-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AGE/tiku/0mWopEjhfqDbaeYtyjUDjQODLryqdeBYV5o7ov4QyzErPRZA8RTYK1c Wfp6XPZWdynIOavNxoiWfg== 0000891092-02-000500.txt : 20020416 0000891092-02-000500.hdr.sgml : 20020416 ACCESSION NUMBER: 0000891092-02-000500 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020415 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PORTA SYSTEMS CORP CENTRAL INDEX KEY: 0000079564 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 112203988 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-08191 FILM NUMBER: 02610425 BUSINESS ADDRESS: STREET 1: 575 UNDERHILL BLVD CITY: SYOSSET STATE: NY ZIP: 11791 BUSINESS PHONE: 5163649300 MAIL ADDRESS: STREET 1: 575 UNDERHILL BLVD CITY: SYOSSET STATE: NY ZIP: 11791 10-K 1 e13297_10k.txt ANNUAL REPORT ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K (Mark One) [x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 2001 ----------------- [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from _______to_______ Commission file number 1-8191 ------ PORTA SYSTEMS CORP. (Exact name of registrant as specified in its charter) Delaware 11-2203988 - -------- ---------- (State or other jurisdiction (IRS Employer of incorporation or organization) Identification No.) 575 Underhill Boulevard, Syosset, New York 11791 - ------------------------------------------ ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (516) 364-9300 -------------- Securities registered pursuant to Section 12(b) of the Act: Common Stock, par value $.01 American Stock Exchange - ---------------------------- ----------------------- (Title of Class) (Name of Exchange on which registered) Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10K or any amendment to this Form 10K. [X] State aggregate market value of the voting stock held by non-affiliates of the registrant: $997,696 as of March 31, 2002. Indicate the number of shares outstanding of each of the registrant's class of common stock, as of the latest practicable date: 9,976,964 shares of Common Stock, par value $.01 per share, as of March 31, 2002. DOCUMENTS INCORPORATED BY REFERENCE None ================================================================================ Item 1. Business Porta Systems Corp. develops, designs, manufactures and markets a broad range of standard and proprietary telecommunications equipment and integrated software applications for sale domestically and internationally. Our core products, focused on ensuring communications for service providers worldwide, fall into three categories: Computer-based operation support systems. Our operations support systems, which we call our OSS systems, focus on the access loop and are components of telephone companies' service assurance and service delivery initiatives. The systems primarily focus on trouble management, line testing, network provisioning, inventory and assignment, and automatic activation, and most currently single ended line qualification for the delivery of xDSL high bandwidth services. We market these systems principally to foreign telephone operating companies in established and developing countries primarily in Asia, South and Central America and Europe. Telecommunications connection and protection equipment. These systems are used to connect copper-wired telecommunications networks and to protect telecommunications equipment from voltage surges. We market our copper connection equipment and systems to telephone operating companies and customer premise systems providers in the United States and foreign countries. Signal processing equipment. These products, which we sell principally for use in defense and aerospace applications, support copper wire-based communications systems. Porta Systems Corp. is a Delaware corporation incorporated in 1972 as the successor to a New York corporation incorporated in 1969. Our principal offices are located at 575 Underhill Boulevard, Syosset, New York 11791; telephone number, 516-364-9300. References to Porta and to "we," "us", "our," and words of like import refer to Porta Systems Corp. and its subsidiaries, unless the context indicates otherwise. Forward-Looking Statements Statements in this Form 10-K annual report may be "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, but are not limited to, statements that express our intentions, beliefs, expectations, strategies, predictions or any other statements relating to our future activities or other future events or conditions. These statements are based on current expectations, estimates and projections about our business based, in part, on assumptions made by management. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may, and probably will, differ materially from what is expressed or forecasted in the forward-looking statements due to numerous factors, including those risks discussed from time to time in this Form 10-K annual report, including the risks described under "Risk Factors" and in other documents which we file with the Securities and Exchange Commission. In addition, such statements could be affected by risks and uncertainties related to our financial conditions, factors which affect the telecommunications industry, market and customer acceptance, competition, government regulations and requirements and pricing, as well as general industry and market conditions and growth rates, and general economic conditions. Any forward-looking statements speak only as of the date on which they are made, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of this Form 10-K. 1 of 31 Risk Factors We are incurring losses from our operations, and our losses are continuing. We incurred a net loss of $14,774,000, or $1.50 per share (basic and diluted), on sales of $28,062,000 for 2001, following a loss of $10,176,000, or $1.04 per share (basic and diluted) for 2000, our losses are continuing and we expect that our losses will continue unless we are able both to significantly increase our revenue and reduce our expenses. We cannot give assurance that we will be able to operate profitably in the future, and if we are unable to operate profitably, we may be unable to continue in business. Because of our decreasing revenues together with problems facing both the telecommunications industry and the economy, we may not be able to continue in business. As a result of the deterioration of our operating revenue resulting from both market conditions and our financial condition, we are evaluating various options, including the sale of one or more of our divisions as well as a reorganization under the Bankruptcy Code. Our independent auditors have included an explanatory paragraph relating to our ability to continue as a going concern in their report on our financial statements. Because of our substantial losses in 2001, 2000 and 1999, our stockholders' deficit of $ 25,849,000 at December 31, 2001, and our working capital deficit of $31,236,000 as of December 31, 2001 our auditors included in their report an explanatory paragraph about our ability to continue as a going concern. We require substantial financing to meet our working capital requirements and our principal lender is providing us with financing at its discretion. We had a working capital deficit at December 31, 2001 of $31,236,000. As of December 31, 2001, our current liabilities include $22,095,000 due to our senior lender, all of which is due and payable on December 31, 2002, at which time our agreement with the senior lender will terminate. In addition, subordinated notes in the principal amount of $6,144,000 plus accrued interest were outstanding as of December 31, 2001. These subordinated notes became due on July 3, 2001. Subsequent to December 31, 2001, the trustee of our subordinated debentures in the principal amount of $500,000, which will mature on July 1, 2002, served us with a notice of default for failure to pay interest. Our senior lender has prohibited us from making any payments on any of the subordinated debt. At December 31, 2001, we did not have sufficient resources to pay the senior lender when our obligations to the senior lender mature on December 31, 2002, or the subordinated notes, and we do not expect to generate the necessary cash from our operations to enable us to make those payments. Since December 31, 2001, our senior lender has agreed to advance us up to $1,500,000; however, such advances are at the discretion of the senior lender and are dependent on, among other things, the perception of the senior lender that we are either stemming our losses or effecting a sale of one or more of our divisions. Furthermore, if the Company sells a division, the agreement with the Company's senior lender requires it to pay the net proceeds to the senior lender. As a result of this provision and the Company's obligations to the holders of subordinated debt, unless the lenders consent to the Company retaining a portion of the net proceeds from any sale for its operations, the Company will not receive any significant amount, and may not receive any of the net proceeds from any such sale for working capital. If the senior lender ceases funding our operations, unless we have obtained alternative financing, we will be unable to continue in business. Furthermore, unless we obtain funding from another source, including the sale of one of more of our divisions, we will not be able to pay our senior lender on December 31, 2002, and we may not be able to continue in business. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Because of our failure to pay our subordinated debt, the holders of the subordinated debt may seek to obtain and enforce judgments against us, which could cause a default under our agreement with our senior lender. One holder of subordinated notes has already commenced an action against us seeking payment of his note, and, because of our failure to pay the notes when due, other holders may bring similar actions. If such holders prevail in such actions and seek to enforce a judgment against us, we may be in default under our agreement with our senior lender, and we may seek, or our senior lender may seek or require us to seek, protection under the Bankruptcy Code. 2 of 31 Because of our financial condition, we have not been able to pay our creditors on a timely basis, and some of our creditors have obtained judgments against us. As a result of our continuing financial difficulties, a number of creditors have engaged attorneys or collection agencies or commenced legal actions against us, and some of them have obtained judgments against us, including a former landlord which has obtained a $400,000 judgment against us. The creditors include five former senior executives who have deferred compensation agreements with us. The total payments due under these agreements are approximately $1.9 million, of which $46,000 was due at December 31, 2001 and an additional $100,000 has become due in 2002. Other claimants who have already either commenced litigation or otherwise sought collection are due approximately $600,000. If we are unable to reach a settlement with these creditors and others who have not yet brought claims, and these claimants obtain judgments against us or seek to enforce a judgment against us, it may be necessary for us, or our senior lender may require us, to seek protection under the Bankruptcy Code. Our largest customer has ceased placing orders for OSS products with us and has significantly decreased orders for our copper connection/protection products, which are having a material adverse effect upon our business. Our largest customers are British Telecommunications and Fujitsu Telecommunications LTD, which purchases telecommunications equipment from us for sale to British Telecommunications. Sales to British Telecommunications declined significantly during the past year. British Telecommunications has informally advised us that it will not place orders with us for OSS products until we can demonstrate that we are financially viable. The decline in sales of connection/protection products for British Telecommunications reflects both our financial condition and industry conditions generally. We have not been able to replace the sales made to British Telecommunications and we cannot not give any assurance that we will be able to. The reluctance of British Telecommunications to place orders for OSS products may affect the willingness of other telecommunications companies to order new OSS products from us. The reduced level of our sales resulting from the decline in sales to British Telecommunications is continuing to impair our business, and, if we are not able to replace these sales, or generate new business from British Telecommunications or Fujitsu, we may not be able to continue in business. Since we sell to telecommunications companies, our sales are affected by economic and other factors that affect that industry, both domestically and internationally. During the past two years, the telecommunications industry has been affected by an international slowdown, and many, if not most, telecommunications companies have scaled back plans for expansion, which has resulted in a significant drop in the requirements for products including products such as our OSS products and our connection/protection products. We cannot assure you that there will be any positive change in the purchasing patterns of telecommunications companies or that we will benefit from any positive change which may occur. Because of our financial condition, we may not be able to perform on our contracts which may subject us to loss of business and penalties. We are having and we may continue to have difficulty performing our obligations under our contracts, which could result in the cancellation of contracts, the loss of future business and penalties for non-performance. 3 of 31 We are heavily dependent on foreign sales. Approximately 54% of our sales in 2001, 66% of our sales in 2000 and 62% of our sales for 1999, were made to foreign telephone operating companies. In selling to customers in foreign countries, we are exposed to inherent risks not normally present in the case of our sales to United States customers, including extended delays in both completing the installation and receiving the final payment from our customers for our Operational Support Systems contracts, and as well as further risks relating to political and economic changes. Furthermore, our financial condition has impaired our ability to generate new business in the international market as potential customers express concern about our ability to perform. We have granted to British Telecommunications rights to our technology. Under our agreement with British Telecommunications, we gave British Telecommunications the right to use our connection/protection technology or have products using our technology manufactured for it by others. As a result, British Telecommunication may have the right to use our technology and purchase products based on our technology from others, which has resulted and may continue to result in a significant decline in our sales to British Telecommunications. We experience difficulties with Operations Support Systems contracts. We experience delays in purchaser acceptance of the Operations Support Systems and our receipt of final contract payments in connection with a number of foreign sales. In addition, we have no steady or predictable flow of orders for Operations Support Systems and the negotiation of a contract for an operations support system is an individualized and highly technical process. These contracts typically contain performance guarantees by us and clauses imposing penalties on us if we do not meet the contractual in-service dates. The installation, testing and purchaser acceptance phases of these contracts may last longer than contemplated by the contracts and, accordingly, amounts due under the contracts may not be collected for extended periods. Furthermore, our Operation Support Systems contracts typically contain performance guarantees by us and clauses imposing penalties if we do not meet "in-service" dates. Because of our small size and our financial problems, we may have difficulty competing for business. We compete directly with a number of large and small telephone equipment manufacturers in the United States, with Lucent Technologies, Inc. continuing to be our principal United States competitor. Our competitors are using our financial difficulties in successfully competing against us. We anticipate that our loss for 2001, our working capital deficiency and the scheduled expiration of our financing agreement may continue to place us in a competitive disadvantage, particularly in seeking Operations Support Systems contracts, where we frequently deal with national telecommunications companies. We face significant competition for both foreign and domestic sales. In both foreign and domestic markets, we face considerable competition from other United States and foreign telephone equipment manufacturers most of which are larger and have substantially greater financial resources than us. In addition, if we establish facilities in foreign countries, we face risks associated with currency devaluation, difficulties in either converting local currency into dollars or transferring funds to the United States, local tax and currency regulations and political instability. We require access to current technological developments. We rely primarily on the performance and design characteristics of our products and we try to offer our products at prices and with warranties that will make our products competitive. Our business could be adversely affected if we cannot obtain licenses for such updated technology or self develop state-of-the-art technology. Because of our financial problems, we are not able to devote any significant effort to research and development, which could increase our difficulties in making sales of our products. We rely on certain key employees. We may be dependent upon the continued employment of certain key employees, including our senior executive officers. Our failure to retain such employees may have a material adverse effect upon our business. Because of our financial problems we have experienced key personnel losses. 4 of 31 To the extent that these losses continue or are accelerated, we may be unable to provide our customers with necessary service, which could result in the failure to generate new business. We do not meet the continued listing standards of the American Stock Exchange, and we may be delisted from that exchange. If we are delisted from the American Stock Exchange, our stock will be traded on the OTC Bulletin Board and will be subject to the Securities and Exchange Commission's penny stock rules, which impose additional sales practice requirements on broker-dealers which sell our stock to persons other than established customers and institutional accredited investors. These rules may affect the ability of broker-dealers to sell our common stock and may affect the ability of our stockholders to sell any common stock they may own. We do not pay dividends on common stock. Products Operations Support Systems. We sell our OSS systems primarily to telephone operating companies in established and developing countries in Asia, South and Central America and Europe, and to a lesser extent, in the United States. Our principal OSS systems are computer-based testing, provisioning, activation and trouble management products which include software and capital equipment and typically sell for prices ranging from several hundred thousand to several million dollars. The testing products are designed to automatically test for and diagnose problems in customer telephone lines and to notify telephone company service personnel of required maintenance. The associated trouble management system provides automated record keeping (including repair and disposition records) and analyzes these records to enable the telephone company to identify recurring problems and equipment deterioration and to fulfill maintenance service level agreement obligations. The integration of these systems provides a service assurance function for telephone companies. A major component of the testing system is the "test head," which provides the access to, and tests the required telephone line. We have continually developed our test head capability to meet the changing requirements of the customer loop, and have recently introduced our latest advanced technology platform (sixth generation) product, the MKIII. An enhanced version of the MKIII, the Sherlock, will provide the capability to determine whether customer lines are xDSL capable, enabling telephone companies to expeditiously characterize their outside plant, and optimize their responsiveness to market conditions. Our other software applications, including the automated assignment of facilities and activation of service, form part of a telephone company's service activation function, and can be integrated with the testing and trouble management systems, to provide a comprehensive access loop capability. In addition, if requested by customers, Porta develops software to meet specific customer requirements, including integration of its systems with telephone company legacy or third party OSS systems. Our OSS products are complex and, in most applications, incorporate features designed to respond to the purchaser's operational requirements and the particular characteristics of the purchaser's telephone system and operational processes. As a result, the negotiation of a contract for an OSS system is an individualized and highly technical process. In addition, contracts for OSS systems frequently provide for manufacturing, delivery, installation, testing and purchaser acceptance phases, which take place over periods ranging from several months to a year or more. These contracts typically contain performance guarantees by us and clauses imposing penalties if "in-service" dates are not met. The installation, testing and purchaser acceptance phases of these contracts may last longer than contemplated by the contracts and, accordingly, amounts due under the contracts may not be collected for extended periods and, in some instances, may not be collected. Delays in purchaser acceptance of the systems and in our receipt of final contract payments have occurred in connection with a number of foreign sales. In addition, we have not experienced a steady or predictable flow of orders for OSS systems. 