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                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549

                                   FORM 10-K

(Mark One)

            [x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                 SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]

                  For the fiscal year ended December 31, 1997

          [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
               SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

                For the transition period from _______to_______

                         Commission file number 1-8191

                              PORTA SYSTEMS CORP.
             (Exact name of registrant as specified in its charter)

Delaware                                                    11-2203988
(State or other jurisdiction                                (IRS Employer
of incorporation or organization)                           Identification No.)

575 Underhill Boulevard, Syosset, New York                  11791
(Address of principal executive offices)                    (Zip Code)

Registrant's telephone number, including area code:         (516) 364-9300

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, par value $.01                             American Stock Exchange
      (Title of Class)                                   (Name of Exchange 
                                                         on which registered)

Securities registered pursuant to Section 12(g) of the Act:

                                      None

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

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

      State aggregate market value of the voting stock held by non-affiliates of
the registrant: $34,745,149 as of March 5, 1998.

      Indicate  the  number of shares  outstanding  of each of the  registrant's
class of common stock, as of the latest  practicable  date:  9,265,373 shares of
Common Stock, par value $.01 per share, as of March 5, 1998.

                      DOCUMENTS INCORPORATED BY REFERENCE

The  registrant's  definitive proxy statement in connection with its 1997 Annual
Meeting  of  Stockholders  to be  filed  within  120  days of the  close  of the
registrant's  fiscal  year is  incorporated  by  reference  into Part III of the
Report.

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<PAGE>

Item 1.  Business

      Porta Systems Corp. (the "Company")  develops,  designs,  manufactures and
markets a broad range of proprietary and standard  telecommunications  equipment
and  systems for sale  domestically  and  internationally.  The  Company's  core
products fall into three categories:

      Computer-based  operation  support  systems  ("OSS").  The  Company's  OSS
systems  automate  the  operational,  administrative,  maintenance  and  testing
functions within telephone companies.  These systems are marketed principally to
foreign telephone operating  companies in established and developing  countries,
primarily in Asia, South and Central America and Europe.

      Telecommunications  connection and protection equipment. These systems are
used  to  connect  copper-wired   telecommunications  networks  and  to  protect
telecommunications   equipment  from  voltage  surges.   The  Company's   copper
connection  equipment and systems are marketed to telephone  operating companies
in the United States and foreign countries.

      Signal  processing  equipment.  These products  support copper  wire-based
communications systems and are sold principally for use in defense and aerospace
applications.

      In March 1996 the Company sold its fiber optics  connector  business  and,
accordingly,  its products are designed for use by  telecommunication  companies
and other  users  that  utilize  copper  wire,  and not fiber  optics  for their
transmission  facilities.  See Item 7  Management  Discussion  and  Analysis  of
Financial Condition and Results of Operations.

      Porta Systems Corp. is a Delaware corporation  incorporated in 1972 as the
successor  to a  New  York  corporation  incorporated  in  1969.  The  Company's
principal  offices are located at 575  Underhill  Boulevard,  Syosset,  New York
11791;  telephone  number,  516-364-9300.  References to the Company include its
subsidiaries, unless the context indicates otherwise.

Products

      Operations  Support  Systems.  OSS systems are used primarily by telephone
operating  companies.  The Company's  principal  OSS system is a  computer-based
testing  product--the  Line Condition Report,  ("LCR")  system--which is a major
item of capital  equipment and typically  sells for prices  ranging from several
hundred thousand to several million dollars.  The Company also  manufactures and
sells a number of other products,  primarily  software based,  which are used in
testing, maintenance, provisioning and repair of telephone equipment.

      The LCR, introduced in the mid-1970's,  was the first  computer-controlled
electronic  system  used to  automatically  test for and  diagnose  problems  in
customer  telephone lines and to notify telephone  company service  personnel of
required  maintenance.  The associated  Mechanized Line Record ("MLR")  database
system  provides  automated  record keeping  (including  repair and  disposition
records) and analyzes these records for identification of recurring problems and
equipment  deterioration.  The  Company's  LCR  systems  are  sold to  telephone
operating  companies  in a number of foreign  countries as well as in the United
States.

      The Company's software, which can be packaged and integrated with the LCR,
provides additional OSS functions, such as the automated assignment of telephone
company facilities and activation of service.  In addition,  pursuant to certain
contracts  with  customers,  the  Company  develops  software  to meet  specific
customer requirements.


                                       1
<PAGE>

      The  Company's  OSS  products  are  complex  and,  in  most  applications,
incorporate  features  designed  to  respond  to  the  purchaser's   operational
requirements  and the particular  characteristics  of the purchaser's  telephone
system.  As a result,  the  negotiation  of a  contract  for an OSS system is an
individualized  and highly  technical  process.  In addition,  contracts for OSS
systems frequently provide for manufacturing,  delivery,  installation,  testing
and  purchaser  acceptance  phases,  which take place over periods  ranging from
several months to a year or more. Such contracts  typically contain  performance
guarantees  by the  Company  and clauses  imposing  penalties  on the Company if
"in-service"  dates  are  not  met.  The  installation,  testing  and  purchaser
acceptance  phases of these  contracts may last longer than  contemplated by the
contracts and, accordingly, amounts due under the contracts may not be collected
for extended periods.  Delays in purchaser  acceptance of the systems and in the
Company's  receipt of final contract payments have occurred in connection with a
number of foreign sales.  In addition,  the Company has not experienced a steady
or predictable flow of orders for OSS systems.

      Telecommunications    Connection    Equipment.    The   Company's   copper
connection/protection  equipment  and  systems are used by  telephone  operating
companies,   by  owners  of   private   telecommunications   equipment   and  by
manufacturers  and suppliers of telephone  central office and customer  premises
equipment.   Products   of  the  types   comprising   the   Company's   line  of
telecommunications  connection  equipment are included as integral  parts of all
domestic and foreign telephone and telecommunications systems. Such products are
sold in a worldwide market,  which generally grows in proportion to increases in
the number of  telephone  subscribers  and owners of private  telecommunications
equipment,  as well as to  increases  in  upgrades to modern  digital  switching
technology.

      The  Company's  connection  equipment  consists  of  connector  blocks and
protection  modules used by telephone  companies  to  interconnect  copper-based
subscriber lines to switching  equipment  lines.  The protector  modules protect
central office  personnel and equipment  from  electrical  surges.  The need for
protection  products has increased as a result of the worldwide  move to digital
technology,  which is extremely sensitive to damage by electrical overloads, and
because   private   owners  of   telecommunications   equipment   now  have  the
responsibility  to protect  their  equipment  from damage  caused by  electrical
surges.  Line  connecting/protecting  equipment usually  incorporates  protector
modules to safeguard  equipment and  personnel  from injury due to power surges.
Currently,  these  products  include a variety of  connector  blocks;  protector
modules  and  frames  used  in  telephone   central   switching   offices,   PBX
installations and multiple user facilities.

      The  Company  also  has  developed  an  assortment  of  frames  for use in
conjunction  with  the  Company's  traditional  line  of   connecting/protecting
products.  Frames  for the  interconnection  of copper  circuits  are  specially
designed  structures  which, when equipped with connector blocks and protectors,
interconnect  and  protect  telephone  lines and  distribute  them in an orderly
fashion allowing access for repairs and changes in line connections.  One of the
Company's   frame   products,   the  CAM   frame,   is   designed   to   produce
computer-assisted  analysis  and for the optimum  placement of  connections  for
telephone lines on the connector blocks mounted on the frame.

      The Company's copper connection/protection products are used by several of
the six regional  Bell holding  companies  as well as by  independent  telephone
operating   companies   in   the   United   States   and   owners   of   private
telecommunications  equipment.  These  products  are  also  purchased  by  other
companies  for  inclusion  within  their  systems.  In addition,  the  Company's
telecommunications  connection  products  have been sold to telephone  operating
companies  in various  foreign  countries.  This  equipment is  compatible  with
existing  telephone  systems  both within and outside the United  States and can
generally  be used  without  modification,  although  the  Company  does  design
modifications to accommodate the specific needs of its customers.


