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                                  UNITED STATES
                       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 (No Fee Required)
                   For the Fiscal Year Ended December 31, 1998
                                       OR
          [ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (No Fee Required)
                        For the transition period from to
                         Commission File Number 0-27460

                     PERFORMANCE TECHNOLOGIES, INCORPORATED
             (Exact name of registrant as specified in its charter)
                               -------------------
                Delaware                                 16-1158413
    (State or other jurisdiction of         (I.R.S. Employer Identification No.)
     incorporation of organization)
                                                              14620
  315 Science Parkway, Rochester New York                  (Zip Code)
 (Address of principal executive offices)
       Registrant's telephone number, including area code: (716) 256-0200
                             ______________________

           Securities registered pursuant to section 12(b) of the Act:
                                      NONE
                            ------------------------

           Securities registered pursuant to section 12(g) of the Act:
                     COMMON STOCK, par value $.01 per share
                                (Title of Class)

         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .

         Indicate by check mark if disclosure of delinquent  filers  pursuant to
Item 405 of Regulation S-K is not contained  herein,  and will not be contained,
to the best of  registrant's  knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part  III of this  Form  10-K or any
amendment to this Form 10-K. [ ]

         The aggregate  market value of the voting stock held by  non-affiliates
of the registrant as of the close of business on March 1, 1999 was approximately
$63,000,000.

         The number of shares outstanding of the registrant's Common Stock, $.01
par value, was approximately 7,323,000 as of March 1, 1999.

                       Documents Incorporated by Reference
         The information  called for by Part III is incorporated by reference to
the definitive  Proxy  Statement for the Annual Meeting of  Stockholders  of the
Company to be held June 8, 1999,  which  will be filed with the  Securities  and
Exchange Commission not later than 120 days after December 31, 1998.
________________________________________________________________________________
                            
<PAGE>

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

                                                                            Page
PART I

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


PART II

Item 5           Market for the Registrant's Common Equity and
                   Related Stockholder Matters                               12
Item 6           Selected Financial Data                                     13
Item 7           Management's Discussion and Analysis of Financial
                   Condition and Results of Operations                       13
Item 7A          Qualitative and Quantitative Disclosures 
                   About Market Risk                                         20
Item 8           Financial Statements and Supplementary Data                 20
Item 9           Changes in and Disagreements with Accountants on
                   Accounting and Financial Disclosure                       33



EXHIBIT 10       Material Contracts
  EXHIBIT 10.1     Revolving Credit Agreement
  EXHIBIT 10.2     Revolving Credit Note
EXHIBIT 21       Subsidiaries of The Registrant
EXHIBIT 27       Financial Data Schedule (FDS)


<PAGE>


PART I


ITEM 1 - Business

Performance Technologies,  Incorporated designs, manufactures and markets a wide
variety of high reliability,  high performance  communications products that are
in one product segment and are grouped into five product  categories:  Wide Area
Networking products, LAN interface products, Mass Storage Interface products and
Inter-system   Connectivity  products.  Most  recently,  the  Company  has  been
developing its second generation family of high performance Network Switches for
Local  Area  Networks.   The  Company's   products  are  targeted   toward  high
performance,  mission  critical  applications  found in the  telecommunications,
financial services,  defense and public safety industries.  Applications include
network  interfaces  for  cellular  telephone  communications,  fiber optic data
communications products used aboard navy vessels, communications servers used in
air traffic control centers and enterprise Ethernet network switching products.

Since its inception in 1981, the Company has  consistently  produced  innovative
networking  solutions  for a wide  variety of computer  architectures  and has a
history of being able to adapt its products to a continually changing technology
driven  marketplace.  The Company has  focused  its  efforts on  providing  high
performance,   unique   application   solutions   where  hardware  and  software
reliability  are a key concern to the end user.  This  strategy  has enabled the
Company to increase both sales and income over the last five years.

As the Company  enters  1999,  management  is focusing  on the  development  and
delivery of new  products  for two distinct  communications  markets:  Wide Area
Networking communications and Local Area Network Switching.

Industry Overview

The need to collect,  store,  analyze and  distribute  information  in a secure,
timely and efficient  manner has become an integral part of the global  economy.
The  acceleration  of  developments  in both computer  technology  and telephony
technology  is  driving  the  convergence  of these  two areas  and  opening  up
substantial opportunities to supply infrastructure related products that address
these evolving technologies. Despite the recent rapid changes in the information
revolution,  there has been a clear distinction between the traditional computer
systems and the telephone  communications networks that connect to the computer.
Another  distinction  is between the network in which  computers  are  connected
within a business office,  Local Area Network (LAN) and the communications  link
to outside the business  office,  Wide Area Network  (WAN).  Recently,  computer
systems used for information processing and the telephone communication networks
are rapidly converging into one unified, but often  geographically  distributed,
architecture  where the  boundaries  between  the two  traditional  systems  are
blurred.  As  a  result,   there  have  been  many  new  hardware  and  software
opportunities   emerging  that  are  directly   related  to  implementing   this
convergence.  There is little doubt that computer  technology,  integrated  with
communication  technology,  is a convincing example of the "sum of the two being
greater than the whole."

Over the past decade, the computer systems used in many enterprises evolved from
large and expensive mainframes connected to numerous unintelligent terminals, to
a client/server  computing model. This contemporary model replaces the mainframe
with  one  or  more  powerful  servers  interconnected  to  intelligent  desktop
computers  through high bandwidth local area networks.  The growing  paradigm of
Client/Server  computer systems has been an ideal model to foster convergence of
data  communications and  telecommunications.  The integration of computers into
the  telecommunication  systems has already provided  enhanced  services such as
800/900 numbers,  call waiting,  caller ID, greater cellular  coverage,  reduced
cell and long  distance  rates,  and faster,  more  expansive  Internet  access.
Similarly,  data  communication  systems have  benefited from  integration  with
telecommunication  systems as individual  computers located throughout the world
are connected to vast communication  facilities with enormous information access
capability.

As a result of this rapid convergence, the market opportunity for networking and
communication  products is rapidly  expanding.  According  to a recent  industry
study, the Ethernet LAN switching market is forecasted to reach over $15 billion
in 1999 and has  been  growing  at over 35% per  year.  The  Wide  Area  Network
communication  arena is expected to grow from $750  million in 1998 to over $4.0
billion by the year 2003. These impressive growth estimates, combined with other
market trends, are expected to cause the computer networking  equipment industry
to  experience  a  substantial  increase  in  demand  as  they  enter  the  next
millennium.  The next rapidly  growing  phase of this  convergence  is likely to
center  around the use of data  communication  networks to also carry  real-time
voice and video  traffic,  in many  instances  bypassing the older voice centric
telecommunications  infrastructure.  The Company's WAN  Communications and Local
Area  Network  Switching  products  address  product  segments  of these  larger
markets.

                                       1
<PAGE>

Strategy

The Company's  strategies are directed at ensuring its products and services are
correctly  positioned to take advantage of the many  opportunities  presented by
the changing  technologies  and  convergence  phenomena.  Major  elements of the
Company's operational strategy include:

Focus on High Performance Mission Critical  Solutions.  The Company continues to
focus its development  efforts on addressing specific needs for high performance
Wide Area and Local Area  Networking.  The  Company's  products  provide  unique
mission  critical  solutions  where  reliability and performance are the primary
concerns  of the  user.  Typical  applications  that  demonstrate  this  mission
critical focus include  network  interfaces for cellular  telephone  transmitter
sites,  fault-tolerant Fiber Digital Data Interface (FDDI) adapter products used
aboard Navy vessels and terrestrial military vehicles,  network adapters used in
the control and billing systems of traditional  telecommunications  networks and
communications  servers  used in both rail and air traffic  control.  To a large
degree, the Company has avoided networking and communication products that would
be  sold  into  the  commodity  desktop  office  or  home   environment,   often
characterized by low price, large volumes and fierce competition.

Exploit  Technological  Competencies.  Since  its  inception,  the  Company  has
pioneered many innovations in networking and computer technologies including the
VME64  industry  standard,  proprietary  ASICs  and  innovative  "hot  swap" and
"failover"  techniques  to  enhance  equipment   availability  and  reliability.
Building on a strong base of technological competency has allowed the Company to
develop  innovative  products that improve data  communications  performance and
reliability.  Management  intends to continue to leverage  its  competencies  to
position  the Company as a  technological  leader in high  performance  and high
availability WAN and LAN hardware and software products.

Continue to Develop Advanced  Networking  Products.  The Company  recognizes the
need to  continually  upgrade the  performance  of its existing  products and to
develop new  products  which  address the changing  requirements  of WAN and LAN
applications.  Over the past 12 months,  the Company has introduced a variety of
WAN and LAN products  designed for the PCIBus and the new  "industrialized"  PCI
standard   called   CompactPCI   (cPCI)   which   is  being   embraced   by  the
telecommunications and defense industries for next generation equipment. Several
of these products have been early and unique  entrants into the growth  oriented
PCIBus and cPCI arena aimed at supporting complex  communications  protocols and
network  requirements  associated with such  applications as air traffic control
radar systems, Signaling System #7 (SS7) network control systems and channelized
T1/E1 high speed network  interfaces.  These new products have been  responsible
for a variety of potentially significant OEM and partnering  relationships.  The
Company has also  developed a family of switching  products  for  Ethernet  LANs
directed at specific applications requiring high availability. Delivery of these
LAN products  began in 1998 with a unique fault  tolerant model due for shipment
in 1999.

Expand  International  Markets.  The data  communication  markets  served by the
Company are international in scope. Global demand for network products is driven
by the  increasing  need of all societies to be able to  successfully  implement
advanced  networking  and  communications  infrastructures.   Outside  of  North
America,  the Company  markets its products  primarily in Western Europe and the
Asia  Pacific.  In an ongoing  effort to  increase  international  revenue,  the
Company has been investing in the expansion of its marketing,  sales and support
operations in these specific  geographic areas. In 1998, the Company reorganized
its direct sales and support in the European  Economic  Community  (E.E.C).  The
Company now operates a sales and support office in the United Kingdom  providing
coverage  to the Western  European  markets.  In addition to the direct  Company
presence in the E.E.C., the Company continues to employ a variety of third party
organizations to assist in establishing  both OEM and  distribution  accounts in
Europe and the Asia Pacific regions.  In 1998,  international  revenue increased
substantially  over the previous year and represented 23% of annual sales.  This
growth was directly  attributable  to several  successful OEM  relationships  in
Europe.  As corporate  revenue grows in the Pacific Asia area, the Company would
anticipate opening a direct sales and service center in this area of the world.

                                       2
<PAGE>

Leverage  Software   Expertise.   The  Company  has  a  growing   competency  in
communications, networking and high availability software expertise. The Company
has significantly expanded its ability for offering communication  protocols for
Wide Area  Networks by combining  its east and west coast  software  engineering
organizations. In addition, the Company has invested substantially in developing
fault tolerant and hardened  software  implementations  used in both WAN and LAN
products.  Management  believes  focusing  on  increasing  software  content  in
products  emphasizing high availability and reliability features is an important
element of the Company's future product strategy.

Capitalize  on Internal  Manufacturing  Expertise.  Unlike many of its  industry
competitors,   the  Company  does  not  rely  upon  third  party   manufacturing
subcontractors for assembly, test and quality control of its products.  Instead,
the Company operates a  state-of-the-art  manufacturing  facility that gives the
Company the  flexibility  to meet  customer  requirements,  produce high quality
products  and  make  timely  shipments.  The  Company's  manufacturing  facility
operates under an integrated MRP system that significantly reduces lead-time and
inventory investment and facilitates effective demand forecasting. This in-house
manufacturing  capability  provides  the  Company  with  the  means  to  quickly
manufacture new products without the delays normally  associated with the use of
manufacturing  subcontractors.  During 1998,  additional surface mount equipment
was installed to assure continued high quality assembly with sufficient capacity
to meet expected  delivery  requirements  for the Company's  expanding  customer
base.  The  Company's  manufacturing  process  is  certified  under the ISO 9002
quality program.

Products

The  Company's  products  include  a  wide  variety  of   fault-tolerant,   high
performance  solutions  for  WAN  communications,   LAN  connectivity  and  mass
storage/retrieval applications. The Company historically has addressed the needs
of the  client/server  computing  environment  with a  family  of  hardware  and
software  products which operate on a number of open standards and allow ease of
use with a variety of popular high performance computer platforms. The Company's
products   have   traditionally   been   grouped  into  five   categories:   WAN
Communications  products,  LAN  Interface  Adapter  products,   Network  Systems
products,   Mass  Storage  Interface  products  and  Inter-system   Connectivity
products.  The Company has also been developing its second generation of network
switches for Local Area  Networks.  As the Company  enters 1999,  management  is
focusing on the  development  and  delivery  of new  products  for two  distinct
communications  markets:  Wide Area  Networking  communications  and Local  Area
Network Switching.