5 of 31 Telecommunications Connection Equipment. Our copper connection/protection equipment and systems are used by telephone operating companies, by owners of private telecommunications equipment and by manufacturers and suppliers of telephone central office and customer premises equipment. Products of the types comprising our telecommunications connection equipment are included as integral parts of all domestic and foreign telephone and telecommunications systems. Such products are sold in a worldwide market, which generally grows in proportion to increases in the number of telephone subscribers and owners of private telecommunications equipment, as well as to increases in upgrades to modern digital switching technology such as DSL, ADSL, and ISDN lines. Our connection equipment consists of connector blocks and protection modules used by telephone companies to interconnect copper-based subscriber lines to switching equipment lines. The protector modules protect central office personnel and equipment from electrical surges. The need for protection products has increased as a result of the worldwide move to digital technology, which is extremely sensitive to damage by electrical overloads, and because private owners of telecommunications equipment now have the responsibility to protect their equipment from damage caused by electrical surges. Line connecting/protecting equipment usually incorporates protector modules to safeguard equipment and personnel from injury due to power surges. Currently, these products include a variety of connector blocks, protector modules and frames used in telephone central switching offices, PBX installations, multiple user facilities and customer premise applications. We also have developed an assortment of frames for use in conjunction with our traditional line of connecting/protecting products. Frames for the interconnection of copper circuits are specially designed structures which, when equipped with connector blocks and protectors, interconnect and protect telephone lines and distribute them in an orderly fashion allowing access for repairs and changes in line connections. One of our frame products, the CAM frame, is designed to produce computer-assisted analysis for the optimum placement of connections for telephone lines and connector blocks mounted on the frame. Our copper connection/protection products are used by many of the Regional Bell Operating Companies as well as by independent telephone operating companies in the United States and owners of private telecommunications equipment. These products are also purchased by other companies for inclusion within their systems. In addition, our telecommunications connection products have been sold to telephone operating companies in various foreign countries. This equipment is compatible with existing telephone systems both within and outside the United States and can generally be used without modification, although we do custom design modifications to accommodate the specific needs of our customers. Signal Processing Products. Our signal processing products include data bus systems and wideband transformers. Data bus systems, which are the communication standard for military and aerospace systems, require an extremely high level of reliability and performance. Wideband transformers are required for ground noise elimination in video imaging systems and are used in the television and broadcast, medical imaging and industrial process control industries. 6 of 31 The table below shows, for the last three fiscal years, the contribution made to our sales by each of its major categories of the telecommunications industry: Sales by Product Category Years Ended December 31, 2001 2000 1999 ---- ---- ---- (Dollars in thousands) OSS Systems $ 8,874 32% $22,296 44% $14,254 37% Line Connecting /Protecting Equipment 12,756 46% 20,546 40% 18,189 47% Signal Processing 5,737 20% 7,644 15% 6,328 16% Other 695 2% 654 1% 165 0% ------- ------- ------- ------- ------- ------- Total $28,062 100% $51,140 100% $38,936 100% ======= ======= ======= ======= ======= ======= Markets We supply equipment and systems to telephone companies which provides improved services to ensure communication to their customers. In addition, we provide businesses with systems which improve their internal telecommunication systems. Telephone networks in certain regions of the world, notably Latin America, Eastern Europe and certain areas in the Asia/Pacific region, were designed to carry voice traffic and are not well suited for high-speed data transmissions or for other forms of telecommunications that operate more effectively with digital telecommunications equipment and lines. The telephone networks in these countries are also characterized by a very low ratio of telephone lines to population. Countries with emerging telecommunication networks have to rapidly add access lines in order to increase the availability of telephone service and to significantly upgrade the quality of the lines already in service. Our OSS systems are designed to meet many of the needs of a rapidly changing telephone network. OSS systems facilitate rapid change and expansion without a comparable increase in the requirement for skilled technicians, while the computerized line test system insures increased quality and rapid maintenance and repair of subscriber local loops. The automated database, which computerizes the inventory and maintenance history of all subscriber lines in service, helps to keep the rapid change under control. During 2001, approximately 32% of our sales consisted of OSS products and services. As a telephone company expands the number of its subscriber lines, it also requires additional connection equipment to interconnect and protect those lines in its central offices. We provide a line of copper connection equipment for this purpose. Recent trends towards the transmission of high frequency signals on copper lines are sustaining this market. Less developed countries, such as those with emerging telecommunications networks or those upgrading to digital switching systems, provide a growing market for copper connection and protection equipment. 7 of 31 The increased sensitivity of the newer digital switches to small amounts of voltage requires the telephone company which is upgrading its systems to digital switching systems to also upgrade its central office connection/protection systems in order to meet these more stringent protection requirements. We supply central office connection/protection systems to meet these needs. During 2001, approximately 46% of our sales were made to customers in this category. Our line of signal processing products is supplied to customers in the military and aerospace industry as well as manufacturers of medical equipment and video systems. The primary communication standard in new military and aerospace systems is the MIL-STD-1553 Command Response Data Bus, an application which requires an extremely high level of reliability and performance. Products are designed to be application specific to satisfy the requirements of each military or aerospace program. Our wideband transformers are required for ground noise elimination in video imaging systems and are used in the television and broadcast, medical imaging and industrial process control industries. If not eliminated, ground noise caused by poor electrical system wiring or power supplies, results in significant deterioration in system performance, including poor picture quality and process failures in instrumentation. The wideband transformers provide a cost effective and quick solution to the problem without the need of redesign of the rest of the system. During 2001, signal processing equipment accounted for approximately 20% of our sales. Marketing and Sales We operate through three business units, which are organized by product line, and with each having responsibility for the sales and marketing of its products. When appropriate to obtain sales in foreign countries, we may enter into business arrangements and technology transfer agreements covering our products with local manufacturers and participate in manufacturing and licensing arrangements with local telephone equipment suppliers. In the United States and throughout the world, we use independent distributors in the marketing of all copper based products to the regional bell operating companies and the customer premises equipment market. All distributors marketing copper-based products also market directly competing products. In addition, Porta continues to promote the direct marketing relationships it developed in the past with telephone operating companies. We had a non-exclusive supply agreement with British Telecommunications covering our connecting/protecting products. This agreement, which did not provide for any purchase commitments by British Telecommunications, expired on August 31, 2001. British Telecommunications purchased line connecting/protecting products amounting to $3,339,000 (12% of sales) in 2001, $4,261,000 (8% of sales) in 2000, and $6,566,000 (17% of sales) in 1999. During these years, we also sold our products to unaffiliated suppliers for resale to British Telecommunications. We have a cross-licensing agreement with British Telecommunications which, in effect, enables British Telecommunications to use certain of our proprietary information to modify or enhance products provided to British Telecommunications and permits British Telecommunications to manufacture or engage others to manufacture those products. Although we have been negotiating with British Telecommunications with respect to a new non-exclusive supply agreement and British Telecommunications has made modest purchases of copper connection/protection products from us, as of the date of this report we have not reached an agreement with British Telecommunications, and we may not be able to enter into such an agreement. If we do not sell products to British Telecommunications, whether pursuant to a supply agreement or otherwise, our business could be impaired. 8 of 31 Our OSS systems historically have been sold to foreign telephone operating companies which are government controlled. Recently, we entered into sales, marketing and management co-operative agreements and strategic alliances with various companies. During 2000, we entered into a multi-year sales, marketing, and management co-operative agreement with Fujitsu Telecommunications to market Internet infrastructure products. Under the agreement, Fujitsu will sell and market Porta's advanced Internet infrastructure technologies, including ADSL Single Ended Line Qualification System for broadband services and the sixth generation Sherlock remote test unit to telecom service operators in the United Kingdom, principally British Telecommunications, and certain other European countries. During 2001 and 2000, we had sales pursuant to this agreement of $3,200,000 (11% of sales) and $12,051,000 (24% of sales), respectively. Our signal processing products are sold primarily to US military and aerospace prime contractors, and domestic original equipment manufacturers and end users. The following table sets forth for the last three fiscal years our sales to customers by geographic region: Sales to Customers By Geographic Region (1) Year Ended December 31, 2001 2000 1999 ---- ---- ---- (Dollars in thousands) North America $13,356 48% $22,795 45% $14,664 38% United Kingdom 8,060 29% 20,244 40% 15,673 40% Asia/Pacific 4,552 16% 5,429 10% 4,159 11% Other Europe 1,761 6% 2,482 5% 3,130 8% Latin America 288 1% 146 0% 1,257 3% Other 45 0% 44 0% 53 0% ------- ------- ------- ------- ------- ------- Total Sales $28,062 100% $51,140 100% $38,936 100% ======= ======= ======= ======= ======= ======= (1) For information regarding the amount of sales, operating profit or loss and identifiable assets attributable to each of our divisions and geographic areas, see Note 23 of Notes to the Consolidated Financial Statements. In selling to customers in foreign countries, we face inherent risks not normally present in the case of sales to United States customers, including increased difficulty in identifying and designing systems compatible with purchasers' operational requirements; extended delays under OSS systems contracts in the completion of testing and purchaser acceptance phases and difficulty in our receipt of final payments and political and economic change. In addition, to the extent that we establish facilities in foreign countries or to the extent that payment is denominated in the local currency, we face risks associated with currency devaluation, inability to convert local currency into dollars, as well as local tax regulations and political instability. 9 of 31 Manufacturing Our computer-based testing products include proprietary testing circuitry and computer programs, which provide platform-independent solutions based on UNIX or UNIX compatible operating systems. The testing products also incorporate disk data storage, teleprinters, file servers and personal computers purchased by us. These products are installed and tested by us at our customers' premises. At present, our manufacturing operations are conducted at facilities located in Syosset, New York and Matamoros, Mexico. From time to time we also use subcontractors to augment various aspects of our production activities and periodically explore the feasibility of conducting operations at lower cost manufacturing facilities located abroad. In selling to foreign telephone companies, we may be required to provide local manufacturing facilities and, in conjunction with these facilities, we may grant the facility a license to our proprietary technology. Source and Availability of Components We generally purchase the standard components used in the manufacture of our products from a number of suppliers. We attempt to assure ourselves that the components are available from more than one source. We purchase all of our MKIII test units from two suppliers. We purchase the majority of our workstations and servers used in its OSS systems from Compaq Computer Corporation. However, we could use other computer equipment in our systems if we were unable to purchase Compaq products. Other components, such as personal computers and line printers used in connecting with our electronic products, are readily available from a number of sources. Significant Customers During 2001, our five largest customers accounted for sales of $13,444,000, or approximately 48% of sales, and, during 2000, our five largest customers accounted for sales of $28,323,000, or approximately 55% of sales. Our largest customer in 2001 with sales of $3,485,000, or approximately 12% of sales was Philippine Long Distance Telephone. Our largest customer in 2000 with sales of $12,051,000, or approximately 24% of sales was Fujitsu Telecommunications. Our sales to Fujitsu Telecommunications were $3,200,000, or approximately 11% of sales in 2001. A significant amount of sales of our products for use by British Telecommunications were sold to Fujitsu Telecommunications, as purchasing agent for British Telecommunications. As a result, most of the sales to Fujitsu Telecommunications were for use by British Telecommunications. Direct sales to British Telecommunications were $3,339,000, or 12% of sales, for 2001 and $5,098,000, or 10% of sales, for 2000. Any significant interruption or decline in sales to Fujitsu Telecommunications or British Telecommunications may have a materially adverse effect upon our operations. During 2000, sales to a Mexican telephone company were $5,507,000, or approximately 11% of sales. No other customers account for 10% or more of our sales for either year. The former Bell operating companies continue to be the ultimate purchasers of a significant portion of our products sold in the United States, while sales to foreign telephone operating companies constitute the major portion of our foreign sales. Our contracts with these customers require no minimum purchases by such customers. Significant customers for the signal processing products include major US aerospace companies, the Department of Defense and original equipment manufacturers in the medical imaging and process control equipment industries. We sell both catalog and custom designed products to these customers. Some contracts are multi-year procurements. Backlog At December 31, 2001, our backlog was approximately $6,100,000 compared with approximately $10,000,000 at December 31, 2000. Of the December 31, 2001 backlog, approximately $5,000,000 represented orders from foreign telephone operating companies. We expect to ship substantially all of our December 31, 2001 backlog during 2002. 10 of 31 Intellectual Property Rights We own a number of domestic utility and design patents and have pending patent applications for these products. In addition, we have foreign patent protection for a number of our products. From time to time we enter into licensing and technical information agreements under which we receive or grant rights to produce certain subcomponents used in our products. These agreements are for varying terms and provide for the payment or receipt of royalties or technical license fees. While we consider patent protection important to the development of our business, we believe that our success depends primarily upon our engineering, manufacturing and marketing skills. Accordingly, we do not believe that a denial of any of our pending patent applications, expiration of any of our patents, a determination that any of the patents which have been granted to us are invalid or the cancellation of any of our existing license agreements would have a material adverse effect on our business. Competition The telephone equipment market in which we do business is characterized by intense competition, rapid technological change and a movement to private ownership of telecommunications networks. In competing for telephone operating company business, the purchase price of equipment and associated operating expenses have become significant factors, along with product design and long-standing equipment supply relationships. In the customer premises equipment market, we are functioning in a market characterized by distributors and installers of equipment and by price competition. We compete directly with a number of large and small telephone equipment manufacturers in the United States, with Lucent Technologies continuing to be our principal United States competitor. Lucent's greater resources, extensive research and development facilities, long-standing equipment supply relationships with the operating companies of the regional holding companies and history of manufacturing and marketing products similar in function to those produced by us continue to be significant factors in our competitive environment. Currently, Lucent and a number of companies with greater financial resources than us produce, or have the design and manufacturing capabilities to produce, products competitive with our products. In meeting this competition, we rely primarily on the engineered performance and design characteristics of our products to comparable performance or design, and endeavors to offer our products at prices and with warranties that will make our products compete world wide. In connection with overseas sales of our line connecting/protecting equipment, we have met with significant competition from United States and foreign manufacturers of comparable equipment and we expect this competition to continue. In addition to Lucent, a number of our overseas competitors have significantly greater resources than we do. We compete directly with a limited number of substantial domestic and international companies with respect to our sales of OSS systems. In meeting this competition, we rely primarily on the features of our line testing equipment, our ability to customize systems and endeavor to offer such equipment at prices and with warranties that make them competitive. In addition to the quality and price of the products being offered, the financial stability of a supplier, especially for OSS contracts, is a crucial element. Because these contracts require the supplier to spend considerable funds before the project is completed and require ongoing maintenance service, potential customers consider the financial stability of the supplier as a major consideration in awarding a contract. Our financial position, combined with our recent losses, our working capital deficiency and the scheduled expiration of our financing agreement with our senior 11 of 31 lender, and the decision of British Telecommunications not to place orders for new OSS products from us and its reduced level of purchases of copper connection/protection products may place us at a competitive disadvantage in seeking new business and new orders for existing customers. Research and Development Activities We spent approximately $4,400,000 in 2001, $5,800,000 in 2000, and $6,100,000 in 1999 on research and development activities. All research and development was company sponsored and is expensed as incurred. As a result of our financial difficulties, we have scaled down our research and development effort, which could hurt our ability to offer competitive products. Employees As of March 31, 2002, we had 274 employees of which 58 were employed in the United States, 182 in Mexico, 27 in the United Kingdom, 3 in Poland, 3 in Chile, and 1 in China. We believe that our relations with our employees are good, and we have never experienced a work stoppage. Our employees are not covered by collective bargaining agreements, except for our hourly employees in Mexico who are covered by a collective bargaining agreement that expires on December 31, 2002. Item 2. Properties We currently lease approximately 20,400 square feet of executive, sales, marketing and research and development space in Syosset, New York; and 7,000 square feet of office space located in Charlotte, North Carolina, which has been vacated. These facilities represent substantially all of our office, plant and warehouse space in the United States. The Syosset, New York lease expires December 2005, and the Charlotte, North Carolina lease expires in November 2004. The annual rental related to the New York property is approximately $350,000. All rental expense related to the North Carolina facility was accrued in 2000. During 2001, the Company sold its Glen Cove, New York facility for $1,850,000 and recognized a gain on the sale of $684,000, net of expenses of $180,000. Our wholly-owned United Kingdom subsidiary leases approximately 34,300 square foot facility in Coventry, England, which facility comprises all of our office, plant and warehouse space. The lease expires in 2019. The aggregate annual rental is approximately $225,000. Our wholly-owned Mexican subsidiary owns an approximately 40,000 square foot manufacturing facility in Matamoros, Mexico. We believe our properties are adequate for our needs. 12 of 31 Item 3. Legal Proceedings In July 2001, the holder of a subordinated note in the principal amount of $500,000 commenced an action against the Company in the United States District Court for the Southern District of New York seeking payment of the principal and accrued interest on their subordinated notes which were payable in July 2001. The payment of the note is subordinated to payment of the Company's senior debt and the Company believes that the subordination provision of the note prohibits payment by the Company. The plaintiffs' motion for a summary judgment was recently denied by the court on the grounds that the terms of the note did not give them permission to obtain a judgment while Porta remained in default to the senior debt holder. The Company's obligations under the subordinated notes are reflected as current liabilities on the Company's balance sheet. In March 2000, we suspended (with pay) Messrs. Ronald Wilkins and Michael Bahlo, two of our executive officers, from their positions pending completion of our investigation of certain matters that had come to our attention. Prior to the completion of this investigation, however, these two executives accepted positions with another company and thereby voluntarily resigned from their positions with us. In February 2001, these two executives, together with a third former executive officer, Mr. Michael Lamb, who similarly resigned from his position with us, filed suit in the Supreme Court for the State of New York, County of New York, entitled Ronald Wilkins, Michael Bahlo and Michael Lamb v. Porta Systems Corp., Index No 600677/01. The complaint asserts various claims against us based on the allegation that each of these three executives was improperly terminated from his employment without cause, and seeks compensatory damages, liquidating damages and attorney's fees. We have filed an answer and counterclaim against the plaintiffs. We believe that we have valid defenses to the claims and intend to defend this action vigorously and to assert counterclaims against these former executives. In July 1996, an action was commenced against Porta and certain present and former directors in the Supreme Court of the State of New York, New York County by certain stockholders and warrant holders of Porta who acquired their securities in connection with the acquisition by Porta of Aster Corporation. The complaint alleges breach of contract against Porta and breach of fiduciary duty against the directors arising out of an alleged failure to register certain restricted shares and warrants owned by the plaintiffs. The complaint seeks damages of $413,000; however, counsel for the plaintiff has advised Porta that additional plaintiffs may be added and, as a result, the amount of damages claimed may be substantially greater than the amount presently claimed. Porta believes that the defendants have valid defenses to the claims. Discovery is proceeding, although there has been no significant activity in this matter subsequent to December 31, 1999. 13 of 31 Item 4. Submission of Matters to a Vote of Securities Holders During the fourth quarter of 2001, no matters were submitted to a vote of security holders of the Company. Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters Our common stock is traded on the American Stock Exchange, Inc. under the symbol PSI. The following table sets forth, for 2000 and 2001, the quarterly high and low sales prices for our common stock on the consolidated transaction reporting systems for American Stock Exchange listed issues. High Low ---- --- 2000 First Quarter $4.88 $0.81 Second Quarter 3.63 1.56 Third Quarter 2.00 0.88 Fourth Quarter 1.00 0.38 2001 First Quarter $1.06 $0.22 Second Quarter 0.40 0.21 Third Quarter 0.30 0.10 Fourth Quarter 0.17 0.05 We did not declare or pay any cash dividends in 2001 or 2000. It is our present policy to retain earnings, if any, to finance the growth and development of the business, and therefore, we do not anticipate paying cash dividends on its common stock in the foreseeable future. In addition, Porta's agreement with its senior lender prohibits it from paying cash dividends on its common stock. As of March 12, 2002, we had approximately 983 stockholders of record and the closing price of our common stock was $0.10. We did not issue any unregistered securities during 2001. We do not meet the continued listing standards of the American Stock Exchange, and we may be delisted from that exchange. If we are delisted from the American Stock Exchange, our stock will be traded on the OTC Bulletin Board and will be subject to the Securities and Exchange Commission's penny stock rules. 14 of 31 Item 6. Selected Financial Data The following table sets forth certain selected consolidated financial information. For further information, see the Consolidated Financial Statements and other information set forth in Item 8 and Management's Discussion and Analysis of Financial Condition and Results of Operations set forth in Item 7:
Year Ended December 31, ----------------------- 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- (In thousands, except per share data) Income Statement Data: Sales $ 28,062 $ 51,140 $ 38,936 $ 59,343 $ 62,230 Operating income (loss) (11,453) (5,153) (9,709) 4,566 6,101 Debt conversion expense -- -- -- (945) (11,458) Income (loss) before discontinued operations and extraordinary item (14,774) (10,176) (13,686) 451 (7,021) Net income (loss) (14,774) (10,176) (13,686) 527 (6,899) Basic per share amounts: Continuing operations $ (1.50) $ (1.04) $ (1.44) $ 0.05 $ (2.26) Net income (loss) $ (1.50) $ (1.04) $ (1.44) $ 0.06 $ (2.22) Diluted per share amounts: Continuing operations $ (1.50) $ (1.04) $ (1.44) $ 0.04 $ (2.26) Net income (loss) $ (1.50) $ (1.04) $ (1.44) $ 0.05 $ (2.22) Cash dividends declared -- -- -- -- -- Number of shares used in calculating net income (loss) per share-basic 9,878 9,763 9,489 9,281 3,111 Number of shares used in calculating net income (loss) per share-diluted 9,878 9,763 9,489 9,785 3,111 Balance Sheet Data: Total assets $ 17,833 $ 34,174 $ 43,448 $ 52,136 $ 51,000 Working capital (deficiency) $(31,236) $(24,152) $ 6,135 $ 14,262 $ 7,286 Long-term debt excluding current maturities $ -0- $ 376 $ 21,902 $ 17,238 $ 18,858 Stockholders' equity (deficit) $(25,849) $(10,792) $ (1,387) $ 11,984 $ 6,813
15 of 31 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Critical Accounting Policies and Estimates Financial Reporting Release No. 60, which was recently released by the Securities and Exchange Commission, requires all companies to include a discussion of critical accounting policies and methods used in the preparation of financial statements. Note 1 of Notes to Consolidated Financial Statements, included elsewhere on this annual report on Form 10-K, includes a summary of the significant accounting policies and methods used in the preparation of our consolidated financial statements. We believe the following critical accounting policies affect the significant judgements and estimates used in the preparation of our financial statements: Use of Estimates The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Among the more significant estimates included in these consolidated financial statements are the estimated allowance for doubtful accounts receivable, inventory reserves, percentage of completion for long-term contracts, goodwill valuation and the deferred tax asset valuation allowance. Actual results could differ from those and other estimates. Revenue Recognition Revenue, other than from long-term contracts for specialized products, is recognized when a product is shipped. Revenues and earnings relating to long-term contracts for specialized products are recognized on the percentage-of-completion basis primarily measured by the attainment of milestones. Anticipated losses, if any, are recognized in the period in which they are identified. Goodwill Goodwill represents the difference between the purchase price and the fair market value of net assets acquired in business combinations treated as purchases. Goodwill is amortized on a straight-line basis over the estimated useful life as determined by events and circumstances of the business combination that gave rise to the goodwill. We assess the recoverability of unamortized goodwill using the undiscounted projected future cash flows from the related businesses. 16 of 31 Our consolidated statements of operations for the three years ended December 31, 2001, 2000 and 1999, respectively, as a percentage of sales is as follows: Years Ended December 31, 2001 2000 1999 ---- ---- ---- Sales 100% 100% 100% Cost of sales 71% 70% 74% ---- ---- ---- Gross Profit 29% 30% 26% Selling, general and administrative expenses 33% 28% 35% Research and development expenses 16% 12% 16% Goodwill impairment 21% -- -- ---- ---- ---- Operating loss (41%) (10%) (25%) Interest expense (16%) (9%) (9%) Gain on sale of assets 2% -- -- Other 1% (1%) 1% ---- Loss before income taxes, equity in net loss of joint venture and minority interest (54%) (20%) (33%) Income tax benefit (expense), equity in net loss of joint venture and minority interest 1% -- (2%) ---- ---- ---- Net loss (53%) (20%) (35%) ==== ==== ==== 17 of 31 Results of Operations Years Ended December 31, 2001 and 2000 Our sales for 2001 were $28,062,000 compared to $51,140,000 in 2000, a decrease of $23,078,000 (45%). The decrease in revenue is attributed to the decline in sales from all divisions. OSS sales for 2001 were $8,874,000, compared to 2000 sales of $22,296,000, a decrease of $13,422,000 (60%). The decline in sales from 2000 to 2001 is attributed to the completion during 2000 of certain sales contracts secured during 1999 and failure to secure new contracts as a result of the negative impact of reduced opportunities in Europe, delays we encountered in obtaining software from a vendor necessary to complete certain contracts and our financial difficulties. We expect to recognize the balance of the revenue from the in process OSS contracts during 2002. Sales of OSS systems are not made on a recurring basis to customers, but are the result of extended negotiations that frequently cover many months and do not always result in a contract. In addition, OSS contracts may include conditions precedent, such as the customer obtaining financing or bank approval, and the contracts are not effective until the conditions are satisfied. Line connection/protection equipment sales for 2000 decreased approximately $7,790,000 (38%) from $20,546,000 in 2000 to $12,756,000 in 2001. The reduced sales level reflected a decrease in volume of sales to United States, United Kingdom and Mexican customers. The results were adversely affected by the general slowdown in the telecommunications industry. Signal processing revenue for 2001 compared to 2000 decreased by $1,907,000 (25%) from $7,644,000 to $5,737,000. The decrease in sales primarily reflects delays in the receipt of certain anticipated contracts and a general slowdown in the order rate from customers during 2001. Gross margin decreased from 30% in 2000 to 29% in 2001. The decrease in gross margin is primarily attributed to the lower sales volume in the OSS division causing inefficiency resulting from our inability to absorb our fixed expenses associated with the OSS contracts over our revenue base. Selling, general and administrative expenses decreased by $5,257,000 (36%) from $14,573,000 in 2000 to $9,316,000 in 2001. The decrease from 2000 to 2001 primarily reflects reduced professional legal expenses and decreased expenses reflecting our reorganization of our sales and marketing efforts of the OSS division. Research and development expenses decreased by $1,403,000 (24%) from $5,830,000 in 2000 to $4,427,000 in 2001. The decreased expense in 2001 resulted from our efforts to reduce our expenses primarily related to the OSS business. In December 2001, we determined that $5,802,000 of goodwill associated with our OSS business unit was impaired, and we recorded an impairment loss in that amount. This assessment was based on the continued decline in sales and losses generated by the business unit over the past several years and the declining prospects for additional sales of the products based on the older technology that originally gave rise to the goodwill. In addition, there are presently no negotiations in progress for the sale of the OSS division. As a result of the above, we had an operating loss of $11,453,000 in 2001 versus operating loss of $5,153,000 in 2000. Interest expense for 2001 decreased by $20,000 from $4,500,000 for 2000 to $4,480,000 in 2001. 18 of 31 Results of Operations (continued) During 2001, we sold our Glen Cove, New York facility for $1,850,000 and recognized a gain on the sale of $684,000, net of expenses of $180,000. Of the net proceeds of $1,670,000, $474,000 was used to reduce outstanding principal and $350,000 to reduce outstanding interest obligations to our senior lender. We retained the remaining proceeds of $846,000 for working capital purposes. As of December 31, 2001, we had a net income tax benefit of $203,000 which is comprised of income tax expense of $58,000 and benefit of $261,000. The benefit reflects the reduction of an accrual for potential tax liability to one of our subsidiaries that had previously operated in Puerto Rico as a result of the expiration of the statute of limitations. As the result of the foregoing, the 2001 net loss was $14,774,000, $1.50 per share (basic and diluted), compared with a net loss of $10,176,000, $1.04 per share (basic and diluted) for 2000. Our losses are continuing into 2002, and we cannot give any assurance that we will be able to operate profitably in the future. As a result of the deterioration of our operating revenue resulting from both market conditions and our financial condition, we are evaluating various options, including the sale of one or more of our divisions as well as a reorganization under the Bankruptcy Code. Years Ended December 31, 2000 and 1999 Our sales for 2000 were $51,140,000 compared to $38,936,000 in 1999, an increase of $12,204,000 (31%). The increase in revenue is attributed principally to completion of contracts from our OSS division, although all divisions achieved increased revenues in 2000 as compared to 1999. OSS sales for 2000 were $22,296,000, compared to 1999 sales of $14,254,000, an increase of $8,042,000 (56%). During 2000, OSS sales resulted primarily from the completion of OSS contracts, which were secured during the latter part of 1999. We expect to complete revenue recognition from these OSS contracts in 2001. Sales of OSS systems are not made on a recurring basis to customers, but are the result of extended negotiations that frequently cover many months and do not always result in a contract. In addition, OSS contracts may include conditions precedent, such as the customer obtaining financing or bank approval, and the contracts are not effective until the conditions are satisfied. Line connection/protection equipment sales for 2000 increased approximately $2,357,000 (13%) from $18,189,000 in 1999 to $20,546,000 in 2000. The improved sales level reflected an increase in volume of sales to United States and Mexican customers, which were offset by a decrease in sales to customers in the United Kingdom. Signal processing revenue for 2000 compared to 1999 increased by $1,316,000 (21%) from $6,328,000 to $7,644,000. The increase in sales primarily reflects accommodations made to customers where requested delays in deliveries in 1999 of orders were shipped during 2000. Gross margin increased from 26% in 1999 to 30% in 2000. The increase in gross margin is primarily attributed to the higher sales volume in the OSS division. However, the increase in revenue was still not satisfactory in completely eliminating the inefficiency resulting from our inability to absorb our fixed expenses associated with the OSS contracts over our revenue base. This improvement in gross margin was slightly offset by a lower gross margin in connection/protection products in 2000 compared to 1999 due to changes in product mix. Selling, general and administrative expenses increased by $970,000 (7%) from $13,603,000 in 1999 to $14,573,000 in 2000. The increase from 1999 to 2000 primarily reflects higher than anticipated professional legal expenses due primarily to litigation involving us, particularly litigation and settlement of a dispute with a vendor. 19 of 31 Results of Operations (continued) Research and development expenses decreased by $260,000 (4%) from $6,090,000 in 1999 to $5,830,000 in 2000. The decreased expense in 2000 resulted from the completion during 2000 of certain efforts to develop new products primarily related to the OSS business. As a result of the above, we had an operating loss of $5,153,000 in 2000 versus operating loss of $9,709,000 in 1999. The reduced operating loss for 2000 reflects continued profitability in our line connection/protection equipment and signal processing divisions, and a reduction of the operating loss in our OSS division from $10,650,000 in 1999 to $6,201,000 in 2000. Interest expense for 2000 increased by $929,000 from $3,571,000 for 1999 to $4,500,000 in 2000. This change is attributable primarily to increased levels of borrowing from the Company's senior lender and non cash interest expense associated with the issuance and re-pricing of warrants held by the senior lender and subordinated note holders (See Notes 7 and 9 of Notes to Consolidated Financial Statements). During 2000, we requested the early termination of our obligations to a number of current and former executive officers regarding the funding of split dollar life insurance policies in order to obtain approximately $1,200,000 of premiums paid by us into the policies. Due to the early termination, we agreed to forfeit approximately $600,000 of premiums and terminate our interest in the policies which amount was charged to other expenses during 2000. As the result of the foregoing, the 2000 net loss was $10,176,000, $1.04 per share (basic and diluted), compared with a net loss of $13,686,000, $1.44 per share (basic and diluted) for 1999. Liquidity and Capital Resources At December 31, 2001, we had cash and cash equivalents of $1,204,000 compared with $2,366,000 at December 31, 2000. Our working capital deficit was $31,236,000 at December 31, 2001 compared to a working capital deficit of $24,152,000 at December 31, 2000. The working capital deficit reflects the current liabilities to the senior and subordinated lenders together with the effect of the reduced level of business, which resulted in reduced cash, receivables and inventory. During 2001, we used $3,779,000 of cash to support our operations. Our principal source of funds during 2001 was borrowings from our senior lender. As of December 31, 2001, our debt includes $22,095,000 of senior debt which matured on January 7, 2002, and $6,144,000 of subordinated debt which became due on July 3, 2001. We were unable to pay the interest payment on the subordinated notes of approximately $1,358,000 which represents interest from July 2000 through December 2001. At December 31, 2001, we did not have sufficient resources to pay either the senior lender or the subordinated lenders and it is unlikely that we can generate such cash from our operations, and our senior lender has precluded us from making payments on the subordinated debt. 20 of 31 Liquidity and Capital Resources (continued) On March 1, 2002, our senior lender and we agreed to an amended and restated loan and security agreement whereby a new term loan was established with a maximum principal amount of $1,500,000. The agreement allows us to draw monies subject to our senior lender's receipt and approval of a weekly disbursement budget. Obligations under the new term loan shall bear interest at 12%. Secondly, the agreement establishes all indebtedness prior to March 1, 2002 as an old term loan in the amount of $22,610,000, which includes the balance due at December 31, 2001 plus accrued interest though March 1, 2002. The old term loan shall bear no interest until such time as the senior lender in its sole discretion notifies us that interest shall be payable. Both the new and old term loans expire on December 31, 2002. As part of this agreement, the senior lender continues to preclude us from making any payments on indebtedness to any subordinated creditors except to pay accounts payable in the ordinary course of business. The $1,500,000 being advanced by our senior lender is being advanced at the discretion of the senior lender and such advances are dependent on, among other things, the perception of the senior lender that we are either stemming our losses or effecting a sale of one or more of our divisions. If the senior lender ceases funding our operations, unless we have obtained alternative financing, we will be unable to continue in business. Furthermore, unless we obtain funding from another source, including the sale of one of more of our divisions, we will not be able to pay our senior lender on December 31, 2002, and we may not be able to continue in business. As of December 31, 2001, we had remaining outstanding $382,000 of 6% Debentures, net of original issue discount of $3,000, which mature July 2, 2002. The face amount of the outstanding 6% Debentures was $385,000. The interest accrued on the 6% Debentures is payable on July 1 of each year. Due to the restriction imposed by our senior lender precluding us from making any payments on indebtedness to any subordinated debt holder, we were unable to pay the interest due on July 1, 2001. Thus, interest due at December 31, 2001 was $35,000. Additionally, we have been notified by the trustee that the non-payment of the interest caused an event of default. As of December 31, 2001, we had outstanding $6,144,000 of subordinated notes, all of which became due during 2001. We did not have the resources to pay, and we did not pay, either the principal or interest on the subordinated notes and are restricted by our senior lender from making such payments. The holder of a subordinated note in the principal amount of $500,000 has commenced an action seeking payment of the principal and interest on his note. However, the court recently denied the holder's motion for a summary judgment on the grounds that the terms of the note did not give him permission to obtain a judgment while we remained in default to the senior debt holder. As a result of our continuing financial difficulties: o we are having and we may continue to have difficulty performing our obligations under our contracts, which could result in the cancellation of contracts or the loss of future business and penalties for non-performance; and o a number of creditors, including one holder of our subordinated notes, as discussed above, have engaged attorneys or collection agencies or commenced legal actions against us, and some of them have obtained judgments against us, including a former landlord who has obtained a $400,000 judgment against us. The creditors include five former senior executives who have deferred compensation agreements with us. The total payments due under these agreements are approximately $1.9 million, of which $46,000 was due at December 31, 2001 and an additional $100,000 has become due in 2002. Other claimants who have already either commenced litigation or otherwise sought collection or who have obtained judgments against us are due approximately $600,000. If we are unable to reach a settlement with these creditors and others who have not yet brought claims, and these claimants obtain judgments against us or, in the case of creditors who have already 21 of 31 obtained judgments, if the creditors seek to enforce the judgment, it may be necessary for us, or our senior lender may require us, to seek protection under the Bankruptcy Code. We are seeking to address our need for liquidity by exploring alternatives, including the possible sale of one or more of our divisions. During 2000 and 2001 we were engaged in discussions with respect to the possible sale of our divisions; however, those negotiations were terminated without an agreement having been reached. Although we are engaged in preliminary discussions with respect to the sale of one of our divisions, we have not signed any agreements with respect to such a sale, and we cannot give any assurance that we will be able to sell any divisions on reasonable terms, if at all. Furthermore, if we sell a division, we anticipate that a substantial portion of the net proceeds will be made to our senior lender and we will not receive any significant amount of working capital from such a sale. During 2001 and early 2002, we have taken steps to reduce overhead and headcount. We will continue to look to reduce costs while we seek additional business from new and existing customers. Our senior lender has precluded us from making any payments on indebtedness to any subordinated creditors. Because of our present stock price, it is highly unlikely that we will be able to raise funds through the sales of our equity securities, and our financial condition prevents us from issuing debt securities. In the event that we are unable to extend our debt obligations and sell one or more of our divisions, we cannot assure you that we will be able to continue in operations. Furthermore, we believe that our losses and our financial position are having and will continue to have an adverse effect upon our ability to develop new business as competitors and potential customers question our ability both to perform our obligations under any agreements we may enter and to continue in business. We have been informally advised by British Telecommunications, which is one of our largest customers that, because of our financial position, it will not place orders with us for OSS products until we can demonstrate that we are financially viable. However, this customer continues to place orders for OSS maintenance and modest orders for line test products. The loss of this customer would have a material adverse effect upon our operations. In addition, our auditors included in their report an explanatory paragraph about our ability to continue as a going concern. Item 7A. Quantitative and Qualitative Disclosure About Market Risk. Although we conduct operations outside of the United States, most of our contracts and sales are dollar denominated. A portion of the revenue from our United Kingdom operations and the majority of our United Kingdom expenses are denominated in Sterling. Any Sterling-denominated receipts are promptly converted into United States dollars. We do not engage in any hedging or other currency transactions. For 2002, the currency translation adjustment was not significant in relation to our total revenue. Item 8. Financial Statements and Supplementary Data. See Exhibit I Item 9. Changes In and Disagreements With Accountants On Accounting and Financial Disclosure. Not Applicable 22 of 31 Part III Item 10. Directors and Executive Officers Set forth below is information concerning our directors:
Name Principal Occupation or Employment Director Since Age ---- ---------------------------------- -------------- --- William V. Carney(1) Chairman of the board and chief executive officer 1970 65 Michael A. Tancredi Senior vice president, secretary and treasurer 1970 72 Warren H. Esanu1(1,2) Of counsel to Esanu Katsky Korins & Siger, LLP, attorneys at law 1997 59 Herbert H. Feldman1(1,2) President, Alpha Risk Management, Inc., independent risk management consultants 1989 68 Marco M. Elser Managing director of Elser & Co., an investment advisory firm 2000 43
- ---------- (1) Member of the executive committee. (2) Member of the audit and compensation committees. Mr. Carney has been chairman of the board and chief executive officer since October 1996. He was vice chairman from 1988 to October 1996, senior vice president from 1989 to October 1996, chief technical officer since 1990 and secretary from 1977 to October 1996. He also served as senior vice president-mechanical engineering from 1988 to 1989, senior vice president-connector products from 1985 to 1988, senior vice president-manufacturing from 1984 to 1985 and senior vice president-operations from 1977 to 1984. Mr. Tancredi has been senior vice president, secretary and treasurer since January 1997. He has been vice president-administration since 1995 and treasurer since 1978, having served as vice president-finance and administration from 1989 to 1995 and vice president-finance from 1984 to 1989. Mr. Esanu has been a director since April 1997 and also served as a director from 1989 to 1996. He was also our chairman of the board from March 1996 to October 1996. He has been of counsel to Esanu Katsky Korins & Siger, LLP, attorneys at law, for more than the past five years. Mr. Esanu is also a founding partner and chairman of Paul Reed Smith Guitars Limited Partnership (Maryland), a leading manufacturer of premium-priced electrical guitars. He is also a senior officer and director of a number of privately held real estate investment and management companies. Mr. Elser has been the managing director of Elser & Co., an investment advisory firm more than the past five years. He has also been associated with Northeast Securities, a US-based broker dealer and is responsible for the Italian office, which he founded in 1994. Mr. Feldman has been president of Alpha Risk Management, Inc., independent risk management consultants, for more than the past five years. 23 of 31 Set forth is information concerning our executive officers: Name of Executive Officer Position Age - ------------------------- -------- --- William V. Carney Chairman of the board and chief executive officer 65 Michael A. Tancredi Senior vice president, secretary and treasurer 72 Edward B. Kornfeld Senior vice president-operations and chief financial officer 58 David L. Rawlings Senior vice president 58 All of our officers serve at the pleasure of the board of directors. Messrs. Carney and Tancredi are also members of the board of directors as stated above. There is no family relationship between any of the executive officers listed below. Mr. Kornfeld, 58, has been senior vice president-operations since 1996 and chief financial officer since October 1995. He was vice president-finance from October 1995 until 1996. For more than five years prior thereto, Mr. Kornfeld held positions with several companies for more than five years, including Excel Technology Inc. (Quantronix Corp.) and Anorad Corporation. Mr. Rawlings, 58, has been vice president since March 1996. Mr. Rawlings was assistant vice president of research and development-copper products from 1992 until March 1996. Item 11. Executive Compensation The following table shows the compensation we paid to our chief executive officer and the four most highly compensated executive officers, other than the chief executive officer, whose salary and bonus earned exceeded $100,000 for the year ended December 31, 2001. 24 of 31 SUMMARY COMPENSATION TABLE
Annual Long-Term Compensation Compensation ------------ ------------ (Awards) Restricted Options, Stock Awards SARs All other Name and Principal Position Year Salary Bonus (Dollars) (Number) Compensation - --------------------------- ---- ------ -------- --------- -------- ------------ William V. Carney, Chairman of the 2001 $240,000 -- -- -- $ 7,981 board and chief executive officer 2000 240,000 -- -- -- 29,556 1999 240,000 -- -- -- 31,996 Edward B. Kornfeld, Senior vice 2001 192,000 -- -- -- 4,872 president - operations and chief 2000 192,000 -- -- -- 4,872 financial officer 1999 192,000 -- -- -- 5,553 David Rawlings, Senior vice president, 2001 146,750 -- -- 5,000 4,343 connector division 2000 142,000 -- -- 10,000 4,287 1999 131,119 -- -- -- 4,953 Prem Chandran, Senior vice president, 2001 135,750 -- -- 5,000 2,666 signal division 2000 131,000 -- -- 10,000 2,562 1999 120,119 -- -- -- 2,808
- ---------- 25 of 31 In 2002, Mr. Chandran resigned as an officer. "All Other Compensation" includes a payment to the executive's account pursuant to our 401(k) Plan, premiums paid with respect to the equity split dollar program (in 2000 and 1999), group life insurance in amounts greater than that available to all employees and special long term disability coverage. Set forth below is a chart that shows, for 2001, the components of "All Other Compensation" listed in the Summary Compensation Table. Mr. Carney Mr. Kornfeld Mr. Rawlings Mr. Chandran ---------- ------------ ------------ ------------ 401(k) Match $ 2,550 $ 2,550 $ 2,021 $ 1,856 Supplemental Insurance 5,431 2,322 2,322 810 Certain of our officers named in the summary compensation table or their affiliates are parties to employment or other agreements providing for compensation during and after their employment. Employment Agreements. We have entered into employment agreements with Messrs. Carney and Kornfeld. The agreements continue on a year-to-year basis, for January 1 of each year, unless terminated on prior notice of not less than 120 days for Mr. Carney and 90 days for Mr. Kornfeld. Salary is determined by the board, except that the salary may not be reduced except as a part of a salary reduction program applicable to all executive officers. Upon death or termination of employment as a result of a disability, the officer or his estate is to receive a payment equal to three months salary. Upon a termination without cause, Mr. Carney is entitled to receive his then current salary for 36 months, and Mr. Kornfeld is entitled to receive his then current salary for six months plus one month for each full year of service up to a maximum aggregate of 24 months. In the event that an executive is covered by an executive severance agreement, including the salary continuation agreements (as described below), which provides for payments upon termination subsequent to a "change of control," the executive would be entitled to the greater of the severance arrangements as described in this paragraph or the severance payments under the executive severance agreements. Salary Continuation Agreements. We are party to salary continuation agreements with Messrs. Carney and Kornfeld. The salary continuation agreements provide that, in the event that a change of control occurs and the executive's employment with us is subsequently terminated by us other than for cause, death or disability, or is terminated by the executive as a result of a substantial alteration in the executive's duties, compensation or other benefits, the executive shall be entitled to the payment of an amount equal to his monthly salary at the rate in effect as of the date of his termination (or, if higher, as in effect immediately prior to the change in control) plus the pro rata monthly amount of his most recent annual bonus paid immediately before the change of control multiplied by 36 in the case of Mr. Carney and 24 in the case of Mr. Kornfeld. For purposes of the salary continuation agreements, a change of control is defined as one which would be required to be reported in response to the proxy rules under the Securities Exchange Act of 1934, as amended, the acquisition of beneficial ownership, directly or indirectly, by a person or group of persons of our securities representing 25% or more of the combined voting power of our then outstanding securities, or, during any period of two consecutive years, if individuals who at the beginning of such period constituted the board cease for any reason to constitute at least a majority thereof unless the election of each new director was nominated or ratified by at least two-thirds of the directors then still in office who were directors at the beginning of the period. The change of control must occur during the term of the salary continuation agreement, which in each case is currently through December 31, 2001 and is renewed automatically unless we give timely notice prior to January 1 of any year of our election not to renew the agreement. If such a change of control occurs during the effectiveness of the salary continuation agreement, any termination of such covered employee during the 18 months following the change of control will result in the payment of the compensation described above. 26 of 31 Item 12. Principal Holders of Securities and Security Holdings of Management The following table and discussion provides information as to the shares of common stock beneficially owned on March 15, 2002 by: o each director; o each officer named in the summary compensation table; o each person owning of record or known by us, based on information provided to us by the persons named below, to own beneficially at least 5% of our common stock; and o all officers and directors as a group. Shares of Common Percentage of Stock Beneficially Outstanding Name Owned Common Stock ---- ----- ------------ William V. Carney 303,021 3.0% Michael A. Tancredi 114,238 1.1% Warren H. Esanu 116,500 1.1% Herbert H. Feldman 71,000 * Marco M. Elser 360,324 3.6% Edward B. Kornfeld 114,317 1.1% David Rawlings 27,820 * Prem Chandran 25,240 * All directors and officers as a group (12 individuals) 1,216,906 12.2% - ---------- * Less than 1% The shares for all officers and directors as a group do not include shares owned by Mr. Chandran, who is no longer an officer. Except as otherwise indicated each person has the sole power to vote and dispose of all shares of common stock listed opposite his name. The number of shares owned by our directors and officers named in the summary compensation table includes shares of common stock which are issuable upon exercise of options and warrants that are exercisable at March 15, 2002 or will become exercisable within 60 days after that date. Set forth below is the number of shares of common stock issuable upon exercise of those options and warrants for each of these directors and officers. Name Shares ---- ------ William V. Carney 180,000 Michael A. Tancredi 75,000 Warren H. Esanu 61,500 Herbert H. Feldman 51,000 Marco M. Elser 5,000 Edward B. Kornfeld 88,000 David Rawlings 27,820 Prem Chandran 25,240 All officers and directors as a group 564,325 27 of 31 The shares of common stock issuable upon exercise of Mr. Esanu's options and warrants include warrants to purchase 12,500 shares of common stock issuable upon warrants held by Elmira Realty Management Corp. pension and profit sharing plan. Mr. Esanu has the sole voting and dispositive power with respect to shares issuable upon exercise of these warrants. All other directors and officers named in the table hold only options. Item 13. Certain Relationships and Related Transactions During 2001, Warren H. Esanu, a director, served as a member of our audit and compensation committees. During 2001, the law firm of Esanu Katsky Korins & Siger, LLP, to which Mr. Esanu is of counsel, provided legal services to us, for which it received fees of $486,220. Esanu Katsky Korins & Siger, LLP is continuing to render legal services to us during 2002. Part IV Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K. (a) Document filed as part of this Annual Report on Form 10-K: (i) Financial Statements. See Index to Consolidated Financial Statements under Item 8 hereof. (ii) Financial Statement Schedules. None Schedules not listed above have been omitted for the reasons that they were inapplicable or not required or the information is given elsewhere in the financial statements. Separate financial statements of the registrant have been omitted since restricted net assets of the consolidated subsidiaries do not exceed 25% of consolidated net assets. (b) Reports on Form 8-K None. 28 of 31 (c) Exhibits Exhibit No. Description of Exhibit - ----------- ---------------------- 3.1 Certificate of Incorporation of the Company, as amended to date, incorporated by reference to Exhibit 4 (a) of the Company's Annual Report on Form 10-K for the year ended December 31, 1991. 3.2 Certificate of Designation of Series B Participating Convertible Preferred Stock, incorporated by reference to Exhibit 3.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995. 3.3 By-laws of the Company, as amended to date, incorporated by reference to Exhibit 3.3 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995. 4.1 Amended and Restated Loan and Security Agreement dated as of November 28, 1994, between the Company and Foothill ("Foothill") Capital Corporation, incorporated by reference to Exhibit 2 to the Company's Current Report on Form 8-K dated November 30, 1994. 4.2 Amendment Number One dated February 13, 1995 to the Amended and Restated Loan and Security Agreement dated as of November 28, 1994 between the Company and Foothill, incorporated by reference to Exhibit 4.7 of the Company's Annual Report on Form 10K for the year ended December 31, 1995. 4.3 Amendment Number Two dated March 30, 1995 to the Amended and Restated Loan and Security Agreement dated as of November 28, 1994 between the Company and Foothill, incorporated by reference to Exhibit 4.7.2 of the Company's Annual Report on Form 10K for the year ended December 31, 1995. 4.4 Amended and Restated Secured Promissory Note dated February 13, 1995, incorporated by reference to Exhibit 4.9 of the Company's Annual Report on Form 10K for the year ended December 31, 1995. 4.5 Amendment Number Three to Amended and Restated Loan and Security Agreement dated March 12, 1996, between the Company and Foothill, incorporated by reference to Exhibit 4.11 of the Company's Annual Report on Form 10K for the year ended December 31, 1995. 4.6 Warrant to Purchase Common Stock of the Company dated November 28, 1994 executed by the Company in favor of Foothill, incorporated by reference to Exhibit 6 to the Company's Current Report on Form 8-K dated November 30, 1994. 4.7 Lockbox Operating Procedural Agreement dated as of November 28, 1994 among Chemical Bank, the Company and Foothill, incorporated by reference to Exhibit 7 to the Company's Current Report on Form 8-K dated November 30, 1994. 29 of 31 Exhibits (continued) Exhibit No. Description of Exhibit 4.8 Combined Amendment No. Four dated as of March 1, 2002 to Amended and Restated Loan and Security agreement between Foothill and the Company. 10.1 Form of Executive Salary Continuation Agreement, incorporated by reference to Exhibit 19 (cc) of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1985. 10.2 Lease dated December 17, 1990 between the Company and LBA properties, Inc., incorporated by reference to Exhibit 10 (d) of the Company's annual report on Form 10-K for the year ended December 31, 1990. 10.3 Employee Stock Bonus Program filed as Exhibit 4.3 to the Form S-8 dated February 12, 1999 and incorporated herein by reference. 10.4 1999 Stock Option Plan filed as Exhibit A to the Proxy Statement for the 1999 Annual Meeting to Stockholders and incorporated herein by reference. 10.5 1996 Stock Option Plan filed as Exhibit A to the Proxy Statement for the 1996 Annual Meeting to Stockholders and incorporated herein by reference. 10.6 1998 Stock Option Plan filed as Exhibit 4.2 to the Form S-8 dated December 3. 1998 and incorporated herein by reference. 10.7 Senior Officers and Directors Stock Purchase Program filed as Exhibit 4.2 to the Form S-8 dated February 12, 1999 and incorporated herein by reference. 10.8 Employee Stock Purchase Plan filed as Exhibit 4.1 to the Form S-8 dated February 12, 1999 and incorporated herein by reference. 22 Subsidiaries of the Company, incorporated by reference to Exhibit 22.1 of the Company's Annual Report on Form 10K for the year ended December 31, 1995. 23 Consent of Independent Auditors. 30 of 31 SIGNATURES Pursuant to the requirements of Section 13 or 15(b) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PORTA SYSTEMS CORP. Dated April 12, 2002 By /s/ William V. Carney ------------------------- William V. Carney Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Each person whose signature appears below hereby authorizes William V. Carney and Edward B. Kornfeld or either of them acting in the absence of the others, as his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all amendments to this report, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission.
Signature Title Date - ------------------------- -------------------------------------------- -------------- /s/ William V. Carney Chairman of the Board, April 12, 2002 ---------------------- Chief Executive Officer and Director William V. Carney (Principal Executive Officer) /s/ Edward B. Kornfeld Senior Vice President and April 12, 2002 ---------------------- Chief Financial Officer Edward B. Kornfeld (Principal Financial and Accounting Officer) ______________________ Director April 12, 2002 Warren H. Esanu /s/ Michael A. Tancredi Director April 12, 2002 ---------------------- Michael A. Tancredi /s/ Herbert H. Feldman Director April 12, 2002 ---------------------- Herbert H. Feldman /s/ Marco Elser Director April 12, 2002 ---------------------- Marco Elser
31 of 31 Exhibit I Item 8. Financial Statements and Supplementary Data Index Page Report of Independent Certified Public Accountants F-2 Consolidated Financial Statements and Notes: Consolidated Balance Sheets, December 31, 2001 and 2000 F-3 Consolidated Statements of Operations and Comprehensive Loss, Years Ended December 31, 2001, 2000 and 1999 F-4 Consolidated Statements of Stockholders' Equity (Deficit), Years Ended December 31, 2001, 2000 and 1999 F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 2001, 2000 and 1999 F-6 Notes to Consolidated Financial Statements F-7 F-1 Report of Independent Certified Public Accountants The Board of Directors and Stockholders of Porta Systems Corp. Syosset, New York We have audited the accompanying consolidated balance sheets of Porta Systems Corp. and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations and comprehensive loss, stockholders' equity (deficit), and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Porta Systems Corp. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered substantial losses from operations in 2001, 2000 and 1999 and, as of December 31, 2001, has a stockholders' deficit of $25,849,000 and a working capital deficit of $31,236,000. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ BDO SEIDMAN, LLP -------------------- BDO SEIDMAN, LLP Melville, New York March 15, 2002 F-2 PORTA SYSTEMS CORP. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 2001 and 2000 (in thousands, except shares and par value)
Assets 2001 2000 ------ ---- ---- Current assets: Cash and cash equivalents $ 1,204 2,366 Accounts receivable - trade, less allowance for doubtful accounts of $2,168 in 2001 and $2,477 in 2000 4,284 7,425 Inventories 5,206 7,150 Prepaid expenses and other current assets 852 1,130 -------- -------- Total current assets 11,546 18,071 Property, plant and equipment, net 2,328 4,555 Goodwill, net of amortization of $1,501 in 2001 and $5,003 in 2000 3,761 10,357 Other assets 198 1,191 -------- -------- Total assets $ 17,833 34,174 ======== ======== Liabilities and Stockholders' Deficit Current liabilities: Senior debt $ 22,095 20,746 Subordinated notes 6,144 6,144 6% Convertible subordinated debentures 382 -- Accounts payable 7,023 7,173 Accrued expenses 3,417 5,385 Accrued interest payable 1,593 766 Accrued commissions 1,607 1,553 Accrued deferred compensation 196 196 Income taxes payable 314 259 Short-term loans 11 1 -------- -------- Total current liabilities 42,782 42,223 -------- -------- 6% Convertible subordinated debentures -- 376 Deferred compensation 900 987 Income taxes payable -- 154 Other long-term liabilities -- 918 Minority interest -- 308 -------- -------- Total long-term liabilities 900 2,743 -------- -------- Total liabilities 43,682 44,966 -------- -------- Commitments and contingencies Stockholders' deficit: Preferred stock, no par value; authorized 1,000,000 shares, none issued -- -- Common stock, par value $.01; authorized 20,000,000 shares, issued 9,947,421 and 9,817,165 shares in 2001 and 2000, respectively 99 98 Additional paid-in capital 76,056 75,980 Accumulated deficit (95,909) (81,135) Accumulated other comprehensive loss: Foreign currency translation adjustment (4,157) (3,797) -------- -------- (23,911) (8,854) Treasury stock, at cost, 30,940 shares (1,938) (1,938) -------- -------- Total stockholders' deficit (25,849) (10,792) -------- -------- Total liabilities and stockholders' deficit $ 17,833 34,174 ======== ========
See accompanying notes to consolidated financial statements. F-3 PORTA SYSTEMS CORP. AND SUBSIDIARIES Consolidated Statements of Operations and Comprehensive Loss Years ended December 31, 2001, 2000 and 1999 (in thousands, except per share amounts)
2001 2000 1999 ---- ---- ---- Sales $ 28,062 51,140 38,936 Cost of sales 19,970 35,890 28,952 -------- -------- -------- Gross profit 8,092 15,250 9,984 -------- -------- -------- Selling, general and administrative expenses 9,316 14,573 13,603 Research and development expenses 4,427 5,830 6,090 Goodwill impairment 5,802 -- -- -------- -------- -------- Total expenses 19,545 20,403 19,693 -------- -------- -------- Operating loss (11,453) (5,153) (9,709) Interest expense (4,480) (4,500) (3,571) Interest income 31 129 188 Gain on sale of assets 684 -- -- Other income (expense), net 191 (813) 218 -------- -------- -------- Loss before income taxes, equity in net loss of joint venture and minority interest (15,027) (10,337) (12,874) Income tax benefit (expense) 203 (227) (873) Equity in net loss of joint venture (175) -- -- Minority interest 225 388 61 -------- -------- -------- Net loss $(14,774) (10,176) (13,686) ======== ======== ======== Other comprehensive income (loss): Foreign currency translation adjustments (360) 99 (142) -------- -------- -------- Comprehensive loss $(15,134) (10,077) (13,828) ======== ======== ======== Basic per share amounts: Net loss per share of common stock $ (1.50) (1.04) (1.44) ======== ======== ======== Weighted average shares of common stock outstanding 9,878 9,763 9,489 ======== ======== ======== Diluted per share amounts: Net loss per share of common stock $ (1.50) (1.04) (1.44) ======== ======== ======== Weighted average shares of common stock outstanding 9,878 9,763 9,489 ======== ======== ========