                                       2
<PAGE>

      Signal  Processing  Products.  The Company's  signal  processing  products
include data bus system and wideband  transformers.  Data bus systems, which are
the  communication  standard  for  military and  aerospace  systems,  require an
extremely high level of reliability and performance.  Wideband  transformers are
required for ground noise  elimination in video imaging  systems and are used in
the television and broadcast,  medical  imaging and industrial  process  control
industries.

      The table below shows,  for the last three fiscal years,  the contribution
made  to  the  Company's   sales  by  each  of  its  major   categories  of  the
telecommunications industry:

                            Sales by Product Category

                                     Years Ended December 31,
                                     ------------------------
                         1997                  1996                   1995
                         ----                  ----                   ----
                                      (Dollars in thousands)

OSS Systems         $29,561     48%      $26,804      46%       $28,988     47%
                                                               
Line Connecting                                                
/Protecting                                                    
Equipment (*)        23,753     38%       23,249      40%        26,867     44%
                                                                               
Signal Processing     8,280     13%        7,597      13%         4,857      8%
                                                               
Other                   636      1%          337       1%           469      1%
                    -------    ---       -------     ---        -------    --- 
                                                               
Total               $62,230    100%      $57,987     100%       $61,181    100%
                    =======    ===       =======     ===        =======    === 

(*)   Includes sales of fiber optics products of $447,000 in 1996 and $6,513,000
      in 1995. The assets comprising the fiber optics business unit were sold in
      March 1996.

Markets for the Company's Products

      The Company supplies equipment and systems to telephone  companies used to
provide improved services to their customers.  In addition, the Company provides
businesses with systems, which improve their internal telecommunication systems.

      Typically,  telephone  networks in certain  regions of the world,  notably
Latin  America,  Eastern  Europe and certain areas in the  Asia/Pacific  region,
utilize telephone-switching systems which use analog technology.  These networks
were designed to carry voice traffic and are not well suited for high-speed data
transmissions  or for  other  forms  of  telecommunications  that  operate  more
effectively with digital  telecommunications  equipment and lines. The telephone
networks  in these  countries  are  also  characterized  by a very low  ratio of
telephone  lines  to  population.   Countries  with  emerging  telecommunication
networks have to rapidly add access lines in order to increase the  availability
of telephone  service  among its  population  and to  significantly  upgrade the
quality of the lines already in service.


                                       3
<PAGE>

      The  Company's  OSS  systems  are  designed to meet many of the needs of a
rapidly  changing  telephone  network.  OSS systems  facilitate rapid change and
expansion  without  a  comparable   increase  in  the  requirement  for  skilled
technicians,  while the computerized  line test system insures increased quality
and rapid  maintenance  and repair of  subscriber  local  loops.  The  automated
database,  which  computerizes  the  inventory  and  maintenance  history of all
subscriber lines in service, helps to keep the rapid change under control.

      During 1997,  approximately  48% of the Company's  sales  consisted of OSS
products.

      As a telephone company expands the number of its subscriber lines, it also
requires  connection  equipment to  interconnect  and protect those lines in its
central offices.  The Company provides a line of copper connection equipment for
this purpose.  Recent trends towards the transmission of high frequency  signals
on copper lines are sustaining this market.  Less developed  countries,  such as
those with emerging  networks or those upgrading to digital  switching  systems,
provide a growing market for copper connection and protection equipment.

      The increased  sensitivity of the newer digital  switches to small amounts
of voltage  requires the  telephone  company  which is upgrading  its systems to
digital    switching    systems   to   also    upgrade   its   central    office
connection/protection  systems in order to meet these more stringent  protection
requirements.  The Company supplies central office connection/protection systems
to meet these needs.

      During  1997,  approximately  38% of the  Company's  sales  were  made  to
customers in this category.

      The Company's line of signal processing  products is supplied to customers
in the  military  and  aerospace  industry as well as  manufacturers  of medical
equipment and video systems. The primary communication  standard in new military
and  aerospace  systems  is the  MIL-STD-1553  Command  Response  Data Bus,  and
applications  require an extremely  high level of reliability  and  performance.
Products are designed to be application  specific to satisfy the requirements of
each military or aerospace program.

      The  Company's  wideband   transformers  are  required  for  ground  noise
elimination  in  video  imaging  systems  and  are  used in the  television  and
broadcast,  medical imaging and industrial  process control  industries.  If not
eliminated,  ground  noise  caused  by poor  electrical  system  wiring or power
supplies,  results in  significant  deterioration  in system  performance  (poor
picture  quality,  process  failures in  instrumentation,  etc.).  The  wideband
transformers  provide a cost effective and quick solution to the problem without
the need of redesign of the rest of the system.

      During 1997, signal processing  equipment  accounted for approximately 13%
of the Company's sales.


                                       4
<PAGE>

Marketing and Sales

      The Company operates through three business units,  which are organized by
product line, and with each having responsibility for the sales and marketing of
its products.

      When  appropriate  to obtain sales in foreign  countries,  the Company may
enter into arrangements and technology transfer agreements covering its products
with  local   manufacturers  and  participate  in  manufacturing  and  licensing
arrangements with local telephone equipment suppliers.

      In  the  United  States  and  throughout  the  world,   the  Company  uses
independent  distributors  in the marketing of Company  products to the customer
premises equipment market. All distributors marketing copper-based products also
market  directly  competing  products.  In  addition,  the Company  continues to
promote the direct marketing  relationships it forged in the past with telephone
operating companies.

      In November  1996, the Company  amended its supply  agreement with British
Telecommunications  plc  ("BT")  for the  Company's  line  connecting/protecting
products.  The amended  agreement  will expire on August 31, 2001, and provides,
among other things,  that the Company may no longer be the exclusive supplier to
BT for these products. During 1997, 1996, and 1995, BT purchased $9,397,000 (15%
of  sales),   $9,296,000  (16%  of  sales),   and  $8,060,000  (13%  of  sales),
respectively, of the Company's line connecting/protecting products. During these
years,  additional  sales  of the  Company's  products  were  also  made  at the
direction  of BT to certain  unaffiliated  suppliers to BT for resale to BT. The
amended contract also provides for a cross license which, in effect,  enables BT
to use certain of the  Company's  proprietary  information  to modify or enhance
products  provided to BT and permits those products to be  manufactured by BT or
others for its own purposes.

      The Company's OSS systems have  primarily  been sold to foreign  telephone
operating companies (which are sometimes controlled by foreign governments), and
the  contracts  relating  to OSS  systems are  principally  negotiated  directly
between the Company and these purchasers.

      The Signal  Processing  line of products is sold  primarily to US military
and aerospace prime contractors, and domestic OEMs and end users.


                                       5
<PAGE>

      The  following  table  sets  forth  for the last  three  fiscal  years the
Company's sales to customers by geographic region:

                  Sales to Customers By Geographic Region (1)

                                        Year Ended December 31,
                                        -----------------------
                           1997                 1996                  1995
                           ----                 ----                  ----
                                        (Dollars in thousands)

United States
and Puerto Rico       $17,980    29%       $17,644    30%       $16,445     27%
                                                                
United Kingdom         18,640    30%        16,000    28%        22,230     36%
                                                                
Other Europe           10,587    17%         5,416     9%         2,831      5%
                                                                
Asia/Pacific           10,278    17%        15,812    27%        13,470     22%
                                                                
Latin America           3,718     6%         1,738     3%         4,743      8%
                                                                
Middle East               879     1%         1,248     2%           899      1%
                                                                
Other                     148     0%           129     1%           563      1%
                      -------   ---        -------   ---        -------    --- 
                                                                
Total Sales           $62,230   100%       $57,987   100%       $61,181    100%
                      =======   ===        =======   ===        =======    === 

(1)   For information  regarding the amount of sales,  operating  profit or loss
      and identifiable assets  attributable to each of the Company's  geographic
      areas, see Note 23 to the Consolidated Financial Statements.

