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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, 1997
                                              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. [X]

     The aggregate  market value of the voting stock held by  non-affiliates  of
the   registrant  as  of  the  close  of  business  on  February  25,  1998  was
approximately $99,872,000.

     The number of shares outstanding of the registrant's Common Stock, $.01 par
value, was approximately 7,273,000 as of February  25,  1998.

                             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 3, 1998,  which will be filed with the  Securities and Exchange
Commission not later than 120 days after December 31, 1997.
--------------------------------------------------------------------------------
                                    -Cover Page of 37 Pages-



<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                                 11
Item 6        Selected Financial Data                                        12
Item 7        Management's Discussion and Analysis of Financial
                 Condition and Results of Operations                         13

Item 8        Financial Statements and Supplementary Data                    18
Item 9        Changes in and Disagreements with Accountants on
                 Accounting and Financial Disclosure                         33


PART III

Item 10       Directors and Executive Officers of the Registrant             34
Item 11       Executive Compensation                                         34
Item 12       Security Ownership of Certain Beneficial Owners
                 and Management                                              34
Item 13       Certain Relationships and Related Transactions                 34


PART IV

Item 14       Exhibits, Financial Statement Schedules, Reports on Form 8-K   35



<PAGE>
PART I


ITEM 1 - Business

Performance Technologies,  Incorporated designs, manufactures and markets a wide
variety of fault-tolerant, high performance communications,  networking and data
storage interface  products.  The company's products are designed to enhance the
performance of customers'  computer  network  systems and include local and wide
area network interface adapters,  communications servers, mass storage interface
products and  sophisticated  software  communications  solutions.  The company's
products are  targeted  toward high  performance,  mission  critical  networking
solutions for the  telecommunications,  financial  services,  defense and public
safety  industries.   Applications   include  network  interfaces  for  cellular
telephone communications,  data storage products found in bank ATMs, fiber optic
data communications products used aboard navy vessels and communications servers
used in air traffic control centers.

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
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  significantly
increase both sales and income over the last five years.

All  references  to  the  "company"  herein  include  Performance  Technologies,
Incorporated,  the company's  wholly-owned foreign sales subsidiary,  PTI Virgin
Islands  Company,  Ltd.  and  the  company's  wholly-owned   subsidiary,   UconX
Corporation (UconX).

Industry Overview

The need to collect,  store,  analyze and  distribute  information  in a secure,
timely  and  efficient  manner  has  become  an  integral  part of  operating  a
successful  organization.  Developments in computer  technology have resulted in
less reliance on  centralized  mainframes  and greater  reliance on  distributed
computing. In its initial stages of evolution,  distributed computing led to the
computer software architecture concept of "client/server" systems. Client/server
computing  systems have typically  included a large number of desktop  computers
interconnected  with one, or often more than one,  server.  The server  provides
central resources to all remote computer users and provides common services such
as printing, communications, data backup and information gateways to other local
or distant  client/server  systems.  The  client/server  model has  continued to
evolve from a site based system that was typically found in a limited geographic
area (e.g. campus, manufacturing complex or office environment) to client/server
systems that are worldwide in their reach and operation. The fundamental premise
of this expanding  computer and information  paradigm relies heavily on computer
data  networking  for both  LANs  (Local  Area  Network)  to  provide  the local
client-to-server  communications  and WANs  (Wide  Area  Network)  for  seamless
communication  between  servers which may be located on different  continents of
the world.

As a result of the rapidly  growing  installed base of  client/server  computing
systems,  the market opportunity for client/server  networking and communication
products is rapidly expanding.  According to a recent industry study, there were
approximately  33 million Ethernet LAN connections  installed  worldwide in 1993
and the number of those  connections  is  expected to grow to over 84 million by
1998.  The WAN  communication  area is also  expected to grow at a similar pace.
This  growth,  combined  with other  market  trends,  is  expected  to cause the
computer  networking  equipment  industry to continue to experience  substantial
increase in demand into the next millennium.

Strategy

The  company's  strategy is to enhance the  performance  of  customers'  network
systems by  providing a wide variety of  fault-tolerant,  high  performance  and
easily  managed   networking   solutions   targeted   toward  mission   critical
applications. Major elements of the company's operational strategy include:

                                       1
<PAGE>

Focus on High Performance Mission Critical  Solutions.  The company continues to
focus its development  efforts on addressing specific needs for high performance
networking.  The  company's  products  have  provided  unique  mission  critical
solutions where  reliability  and  performance  are the primary  concerns of the
user.   Applications   include   network   interfaces  for  cellular   telephone
communications,  fault-tolerant  Fiber  Digital Data  Interface  (FDDI)  adapter
products   used  aboard  navy  vessels  and   terrestrial   military   vehicles,
communications  servers used in air traffic  control and data  storage  products
found in bank ATMs. 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 dominated by low price and large volumes.

Exploit  Technological  Competencies.  Since  its  inception,  the  company  has
pioneered many innovations in networking technology including the VME64 industry
standard,  proprietary ASICs and the early use of the SCSIbus standard for local
area networking.  These  technological  competencies have allowed the company to
develop  products  that improve  network  performance  without  rendering an end
user's network equipment  obsolete.  Management  intends to continue to leverage
off of these  competencies to position the company as a technological  leader in
high performance 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
users. 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 Compact PCI (cPCI).  Several of these products have been early and unique
entrants into the growth oriented  PCIbus and cPCI arena for supporting  complex
communications  protocols and networks. These new products have been responsible
for a variety of potentially significant OEM and partnering  relationships.  The
company has also  developed  switching  products for Ethernet  LANs  directed at
specific  applications  requiring high  availability for which it plans to start
deliveries in 1998.

Expand International  Markets. The networking and computer markets served by the
company are international in scope. Global demand for network products,  such as
those  manufactured  by the company,  is driven by the increasing  dependence of
business on the successful implementation of networking  infrastructures.  While
the company  markets  its  products  in Europe and the Asia  Pacific  countries,
currently  international  sales only  account  for  approximately  10% of sales.
During 1996,  the company  expanded its direct sales  presence into the European
Economic  Community  (E.E.C)  with the  opening  of a sales  office  in  Munich,
Germany. The company intends to continue expanding its international  efforts in
the Asia Pacific  countries and the European  arena.  In 1998,  the company will
employ a variety of third  party  organizations  to assist in  establishing  and
developing  both OEM and  distribution  accounts in Europe and the Asia  Pacific
regions.  This expanded effort will augment the company's  existing direct sales
office  operations  that  exist in the E. E. C.  arena.  (See  Footnote A to the
consolidated financial statements included elsewhere in this report).

Leverage Software Expertise.  The company has successfully employed its software
expertise in targeted  industries  and  applications,  including  financial data
information  services,  air traffic radar installations and defense applications
and deep space telemetry. The company plans to continue to leverage its existing
networking and mass storage interface software expertise in distributed  network
management and control,  integration of legacy networking  protocols and virtual
LAN implementation.

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 for the manufacturing 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  equipment  and make  timely  deliveries.  The  company's
manufacturing   facility   operates   under  an   integrated   MRP  system  that
significantly  reduces  lead  time and  inventory  investments  and  facilitates
effective demand forecast.  This in-house manufacturing  capability provides the
company  with the means to  quickly  launch  new  products  without  the  delays
normally associated with the use of manufacturing subcontractors. It is expected
that additional capital expansion in surface mount component capacity will occur
over the next  12-18  months to assure  continued  high  quality  assembly  with
adequate  capacity to meet  expected  delivery  requirements  for the  company's
expanding  customer base. During 1997, the company's  manufacturing  process was
certified under the ISO 9002 quality program.

                                       2
<PAGE>

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.  These
platforms include systems built on the VMEbus standard,  the SBus standard,  the
newer PCIbus  standard now found on a broad range of computer  platforms and the
emerging  industrial  standard,  cPCI . 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.

WAN Interface  Adapter  Products.  The company's WAN interface  adapter products
include modules that provide connectivity between the SBus, VMEbus, PCI and cPCI
computer platforms and the wide area communications  network.  The company's WAN
interface  adapter  products are found in a wide variety of  applications  which
include network interfaces for cellular telephone transmitter sites, billing and
control information for long distance telephone  communications,  and control of
remote police,  ambulance and municipal radio  transmitter  locations.  Selected
end-users  include  Lucent  Technologies,   Digital  Equipment  Corporation  and
QualComm  Corporation.  Products  include  interface  adapters for use in VMEbus
systems and high speed interface adapters for the Sun Microsystems' SBus market.
During 1996, the company  released  three WAN interface  adapters for the PCIbus
architecture.  In 1997 this family of PCI WAN  products  was expanded to include
the new cPCI format which is directed at applications that require a more rugged
and modular form factor.  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 interface adapter products are designed
for  applications  that require high  performance and high speed  communications
capability.  All of the company's products are  "intelligent,"  containing their
own  microprocessors  and  memory.  This  architecture  allows  these  interface
adapters to off-load  many of the  lower-level  communications  tasks that would
typically be performed by the host platform,  greatly  improving  overall system
performance.  The family of WAN  interface  adapter  products  is  supported  by
extensive communications software developed by both the company, through its San
Diego based  communications  protocol  engineering group, and a variety of third
party partners.  WAN sales represented 47% of total sales for 1997,  compared to
42% for 1996.