WAN Communications  Products. The Company's WAN Communications  products provide
customers with hardware and software  solutions  which support a variety of open
system platforms. These open systems include VMEbus, SBus, PCIBus, CompactPCIbus
(cPCI) and PMCbus. The Company offers software support for its products across a
variety of commonly used operating systems including Microsoft's WindowsNTJ, Sun
Microsystems'  SolarisJ,  Wind  River's  VxWorks,  and QNX.  In  addition to the
advanced  hardware network interface  products,  the Company offers an extensive
suite of advanced  communication  software such as X.25, Frame Relay, High Level
Data Link Control (HDLC)  variants,  Signaling System #7 (SS7), and a variety of
protocols to facilitate high and low speed  communications.  The  communications
software  content is further expanded by the Company's  channelized  support for
T1/E1  data  rates and  software  protocol  tool kits for  specialized  customer
development.  The growth in the Wide Area Networking (WAN) communications market
is being driven by the expansion of the Internet,  cellular  communications  and
the convergence  occurring between data  communications and  telecommunications.
WAN Communications product customers include Lucent Technologies, Compaq/Digital
Equipment Corporation, QualComm Inc., Alcatel Inc., Motorola Corporation and ADC
NewNet.  Product  applications  cover a variety  of uses  including:  High speed
Internet  connections for server products,  T1/E1 products used for SS7 products
and communications for rail and subway signaling.

During 1998, the Company released three new Wide Area Network interface adapters
for the cPCIbus  architecture.  These products were designed  specifically  with
features  that  are  required  in  advanced   telecommunications   applications,
including  the  necessary  capability  for "hot  swap  replacement."  Management
believes  that  the  Company's  cPCI  products  are some of the  first  products
available to cPCI users for high speed WAN communications.  All of the Company's
WAN  Communications  products are designed  for  applications  that require high
performance  and  high  speed  communications   capability.   To  support  these
applications,  the Company's  products are  "intelligent,"  containing their own
microprocessors  and memory.  This  architecture  allows these network interface
products  to perform  many of the  lower-level  communications  tasks that would
typically be performed by the host platform,  greatly  improving  overall system
performance and capability. During 1998, the Company also expanded its family of
WAN software protocol products with emphasis on enhancing speed and reliability.
WAN product sales  represented 58% of total sales for 1998,  compared to 47% for
1997 and has been the highest  growth product area for the Company over the past
three years .

                                       3
<PAGE>

Local  Area  Network  Switching.  The  Company  has  been  developing  a  second
generation family of high performance 100Mbit/Gigabit Network Switches for Local
Area Networks which offer a variety of unique technical  features.  During 1998,
the Company  completed  development of its new Nebula (TM) 4000 workgroup switch
and its new Nebula 6000 high density departmental switch. The centerpiece of the
Company's  Local Area Network switch  strategy is the Nebula 8000 Fault Tolerant
Backbone  Switch.  This 100/1000  Ethernet switch is the first network switch to
offer true fault tolerance at an affordable  price.  The Nebula 8000's redundant
switch fabric has been  engineered for maximum  availability  and its innovative
design ensures that no single point of failure will shutdown a network.

The market  demands  for fault  tolerant  computing  and  networking  are rising
rapidly.  Server  manufacturers  including  Compaq  Computer  Corp.  and  Tandem
Computers have developed server clusters to meet their customers' fault tolerant
server  requirements.  Networking  companies,  including  Novell,  are  actively
promoting and selling  networking  solutions for mission critical  applications.
Management  believes that  deployment of its fault tolerant  technologies in the
new Nebula 8000 Backbone Switch differentiates PTI from the other vendors in the
network switching marketplace. This new product is being positioned for Ethernet
based  business  and  mission   critical   applications  in  enterprises   where
"round-the-clock"  operations demand highly resilient  network  infrastructures.
Prospective  customers in the banking,  brokerage,  medical  imaging and defense
industries are expressing serious interest in this product.

As of March 1999, the Nebula 8000 was operating in a number of early beta sites,
including the Company's communications network.  Additional beta sites have been
selected and units are expected to be installed in these  locations in April and
May. Shipments to customers are expected to commence in the second quarter 1999.

LAN Interface  Adapter  Products.  The Company's LAN Interface  Adapter products
consist primarily of products often referred to as Network Interface Controllers
(NICs) for a variety of LANs and computer platforms.  These products represented
20% of sales in 1998 and 1997. These products  currently  operate on the PCIBus,
SBus and VMEbus computer  platforms and include  connections for a popular range
of Ethernet  and FDDI  standards  and a unique FDDI  concentrator  product  that
operates on the VMEbus. Applications for the Company's Ethernet and FDDI network
adapter products include a convenient  interface between computer  platforms and
LANs used in commercial, educational or industrial organizations and a shipboard
FDDI  LAN  used  by  the  U.S.  Department  of  Defense  to  integrate  tactical
workstations  onboard Navy vessels. All of these NICs permit easy integration of
SBus,  PCIBus or VMEbus  computer  systems to an FDDI or Ethernet  LAN. The FDDI
adapters  support the  Company's  alternate  path FDDI  topology,  ensuring  the
highest available levels of resiliency and data integrity for fault-tolerant and
mission critical  markets.  The Company actively supports software supplied with
its newest  PCI-based  FDDI  adapters to be compatible  with computer  platforms
utilizing both the Sun Microsystems' Solaris and WindowsNT operating systems. It
is  management's  belief that the FDDI  technology  as a LAN  technology  is not
growing  and the  Company's  FDDI  products  are in the  harvest  phase of their
product life cycle and a decline can be predicted over the next 18-24 months.

Network Systems  Products.  The Company's  Network Systems  products  consist of
system level  equipment  used in the  construction  and  deployment  of computer
networks.  These  products  represented  6% of sales in 1998,  compared to 9% in
1997. The engineering  staff supporting this product group was reassigned at the
beginning of 1998 to develop software for WAN Communications products.
Traditionally this group has included:

                                       4
<PAGE>

Communications  Servers.  Communications  servers  are  multipurpose  LAN-to-WAN
bridging  systems  supported  by  software  from the  Company's  San Diego based
communication protocol engineering center. The products in this category include
a low cost, limited server solution for installations  requiring from one to six
WAN connections and up to two Ethernet LAN  connections.  Using unique software,
the  communications  servers can be  configured to provide a variety of protocol
packages  and  supporting   protocols  including   bisynchronous,   asynchronous
communications  financial  market feeds and radar receivers.  The  communication
server  products from the Company can be found in data  collection  applications
including  NASA's  deep  space  network,  in air  traffic  control  centers  for
retrieving  radar data from  remote  radar  antenna  sites and in the US Weather
Service  infrastructure  for  retrieving  weather  satellite  and radar  images.
Management  believes this product  offering  will see continued  growth in 1999.
Since  communications  servers are directly aligned with the Company's Wide Area
Network  communications  products,  these  products  will  be  reported  in that
grouping in 1999.

Communications   Subsystems.   The  Company's   "front-end"  I/O  communications
subsystem  product supports  multiple disk storage  controllers or communication
interface modules.  This product was co-developed by the Company and a large OEM
customer and is used as a  communications  nexus for high powered  workstations.
Since this is a very specialized  product offering with a limited customer base,
management expects revenue from this product to decline in 1999.

Mass Storage Interface  Products.  The Company's Mass Storage Interface products
consist of adapters and  software  that connect  various  external  disk storage
systems,  such as  Redundant  Array of  Inexpensive  Disks  (RAIDs) to  computer
servers using the SCSI, UltraSCSI and Fibre Channel  technologies.  During 1998,
the Company  introduced new products  designed to operate on the PCIBus standard
using Fibre  Channel.  As the  technologies  have  changed in this  market,  the
products have increasingly become "commoditized"  thereby reducing the Company's
ability to achieve  value-added  pricing.  While the Company is  supporting  the
current  customer base in their transition from older  technologies,  it expects
revenue to decline in 1999 and beyond.  This  product  group  represented  9% of
sales in 1998, compared to 14% in 1997.

Inter-system  Connectivity  Products.  The Company's  Inter-system  Connectivity
products permit dissimilar  computer  standards to be connected.  These products
are typically used by OEMs and systems  integrators for custom  applications and
allow  their  customer's  to maintain  their  investment  in existing  installed
equipment.  These products  represented 7% of sales in 1998,  compared to 10% in
1997.  Management does not believe these products are strategic to the Company's
future growth and is not investing in this business segment. Management believes
there will be further declines in this revenue during 1999.

Sales, Marketing and Distribution

The Company  markets its  products  worldwide  to a broad  spectrum of customers
through  various  channels  including  OEMs,  VARs,   distributors  and  systems
integrators.  Greater than 85% of the Company's North American  business is sold
through the Company's  direct sales force to OEMs and systems  integrators.  The
remainder is sold to end users through distributors and VARs.

Due to the  technical  nature  of the  Company's  products  sold to OEMs,  it is
essential  that the  Company's  salespeople  are  technically  oriented  and are
knowledgeable in the network and communications fields.

In North America,  the Company operates four direct sales offices located in San
Diego  California,  Rochester New York,  Old Saybrook  Connecticut,  and Houston
Texas.  The Company  also  maintains  its European  sales and support  office in
London.  Currently, 22 sales, marketing and support personnel sell the Company's
products.  In addition,  independent  sales  representatives  covering  selected
geographic  areas, and distributors or integrators  handling  selected  products
supplement the Company's direct sales team on a worldwide basis.

The Company also sells products,  including mass storage interface  products and
certain LAN interface products,  to distributors.  In addition,  a small, highly
focused group of distributors,  VARs and integrators are involved in selling the
Company's network and fault tolerant switching  products.  The "vertical market"
business  focus of these  VARs  and  integrators  is  targeted  toward  specific
applications  which are considered  mission  critical such as "7 day by 24 hour"
operations in the following industries:  airline, trading floor applications for
the financial industry and medical systems in hospitals.  Distributors, VARs and
integrators who sell the Company's  products are managed by the Company's direct
sales force.  Several marketing strategies are used to support these third party
organizations  including advertising in trade publications,  sponsoring customer
training  sessions and  participating  in trade shows  throughout North America,
Western Europe and the Pacific Rim.

                                       5
<PAGE>

OEM customers  typically  provide the Company with a rolling forecast for orders
placed  two to three  months in  advance  of  shipment.  VARs,  integrators  and
distributors typically provide the Company with orders placed 30 days in advance
of shipment.  Sales of the Company's  products to OEM customers are subject to a
number of factors outside the Company's control, including pricing, availability
and acceptance of these products by the OEM's customers and potential customers.

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

International  sales  represented  23% of the  Company's  net  sales in 1998 (as
compared  to  10%  and  11%  for  1997  and  1996,  respectively).   While  1998
international revenue represents a substantial increase over previous years, the
Company continues to believe that the international  markets represent important
untapped opportunities for its products. Management believes that it can develop
expanded sales channels and marketing alliances with respect to new and existing
international  markets  and  is  actively  pursuing  these  relationships.   The
Company's   products  are  currently  sold  by  approximately  25  international
distributors  throughout  the major  industrialized  countries in Europe and the
Asia  Pacific.  The Company also  operates a sales and  marketing  office in the
United Kingdom to better support its Western  European  customers.  In addition,
the Company  continues to engage two  international  marketing  organizations to
assist in more aggressive  development of the Pacific Rim and other  territories
across all of its product offerings.  Use of these third party  organizations is
primarily viewed as an interim step that will to lead to additional direct sales
offices in Europe and the  Pacific  Rim,  assuming  the Asian  economic  climate
improves.  International  sales are  subject  to  import  and  export  controls,
transportation  delays and  interruptions,  foreign currency exchange rates, and
foreign governmental regulations.  All payments for shipments outside the United
States are made in U.S. dollars.

Customers

The Company has over 300 active customers worldwide, including major OEMs, Value
Added Resellers,  systems integrators,  and educational/research  organizations.
Many of the Company's  major  customers are Fortune 500 companies.  In 1998, the
largest single customer  represented 13% of sales (Compaq Computer  Corp.),  and
the top five customers accounted for 39% of 1998 revenue.

Generally, the Company's customers can be grouped into two categories. The first
category includes customers that are technically oriented and assemble a product
or system for a specific end use, using components and subassemblies supplied by
vendors such as the Company.  These  products or systems are  typically  sold on
either a repetitive  basis or on a lower volume,  purpose-built  basis.  End use
equipment  or  systems  sold by OEMs on a  repetitive  basis  incorporating  the
Company's products often include  applications such as sophisticated  enterprise
servers  with  high  speed  WAN  interconnections  to the  Internet  or  private
communication  facilitates  specialized  Signaling  System  #7  server  clusters
installed  worldwide by many  telecommunications  organizations  for 800 and 900
number implementations. Examples of lower volume purpose-built end use equipment
incorporating  the Company's  products  include FDDI networks used by the United
States Navy for shipboard use, communication servers for deep space network used
by space research  organizations  and data  collection  network  systems for air
traffic control and radar installations.

