 $2,916,000 $1,164,000 $3,551,000
============= ============ ============= ============ =============

Year ended December 31, 2001
Deducted in the Consolidated
Balance Sheet from Inventories

Reserve for inventory obsolescence $1,124,000 $ 708,000 $1,013,000 $ 819,000
============= ============ ============= ============ =============

Year ended December 31, 2000
Deducted in the Consolidated
Balance Sheet from Inventories

Reserve for inventory obsolescence $ 918,000 $1,027,000 $ 821,000 $1,124,000
============= ============ ============= ============ =============

(1) The value assigned to the reserve for inventory obsolescence at October 2,
2002 for the inventory associated with the Ziatech acquisition.

There were no other financial statement schedules required to be filed because
they are not applicable or the required information is shown in the Consolidated
Financial Statements or notes thereto.

(3) Exhibits
Exhibit Ref.
Number Number Description

2.1 (12) Stock Purchase Agreement between Intel Corporation and
the Registrant, dated as of September 12, 2002.
3.1 (1) Restated Certificate of Incorporation
3.2 (5) Certificate of Amendment
3.3 (1) Amended By-laws
4.1 (1) Form of Common Stock Certificate
4.2 (1) Amended and Restated 1986 Incentive Stock Option Plan
4.4 (6) February 2000 Amendment to Amended and Restated 1986
Incentive Stock Option Plan
4.5 (7) Rights Agreement
4.6 (9) 2001 Incentive Stock Option Plan
10 (1) Material Contracts
10.1 (3) Revolving Credit Agreement dated as of December 30, 1998
between the Registrant and The Chase Manhattan
Bank, N.A.
10.1a (8) Amendment Number One to Revolving Credit Agreement dated
as of November 1, 2000 between the Registrant and
The Chase Manhattan Bank, N.A.
10.1b (11) Amendment Number Two to Revolving Credit Agreement dated
as of October 30, 2002 between the Registrant and
JPMorgan Chase Bank, formerly known as The Chase
Manhattan Bank, N.A.
10.1c (*) Amendment Number Three to Revolving Credit Agreement
dated as of March 13, 2003 between the Registrant
and JPMorgan Chase Bank, formerly known as The
Chase Manhattan Bank, N.A.
10.2 (3) Revolving Credit Note in the amount of $5,000,000 dated
December 30, 1998 given by the Registrant to The
Chase Manhattan Bank, N.A.
10.3 (1) Security Agreements granted by the Registrant to The
Chase Manhattan Bank, N.A. dated as of April 13,
1985, April 13, 1993 and as of June 17, 1993, and
with respect to Performance Computer Corporation
only, the Security Agreement dated as of June 17,
1993 granted to The Chase Manhattan Bank, N.A.
by Performance Computer Corporation and certain
other Affiliates of the Registrant (which other
Affiliates have been released) and all amendments
and modifications thereto
10.10 (1)(10) Sublease Agreement between the Registrant and C & J
Enterprises dated as of September 1, 1990 - as
amended
10.16 (1) License Agreement between the Registrant and Spider
Systems Limited dated March 18, 1992
10.28 (1) Adoption Agreement between the Registrant and Principal
Mutual Life Insurance Company dated September 20,
1993
10.29 (1) The Principal Financial Group Prototype Basic Savings
Plan dated May 7, 1990
10.30 (1) Form of Stock Option Agreement
10.31 (1) Form of Warrant Agreement
10.32 (4) Share Acquisition Agreement between Registrant and
MicroLegend Telecom Systems, Inc. as of December 2,
1999
10.33 (4) Amendment to Share Acquisition Agreement between
Registrant and MicroLegend Telecom Systems, Inc. as
of December 10, 1999
10.33a (10) Lease Agreement dated as of May 19, 2001 between the
Registrant and Christa PT, LLC
10.33b (10) First Amendment to Lease dated as of July 19, 2001
between the Registrant and Christa PT, LLC
10.33c (10) Second Amendment to Lease dated as of July 31, 2001
between the Registrant and Christa PT, LLC
21 (*) Subsidiaries
23.1 (*) Consent of PricewaterhouseCoopers, LLP
99.1 (*) Chief Executive Officer Sarbanes-Oxley 906 Certification
99.2 (*) Chief Financial Officer Sarbanes-Oxley 906 Certification
- --------------------------------------------------------------------------------
(1) Incorporated by reference to the Registrant's Registration Statement
on Form S-1 filed November 22, 1995 (Registration No. 33-99684).
(2) Incorporated by reference to the Registrant's Registration Statement
on Form S-8 filed July 30, 1997 (Registration No. 333-32421).
(3) Incorporated by reference to the Annual Report on Form 10-K filed March
30,1999.
(4) Incorporated by reference to the Registrant's Registration Statement on
Form S-3 filed January 28, 2000 (Registration No. 333-94371).
(5) Incorporated by reference to the Annual Report on Form 10-K filed on
March 30, 2000.
(6) Incorporated by reference to the Registrant's Registration Statement
on Form S-8 filed June 21, 2000 (Registration No. 333-39834).
(7) Incorporated by reference to the Registrant's Registration Statement on
Form 8-A filed November 8, 2000 (Registration No. 000-27460).
(8) Incorporated by reference to the Annual Report on Form 10-K filed on
March 30, 2001.
(9) Incorporated by reference to the Registrant's Registration Statement
on Form S-8 filed June 3, 2002 (Registration No. 333-89636).
(10) Incorporated by reference to the Quarterly Report on Form 10-Q filed on
August 14, 2001.
(11) Incorporated by reference to the Quarterly Report on Form 10-Q filed on
November 5, 2002.
(12) Incorporated by reference to the Current Report on Form 8-K filed October
17, 2002.
(*) Filed with this Form 10-K.