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  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 United States Navy
to integrate  tactical  workstations  on board Navy  vessels.  All of these NICs
permit easy  integration  of SBus, PCI or VMEbus  computer  system 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  TM  and
Microsoft's Windows NT TM operating systems.  LAN sales represented 20% of total
sales for 1997, compared to 21% in 1996.

Network Systems  Products.  The company's  network systems  products  consist of
systems level  equipment  used in the  construction  and  deployment of computer
networks. These products represented 9% of total sales for 1997, compared to 11%
in 1996 and include:


                                       3
<PAGE>


Communications  Servers.  Communications  servers are  multi-purpose  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. For larger installations
or special requirements,  the company offers a series of communications  servers
built on the VMEbus  standard which offer up to 96 WAN  connections and multiple
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 and in air
traffic  control  centers for  retrieving  radar data from remote radar  antenna
sites.

Front-end Communications  Subsystems.  The company's "front-end"  communications
subsystems product supports the concurrent use of up to eight SBus "add-in" disk
storage  controllers or communication  interface modules.  This product has been
co-developed  by  the  company  and a  large  OEM  customer,  and is  used  as a
communications  nexus for high powered  workstations,  allowing  them to link up
efficiently  with a new line of  supercomputers.  The system,  with its extended
SBus module  capability,  enables the OEM user to greatly increase the number of
workstations serviced by each front end processor,  lowering costs and improving
system reliability.

Ethernet  Switch.  The company is  executing  a market and  product  development
effort utilizing products  associated with Ethernet  switching  technology which
offers a variety of unique  technical  features  directed  at  connectivity  for
Ethernet LANs which require high availability and tolerance to network equipment
failures. This new family of company-designed second generation 100 Mbit/Gigabit
Ethernet Switching products debuted in the Fall of 1997 and is expected to begin
initial shipments in mid 1998 after field trials are completed.

Mass Storage Interface  Products.  The company's mass storage interface products
consist of adapters that connect  various mass storage  products  using the SCSI
and newer  UltraSCSI  standard  to  computers  based on VMEbus,  SBus and PCIbus
platforms.  The company's existing SCSI interface products are often used to add
external  disk  storage  to  workstations.  More  complex  applications  include
Redundant  Array of  Inexpensive  Disks  (RAID)  interfaces  which  are found in
mission critical,  high reliability and high  availability  applications such as
police/fire  dispatch,  bank automated teller  applications and hospital patient
data base  systems.  Coupled with the  Company's  RAID  software,  the interface
product enables Sun workstation users to connect RAID products sold by major OEM
suppliers.  During 1997, the company introduced a mass storage interface product
designed  to  operate  on  the  PCIbus   standard   and  provide   mass  storage
interconnectivity  via  Fibre  Channel.   Fibre  Channel  is  one  of  the  most
contemporary  interconnection  standards  for the new array of high  performance
disk drive and RAID  subsystems.  Future  products  are  expected  to expand the
company's strong presence in this market by providing Fibre Channel connectivity
on the cPCI standard.  Mass storage products  represented 14% of total sales for
1997, compared to 16% in 1996.

Inter-system  Connectivity  Products.  The company's  inter-system  connectivity
products permit dissimilar  computer  standards to be connected.  These products
are typically  provided to OEMs and systems  integrators  that are involved with
custom  applications  such as  connecting a Sun  workstation  to printing  press
control  electronics for a new color printing press.  Selected end-users include
Indigo, an Israeli printing equipment  company,  Data Cube, an imaging subsystem
supplier,  and Credence  Corporation,  a manufacturer of equipment that produces
electronic  integrated  circuits.  By allowing a customer to connect  dissimilar
computer standards,  the company's products preserve that customer's  investment
in existing installed  equipment.  These products represented 10% of total sales
in 1997,  compared to 10% in 1996. The company is not investing in this group of
products and potential declines in these revenues may occur in 1998.



                                       4
<PAGE>

Sales, Marketing and Distribution

The company currently markets its products world-wide to a broad spectrum of end
user customers through various channels  including OEMs, VARs,  distributors and
systems  integrators.  Currently,  nearly  90% of the  company's  sales are made
domestically while the remainder represents  international sales.  Approximately
80% 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.

In North America, the company operates five direct sales offices, located in San
Diego,  California,  Rochester,  New York,  Old Saybrook,  Connecticut,  Houston
Texas,  and  Minneapolis,  Minnesota.  The  company  also  maintains  a European
presence through a sales office in Munich,  Germany.  Currently,  17 technically
trained sales,  marketing and support  personnel  conduct the company's  selling
efforts out of these offices.  In addition,  independent  sales  representatives
covering selected  geographic areas and distributors  handling selected products
supplement  the company's  direct sales team on a worldwide  basis.  The company
believes  that due to the technical  nature of its products,  it is essential to
employ  sales  people who are  knowledgeable  in the network and  communications
fields and are able to adequately respond to inquiries that arise concerning the
capability and performance levels of the company's products.

Many of the company's products are provided to OEMs and systems  integrators and
are sold through a combination of selling  efforts by the company's  sales force
and the efforts of a small number of independent  sales  representatives.  These
independent sales  representatives  operate under the direct  supervision of the
company's  sales force and carry out sales of  specified  products  primarily in
selected North American geographic areas. The independent sales  representatives
are  compensated  by  commissions  paid on product  orders.  The OEMs or systems
integrators  serviced by the company's sales  organization and independent sales
representatives  generally  require a high level of  technical  support  and are
usually  involved  with  applications  that require  company  products  that are
ultimately  included  as a  subsystem  or  component  in  an  OEM's  or  systems
integrator's final product.

The company also sells products to distributors that are end user oriented, such
as network systems  products,  data storage  interface  products and certain LAN
interface products. Distributors purchase the company's products and resell them
to their VARs or end-users.  Distributors  who sell the  company's  products are
currently  managed by the company's  direct sales force. The company carries out
several marketing strategies to support these distributors including advertising
in national and international trade  publications,  sponsoring customer training
sessions and  participating  in trade shows  throughout  North America,  Western
Europe and the Pacific Rim.

OEM customers  typically  provide the company with a rolling forecast for orders
placed  two to three  months in  advance  of  shipment.  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.

With  all of its  products,  the  company  executes  various  ongoing  marketing
strategies  designed  to  attract  new  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.

The  company  continues  to believe  that the  international  market  represents
untapped  opportunities  for the  company's  products as sales  outside the U.S.
represented  only 10% of the  company's net sales in 1997 as compared to 11% and
14% for 1996 and 1995,  respectively.  In the  past,  the  company  has sold its
products  within  Europe and the Asia  Pacific  countries  through  distributors
managed by sales  individuals who reside at corporate  offices in North America.
Management  believes that it can develop  expanded  sales channels and marketing
alliances  with  respect to both new and  existing  international  markets.  The
company's   products  are  currently  sold  by  25  international   distributors
throughout  the major  industrialized  countries  in Europe and the Asia Pacific
area.  The company  also  operates a sales  office in Munich,  Germany to better
support the Western European markets.  In addition,  the company has engaged two
international  marketing  organizations to assist in more aggressive development
of the  Pacific  Rim and Western  Europe  territories  across all of its product
offerings.  This is  viewed  as an  interim  step  that is  designed  to lead to
additional  direct  sales  offices in Europe  and  assuming  the Asian  economic
climate  improves,  an initial  sales  office in the Pacific Rim by late 1998 or
early  1999.  International  sales are  subject to import  and export  controls,
transportation  delays and  interruptions,  foreign currency exchange rates, and
foreign  governmental  regulations.  All payments  for sales  outside the United
States are made in U.S. dollars.

                                       5
<PAGE>

Customers

The  company  has over 300 active  customers  worldwide,  including  major OEMs,
systems integrators, and educational/research  organizations,  many of which are
Fortune 500 companies.

The company has two general  types of  customers.  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  using  the  company's  products  include a
sophisticated   workstation   and   server   computers   with  high   speed  WAN
interconnections to the Internet or private communication  facilitates,  a check
scanning console  provided to banks to convert  canceled check  information into
electronic  images and mass data  storage  equipment  provided  by RAID  systems
manufacturers to commercial users such as police/fire departments, hospitals and
government  organizations.  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,  deep space network data  collection  for
space research and data  collection/network  systems for air traffic control and
radar  installations.  The  second  category  includes  customers  that are less
technically proficient. These customers require products that are expected 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 NICs) and selected WAN interface products
operating on the SBus and PCIbus standards. In 1997, the largest single customer
represented  8% of sales and the top five  customers  accounted  for 34% of 1997
revenues.

Backlog

At March 2, 1998, the backlog of scheduled orders was $4.7 million,  compared to
$6.1 million at March 9, 1997.  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 computer  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 interface product
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 Cyclone,  Inc. 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 and Emulex Corporation.