      In selling to customers in foreign countries, there are inherent risks not
normally  present  in the case of sales to United  States  customers,  including
increased  difficulty in  identifying  and  designing  systems  compatible  with
purchasers'  operational   requirements;   extended  delays  under  OSS  systems
contracts  in the  completion  of testing and  purchaser  acceptance  phases and
difficulty in the Company's receipt of final payments and political and economic
change. In addition,  to the extent that the Company  establishes  facilities in
foreign countries, the Company faces risks associated with currency devaluation,
inability to convert  local  currency into dollars,  local tax  regulations  and
political instability.


                                       6
<PAGE>

Manufacturing

      The  Company's  computer-based  testing  products  include  the  Company's
proprietary   testing   circuitry   and   computer   programs,   which   provide
platform-independent  solutions  based  on  UNIX or  UNIX  compatible  operating
systems. The testing products also incorporate disk data storage, data terminals
("CRTs"), teleprinters, minicomputers and personal computers (PC's) purchased by
the  Company.  These  products  are  installed  and tested by the Company on its
customers' premises.

      At present,  the  Company's  manufacturing  operations  are  conducted  at
facilities  located in Glen Cove, New York;  Matamoros,  Mexico and Seoul, South
Korea. The Company from time to time also uses subcontractors to augment various
aspects of its production  activities and periodically  explores the feasibility
of conducting operations at lower cost manufacturing  facilities located abroad.
In pursuing sales  opportunities with foreign telephone  companies,  the Company
may locate its production activities in foreign countries which require domestic
involvement in the production of equipment purchased for their telephone systems
and in foreign countries which, in addition,  require full or partial technology
transfers  to domestic  enterprises.  In  addition,  the  Company  had  software
development sites in Syosset, New York, Charlotte, North Carolina, and Coventry,
United Kingdom.

Source and Availability of Components

      The  Company  generally  purchases  the  standard  components  used in the
manufacture of its products from a number of suppliers.  The Company attempts to
assure itself that the components  are available from more than one source.  The
Company purchases the majority of its minicomputers used in its OSS systems from
Digital  Equipment  Corporation  ("DEC").  However,  the Company could use other
computer  equipment  in its systems if the Company  were unable to purchase  DEC
products.  Other components,  such as CRTs and teleprinters,  used in connecting
with the Company's  electronic products could be obtained from alternate sources
and readily integrated with the Company's products.

Significant Customers

      During the years ended  December  31, 1997 and 1996,  the  Company's  five
largest  customers  accounted for sales of $30,633,000,  or approximately 49% of
sales,  and $  27,807,000,  or  approximately  48% of sales,  respectively.  The
Company's  largest  customer is BT. Sales to BT for the year ended  December 31,
1997  and  1996  amounted  to  $13,876,000  and  $11,308,000,  respectively,  or
approximately 22% and 20%, respectively,  of the Company's sales for such years.
Therefore,  any  significant  interruption  or decline in sales to BT may have a
materially adverse effect upon the Company's  operations.  During 1996, sales to
the Philippines Long Distance Telephone were $7,034,000, or approximately 12% of
sales.  No other  customers  account for 10% or more of the Company's  sales for
either year.

      In  addition,  the former  Bell  operating  companies  continue  to be the
ultimate  purchasers of a significant  portion of the Company's products sold in
the  United  States,  while  sales  to  foreign  telephone  operating  companies
constitute  the major  portion of the  Company's  foreign  sales.  The Company's
contracts with these customers  require no minimum  purchases by such customers.
Significant  customers for the Signal  Processing  products include the major US
Aerospace  companies,  Department  of  Defense  service  depots  and OEMs in the
medical imaging and process control equipment.  Both catalog and custom designed
products  are  sold  to  these   customers.   Some   contracts  are   multi-year
procurements.


                                       7
<PAGE>

Backlog

      At December 31, 1997, the Company's backlog was $19,558,000  compared with
approximately  $18,296,000  at  December  31,  1996.  Of the  December  31, 1997
backlog,  approximately  $15,948,000  represented  orders from foreign telephone
operating companies,  including $4,474,000 attributable to the contract with BT.
See "Marketing and Sales".  The Company expects to ship substantially all of its
December 31, 1997 backlog  during 1998.  However,  certain of the  Company's OSS
contracts provide for deliveries subsequent to December 31, 1998.

Patents

      The  Company is the owner of a number of utility  and design  patents  and
patent  applications.  In  addition,  the  Company  has  sought  foreign  patent
protection for a number of its products.

      From  time to  time  the  Company  enters  into  licensing  and  technical
information  agreements  under  which it  receives  or grants  rights to produce
certain specified  subcomponents used in certain of the Company's products or in
connection  with products  developed by the Company.  These  agreements  are for
varying  terms and provide for the payment or receipt of  royalties or technical
license fees.

      While the Company considers patent protection important to the development
of its  business,  and produces  certain  subcomponents  of its  products  under
licensing  agreements,  the Company believes that its success depends  primarily
upon its  engineering,  manufacturing  and marketing  skills.  Accordingly,  the
Company  does  not  believe  that  a  denial  of  any  of  its  pending   patent
applications,  expiration of any of its patents, a determination that any of the
patents which have been granted to it are invalid or the  cancellation of any of
its existing  license  agreements  would have a material  adverse  effect on the
Company's business.

Competition

      The  telephone  equipment  market in which the  Company  does  business is
characterized by intense competition,  rapid technological change and a movement
to private ownership of telecommunications equipment. In competing for telephone
operating  company  business,  the purchase  price of equipment  and  associated
operating  expenses have become significant  factors,  along with product design
and  long-standing  equipment  supply  relationships.  In the customer  premises
equipment  market,  the  Company is  functioning  in a market  characterized  by
distributors and installers of equipment and by commodity pricing.

      The Company  competes  directly with a number of large and small telephone
equipment   manufacturers  in  the  United  States,   with  Lucent  Technologies
("Lucent")  continuing to be the Company's  principal United States  competitor.
Lucent's  greater  resources,  extensive  research and  development  facilities,
long-standing equipment supply relationships with the operating companies of the
regional holding companies and history of manufacturing  and marketing  products
similar in function to those produced by the Company  continue to be significant
factors in the Company's competitive environment.

      Currently,  Lucent  and a  number  of  companies  with  greater  financial
resources  than the  Company  produce,  or have  the  design  and  manufacturing
capabilities to produce,  products  competitive with the Company's products.  In
meeting this  competition,  the Company relies  primarily on the performance and
design  characteristics  of its products of  comparable  performance  or design,
endeavors to offer its products at prices and with warranties that will make its
products competitive.


                                       8
<PAGE>

      In  connection  with  overseas  sales  of its  line  connecting/protecting
equipment,  the Company has met with significant  competition from United States
and foreign  manufacturers of comparable  equipment and expects this competition
to  continue.  In  addition  to  Lucent,  a  number  of the  Company's  overseas
competitors have significantly greater resources than the Company.

      The  Company  competes  directly  with a  limited  number  of  substantial
domestic and  international  companies with respect to its sales of OSS systems.
In meeting this competition, the Company relies primarily on the features of its
line testing equipment,  its ability to customize systems and endeavors to offer
such equipment at prices and with warranties that will make them competitive.

Research and Development Activities

      During the fiscal  years  ended  December  31,  1997,  1996 and 1995,  the
Company   spent   approximately   $5,361,000,    $3,848,000,   and   $6,103,000,
respectively,  on its  research  and  development  activities.  All research and
development was company sponsored and is expensed as incurred.

Employees

      As of February 28, 1998,  the Company had 457  employees of which 134 were
employed in the United States,  229 in Mexico,  48 in the United  Kingdom,  5 in
Poland  and 41 in  Korea.  The  Company  believes  that its  relations  with its
employees are good, and it has never experienced a work stoppage.  The Company's
employees are not covered by collective  bargaining  agreements,  except for its
hourly employees in Mexico who are covered by a collective  bargaining agreement
that expires on December 31, 1998.