See accompanying notes to consolidated financial statements. F-4 PORTA SYSTEMS CORP. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity (Deficit) Years ended December 31, 2001, 2000 and 1999 (In thousands)
Receivable Total Common Stock Accumulated for Stock- ----------- Additional Other Employee holders' No. of Par Value Paid-in Comprehensive Accumulated Treasury Stock Equity/ Shares Amount Capital (Loss) Deficit Stock Purchases (Deficit) --------------------------------------------------------------------------------------------- Balance at December 31, 1998 9,485 $95 $75,135 $(3,754) $(57,273) $(1,938) $(281) $ 11,984 Net loss 1999 -- -- -- -- (13,686) -- -- (13,686) Common stock issued 154 1 119 -- -- -- -- 120 Warrants re-priced -- -- 56 -- -- -- -- 56 Collection of receivable from directors and officers under stock purchase program -- -- -- -- -- 281 281 Foreign currency translation adjustment -- -- -- (142) -- -- -- (142) --------------------------------------------------------------------------------------------- Balance at December 31, 1999 9,639 96 75,310 (3,896) (70,959) (1,938) -0- (1,387) Net loss 2000 -- -- -- -- (10,176) -- -- (10,176) Common stock issued 178 2 174 -- -- -- -- 176 Warrants issued or re-priced -- -- 496 -- -- -- -- 496 Foreign currency translation adjustment -- -- -- 99 -- -- -- 99 --------------------------------------------------------------------------------------------- Balance at December 31, 2000 9,817 98 75,980 (3,797) (81,135) (1,938) -0- (10,792) Net loss 2001 -- -- -- -- (14,774) -- -- (14,774) Common stock issued 130 1 37 -- -- -- -- 38 Warrants re-priced -- -- 39 -- -- -- -- 39 Foreign currency translation adjustment -- -- -- (360) -- -- -- (360) --------------------------------------------------------------------------------------------- Balance at December 31, 2001 9,947 $99 $76,056 $(4,157) $(95,909) $(1,938) $-0- $(25,849) ======== === ======= ======= ======== ======= ===== ========
See accompanying notes to consolidated financial statements F-5 PORTA SYSTEMS CORP. AND SUBSIDIARIES Consolidated Statements of Cash Flows (Note 22) Years ended December 31, 2001, 2000 and 1999 (In thousands)
2001 2000 1999 ---- ---- ---- Cash flows from operating activities: Net loss $(14,774) (10,176) (13,686) Adjustments to reconcile net loss to net cash used in operating activities: Non-cash financing expenses 123 373 18 Gain on sale of assets (684) -- -- Non-cash compensation expense -- -- 8 Depreciation and amortization 1,909 1,911 1,677 Goodwill impairment 5,802 -- -- Amortization of debt discounts 6 56 326 Minority interest (225) (388) (61) Equity in loss of joint venture 175 -- -- Changes in operating assets and liabilities: Accounts receivable 3,141 4,712 7,665 Inventories 1,944 1,743 51 Prepaid expenses 278 243 343 Other assets 867 1,427 113 Accounts payable, accrued expenses and other liabilities (2,341) (2,405) 238 -------- -------- -------- Net cash used in operating activities (3,779) (2,504) (3,308) -------- -------- -------- Cash flows from investing activities: Repayment of receivables from stock purchase program -- -- 281 Net proceeds from the sale of assets 1,670 -- -- Capital expenditures, net (196) (1,533) (951) -------- -------- -------- Net cash provided by (used in) investing activities 1,474 (1,533) (670) -------- -------- -------- Cash flows from financing activities: Proceeds from senior debt 2,222 5,010 6,150 Repayments of senior debt (873) (1,782) (1,820) Proceeds from subordinated debentures and warrants -- 80 64 Proceeds from the exercise of options and warrants 38 176 -- Proceeds (repayments) of notes payable/short-term loans 10 (43) (100) -------- -------- -------- Net cash provided by financing activities 1,397 3,441 4,294 -------- -------- -------- Effect of exchange rate changes on cash (254) (283) (115) -------- -------- -------- Increase (decrease) in cash and cash equivalents (1,162) (879) 201 Cash and equivalents - beginning of year 2,366 3,245 3,044 -------- -------- -------- Cash and equivalents - end of year $ 1,204 2,366 3,245 ======== ======== ========
See accompanying notes to consolidated financial statements. F-6 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001 and 2000 (1) Summary of Significant Accounting Policies Nature of Operations and Principles of Consolidation Porta Systems Corp. ("Porta" or the "Company") designs, manufactures and markets systems for the connection, protection, testing and administration of public and private telecommunications lines and networks. The Company has various patents for copper and software based products and systems that support voice, data, image and video transmission. Porta's principal customers are the U.S. regional telephone operating companies and foreign telephone companies. The accompanying consolidated financial statements include the accounts of Porta and its majority-owned or controlled subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. Revenue Recognition Revenue, other than from long-term contracts for specialized products, is recognized when a product is shipped. Revenues and earnings relating to long-term contracts for specialized products are recognized on the percentage-of-completion basis primarily measured by the attainment of milestones. Anticipated losses, if any, are recognized in the period in which they are identified. Concentration of Credit Risk Financial instruments, which potentially subject Porta to concentrations of credit risk, consist principally of cash and accounts receivable. At times such cash in banks exceeds the FDIC insurance limit. As discussed in notes 18 and 23, substantial portions of Porta's sales are to customers in foreign countries. The Company's credit risk with respect to new foreign customers is reduced by obtaining letters of credit for a substantial portion of the contract price, and by monitoring credit exposure related to each customer. Cash Equivalents The Company considers investments with original maturities of three months or less at the time of purchase to be cash equivalents. Cash equivalents consist of commercial paper. Inventories Inventories are stated at the lower of cost (on the average or first-in, first-out methods) or market. Property, Plant and Equipment Property, plant and equipment are carried at cost. Leasehold improvements are amortized over the term of the lease. Depreciation is computed using the straight-line method over the related assets' estimated lives. (Continued) F-7 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Deferred Computer Software Software costs incurred for specific customer contracts are charged to cost of sales at the time revenues on such contracts are recognized. Software development costs relating to products the Company offers for sale are deferred in accordance with Statement of Financial Accounting Standards (SFAS) No. 86 "Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed." These costs are amortized to cost of sales over the periods that the related product will be sold, up to a maximum of four years. Amortization of computer software costs, which all relate to products the Company offers for sale, amounted to approximately $0, $0, and $82,000 in 2001, 2000 and 1999, respectively. Goodwill Goodwill represents the difference between the purchase price and the fair market value of net assets acquired in business combinations treated as purchases. Goodwill is amortized on a straight-line basis over the estimated useful life as determined by events and circumstances of the business combination that gave rise to the goodwill. The Company assesses the recoverability of unamortized goodwill using the undiscounted projected future cash flows from the related businesses (note 6). Income Taxes Deferred income taxes are recognized based on the differences between the tax bases of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years. Further, the effects of tax law or rate changes are included in income as part of deferred tax expense or benefit for the period that includes the enactment date (note 15). Foreign Currency Translation Assets and liabilities of foreign subsidiaries are translated at year-end rates of exchange, and revenues and expenses are translated at the average rates of exchange for the year. Gains and losses resulting from translation are accumulated in a separate component of stockholders' equity. Gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than the functional currency) are included in comprehensive income or loss. Net Loss Per Share Basic net loss per share is based on the weighted average number of shares outstanding. Diluted net loss per share is based on the weighted average number of shares outstanding plus the dilutive effect of potential shares of common stock, as if such shares had been issued. For 2001, 2000 and 1999, no dilutive potential shares of common stock were added to compute diluted loss per share because the effect was anti-dilutive. (Continued) F-8 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Reclassifications Certain reclassifications have been made to conform prior years' consolidated financial statements to the 2001 presentation. Accounting for Stock-Based Compensation The Company follows the Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation". Porta has elected not to implement the fair value based accounting method for employee stock options, but has elected to disclose the pro-forma net income and earnings per share as if such method had been used to account for stock-based compensation cost as described in the Statement. Accounting for the Impairment of Long-Lived Assets The Company follows the Statement of Financial Accounting Standard No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of". Porta believes that there is no impairment of its long-lived assets except for goodwill as discussed in note 6. Use of Estimates The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Among the more significant estimates included in these consolidated financial statements are the estimated allowance for doubtful accounts receivable, inventory reserves, percentage of completion for long-term contracts, goodwill valuation and the deferred tax asset valuation allowance. Actual results could differ from those and other estimates. New Accounting Pronouncements In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets" effective for fiscal years beginning after December 15, 2001. It also issued SFAS No. 143, "Accounting for Obligations Associated with the Retirement of Long-Lived Assets" in August 2001 and SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" in October 2001. SFAS141 requires the use of the purchase method of accounting and prohibits the use of the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001. SFAS 141 also requires that the Company recognize acquired intangible assets apart from goodwill if the acquired intangible assets meet certain criteria. SFAS 141 applies to all business combinations initiated after June 30, 2001 and for purchase business combinations completed on or after July 1, 2001. It also requires, upon adoption of SFAS 142, that the Company reclassify the carrying amounts of intangible assets and goodwill based on the criteria in SFAS 141. (Continued) F-9 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued SFAS142 requires, among other things, that companies no longer amortize goodwill, but instead, test goodwill for impairment at least annually. In addition, SFAS 142 requires that the Company identify reporting units for the purposes of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets, and cease amortization of intangible assets with an indefinite useful life. An intangible asset with an indefinite useful life should be tested for impairment in accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in fiscal years beginning after December 15, 2001 to all goodwill and other intangible assets recognized at that date, regardless of when those assets were initially recognized. SFAS 142 requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is also required to reassess the useful lives of other intangible assets within the first interim quarter after adoption of SFAS 142. The Company's previous business combinations were accounted for using the purchase method. As of December 31, 2001, the net carrying amount of goodwill is $3,761,000. Currently, the Company is assessing, but has not yet determined, how the adoption of SFAS 141 and SFAS 142 will impact its financial position and results of operations. SFAS143 establishes standards for the reporting of obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It also provides accounting guidance for legal obligations associated with the retirement of tangible long-lived assets. SFAS 143 is effective for fiscal years beginning after June 15, 2002 with early adoption permitted. The Company expects that the provisions of SFAS 143 will not have a material effect on its consolidated results of operations. SFAS144 establishes a single accounting model for the impairment or disposal of long-lived assets and new standards for reporting discontinued operations. The provisions of SFAS 144 are effective in fiscal years beginning after December 15, 2001 and in general are to be applied prospectively. The Company is currently evaluating the provisions of SFAS 144 but does not expect they will have a material effect on its consolidated results of operations upon adoption. (2) Liquidity As of December 31, 2001, Porta's debt included $22,095,000 of senior debt, which matured on January 7, 2002, and $6,144,000 of subordinated debt, which matured on July 3, 2001. The Company was unable to pay the principal ($6,144,000) or interest ($1,358,000) on the subordinated notes. The amount of interest represents interest from July 2000 through December 2001. At December 31, 2001, the Company did not have sufficient resources to pay either the senior lender or the subordinated lenders and it is likely that it cannot generate such cash from its operations, and the senior lender had precluded the Company from making payments on the subordinated debt. (Continued) F-10 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued On March 1, 2002, the Company and its senior lender agreed to an amended and restated loan and security agreement whereby a new term loan was established with a maximum principal amount of $1,500,000. The agreement allows the Company to draw monies subject to the senior lender's receipt and approval of a weekly disbursement budget. However, the advances are at the discretion of the senior lender. Obligations under the new term loan bear interest at 12% per annum. The amended agreement establishes all indebtedness prior to March 1, 2002 as an old term loan in the amount of $22,610,000, which includes the balance due at December 31, 2001 plus accrued interest through March 1, 2002. The old term loan shall bear no interest until such time as the senior lender in its sole discretion notifies the Company that interest shall be payable. Both the new and old term loans are payable on December 31, 2002. As part of this agreement, the senior lender continues to preclude the Company from making any payments on indebtedness to any subordinated creditors, but the Company is not prohibited from paying accounts payable in the normal course of business. The agreement also requires the Company to diligently pursue the sale of one or more of its divisions and pay the net proceeds from such sale to the senior lender, which may not leave the Company with sufficient capital for its operations. The $1,500,000 being advanced by the Company's senior lender is being advanced at the discretion of the senior lender and such advances are dependent on, among other things, the perception of the senior lender that the Company is either stemming its losses or effecting a sale of one or more of its divisions. If the senior lender ceases funding Porta's operations, unless it has obtained alternative financing, the Company will be unable to continue in business. Furthermore, unless the Company obtains funding from another source, including the sale of one of more of its divisions, Porta will not be able to pay its senior lender on December 31, 2002, and Porta may not be able to continue in business. As of December 31, 2001, the Company had remaining outstanding $382,000 of 6% Debentures, net of original issue discount of $3,000, which mature July 2, 2002. The face amount of the outstanding 6% Debentures was $385,000. The interest accrued on the 6% Debentures is payable on July 1 of each year. Due to the restriction imposed by the Company's senior lender precluding it from making any payments on indebtedness to any subordinated debt holder, the Company was unable to pay the interest due on July 1, 2001. Thus, interest due at December 31, 2001 was $35,000. Additionally, the trustee has notified the Company that the non-payment of the interest caused an event of default. As of December 31, 2001, the Company had outstanding $6,144,000 of subordinated notes, all of which became due during 2001. The Company did not have the resources to pay, and it did not pay, either the principal or interest on the subordinated notes and is restricted by its senior lender from making such payments. The holder of a subordinated note in the principal amount of $500,000 has commenced an action seeking payment of the principal and interest on his note. However, the court recently denied the holder's motion for a summary judgment on the grounds that the terms of the note did not give him permission to obtain a judgment while the Company remained in default to the senior debt holder. (Continued) F-11 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued As a result of its continuing financial difficulties: o the Company is having and may continue to have difficulty performing its obligations under its contracts, which could result in the cancellation of contracts or the loss of future business and penalties for non-performance; and o a number of creditors, including one holder of Porta's subordinated notes, as discussed above, have engaged attorneys or collection agencies or commenced legal actions against the Company, and some of them have obtained judgments against the Company, including a former landlord who has obtained a $400,000 judgment against the Company. The creditors include five former senior executives who have deferred compensation agreements with the Company. The total payments due under these agreements are approximately $1.9 million, of which $46,000 was due at December 31, 2001 and an additional $100,000 has become due in 2002. Other claimants who have already either commenced litigation or otherwise sought collection or have obtained a judgment against the Company are due approximately $600,000. If Porta is unable to reach a settlement with these creditors and others who have not yet brought claims, and these claimants obtain judgments against the Company or seek to enforce judgments against the Company, it may be necessary for it, or its senior lender may require it, to seek protection under the Bankruptcy Code. The Company is seeking to address its need for liquidity by exploring alternatives, including the possible sale of one or more of its divisions. During 2000 and 2001, the Company was engaged in discussions with respect to the possible sale of its divisions; however, those negotiations were terminated without an agreement having been reached. Although the Company is engaged in preliminary discussions with respect to a sale of one of its divisions, the Company has not signed any agreements with respect to such a sale, and it may not be able to sell any of its divisions on reasonable terms. Furthermore, if the Company sells a division, the agreement with the Company's senior lender requires it to pay the net proceeds to the senior lender. As a result of this provision and the Company's obligations to the holders of subordinated debt, unless the lenders consent to the Company retaining a portion of the net proceeds from any sale for its operations, the Company will not receive any significant amount, and may not receive any of the net proceeds from any such sale for working capital. During 2001 and early 2002, the Company has taken steps to reduce overhead and headcount. The Company will continue to look to reduce costs while it seeks additional business from new and existing customers. Because of its present stock price, it is highly unlikely that the Company will be able to raise funds through the sales of its equity securities, and Porta's financial condition prevents it from issuing debt securities. In the event that the Company is unable to extend its debt obligations and sell one or more of its divisions, it cannot be assured that the Company will be able to continue in operations. Furthermore, the Company believes that its losses and its financial position are having and will continue to have an adverse effect upon its ability to develop new business as competitors and potential customers question its ability both to perform its obligations under any agreements it may enter and to continue in business. The Company has been informally advised by British Telecommunications, which is one of its largest customers that, because of Porta's financial position, this customer will not place orders with the Company for its OSS products until it can demonstrate that it is financially viable. However, this customer continues to place orders for OSS maintenance and modest orders for line test products. The loss of this customer would have a material adverse effect upon the Company's operations. F-12 These financial statements have been prepared assuming that the Company will continue as a going concern and, accordingly, do not include any adjustments that might result from the outcome of the uncertainties described above. PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (3) Accounts Receivable Accounts receivable included approximately $500,000 and $0 at December 31, 2001 and 2000, respectively, of revenues earned but not yet contractually billable relating to long-term contracts for specialized products. All such amounts at December 31, 2001 are expected to be billed in 2002. In addition, accounts receivable included approximately $311,000 and $1,197,000 at December 31, 2001 and 2000, respectively, of retainage balances due on various long-term contracts. All such amounts, net of reserves, at December 31, 2001 are expected to be collected in 2002 and all such amounts, net of reserves, at December 31, 2000, were collected in 2001. The allowance for doubtful accounts receivable was $2,168,000 and $2,477,000 as of December 31, 2001 and 2000, respectively. The allowance for doubtful accounts was increased by provisions of $0, $730,000, and $1,070,000 and decreased by write-offs of $309,000, $132,000, and $106,000 for the years ended December 31, 2001, 2000, and 1999, respectively. (4) Inventories Inventories consist of the following: December 31, 2001 2000 ---- ---- Parts and components $3,217,000 4,973,000 Work-in-process 192,000 543,000 Finished goods 1,797,000 1,634,000 ---------- ---------- $5,206,000 7,150,000 ========== ========== (5) Property, Plant and Equipment Property, plant and equipment consists of the following: December 31 ----------------- Estimated 2001 2000 useful lives ---- ---- ------------ Land $ 132,000 246,000 -- Buildings 1,060,000 2,284,000 30 years Machinery and equipment 7,221,000 8,870,000 3-10 years Furniture and fixtures 2,557,000 2,700,000 8 years Transportation equipment 84,000 133,000 4 years Tools and molds 4,108,000 