The second category are customers  requiring products to be self-installing  and
require limited knowledge of the products'  internal  operation.  These products
are  often  referred  to as  "plug  n' play" or  "shrink  wrapped,"  implying  a
readiness  to  simply  install  the end  application  without  the  need to have
extensive  technical  knowledge.  The  Company's  products  that fit  into  this
category are the SBus and PCIBus Mass Storage Interface, the SBus and PCIBus LAN
products  (Ethernet  and  FDDI  Niches)  and  selected  WAN  Interface  products
operating on the SBus and PCIBus standards.

                                       6
<PAGE>

Backlog

At March 7, 1999, the backlog of scheduled orders was $7.7 million,  compared to
$4.7 million at March 2, 1998.  Although  orders are subject to  cancellation in
the normal course of business,  historically  the Company has filled most of its
firm orders. (See Management's  Discussion & Analysis included elsewhere in this
report).

Seasonality

The  Company's  business is  generally  not  considered  to have large  seasonal
swings,  but some of the business  (primarily LAN Interface products and Network
Systems products) is project-related, driven by customer demand, which can cause
quarterly fluctuations in revenues.

Environmental Matters

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

Competition

The market for communications, networking and mass storage interface products is
intensely  competitive and  characterized  by rapid  technological  innovations,
resulting   in   new   product    introductions   and   frequent   advances   in
price/performance  ratios.  Competitive factors in this industry include product
performance and functionality, product quality and reliability, customer service
and support,  marketing capability,  corporate reputation and brand recognition,
and increases in relative  price/performance  ratios. In the WAN  communications
market, the Company's products compete with products from SBE Incorporated, Adax
Incorporated and Digi  International  Incorporated.  In the emerging cPCI arena,
the Company's competition is less well-defined,  although early entrants include
Force Computers, a division of Solectron Corporation, and SBS Technologies, Inc.
In  the  LAN  Interface  product  market,  the  Company  competes  with  Network
Peripherals Inc., Osicom Technologies,  Incorporated and Interphase Corporation.
In the Mass Storage  Interface  product market,  the Company  competes with such
companies as Interphase Corporation,  MacroLink Incorporated,  Sun Microsystems,
Emulex Corporation, Qlogic Corporation and Adpatec, Incorporated.

In the Local Area Network Switching  market,  the Company is focusing on a niche
application,  fault  tolerance.  However,  many of the  companies in this market
focus on broad  applications  products  and have greater  technical  and capital
resources, more marketing experience, larger research and development staffs and
better production facilities than the Company. In recent years the local network
switching   market  has  become   increasingly   concentrated  as  a  result  of
consolidations in the industry. Cisco Systems Inc., the industry routing leader,
has acquired companies that have historically  competed with the Company.  These
consolidations are likely to permit Cisco and other of the Company's competitors
such as Cabletron  Systems,  3Com Corp and Xylan Corp,  to devote  significantly
greater resources to the development and marketing of new competitive networking
products  and  the   marketing  of  existing   products   through  their  larger
distribution  networks to their larger  installed  customer  bases.  The Company
expects that  competition  will increase  substantially as a result of these and
other industry  consolidations,  as well as the emergence of new competitors and
new  technologies.  Increased  competition  could  result  in price  reductions,
reduced  margins and loss of market  share,  all of which would  materially  and
adversely  affect  the  Company's  business,  operating  results  and  financial
condition.

Research and Development

The Company's research and development expenses,  plus costs attributable to the
development  of  software,  for  1998,  1997 and 1996  were  approximately  $4.2
million,  $3.7 million and $3.0 million,  respectively.  These expenses  consist
primarily of employee  costs and material  consumed in developing  and designing
new products.  To a lesser degree,  there have been limited  expenses devoted to
technology acquisition, software license/tools and contract product development.

                                       7
<PAGE>

The Company  has, as a result of prior  research and  development  expenditures,
developed  significant core  competencies  applicable to high speed  fiber-optic
local area networking,  wide area networking,  and fault tolerant switching. The
Company expects that research and development  funding will continue to increase
significantly in 1999. This funding will be directed at further leveraging these
competencies  and carrying out  additional  product  development in the areas of
communications and network  switching.  In carrying out this focused effort, the
Company has increased its internal  capability to design and implement ASICs and
has invested  substantially in integrating and expanding its  communication  and
networking  software  competency.   These  competencies  will  be  an  important
cornerstone for continued  future  enhancements of WAN network products and high
performance  fault  tolerant  switching  architectures  to support the  emerging
Gigabit Ethernet LAN technology.

Proprietary Technology

The Company's  success  depends upon the Company's  proprietary  technology.  To
date, the Company has relied  principally  upon  trademark,  copyright and trade
secret laws to protect its proprietary technology.  The Company generally enters
into confidentiality or license agreements with its distributors,  customers and
potential  customers and limits access to and distribution of the source code to
its software and other  proprietary  information.  The  Company's  employees are
subject  to the  Company's  employment  policy  regarding  confidentiality.  The
Company's  software  products and  accessories  are provided to customers  under
license,  generally in the form of object code,  which provides a high degree of
confidentiality  with respect to the  intellectual  property value.  Much of the
Company's proprietary  technology is found in the Company's source code which is
embedded in silicon chips,  making it extremely  difficult to  misappropriate or
reverse engineer.  Such methods may not afford complete protection and there can
be no assurance that the  confidentiality  agreements  will not be breached,  or
that such agreements will be enforceable, or that the Company will have adequate
remedies for any breach,  or that the Company's trade secrets will not otherwise
become  known  to  or   independently   developed  by  competitors.   If  patent
applications  are filed by the Company in the future,  there can be no assurance
that any patents can be granted, or that, if granted, such patents would provide
the Company with meaningful  protection from competition.  The Company currently
has  an  outstanding  patent  application  pending  for  a  variety  of  aspects
associated  with its  fault  tolerant  network  switching  products.  Management
expects the U.S. Patent office to render a ruling on this application in 1999.

There can be no  assurance  that  third  parties  will not  assert  intellectual
property infringement claims against the Company.  Although no written claims or
litigation  relating  to any such  matters  are  currently  pending  against the
Company,  the Company has not  conducted  any searches or obtained an opinion of
counsel with respect to its  proprietary  rights.  Accordingly,  there can be no
assurance  that no claims will be  initiated,  that the Company would prevail in
any such  litigation  seeking  damages or an injunction  against the sale of the
Company's  products,  or if necessary,  that the Company would be able to obtain
any necessary  licenses on reasonable terms or at all. Any such litigation could
be  protracted  and  costly  and could  have a  material  adverse  affect on the
Company's results of operations regardless of the outcome of the litigation.

Suppliers

Certain  components  used in the  Company's  products,  such as specific  single
source  microprocessors,  custom ASICs,  FDDI  interface  components  and highly
integrated PCIBus and VMEbus interface components,  are only currently available
to the Company from limited sources.  Technology oriented markets are especially
subject  to rapid  change.  As a  result,  over  the  course  of short  periods,
components  utilized by the Company face  ongoing "End of Life" risks.  To date,
the Company has generally been able to obtain adequate supplies of components or
has redesigned specific products when adequate components are not available. The
Company obtains components on a purchase order basis and does not generally have
long-term contracts with any of these suppliers.  In addition,  shortages of raw
materials could negatively  affect the Company's  ability to meet its production
obligations  and result in increased  prices to the Company for affected  parts.
The  Company's  inability  in the  future  to obtain  sufficient  limited-source
components, or to develop alternative sources, could result in delays in product
introductions  or shipments,  premature  End of Life of the Company's  products,
and/or increased component prices could negatively affect gross margins,  any of
which  could  have a  material  adverse  effect  on  the  Company's  results  of
operations.  The  Company  would  also be  negatively  affected  if it does  not
maintain adequate capital resources to fund component purchases.

                                       8
<PAGE>

Manufacturing

The Company  maintains a  state-of-the-art  product  assembly and  manufacturing
facility in Rochester,  New York. This facility operates under an integrated MRP
system that  significantly  reduces  lead-time  and  inventory  investments  and
facilitates  effective demand  forecast.  In December 1997, the Company received
ISO 9002  certification of its manufacturing  facilities and quality  management
systems.  By  maintaining  an  in-house  manufacturing  capability,   management
believes that the Company has, to a certain  extent,  insulated  itself from the
risks inherent in dealing with independent  subcontractors.  These risks include
timing  delays  that often  result  when  subcontractors  are unable to meet the
manufacturing requirements of their customers. In addition, through its in-house
manufacturing  capability,  the Company is able to oversee  directly its quality
control process and the timeliness of product delivery.  The Company has limited
alternative  capabilities  through  third  parties,  however,  to  perform  such
manufacturing  activities.  In the event of an interruption of production at its
manufacturing  facility,  the Company's  ability to deliver products in a timely
fashion would be compromised,  which would have a material adverse effect on the
Company's results of operations.

Employees

As of March 1, 1999, the Company had 140 full-time  employees,  10 part time and
contract employees and 3 Engineering Cooperative employees.  Management believes
its  relations  with its employees  are good.  The  Company's  employees are not
subject to collective bargaining agreements.

 These employees work in the following areas:

                  Research and Development                    53
                  Marketing and Sales                         22
                  Manufacturing                               59
                  General and Administrative                  19

Competition  for technical  personnel in the Company's  marketplace  is intense.
Management believes that the Company's future success will depend on its ability
to continue to attract and retain qualified personnel.

Risk Factors

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

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

                                       9
<PAGE>

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

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

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

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

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

                                       10
<PAGE>

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

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

Dependence  on  Personnel.  The  Company's  success  depends  on  the  continued
contributions of its personnel,  many of whom would be difficult to replace.  It
will also  depend on its  ability  to  attract  and  retain  skilled  employees.
Although the Company's employees are subject to the Company's  employment policy
regarding  confidentiality  and  ownership  of  inventions,  employees  are  not
otherwise subject to employment agreements or non-competition covenants. Changes
in personnel could adversely affect the Company's operating results.


ITEM 2 - Properties

The Company's principal executive offices, manufacturing and the majority of its
research and development  personnel are located in a 30,000 square foot building
in Rochester,  New York.  The lease for this facility  expires in the year 2001.
The Company has an option to renew the lease for two successive five-year terms.
There is  currently  no excess  office  capacity  at this  facility.  Management
believes  additional  office space will be needed to  accommodate  the Company's
growth in the near  term and that  adequate  office  space is  available  in and
around the Rochester  area. The Company also leases  approximately  6,800 square
feet of office space in San Diego,  California pursuant to a lease which expires
in  November  1999.  This  facility  houses  part  of  the  Company's   software
engineering and sales operations. The Company also leases sales offices at three
other locations.


ITEM 3 - Legal Proceedings

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


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

No  matters  were  submitted  to a vote of  security  holders  during the fourth
quarter of the year ended December 31, 1998.


                                       11
<PAGE>

PART II


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

The  Company's  Common Stock trades on The NASDAQ Stock Market under the trading
symbol  "PTIX".  The  following  table sets forth the high and the low quarterly
closing prices of the Common Stock during the two most recent years, as reported
on the NASDAQ Stock Market.  These prices represent  quotations among securities
dealers without adjustments for retail markups, markdowns or commissions and may
not represent actual transactions. 
<TABLE> 
<CAPTION>

             1998                          High             Low
         ---------------                 -------          -------
<S>                                      <C>              <C>    
         First Quarter                   $ 19.25          $ 13.13
         Second Quarter                    15.25            10.25
         Third Quarter                     11.63             9.00
         Fourth Quarter                  $ 13.50         $   9.00

             1997                          High             Low
         ---------------                 -------          -------
         First Quarter                  $   8.67         $   6.83
         Second Quarter                     10.33            7.00
         Third Quarter                      19.38           10.00
         Fourth Quarter                   $ 21.75        $  13.50
</TABLE>

As of March 1, 1999,  there  were 188  stockholders  of record of the  Company's
Common Stock.

To date,  the Company has not paid cash  dividends on its Common Stock and there
can be no assurances that the Company will do so at any time in the future.