                                       6
<PAGE>

Many of the company's  competitors 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  internetworking
product  market has become  increasingly  concentrated  as a result of increased
consolidation 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
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  1997,  1996 and 1995  were  approximately  $3.7
million,  $3.0  million  and $2.0  million,  respectively.  This  represents  an
increase of 26% from 1996 to 1997. 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.

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,  switching  and  mass  storage
interface  solutions.  The company expects that research and development funding
will continue to increase  significantly  in 1998. This funding will be directed
at further  leveraging these  competencies  and carrying out additional  product
development in the areas of communications and network switching. These research
and development  programs are expected to include expansion of both hardware and
software related to WAN and LAN network adapter products,  continued enhancement
of the current LAN/FDDI offerings, next generation Ethernet switching, expansion
of mass storage interface  products to encompass Fibre Channel  technologies and
expanded  communication server products. In addition to specific product related
expenditures,  the company has increased  its internal  capability to design and
implement  ASICs.  This will be an important  cornerstone  for continued  future
enhancements of WAN and LAN network adapters,  advanced mass storage  interfaces
and high  performance  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,  however, and
there  can be no  assurance  that  the  confidentiality  agreements  will not be
breached,  that such agreements will be enforceable,  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.

                                       7
<PAGE>

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  matter  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.  Although to date the company has generally
been able to obtain adequate supplies of these  components,  the company obtains
these components on a purchase order basis and does not generally have long-term
contracts with any of these suppliers.  The company's standard purchase order is
limited in nature.  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, and increased component prices could negatively affect gross margins,
either 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.

Manufacturing

The company  maintains a  state-of-the  art product  assembly and  manufacturing
facility at its Rochester,  New York facility.  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.  The company
does not have to compete with those who may be using  subcontractors,  nor is it
subject to the 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 February 28, 1998,  the company had 140  full-time  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                    46
                  Marketing and Sales                         20
                  Manufacturing                               57
                  General and Administrative                  17

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.

                                       8
<PAGE>

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
revenues  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  revenues 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  internetworking
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  revenues 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  revenues and operating
results.

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

Dependence on Sun Microsystems,  Inc.  Products.  Many of the company's products
are designed and manufactured to be compatible with workstations manufactured by
Sun  Microsystems,  Inc. The  company's  business  opportunities  and results of
operations are dependent,  in part, on continued growth and market acceptance of
systems  manufactured and marketed by Sun Microsystems,  Inc. In the event these
systems are no longer commercially acceptable, or in the event Sun Microsystems,
Inc.  were to curtail its  manufacturing  and marketing of those  systems,  this
would have a material  adverse  effect on the  company's  revenues and operating
results.

                                       9
<PAGE>

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,  revenues 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  revenues
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  revenues  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 and has not
filed any patent applications for its products. If patent applications are filed
by the company,  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.

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  revenues 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 revenues 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.

                                       10
<PAGE>

ITEM 2 - Properties

The company's  principal  executive  offices,  manufacturing  facilities and the
majority of its research and  development  facilities  are located in Rochester,
New York in a 30,000  square foot  building in a high  technology  business park
that was  constructed  specifically  for the company in 1990. 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. 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 a portion  of the  company's
software engineering,  sales and marketing  operations.  The company also leases
sales offices at five locations. There is currently no excess office capacity at
the company's  Rochester,  New York facility,  and management  believes that the
company  will have to identify  and obtain  additional  office  space in 1998 to
accommodate  the  company's  operations.  Management  believes  that  there  are
adequate office facilities available in and around the Rochester area.

ITEM 3 - Legal Proceedings

From time to time,  the  company is involved  in  litigation  relating to claims
arising out of its  operations in the normal course of business.  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, 1997.

PART II

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

The company's  Common Stock is traded on the NASDAQ National Market System under
the trading  symbol  "PTIX".  The  following  table sets forth,  for the periods
indicated, the high and the low closing prices for the Common Stock, as reported
on the NASDAQ  National Market System since January 24, 1996, the effective date
of the company's  Registration  Statement on Form S-1 for the company's  initial
public offering of its Common Stock.  These prices  represent  quotations  among
securities  dealers  without  adjustments  for  retail  markups,   markdowns  or
commissions and may not represent actual  transactions.  Where appropriate,  all
prices have been adjusted for the company's  three-for-two  stock split effected
in September 1997.
<TABLE>
<CAPTION>
                  1997                     High             Low
                  ----                     ----             ---
         <S>                            <C>              <C>    

         First Quarter                  $  8.67          $  6.83
         Second Quarter                   10.33             7.00
         Third Quarter                    19.38            10.00
         Fourth Quarter                 $ 21.75          $ 13.50

                  1996                     High              Low
                  ----                     ----              ---
         First Quarter
         (from January 24, 1996)        $  8.50          $  5.33
         Second Quarter                   11.83             7.83
         Third Quarter                     9.67             8.08
         Fourth Quarter                 $  8.17          $  6.44
</TABLE>


                                       11
<PAGE>

As of February 25, 1998,  there were 198 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.
<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                                         1,588,000
Purchase of real estate                                               0
Acquisition of other business(es)                                     0
Repayment of debt                                                     0
General working capital purposes                                      0
Temporary investments                                         2,679,000
Inventory for new products                                    1,265,000
Software development                                          1,084,000
Product development                                           4,800,000
                                                           ------------
Total use of proceeds                                      $ 11,416,000
                                                           ============
</TABLE>

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

For the Years Ended December 31: ........       1997        1996        1995        1994       1993
                                               -----       -----       -----       -----      ----- 
<S>                                         <C>         <C>         <C>         <C>        <C>   
                                           
Sales ...................................   $ 30,336    $ 24,843    $ 17,891    $ 12,562   $ 10,805
Income from continuing operations .......      5,131       3,734       2,393       1,618      1,218
Loss from discontinued operations .......                                (19)     (1,133)      (455)
Basic earnings per share:
    Income from continuing operations (1)   $    .71    $    .53    $    .52    $    .36   $    .27
    Weighted average common shares ......      7,231       7,020       4,590       4,549      4,509
Diluted earnings per share:
    Income from continuing operations (1)   $    .68    $    .52    $    .52    $    .34   $    .26
    Weighted average common and common
        equivalent shares ...............      7,522       7,248       4,623       4,705      4,640

At December 31: .........................       1997        1996        1995        1994       1993
                                               -----       -----       -----       -----      -----  
Working capital .........................   $ 26,584    $ 20,965    $  6,215    $  4,369   $  4,689
Total assets ............................     31,626      26,089      10,523       9,312      9,246
Long-term debt, less current portion ....   $     18    $     30    $     57    $    622   $  1,504

(1)  All per  share  amounts  have  been  adjusted  where  appropriate,  for the
three-for-two stock split effected in September 1997.
</TABLE>


                                       12
<PAGE>

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

The following  discussion and analysis of the company's  financial condition and
results of operations during the periods included in the accompanying  financial
statements focuses on the company's  continuing  operations and does not include
any  discussion  or  analysis  with  respect  to  those   operations  that  were
discontinued in 1995.

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

In 1997,  the  company  achieved  record  revenues  and income  from  continuing
operations  for the  fifth  consecutive  year and the  second  record  year as a
publicly  traded  company.  Net  income in 1997  increased  by 37% and  revenues
increased by 22%. At the end of 1997, the company had  approximately $21 million
in cash, cash equivalents and marketable securities and no significant debt. For
1997, the company generated income from operations,  excluding  depreciation and
amortization  (EBITDA),  of $8.7  million as compared  to $5.9  million in 1996.
EBITDA, however, does not represent cash from operating activities as defined by
generally accepted  accounting  principles (see consolidated  statements of cash
flows).  Return on equity  for 1997 was 20.2% and  return on assets  was  17.8%.
While the company's  customer related  activities  continue at very high levels,
management  is  monitoring  the 1998  first  quarter  order  rate  and  shipment
activities closely. A softening in orders was noted in the latter months of 1997
as a number of customers adjusted  inventories and took a cautious position with
respect to the market  disruptions  in certain areas of the world.  As a result,
the company entered 1998 with a lower than traditional backlog.

On September 15, 1997, the company  effected a three-for-two  stock split in the
form of a 50% stock dividend which increased the number of shares outstanding to
7.2 million shares.