4,124,000 8 years Leasehold improvements 822,000 858,000 Term of lease ---------- ---------- 15,984,000 19,215,000 Less accumulated depreciation and amortization 13,656,000 14,660,000 ---------- ---------- $2,328,000 4,555,000 ========== ========== During 2001, the Company sold its Glen Cove, New York facility for $1,850,000 and recognized a gain on the sale of $684,000, net of expenses of $180,000. Of the net proceeds of $1,670,000, $474,000 was used to reduce outstanding principal and $350,000 to reduce outstanding interest obligations to the Company's senior lender. The Company retained the remaining proceeds of $846,000 for working capital purposes. (Continued) F-13 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (6) Goodwill As of December 31, 2001 and 2000, unamortized goodwill was $3,761,000 and $10,357,000, respectively. In December 2001, the Company determined that $5,802,000 of goodwill associated with its OSS business unit was impaired and as such recorded an impairment loss. This assessment was based on the continued decline in sales and losses generated by the business unit over the past several years and the declining prospects for additional sales of the products based on the older technology that originally gave rise to the goodwill. Additionally, there are presently no ongoing negotiations regarding the sale of the OSS division. During 2000 and 1999, in view of recent competitive developments in the telecommunications market place and Porta's changing business model in response, management reassessed the useful life of certain of its goodwill. At that time, in management's opinion, there was no impairment in the carrying value of this long-lived intangible asset (based upon an analysis of undiscounted future cash flows), and management determined that the useful life of the goodwill should be shortened to be more reflective of the current rate of technology change and competitive conditions. Accordingly, management changed the estimated useful life of certain goodwill from an original life of 40 years to a remaining life of 13 years in 1999 and 10 years in 2000, which changes were applied prospectively from the fourth quarters of 1999 and 2000. These changes in accounting estimate increased amortization expense in 2000 and in 1999 by approximately $25,000 and $58,000, respectively. Goodwill associated with one of Porta's other business units of $3,761,000 is amortized on a straight-line basis over a remaining life of 29 years. The Company has determined that there is no impairment of this asset. (7) Senior Debt On December 31, 2001 and 2000, Porta's senior debt consisted of debt under its credit facility in the amount of $22,095,000 and $20,596,000, respectively, and a non-interest bearing deferred funding fee note payable to the senior lender in the amounts of $0 and $150,000, respectively. As of December 31, 2001, the total outstanding principal balance was due on January 7, 2002, and has been classified as a current liability. (See Note 2) (Continued) F-14 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued During 2000, the Company and its senior lender agreed to extend the loan and security agreement to July 3, 2001. As part of the agreement, Porta agreed to reduce the exercise price of outstanding warrants to purchase 471,000 shares of common stock held by its senior lender to $2.00 per share. The value of the reduction of the warrant price was $169,000 which was recorded as deferred financing expense and additional paid in capital in 2000. In addition, during 2000, the Company and its senior lender agreed to increase the revolving line maximum by $2,000,000 from $9,000,000 to $11,000,000 through January 1, 2001. As of December 31, 2000, the Company had borrowed $1,160,000 under the increased revolving line. As consideration, the Company issued to its senior lender a five-year warrant to purchase 100,000 shares of common stock at $2.00 per share. The value of the warrants issued was $129,000 which was recorded as deferred financing expense and additional paid in capital in 2000. The balance of the facility is comprised of a term loan. The credit facility is secured by substantially all of Porta's assets. All obligations, except undrawn letters of credit, letter of credit guarantees and the deferred fee notes, bear interest at 12%. The Company incurs a fee of 2% per annum on the average balance of letter of credit guarantees outstanding. In connection with the senior lender's waiver of non-compliance during 2000, the Company reduced from $2.00 per share to $1.00 per share, the exercise price of warrants to purchase 571,000 shares of common stock which are held by the lender. The value of the reduction in exercise price was $59,000 and recorded as deferred financing expense and additional paid in capital. Based upon the warrant transactions during 2000, additional non-cash interest expense of $289,000 was recognized. The agreement also provided for loan principal payments of $400,000 on the last day of each quarter during the term of the agreement. As part of the agreement, the loan amortization shall first be applied to the non-interest bearing notes payable until these notes are paid in full and then to the term loan. The agreement also requires the Company to pay additional principal payments if its cash flow exceeds certain amounts. A monthly facility fee payment of $50,000 continuing to the end of the agreement is also required. On January 2, 2001, Porta did not have the resources to repay the $1,160,000 of principal due. In March 2001, the senior lender agreed to allow the Company to defer the repayment of borrowings related to the increased maximum, defer all monthly facility fees and the April 1, 2001 principal payment to the earlier of the termination of the agreement of July 3, 2001 or the sale of one or more of the divisions of the Company. The agreement also precluded the Company from making any payments on indebtedness to any subordinated creditors, although it permits payment of accounts payable in the ordinary course of business. In April 2001, the Company and its senior lender agreed to add all current and future interest due, which will be computed at 14%, to the principal balance through the loan expiration date. As consideration, the Company agreed to reduce the exercise price of the outstanding warrants to purchase approximately 570,000 shares of common stock held by its senior lender to $0.25 per share. The value of the reduction in exercise price was $39,000, which was recorded as interest expense and additional paid in capital. On the July 3, 2001, the loan expiration date, the Company did not have the resources to repay the loan, at which time the senior lender and the Company executed an extension agreement for approximately a one month period, which extensions continued monthly though February 2002. (Continued) F-15 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Subsequent to December 31, 2001, the senior lender agreed to an amended and restated loan and security agreement whereby a new term loan was established with a maximum principal amount of $1,500,000. The agreement allows the Company to draw monies subject to the senior lender's receipt and approval of a weekly disbursement budget. Any advances under this agreement are subject to the discretion of the senior lender. Obligations under the new term loan bear interest at 12%, which interest shall accrue monthly and be applied to the principal until September 1, 2002 when interest for the month of August 2002 shall be paid and interest shall continue to be paid each subsequent month. The agreement provides that all indebtedness prior to March 1, 2002 is reflected as an old term loan in the amount of $22,610,000, which includes the principal balance due at December 31, 2001 plus accrued interest though March 1, 2002. The old term loan bears no interest until such time as the senior lender in its sole discretion notifies the Company that interest shall be payable. Both the new and old term loans are due on December 31, 2002. Additionally, the senior lender has prohibited the Company from making any payments on indebtedness to any subordinated creditors, but the Company is not prohibited from paying accounts payable in the ordinary course of business. Finally, the agreement allows for standby letters of credit not to exceed a maximum of $573,000. (8) 6% Convertible Subordinated Debentures As of December 31, 2001 and 2000 Porta had outstanding $382,000 and $376,000 of its 6% convertible subordinated debentures due July 1, 2002 (the "Debentures"), net of original issue discount of $3,000 and $9,000, respectively. The face amount of the outstanding Debentures was $385,000 at both December 31, 2001 and 2000. The Debentures are convertible at any time prior to maturity into Common Stock of the Company at a conversion rate of 8.333 shares for each $1,000 face amount of Debentures, subject to adjustment under certain circumstances. The Company has not paid interest on these Debentures since July 2000, and its senior lender prohibits it from making any payments of principal and interest (note 7). At December 31, 2001 and 2000, accrued interest on the debentures was $35,000 and $12,000, respectively. Subsequent to December 31, 2001, the trustee of the Debentures gave notice to the Company that it was in default under the indenture and the Debentures. (9) Subordinated Notes As of December 31, 2001 and 2000, $6,144,000 of Subordinated Notes were outstanding. As of December 31, 2001, $6,144,000 of principal and $1,358,000 of accrued interest were due and payable. However, Porta did not have the resources to pay the $6,144,000 principal and $1,358,000 of interest due on the subordinated debt. In addition, the senior lender had precluded the Company from making payments on the subordinated debt (note 7). During 2001, one of the noteholders unsuccessfully attempted to obtain a judgment compelling the Company to pay the past due Notes and related interest (note 21). (Continued) F-16 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued During December 1999, Porta (a) extended its maturity date of the $6,000,000 outstanding principal amount of Subordinated Notes to January 3, 2001 with the right to extend the maturity date to July 3, 2001 if Porta achieves certain financial results, (b) increased the interest rate of the Subordinated Notes to 14% per annum during the initial term and to 15% during the extended term, (c) reduced the exercise price of the previously issued Series B and C Warrants to $1.00 per share, (d) granted the holders of the Subordinated Notes the right to a payment in kind option, whereby the note holder has the right to receive interest in the form of a new subordinated note in the principal amount equal to 125% of the interest then due, with the new subordinated note bearing interest at the rate of 125% of the then current interest rate of the Subordinated Notes, and (e) agreed that, if Porta extends the maturity date of the Subordinated Notes to July 3, 2001, it will issue to the noteholders New Warrants to purchase a total of 300,000 shares of Common Stock at the average closing price of the Common Stock for five trading days preceding January 3, 2001. As a result of the amendment to the Subordinated Notes, Porta recorded a discount of approximately $56,000 relating to the re-pricing of the warrants and additional interest expense for Noteholders who elected the paid in kind option at December 31, 1999 of approximately $13,000. In connection with a further amendment of the Subordinated Notes in April 2000, the Company agreed to issue to the noteholders New Warrants to purchase an aggregate of 127,500 shares of Common Stock at $3.00 per share, the value of which was determined to be $140,000 and recorded as deferred financing expenses and additional paid in capital in 2000. Additional non-cash interest expense of $84,000 was recorded during 2000 in connection with this transaction. (10) Joint Venture The Company has a 50% interest in a joint venture agreement with a Korean partner. Unless otherwise terminated in accordance with the joint venture agreement, the joint venture will terminate on December 31, 2010. The Company's option to acquire an additional 1% interest of the joint venture, for approximately $190,000 expired during 2001. Prior to October 1, 2001, the Company consolidated the operations of the joint venture since the Company could obtain a controlling interest at its election and the joint venture was entirely dependent on the Company for the products it sells and receives management assistance from the Company. The joint venture partner's interest is shown as a minority interest through September 30, 2001. Based on the expiration of the option agreement, the reduced volume of products sold to the joint venture and reduced level of management assistance provided to the joint venture, Porta's share of the losses on its investment have been recorded on the equity method effective October 1, 2001. As such losses are in excess of Porta's investment, and Porta does not guaranty such excess losses, the investment in the joint venture is carried at $0 as of December 31, 2001. (11) Stockholders' Equity Porta had outstanding warrants to its senior lender to purchase 571,152 shares of common stock, which are immediately exercisable at $0.25 per share and for which 471,152 expire on November 30, 2002 and 100,000 expire on June 6, 2005. Porta had outstanding to an investment banker warrants to purchase 400,000 shares of common stock at $1.56 per share which expire April 2002. (Continued) F-17 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued See Note 9 in connection with the issuance of the Series B and C Warrants as part of the private placement of the subordinated Notes and the amendment of the terms of the Subordinated Notes and Series B and C Warrants. As of December 31, 2001, Porta had stock purchase warrants outstanding to purchase 15,000 shares of common stock at an exercise price of $1.8125 per share until May 2005 of which warrants to purchase 10,000 shares of common stock are immediately exercisable. Under a 1984 Employee Incentive Plan, Porta provided an opportunity for certain employees of the Company and its subsidiaries to acquire subordinated convertible debentures. As a result, as of December 31, 1998, there was $13,000 of employee promissory notes receivable outstanding, of which the maturity date has been extended to April 1999. During 1998, the Board of Directors approved a reduction in the original issue price of the debentures to the then current market rate of the common stock, approximately $1.38 per share, which common stock was held by Porta as collateral for the notes. Accordingly, the related receivable from employees was reduced from $307,000 to $13,000 to reflect the new valuation. The reduction on the original issue resulted in a non-cash compensation charge in 1998 of $298,000. During 1999, all of the receivables from employees were paid. (12) Stockholder Rights Plan Porta has a Stockholder Rights Plan in which preferred stock purchase rights were distributed to stockholders as a dividend at the rate of one right for each common share. This plan has expired. (13) Employee Benefit Plans Porta has deferred compensation agreements with certain present and former officers and employees, with benefits commencing at retirement equal to 50% of the employee's base salary, as defined. Payments under the agreements will be made for a period of fifteen years following the earlier of attainment of age 65 or death. During 2001, 2000 and 1999, Porta accrued approximately $166,000, $180,000 and $180,000, respectively, under these agreements. In 1986, Porta established the Porta Systems Corp. 401(k) Savings Plan for the benefit of eligible employees, as defined in the Savings Plan. Participants contribute a specified percentage of their base salary up to a maximum of 15%. Porta will match a participant's contribution by an amount equal to 25% of the first 6% contributed by the participant. A participant is 100% vested in the balance to his credit. For the years ended December 31, 2001, 2000 and 1999, Porta's contribution amounted to $54,000, $72,000 and $93,000, respectively. In 1999, Porta established the Employee Stock Purchase Plan for the benefit of eligible employees, as defined in the Purchase Plan, which permits employees to purchase Porta's common stock at discounts up to 10%. Porta has reserved 1,000,000 shares of Porta stock for issuance under the plan. During 2001 and 2000, 130,256 and 84,804 shares, respectively, were issued pursuant to the Purchase Plan. Subsequent to December 31, 2001, Porta issued approximately 29,500 shares of stock to the participants of the Purchase Plan. Porta does not provide any other post-retirement benefits to any of its employees. (Continued) F-18 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (14) Incentive Plans During 1999, Porta established an Employee Stock Bonus Plan whereby stock may be given to non-officers or directors to recognize the contributions of employees. A maximum of 100,000 shares of common stock is reserved for issuance pursuant to the Bonus Plan. During 1999 Porta issued 4,250 shares of common stock pursuant to the Bonus Plan and recorded a charge of approximately $8,000. No shares of common stock were issued pursuant to the Bonus Plan during 2001 and 2000. Porta's 1986 Stock Incentive Plan ("1986 Plan"), expired in March 1996, although options granted prior to the expiration date remain in effect in accordance with their terms. Options granted under the 1986 Plan may be incentive stock options, as defined in the Internal Revenue Code, or options that are not incentive stock options. The exercise prices for all options granted were equal to the fair market value at the date of grant. Porta's 1996 Stock Incentive Plan ("1996 Plan") covers 450,000 shares of common stock. Incentive stock options cannot be issued subsequent to ten years from the date the 1996 Plan was approved. Options under the 1996 Plan may be granted to key employees, including officers and directors of the Company and its subsidiaries, except that members and alternate members of the stock option committee are not eligible for options under the 1996 Plan. The exercise prices for all options granted were equal to the fair market value at the date of grant and vest as determined by the board of directors. In addition, the 1996 Plan provides for the automatic grant to non-management directors of non-qualified options to purchase 2,000 shares on May 1st of each year commencing May 1, 1996, based upon the average closing price of the last ten trading days of April of each year. Porta's 1998 Non-Qualified Stock Option Plan ("1998 Plan") covers 450,000 shares of common stock. Options under the 1998 Plan may be granted to key employees, including officers and directors of the Company and its subsidiaries. The exercise prices for all options granted were equal to the fair market value at the date of grant and vest as determined by the board of directors. Porta's 1999 Incentive and Non-Qualified Stock Option Plan ("1999 Plan") covers 400,000 shares of common stock. Incentive stock options cannot be issued subsequent to ten years from the date the 1999 Plan was approved. Options under the 1999 Plan may be granted to key employees, including officers and directors of the Company and its subsidiaries, except that members and alternate members of the stock option committee are not eligible for options under the 1999 Plan. The exercise prices for all options granted were equal to the fair market value at the date of grant and vest as determined by the board of directors. In addition, the 1999 Plan provides for the automatic grant to non-management directors of non-qualified options to purchase 5,000 shares on May 1st of each year commencing May 1, 1999, based upon the average closing price of the last ten trading days of April of each year; provided, however, that the non-management directors will not be granted non-qualified options pursuant to the 1999 Plan for any year to the extent options are granted under the 1996 Plan for such year. (Continued) F-19 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued During 1999, pursuant to an employment contract with an officer, Porta issued options to purchase 15,000 shares of common stock at $1.75 per share. The exercise prices approximated market value on the date of issuance. The options expire in May 2005. As of December 31, 2001, 10,000 of the options are vested. Porta applies APB Opinion 25, "Accounting for Stock Issued to Employees" ("APB 25") and related Interpretations in accounting for the 1999, 1998, 1996 and 1986 Plans. Under APB 25, no compensation cost is recognized for options granted to employees at exercise prices greater than or equal to fair market value of the underlying common stock at the date of grant. Porta has adopted the disclosure only provisions of Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation" ("SFAS No.123") which requires the Company to provide, beginning with 1995 grants, pro forma information regarding net income (loss) and net income (loss) per common share (basic and diluted) as if compensation costs for Porta's stock option plans had been determined in accordance with the fair value method prescribed in SFAS No.123. If Porta had elected to recognize compensation costs based on fair value of the options granted at grant date as prescribed by SFAS No. 123, net loss and net loss per share (basic and diluted) would have been increased to the pro forma amounts indicated below: (Dollars in thousands, except per share data) 2001 2000 1999 ---- ---- ---- Pro forma net loss $(14,787) $(10,393) $(14,280) Pro forma net loss per share (basic and diluted) $ (1.50) $ (1.06) $ (1.50) The weighted-average fair values of options granted were $0.23, $ 1.62 and $1.36 per share in 2001, 2000 and 1999, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions for 2001, 2000 and 1999: 2001 2000 1999 ---- ---- ---- Dividends: $0.00 per share $0.00 per share $0.00 per share Volatility: 100% 57.64%-68.70% 45.80%-80.00% Risk-free interest: 4.22%-5.48% 5.54%-6.53% 4.50%-6.40% Expected term: 5 - 9.6 years 5 years 5 years (Continued) F-20 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued A summary of the status of Porta's stock option plans as of December 31, 2001, 2000, and 1999, and changes during the years ending on those dates is presented below:
2001 2000 1999 ------------------------- ----------------------- --------------------------- Shares Weighted Shares Weighted Shares Weighted Under Average Under Average Under Average Option Exercise Price Option Exercise Price Option Exercise Price ------ -------------- ------ -------------- ------ -------------- Outstanding beginning of year 949,713 $2.55 870,538 $2.51 907,965 $3.42 Granted 55,000 0.29 108,500 3.12 27,700 1.74 Exercised -- (6,000) 1.50 -- Forfeited (203,008) 2.58 (23,325) 2.80 (65,127) 15.04 ------- ------- ------- Outstanding end of year 801,705 $3.96 949,713 $2.55 870,538 $2.51 ======= ======= ======= Options exercisable at year-end 698,105 807,780 799,238 ======= ======= =======
The following table summarizes information about stock options outstanding under the stock option plans at December 31, 2001:
Options Outstanding Options Exercisable -------------------------------------------------- ---------------------------------- Range of Outstanding Remaining Weighted-average Exercisable Weighted-Average Exercise Prices at 12/31/01 Contractual Life Exercise Price at 12/31/01 Exercise Price --------------- ----------- ---------------- -------------- ----------- -------------- <$1.00 55,000 6.7 years $0.29 31,000 $0.31 $1.00 - 1.99 280,780 5.5 years $1.51 280,613 $1.51 $2.00 - 2.99 51,175 3.8 years $2.25 50,375 $2.26 $3.00 - 3.99 411,750 2.6 years $3.24 333,117 $3.26 $4.00 - 5.00 3,000 0.8 years $5.00 3,000 $5.00