Item 2.  Properties

      The  Company  currently  leases   approximately   20,400  square  feet  of
executive,  sales,  marketing  and research  and  development  space  located in
Syosset,  New  York;  5,300  square  feet of  office  space  used  for  software
development  located in  Charlotte,  North  Carolina;  and 15,000 square feet of
manufacturing space located in Kingsville, Texas. The Company also owns a 31,000
square foot manufacturing and research and development  facility located in Glen
Cove, New York. These facilities  represent  substantially  all of the Company's
office,  plant and warehouse space in the United States.  The Syosset,  New York
lease expires  December  2000;  the  Charlotte,  North Carolina lease expires in
April 1999 and the  Kingsville,  Texas lease expire December 1999. The aggregate
annual rental is approximately $400,000.

      The Company's  wholly-owned  Mexican subsidiary owns approximately  40,000
square foot  manufacturing  facility  Matamoros,  Mexico. A wholly-owned  United
Kingdom  subsidiary  owns a 34,261  square foot  facility in Coventry,  England,
which facility comprises all of the Company's office,  plant and warehouse space
in the United Kingdom.

      The Company believes its properties are adequate for its needs.


                                       9
<PAGE>

Item 3.  Legal Proceedings

      In July 1996,  an action was  commenced  against  the  Company and certain
present and former  directors in the Supreme Court of the State of New York, New
York  County by certain  stockholders  and  warrant  holders of the  Company who
acquired their  securities in connection  with the acquisition by the Company of
Aster Corporation.  The complaint alleges breach of contract against the Company
and breach of  fiduciary  duty against the  directors  arising out of an alleged
failure  to  register  certain  restricted  shares  and  warrants  owned  by the
plaintiffs.  The complaint seeks damages of $413,000;  however,  counsel for the
plaintiff has advised the Company that  additional  plaintiffs may be added and,
as a result, the amount of damages claimed may be substantially greater than the
amount  presently  claimed.  The Company believes that the defendants have valid
defenses to the claims. The action is currently in the discovery stage.

      In July 1996, the Securities and Exchange Commission (the "SEC") issued an
order  (the  "Order")  directing  a  private  investigation  of the  Company  to
determine whether there has been a violation of Federal securities laws. The SEC
indicated  to counsel  for the  Company  that the  investigation  relates to the
position of the SEC staff that the  independence  of the Company's  auditors for
1995, KPMG Peat Marwick LLP ("Peat Marwick"),  was adversely impacted by certain
relationships  involving  Peat  Marwick,  on the  one  hand,  and  KPMG  BayMark
Strategies LLC ("BayMark") and Edward R. Olson, the President of BayMark and the
Company's  former interim  president and chief operating  officer,  on the other
hand.  Although  the Company  does not agree with the  position of the SEC staff
with respect to the  independence  of Peat Marwick,  the Company is  cooperating
with the SEC's  investigation.  The Company retained BDO Seidman, LLP to reaudit
the Company's 1995 financial statements, which reaudit resulted in no changes to
the Company's 1995 financial  statements as audited by Peat Marwick. The Company
does not believe that the investigation will result in any material liability on
the part of the  Company.  The  Company  is not  aware of any  further  activity
respecting this investigation since November 1996.

Item 4.  Submission of Matters to a Vote of Securities Holders

      During the fourth  quarter of 1997,  there were no matters  required to be
submitted to a vote of security holders of the Company.


                                       10
<PAGE>

Item Pursuant to  Instruction 3 of Item 401 (b) of Regulation S-K:

Executive Officers of the Company

Name and Position                                   Age
-----------------                                   ---

William V. Carney                                    60
Chairman of the Board
Chief Executive Officer

Seymour Joffe                                        68
President and
Chief Operating Officer

Michael A. Tancredi                                  68
Senior Vice President
Secretary and Treasurer

Edward B. Kornfeld                                   54
Senior Vice President - Operations
Chief Financial Officer

John J. Gazzo                                        54
Senior Vice President

Prem G. Chandran                                     45
Vice President

Edmund Chiodo                                        43
Vice President

David Rawlings                                       54
Vice President

William Novelli                                      66
Vice President

Gerald Hammond                                       43
Vice President

      All of the  Company's  officers  serve  at the  pleasure  of the  Board of
Directors.  Of the executive officers listed above,  Messrs.  Carney,  Joffe and
Tancredi  are also  members  of the  Board  of  Directors.  There  is no  family
relationship between any of the executive officers listed above.


                                       11
<PAGE>

      Mr. Carney  was elected as Chairman  of the Board of  Directors  and Chief
Executive  Officer in 1996 and has served as a director since 1970.  Previously,
Mr.  Carney had served as  Secretary  since 1970,  Senior Vice  President  since
November 1989 and Chief  Technical  Officer from  December  1990. He was elected
Vice  Chairman  in  January  1988.  He  was  Senior  Vice   President-Mechanical
Engineering   from   January   1988  to  November   1989  and  was  Senior  Vice
President-Manufacturing   from  March  1984  to  February   1985,   Senior  Vice
President-Operations  from June 1977 to February  1984 and Vice  President  from
1970 to June 1977.

      Mr. Joffe was elected  President and Chief Operating  Officer in 1996. Mr.
Joffe,  who  served as  director  of the  Company  from  1987 to 1992,  has most
recently  served the  Company as senior  consultant  to its  Operations  Support
Systems (OSS) business.  Mr. Joffe has been Chairman of JSI International,  Inc.
which  represents  companies  in the  marketing  and  positioning  of  high-tech
products  and serves in the Asia Pacific  area.  Mr. Joffe has also served as an
officer and director of a number of public and private companies involved in the
computer and telecommunications industries.

      Mr. Tancredi  was elected  Senior Vice President and Secretary in 1996. He
has been  Treasurer  since April 1978 and Director  since 1970. He had served as
Vice President between March 1984 to October of 1996. He was Vice President from
April 1978 to February 1984 and Comptroller from April 1971 to March 1978.

      Mr. Kornfeld  was elected a Senior Vice  President-Operations  in 1996. He
has served as Vice  President-Finance and Chief Financial Officer of the Company
since October 1995.  Prior to his election to this position,  Mr.  Kornfeld held
positions  with  several  companies  for more than five years,  including  Excel
Technology Inc. (Quantronix Corp.) and Anorad Corporation.

      Mr. Gazzo was elected  Senior Vice  President  in March 1996.  He has been
Vice President-Marketing of the Company since April 1993 and was general manager
of its Porta  Electronics  Division from November 1989 to April 1993; he was the
Company's Vice  President-Research  and Development  from March 1984 to November
1989 and was Vice  President-Engineering  from February  1978 to February  1984.
Prior to that time, he was Chief Engineer of the Company.

      Mr. Chandran was elected Vice President in December 1995. Mr. Chandran had
been with the Company as Assistant Vice President of Engineering since 1991.

      Mr. Chiodo was elected Vice  President in March 1996.  Mr. Chiodo had been
with the Company since 1980. During that time he has held various positions with
in the Company, most recently as Assistant Vice President of OSS operations.

      Mr. Rawlings  was elected Vice President in March 1996.  Mr.  Rawlings has
been the Assistant Vice President of Research and  Development - Copper products
since 1992.

      Mr. Novelli  was elected Vice  President in December 1996. Mr. Novelli has
been the Assistant Vice President of Sale and Marketing - Copper  products since
1989.

      Mr. Hammond was elected Vice President in March 1997. Mr. Hammond has been
with the Company since 1970. During that time he has held various positions with
the  Company,  most  recently  as  Assistant  Vice  President  of  Research  and
Development.