The  company's  revenues are  generated  from  products  designed to enhance the
performance of network systems based on varied computer architectures  including
VMEbus,  SBus and PCIbus.  The company's  products operate on various  operating
systems  including  UNIX,  Windows NT TM,  VxWorks and Linux.  The company has a
history of adapting its products to a continually  changing  marketplace and the
historical  increase of sales is primarily the result of developing new products
and of increasing the unit sales volumes of existing products.  During 1997, the
company  introduced  and began  shipping  several  new  communications  and mass
storage interface  products for the PCIbus market and announced new products for
the cPCI  market.  cPCI is a new  standard bus  architecture  that  combines the
attributes of the VMEbus and PCIbus hardware into a ruggedized industrial system
for the embedded OEM  marketplace.  Initially  the company will migrate its Wide
Area  Network  adapter  products to this new  standard  but later in 1998,  mass
storage adapters based on SCSI and Fibre Channel technologies will be available.
These new products  will  initially be directed  toward  telecommunications  and
industrial  applications.   Cooperative  marketing  relationships  with  Ziatech
Corporation and VI Computer Inc.,  both selling  processors for the cPCI market,
were  announced  in  January  1998.  Even in this early  stage of this  emerging
market,  the company is seeing significant new business  opportunities  based on
this  technology.  Production  units of the WAN cPCI  products will be available
during the second  half of 1998.  The  company  also  introduced  three new fast
Ethernet  switch products which expands the Nebula TM product line with the next
generation  of  fast  Ethernet  products  and  incorporates  features  for  high
reliability  and  fault  tolerance.  Production  units  of these  new  switching
products are expected to be available in second quarter of 1998.
                                       13
<PAGE>

Historically,  approximately  65% to 85% of the  company's  revenues  have  been
generated by sales of products to OEMs.  During 1997,  the company  entered into
three distribution  relationships to broaden its worldwide  distribution network
of VARs,  distributors  and systems  integrators  for the company's SBus and PCI
products.  In  addition,  a  relationship  was  established  with  International
Business  Development  Specialist  (IBDS) to enhance the company's  distribution
efforts   in  the   Asia-Pacific   region  and  other   international   regions.
International  sales were $3.0 million in 1997, compared to $2.6 million in 1996
and $2.5 million in 1995.

At the end of 1997, the company  integrated the operations and assets of its San
Diego based subsidiary,  UconX Corporation,  into its corporate operations.  The
company believes that a combined  corporate  structure can better  capitalize on
the unique  capabilities  and  resources of the  individual  organizations.  The
engineering  staff for this location has been assigned to accelerate  certain of
the company's WAN development  projects.  The company  believes that redirecting
these valuable  engineering  resources  onto  corporate  projects will result in
delivering  WAN  products to market more  rapidly.  The products and services of
UconX will continue to be supported and sold, but  consolidated  revenues may be
impacted in the short term.

In December  1997,  the company  was  awarded ISO 9002  Certification  achieving
compliance with quality standards developed by the International Organization of
Standardization of Geneva,  Switzerland.  The company believes that securing the
ISO 9002  Certification  validates and  reinforces  the company's  commitment to
manufacturing products to the highest quality standards.

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,
                                                1997      1996       1995
                                                ----      ----       ----
<S>                                            <C>       <C>        <C>    
Sales ...................................      100.0%    100.0%     100.0%
Cost of goods sold ...........................  41.8      43.7       44.4
                                               -----     -----      -----
Gross profit .................................  58.2      56.3       55.6
                                               -----     -----      -----

Operating expenses:
   Selling and marketing .....................  13.1      12.9       11.8
   Research and development ................... 12.3      11.9       10.9
   General and administrative .................  8.9      11.0       14.6
                                               -----     -----      -----
         Total operating expenses ............. 34.3      35.8       37.3
                                               -----     -----      -----
Income from operations .......................  23.9      20.5       18.3

Other income, net ............................   3.4       3.0        1.1
                                               -----     -----      -----
Income before taxes and minority interest ....  27.3      23.5       19.4

Provision for income taxes ...................  10.4       8.4        5.8
Minority interest ............................   0.0      (0.1)      (0.2)
                                               -----     -----      -----
   Income from continuing operations ........   16.9%     15.0%      13.4%
                                               =====     =====      =====
</TABLE>



                                       14
<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. The company continues to
believe that there are significant opportunities for the company's Fibre Channel
adapter and is working on establishing  new agreements with certain OEM's within
the next few months.

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.   Management   expects  to  increase   marketing
expenditures for  advertising,  trade shows and promotion in an effort to expand
sales of controller and switching products.

                                       15
<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.  The company  expects to commit  greater  resources to research and
development  in  the  future,   including   hiring  engineers  for  new  product
development and greater product  development  resources  associated with the new
switching products.

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.


Year Ended December 31, 1996, Compared with the Year Ended December 31, 1995

Sales.  Sales  for 1996  increased  by  $6,952,000  (39%) to  $24,843,000,  from
$17,891,000 for 1995. 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.  The increase in sales is primarily attributable to the growing demand
for the company's WAN and LAN Adapter  products.  The company began shipping new
PCI based WAN and LAN adapter  products in 1996 and revenues  nearly  reached $1
million for these  products.  WAN and LAN adapter product sales each grew by 62%
in 1996 and represented  42% and 21%,  respectively of total sales for the year.
Network Systems  products grew 57% in 1996 and were 11% of total sales for 1996.
Revenues from Mass Storage  interface  products  increased to $3,869,000 in 1996
and  grew  by 20% for  the  year.  Inter-system  Connectivity  product  revenues
decreased from 18% of sales in 1995, to 10% in 1996. 

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 1996  increased by  $4,051,000  to  $13,994,000,  from
$9,943,000  for 1995 due to increased  sales  volumes.  Gross margin  percentage
improved to 56.3% of sales for 1996,  from 55.6% in 1995. 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 $8,907,000,  or
35.8% of sales  for 1996,  from  $6,670,000,  or 37.3% of sales  for  1995.  The
company  made  significant  investments  in  sales,   marketing,   research  and
development during 1996 while reducing its general and  administrative  expenses
as a percentage of sales.

Selling and marketing expenses increased by 52% to $3,210,000, or 12.9% of sales
for 1996, from  $2,106,000,  or 11.8% of sales for 1995. The company added sales
people in North  America and in Europe and  commissions  increased due to higher
sales  levels.  The company also added staff to the  marketing  department in an
effort to promote the company's products more extensively.  The company spent an
additional  $600,000 in advertising and trade show expenses in 1996 to introduce
several new products and to improve its  presence in the  marketplace.  

                                       16
<PAGE>

Research and development  expenses  increased by 51% to $2,960,000,  or 11.9% of
sales for 1996, compared to $1,955,000, or 10.9% of sales for 1995. 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 1996 was primarily
attributable  to  hiring   additional   hardware  and  software   engineers  and
compensation related expenses.

General and administrative  expenses increased by 5% to $2,737,000,  or 11.0% of
sales for 1996, compared to $2,609,000, or 14.6% of sales for 1995. The decrease
as a percentage of sales, is primarily  attributable  to maintaining  control of
administrative expenses while sales increased by nearly 40%.

Other income,  net. Other income consists  primarily of interest income.  During
1996,  the company  earned  interest  income on the net  proceeds of its initial
public  offering  of Common  Stock.  The funds are  primarily  invested in money
market  funds,  high  quality  short  term  commercial  paper  and  US  Treasury
securities maturing in 8 to 12 months.

Income Taxes. The provision for income taxes for 1996 is based upon the combined
federal and state  effective tax rate of 35.6%,  compared to 29.8% in 1995.  The
primary  reasons  for the  increase  in the  combined  tax rate  are the  higher
utilization of carryforward research and development tax credits in 1995 and the
foreign sales exemption.


Liquidity and Capital Resources

At December 31, 1997, the company's  primary  source of liquidity  included cash
and cash equivalents of $8,833,000,  marketable  securities with a maturity less
than one year of  $12,010,000  and available  borrowings  of $3,000,000  under a
revolving  credit facility with a bank. No amounts were  outstanding  under this
credit  facility as of December  31,  1997.  The company had working  capital of
$26,584,000 at December 31, 1997, compared to $20,965,000 at December 31, 1996.

Cash generated by operating activities was $5,821,000, $3,642,000 and $3,297,000
in 1997,  1996 and 1995,  respectively.  The  increase  in cash  generated  from
operating  activities  in 1997 is  attributable  to greater net income and a net
increase in operating assets and liabilities.

Cash used in investing  activities  was  $7,093,000,  $7,469,000 and $619,000 in
1997, 1996 and 1995,  respectively.  During 1997,  investing activities included
the purchase of marketable securities of $13,008,000, the maturity of marketable
securities  of  $7,100,000,  and net capital  equipment  purchases  of $481,000.
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
and included within investing activities were $704,000, $380,000 and $193,000 in
1997, 1996 and 1995, respectively.

Cash provided by financing  activities of $78,000 for 1997 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.  During  1995,  cash used by  financing
activities  consisted primarily of borrowings and repayment of borrowings on the
company's line of credit.

Many companies are facing a potential issue regarding the ability of information
systems to  accommodate  the coming year 2000.  The company  has  evaluated  its
information  systems and believes that an appropriate plan is in place to ensure
that all  critical  systems  can,  or will be able to,  accommodate  the  coming
century without  material adverse effect on the company's  financial  condition,
results of  operations,  capital  spending or  competitive  position.  Such plan
consists of obtaining  upgrades of its  information  systems from the  company's
software  vendor to be year 2000  compatible.  The current  products sold by the
company do not require any  programming  date  changes to function as  intended;
however,  the new switching  products do require date sensitive  programming and
are being developed to be year 2000 compatible.