(4) Reports on Form 8-K

The following reports were filed during the three month period ended December
31, 2002:

On October 16, 2002 the Company filed a Current Report on Form 8-K, Item 5 -
Other; The Company announced the resignation of Arlen Vanderwel as a Director of
Performance Technologies, Incorporated, effective October 1, 2002, citing
concerns about requiring continued review of potential conflicts of interests
with his current employer as the Company expands its product and market breadth.
No financial statements were filed with the Form 8-K.

On October 17, 2002 the Company filed a Current Report on Form 8-K, Item 2 -
Acquisition or Disposition of Assets; On October 2, 2002 the Company acquired a
portion of Intel Corporation's Embedded Communications Platform Division
(formerly Ziatech Corporation). The acquisition was completed pursuant to the
Stock Purchase Agreement, dated September 12, 2002, between Intel Corporation
and Performance Technologies, Incorporated to acquire all the issued and
outstanding shares of Ziatech Corporation. No financial statements were filed
with the Form 8-K.

On December 16, 2002 the Company filed a Current Report on Form 8-K/A, Item 7 -
Financial Statements; This amendment was filed to provide historical financial
information required by Item 7(a) and the pro forma financial information
required by Item 7(b) of Form 8-K, which information was unavailable when the
Company's Current Report of Form 8-K, dated October 17, 2002, was filed.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.

PERFORMANCE TECHNOLOGIES, INCORPORATED

Date: March 26, 2003 By:/s/ DONALD L. TURRELL
------------------------
Donald L. Turrell
President and
Chief Executive Officer

By:/s/ DORRANCE W. LAMB
Dorrance W. Lamb
Chief Financial Officer and
Vice President of Finance

Pursuant to the requirements of the Securities Act of 1934, the following
persons on behalf of the registrant and in the capacities and on the dates
indicated have signed this report.

Signature Title Date

/s/JOHN M. SLUSSER Chairman of the Board, Chief March 26, 2003
- ------------------
John M. Slusser Strategic Officer and Director

/s/DONALD L. TURRELL President, Chief Executive March 26, 2003
- --------------------
Donald L. Turrell Officer and Director

/s/DORRANCE W. LAMB Chief Financial Officer, and March 26, 2003
- -------------------
Dorrance W. Lamb Vice President of Finance

/s/BERNARD KOZEL Director March 26, 2003
- ----------------
Bernard Kozel

/s/CHARLES E. MAGINNESS Director March 26, 2003
- -----------------------
Charles E. Maginness

/s/STUART B. MEISENZAHL Director March 26, 2003
- -----------------------
Stuart B. Meisenzahl

/s/JOHN E. MOONEY Director March 26, 2003
- -----------------
John E. Mooney

/s/PAUL L. SMITH Director March 26, 2003
- ----------------
Paul L. Smith

/s/ROBERT L. TILLMAN Director March 26, 2003
- --------------------
Robert L.Tillman

Certification of Chief Executive Officer

I, Donald L. Turrell certify that:

1. I have reviewed this annual report on Form 10-K of Performance
Technologies, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:

a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):

a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.