The following table  summarizes the proceeds from the sale of securities and use
of  proceeds  therefrom  in  connection  with the  Registrant's  Initial  Public
Offering on January 24,  1996.  Amounts  reported  represent  an estimate of the
amount of these  expenditures.  As of December 31, 1998,  offering proceeds have
been used in full.
<TABLE>
<CAPTION>

Proceeds from the sale of securities:
<S>                                                           <C>         
Gross proceeds                                                $ 12,800,000
Less:    Underwriter's commission                                  896,000
         Finder's fees                                                   0
         Underwriter's expenses                                     27,000
         Payments to Directors, Officers, General Partners               0
         Other                                                     461,000
                                                              ------------
Net proceeds                                                  $ 11,416,000
                                                              ============

Use of Proceeds:
Construction of facilities                                    $          0
Purchase of machinery                                            1,976,000
Purchase of real estate                                                  0
Acquisition of other business(es)                                        0
Repayment of debt                                                        0
General working capital purposes                                         0
Temporary investments                                                    0
Inventory for new products                                       1,265,000
Software development                                             1,575,000
Product development                                              6,600,000
                                                              ------------
Total use of proceeds                                         $ 11,416,000
                                                              ============
</TABLE>

                                       12
<PAGE>


ITEM 6 - Selected Financial Data
          (in thousands, except per share amounts)
<TABLE>
<CAPTION>

For the Years Ended December 31:                1998         1997         1996         1995         1994  
-------------------------------                -----        -----        -----        -----        -----
<S>                                          <C>          <C>          <C>          <C>          <C>    
Sales                                        $30,202      $30,336      $24,843      $17,891      $12,562
Income from continuing operations              5,783        5,131        3,734        2,393        1,618
Loss from discontinued operations                                                       (19)      (1,133)
Basic earnings per share:  
    Income from continuing operations        $   .80      $   .71       $  .53      $   .52      $   .36
    Weighted average common shares             7,274        7,231        7,020        4,590        4,549
Diluted earnings per share:
    Income from continuing operations        $   .76      $   .68       $  .52      $   .52      $   .34
    Weighted average common and common
        equivalent shares                      7,568        7,522        7,248        4,623        4,705

At December 31:                                 1998         1997         1996         1995         1994  
-------------------------------                -----        -----        -----        -----        -----
Working capital                              $31,790      $26,584      $20,965      $ 6,215      $ 4,369
Total assets                                  37,835       31,626       26,089       10,523        9,312
Long-term debt, less current portion         $     6      $    18      $    30      $    57      $   622
</TABLE>


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

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

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

Overview

The Company achieved record earnings for the fifth  consecutive year in 1998 and
the third  consecutive  year as a publicly  traded  company.  Net income in 1998
amounted  to $5.8  million,  19% of sales,  compared  to $5.1  million  in 1997.
Revenue  was $30.2  million in 1998,  compared  to $30.3  million  in 1997.  The
Company did not meet management's revenue expectations in 1998 primarily because
the award of a  follow-on  Department  of Defense  contract  was  delayed  until
September 1998 and because  completion of the Nebula 8000 fault tolerant network
switch  has been  delayed  until  the  second  quarter  of 1999.  The  Company's
financial  performance  improved  significantly  during the second half of 1998:
Sales  during the second half of the year were 25% higher than in the first half
and  diluted  earnings  per share were $.46,  compared to $.29,  58% higher.  At
year-end  1998,  the  Company  had $25.6  million  in cash and cash  equivalents
($3.38/per  share) and virtually no debt. For 1998, the Company generated income
from  operations,  excluding  depreciation  and  amortization  (EBITDA)  of $8.6
million and cash from operating activities amounted to $6.5 million, compared to
$5.8  million  for 1997.  Return on equity for 1998 was 19% and return on assets
was 17%. During 1998,  international  sales increased to $7.2 million, or 23% of
sales, compared to $3.0 million, or 10% of sales in 1997.

                                       13
<PAGE>

As the Company  enters  1999,  management  is focusing  on the  development  and
delivery of new  products  for two distinct  communications  markets:  Wide Area
Networking communications and Local Area Network Switching.

Wide Area Networking:  The Company's overall Wide Area Networking strategy is to
provide  customers with hardware and software product  solutions which support a
variety of open system platforms and operating  systems.  The growth in the Wide
Area Networking (WAN) communications  market is being driven by the expansion of
the Internet, cellular communications and the convergence occurring between data
communications  and  telecommunications.  At the same time, the technologies for
Wide Area Networking products are changing  dramatically.  Server,  workstation,
and telecommunications  providers are migrating their platforms and applications
from older bus standards such as VMEbus and SBus, to the newer standard hardware
bus  architectures;  PCIBus and  CompactPCI.  These  technology  changes offer a
significant opportunity for the Company. PTI began developing WAN communications
products for the PCIBus market in 1995.  In 1996,  PCIBus  products  represented
less than 7% of the  Company's WAN revenue.  Through a  combination  of internal
development,   licensing  and  strategic  partnering,   the  Company  created  a
comprehensive  group of Wide Area  Networking  communications  products for this
market.  During 1997 and 1998,  PTI WAN  product  revenue  increased  by 90% and
PCIBus  products  represented 48% of the Company's WAN revenue in 1998. The next
emerging WAN market the Company is addressing is  CompactPCI  (cPCI).  cPCI is a
new standard  hardware bus  architecture  that  combines the  attributes  of the
VMEbus and PCIBus into a ruggedized  industrial hardware system for the embedded
OEM marketplace.  The  telecommunications  and defense industries are expressing
great  interest in the cPCI system  architecture  for meeting their  application
requirements. Currently, the Company's cPCI WAN products are being evaluated for
numerous  potential  integration  opportunities  and we expect shipments of cPCI
products in the second half of 1999.

To  complement  the  Company's  hardware  development,   communication  software
protocols have been  developed for the PCIBus and cPCI product lines  including:
Frame  Relay,  Signaling  System #7 (SS7),  X.25,  High-Level  Data Link Control
(HDLC) and a variety of protocols to facilitate high and low speed
communications.

The  markets and  applications  for Wide Area  Network  products  are  expanding
rapidly.  In order to gain broader market  penetration,  the Company established
strategic  partnering  relationships with a number of major server,  workstation
and  telecommunications  equipment suppliers including Sun Microsystems,  Compaq
Computers, Nortel Networks and ADC NewNet, as well as several leading CompactPCI
platform manufacturers.

Local  Area  Network  Switching:  The  Company  has been  developing  its second
generation family of high performance 100Mbit/Gigabit Network Switches for Local
Area  Networks.  During  1998,  the  Company  completed  development  of its new
Nebula(TM)  4000  workgroup   switch  and  its  new  Nebula  6000  high  density
departmental  switch. The centerpiece of the Company's Local Area Network switch
strategy  is the Nebula  8000 Fault  Tolerant  Backbone  Switch.  This  100/1000
Ethernet  switch is the first network switch to offer true fault tolerance at an
affordable  price. The Nebula 8000's redundant switch fabric has been engineered
for maximum  availability and its innovative design ensures that no single point
of failure will shutdown a network.

The market  demands  for fault  tolerant  computing  and  networking  are rising
rapidly.  Server  manufacturers  including Compaq Computers and Tandem Computers
have developed  server clusters to meet their  customers'  fault tolerant server
requirements.  Networking  companies including Novell are actively promoting and
selling  networking  solutions  for mission  critical  applications.  Management
believes that  deployment of its fault tolerant  technologies  in the new Nebula
8000 Backbone  Switch  differentiates  PTI from the other vendors in the network
switching  marketplace.  This new product is being positioned for Ethernet based
business   and   mission    critical    applications   in   enterprises    where
"round-the-clock"  operations demand highly resilient  network  infrastructures.
Prospective  customers in the banking,  brokerage,  medical  imaging and defense
industries are expressing serious interest in this product.

As of March 1999, the Nebula 8000 was operating in a number of early beta sites,
including the Company's communications network.  Additional beta sites have been
selected and units are expected to be installed in these  locations in April and
May. Shipments to customers are expected to commence in the second quarter.



                                       14
<PAGE>

Results of Operations

The following table sets forth,  for the years indicated,  certain  consolidated
financial  data  expressed as a percentage of sales and is included as an aid to
understanding  the Company's  results and should be read in conjunction with the
selected  financial data and Consolidated  Financial  Statements  (including the
notes thereto) appearing elsewhere in this report:
<TABLE> 
<CAPTION>

                                                        Year Ended December 31,
                                                         1998     1997     1996   
                                                        -----    -----    -----   
<S>                                                     <C>      <C>      <C>   
Sales ..............................................    100.0%   100.0%   100.0%
Cost of goods sold .................................     40.9     41.8     43.7
                                                        -----    -----    -----   
Gross profit .......................................     59.1     58.2     56.3
                                                        -----    -----    -----   

Operating expenses:
   Selling and marketing ...........................     13.3     13.1     12.9
   Research and development ........................     13.8     12.3     11.9
   General and administrative ......................      6.7      8.9     11.0
                                                        -----    -----    -----   
         Total operating expenses ..................     33.8     34.3     35.8
                                                        -----    -----    -----   
Income from operations .............................     25.3     23.9     20.5

Other income, net ..................................      4.2      3.4      3.0
                                                        -----    -----    -----   
Income before income taxes and minority interest ...     29.5     27.3     23.5

Provision for income taxes .........................     10.4     10.4      8.4
Minority interest ..................................      0.0      0.0     (0.1)
                                                        -----    -----    -----   
   Net income ......................................     19.1%    16.9%    15.0%
                                                        =====    =====    =====
</TABLE>

Year Ended December 31, 1998, compared with the Year Ended December 31, 1997

Sales.  Sales for 1998 were  $30,202,000,  compared to  $30,336,000 in 1997. The
Company's  sales are in one product  segment and are grouped  into five  product
categories: WAN communications products, LAN interface products, Network Systems
products,   Mass  Storage  Interface  products  and  Inter-system   Connectivity
products. Beginning in 1999, sales will be grouped into four product categories:
WAN communications products, LAN interface products, Network Switching and Other
(combining  Network  Systems  products,  Mass  Storage  Interface  products  and
Inter-system Connectivity products).

Shipments of WAN communications  products  represented 58% of sales during 1998,
compared to 47% in 1997. The increase in WAN sales is primarily  attributable to
the development of several new PCIBus products being sold to customers including
Sun  Microsystems,  Compaq  Computers and ADC NewNet.  During 1998,  the Company
experienced  a decline in VMEbus and SBus  revenue as  customers  moved to newer
technologies.  The  Company  has  developed  several  new WAN  products  for the
CompactPCI   market  and  these   products   are  in   evaluation   by  numerous
telecommunications   and  defense  suppliers.   Management  expects  PCIBus  and
CompactPCI  revenue  to  increase  in 1999  while the  VMEbus  and SBus  revenue
declines as these technologies become less prevalent.

Shipments of LAN interface  products  amounted to 20% of sales in 1998 and 1997.
The largest share of the Company's LAN interface  product  business is generated
from Commercial  Off-the-Shelf  (COTS) Department of Defense  projects.  Defense
project  revenue  declined  in 1998 by 13%  because  the award of a  significant
multi-year  contract was delayed until mid-September and interim orders were not
received  during  the  delay  period.  Also in the  third  quarter  of  1998,  a
significant  contract  was  received  from a new OEM  customer  for  PCIBus  LAN
products.  PCIBus products represented almost 13% of LAN revenue in 1998, versus
0% in 1997. Revenue from this OEM customer could approach $1.0 million in 1999.

Shipments of Network Systems products  represented 6% of sales in 1998, compared
to 9% in 1997.  Network  Systems are  primarily  comprised  of  shipments of I/O
subsystems  to an OEM customer  and sales of  specialized  communication  server
hardware and protocol software for specialty WAN  applications.  As anticipated,
shipments to the OEM customer  declined by  approximately $1 million in 1998 and
sales  of  specialized   communication   servers  also  declined  in  1998.  The
engineering staff supporting the server business was reassigned at the beginning
of 1998 to develop software for WAN communications  products.  A further decline
in Network Systems product revenue is expected in 1999 and beyond.

                                       15
<PAGE>

Shipments of Mass Storage  Interface  products for 1998 amounted to 9% of sales,
compared to 14% in 1997.  The  technologies  used in this market are moving from
SBus to PCIBus and from SCSI to Fibre  Channel.  The PCIBus  market has become a
commodity market with greater  competition and lower pricing.  While this market
was also  moving to the  Fibre  Channel  technology,  there  were  delays in the
adoption of standards.  As a result of these factors,  the Company's  PCIBus and
Fibre Channel  products do not effectively  compete in today's market. A further
decline in mass storage product revenue is forecasted in 1999 and beyond.

Shipments of Inter-system  Connectivity products represented 7% of sales in 1998
compared to 10% of sales in 1997.  The Company is not investing in this group of
products and a declining trend for this revenue is expected.

Gross Profit.  Gross profit consists of sales, less cost of goods sold including
materials costs, manufacturing expenses and amortization of software development
costs.  Gross  profit  in  1998  increased  by  $222,000  to  $17,863,000,  from
$17,641,000 in 1997.  Gross margin improved to 59% of sales in 1998, from 58% in
1997. While gross margin for the Company's WAN, LAN interface and Other products
is expected to average 59% or 60% in 1999,  the gross  margin on the new network
switching  products  is  forecasted  to average  approximately  45% for the year
because the Company intends to aggressively price these products in the market.

Total Operating Expenses.  Total operating expenses remained relatively constant
at 34% of sales in 1998 and  1997.  The  Company  increased  its  investment  in
research and development  during 1998, while  controlling  selling and marketing
expenses and reducing its general and administrative expenses.

Selling and marketing  expenses increased to $4,023,000 in 1998, from $3,988,000
in 1997, 13% of sales in 1998 and 1997. During 1998, the Company delayed certain
planned marketing and promotional  activities associated with the Nebula 8000 in
order to coordinate spending with the product's availability.  During the second
half of 1998,  the sales and  marketing  staff for the network  switch group was
increased in order to have a greater impact on sales in 1999. Management intends
to market its new products  aggressively in 1999 and expects sales and marketing
expenses to increase as a percentage of sales.