                                       17
<PAGE>

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


                                                      
ITEM 8 - Financial Statements and Supplementary Data

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

   Report of Independent Accountants ................................   19
   Consolidated Balance Sheets at December 31, 1997 and 1996 ........   20
   Consolidated Statements of Income for the Three Years
      Ended December 31, 1997 .......................................   21
   Consolidated Statements of Changes in Stockholders' Equity
      for the Three Years Ended December 31, 1997 ...................   22
   Consolidated Statements of Cash Flows for the Three Years
      Ended December 31, 1997 .......................................   23
   Notes to Consolidated Financial Statements .......................   25

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.




                                       18
<PAGE>

                        Report of Independent Accountants



February 16, 1998



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, 1997
and 1996,  and the results of their  operations and their cash flows for each of
the three years in the period  ended  December  31,  1997,  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/Price Waterhouse LLP
-----------------------
Price Waterhouse LLP
Rochester, New York


                                       19
<PAGE>



<TABLE>
<CAPTION>

             PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS

                                     ASSETS


                                                           December 31,
                                                       1997             1996 
                                                      ------           ------
<S>                                                <C>             <C>   

Current assets:
 Cash and cash equivalents ....................   $  8,833,000     $ 10,027,000
 Marketable securities ........................     12,010,000        6,102,000
 Accounts receivable, net (Note B) ............      4,956,000        3,234,000
 Inventories, net (Note C) ....................      3,329,000        4,032,000
 Prepaid expenses and other ...................        346,000          284,000
 Deferred taxes (Note J) ......................        466,000          419,000
                                                  ------------     ------------
         Total current assets ...................   29,940,000       24,098,000

Equipment and improvements, net (Note D) ........      982,000        1,267,000
Software development, net (Note K) ..............      579,000          549,000
Other assets (Note E) ...........................      125,000          175,000
                                                  -------------    ------------
         Total assets ........................... $ 31,626,000     $ 26,089,000
                                                  ============     ============

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
 Current portion of long term debt (Note G) ...   $     12,000     $     26,000
 Accounts payable ..............................       824,000          953,000
 Income taxes payable ..........................       255,000           23,000
 Accrued expenses (Note F) .....................     2,265,000        2,131,000
                                                  ------------     ------------
         Total current liabilities ..............    3,356,000        3,133,000

Long term debt, less current portion (Note G) ...       18,000           30,000
Deferred taxes (Note J) .........................      220,000          219,000
                                                  ------------     ------------
         Total liabilities .......................   3,594,000        3,382,000
                                                  ------------     ------------

Commitments (Note H)

Stockholders' equity (Notes I, O)
 Preferred stock - $.01 par value: 1,000,000
  shares authorized; none issued at 
  December 31,  1997 and 1996
 Common stock - $.01 par value;  15,000,000 shares
  authorized; 7,414,732 and 4,899,418 shares issued
  at December 31, 1997 and 1996, respectively ....      74,000           49,000
 Additional paid-in capital ....................    13,055,000       12,885,000
 Retained earnings .............................    15,061,000        9,930,000
 Treasury stock-at cost, 147,282 and 98,117 
  shares held at December 31, 1997 and 1996 ...       (158,000)        (157,000)
                                                  ------------     ------------
         Total stockholders' equity ..............  28,032,000       22,707,000
                                                  ------------     ------------
         Total liabilities and 
           stockholders' equity ................. $ 31,626,000     $ 26,089,000
                                                  ============     ============




<FN>


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

</FN>
</TABLE>

                                       20
<PAGE>

<TABLE>
<CAPTION>



             PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF INCOME



                                             Year Ended December 31,
                                        1997            1996            1995
                                       ------          ------          ------
<S>                                <C>             <C>             <C>   


Sales ............................ $ 30,336,000    $ 24,843,000    $ 17,891,000
Cost of goods sold ...............   12,695,000      10,849,000       7,948,000
                                   ------------    ------------    ------------
Gross profit .....................   17,641,000      13,994,000       9,943,000
                                   ------------    ------------    ------------

Operating expenses:
 Selling and marketing ...........    3,988,000       3,210,000       2,106,000
 Research and development ........    3,720,000       2,960,000       1,955,000
 General and administrative ......    2,711,000       2,737,000       2,609,000
                                   ------------    ------------    ------------
         Total operating expenses    10,419,000       8,907,000       6,670,000
                                   ------------    ------------    ------------
Income from operations ...........    7,222,000       5,087,000       3,273,000

Other income, net ................    1,051,000         750,000         203,000
                                   ------------    ------------    ------------
Income before taxes and 
 minority interest ...............    8,273,000       5,837,000       3,476,000

Provision for income taxes (Note J)   3,142,000       2,079,000       1,037,000
                                   ------------    ------------    ------------
Income before minority interest ..    5,131,000       3,758,000       2,439,000

Minority interest ................                      (24,000)        (46,000)
                                   ------------    ------------    ------------
Income from continuing operations     5,131,000       3,734,000       2,393,000

Loss from discontinued operations,
 net of tax benefits (Note O) ....                                      (19,000)
                                   ------------    ------------    ------------
Net income........................ $  5,131,000    $  3,734,000    $  2,374,000
                                   ============    ============    ============  


Basic earnings per share (Note L):
 Income from continuing operations $        .71    $       .53     $        .52
                                   ============    ============    ============  
 Net income ...................... $        .71    $       .53     $        .52
                                   ============    ============    ============ 

Diluted earnings per share (Note L):
 Income from continuing operations $        .68    $       .52     $        .52
                                   ============    ============    ============ 
 Net income ...................... $        .68    $       .52     $        .51
                                   ============    ============    ============  







<FN>

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

                                       21
<PAGE>



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

<TABLE>
<CAPTION>


                                   Additional
                   Common Stock    Paid-In     Treasury  Retained
                  Shares   Amount  Capital     Stock     Earnings       Total
                  ------   ------  -------     -----     --------       -----
<S>             <C>       <C>     <C>         <C>       <C>         <C>

Balance - 
 January 1,1995 3,156,688 $32,000 $ 1,123,000 $(138,000)$ 4,392,000 $ 5,409,000

1995 Net income                                           2,374,000   2,374,000
Exercise of 
 options/warrants 106,910   1,000     165,000                           166,000
Issuance of 
 warrants                              62,000                            62,000
Tax benefit - 
 warrant and 
 option plans                          64,000                            64,000
Purchase of 
 treasury stock -
 6,084 shares                                   (18,000)                (18,000)
Distribution to
 stockholders -
 spin off(Note O)                                          (570,000)   (570,000)
                ---------  ------  ----------  --------  ----------   ---------
Balance - 
 December 31,
 1995           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 
 (Note I)       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
                =========  ======  ==========  ========  ==========  ==========





<FN>

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

                                       22
<PAGE>

<TABLE>
<CAPTION>



             PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

                                                 Year Ended December 31,
                                             1997          1996         1995
                                            ------        ------       ------
<S>                                      <C>           <C>          <C>    

Cash flows from operating activities
 Net income                              $ 5,131,000   $ 3,734,000   $2,374,000
 Non-cash adjustments:
  Depreciation and amortization            1,490,000       831,000      675,000
  Reserve for inventory obsolescence         262,000       609,000      293,000
  Deferred income taxes                      (46,000)     (119,000)     (73,000)
  Other                                       21,000      (113,000)     236,000
 Changes in operating assets 
  and liabilities:
  Accounts receivable                     (1,743,000)     (895,000)    (803,000)
  Inventories                                441,000    (1,229,000)    (783,000)
  Prepaid expenses and other                 (62,000)       25,000     (239,000)
  Accounts payable                          (129,000)     (474,000)     385,000
  Accrued expenses                           134,000       892,000      834,000
  Income taxes payable                       322,000       381,000      (97,000)
  Discontinued operations - non-cash 
   charges and working capital charges                                  495,000
                                          ----------    ----------    ---------
 Net cash provided by 
  operating activities                     5,821,000     3,642,000    3,297,000
                                          ----------    ----------    ---------   

Cash flows from investing activities
 Cash purchases of equipment
  and improvements, net                     (481,000)     (719,000)    (297,000)
 Capitalized software development           (704,000)     (380,000)    (193,000)
 Purchase of marketable securities       (13,008,000)   (6,102,000)
 Maturities of marketable securities       7,100,000
 Purchase of remaining shares 
  in subsidiary                                           (268,000)
 Investing activities of 
  discontinued operations                                              (129,000)
                                          ----------    ----------    ---------                 
 Net cash used by investing activities    (7,093,000)   (7,469,000)   ( 619,000)
                                          ----------    ----------    ---------

Cash flows from financing activities
 Payments on capital lease obligations       (15,000)      (62,000)     (63,000)
 Repayment of line of credit
  and notes payable                          (11,000)      (12,000)  (1,446,000)
 Exercise of stock options and warrants      104,000        74,000      142,000
 Net proceeds from issuance of common stock             11,388,000                                        
 Borrowings from line of credit                                         535,000
                                          ----------    ----------    ---------
Net cash provided (used)
  by financing activities                     78,000    11,388,000     (832,000)
                                          ----------    ----------    ---------
Net (decrease) increase in 
 cash and cash equivalents                (1,194,000)    7,561,000    1,846,000