Date: March 26, 2003 By:/s/ Donald L. Turrell
--------------------------------
Donald L. Turrell
Chief Executive Officer

Certification of Chief Financial Officer

I, Dorrance W. Lamb, certify that:

1. I have reviewed this annual report on Form 10-K of Performance
Technologies, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:

a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):

a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.

Date: March 26, 2003 By:/s/ Dorrance W. Lamb
--------------------------------
Dorrance W. Lamb
Chief Financial Officer

Exhibit 10.1c
AMENDMENT THREE TO
CREDIT AGREEMENT

dated as of March 13, 2003

between

JPMORGAN CHASE BANK, formerly
known as The Chase Manhattan Bank

and

PERFORMANCE TECHNOLOGIES, INCORPORATED

AMENDMENT NUMBER THREE TO CREDIT AGREEMENT

This Amendment is dated as of March 13, 2003, is made by and between
PERFORMANCE TECHNOLOGIES, INCORPORATED, a Delaware corporation with its
principal office located at 205 Indigo Creek Drive, Rochester, New York 14626
("Borrower") and JPMORGAN CHASE BANK, formerly known as The Chase Manhattan
Bank, with an office at One Chase Square, Rochester, New York 14643 ("Bank").

Statement of the Premises

Borrower and Bank have previously entered into, among other agreements, a
Credit Agreement, dated as of December 30, 1998 which was amended by Amendment
Number One, dated November 1, 2000 and Amendment Number Two, dated October 30,
2002 (the "Credit Agreement"). The Borrower and the Bank desire to amend the
Credit Agreement as referenced herein.

Statement of Consideration

Accordingly, in consideration of the premises and under the authority of
Section 5-1103 of the New York General Obligations Law, Borrower and Bank agree
as follows:

Agreement

1. Defined Terms. The terms "this Agreement," "hereunder" and similar
references in the Credit Agreement shall be deemed to refer to the Credit
Agreement as amended by this Amendment Number Three. Capitalized terms used and
not otherwise defined herein shall have the meanings ascribed to such terms in
the Credit Agreement.

2. Amendment. Effective upon the satisfaction of all conditions specified
in Section 4 hereof, the Credit Agreement is hereby amended as follows:

A. The definition of "Revolving Credit Termination Date" is superseded
and replaced in its entirety and amended to read:

"Revolving Credit Termination Date" means April 15, 2003; provided that
if such date is not a Banking Day, the Revolving Credit Termination
Date shall be the next succeeding Banking Day.

3. Representations. The Borrower hereby represents and warrants to the Bank
that: (i) the covenants, representations and warranties set forth in the Credit
Agreement are true and correct on and as of the date of execution hereof as if
made on and as of said date and as if each reference therein to the Credit
Agreement were a reference to the Credit Agreement as amended by this Amendment;
(ii) no Event of Default specified in the Credit Agreement and no event, which,
with the giving of notice or lapse of time or both, would become such an Event
of Default has occurred and is continuing; (iii) since the date of the Credit
Agreement, there has been no material adverse change in the financial condition
or business operations of the Borrower which has not been disclosed to Bank;
(iv) the making and performance by the Borrower of this Amendment have been duly
authorized by all necessary corporate action; and (v) the security interest
granted by the Borrower to the Bank pursuant to the Security Agreement
constitutes a valid, binding and enforceable, first in priority lien on all
Collateral subject to such Security Agreement.

4. Conditions of Effectiveness. This Amendment (including Section 4 hereof)
shall become effective when and only when Bank shall have received counterparts
of this Amendment executed by Borrower and Bank.