Research and development  expenses  increased by 12.0% to $4,165,000,  or 14% of
sales in 1998, compared to $3,720,000,  or 12% of sales in 1997.  Recruiting and
hiring engineers continues to be one of the Company's greatest challenges. While
a number of engineers were hired during 1998, the Company  continues to actively
recruit to fill open positions and has engaged outside  engineering  consultants
to assist on new product  development  projects.  The  increase in research  and
development  expenses in 1998 was primarily  the result of new engineers  hired,
outside engineering consultants,  and higher development costs for new products.
Management  believes research and development  expenses can fluctuate  quarterly
during 1999 but will only  increase  modestly as a  percentage  of sales for the
year.

General and administrative  expenses decreased to $2,035,000,  or 7% of sales in
1998,  compared  to  $2,711,000,  or 9% of  sales  in 1997.  While  the  Company
maintains tight control over its general and administrative  expenses, more than
one-half  of the 1998  expense  reduction  was  associated  with the Company not
achieving the internal growth goals and objectives  established in the Company's
1998 annual  incentive  plan.  Management  believes  general and  administrative
expenses should decline as a percentage of sales in 1999.

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

Income Taxes. The provision for income taxes for 1998 is based upon the combined
federal and state effective tax rate of 35%, compared to 38% in 1997.



                                       16
<PAGE>

Year Ended December 31, 1997, compared with the Year Ended December 31, 1996

Sales.  Sales  for 1997  increased  by  $5,493,000  (22%) to  $30,336,000,  from
$24,843,000 for 1996. The Company's  products are grouped into five  categories:
WAN Interface Adapter products, LAN Interface Adapter products,  Network Systems
products,   Mass  Storage  Interface  products  and  Inter-system   Connectivity
products.

Shipments  of WAN  Interface  Adapter  products  amounted to 47% of sales during
1997,  compared to 42% for 1996. This increase is attributable to  introductions
over the last twelve to eighteen  months of several new WAN products and several
new OEM customers  integrating  these products into their product  applications.
Shipments of LAN Interface  Adapter  products for 1997 amounted to 20% of sales,
compared to 21% for 1996.  The largest  share of the  Company's  LAN business is
generated from Commercial  Off-the-Shelf  (COTS) Defense  applications  which is
project-oriented and is difficult to predict on a quarterly basis.  Combined WAN
and LAN sales grew by 30% in 1997 and represented 77% of the Company's  business
in the fourth quarter of 1997.

Shipments of Network Systems products  represented 9% of total sales in 1997 and
11% for 1996.  Network  Systems are  primarily  comprised  of  shipments  of I/O
subsystems to a major OEM customer and specialty protocol software business sold
by the Company's subsidiary, UconX Corporation.  During the first nine months of
1997,  shipments of the I/O subsystem to this customer  represented $1.6 million
of revenue.  Due to what  appears to be a slowdown in orders for the  customer's
product that  incorporates  the Company's I/O subsystem  product,  this customer
requested delays of its fourth quarter  deliveries and has not placed any orders
for  product  deliveries  for the first  half of 1998.  The  specialty  software
protocol   business   is   typically   project-oriented   which  can  result  in
fluctuations.  The  volume of this  business  in 1997 was less  than  originally
forecasted and at the end of 1997, the Company integrated the UconX organization
into its corporate  structure.  The products and services of UconX will continue
to be sold but  future  engineering  efforts  will be more  focused on PTI's WAN
projects.

Shipments of Mass Storage Interface  products for 1997 amounted to 14% of sales,
compared  to 16% in  1996.  The  decrease  in sales  volume  is  believed  to be
attributable to a slow down in the RAID/disk drive market  primarily  associated
with the  Pacific  Rim  economic  issues in the fourth  quarter  and  technology
changes occurring in this market. These changes include customers  transitioning
from SBus to PCIBus  applications  and from the slower  SCSI  adapters to faster
Fibre  Channel  adapters.  The Company has been  transitioning  its products and
customers into these new technologies; however, the decline in the SBus business
has been greater than the increase in the PCI business.

Shipments of Inter-system  Connectivity  products  represented 10% of sales 1997
and 10% of total  sales  1996.  The  Company is not  investing  in this group of
products and a declining trend in these revenues is expected.

Gross Profit.  Gross profit consists of sales, less cost of goods sold including
materials costs, manufacturing expenses and amortization of software development
costs.  Gross  profit for 1997  increased by  $3,647,000  to  $17,641,000,  from
$13,994,000  for 1996 due to increased  sales volumes.  Gross margin  percentage
improved to 58.2% of sales for 1997,  from 56.3% in 1996. The improved margin is
attributable  to  favorable  product mix along with  manufacturing  efficiencies
associated with higher sales volumes.

Total Operating Expenses.  Total operating expenses increased to $10,419,000 for
1997, from $8,907,000 for 1996, but declined as a percentage of sales from 35.8%
in 1996 to 34.3% in 1997.  The Company made  significant  investments  in sales,
marketing,  research and development  during 1997 while reducing its general and
administrative expenses as a percentage of sales.

Selling and marketing  expenses  increased by 24.2% to  $3,988,000,  or 13.1% of
sales for 1997, from  $3,210,000,  or 12.9% of sales for 1996. The Company added
staff to the  sales  and  marketing  departments  resulting  in an  increase  of
compensation-related  expenses  in an effort to promote the  Company's  products
more  extensively  and increase market  penetration.  Spending for marketing and
promotion  increased  in 1997 as  compared to 1996,  primarily  due to the costs
incurred to introduce  the new  switching  products and to improve the Company's
presence in the marketplace.

                                       17
<PAGE>

Research and development expenses increased by 25.7% to $3,720,000,  or 12.3% of
sales for 1997, compared to $2,960,000, or 11.9% of sales for 1996. Research and
development  expenses consist primarily of employee salaries and benefits costs,
cost of materials  consumed in  developing  and designing new products and, to a
lesser extent,  contract  development.  Certain engineering  expenses associated
with the  development of software are capitalized and amortized to cost of goods
sold.  The increase in research and  development  expenses in 1997 was primarily
attributable to the hiring of eight additional  engineers and the development of
the new ASIC for the new switching  products.  The Company needs to  continually
invest in new product  development to stay abreast of  technological  changes in
its markets.

General and  administrative  expenses  decreased  to 8.9% of sales for 1997,  or
$2,711,000,  compared to $2,737,000, or 11.0% of sales for 1996. The decrease as
a  percentage  of sales is  primarily  attributable  to  maintaining  control of
administrative expenses.

Other income,  net. Other income consists primarily of interest income from cash
equivalents and marketable securities. The funds are primarily invested in money
market  funds,  high  quality  short  term  commercial  paper and U.S.  Treasury
securities maturing in less than 12 months.

Income Taxes. The provision for income taxes for 1997 is based upon the combined
federal and state  effective  tax rate of 38%,  compared  to 35.6% in 1996.  The
primary  reasons  for the  increase  in the  combined  tax rate  are the  higher
research and  development  tax credits  generated in 1996 and a lower benefit of
state income taxes in 1997.


Liquidity and Capital Resources

At December 31, 1998, the Company's  primary  source of liquidity  included cash
and cash equivalents of $25,627,000 and available borrowings of $5,000,000 under
a revolving credit facility with a bank. No amounts were outstanding  under this
credit  facility as of December  31,  1998.  The Company had working  capital of
$31,790,000 at December 31, 1998, compared to $26,584,000 at December 31, 1997.

Cash generated by operating activities was $6,503,000, $5,821,000 and $3,642,000
in 1998,  1997 and 1996,  respectively.  The  increase  in cash  generated  from
operating  activities in 1998 is attributable to greater net income and non-cash
adjustments offset by a net increase in operating assets and liabilities.

Cash provided by investing  activities was  $10,960,000 in 1998 and cash used in
investing   activities   was   $7,093,000  and  $7,469,000  in  1997  and  1996,
respectively.  During  1998,  investing  activities  included  the  purchase  of
marketable  securities of $6,000,000,  the maturity of marketable  securities of
$18,010,000,  and capital  equipment  purchases of $429,000.  Capital  equipment
purchases  consist  primarily of manufacturing  equipment,  office equipment and
computer and related  equipment used in  engineering.  In addition,  the Company
capitalizes  certain  software   development  costs.  Amounts  capitalized  were
$621,000, $704,000 and $380,000 in 1998, 1997 and 1996, respectively.

In March 1998,  the Board of Directors  authorized  the repurchase of up to $5.0
million of the Company's  Common Stock. As of December 31, 1998, the Company had
repurchased  a total of 78,437  shares at total cost of  $736,000.  The  program
authorized in 1998 is still in effect. Cash provided by financing  activities of
$67,000 and $78,000 for 1998 and 1997, respectively,  was principally the result
of the  exercise of stock  options.  During  1996,  cash  provided by  financing
activities was principally  the result of the Company's  initial public offering
of its Common Stock in January 1996.


                                       18
<PAGE>

Impact of the Year 2000 Issue

Many companies are facing a potential issue regarding the ability of information
systems to  accommodate  the coming year 2000. The Year 2000 issue is the result
of computer  programs  using only the last two digits to indicate  the year.  If
uncorrected, such computer programs will be unable to interpret dates beyond the
year 1999,  which could cause computer  system failure or other computer  errors
disrupting  operations.  The Company  recognizes the importance of the Year 2000
issue and has been giving it high priority. The Company created a corporate-wide
Year 2000  project team and the team's  objective is to ensure an  uninterrupted
transition  into the Year  2000.  The  scope of the Year 2000  readiness  effort
includes (i) information  technology ("IT") such as software and hardware;  (ii)
non-IT systems or embedded technology; and (iii) readiness of key third parties,
including suppliers and customers.  If needed  modifications and conversions are
not made on a timely  basis,  the Year 2000 issue could have a material  adverse
effect on the Company's results of operations or financial condition.

The Company has completed  phase I of its readiness  plan for its IT systems and
non-IT  systems.  This phase  consisted of evaluating  its systems and equipment
based on the current status and normal scheduled upgrade and replacement of such
system  components.  The Company is in the process of completing  Phase II which
consists  of  testing IT system and  non-IT  system  components  whose Year 2000
status  cannot be  determined  by research and has begun  certain parts of Phase
III,  upgrading  its IT system.  The  remaining  parts of Phase III are  planned
during the third quarter 1999, and will consist of upgrading and/or  replacement
of non-IT system components specifically required for Year 2000 readiness. Phase
IV,  planned  during the  fourth  quarter of 1999,  will  consist of  finalizing
contingency plans for temporary operation should unexpected difficulties with IT
systems and non-IT systems occur.  The  development of these  contingency  plans
began in conjunction with upgrading its IT system.

In addition  to internal  Year 2000 IT and non-IT  remediation  activities,  the
Company  has  contacted  key  suppliers  to  assure  no   interruption   in  the
relationship between the Company and these important third parties from the Year
2000 issue.  The Company is waiting for responses from these suppliers to assess
if such third  parties have any known Year 2000 issues.  If third parties do not
convert their  systems in a timely  manner and in a way that is compatible  with
the Company's systems,  the Year 2000 issue could have a material adverse effect
on Company  operations.  The Company believes that its diligent actions with key
suppliers will minimize these risks.

The vast majority of the Company's products are not date sensitive.  The Company
has of  summarized  information  on its products and this  information  has been
available to customers since November 1998.

While the  Company  expects its  internal IT and non-IT  systems to be Year 2000
compliant  by the dates  specified  within its  internal  plan,  the  Company is
working on a  contingency  plan  specifying  what the  Company  will do if it or
important third parties are not Year 2000 compliant by the required  dates.  The
Company expects to have such a contingency  plan finalized by the second half of
1999.

Through  December  1998,  the Company has not incurred  significant  incremental
costs related to the Year 2000 issue.  The total projected  incremental  cost is
estimated to be $150,000. The Company is expensing as incurred all costs related
to the  assessment  and  remediation of the Year 2000 issue unless the nature of
the item is an upgrade or  replacement of a system with a useful life that meets
the capitalization  policy of the Company.  These costs are being funded through
operating cash flows.  The Company's total cost for the Year 2000 issue includes
estimated costs and time associated  with  interfacing  with third parties' Year
2000 issues. These estimates are based on current information.

The  Company's  current  estimates of the amount of time and costs  necessary to
remediate and test its computer systems are based on the facts and circumstances
existing  at this time.  The  estimates  were made using  assumptions  of future
events  including the continued  availability  of certain  resources,  Year 2000
modification  plans,  implementation  success  by key  third-parties,  and other
factors. New developments may occur that could affect the Company's estimates of
the  amount of time and costs  necessary  to modify  and test its IT and  non-IT
systems  for Year  2000  compliance.  These  developments  include,  but are not
limited to: (i) the  availability  and cost of  personnel  trained in this area;
(ii) the  ability  to  locate  and  correct  all  relevant  computer  codes  and
equipment,  and (iii) the  planning  and Year 2000  compliance  success that key
customers and suppliers  attain. 