Cash and cash equivalents
 at beginning of year                     10,027,000     2,466,000      620,000
                                          ----------    ----------    ---------
Cash and cash equivalents
 at end of year                          $ 8,833,000   $10,027,000   $2,466,000
                                          ==========    ==========    =========



<FN>

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

                                       23
<PAGE>


<TABLE>
<CAPTION>



             PERFORMANCE TECHNOLOGIES, INCORPORATED AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Continued)



SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

                                                Year Ended December 31,
                                             1997          1996         1995
                                            ------        ------       ------


<S>                                      <C>           <C>          <C> 
                                                                         
Interest paid                            $     4,000   $    13,000  $    24,000
Income taxes paid                        $ 2,865,000   $ 1,853,000  $ 1,371,000



SCHEDULE OF NON-CASH INVESTING AND FINANCING TRANSACTIONS

Spin off to stockholders
   Accounts receivable                                              $    13,000
   Inventory                                                            642,000
   Prepaid expenses                                                      29,000
   Deferred tax assets                                                   47,000
   Equipment and improvements, 
    net of accumulated depreciation                                     331,000
   Software capitalization, net of amortization                         472,000
   Accounts payable                                                    (139,000)
   Accrued expenses                                                    (117,000)
   Income taxes payable                                                  (5,000)
   Capital lease obligations, short term                                 (1,000)
   Deferred tax liabilities                                            (202,000)
   Loan payable                                                        (500,000)
                                                                     ----------
      Net distribution                                              $   570,000
                                                                     ==========












<FN>






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

                                       24
<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 at 315 Science
Parkway,  Rochester, New York. The company and its subsidiaries design, develop,
manufacture  and market high  performance  communications,  networking  and data
storage interface  products.  The company's products are designed to enhance the
performance of customers'  computer  network  systems and include local and wide
area  network  interface  adapters,   communication  servers  and  mass  storage
interface   products.   The  company  also   provides   sophisticated   software
communications  solutions.  Applications for the company's products are targeted
toward high  performance,  mission  critical  networking  solutions and include:
network interfaces for cellular telephone communications,  FDDI adapter products
used aboard navy  vessels,  communications  servers used in air traffic  control
centers and data storage products found in bank automated teller machines.

Segment Data,  Geographic  Information  and Significant  Customers:  The company
operates in one industry  segment.  Export sales to customers outside the United
States  represent  9.9%,  10.8%,  and 14.2% of the company's sales for the years
ended December 31, 1997, 1996 and 1995,  respectively.  For 1997, 1996 and 1995,
four customers  accounted for approximately 28%, 30% and 21%,  respectively,  of
the company's sales, with no single customer  representing  greater than 8%, 12%
and 6%, respectively, of the company's sales.

Principles of Consolidation:  The consolidated  financial statements include the
accounts of the company and its  wholly-owned  subsidiaries,  PTI Virgin Islands
Company,   Ltd.,  and  UconX  Corporation  (Note  E).  Manutech  Corporation  of
Rochester,  Videk  Corporation,  the Performance  Telecom  business unit and the
InformationView  business unit have been shown in the Consolidated Statements of
Income and Consolidated Statements of Cash Flows for the year ended December 31,
1995  as  discontinued   operations  (Note  O).  All  significant   intercompany
transactions have been eliminated.

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 revenues 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.

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

Fair  Value of  Financial  Instruments:  The  carrying  amount of the  company's
financial   instruments,   including  cash  and  cash  equivalents,   marketable
securities,  accounts receivable,  accounts payable,  accrued expenses and loans
approximates  their fair value at December  31,  1997,  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.


                                       25
<PAGE>


Revenue  Recognition:  Revenue from hardware  sales is  recognized  upon product
shipment.  Revenue from consulting and other  professional  service contracts is
recognized when earned on the basis of hours incurred at contract rates for time
and material agreements.

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.  At December 31, 1997,  cost
approximates fair market value.

Equipment and  Improvements:  Equipment and  improvements  are recorded at cost.
Depreciation is provided for 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 at December 31, 1997 and 1996:
<TABLE>
<CAPTION>

                                                             December 31,
                                                         1997           1996
                                                        ------         ------
<S>                                                 <C>           <C>   

Accounts receivable                                 $  5,148,000  $   3,405,000
Less:  allowance for doubtful accounts                  (192,000)      (171,000)
                                                    ------------  -------------
      Net                                           $  4,956,000  $   3,234,000
                                                    ============  =============
</TABLE>

                                       26
<PAGE>


Note C - Inventories

Inventories consisted of the following at December 31, 1997 and 1996:
<TABLE>
<CAPTION>

                                                             December 31,
                                                         1997           1996
                                                        ------         ------
<S>                                                 <C>           <C> 

Purchased parts and components                      $    954,000  $   1,601,000
Work in process                                        2,580,000      2,641,000
Finished goods                                           333,000        292,000
                                                    ------------  -------------
                                                       3,867,000      4,534,000
Less:  reserve for inventory obsolescence               (538,000)      (502,000)
                                                    ------------  ------------- 
      Net                                           $  3,329,000  $   4,032,000
                                                    ============  =============
</TABLE>

Note D - Equipment and Improvements

Equipment and  improvements  consisted of the following at December 31, 1997 and
1996:
<TABLE>
<CAPTION>
                                                             December 31,
                                                         1997           1996
                                                        ------         ------
<S>                                                 <C>           <C> 
                                                                                            
Engineering equipment and software                  $  1,294,000  $   1,247,000
Manufacturing equipment                                1,140,000      1,295,000
Furniture and equipment                                  785,000        702,000
Leasehold improvements                                   130,000        123,000
                                                    ------------  -------------       
                                                       3,349,000      3,367,000
Less:  accumulated depreciation and amortization      (2,367,000)    (2,100,000)
                                                    ------------  -------------                             
      Net                                           $    982,000  $   1,267,000
                                                    ============  =============
</TABLE>

Total depreciation and amortization  expense for equipment and improvements from
continuing  operations  for  1997,  1996  and 1995 was  $426,000,  $417,000  and
$318,000, respectively.

At December  31, 1996 fixed  assets held under  capital  lease  agreements  were
$271,000 and related accumulated amortization was $238,000. Related amortization
expense from  continuing  operations was $29,000,  $29,000 and $60,000 for 1997,
1996 and 1995, respectively.

Note E -  Other Assets

During 1996, the Company paid $268,000 to acquire the remaining  shares of UconX
Corporation resulting in UconX becoming a wholly-owned subsidiary. In connection
with  this   transaction,   additional   goodwill  of  $188,000  was   recorded.
Amortization  expense  from  continuing  operations  for  goodwill  was $50,000,
$45,000  and  $34,000  for the years ended  December  31,  1997,  1996 and 1995,
respectively.

Note F - Accrued Expenses

Accrued expenses consisted of the following at December 31, 1997 and 1996:
<TABLE>
<CAPTION>

                                                             December 31,
                                                         1997           1996
                                                        ------         ------
<S>                                                 <C>           <C> 
Accrued compensation                                $  1,500,000  $   1,431,000
Accrued payroll and other taxes                          126,000        266,000
Other accrued expenses                                   639,000        434,000
                                                    ------------  -------------
      Total                                         $  2,265,000  $   2,131,000
                                                    ============  =============

</TABLE>

                                       27
<PAGE>


Note G - Long Term Debt and Credit Agreement

At December 31, 1997,  the company has a revolving  credit loan agreement with a
bank  under  which it can  borrow up to $3  million.  Borrowings  bear  interest
ranging  between 150 basis  points above the Libor rate to the bank's prime rate
and 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,  1997.  There were no balances  outstanding
under this agreement at December 31, 1997 and 1996.

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.

A summary of the long term debt  outstanding at December 31, 1997 and 1996 is as
follows:
<TABLE>
<CAPTION>

                                                            December 31,
                                                        1997           1996
                                                       ------         ------
<S>                                                 <C>           <C> 
Loan payable                                        $  30,000     $   41,000
Capital lease obligations                                             15,000
                                                    ---------     ----------
                                                       30,000         56,000
Less:  current portion                                (12,000)       (26,000)
                                                    ---------     ---------- 
Long term portion                                   $  18,000     $   30,000
                                                    =========     ==========
</TABLE>

As of December 31, 1997,  the  aggregate  maturities of the loan payable for the
years ending December 31, 1998, 1999, and 2000 were $12,000, $12,000 and $6,000,
respectively.

Note H - Commitments

The company leases  facilities and equipment under operating  leases.  Under the
terms of the facility  lease 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.   The  company  has   co-guaranteed
approximately  $1,250,000 of the mortgage  obtained to finance the building.  In
recognition  of this  guarantee,  the company has the right of first  refusal to
purchase the facility at a discounted price, should the owners elect to sell.