(15) Income Taxes The provision (benefit) for income taxes consists of the following:
2001 2000 1999 -------------------- -------------------- --------------------- Current Deferred Current Deferred Current Deferred ------- -------- ------- -------- ------- -------- Federal $ -- -- -- -- -- 716,000 State and foreign (203,000) -- 227,000 -- 62,000 95,000 --------- -- --------- -- --------- --------- Total $(203,000) -- 227,000 -- 62,000 811,000 ========= == ========= == ========= =========
The domestic and foreign components of loss before provision for income taxes were as follows: 2001 2000 1999 ---- ---- ---- United States $(11,578,000) (7,519,000) (7,516,000) Foreign (3,399,000) (2,430,000) (5,297,000) ------------ ---------- ----------- Loss before provision for income taxes $(14,977,000) (9,949,000) (12,813,000) ============ ========== =========== (Continued) F-21 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued A reconciliation of Porta's income tax provision and the amount computed by applying the statutory U.S. federal income tax rate of 34% to loss from continuing operations before income taxes is as follows:
2001 2000 1999 ---- ---- ---- Tax expense (benefit) at statutory rate $(5,092,000) (3,383,000) (4,356,000) Increase (decrease) in income tax benefit resulting from: Increase (decrease) in valuation allowance 3,057,000 2,776,000 5,486,000 State and foreign taxes, less applicable federal benefits (211,000) (127,000) (368,000) Non-deductible goodwill impairment 1,973,000 -- -- Other expenses not deductible for tax 333,000 345,000 152,000 Foreign income taxed at rates Different from U.S. statutory rate (19,000) 25,000 (5,000) Estimated NOL adjustments, including Section 382 limitation -- 594,000 -- Reversal of prior year's accrual (262,000) Other 18,000 (3,000) (36,000) ----------- ----------- ----------- $ (203,000) 227,000 873,000 =========== =========== ===========
Porta has unused United States tax net operating loss (NOL) carryforwards of approximately $89,000,000 expiring at various dates between 2009 and 2021. Due to the change in ownership which resulted from the conversion of Porta's Zero coupon subordinated convertible notes to common stock, Porta's usage of its NOL will be limited in accordance with Internal Revenue Code section 382. Porta's carryforward utilization of the NOL is limited to $1,767,000 per year. The carryforward amounts are subject to review by the Internal Revenue Service (IRS). In addition, Porta has foreign NOL carryforwards of approximately $5,700,000 with indefinite expiration dates. Porta's United States net operating loss carryforwards (after limitations as described above) expire in the following years: 2009 $ 4,106,000 2010 18,880,000 2011 884,000 2018 37,000 2019 7,546,000 2020 8,441,000 2021 3,961,000 ----------- $43,855,000 =========== The components of the deferred tax assets, the net balance of which zero after the valuation allowance, as of December 31, 2001 and 2000 are as follows: 2001 2000 ---- ---- Deferred tax assets: Inventory $ 1,370,000 1,211,000 Allowance for doubtful accounts receivable 835,000 828,000 Benefits of tax loss carryforwards 18,734,000 16,622,000 Benefit plans 633,000 845,000 Accrued commissions 619,000 581,000 Other 917,000 390,000 Depreciation 818,000 392,000 ------------ ------------ 23,926,000 20,869,000 Valuation allowance (23,926,000) (20,869,000) ------------ ------------ $ -- -- ============ ============ (Continued) F-22 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Deferred taxes result from temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements. The temporary differences result from costs required to be capitalized for tax purposes by the US Internal Revenue Code, and certain items accrued for financial reporting purposes in the year incurred but not deductible for tax purposes until paid. Because of Porta's losses in 2001 and 2000, a valuation allowance for the entire deferred tax asset was provided due to the uncertainty as to future realization. The income tax returns of Porta and its subsidiary operating in Puerto Rico were examined by the IRS for the tax year ended December 31, 1989. As a result of this examination, the IRS increased the Puerto Rico subsidiary's taxable income resulting from intercompany transactions, with a corresponding increase in Porta's net operating losses. The settlement amounted to approximately $953,000. Porta is currently in a structured settlement with the IRS, which is reviewed annually, whereby monthly payments will be made to liquidate the settlement. The aggregate annual amounts payable by Porta, including interest on the unpaid amounts at a current rate of 7%, is $240,000 in 2001. As of December 31, 2001, Porta has not made all the required payments through that date under the settlement and has been in correspondence with the IRS to obtain an offer in compromise. As of December 31, 2001, $274,000 remains outstanding. No provision was made for U.S. income taxes on the undistributed earnings of Porta's foreign subsidiaries as it is management's intention to utilize those earnings in the foreign operations for an indefinite period of time or repatriate such earnings only when tax effective to do so. At December 31, 2001, undistributed earnings of the foreign subsidiaries amounted to approximately $1,186,000. It is not practicable to determine the amount of income or withholding tax that would be payable upon the remittance of those earnings. (16) Leases At December 31, 2001, Porta and its subsidiaries leased manufacturing and administrative facilities, equipment and automobiles under a number of operating leases. Porta is required to pay increases in real estate taxes on the facilities in addition to minimum rents. Total rent expense for 2001, 2000, and 1999 amounted to approximately $793,000, $1,357,000 and $874,000, respectively. All rental expense related to the Company's North Carolina facility, which has been vacated, were accrued in 2000. The landlord of the North Carolina facility has obtained a $400,000 judgment against the Company. Minimum rental commitments, exclusive of future escalation charges, for each of the next five years are as follows: 2002 $1,005,000 2003 774,000 2004 720,000 2005 555,000 2006 222,000 Thereafter 2,914,000 ---------- $6,190,000 ========== (Continued) F-23 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (17) Contingencies At December 31, 2001, Porta was contingently liable for outstanding letters of credit aggregating approximately $573,000 as security for the performance of certain long-term contracts. Porta is a party to legal actions arising out of the ordinary conduct of its business. Management believes that the settlement of these matters will not have a materially adverse effect on the financial position of the Company (note 21). As a result of the Company's continuing financial difficulties, a number of creditors have engaged attorneys or collection agencies or commenced legal actions against the Company, and some of them have obtained judgments against the Company, including a former landlord of the North Carolina facility, which has obtained a $400,000 judgment against the Company (note 15). The creditors include five former senior executives who have deferred compensation agreements with the Company. The total payments due under these agreements are approximately $1.9 million, of which $46,000 was due at December 31, 2001 and an additional $100,000 has become due in 2002. Other claimants who have already either commenced litigation or otherwise sought collection or have obtained a judgment against the Company are due approximately $600,000. (18) Major Customers During the years ended December 31, 2001, 2000 and 1999, Porta's five largest customers accounted for sales of $13,444,000, or approximately 48% of sales, $28,323,000, or approximately 55% of sales, and $19,700,000, or approximately 51% of sales, respectively. Porta's largest customer in 2001 with sales of $3,485,000, or approximately 12% of sales, was Philippines Long Distance Telephone (PLDT). However, Porta's sales to British Telecommunications plc ("BT") directly of $3,339,000, approximately 12% of sales, and through Fujitsu Telecommunications Europe LTD ("FTEL") as purchasing agent to BT of $3,200,000, approximately 11% of sales in 2001, combined for sales of $6,539,000, approximately 23% of sales, in 2001. Porta's largest customer in 2000 with sales of $12,051,000, or approximately 24% of sales, was Fujitsu Telecommunications Europe LTD ("FTEL"). A significant amount of sales of the Company's products for use by British Telecommunications plc ("BT") were sold to FTEL as purchasing agent to BT. Porta's largest customer in 1999 was BT. Direct sales to BT for the year ended December 31, 2001, 2000 and 1999 amounted to $3,339,000, $5,098,000 and $7,825,000, respectively, or approximately 12%, 10% and 20%, respectively, of Porta's sales for such years. Direct sales to FTEL for the year ended December 31, 2001 and 2000 amounted to $3,200,000, and $12,051,000, respectively, or approximately 11% and 24%, respectively, of Porta's sales for such years. Therefore, any significant interruption or decline in sales to FTEL or BT may have a materially adverse effect upon Porta's operations. During 2000, sales to a Mexican telephone company were $5,507,000, or approximately 11% of sales. No other customers account for 10% or more of Porta's sales for any year. Approximately 19% and 26%, respectively, of Porta's accounts receivable are due from the five largest customers as of December 31, 2001 and 2000, respectively. (Continued) F-24 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (19) Fair Values of Financial Instruments Cash equivalents, accounts receivable, accounts and notes payable, and short-term loans are reflected in the consolidated financial statements at fair value because of the short term maturity of these instruments. The fair value of Porta's long-term debt cannot be reasonably estimated due to the lack of marketability of such instruments. (20) Net Loss Per Share The following table sets forth the computation of basic and diluted net loss per share:
2001 2000 1999 ---- ---- ---- Numerator-Basic and diluted Net loss per share: Net loss $(14,774,000) $(10,176,000) $(13,686,000) ============ ============ ============ Denominator: Denominator for basic and diluted net loss per share -weighted-average shares 9,878,000 9,763,000 9,489,000 ============ ============ ============ Basic per share amounts: Net loss per share of common stock $ (1.50) $ (1.04) $ (1.44) ============ ============ ============ Diluted per share amounts: Net loss per share of common stock $ (1.50) $ (1.04) $ (1.44) ============ ============ ============
Options to purchase 806,705, 649,733 and 638,508 shares of common stock for 2001, 2000 and 1999, respectively, with exercise prices ranging from $0.22 to $5.00, $1.69 to $5.00 and $1.69 to $5.00 for 2001, 2000 and 1999, respectively, were outstanding but not included in the computation of diluted net loss per share because the exercise prices were greater than the average market price of common stock during such years. Warrants to purchase 1,776,152, 195,500 and 913,000 shares of common stock for 2001, 2000 and 1999, respectively, with exercise prices ranging from $0.25 to $1.81, $1.81 to $17.50 and $1.56 to $17.50 for 2001, 2000 and 1999, respectively, were outstanding but not included in the computation of diluted net loss per share because the exercise prices were greater than the average market price of common stock during such years. (Continued) F-25 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (21) Legal Matters In July 2001, the holder of a subordinated note in the principal amount of $500,000 commenced an action against the Company in the United States District Court for the Southern District of New York seeking payment of the principal and accrued interest on their subordinated notes which were payable in July 2001. The payment of the note is subordinated to payment of the Company's senior debt and the Company believes that the subordination provision of the note prohibits payment by the Company. The plaintiffs' motion for a summary judgment was recently denied by the court on the grounds that the terms of the note did not give them permission to obtain a judgment while Porta remained in default to the senior debt holder. The Company's obligations under the subordinated notes are reflected as current liabilities on the Company's balance sheet. In March 2000, the Company suspended (with pay) Messrs. Ronald Wilkins and Michael Bahlo, two of its executive officers, from their positions pending completion of the Company's investigation of certain matters that had come to its attention. Prior to the completion of this investigation, however, these two executives accepted positions with another company and thereby voluntarily resigned from their positions with the Company. In February 2001, these two executives, together with a third former executive officer, Mr. Michael Lamb, who similarly resigned from his position with the Company, filed suit in the Supreme Court for the State of New York, County of New York. The complaint asserts various claims against the Company based on the allegation that each of these three executives was improperly terminated from his employment without cause, and seeks compensatory damages, liquidating damages and attorney's fees. The Company has filed an answer and counterclaim against the plaintiffs. The Company believes that it has valid defenses to the claims and intends to defend this action vigorously and to assert counterclaims against these former executives. In July 1996, an action was commenced against Porta and certain present and former directors in the Supreme Court of the State of New York, New York County by certain stockholders and warrant holders of Porta who acquired their securities in connection with the acquisition by Porta of Aster Corporation. The complaint alleges breach of contract against Porta and breach of fiduciary duty against the directors arising out of an alleged failure to register certain restricted shares and warrants owned by the plaintiffs. The complaint seeks damages of $413,000; however, counsel for the plaintiff have advised Porta that additional plaintiffs may be added and, as a result, the amount of damages claimed may be substantially greater than the amount presently claimed. Porta believes that the defendants have valid defenses to the claims. Discovery is proceeding, although there has been no significant activity in this matter subsequent to December 31, 1999. See Note 16, in connection with a judgment by a former landlord, and Note 17, in connection with claims against the Company by creditors. (Continued) F-26 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (22) Cash Flow Information (1) Supplemental cash flow information for the years ended December 31, is as follows: 2001 2000 1999 ---- ---- ---- Cash paid for interest $ 933 3,763 3,117 ===== ===== ===== Cash paid for income taxes $ 131 183 379 ===== ===== ===== (2) Non-cash transactions: (i) In 1999, in connection with advisory services provided by an investment banking firm, the Company issued 150,000 shares of common stock valued at approximately $113,000 (notes 7 and 10). (ii) In 1999, Porta incurred a non-cash charge of $56,000 as a result of the reduction in the exercise price of the Series B and Series C Warrants (note 9). (iii) In 2000, Porta incurred a non-cash charge of $140,000 as a result of the issuance New Warrants (note 9). (iv) In 2000, Porta incurred a non-cash charge of $169,000 as a result of the reduction in the exercise price of the Warrants issued to its senior lender (note 7). (v) In 2000, Porta incurred a non-cash charge of $129,000 as a result of Warrants issued to its senior lender in connection with an increase in its revolving line of credit to its senior lender (note 7). (vi) In 2000, Porta incurred a non-cash charge of $59,000 as a result of the reduction in the exercise price of the Warrants issued to its senior lender in connection with a waiver of default (note 7). (vii) In 2001, Porta incurred a non-cash charge of $39,000 as a result of the reduction in the exercise price of the Warrants issued to its senior lender in connection with an agreement to add all current and future interest due to the principal balance through the loan expiration date (note 7). (Continued) F-27 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (23) Segment and Geographic Data Porta has three reportable segments: Line Connection and Protection Equipment ("Line") whose products interconnect copper telephone lines to switching equipment and provides fuse elements that protect telephone equipment and personnel from electrical surges; Operating Support Systems ("OSS") whose products automate the testing, provisioning, maintenance and administration of communication networks and the management of support personnel and equipment; and Signal Processing ("Signal") whose products are used in data communication devices that employ high frequency transformer technology. The factors used to determine the above segments focused primarily on the types of products and services provided, and the type of customer served. Each of these segments is managed separately from the others, and management evaluates segment performance based on operating income. 2001 2000 1999 ---- ---- ---- Revenue: Line $ 12,756,000 20,546,000 18,189,000 OSS 8,874,000 22,296,000 14,254,000 Signal 5,737,000 7,644,000 6,328,000 ------------ ---------- ----------- $ 27,367,000 50,486,000 38,771,000 ============ ========== =========== Segment profit: Line $ 1,275,000 3,665,000 3,582,000 OSS (10,518,000) (6,201,000) (10,650,000) Signal 1,449,000 2,088,000 1,884,000 ------------ ---------- ----------- $ (7,794,000) (448,000) (5,184,000) ============ ========== =========== Depreciation and amortization: Line $ 374,000 424,000 505,000 OSS 1,262,000 1,262,000 881,000 Signal 166,000 162,000 199,000 ------------ ---------- ----------- $ 1,802,000 1,848,000 1,585,000 ============ ========== =========== Total identifiable assets: Line $ 5,990,000 8,508,000 7,921,000 OSS 4,268,000 14,942,000 21,637,000 Signal 5,557,000 6,591,000 7,965,000 ------------ ---------- ----------- $ 15,815,000 30,041,000 37,523,000 ============ ========== =========== Capital expenditures: Line $ 132,000 340,000 415,000 OSS 55,000 1,132,000 670,000 Signal 0 45,000 27,000 ------------ ---------- ----------- $ 187,000 1,517,000 1,112,000 ============ ========== =========== (Continued) F-28 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The following table reconciles segment totals to consolidated totals:
2001 2000 1999 ---- ---- ---- Revenue: Total revenue for reportable segments $ 27,367,000 50,486,000 38,771,000 Other revenue 695,000 654,000 165,000 ------------ ------------ ------------ Consolidated total revenue $ 28,062,000 51,140,000 38,936,000 ============ ============ ============ Operating loss: Total segment loss for reportable segments $ (7,794,000) (448,000) (5,184,000) Corporate and unallocated (3,659,000) (4,705,000) (4,525,000) ------------ ------------ ------------ Consolidated total operating loss $(11,453,000) (5,153,000) (9,709,000) ============ ============ ============ Depreciation and amortization: Total for reportable segments $ 1,802,000 1,848,000 1,585,000 Corporate and unallocated 107,000 63,000 92,000 ------------ ------------ ------------ Consolidated total deprecation and amortization $ 1,909,000 1,911,000 1,677,000 ============ ============ ============ Total assets: Total for reportable segments $ 15,815,000 30,041,000 37,523,000 Corporate and unallocated 2,018,000 4,133,000 5,925,000 ------------ ------------ ------------ Consolidated total assets $ 17,833,000 34,174,000 43,448,000 ============ ============ ============ Capital expenditures: Total for reportable segments $ 187,000 1,517,000 1,112,000 Corporate and unallocated 9,000 16,000 79,000 ------------ ------------ ------------ Consolidated total capital expenditures $ 196,000 1,533,000 1,191,000 ============ ============ ============
The following table presents information about the Company by geographic area: 2001 2000 1999 ---- ---- ---- Revenue: United States $12,999,000 17,225,000 14,368,000 United Kingdom 8,060,000 20,244,000 15,673,000 Asia/Pacific 4,552,000 5,429,000 4,159,000 Other Europe 1,761,000 2,482,000 3,130,000 Latin America 288,000 146,000 1,257,000 Other North America 357,000 5,570,000 296,000 Other 45,000 44,000 53,000 ----------- ----------- ----------- Consolidated total revenue $28,062,000 51,140,000 38,936,000 =========== =========== =========== Consolidated long-lived assets: United States $ 5,301,000 12,115,000 12,011,000 United Kingdom 583,000 1,107,000 2,398,000 Other North America 523,000 568,000 618,000 Asia/Pacific 0 612,000 200,000 Latin America 8,000 14,000 35,000 Other 2,000 3,000 8,000 ----------- ----------- ----------- 6,417,000 14,419,000 15,270,000 Current and other assets 11,416,000 19,755,000 28,178,000 ----------- ----------- ----------- Consolidated total assets $17,833,000 34,174,000 43,448,000 =========== =========== =========== (Continued) F-29 PORTA SYSTEMS CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (24) Quarterly Information (Unaudited) The following presents certain unaudited quarterly financial data:
Quarter Ended -------------------------------------------------------------------- March 31, 2001 June 30, 2001 September 30, 2001 December 31, 2001 -------------- ------------- ------------------ ----------------- Net sales $ 7,042,000 $ 8,915,000 $ 6,039,000 $ 6,066,000 Gross profit 1,414,000 2,925,000 1,503,000 2,250,000 Net income (loss) (3,233,000) (2,511,000) (1,898,000) (7,132,000) Net income (loss) per share: Basic $(0.33) $(0.25) $(0.19) $(0.73) Diluted $(0.33) $(0.25) $(0.19) $(0.73)
Quarter Ended -------------------------------------------------------------------- March 31, 2000 June 30, 2000 September 30, 2000 December 31, 2000 -------------- ------------- ------------------ ----------------- Net sales $15,928,000 $13,828,000 $11,195,000 $10,189,000 Gross profit 5,716,000 3,570,000 2,852,000 3,112,000 Net income (loss) 306,000 (2,887,000) (3,156,000) (4,439,000) Net income (loss) per share: Basic $0.03 $(0.30) $(0.32) $(0.45) Diluted $0.03 $(0.30) $(0.32) $(0.45)
Quarter Ended -------------------------------------------------------------------- March 31, 1999 June 30, 1999 September 30, 1999 December 31, 1999 -------------- ------------- ------------------ ----------------- Net sales $ 9,526,000 $ 9,109,000 $ 8,397,000 $11,904,000 Gross profit 2,811,000 2,639,000 1,878,000 2,656,000 Net loss (1,744,000) (2,940,000) (3,999,000) (5,003,000) Net loss per share: Basic $(0.18) $(0.31) $(0.42) $(0.53) Diluted $(0.18) $(0.31) $(0.42) $(0.53)