                                       19
<PAGE>

Year 2000  compliance is an issue for virtually all  businesses,  whose computer
systems and applications may require significant  hardware and software upgrades
or modifications. Companies owning and operating such systems may plan to devote
a  substantial  portion  of their  information  systems'  spending  to fund such
upgrades and  modifications.  It is the Company's  intention to fulfill its plan
and  become  Year  2000  compliant;  however,   uncertainties  exist  about  the
thoroughness  of how other  companies,  vendors,  customers  and  other  service
providers,  that the  Company  does  business  with will be  successful  at also
becoming Year 2000 compliant.  These other  companies,  regardless of the dollar
volume transacted with the Company,  may significantly affect either directly or
indirectly the operations of the Company.  Where  practicable,  the Company will
attempt to mitigate  its risks with  respect to the failure of  suppliers  to be
Year 2000  compliant.  In the event that suppliers are not Year 2000  compliant,
the Company will seek alternative  sources of supplies.  However,  such failures
remain a possibility  and could have an adverse impact on the Company's  results
of operations or financial condition.

ITEM 7A - Quantitative and Qualitative Disclosures About Market Risk 

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


ITEM 8 - Financial Statements and Supplementary Data

Index to Financial Statements: ..................................... Page

   Report of Independent Accountants ...............................   21
   Consolidated Balance Sheets at December 31, 1998 and 1997 .......   22
   Consolidated Statements of Income for the Three Years
      Ended December 31, 1998 ......................................   23
   Consolidated Statements of Changes in Stockholders' Equity
      for the Three Years Ended December 31, 1998 ..................   24
   Consolidated Statements of Cash Flows for the Three Years
      Ended December 31, 1998 ......................................   25
   Notes to Consolidated Financial Statements ......................   26

Index to Financial Statement Schedules:

All schedules have been omitted  because they are not applicable or the required
information is shown in the financial statements or notes thereto.



                                       20
<PAGE>


                        Report of Independent Accountants



February 12, 1999



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

In our opinion, the consolidated financial statements listed in the accompanying
index  present  fairly,  in all material  respects,  the  financial  position of
Performance Technologies, Incorporated and its subsidiaries at December 31, 1998
and 1997,  and the results of their  operations and their cash flows for each of
the three years in the period  ended  December  31,  1998,  in  conformity  with
generally accepted  accounting  principles.  These financial  statements are the
responsibility of the Company's management;  our responsibility is to express an
opinion on these  financial  statements  based on our audits.  We conducted  our
audits of these  statements  in  accordance  with  generally  accepted  auditing
standards which require that we plan and perform the audit to obtain  reasonable
assurance   about  whether  the  financial   statements  are  free  of  material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the  amounts  and  disclosures  in  the  financial  statements,   assessing  the
accounting  principles  used and significant  estimates made by management,  and
evaluating the overall  financial  statement  presentation.  We believe that our
audits provide a reasonable basis for the opinion expressed above.

/s/PricewaterhouseCoopers  LLP

PricewaterhouseCoopers LLP
Rochester, New York














                                       21
<PAGE>


<TABLE>
             PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
<CAPTION>

                                     ASSETS
                                                           December 31,
                                                      1998             1997  
                                                     ------           ------
<S>                                                <C>              <C>
Current assets:
   Cash and cash equivalents ...............       $25,627,000      $ 8,833,000
   Marketable securities ...................                         12,010,000
   Accounts receivable, net ................         4,799,000        4,956,000
   Inventories, net ........................         4,425,000        3,329,000
   Prepaid expenses and other ..............           679,000          346,000
   Deferred taxes ..........................           549,000          466,000
                                                   -----------      -----------
         Total current assets ..............        36,079,000       29,940,000

Equipment and improvements, net ............           934,000          982,000
Software development, net ..................           822,000          579,000
Other assets ...............................           125,000
                                                   -----------      ----------- 
         Total assets ......................       $37,835,000      $31,626,000
                                                   ===========      ===========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
   Current portion of long term debt .........     $    12,000      $    12,000
   Accounts payable ..........................       1,932,000          824,000
   Income taxes payable ......................         507,000          255,000
   Accrued expenses ..........................       1,838,000        2,265,000
                                                   -----------      ----------- 
         Total current liabilities ...........       4,289,000        3,356,000

Long term debt, less current portion .........           6,000           18,000
Deferred taxes ...............................         288,000          220,000
                                                   -----------      ----------- 
         Total liabilities ...................       4,583,000        3,594,000
                                                   -----------      ----------- 

Commitments

Stockholders' equity:
 Preferred stock - $.01 par value: 1,000,000
  shares  authorized;  none issued
 Common stock - $.01 par value; 15,000,000 shares
  authorized; 7,466,412 and 7,414,732 shares issued
  at December 31, 1998 and 1997, respectively ..        75,000           74,000
Additional paid-in capital .....................    13,250,000       13,055,000
Retained earnings ..............................    20,844,000       15,061,000
Treasury stock - at cost, 226,919 and 147,282
  shares held at December 31, 1998 and 1997,
 respectively ..................................      (917,000)        (158,000)
                                                   -----------      ----------- 
     Total stockholders' equity ................    33,252,000       28,032,000
                                                   -----------      ----------- 
     Total liabilities and stockholders' equity    $37,835,000      $31,626,000
                                                   ===========      =========== 





<FN>

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

</FN>
</TABLE>



                                       22
<PAGE>


<TABLE>

             PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF INCOME


<CAPTION>

                                              Year Ended December 31,
                                         1998           1997           1996     
                                     ------------   ------------   ------------ 
<S>                                  <C>            <C>            <C>         

Sales ...........................    $ 30,202,000   $ 30,336,000   $ 24,843,000
Cost of goods sold ..............      12,339,000     12,695,000     10,849,000
                                     ------------   ------------   ------------
Gross profit ....................      17,863,000     17,641,000     13,994,000
                                     ------------   ------------   ------------ 

Operating expenses:
   Selling and marketing ........       4,023,000      3,988,000      3,210,000
   Research and development .....       4,165,000      3,720,000      2,960,000
   General and administrative ...       2,035,000      2,711,000      2,737,000
                                     ------------   ------------   ------------ 
         Total operating expenses      10,223,000     10,419,000      8,907,000
                                     ------------   ------------   ------------ 
Income from operations ..........       7,640,000      7,222,000      5,087,000

Other income, net ...............       1,289,000      1,051,000        750,000
                                     ------------   ------------   ------------ 
Income before income taxes and
 minority interest ..............       8,929,000      8,273,000      5,837,000

Provision for income taxes ......       3,146,000      3,142,000      2,079,000
                                     ------------   ------------   ------------ 
Income before minority interest .       5,783,000      5,131,000      3,758,000

Minority interest ...............                                       (24,000)

Net income ......................    $  5,783,000   $  5,131,000   $  3,734,000
                                     ============   ============   ============


Basic earnings per share ........    $        .80   $        .71   $        .53
                                     ============   ============   ============ 

Diluted earnings per share ......    $        .76   $        .68   $        .52
                                     ============   ============   ============ 

















<FN>


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

</FN>
</TABLE>


                                       23
<PAGE>


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



<CAPTION>
                                  Additional
                  Common Stock     Paid-In    Treasury    Retained
                 Shares  Amount    Capital     Stock      Earnings     Total     
               ----------------- ----------- ---------- ----------- -----------
<S>            <C>       <C>     <C>         <C>        <C>         <C>       
Balance -
 January 1,
 1996          3,263,598 $33,000 $ 1,414,000 $ (156,000)$ 6,196,000 $ 7,487,000

1996 Net income                                           3,734,000   3,734,000
Exercise of
 options/warrants 35,820              74,000                             74,000
Tax benefit -
 warrant and
 option plans                         25,000                             25,000
Purchase of
 treasury stock -
 37 shares                                       (1,000)                 (1,000)
Initial public
 offering stock
 proceeds      1,600,000  16,000  11,372,000                         11,388,000
               --------- ------- ----------- ---------- ----------- -----------
Balance -
 December 31,
 1996          4,899,418  49,000  12,885,000   (157,000)  9,930,000  22,707,000

1997 Net income                                           5,131,000   5,131,000
Exercise of
 options          51,325   1,000     104,000                            105,000
Tax benefit -
 option plan                          90,000                             90,000
Three-for-two
 stock split   2,463,989  24,000     (24,000)
Purchase of
 treasury stock -
 71 shares                                       (1,000)                 (1,000)
               --------- ------- ----------- ---------- ----------- -----------  
Balance -
 December 31,
 1997          7,414,732  74,000  13,055,000   (158,000) 15,061,000  28,032,000

1998 Net income                                           5,783,000   5,783,000
Exercise of
 options          51,680   1,000     101,000                            102,000
Tax benefit -
 option plan                          94,000                             94,000
Purchase of
 treasury stock -
 79,637 shares                                 (759,000)               (759,000)
               --------- ------- ----------- ---------- ----------- -----------  
Balance -
 December 31,
 1998          7,466,412 $75,000 $13,250,000 $ (917,000)$20,844,000 $33,252,000
               ========= ======= =========== ========== =========== ===========
















<FN>

   The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>



                                       24
<PAGE>


<TABLE>
             PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<CAPTION>
                                               Year Ended December 31,
                                          1998           1997           1996     
                                         ------         ------         ------
<S>                                  <C>            <C>            <C>       
Cash flows from operating activities
 Net income                          $  5,783,000   $  5,131,000   $  3,734,000
 Non-cash adjustments:
  Depreciation and amortization           975,000      1,490,000        831,000
  Reserve for inventory obsolescence      802,000        262,000        609,000
  Deferred income taxes                   (15,000)       (46,000)      (119,000)
  Other                                    23,000         21,000       (113,000)
 Changes in operating assets
  and liabilities:
  Accounts receivable                     137,000     (1,743,000)      (895,000)
  Inventories                          (1,898,000)       441,000     (1,229,000)
  Prepaid expenses and other             (331,000)       (62,000)        25,000
  Accounts payable and
   accrued expenses                       681,000          5,000        418,000
  Income taxes payable                    346,000        322,000        381,000
                                     ------------   ------------   ------------
Net cash provided by
 operating activities                   6,503,000      5,821,000      3,642,000
                                     ------------   ------------   ------------ 

Cash flows from investing activities
 Purchase of equipment
  and improvements, net                  (429,000)      (481,000)      (719,000)
 Capitalized software development        (621,000)      (704,000)      (380,000)
 Purchase of marketable securities     (6,000,000)   (13,008,000)    (6,102,000)
 Maturities of marketable securities   18,010,000      7,100,000
 Purchase of remaining shares
  in subsidiary                                                        (268,000)
                                     ------------   ------------   ------------ 
Net cash provided (used)
 by investing activities               10,960,000     (7,093,000)    (7,469,000)
                                     ------------   ------------   ------------ 

Cash flows from financing activities
 Repayment of long-term debt              (12,000)       (26,000)       (74,000)
 Exercise of stock options and
  warrants                                 79,000        104,000         74,000
 Purchase of treasury stock              (736,000)
 Net proceeds from issuance of
  common stock                                                       11,388,000
                                     ------------   ------------   ------------ 
Net cash (used) provided
 by financing activities                 (669,000)        78,000     11,388,000
                                     ------------   ------------   ------------

Net increase (decrease) in
 cash and cash equivalents             16,794,000     (1,194,000)     7,561,000

Cash and cash equivalents
 at beginning of year                   8,833,000     10,027,000      2,466,000
                                     ------------   ------------   ------------ 

Cash and cash equivalents
 at end of year                      $ 25,627,000   $  8,833,000   $ 10,027,000
                                     ============   ============   ============


Supplemental disclosure of cash flow information:

 Interest paid                       $      4,000   $      4,000   $     13,000
 Income taxes paid                   $  2,827,000   $  2,865,000   $  1,853,000
Non-cash financing activity
 Exercise of stock options using
  1,200 shares of common stock       $     23,000




<FN>

   The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>



                                       25
<PAGE>


             PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


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

The Company: Performance Technologies, Incorporated was formed in 1981 under the
laws of the State of Delaware and maintains its corporate  offices in Rochester,
New  York.  The  Company  designs,  develops,   manufactures  and  markets  high
reliability,  and high availability  network switching and other  communications
solutions.

Segment Data,  Geographic  Information  and Significant  Customers:  The Company
operates in one industry  segment.  Export sales to customers outside the United
States  represent  23%, 10% and 11% of the  Company's  sales for the years ended
December 31, 1998,  1997 and 1996,  respectively.  For 1998, 1997 and 1996, four
customers  accounted for approximately  35%, 28% and 30%,  respectively,  of the
Company's sales, with no single customer  representing  greater than 13%, 8% and
12%, respectively, of the Company's sales.