Future minimum lease  payments for all operating  leases having a remaining term
in excess of one year at December 31, 1997 are as follows:
<TABLE>
<CAPTION>
          <S>                                                      <C>   

                                                                     Operating
                                                                       Leases
          1998                                                     $   450,000
          1999                                                         452,000
          2000                                                         371,000
          2001                                                         164,000
          2002                                                           7,000
                                                                   -----------
          Total minimum lease payments                             $ 1,444,000
                                                                   ===========
</TABLE>

  
Rental expense from  continuing  operations  amounted to $557,000,  $500,000 and
$563,000 for 1997,  1996 and 1995,  respectively.  Rental income from continuing
operations amounted to $9,000 and $134,000 for 1996 and 1995, respectively.


                                       28
<PAGE>
  

Note I - Stockholders'  Equity

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.

In 1986,  the company  established  an Incentive  Stock Option Plan  pursuant to
which  1,800,000  shares of common stock 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  value at the date of grant (not less than 110% of the
fair  market  value in the case of  holders  of more  than 10% of the  company's
common stock).  Options granted under the 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.

The following table summarizes stock option activity under this plan:
<TABLE>
<CAPTION>


                                      Number of Shares            Price Ranges
                                      ----------------            ------------
<S>                                        <C>                   <C>    

Outstanding at January 1, 1995             273,201
Granted                                     24,000               $1.83-$  2.01     
Exercised                                  (87,615)              $1.22-$  2.00
Expired                                     (9,600)              $1.52-$  1.67
                                          --------                ------------

Outstanding at December 31, 1995           199,986               $1.22-$  2.01
Granted                                    348,000               $6.67-$  9.83
Exercised                                  (48,510)              $1.22-$  1.83
Expired                                     (1,282)              $1.52-$  1.83
                                          --------                ------------

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

Outstanding at December 31, 1997           573,501               $1.33-$ 13.00
                                          ========

</TABLE>

At December  31,  1997,  435,335  options  were vested and 855,937  options were
available for future grant under the stock option plan.

During 1995, 75,000 warrants were issued to two of the company's officers, 3,000
warrants  were issued to an outside  director and 750 warrants  were issued to a
consultant.  The warrants are  exercisable for five years from the date of grant
and have an exercise price of $1.83 per share. In 1995, the warrants were valued
at $62,000 and the related charge was recorded to continuing operations.  During
1996, 3,000 of such warrants were exercised.


                                       29
<PAGE>
Note I - Stockholders' Equity (continued)

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.
The effect of this  pronouncement  on 1995,  prior to the public offering of the
company's  common  stock,  is not  significant.  Had  compensation  cost for the
company's stock option plan been determined based on the fair value at the grant
date for awards in 1997 and 1996 consistent with the provisions of SFAS No. 123,
the  company's  net income would have been  reduced to the pro forma  amounts of
$4,371,000  and  $3,198,000,  respectively.  Basic earnings per share would have
been reduced to the pro forma  amounts of $.60 and $.46,  respectively.  Diluted
earnings per share would have been reduced to the pro forma  amounts of $.58 and
$.44, respectively.

The assumption  regarding the stock options issued in 1997 and 1996 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 1997 and 1996:
dividend yield of 0%;  expected  volatility of 61% and 65%;  risk-free  interest
rate of 6.5% and 6.2%; and expected lives of five years.

Note J - Income Taxes

The provisions for income taxes from  continuing  operations for 1997,  1996 and
1995 were as follows:
<TABLE>
<CAPTION>
                                                Year ended December 31,
Current income taxes .................    1997           1996           1995
                                         ------         ------         ------
   <S>                                <C>            <C>            <C>    

   Federal ...........................$ 2,814,000    $ 1,852,000    $   916,000
   State .............................    374,000        346,000        194,000
                                      -----------    -----------    -----------
                                        3,188,000      2,198,000      1,110,000
Deferred provision (benefit) ......       (46,000)      (119,000)       (73,000)
                                      -----------    -----------    -----------
   Total provision ................   $ 3,142,000    $ 2,079,000    $ 1,037,000
                                      ===========    ===========    ===========
</TABLE>

The provision  for income taxes from  continuing  operations  differs from those
computed using the federal tax rate of 34% due to the following:
<TABLE>
<CAPTION>
                                                    Year ended December 31,
                                                   1997       1996       1995
                                                  ------     ------     ------  
<S>                                               <C>         <C>        <C> 
Federal income tax at statutory rate ...........   34.0%      34.0%      34.0%
Research and development tax credits ...........   (2.0)      (2.7)      (4.8)
State tax provision, net of federal benefit ....    2.9        3.9        3.6
Other ..........................................    3.1        0.4       (3.0)
                                                  ------     ------     ------           
Effective tax rate .............................   38.0%      35.6%      29.8%
                                                  ======     ======     ======
</TABLE>
The company's  net deferred  income tax balance as of December 31, 1997 and 1996
consists of the following:
<TABLE>
<CAPTION>
                                                            December 31,
Deferred tax liabilities                                 1997           1996
------------------------                                ------         ------
<S>                                                 <C>           <C> 
Capitalized software development cost, net          $    220,000  $     219,000
                                                    ------------  -------------
Deferred tax assets
-------------------
Accrued vacation, payroll and 
  other accrued expenses                                (101,000)      (121,000)
Inventory obsolescence reserve and 
  other inventory related items                         (205,000)      (171,000)
Bad debt reserve                                         (73,000)       (68,000)
Research tax credits                                     (31,000)       (35,000)
Other                                                    (56,000)       (24,000)
                                                    ------------  -------------
   Total deferred tax assets                            (466,000)      (419,000)
                                                    ------------  -------------
      Net deferred tax asset                        $   (246,000) $    (200,000)
                                                    ============  =============
</TABLE>
The carryforward research credits begin to expire in 2006.

                                       30
<PAGE>
Note K - Research and Software Development Costs

The Corporation incurred research and software development costs relating to the
development of new products for continuing operations during 1997, 1996 and 1995
as follows:
<TABLE>
<CAPTION>
                                                 Year Ended December 31,
                                            1997          1996          1995
                                           ------        ------        ------
<S>                                   <C>            <C>            <C>  
Gross expenditures for engineering
  and software development            $   4,764,000   $ 3,460,000   $ 2,177,000
Less:  amounts capitalized               (1,044,000)     (500,000)     (222,000)
                                      -------------   -----------   -----------
   Net charged to operating expenses  $   3,720,000   $ 2,960,000   $ 1,955,000
                                      =============   ===========   ===========
</TABLE>

Software  Development  costs consisted of the following at December 31, 1997 and
1996:
<TABLE>
<CAPTION>
                                                            December 31,
                                                          1997          1996
                                                         ------        ------
<S>                                                 <C>             <C> 
Capitalized software development costs                $ 2,442,000   $ 1,398,000
Less:  accumulated amortization                        (1,863,000)     (849,000)
                                                      -----------   -----------
   Net                                                $   579,000   $   549,000
                                                      ===========   ===========
</TABLE>

Amortization of software development costs for continuing operations included in
cost of goods sold was  $1,014,000,  $369,000 and  $323,000  for 1997,  1996 and
1995, respectively.

Note L  - Earnings Per Share

Statement of Financial  Accounting Standards (SFAS) No. 128, Earnings Per Share,
was  adopted  by the  company  in the fourth  quarter  of 1997.  This  statement
replaces the  presentation of primary earnings per share with basic earnings per
share,  and also  requires  presentation  of diluted  earnings per share.  Basic
earnings  per share (EPS) is computed by  dividing  income  available  to common
stockholders by the weighted average number of common shares outstanding for the
period.  Diluted  EPS  reflects  the  potential  dilution  that  could  occur if
securities or other  contracts to issue common stock were exercised or converted
into common  stock or resulted in the  issuance of common stock that then shared
in the earnings of the company.

The following  table  illustrates  the calculation of both basic and diluted EPS
for the years ending December 31, 1997, 1996 and 1995.
<TABLE>
<CAPTION>
                                                Year ended December 31,
                                            1997          1996          1995
                                           ------        ------        ------
<S>                                   <C>            <C>            <C>    
Basic earnings per  share
Net income available 
  to common stockholders              $   5,131,000   $ 3,734,000   $ 2,374,000
                                      -------------   -----------   -----------
Weighted average common shares            7,230,902     7,019,746     4,590,450
                                      -------------   -----------   -----------
  Basic earnings per share            $         .71   $       .53   $       .52
                                      =============   ===========   ===========


                                                Year ended December 31,
                                            1997          1996          1995
                                           ------        ------        ------
                                                                           
Diluted earnings per share
Net income available 
  to common stockholders              $   5,131,000   $ 3,734,000   $ 2,374,000
                                      -------------   -----------   -----------
Weighted average common shares            7,230,902     7,019,746     4,590,450 
                                                                               
Common equivalent shares                    291,016       228,631        32,903
                                      -------------   -----------   -----------
Weighted average common and 
  common equivalent shares                7,521,918     7,248,377     4,623,353
                                      -------------   -----------   -----------
  Diluted earnings per share          $         .68   $       .52   $       .51
                                      =============   ===========   ===========
</TABLE>

Discontinued operations reduced diluted earnings per share by $.01 for 1995.