5. Reference to and Effect on Loan Documents.

A. Upon the effectiveness hereof, each reference in the Credit
Agreement to "this Agreement," "hereunder," "hereof," "herein," or words of like
import, and each reference in the other Loan Documents to the Credit Agreement
shall mean and be a reference to the Credit Agreement as amended hereby.

B. Except as specifically amended above, the Credit Agreement,
and all other Loan Documents shall remain in full force and effect and are
hereby ratified and confirmed.

C. The execution, delivery and effectiveness of this Amendment
shall not operate as a waiver of any right, power or remedy of Bank under any of
the Loan Documents, nor constitute a waiver of any provision of any of the Loan
Documents.

6. Costs and Expenses. Borrower agrees to pay on demand all costs and
expenses of Bank in connection with the preparation, execution and delivery of
this Amendment and the other documents related hereto, including the fees and
out-of-pocket expenses of counsel for Bank.

7. Governing Law. This Amendment shall be governed and construed in
accordance with the laws of the State of New York without regard to any
conflicts-of-laws rules which would require the application of the laws of any
other jurisdiction.

8. Headings. Section headings in this Amendment are included herein for
convenience of reference only and shall not constitute a part of this Amendment
for any other purpose.

9. Execution in Counterparts. This Amendment may be executed in any number
of counterparts and by different parties hereto in separate counterparts, each
of which when so executed and delivered shall be deemed to be an original and
all or which taken together shall constitute but one and the same instrument.

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
executed by their respective representatives thereunto duly authorized as of the
date first above written.

PERFORMANCE TECHNOLOGIES, INCORPORATED

By:/s/ Dorrance W. Lamb
-----------------------------
Its: Vice President Finance
JPMORGAN CHASE BANK
By:/s/ Hollie E. Calderon
-----------------------------
Its: Vice President

Exhibit 21 - Subsidiaries

Performance Technologies, Incorporated
March 26, 2003

PTI Virgin Islands Company, Ltd., a Foreign Sales Corporation

UconX Corporation, a Delaware Corporation doing business in California as UconX

3688283 Canada Inc., a Canada Corporation wholly owned by Performance
Technologies, Incorporated

PerfTech (PTI) Canada Corporation (formerly MicroLegend Telecom Systems, Inc.),
a Canada Corporation wholly owned by 3688283 Canada Inc.

PT North Carolina Corporation (formerly MicroLegend Telecom, Inc.) a Delaware
Corporation

PTI California Corporation (formerly Ziatech Corporation) a California
Corporation

Exhibit 23.1

CONSENT OF INDEPENDENT ACCOUNTANTS

We hereby consent to the incorporation by reference in the Registration
Statement on Form S-3 (No. 333-94371) and S-8 (No. 333-32421, 333-39834,
333-89636) of Performance Technologies, Incorporated of our report dated
February 5, 2003 relating to the financial statements and financial statement
schedules, which appears in this Form 10-K.

/s/ PricewaterhouseCoopers LLP

Rochester, New York
March 28, 2003

Exhibit 99.1

Form of Certification Pursuant to Section 1350 of Chapter 63

Of Title 18 of the United States Code

I, Donald L. Turrell, the Chief Executive Officer of Performance
Technologies, Incorporated, certify that (i) the Form 10-K for the year ended
December 2002 fully complies with the requirements of Section 13(a) or 15(d) of
the Securities Exchange Act of 1934 and (ii) the information contained in the
Form 10-K fairly presents, in all material respects, the financial condition and
results of operations of Performance Technologies, Incorporated.

By:/s/ Donald L. Turrell
----------------------------------
Donald L. Turrell
Chief Executive Officer

March 26, 2003

Exhibit 99.2

Form of Certification Pursuant to Section 1350 of Chapter 63

Of Title 18 of the United States Code

I, Dorrance W. Lamb, the Chief Financial Officer of Performance
Technologies, Incorporated, certify that (i) the Form 10-K for the year ended
December 2002 fully complies with the requirements of Section 13(a) or 15(d) of
the Securities Exchange Act of 1934 and (ii) the information contained in the
Form 10-K fairly presents, in all material respects, the financial condition and
results of operations of Performance Technologies, Incorporated.

By:/s/ Dorrance W. Lamb
----------------------------------
Dorrance W. Lamb
Chief Financial Officer

March 26, 2003