                                       12
<PAGE>

                                    Part II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

      The Company's Common Stock is traded on the American Stock Exchange,  Inc.
under the symbol PSI. The following table sets forth,  for the period January 1,
1996 through  December 31, 1997, the quarterly high and low sales prices for the
Company's Common Stock on the  consolidated  transaction  reporting  systems for
American  Stock  Exchange  listed  issues.  Share prices  listed below have been
restated to give  effect to the one for five  reverse  stock split which  became
effective on August 2, 1996.

                                        High              Low
                                        ----              ---

1996     First Quarter                  6  9/16           3  7/16
         Second Quarter                 4 11/16           3  1/8
         Third Quarter                  3  3/4            1  7/8
         Fourth Quarter                 2  1/2            1  1/4

1997
         First Quarter                  2  1/8            1  3/8
         Second Quarter                 2 15/16           1  1/4
         Third Quarter                  5  1/4            2  5/16
         Fourth Quarter                 4  1/4            3

      The Company did not declare or pay any cash  dividends in 1997 or 1996. It
is the present  policy of the  Company to retain  earnings to finance the growth
and  development of the business and therefore,  the Company does not anticipate
paying  cash  dividends  on its  Common  Stock  in the  foreseeable  future.  In
addition,  the  Company's  Amended  and  Restated  Loan and  Security  Agreement
prohibits the Company from paying cash dividends on its Common Stock.

      As of March 5, 1998,  the  number of  holders  of record of the  Company's
Common Stock was approximately 1,560.

Item 6.  Selected Financial Data

      The following  table sets forth certain  selected  consolidated  financial
information  of the Company.  All share and per share data have been restated to
give effect to the one for five reverse  stock split which  became  effective on
August  2,  1996.  For  further  information,  see  the  Consolidated  Financial
Statements and other information set forth in Item 8 and Management's Discussion
and  Analysis  of  Financial   Condition  and Results of Operations set forth in
Item 7:


                                       13
<PAGE>

<TABLE>
<CAPTION>
                                                                           Year Ended December 31,   
                                                                           -----------------------   
                                                      1997           1996            1995            1994            1993
                                                      ----           ----            ----            ----            ----
                                                                     (In thousands, except per share data)
<S>                                                <C>             <C>             <C>             <C>             <C>      
Income Statement Data:

Sales                                              $ 62,230        $ 57,987        $ 61,181        $ 68,985        $  68,141
Operating income (loss)                               6,101           3,982         (19,884)        (17,541)          (3,916)

Debt conversion expense                             (11,458)           --              --              --               --

Income (loss) before discontinued
   operations and extraordinary item                 (7,021)          1,252         (29,297)        (39,995)          (7,493)

Net income (loss)                                    (6,899)          5,174         (31,041)        (39,995)          (9,545)

Basic per share amounts*:    
   Continuing operations                           $  (2.26)       $   0.57        $ (20.05)       $ (27.51)       $   (5.29)
   Net income (loss)                               $  (2.22)       $   2.37        $ (21.25)       $ (27.51)       $   (6.74)
                            
Diluted per share amounts*: 
   Continuing operations                           $  (2.26)       $   0.23        $ (20.05)       $ (27.51)       $   (5.29)
   Net income (loss)                               $  (2.22)       $   0.94        $ (21.25)       $ (27.51)       $   (6.74)
                              
Cash dividends declared                                --              --              --              --               --

Number of shares used in
   calculating net income (loss)
   per share-basic                                    3,111           2,184           1,461           1,454            1,416

Number of shares used in
   calculating net income (loss)
   per share-diluted                                  3,111           5,528           1,461           1,454            1,416

Balance Sheet Data:

Total assets                                       $ 51,000        $ 51,660        $ 60,591        $ 84,963        $ 109,948

Long-term debt excluding current
   maturities                                      $ 18,858        $ 45,804        $ 55,389        $ 57,310        $  49,931

Stockholders' equity (deficit)                     $  6,813        $(19,702)       $(29,323)       $  1,525        $  39,841
</TABLE>

* Income  or loss per  share for  years  prior to 1997  have  been  restated  in
accordance with the requirements of FASB No. 128.


                                       14
<PAGE>

Item 7. Management Discussion and Analysis of Financial Condition and Results of
Operations.

      The Company's  consolidated  statements of operations  for the three years
ended December 31, 1997, 1996 and 1995,  respectively,  as a percentage of sales
follows:

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

Sales                                              100%        100%        100%
Cost of sales                                       61%         63%         92%
                                                  ----        ----        ----
  Gross Profit                                      39%         37%          8%
Selling, general and
administrative expenses                             20%         23%         27%
Research and development expenses                    9%          7%         10%
Litigation settlement                               --          --           2%
Write down of net assets sold                       --          --           1%
                                                  ----        ----        ----
   Operating income (loss)                          10%          7%        (33%)
Interest expense                                    (5%)        (9%)       (14%)
Gain on sale of assets                              --           4%-        --
Other                                                2%          1%         (1%)
Debt conversion expense                            (19%)        --          --
                                                  ----        ----        ----
Income (loss) from continuing
   operations before income
   taxes and minority interest                     (12%)         3%        (47%)
Income tax expense (benefit)
   and minority interest                            (1%)         1%         -%
                                                  ----        ----        ----
Income (loss) before discontinued
   operations and extraordinary gain               (11%)         2%        (48%)
Provision for loss on disposal
   of discontinued operations                       --          --           6%
Extraordinary gain on early
extinguishment of debt                              --           7%          3%
                                                  ----        ----        ----
Net income (loss)                                  (11%)         7%        (51%)
                                                  ====        ====        ====


                                       15
<PAGE>

Results of Operations

Years Ended December 31, 1997 and 1996

      The Company's sales for 1997 were  $62,230,000  compared to $57,987,000 in
1996, an increase of $4,243,000  (7%).  The increase in revenue is attributed to
improvement in all of the Company's divisions.

      OSS  sales  for  1997  were   $29,561,000,   compared  to  1996  sales  of
$26,804,000,  an  increase of  $2,757,000  (10%).  The  increased  sales  relate
primarily to higher volumes  generated from the  installation of the OSS systems
to the existing customer base.

      Line   connection/protection    equipment   sales   for   1997   increased
approximately  $504,000 (2%) from $23,249,000 in 1996 to $23,753,000  1997. This
increase  relates to improved  domestic  sales,  which were offset by  decreased
sales of a certain  product  line to BT.  During  1997,  the  Company  completed
delivery of products to BT under a prior  agreement and commenced  delivery of a
replacement product. The decline reflected both a decline in the number of units
sold and a lower selling price per unit for the replacement product. At December
31, 1997, the orders from BT for this product reflect a continuation of sales at
the reduced level.

      Signal processing  revenue for 1997 compared to 1996 increased by $683,000
(9%) from $7,597,000 to $8,280,000. The increased revenue was generated from the
earlier than anticipated completion of military orders and non-recurring revenue
from certain engineering services.

      Cost of sales for the year ended  December  31, 1997,  as a percentage  of
sales  compared to 1996,  decreased  from 63% to 61%. The  improvement  in gross
margin  is   attributed  to  the   Company's   continuing   effort  to  increase
manufacturing  productivity  and the absorption,  over a larger revenue base, of
certain fixed expenses associated with the OSS contracts.

      Selling,  general and  administration  expenses decreased by $748,000 (6%)
from  $13,566,000  to  $12,818,000  from December 31, 1997 compared to 1996. The
decrease  reflects  the  Company's  continuing  efforts  to reduce its costs and
expenses.

      Research  and  development  expenses  increased by  $1,513,000  (39%) from
$3,848,000 in 1996 to $5,361,000 in 1997.  The increased  expenses  results from
the  Company's  efforts to develop new  products,  primarily  related to the OSS
business.

      As a result of the above,  the Company had operating  income of $6,101,000
in 1997 versus  $3,982,000 in 1996, an increase of 53%. The Company's  operating
improvement  for the year ended  December  31, 1997,  when  compared to the year
ended December 31, 1996, were the results of increased revenue which allowed for
greater manufacturing  efficiencies,  and the reduced level of selling,  general
and administrative expenses.