                                       31
<PAGE>

Note M - Employee Benefit Plans

The company's  Retirement  Savings Plan  qualifies  under Section  401(k) of the
Internal  Revenue  Code.  Generally,   all  eligible  full  time  employees  may
contribute  up to 20% of their  compensation  subject to the IRS  limitation  of
$9,500 per year toward their retirement on a tax deferred basis. The company has
contributed  matching  contributions  to the  plan  up to  2%,  3% and 3% of the
participant's  compensation  in 1997, 1996 and 1995,  respectively.  The Plan is
administered by the Principal  Financial  Group.  Contributions  from continuing
operations  amounted to $92,000,  $126,000 and $67,000 for 1997,  1996 and 1995,
respectively.  In  conjunction  with the company's  Flexible  Benefits plan, the
company made additional qualified nonelective contributions to employee accounts
in 1997 amounting to $108,000.

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  1997,  1996,  and
1995,  the company paid rent of $318,000,  $307,000 and $297,000,  respectively,
for the use of this location. (Note H)

Note O - Discontinued Operations

In March 1995,  the company sold the assets of the Manutech  business unit for a
net purchase price of $168,000.  Effective March 31, 1995, the company completed
a spin-off  transaction  (the  "Spin-Off")  whereby  the  company's  Performance
Telecom business unit, the  InformationView  business unit, and its wholly owned
subsidiary,  Videk  Corporation,  were combined  into a new entity,  Performance
Telecom  Corporation,  the  stock  of which  was  distributed  to the  Company's
stockholders.  To  accomplish  the Spin-Off,  the  Company's  Board of Directors
declared a distribution  to each of the Company's  stockholders  of one share of
Performance  Telecom stock for each share of the Company's Common Stock owned by
its  stockholders.  The  Spin-Off  was  structured  to  qualify  as  a  tax-free
transaction  under the Internal  Revenue  Code.  This  transaction  represents a
distribution to stockholders and, therefore,  there is no gain or loss reflected
in the company's Consolidated Statements of Income.

The  disposal of Manutech  and the  operations  distributed  in the Spin-Off are
reflected as  discontinued  operations in the company's  consolidated  financial
statements.

A summary of discontinued  operations for the year ended December 31, 1995 is as
follows:
<TABLE>
<CAPTION>

<S>                                                        <C>    

Sales                                                      $   1,634,000
                                                           =============

Loss before income taxes                                   $    (189,000)
Income tax benefit                                               170,000
                                                           -------------
Loss from discontinued operations                          $     (19,000)
                                                           =============
</TABLE>


                                       32
<PAGE>


Note P - Quarterly Results (unaudited)

The following is a summary of unaudited  quarterly results of operations for the
years ended December 31, 1997 and 1996.
<TABLE>
<CAPTION>

                                                  1997
                          -----------------------------------------------------
                                   (in thousands, except per share data)
                          Mar. 31         Jun. 30        Sept. 30       Dec. 31
                          -------         -------        --------       -------
<S>                        <C>             <C>            <C>            <C>  

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
                           ======          ======         ======         ======
Dluted earnings per share  $ 0.15          $ 0.16         $ 0.18         $ 0.18
                           ======          ======         ======         ======


                                                  1996
                          -----------------------------------------------------
                                   (in thousands, except per share data)
                          Mar. 31         Jun. 30        Sept. 30       Dec. 31
                          -------         -------        --------       -------

Sales                      $5,537          $6,463         $6,412         $6,431
Gross profit                3,174           3,721          3,506          3,593
Income from operations      1,313           1,298          1,254          1,222
Net income                 $  897          $  910         $  912         $1,015

Basic earnings per share   $ 0.14          $ 0.13         $ 0.13         $ 0.14
                           ======          ======         ======         ======
Diluted earnings per share $ 0.13          $ 0.12         $ 0.12         $ 0.14
                           ======          ======         ======         ======

</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 3, 1998, which  information  included
therein is incorporated herein by reference.

ITEM 10 - Directors and Executive Officers of the Registrant

The section  entitled  "Election of Directors"  appearing in the company's proxy
statement  for the Annual  Meeting of  Stockholders  to be held on June 3, 1998,
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 3, 1998,
sets forth certain information with respect to the compensation of management of
the company and is incorporated herein by reference.

ITEM 12 - Security Ownership of Certain Beneficial Owners and Management

The  section  entitled  "Security  Ownership  of Certain  Beneficial  Owners and
Management" appearing in the company's proxy statement for the Annual Meeting of
Stockholders  to be held on June 3, 1998,  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 3, 1998,
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         (3)         Amended and Restated Stock Option Plan
10          (1)         Material Contracts
10.1        (2)         Revolving  Credit  Agreement  dated as of October 31,
                             1996 between the Registrant and The Chase Manhattan
                                   Bank, N.A.
10.2        (2)         Revolving  Credit Note in the amount of  $3,000,000
                             dated  October 31, 1996 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
10.15       (1)         License Agreement between the Registrant and Willemijn
                             Houdstermaatschappij BV dated as of January 1, 1994


                                       35
<PAGE>
                                  
Exhibit     Ref.
Number      Number      Description
-------     ------      -----------

10.16       (1)         License  Agreement  between the Registrant and Spider
                             Systems  Limited dated March 18, 1992
10.17       (1)         Technology Transfer Agreement between the Registrant and
                             Newbridge Networks Corporation dated July 5, 1995
10.18       (1)         Real Property Lease for UconX Corporation, as Lessee
10.19       (1)         Line of Credit and  Security  Agreement  between  the
                             Registrant and UconX Corporation dated as of
                             September 1, 1992
10.20       (1)         Amendment to Line of Credit Agreement and Security
                             Agreement  between the Registrant and UconX
                             Corporation dated as of July 1, 1993
10.21       (1)         Second Amendment to Line of Credit and Security
                             Agreement between the Registrant and UconX
                             Corporation dated as of September 2, 1994
10.22       (1)         Employee Confidentiality, Non-Disclosure,
                             Non-Competition and Assignment Agreement between
                             the Registrant, UconX Corporation and Thomas R.
                             Stockey dated August 14, 1992
10.23       (1)         Employee   Confidentiality,    Non-Disclosure,
                             Non-Competition and Assignment Agreement between
                             the Registrant,UconX Corporation and Robert S.
                             Lindstrom dated August 14, 1992
10.24       (1)         Employee   Confidentiality,    Non-Disclosure,
                             Non-Competition and Assignment Agreement between
                             the Registrant, UconX Corporation and Jean M.
                             Lindstrom dated August 14, 1992
10.25       (1)         Employee   Confidentiality,    Non-Disclosure,
                             Non-Competition and Assignment Agreement between
                             UconX Corporation and Kevin Quick dated August 16,
                                      1992
10.26       (1)         Employee   Confidentiality,    Non-Disclosure,
                             Non-Competition   and Assignment Agreement between
                             UconX Corporation and Tim Barba dated August 14,
                             1992
10.27       (1)         Shareholders'  Agreement among the  Registrant,
                             Shareholders of UconX Corporation and UconX
                             Corporation dated as of September 1, 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
11          (1)         Statement re computation of per share earnings
21          (1)         Subsidiaries
23                      Consent of Price Waterhouse LLP, independent accountants
27                      Financial Data Schedule, pursuant to Item 601(c) of 
                             Regulation S-K.

--------------------------------------------------------------------------------
(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's  Quarterly  Report on Form
10-Q/A for the  Quarterly  Period Ended  September  30, 1996 filed  November 14,
1996.
(3) Incorporated by reference to the Registrant Statement on Form S-8 filed July
30, 1997.


(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 19, 1998                                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 19, 1998
-----------------------
Charles E. Maginness                 and Director


S/DONALD L. TURRELL                 President, Chief Executive    March 19, 1998
-----------------------
Donald L. Turrell                   Officer and Director


/s/DORRANCE W. LAMB                 Chief Financial Officer,      March 19, 1998
-----------------------
Dorrance W. Lamb                    and Vice President of Finance


/s/BERNARD KOZEL                    Director                      March 19, 1998
-----------------------
Bernard Kozel


/s/JOHN E. MOONEY                   Director                      March 19, 1998
-----------------------
John E. Mooney


/s/JOHN M. SLUSSER                  Director                      March 19, 1998
-----------------------
John M. Slusser


/S/PAUL L. SMITH                    Director                      March 19, 1998
-----------------------
Paul L. Smith



                                       37
<PAGE>


Exhibit 23  

                         Consent of Independent Accounts

We  hereby  consent  to the  incorporation  by  reference  in  the  Registration
Statement on Form S-8 (No. 333-24477) of Performance Technologies,  Incorporated
of our report dated February 16, 1998 appearing on page 19 of this Form 10-K.

/s/Price Waterhouse LLP
-----------------------
Price Waterhouse LLP
Rochester, New York
March 20, 1998