Principles of Consolidation:  The consolidated  financial statements include the
accounts of the  Company  and its  wholly-owned  subsidiaries.  All  significant
intercompany transactions have been eliminated (Note E).

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

Concentration of Credit Risk: Financial instruments which potentially expose the
Company to significant concentrations of credit risk consist principally of bank
deposits,  marketable securities and accounts receivable.  Marketable securities
consist of high quality short-term interest bearing financial  instruments.  The
Company  performs  ongoing  credit  evaluations  of  its  customers'   financial
condition  and the Company  maintains an allowance  for  uncollectible  accounts
receivable based upon the expected collectibility of all accounts receivable.

Fair Value of  Financial  Instruments:  The  carrying  amounts of the  Company's
financial instruments, including cash and cash equivalents, accounts receivable,
accounts payable,  accrued expenses and loans approximate fair value at December
31, 1998, as the maturity of these  instruments are generally short term. Due to
differences  in the interest  rates on the long term debt compared to prevailing
rates,  the fair  value of these  instruments  does  vary  from  their  carrying
amounts, however, such differences are immaterial.

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

Marketable  Securities:  The Company has classified  all of its marketable  debt
securities  as held to  maturity  and has  accounted  for these  investments  at
amortized  cost.  Accordingly,  no adjustment  for  unrealized  holding gains or
losses has been  reflected in the  Company's  financial  statements.  Marketable
securities  classified as held to maturity are high credit quality securities in
accordance with the Company's investment policy.

Inventories:  Inventories  are  valued at the lower of cost or market  using the
first-in, first-out method.

Revenue  Recognition:  Revenue from hardware  sales is  recognized  upon product
shipment.

                                       26
<PAGE>

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

Equipment and Improvements:  Equipment and improvement purchases are recorded at
cost. Depreciation is computed using the straight-line method over the following
useful lives:

     Machinery and equipment            3-10 years
     Office furniture and equipment     3-5 years
     Leasehold improvements             The lesser of 10 years or the lease term

Upon retirement or disposal of an asset,  the asset and the related  accumulated
depreciation  are eliminated  from the accounts with gains or losses recorded in
the Consolidated Statements of Income.

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

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

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


Note B - Accounts Receivable

Accounts receivable consisted of the following:
<TABLE>
<CAPTION>

                                                          At December 31,
                                                       1998             1997  
                                                      ------           ------
<S>                                                <C>              <C>        
Accounts receivable                                $ 4,992,000      $ 5,148,000
Less:  allowance for doubtful accounts                (193,000)        (192,000)
                                                   -----------      -----------
      Net                                          $ 4,799,000      $ 4,956,000
                                                   ===========      ===========
</TABLE>


Note C - Inventories

Inventories consisted of the following:
<TABLE>
<CAPTION>

                                                          At December 31,
                                                       1998             1997  
                                                      ------           ------      
<S>                                                <C>              <C>        
Purchased parts and components                     $ 1,905,000      $   954,000
Work in process                                      3,011,000        2,580,000
Finished goods                                         130,000          333,000
                                                   -----------      -----------   
                                                     5,046,000        3,867,000
Less:  reserve for inventory obsolescence             (621,000)        (538,000)
                                                   -----------      -----------
      Net                                          $ 4,425,000      $ 3,329,000
                                                   ===========      ===========   
</TABLE>

                                       27
<PAGE>


Note D - Equipment and Improvements

Equipment and improvements consisted of the following:
<TABLE>
<CAPTION>

                                                          At December 31,
                                                       1998             1997  
                                                      ------           ------   
<S>                                                <C>              <C>        
Engineering equipment and software                 $ 1,442,000      $ 1,294,000
Manufacturing equipment                              1,269,000        1,140,000
Furniture and equipment                                874,000          785,000
Leasehold improvements                                 134,000          130,000
                                                   -----------      -----------   
                                                     3,719,000        3,349,000
Less:  accumulated depreciation and amortization    (2,785,000)      (2,367,000)
                                                   -----------      -----------
       Net                                         $   934,000      $   982,000
                                                   ===========      ===========   
</TABLE>

Total  depreciation and amortization  expense for equipment and improvements for
1998, 1997 and 1996 was $418,000, $426,000 and $417,000, respectively.

Note E -  Other Assets

Effective  January 1, 1998, the Company  integrated the operations and assets of
its  San  Diego  based  subsidiary,   Uconx  Corporation,   into  its  corporate
operations.  The  Company  recorded  a  charge  to  operating  expenses  for the
remaining  amount  of  unamortized   goodwill  during  1998  as  its  value  had
significantly  decreased  as a result of declining  revenue of this  subsidiary.
Amortization  expense for  goodwill  was  $123,000,  $50,000 and $45,000 for the
years ended December 31, 1998, 1997 and 1996, respectively.


Note F - Accrued Expenses

Accrued expenses consisted of the following:
<TABLE>
<CAPTION>

                                                           At December 31,
                                                        1998             1997  
                                                       ------           ------  
<S>                                                 <C>              <C>       
Accrued compensation                                $  844,000       $1,500,000
Other accrued expenses                                 994,000          765,000
                                                    ----------       ----------   
      Total                                         $1,838,000       $2,265,000
                                                    ==========       ==========   
</TABLE>


Note G - Long Term Debt and Credit Agreement

During 1998, the Company signed a new two-year  revolving  credit loan agreement
with  a  bank  increasing  the  available  borrowing  capacity  to  $5  million.
Borrowings  bear  interest  ranging  between the bank's  prime rate or one month
LIBOR plus applicable basis points as outlined in the agreement.  Borrowings are
collateralized  by trade accounts  receivable,  inventory,  equipment,  contract
rights and  intangibles.  The  agreement  requires  the Company to meet  certain
financial and non-financial  covenants.  The Company was in compliance with such
covenants at December 31, 1998.  There were no balances  outstanding  under this
agreement at December 31, 1998 and 1997.

In June  1993,  the  Company  borrowed  $80,000  from the City of  Rochester  to
purchase equipment.  The seven year loan bears interest at 2%. The loan is fully
collateralized  by an irrevocable  letter of credit.  This agreement  contains a
covenant  requiring the Company to maintain  substantially all of its operations
located within the  boundaries of the  municipality.  The amount  outstanding at
December 31, 1998 and 1997 was $18,000 and $30,000,  respectively,  and the long
term amount  outstanding  at December  31, 1998 and 1997 was $6,000 and $18,000,
respectively.  As of December 31, 1998,  the  aggregate  maturities  of the loan
payable for the years ending  December 31, 1999 and 2000 are $12,000 and $6,000,
respectively.


                                       28
<PAGE>

Note H - Commitments

The Company leases  facilities and equipment under operating  leases.  Under the
terms of the facility lease for its primary operations which expires in the year
2001,  the Company agrees to pay an annual rental of $270,000 with an adjustment
each year based upon the Consumer  Price Index.  The Company is also required to
pay their pro rata share of the real property  taxes and  assessments,  expenses
and other charges  associated with this facility.  The Company has the option to
renew the lease  for two  successive  periods  of five  years  each at an annual
rental in accordance with the provisions of the lease agreement.

Future minimum lease  payments for all operating  leases having a remaining term
in excess of one year at December 31, 1998 are as follows:
<TABLE>
<CAPTION>
                                                                    Operating
                                                                    Leases   
          <S>                                                     <C>        
          1999                                                    $   512,000
          2000                                                        431,000
          2001                                                        236,000
          2002                                                         81,000
                                                                  -----------
Total minimum lease payments                                      $ 1,260,000
                                                                  ===========
</TABLE>

Rental expense  amounted to $471,000,  $557,000 and $500,000 for 1998,  1997 and
1996, respectively.

Note I - Stockholders'  Equity

In March 1998,  the Board of Directors  authorized  the repurchase of up to $5.0
million of the Company's  Common Stock.  During 1998, the Company  repurchased a
total of 78,437 shares at a total cost of $736,000.

On July 31, 1997, the Board of Directors declared a three-for-two stock split of
the  Company's  common stock  effected in the form of a stock  dividend  paid on
September  15,  1997.  All  agreements   concerning   stock  options  and  other
commitments  payable in shares of the  Company's  common stock  provided for the
issuance of  additional  shares due to the  declaration  of the stock split.  An
amount equal to the par value of the common shares issued was  transferred  from
capital in excess of par value to the common stock  account.  All  references to
number of shares  and to per share  information  in the  consolidated  financial
statements,  except shares authorized and 1996 common shares, have been adjusted
to reflect the stock split on a retroactive basis.

On January 24, 1996,  the Company  completed the issuance of an  additional  1.6
million shares of its common stock through an initial public offering, resulting
in net proceeds of $11.4 million.

Under the Incentive  Stock Option Plan  established  in 1986, 1.8 million common
shares were reserved for grant by the Board of Directors. Options may be granted
to any officer,  director or employee at not less than the fair market values at
the date of grant  (not less than 110% of the fair  market  value in the case of
holders of more than 10% of the Company's  common stock).  Options granted under
the plan  generally  expire five years from the date of grant and generally vest
20% after one year, 50% after two years and 100% after three years.

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


                                       29
<PAGE>

The following table summarizes stock option activity under this plan:
<TABLE>
<CAPTION>
                                                    Weighted-Average   Option
                                   Number of Shares  Exercise Price  Price Range
                                   ---------------- ---------------- -----------
<S>                                       <C>            <C>       <C>

Outstanding at January 1, 1996            199,986         $1.57    $1.22-$ 2.01
Granted                                   348,000         $7.66    $6.67-$ 9.83
Exercised                                 (48,510)        $1.39    $1.22-$ 1.83
Expired                                    (1,282)        $1.69    $1.52-$ 1.83
                                          -------         ------   ------------

Outstanding at December 31, 1996          498,194         $5.84    $1.22-$ 9.84
Granted                                   143,250         $8.13    $7.25-$13.00
Exercised                                 (65,618)        $1.60    $1.21-$ 7.83
Expired                                    (2,325)        $4.93    $1.21-$ 7.83
                                          -------         ------   ------------   

Outstanding at December 31, 1997          573,501         $6.90    $1.33-$13.00
Granted                                   152,250        $13.84    $9.25-$14.63
Exercised                                 (51,680)        $1.97    $1.33-$ 7.58

Expired                                    (1,000)       $13.00          $13.00
                                          -------         ------   ------------   

Outstanding at December 31, 1998          673,071         $8.84    $1.52-$14.63
                                          =======         =====    ============
</TABLE>

At December  31,  1998,  430,267  options  were vested and 704,687  options were
available  for future grant under the stock  option plan.  At December 31, 1998,
75,000 warrants are held by two of the Company's  directors at an exercise price
of $1.83 per share and expire in the year 2000. During 1996, 3,750 warrants were
exercised by an outside director and a consultant.

The Company has adopted the disclosure only provisions of Statement of Financial
Accounting  Standards  No.  123,  "Accounting  for  Stock-Based   Compensation."
Accordingly, no compensation cost has been recognized for the stock option plan.
Had compensation  cost for the Company's stock option plan been determined based
on the fair value at the grant date for awards in 1998 and 1997  consistent with
the provisions of SFAS No. 123, the Company's net income would have been reduced
to the pro forma  amounts of  $4,617,000  and  $4,371,000,  respectively.  Basic
earnings per share would have been reduced to the pro forma  amounts of $.63 and
$.60,  respectively.  Diluted  earnings per share would have been reduced to the
pro forma amounts of $.61 and $.58, respectively.

The assumption  regarding the stock options issued in 1998 and 1997 was that 33%
of such  options  vested  annually.  The  fair  value  of each  option  grant is
estimated on the date of grant using the Black-Scholes option-pricing model with
the  following  weighted-average  assumptions  used for grants in 1998 and 1997:
dividend yield of 0%;  expected  volatility of 62% and 61%;  risk-free  interest
rate of 5.5% and 6.5%; and expected lives of five years.


Note J - Income Taxes

The provisions for income taxes were as follows:
<TABLE>
<CAPTION>

Current income taxes                      1998           1997           1996    
                                         ------         ------         ------
   <S>                                <C>            <C>            <C>        
   Federal                            $ 2,711,000    $ 2,814,000    $ 1,852,000
   State                                  450,000        374,000        346,000
                                      -----------    -----------    ----------- 
                                        3,161,000      3,188,000      2,198,000
Deferred benefit                          (15,000)       (46,000)      (119,000)
                                      -----------    -----------    -----------
   Total provision                    $ 3,146,000    $ 3,142,000    $ 2,079,000
                                      ===========    ===========    ===========
</TABLE>

                                       30
<PAGE>

The provision for income taxes from differ from those computed using the federal
tax rate of 34% due to the following:
<TABLE>
<CAPTION>

                                                 1998        1997        1996
                                                ------      ------      ------
<S>                                              <C>         <C>         <C>  
Federal income tax at statutory rate             34.0%       34.0%       34.0%
Research and development tax credits             (0.5)       (2.0)       (2.7)
State tax provision, net of federal benefit       3.3         2.9         3.9
Other                                            (1.6)        3.1         0.4
                                                ------      ------      ------
   Effective tax rate                            35.2%       38.0%       35.6%
                                                ======      ======      ======
</TABLE>

The Company's net deferred income tax balance consists of the following:
<TABLE>
<CAPTION>

                                                          At December 31,
Deferred tax liabilities                               1998             1997     
------------------------                              ------           ------
<S>                                                <C>              <C>        
Capitalized software development cost, net         $   288,000      $   220,000
                                                   -----------      -----------
Deferred tax assets
-------------------
Accrued vacation, payroll
 and other accrued expenses                           (199,000)        (101,000)
Inventory obsolescence reserve and
 other inventory related items                        (188,000)        (205,000)
Bad debt reserve                                       (68,000)         (73,000)
Research tax credits                                   (27,000)         (31,000)
Other                                                  (67,000)         (56,000)
                                                   -----------      -----------       
   Total deferred tax assets                          (549,000)        (466,000)
                                                   -----------      -----------       
      Net deferred tax asset                       $  (261,000)     $  (246,000)
                                                   ===========      ===========
</TABLE>

The carryforward research credits begin to expire in 2006.