      Interest expense for 1997 decreased by $1,949,000 from $5,328,000 for 1996
to  $3,379,000  in 1997.  The  decrease  in  interest  expense  is  attributable
primarily to the exchange of the Company's  Debentures  for the Notes and common
stock,  which occurred  primarily in the first and second  quarters of 1996, and
repayment of principal to the Company's senior lender. In addition, during 1996,
the Company incurred  additional  interest expense resulting from recognition of
certain deferred borrowing costs related to its loans from its senior lender.


                                       16
<PAGE>

Results of Operations (continued)

      Other income for 1997 included  $700,000  from the final  settlement of an
insolvency   procedure   involving  the  purchaser  of  the  Company's   Israeli
operations, which the Company sold in 1992.

      During 1997, the Company recorded debt conversion  expenses of $11,458,000
as a result of the  exchange of Notes into  common  stock.  The debt  conversion
expense  represents the  difference  between the original  conversion  price per
share of $6.55 and the reduced conversion price per share of $3.65. In addition,
in  connection  with the  transaction  the Company  incurred  legal  expenses of
$234,000 and  incurred  expenses  valued at $578,000  related to the issuance of
common stock and warrants (see Notes to Consolidated Financial Statements,  Note
8).

      During 1997 and 1996, the Company recorded an extraordinary  gain from the
early  extinguishment of its Debentures of $122,000 and $3,922,000,  receptively
(see Notes to Consolidated Financial Statements, Note 8).

      At December 31, 1997,  based upon year-end tax  calculations,  the Company
recorded an income tax benefit of $585,000,  reflecting the difference between a
$802,000  deferred tax asset and the  Company's  tax  expenses of  $217,000,  at
December 31, 1997.

      As the  result  of the  foregoing,  the  Company  incurred  a net  loss of
$6,899,000,  $2.22 per share, for 1997,  compared with net income of $5,174,000,
$2.37 per basic share and $0.94 per diluted  share,  for the year ended December
31, 1996.  Basic  earnings  (loss) per share are based on the  weighted  average
number of shares  outstanding.  Diluted  earnings  (loss) per share are based on
weighted  average number of shares  outstanding  plus dilutive  potential common
shares.  The  calculation  of the diluted  earnings per share for the year ended
December 31, 1996,  assumes the conversion of the Notes which are dilutive.  For
1997, no dilutive potential shares of common stock were added to compute diluted
loss per share because the effect is anti-dilutive.


                                       17
<PAGE>

Results of Operations

Years Ended December 31, 1996 and 1995

      The Company's sales for 1996 were  $57,987,000  compared to $61,181,000 in
1995, a decrease of $3,194,000  (5%). The 1995 sales include sales of $6,513,000
from the  Company's  fiber  optics  business  unit which was sold in March 1996.
Sales of  fiber  optics  products  were  $447,000  in 1996  prior  to the  sale.
Therefore,  sales,  exclusive of fiber optics products,  increased by $2,872,000
(5.3%) from 1995. OSS net revenue  decreased by $2,184,000  for 1996  reflecting
lower levels of sales of the Company's  Korea joint venture,  as well as reduced
sales to BT that was  partially  offset by  increased  sales in Asia and Europe.
Line  connection/protection  equipment revenue for 1996 increased  approximately
$2,448,000  reflecting  improved  domestic  sales, as well as increased sales of
such equipment to BT. Signal processing revenue for 1996 increased by $2,740,000
due to  the  Company's  improved  cash  position  in  1996,  which  enabled  the
completion of backlog orders on an accelerated basis.

      As a result of the sale of the fiber  optics  business  unit,  the Company
extended its credit  agreement  with Foothill which provided funds to enable the
Company to procure  materials to satisfy  outstanding  orders during 1996.  This
positively affected revenue for all operating units in 1996.

      Cost of sales for the year ended  December  31, 1996,  as a percentage  of
sales  compared to 1995,  decreased  from 92% to 63%. This  improvement in gross
margin is attributed  to  manufacturing  efficiencies  created by the ability to
obtain  raw  materials  on a  consistent  basis,  improved  management  and more
efficient  utilization  of  personnel,  and the  elimination  of under  utilized
facilities associated with the fiber optics business.

      Selling, general and administration expenses decreased by $2,990,000 (18%)
from $16,556,000 to $13,566,000 from 1996 compared to 1995. This decrease is due
to the  elimination of the expenses as related to the fiber optics business unit
and the Company's continuing efforts to reduce costs and expenses.

      Research  and  development  expenses  decreased by  $2,255,000  (37%) from
$6,103,000 to $3,848,000  from 1996 compared to 1995. This reduced cost reflects
the Company's efforts to streamline its operations by focusing on those projects
with the highest  potential for success and to a lesser extent,  the elimination
of expenses related to fiber optics business unit.

      The sale of the fiber optics business benefited the Company by allowing it
to close two  facilities,  with a resultant  decrease in personnel  and overhead
costs.  Moreover,  the sale also  enabled  the  Company  to amend and extend its
agreement with its senior lender, Foothill Capital Corp. ("Foothill") and make a
significant  payment to Foothill,  which reduced its ongoing  interest  costs as
described below.

      As a result of the above,  the Company had operating  income of $3,982,000
in 1996 versus an operating loss of $19,884,000 in 1995. The Company's operating
improvement  for 1996,  when compared to 1995,  was the result of its continuing
efforts to bring its costs and expenses in line with its current  level of sales
and the sale of the fiber optics business unit.

      Interest expense decreased for 1996 by $3,156,000 from $8,484,000 for 1995
to $5,328,000 in 1996.  This change is  attributable  primarily to a decrease in
interest  expense  related to the exchange of the  Company's 6%  Debentures  and
repayment of principal to the  Company's  senior lender from the proceeds of the
sale of the fiber  business and the sale of common stock  received in respect of
the sale of its discontinued Israeli operations described in the next paragraph.


                                       18
<PAGE>

Results of Operations (continued)

      During 1996, the Company received $3,456,000 from the sale of common stock
the  settlement  of the  insolvensy  proceeding  involving  the purchaser of the
discontinued  Israeli  operations.  The sale of such stock resulted in a gain of
$2,264,000 which is reflected as a gain on the sale of assets.  During 1995, the
Company  recorded a $3,500,000 loss from the sale of this  discontinued  Israeli
operation.

      During 1996, the Company recorded a $3,922,000 extraordinary gain from the
early  extingushment  of approximately  94% of its Debentures.  During 1995, the
Company recorded an extraordinary  gain of $1,756,000 arising from the Company's
repurchase and retirement of $3,900,000 of its Debentures.

      As the  result of the  foregoing,  the  Company  generated  net  income of
$5,174,000,  $2.37 per basic share ($0.94 per diluted share), for 1996, compared
with a net loss of $31,041,000,  $21.25 per share (basic and diluted), for 1995.
Basic  earnings  (loss) per share are based on the  weighted  average  number of
shares  outstanding.  Diluted  earnings  (loss) per share are based on  weighted
average number of shares  outstanding plus dilutive potential common shares. The
calculation  of the diluted  earnings per share for the year ended  December 31,
1996,  assumes the  conversion  of the Notes which are  dilutive.  For 1995,  no
dilutive potential shares of common stock were added to compute diluted loss per
share because the effect is anti-dilutive.

      The  significant  improvement  in the operations of the Company in 1996 is
the result of several factors including:  the sale of the  non-profitable  fiber
optics business unit, amendment and extension of the Company's loan and security
arrangement  with its senior lender,  restructuring  of the management  team, as
well as, overall greater efficiencies in the Company's manufacturing operations.