Net loss for the quarter ended December 31, 2001 reflects an impairment loss on goodwill of $5,802,000 associated with OSS operations (note 6). Net loss for the quarter ended December 31, 2000 reflects an accrual associated with the reduction of overhead and headcount, and consolidation of OSS operations of approximately $900,000. F-30 EX-4 3 e13297_ex48.txt LOAN AND SECURITY AGREEMENT EXHIBIT 4.8 COMBINED AMENDMENT NUMBER FOUR TO AMENDED AND RESTATED LOAN AND SECURITY AGREEMENT This Combined Amendment Number Four to Amended and Restated Loan and Security Agreement ("Amendment") is entered into as of March 1, 2002 by and between FOOTHILL CAPITAL CORPORATION, a California corporation ("Foothill"), and PORTA SYSTEMS CORP., a Delaware corporation ("Borrower"), in light of the following: A. Borrower and Foothill have previously entered into that certain Amended and Restated Loan and Security Agreement, dated as of November 28, 1994, as amended by amendments number 1 through 15 (collectively, the "Agreement"). B. Borrower and Foothill desire to further amend the Agreement and combine and restate amendments 4 through 15 to the Agreement, as provided for and on the conditions herein. NOW, THEREFORE, Borrower and Foothill hereby amend the Agreement as follows: 1. DEFINITIONS. All initially capitalized terms used in this Amendment shall have the meanings given to them in the Agreement unless specifically defined herein. 2. AMENDMENTS. The Agreement is amended as follows (a) Section 1.1 of the Agreement is amended as follows: (1) The following definitions are hereby deleted, and any references to such definitions in the Agreement should no longer be effective. "Deferred Fee Notes", "Deferred Funding Fee", "Deferred Funding Fee Note", Eligible Accounts", "Eligible Inventory", "Facility Fee", "NWE Advance", "NWE Deferred Funding Fee", "NWE Deferred Funding Fee Note", "NWE Line", "NWE Line Maximum Amount" and "Renewal Date". (2) The following definitions are hereby added: "New Term Loan" means that certain term loan in the principal amount of up to $1,500,000 which is evidenced by that certain Secured Promissory Note, of even date herewith (the "New Term Note") a copy of which is attached hereto as Exhibit A. "Old Term Loan" means that certain term loan in the principal amount of $22,609,930.30 (the Outstanding Obligations as of the close of business on February 28, 2002 (other than L/Cs and L/C Guarantees)) which is evidenced by that certain Second Amended and Restated Secured Promissory Note of even date herewith (the "Old Term Note") which is attached hereto as Exhibit B. (b) Foothill and Borrower agree that as of the close of business on February 28, 2002, the outstanding Obligations, including accrued interest, were $22,609,930.30, in the aggregate, as follows: (i) Revolving Advances - $12,464,600.08 (ii) Term Loan - $10,145,330.22 (iii) L/C and/or L/C Guarantees - $572,538" (c) Sections 2.1, 2.2(a), (b) and (c), 2.4 and 2.8 of the Agreement are hereby deleted. (d) The first sentence of Section 2.2(b)(i) of the Agreement is amended to read as follows: "(i) Subject to the terms and conditions of this Agreement, Foothill agrees to issue commercial or standby letters of credit for the account of Borrower (each, an "L/C") or to issue standby letters of credit or guarantees of payment (each such letter of credit or guarantee, an "L/C Guaranty") with respect to commercial or standby letters of credit issued by another person for the account of Borrower in an aggregate face amount not to exceed $572,538." (e) Section 2.3 of the Agreement is amended to read as follows: "2.3 Term Loans. (a) Foothill has agreed to make the New Term Loan to Borrower to be evidenced by and repayable in accordance with the terms and conditions of the New Term Note, executed by Borrower in favor of Foothill. All amounts evidenced by the New Term Note shall constitute Obligations. Borrower may draw monies under the New Term Loan weekly, subject to receipt and approval of Borrower's weekly disbursements budget. Such budgets shall be submitted to Foothill on Friday before Noon for funding on the following Monday. (b) Borrower has executed and delivered to Foothill the Old Term Note evidencing the outstanding Obligations (other than the L/Cs and L/C Guarantees) as of the close of business on February 28, 2002. All amounts evidenced by the Old Term Note shall constitute Obligations." 2 (f) Section 2.5 of the Agreement is amended by adding the following: "(g) The Obligations under the New Term Note shall bear interest at the rate of 12% per annum, which interest shall accrue monthly and shall be added to principal until September 1, 2002 when interest for the month of August 2002 shall be paid and interest shall continue to be paid on the first day of each subsequent month. (h) The Obligations under the Old Term Loan shall not bear interest from March 1, 2002 until such time as Foothill, in its sole discretion, notifies Borrower in writing that it shall thereafter accrue interest which shall be payable in accordance with Section 2.5(a) through (f)." (g) Section 2.9 of the Agreement is amended to read as follows: 2.9 Sales of Assets or Divisions. Borrower agrees to diligently pursue the sale of one or more of its three business units to non-Affiliates of Borrower in arms length transactions. The initial proceeds of any such sale, after expenses of such sale, shall be paid to Foothill to pay accrued interest on the New Term Note and the outstanding principal balance of the New Term Note. (h) Section 3.4 of the Agreement is amended to read as follows: "3.4 Term. This Agreement shall become effective upon the execution and delivery hereof by Borrower and Foothill and shall continue in full force and effect for a term ending on December 31, 2002, and the maturity date of the Old Term Note and New Term Note shall also be December 31, 2002. The foregoing notwithstanding, Foothill shall have the right to terminate its obligations under this Agreement immediately and without notice upon the occurrence and during the continuation of an Event of Default. (i) Section 9.3 of the Agreement is hereby deleted. (j) During the period from March 1, 2002 through December 31, 2002, Borrower shall not make any payments on Indebtedness to the holders of Borrower's: (i) 6% Convertible Subordinated Debentures or (ii) 12% Subordinated Notes, but Borrower shall not be prohibited from paying accounts payable in the ordinary course of business (k) This Amendment combines, amends and restates Amendments numbers 4 through 15 of the Agreement. 3. EXHIBITS. Exhibits "A", "B" and "C" hereto are added to the Agreement as Exhibits "A", "B" and "C" thereto. 4. REPRESENTATIONS AND WARRANTIES. Borrower hereby affirms to Foothill that (a) all of Borrower's representations and warranties set forth in the Agreement (except for those set forth in Sections 5.10 and 5.11) are true, complete and accurate in all respects as of the date hereof and (b) Exhibit "C" hereto updates Section 5.9 of the Agreement. 3 5. CONDITIONS PRECEDENT AND SUBSEQUENT. (a) The effectiveness of this Amendment is expressly conditioned upon the following: (i) Receipt by Foothill of an executed copy of this Amendment, the New Term Note and the Old Term Note. (b) Prior to the close of business on March 5, 2002, Borrower shall deliver to Foothill its updated projections for the year ending December 31, 2002 ("Fiscal 2002"). Upon Foothill's reasonable approval of the projections, Foothill and Borrower shall, on or before March 11, 2002, amend Section 6.13 of the Agreement to establish financial covenants for Fiscal 2002 based upon such projections. 6. COSTS AND EXPENSES. Borrower shall pay to Foothill all of Foothill's out-of-pocket costs and expenses (including, without limitation, the fees and expenses of its counsel, which counsel may include any local counsel deemed necessary, search fees, filing and recording fees, documentation fees, appraisal fees, travel expenses, and other fees) arising in connection with the preparation, execution, and delivery of this Amendment and all related documents. 7. LIMITED EFFECT. In the event of a conflict between the terms and provisions of this Amendment and the terms and provisions of the Agreement, the terms and provisions of this Amendment shall govern. In all other respects, the Agreement, as amended and supplemented hereby, shall remain in full force and effect. 8. COUNTERPARTS; EFFECTIVENESS. This Amendment may be executed in any number of counterparts and by different parties on separate counterparts, each of which when so executed and delivered shall be deemed to be an original. All such counterparts, taken together, shall constitute one and the same Amendment. This Amendment shall become effective upon the execution of a counterpart of this Amendment by each of the parties hereto. 4 IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first set forth above. FOOTHILL CAPITAL CORPORATION, a California corporation By: Ed Stearns ----------------------------------------- Title: Sr V.P. -------------------------------------- PORTA SYSTEMS CORP., a Delaware corporation By: /s/ William V. Carney ----------------------------------------- Title: CEO -------------------------------------- 5 SECURED PROMISSORY NOTE $1,500,000 Los Angeles, Ca1ifornia March 1, 2002 FOR VALUE RECEIVED, the undersigned ("Maker") hereby promises to pay to FOOTHILL CAPITAL CORPORATION ("Foothill"), or order, at 2450 Colorado Avenue, Suite 3000W, Santa Monica, California 90404, or at such other address as the holder may specify in writing, the principal sum of One Million Five Hundred Thousand Dollars ($l,500,000) or such lesser sum as is advanced by Holder to Maker as the New Term Loan under that certain Amended and Restated Loan And Security Agreement between the Maker and Foothill, dated as of November 28, 1994 (as amended, the "Agreement") plus interest in the manner and upon the terms and conditions set forth below: 1. Rate of Interest This Secured Promissory Note ("Note") shall bear interest at such times and at such rates as set forth in the Agreement 2. Schedule of Payments. Principal and interest under this Note shall be due and payable on December 31, 2002, or sooner as provided in the Agreement. 3. Prepayment This Note may be prepaid at any time in whole or in part, without any premium or penalty whatsoever. Maker is required to prepay this Note under certain circumstances set forth in the Agreement. 4. Holder's Right of Acceleration. Upon the occurrence of an Event of Default under the Agreement including, but not limited to, the failure to pay any installment of principal or interest hereunder when due, the Holder may, at its election and without notice to the Maker, declare the entire balance hereof immediately due and payable. 5. Additional Rights of Holder. If any installment of principal or interest hereunder is not paid when due, the Holder shall have the right to compound interest by adding the unpaid interest to principal, with such amount thereafter bearing interest at the rate provided in this Note in addition to the tights set forth herein, in the Agreement, and under law. Exhibit A 1 6. General Provisions. (a) If this Note is not paid when due, the Maker further promises to pay all costs of collection, foreclosure fees, and reasonable attorneys' fees incurred by the Holder, whether or not suit is filed hereon. (b) The Maker hereby consents to any and all renewals, replacements, and/or extensions of time for payment of this Note before, at or after maturity. (c) The Maker hereby consents to the acceptance, release, or substitution of security for this Note. (d) Presentment for payment, notice of dishonor, protest, and notice of protest are hereby expressly waived (e) Any waiver of any rights under this Note, the Agreement, or under any other agreement, instrument, or paper signed by the Maker is neither valid nor effective unless made in writing and signed by the Holder. (f) No delay or omission on the part of the Holder in exercising any right shall operate as a waiver thereof or of any other right. (g) A waiver by the Holder upon any one occasion shall not be construed as a bar or waiver of any right or remedy on any future occasion. (h) Should any one or more of the provisions of this Note be determined illegal or unenforceable all other provisions shall nevertheless remain effective. (i) This Note cannot be changed, modified, amended, or terminated orally. 7. Security for the Note This Note is secured by the Agreement, and by various other security documents. This Note is subject to all of the terms and conditions thereof including, but not limited to, the remedies specified therein. 8. Choice of Law and Venue. THE VALIDITY OF THIS NOTE, ITS CONSTRUCTION, INTERPRETATION, AND ENFORCEMENT, AND THE RIGHTS OF THE MAKER AND THE HOLDER, SHALL BE DETERMINED UNDER, GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS OF THE STATE OF CALIFORNIA, WITHOUT REGARD TO PRINCIPLES OF CONFLICT OF LAW. TO THE MAXIMUM EXTENT PERMITTED BY LAW, THE MAKER HEREBY AGREES THAT ALL ACTIONS OR PROCEEDINGS ARISING IN CONNECTION WITH THIS NOTE SHALL BE TRIED AND DETERMINED ONLY IN THE STATE AND FEDERAL COURTS LOCATED IN THE COUNTY OF LOS ANGELES, STATE OF CALIFORNIA, OR AT THE SOLE OPTION OF Exhibit A 2 THE HOLDER, IN THE STATE OF NEW YORK OR ANY OTHER COURT IN WHICH THE HOLDER SHALL INITIATE LEGAL OR EQUITABLE PROCEEDINGS AND WHICH HAS SUBJECT MATTER JURISDICTION OVER THE MATTER IN CONTROVERSY. TO THE MAXIMUM EXTENT PERMITTED BY LAW, MAKER HEREBY EXPRESSLY WAIVES ANY RIGHT IT MAY HAVE TO ASSERT THE DOCTRINE OF FORUM NON CONVENIENS OR TO OBJECT TO VENUE TO THE EXTENT ANY PROCEEDING IS BROUGHT IN ACCORDANCE WITH THIS SECTION. 9. Waiver of Jury Trial THE MAKER, TO THE EXTENT IT MAY LEGALLY DO SO, HEREBY EXPRESSLY WAIVES ANY RIGHT TO TRIAL BY JURY OF ANY CLAIM, DEMAND, ACTION, CAUSE OF ACTION, OR PROCEEDING ARISING UNDER OR WITH RESPECT TO THIS NOTE, OR IN ANY WAY CONNECTED WITH, RELATED TO, OR INCIDENTAL TO THE DEALINGS OF THE HOLDER AND THE MAKER WITH RESPECT TO THIS NOTE, OR THE TRANSACTIONS RELATED HERETO, IN EACH CASE WHETHER NOW EXISTING OR HEREAFTER ARISING, AND IRRESPECTIVE OF WHETHER SOUNDING IN CONTRACT, TORT, OR OTHERWISE. THE MAKER, TO THE EXTENT IT MAY LEGALLY DO SO, HEREBY AGREES THAT ANY SUCH CLAIM, DEMAND, ACTION, CAUSE OF ACTION, OR PROCEEDING SHALL BE DECIDED BY A COURT TRIAL WITHOUT A JURY AND THAT THE HOLDER MAY FILE AN ORIGINAL COUNTERPART OF THIS SECTION 9 WITH ANY COURT AS WRITTEN EVIDENCE OF THE CONSENT OF MAKER TO THE WAIVER OF ITS RIGHT TO TRIAL BY JURY. IN WITNESS WHEREOF, this Note has been executed and delivered on the date first set forth above. PORTA SYSTEMS CORP., a Delaware corporation By: /s/ William V. Carney ----------------------------------------- Exhibit A 3 SECOND AMENDED AND RESTATED SECURED PROMISSORY NOTE $22,609,930.30 Los Angeles, California March 1,2002 FOR VALUE RECEIVED, the undersigned ("Maker") hereby promises to pay to FOOTHILL CAPITAL CORPORATION ("Foothill"), or order, at 2450 Colorado Avenue, Suite 3000W, Santa Monica, California 90404, or at such other address as the holder may specify in writing, the principal sum of Twenty Two Million Six Hundred Nine Thousand Nine Hundred Thirty Dollars and Thirty Cents ($22,609,930.30) plus interest in the manner and upon the terms and conditions set forth below. 1. Rate of Interest This Second Amended and Restated Secured Promissory Note ("Note") shall bear interest at such times and at such rates as set forth in that certain Amended and Restated Loan And Security Agreement between the Maker and Foothill, dated as of November 28, 1994 (as amended, the "Agreement"). 2. Schedule of Payments Principal and interest under this Note shall be due and payable on December 31, 2002, or sooner as provided in the Agreement. 3. Prepayment. This Note may be prepaid at any time, in whole or in part, without any premium or penalty whatsoever. Maker is required to prepay this Note under certain circumstances set forth in the Agreement. 4. Holder's Right of Acceleration. Upon the occurrence of an Event of Default under the Agreement including, but not limited to, the failure to pay any installment of principal or interest hereunder when due, the Holder may, at its election and without notice to the Maker, declare the entire balance hereof immediately due and payable. 5. Additional Rights of Holder. If any installment of principal or interest hereunder is not paid when due, the Holder shall have the right to compound interest by adding the unpaid interest to principal, with such amount thereafter bearing Interest at the rate provided in this Note in addition to the rights set forth herein, in the Agreement and under law. Exhibit B 1 6. General Provisions. (a) If this Note is not paid when due, the Maker further promises to pay all costs of collection, foreclosure fees and reasonable attorneys' fees incurred by the Holder, whether or not suit is filed hereon. (b) The Maker hereby consents to any and all renewals, replacements, and/or extensions of time for payment of this Note before, at, or after maturity. (c) The Maker hereby consents to the acceptance, release, or substitution of security for this Note. (d) Presentment for payment, notice of dishonor, protest and notice of protest are hereby expressly waived. (e) Any waiver of any rights under this Note, the Agreement, or under any other agreement, instrument, or paper signed by the Maker is neither valid nor effective unless made in writing and signed by the Holder. (f) No delay or omission on the part of the Holder in exercising any right shall operate as a waiver thereof or of any other right. (g) A waiver by the Holder on any one occasion shall not be construed as a bar or waiver of any right or remedy on any future occasion. (h) Should any one or more of the provisions of this Note be determined illegal or unenforceable all other provisions shall nevertheless remain effective. (i) This Note cannot be changed, modified, amended, or terminated orally. 7. Security for the Note. This Note is secured by the Agreement, and by various other security documents. This Note is subject to all of the terms and conditions thereof including, but not limited to, the remedies specified herein. 8. Amendment and Restatement. This Note amends, restates and replaces that certain Amended and Restated Secured Promissory Note in the original principal amount of Thirteen Million Five Hundred Two Thousand One Hundred Eighty Seven Dollars and Fifty Cents ($13,502,187.50) dated February 13, 1995, which note shall be returned, marked "paid by renewal" to the Maker. 9. Choice of Law and Venue. THE VALIDITY OF THIS NOTE, ITS CONSTRUCTION, INTERPRETATION, AND ENFORCEMENT, AND THE RIGHTS OF THE MAKER AND Exhibit B 2 THE HOLDER, SHALL BE DETERMINED UNDER, GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS OF THE STATE OF CALIFORNIA WITHOUT REGARD TO PRINCIPLES OF CONFLICTS OF LAW. TO THE MAXIMUM EXTENT PERMITTED BY LAW, THE MAKER HEREBY AGREES THAT ALL ACTIONS OR PROCEEDINGS ARISING IN CONNECTION WITH THIS NOTE SHALL BE TRIED AND DETERMINED ONLY IN THE STATE AND COURTS LOCATED IN THE COUNTY OF LOS ANGELES, STATE OF CALIFORNIA, AT THE SOLE OPTION OF THE HOLDER, IN THE STATE OF NEW YORK OR ANY OTHER COURT IN WHICH THE HOLDER SHALL INITIATE LEGAL OR EQUITABLE PROCEEDINGS AND WHICH HAS SUBJECT MATTER JURISDICTION OVER THE MATTER IN CONTROVERSY. TO THE MAXIMUM EXTENT PERMITTED BY LAW, MAKER HEREBY EXPRESSLY WAIVES ANY RIGHT IT MAY HAVE TO ASSERT THE DOCTRINE OF FORUM NON CONVENIENS OR TO OBJECT TO VENUE TO THE EXTENT ANY PROCEEDING IS BROUGHT IN ACCORDANCE WITH THIS SECTION. 10. Waiver of Jury Trial. THE MAKER, TO THE EXTENT IT MAY LEGALLY DO SO, HEREBY EXPRESSLY WAIVES ANY RIGHT TO TRIAL BY JURY OF ANY CLAIM, DEMAND, ACTION, CAUSE OF ACTION, OR PROCEDURE ARISING UNDER OR WITH RESPECT TO THIS NOTE, OR IN ANY WAY CONNECTED WITH, RELATED TO, OR INCIDENTAL TO THE DEALINGS OF THE HOLDER AND THE MAKER WITH RESPECT TO THIS NOTE, OR THE TRANSACTIONS RELATED HERETO, IN EACH CASE WHETHER NOW EXISTING OR HEREAFTER ARISING, AND IRRESPECTIVE OF WHETHER SOUNDING IN CONTRACT, TORT, OR OTHERWISE. THE MAKER, TO THE EXTENT IT MAY LEGALLY DO SO, HEREBY AGREES THAT ANY SUCH CLAIM, DEMAND, ACTION, CAUSE OF ACTION, OR PROCEEDING SHALL BE DECIDED BY A COURT TRIAL WITHOUT A JURY AND THAT THE HOLDER MAY FILE AN ORIGINAL COUNTERPART OF THIS SECTION 9 WITH ANY COURT AS WRITTEN EVIDENCE OF THE CONSENT OF MAKER TO THE WAIVER OF ITS RIGHT TO TRIAL BY JURY. IN WITNESS WHEREOF, this Note has been executed and delivered on the date first set forth above. PORTA SYSTEMS CORP., a Delaware corporation By: /s/ William V. Carney ----------------------------------------- Exhibit B 3 The following represents the status of current litigations being maintained against Porta Systems Corp. 1) In July 1996, an action entitled Greenwich Management Consultants Group, et al. v. Porta Systems Corp., et al. was commenced against the company in New York State Supreme Court. The action arises out of the Company's acquisition of Aster Corporation in which the plaintiffs received certain unregistered shares and and/or warrants to purchase shares in the Company under a merger agreement. The complaint alleges breach of contract against the Company and breach of fiduciary duty against the directors arising out of an alleged failure to register certain restricted shares and warrants owned by the plaintiffs. The complaint seeks damages of $413,000. Although several years ago counsel for the plaintiff advised the Company that additional plaintiffs may be added and, as a result, the amount of damages claimed may become substantially greater, no further plaintiffs have been added and plaintiffs have taken no steps to prosecute the case in the last two years. The Company believes that the defendants have valid defenses to the claims. The case remains in the discovery stage. 2) In March 2000, the Company suspended, with pay, two of its executives from their positions pending completion of the Company's investigation of certain matters that had come to the Company's attention. Prior to the completion of this investigation, however, these two executives accepted positions with another company and thereby voluntarily resigned from their positions with the Company. In February 2001, the two executives, together with a third who similarly resigned from his position with the Company, filed suit in the Supreme Court for the State of New York, County of New York, entitled Ronald Wilkins, Michael Bahlo and Michael Lamb v. Porta Systems Corp., Index No. 6006771. The Complaint in this action was served on the Company in late February. The Company asserts various claims against the Company based on the allegation that each of the former executives was improperly terminated from his employment without cause. The time to answer the Complaint has not yet expired. The Company intends vigorously to defend against this lawsuit, and has asserted counterclaims against these three former executives based, among other things, on their own breaches of their employment agreements with the Company. 3) In July 2001 an action entitled OBOD, et al. v. Porta Systems Corp., Index No. 01, Civ. 6426 (JES), was commenced in U.S. District Court for the Southern District of New York. The plaintiffs are trustees of a Trust which holds a subordinate note from the Company in the amount of $500,000 which is currently in default. By this action, plaintiffs seek to enforce payment under the Note plus interest. Plaintiffs' motion for summary judgment was recently denied by the Court on the grounds that the terms of the Note did not give them permission to obtain a judgment while Porta remained in default to the Senior Debtholder. The action continues to pend but is currently inactive. Exhibit B (to Combined Amendment Number 4) EX-23 4 e13297_ex23.txt CONSENTS OF EXPERTS AND COUNSEL EXHIBIT 23 Consent of Independent Certified Public Accountants The Board of Directors and Stockholders of Porta Systems Corp. Syosset, New York We hereby consent to the incorporation by reference in the Prospectuses constituting a part of the Registration Statements (Reg. No. 33-12146) on Form S-8, (Reg. No. 33-41992) on Form S-8, (Reg. No. 333-48839) on Form S-3, (Reg. No. 333-68321) on Form S-8, and (Reg. No. 333-72369) on Form S-8 of our report dated March 15, 2002, relating to the consolidated financial statements of Porta Systems Corp. and subsidiaries appearing in the Company's Annual Report on Form 10-K for the year ended December 31, 2001. Our report contains an explanatory paragraph regarding the Company's ability to continue as a going concern. /s/ BDO Seidman, LLP BDO SEIDMAN, LLP Melville, New York April 12, 2002 -----END PRIVACY-ENHANCED MESSAGE-----