Note K - Research and Software Development Costs

The Corporation incurred research and software development costs relating to the
development of new products as follows:
<TABLE>
<CAPTION>

                                          1998           1997           1996
                                         ------         ------         ------
<S>                                   <C>            <C>            <C>       
Gross expenditures for engineering
  and software development            $ 4,842,000    $ 4,764,000    $ 3,460,000
Less:  amounts capitalized               (677,000)    (1,044,000)      (500,000)
                                      -----------    -----------    -----------
   Net charged to operating expenses  $ 4,165,000    $ 3,720,000    $ 2,960,000
                                      ===========    ===========    ===========
</TABLE>

Software Development costs consisted of the following:
<TABLE>
<CAPTION>

                                                          At December 31,
                                                       1998             1997
                                                      ------           ------     
<S>                                                <C>              <C>        
Capitalized software development costs             $ 2,216,000      $ 1,723,000
Less:  accumulated amortization                     (1,394,000)      (1,144,000)
                                                   -----------      -----------
   Net                                             $   822,000      $   579,000
                                                   ===========      ===========
</TABLE>

Amortization  of software  development  costs included in cost of goods sold was
$434,000, $1,014,000 and $369,000 for 1998, 1997 and 1996, respectively.


                                       31
<PAGE>

Note L  - Earnings Per Share

Basic  earnings per share (EPS) is computed by dividing net income  available to
common  stockholders by the weighted average number of common shares outstanding
for the period.  Diluted EPS is computed giving effect to all dilutive potential
common shares that were outstanding during the period. Dilutive potential common
equivalent  shares  consist  of the  incremental  common  shares  issuable  upon
exercise of stock options and  warrants.  The following  table  illustrates  the
calculation of both basic and diluted EPS: 
<TABLE> 
<CAPTION>

                                          1998           1997           1996       
                                         ------         ------         ------   
<S>                                    <C>            <C>            <C>
Net income available
 to common stockholders                $5,783,000     $5,131,000     $3,734,000
                                       ----------     ----------     ---------- 
Weighted average common shares          7,274,110      7,230,902      7,019,746
                                       ----------     ----------     ----------
  Basic earnings per share             $      .80     $      .71     $      .53
                                       ==========     ==========     ==========

Diluted earnings per share
Net income available
 to common stockholders                $5,783,000     $5,131,000     $3,734,000
                                       ----------     ----------     ---------- 
Weighted average common shares          7,274,110      7,230,902      7,019,746
Common equivalent shares                  293,396        291,016        228,631
                                       ----------     ----------     ---------- 
Weighted average common and
 common equivalent shares               7,567,506      7,521,918      7,248,377
                                       ----------     ----------     ---------- 
  Diluted earnings per share           $      .76     $      .68     $      .52
                                       ==========     ==========     ========== 
</TABLE>


Note M - Employee Benefit Plans

The Company's  Retirement  Savings Plan  qualifies  under Section  401(k) of the
Internal Revenue Code. The Company's discretionary matching contributions to the
plan were $86,000,  $92,000 and $126,000 for 1998, 1997, and 1996, respectively.
In  conjunction  with the Company's  Flexible  Benefits  plan,  the Company made
additional discretionary qualified contributions to employee accounts which vest
immediately amounting to $128,000, $108,000 and zero for 1998, 1997 and 1996.


Note N - Transactions with Related Parties

The  Company  leases  its  primary  facility  from an entity  controlled  by two
directors of the Company,  one of whom is an officer.  During  1998,  1997,  and
1996, the Company paid rent of $319,000, $318,000 and $307,000, respectively.
(Note H)


                                       32
<PAGE>

Note O - Quarterly Results (unaudited)
<TABLE>
<CAPTION>

                                                          1998                  
                                         (in thousands, except per share data)
                                        Mar. 31    Jun. 30    Sept. 30   Dec. 31
                                        -------    -------    --------   -------
<S>                                      <C>        <C>        <C>        <C>   
Sales                                    $7,411     $6,051     $7,857     $8,883
Gross profit                              4,548      3,569      4,910      4,836
Income from operations                    1,906      1,021      2,017      2,696
Net income                               $1,419     $  861     $1,530     $1,973

Basic earnings per share                 $ 0.20     $ 0.12     $ 0.21     $ 0.27
                                         ======     ======     ======     ======
Diluted earnings per share               $ 0.18     $ 0.11     $ 0.20     $ 0.26
                                         ======     ======     ======     ======


                                                          1997                  
                                         (in thousands, except per share data)
                                        Mar. 31    Jun. 30    Sept. 30   Dec. 31
                                        -------    -------    --------   -------
Sales                                    $7,434     $7,539     $7,606     $7,757
Gross profit                              4,102      4,514      4,343      4,682
Income from operations                    1,563      1,700      1,996      1,963
Net income                               $1,112     $1,200     $1,402     $1,417

Basic earnings per share                 $ 0.15     $ 0.17     $ 0.19     $ 0.20
                                         ======     ======     ======     ======
Diluted earnings per share               $ 0.15     $ 0.16     $ 0.18     $ 0.18
                                         ======     ======     ======     ======
</TABLE>



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

Not Applicable





                                       33
<PAGE>

PART III


The information  required by Part III and each of the following items is omitted
from this Report and presented in the Company's definitive proxy statement to be
filed,  pursuant to Regulation  14A not later than 120 days after the end of the
fiscal year covered by this Report,  in  connection  with the  Company's  Annual
Meeting of Stockholders to be held on June 8, 1999, which  information  included
therein is incorporated herein by reference.


ITEM 10 - Directors and Executive Officers of the Registrant

The section  entitled  "Election of Directors"  appearing in the Company's proxy
statement  for the Annual  Meeting of  Stockholders  to be held on June 8, 1999,
sets forth certain  information with respect to the directors of the Company and
is incorporated herein by reference.


ITEM 11 - Executive Compensation

The section entitled "Executive  Compensation"  appearing in the Company's proxy
statement  for the Annual  Meeting of  Stockholders  to be held on June 8, 1999,
sets forth certain information with respect to the compensation of management of
the Company and is incorporated herein by reference.


ITEM 12 - Security Ownership of Certain Beneficial Owners and Management

The  section  entitled  "Security  Ownership  of Certain  Beneficial  Owners and
Management" appearing in the Company's proxy statement for the Annual Meeting of
Stockholders  to be held on June 8, 1999,  set forth  certain  information  with
respect to the  ownership  of the  Company's  Common  Stock and is  incorporated
herein by reference.


ITEM 13 - Certain Relationships and Related Transactions

The section  entitled  "Certain  Transactions"  appearing in the Company's proxy
statement  for the Annual  Meeting of  Stockholders  to be held on June 8, 1999,
sets forth certain  information with respect to certain  business  relationships
and  transactions  between the Company and its  directors  and  officers  and is
incorporated herein by reference.



                                       34
<PAGE>


PART IV


ITEM 14 - Exhibits, Financial Statement Schedules, Reports on Form 8-K

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

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

(3)      Exhibits
Exhibit        Ref.
Number         Number        Description    
3.1            (1)           Restated Certificate of Incorporation
3.2            (1)           Amended By-laws
4.1            (1)           Form of Common Stock Certificate
4.2            (2)           Amended and Restated Stock Option Plan
10             (1)           Material Contracts
10.1           (--)*         Revolving Credit Agreement dated as of December 30,
                                    1998  between the  Registrant  and The Chase
                                    Manhattan Bank, N.A.
10.2           (--)*         Revolving Credit  Note in the amount of  $5,000,000
                                    dated   December   30,  1998  given  by  the
                                    Registrant to The Chase Manhattan Bank, N.A.
10.3           (1)           Security Agreements  granted by the  Registrant  to
                                    The Chase  Manhattan  Bank, N.A. dated as of
                                    April 13,  1985,  April  13,  1993 and as of
                                    June  17,   1993,   and  with   respect   to
                                    Performance  Computer  Corporation only, the
                                    Security Agreement dated as of June 17, 1993
                                    granted to The Chase Manhattan Bank, N.A. by
                                    Performance Computer Corporation and certain
                                    other  Affiliates of the  Registrant  (which
                                    other Affiliates have been released) and all
                                    amendments and modifications thereto
10.4           (1)           Letter of Intent from the City of  Rochester to the
                                    Registrant dated May 4, 1993
10.5           (1)           Irrevocable Standby Letter of Credit from The Chase
                                    Manhattan Bank, N.A. dated June 4, 1993
10.6           (1)           Promissory Note in the amount of $80,000 dated June
                                    8, 1993 given by the  Registrant to the City
                                    of Rochester
10.7           (1)           Letter of  Credit   and   Reimbursement   Agreement
                                    between C & J Enterprises  and Chase Lincoln
                                    First Bank, N.A. dated September 1, 1990
10.8           (1)           Corporation  Guaranty   Agreement  granted  by  the
                                    Registrant,  PTI Acquisition  Corporation to
                                    Chase Lincoln First Bank,  N.A.  dated as of
                                    September 1, 1990
10.9           (1)           Guaranty Agreement  dated  August 31, 1995  between
                                    the Registrant and the City of Rochester
10.10          (1)           Sublease Agreement between the Registrant and C & J
                                    Enterprises dated as of September 1, 1990
10.11          (1)           Master Equipment  Lease between the  Registrant and
                                    Fleet Credit  Corporation  dated as of March
                                    30, 1992
10.12          (1)           Master Equipment Lease between the Registrant and M
                                    & M Associates dated February 1, 1993
10.13          (1)           Master Equipment Lease between the Registrant and M
                                    & M Associates dated November 1, 1993
10.14          (1)           Agreement between the  Registrant  and Loral Test &
                                    Information Systems dated November 2, 1995


                                       35
<PAGE>

Exhibit        Ref.
Number         Number        Description    
10.15          (1)           License  Agreement  between  the   Registrant   and
                                    Willemijn  Houdstermaatschappij  BV dated as
                                    of January 1, 1994
10.16          (1)           License Agreement between the Registrant and Spider
                                    Systems Limited dated March 18, 1992
10.28          (1)           Adoption  Agreement   between  the  Registrant  and
                                    Principal  Mutual  Life  Insurance   Company
                                    dated September 20, 1993
10.29          (1)           The    Principal  Financial  Group  Prototype Basic
                                    Savings Plan dated May 7, 1990
10.30          (1)           Form of Stock Option Agreement
10.31          (1)           Form of Warrant Agreement
21             (--)*         Subsidiaries
--------------------------------------------------------------------------------
(1) Incorporated by reference to the Registrant's Registration Statement on Form
    S-1 filed  November 22, 1995.  
(2) Incorporated  by reference to the Registrant
    Statement on Form S-8 filed July 30, 1997.
 *  Filed with this Form 10-K













(4)      Reports on Form 8-K
         None











                                       36
<PAGE>


                                   SIGNATURES

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

                                        PERFORMANCE TECHNOLOGIES, INCORPORATED

Date:  March 22, 1999                        By:/s/DONALD L. TURRELL
                                             -----------------------
                                             Donald L. Turrell
                                             President and
                                             Chief Executive Officer

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

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

         Signature                      Title                        Date


/s/CHARLES E. MAGINNESS         Chairman of the Board            March 22, 1999
-----------------------
Charles E. Maginness             and Director


S/DONALD L. TURRELL             President, Chief Executive       March 22, 1999
-----------------------
Donald L. Turrell               Officer and Director


/s/DORRANCE W. LAMB             Chief Financial Officer, and     March 22, 1999
-----------------------
Dorrance W. Lamb                Vice President of Finance


/s/BERNARD KOZEL                Director                         March 22, 1999
-----------------------
Bernard Kozel


/s/JOHN E. MOONEY               Director                         March 22, 1999
-----------------------
John E. Mooney


/s/JOHN M. SLUSSER              Director                         March 22, 1999
-----------------------
John M. Slusser


/S/PAUL L. SMITH                Director                         March 22, 1999
-----------------------
Paul L. Smith

                                       37