Liquidity and Capital Resources

      At  December  31,  1997 the  Company  had cash  and  cash  equivalents  of
$5,091,000  compared with $2,584,000 at December 31, 1996. The Company's working
capital at December 31, 1997 was $6,254,000,  compared to $4,115,000 at December
31, 1996. The  improvement in working capital from December 31, 1996 to December
31, 1997 reflects the effects of positive cash flow generated from the Company's
operations as well as the  conversion of $23,400,000 of debt into equity and the
amendment and extension of the Company's agreement with Foothill.

      As of November 30, 1997,  the Company's  loan and security  agreement with
its senior secured lender,  Foothill, was amended and extended.  Pursuant to the
amendment,  the loan and security  agreement  was extended from November 1998 to
August 1999, and the Company's  availability  under its revolving line of credit
and its letter of credit facility was combined to total $9,000,000. During 1997,
the Company repaid $2,707,000 to Foothill.  Subsequent to December 31, 1997, the
Company repaid  Foothill an additional  $2,950,000 from the proceeds of its 12 %
Subordinated Note private placement as described below.

      As of December 31, 1997, the Company had remaining outstanding  $1,758,000
of the 6%  Debentures,  net of original  issue  discount of  $137,000.  The face
amount of the outstanding 6% Debentures was  $1,895,000.  Subsequent to December
31, 1997,  the Company  issued  approximately  388,000 shares of common stock in
exchanged for  cancellation of $1,510,000 of principal  amount of Debentures and
accrued interest.


                                       19
<PAGE>

Liquidity and Capital Resources (continued)

      The  interest  accrued on the 6%  Debentures  is payable on July 1 of each
year and as of December 31, 1997 was $398,000. At December 31, 1997, the Company
has  failed  to  make  the  interest  payments  due  in  1997,  1996  and  1995.
Accordingly, the 6% Debentures are classified as a current liability at December
31, 1997 and 1996.

      During  1997,  the Company  amended the terms of its Zero Coupon Notes due
January 2, 1998 (the  "Notes") by  reducing  the  conversion  price to $3.65 per
share  from  $6.55  per  share  and  issuing  additional  shares  under  certain
circumstances.  The amended  terms became  effective on November 13, 1997. As of
December 31, 1997, Notes in the principal  amount of  approximately  $23,400,000
were  converted  into  approximately  6,412,000  shares  of  common  stock.  The
conversion of the Notes into common stock reduced debt by $23,400,000, increased
equity by $34,049,000 and resulted in a primarily non-cash charge to earnings of
$11,458,000.  As  of  December  31,  1997,  $2,796,000  of  the  Notes  remained
outstanding,  which were paid on the January 2, 1998 maturity date (See Notes to
Consolidated Financial Statements, Note 8).

      In January 1998, the Company raised  $6,000,000 from the private placement
of 60 units at $100,000 per unit.  Each unit consisted of (a) the Company's 12 %
Subordinated  Note due January 3, 2000 (a "12% Note), in the principal amount of
$100,000,  and (b) a  Series  B Common  Stock  Purchase  Warrant  (a  "Series  B
Warrant") to purchase  10,000  shares of Common Stock at $3.00 per share through
December 31, 2002. The proceeds from the sale of the Units was used  principally
to pay the  remaining  $2,796,000  principal  amount of Notes which had not been
converted (See Notes to Consolidated Financial Statements, Note 8) and to reduce
the Company's senior debt to Foothill by approximately  $2,950,000 (See Notes to
Consolidated  Financial  Statements,  Note 7). The balance of such  proceeds was
added to working capital.

      The Company believes that its current cash position,  internally generated
cash flow and its loan  facility  will be  sufficient  to satisfy the  Company's
anticipated operating needs for at least the ensuing twelve months.

Year 2000 Issue

      Many existing  computer programs use only two digits to identify a year in
a date field. These programs were designed and developed without considering the
impact of the upcoming  change in the century.  If not corrected,  many computer
applications could fail or create erroneous results by or at the year 2000. This
is refered to the as the "Year 2000 Issue."  Management  has initiated a Company
wide program to prepare the Company's computer systems and applications for year
2000  compliance.  The Company  expects to incur internal staff costs as well as
other  expenses  necessary to prepare its systems for the year 2000. The Company
expects  to both  replace  some  systems  and  upgrade  others.  Maintenance  or
modification  costs will be expensed as incurred.  The total cost of this effort
is still being evaluated, but is not expected to be material to the Company.


                                       20
<PAGE>

Item 8. Financial Statements and Supplementary Data.

      See Exhibit I

Item  9.  Changes  In and  Disagreements  With  Accountants  On  Accounting  and
Financial Disclosure.

      Not Applicable

                                    Part III

Item 10, 11, 12, and 13.

      The information called for by Item 10 (Directors and Executive  Officers),
Item  11  (Executive  Compensation),  Item 12  (Security  Ownership  of  Certain
Beneficial  Owners  and  Management),  and Item 13  (Certain  Relationships  and
Related  Transactions)  is  incorporated  herein by reference from the Company's
definitive  proxy  statement for the Annual Meeting of  Shareholders to be filed
with the  Securities  and Exchange  Commission not later than 120 days after the
close of the year ended December 31, 1997.


                                       21
<PAGE>

                                    Part IV

Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K.

(a)   Document filed as part of this Annual Report on Form 10-K:

      (i)   Financial Statements.

            See Index to Consolidated Financial Statements under Item 8 hereof.

      (ii)  Financial Statement Schedules.

            None

      Schedules  not listed  above have been  omitted for the reasons  that they
were  inapplicable  or not required or the information is given elsewhere in the
financial statements.

      Separate  financial  statements of the registrant  have been omitted since
restricted  net  assets of the  consolidated  subsidiaries  do not exceed 25% of
consolidated net assets.

(b)   Reports on Form 8-K

      A current report on form 8-K (Item 5), dated January 2, 1998, was filed.

(c)   Exhibits

   Exhibit No.  Description of Exhibit
   -----------  ----------------------

        3.1     Certificate of Incorporation of the Company, as amended to date,
                incorporated  by  reference  to  Exhibit 4(a) of  the  Company's
                Annual Report on Form 10K for the year ended December 31, 1991.

        3.2     Certificate of Designation of Series B Participating Convertible
                Preferred Stock, incorporated by reference to Exhibit 3.2 of the
                Company's  Annual Report on Form 10K for the year ended December
                31, 1995.

        3.3     By-laws of the  Company,  as amended  to date,  incorporated  by
                reference to Exhibit 3.3 of the Company's  Annual Report on Form
                10K for the year ended December 31, 1995.

        4.1     Amendment dated as of December 16, 1993 to the Warrant Agreement
                among  the  Company,  Aster  Corporation  and  Chemical  Bank as
                successor  to  Manufacturers  Hanover  Trust  Company as Warrant
                Agent, incorporated by reference to Exhibit 4.2 of the Company's
                Annual Report on Form 10-K for the year ended December 31, 1993.

        4.2     Form of Rights  Amendments,  dated as of March 22, 1989  between
                the Company and Manufacturers  Hanover Trust Company,  as Rights
                Agent,  incorporated by reference to the Company's  Registration
                Statement on Form 8-A dated April 3, 1989.


                                       22
<PAGE>

Exhibits (continued)

   Exhibit No.  Description of Exhibit
   -----------  ----------------------

        4.2.1   Amendment No. 1 to Rights Agreement, dated July 28, 1993 between
                the  Company and The Chase  Manhattan  Bank  (formerly  known as
                Chemical Bank, as successor by merger to  Manufacturers  Hanover
                Trust Company) as Rights Agent, incorporated by reference to the
                Company's  Registration  Statement on Form 8-A/A filed August 4,
                1993.

        4.2.2   Amendment  No. 2 to Rights  Agreement,  dated  December 24, 1997
                between the Company and The Chase Manhattan Bank (formerly known
                as  Chemical  Bank,  as  successor  by merger  to  Manufacturers
                Hanover  Trust  Company)  as  Rights  Agent.

        4.3     Warrant issued to Aspen Grove Financial  Corporation to Purchase
                87,500  Shares  of  Common  Stock  dated  as of June  13,  1994,
                incorporated  by  reference  to  Exhibit 4(d) to  the  Company's
                Quarterly  Report on Form 10-Q for the  quarter  ended  June 30,
                1994.

        4.4     Warrant  issued to  Banque  Scandinave  en  Suisse  to  Purchase
                100,000  shares  of  Common  Stock  dated as of June  13,  1994,
                incorporated  by  reference  to  Exhibit 4(f) to  the  Company's
                Quarterly  Report on Form 10-Q for the  quarter  ended  June 30,
                1994.

        4.5     Stock  Option  Agreement  dated as of May 15,  1994  between the
                Company and  Stanley  Kreitman,  incorporated  by  reference  to
                Exhibit 4(a) to  the Company's Quarterly Report on Form 10-Q for
                the quarter ended September 30, 1994.

        4.6     Amended and  Restated  Loan and Security  Agreement  dated as of
                November  28,  1994,  between the Company and  Foothill  Capital
                Corporation,  incorporated  by  reference  to  Exhibit  2 to the
                Company's Current Report on Form 8-K dated November 30, 1994.

        4.7     Amendment  Number One dated February 13, 1995 to the Amended and
                Restated  Loan and Security  Agreement  dated as of November 28,
                1994  between  the  Company and  Foothill  Capital  Corporation,
                incorporated by reference to Exhibit 4.7 of the Company's Annual
                Report on Form 10K for the year ended December 31, 1995.

        4.7.1   Letter Agreement dated as of February 13, 1995,  incorporated by
                reference to Exhibit  4.7.1 of the  Company's  Annual  Report on
                Form 10K for the year ended December 31, 1995.

        4.7.2   Amendment  Number Two dated  March 30,  1995 to the  Amended and
                Restated  Loan and Security  Agreement  dated as of November 28,
                1994  between  the  Company and  Foothill  Capital  Corporation,
                incorporated  by  reference  to Exhibit  4.7.2 of the  Company's
                Annual Report on Form 10K for the year ended December 31, 1995.

        4.8     Secured  Promissory  Note dated  November  28,  1994 made by the
                Company in favor of Foothill Capital  Corporation,  incorporated
                by reference  to Exhibit 4 to the  Company's  Current  Report on
                Form 8-K dated November 30, 1994.


                                       23
<PAGE>

Exhibits (continued)

   Exhibit No.  Description of Exhibit
   -----------  ----------------------

        4.9     Amended and Restated Secured  Promissory Note dated February 13,
                1995,  incorporated by reference to Exhibit 4.9 of the Company's
                Annual Report on Form 10K for the year ended December 31, 1995.

        4.10    Deferred  Funding Fee Note dated  November  28, 1994 made by the
                Company in favor of Foothill Capital  Corporation,  incorporated
                by reference  to Exhibit 5 to the  Company's  Current  Report on
                Form 8-K dated November 30, 1994.

        4.11    Amendment Number Three to Amended and Restated Loan and Security
                Agreement dated March 12, 1996, between the Company and Foothill
                Capital  Corporation,  incorporated by reference to Exhibit 4.11
                of the  Company's  Annual  Report on Form 10K for the year ended
                December 31, 1995.

        4.12    Warrant to Purchase  Common Stock of the Company dated  November
                28, 1994  executed  by the Company in favor of Foothill  Capital
                Corporation,  incorporated  by  reference  to  Exhibit  6 to the
                Company's Current Report on Form 8-K dated November 30, 1994.

        4.12.1  Amendment  Number One to Warrant to Purchase Common Stock of the
                Company dated as of February 13, 1995 executed by the Company in
                favor of Foothill Capital Corporation, incorporated by reference
                to Exhibit 4.12.1 of the Company's Annual Report on Form 10K for
                the year ended December 31, 1995.

        4.13    Assignment of Loans, Liens and Loan Documents dated November 28,
                1994  between  Chemical  Bank,  The Bank of New  York,  Foothill
                Capital Corporation, the Company and certain of the subsidiaries
                of the  Company,  incorporated  by reference to Exhibit 3 to the
                Company's Current Report on Form 8-K dated November 30, 1994.

        4.14    Warrant to Purchase  Common Stock of the Company dated  November
                28, 1994  executed  by the  Company in favor of  Chemical  Bank,
                incorporated by reference to Exhibit 12 to the Company's Current
                Report on Form 8-K dated November 30, 1994.

        4.15    Warrant to Purchase  Common Stock of the Company dated  November
                28,  1994  executed  by the  Company in favor of The Bank of New
                York,  incorporated  by reference to Exhibit 13 to the Company's
                Current Report on Form 8-K dated November 30, 1994.

        4.16    Indenture  dated as of July 1, 1992  between the Company and the
                Bank of New  York  as  trustee,  incorporated  by  reference  to
                Exhibit 4(a) of  the Company's Quarterly Report on Form 10-Q for
                the quarter ended June 30, 1992.

        4.17    Form of Warrant to Purchase Common Stock of the Company dated as
                of  June  1,  1993  between  the  Company  and  Mallory  Factor,
                incorporated  by  reference  to  Exhibit 4(f) of  the  Company's
                Quarterly  Report on Form 10-Q for the quarter  ended  September
                30, 1993.


                                       24
<PAGE>

Exhibits (continued)

   Exhibit No.  Description of Exhibit
   -----------  ----------------------

        4.18    Form of Warrant  Agreement  dated as of August 12, 1993  between
                the  Company and  Berenson  Minella & Company,  incorporated  by
                reference to Exhibit 4(e) of  the Company's  Quarterly Report on
                Form 10-Q for the quarter ended September 30, 1993.

        4.19    Lockbox Operating  Procedural Agreement dated as of November 28,
                1994 among  Chemical  Bank,  the  Company and  Foothill  Capital
                Corporation,  incorporated  by  reference  to  Exhibit  7 to the
                Company's Current Report on Form 8-K dated November 30, 1994.

        4.20    Security Agreement,  dated as of July 16, 1993, made by Woo Shin
                Electro-Systems   Company  to  Chemical  Bank,  incorporated  by
                reference to Exhibit 4(b)(iv) of the Company's  Quarterly Report
                on Form 10-Q for the quarter ended June 30, 1993.

        4.21    Indenture dated as of November 30, 1995, between the Company and
                American  Stock  Transfer  &  Trust  Company,   incorporated  by
                reference to Exhibit 4.21 of the Company's Annual Report on Form
                10K for the year ended December 31, 1995.

        4.22    Supplemental  Indenture dated as of October 10, 1997 between the
                Company   and   American   Stock   Transfer  &  Trust   Company,
                incorporated  by reference to Exhibit 4.22 of the Company's Form
                8-K dated October 10, 1997.

        4.23    Amendment No. Five dated as of November 30, 1997, to Amended and
                Restated Loan and Security  agreement  between  Foothill Capital
                Corp. ("Foothill") and the Company,  including amendments to the
                warrants held by Foothill,  incorporated by reference to Exhibit
                4.23 of the Company's Form 8-K dated January 2, 1998.

        10.1    Form  of  Split   Dollar   Agreement--more   than   ten   years,
                incorporated  by  reference  to Exhibit  19(d) of the  Company's
                Quarterly  Report on Form 10-Q for the quarter  ended  September
                30, 1985.

        10.2    Form  of  Split   Dollar   Agreement--less   than   ten   years,
                incorporated  by  reference  to Exhibit  19(e) of the  Company's
                Quarterly  Report on Form 10-Q for the quarter  ended  September
                30, 1985.

        10.3    Form of Amendment No. 1 to Split Dollar Agreement--less than ten
                years--Acceleration  upon  change of  control,  incorporated  by
                reference to Exhibit 10.3 of the Company's Annual Report on Form
                10-K for the year ended December 31, 1988.

        10.4    Form of Executive Salary Continuation Agreement, incorporated by
                reference to Exhibit 19(cc) of the Company's Quarterly Report on
                Form 10-Q for the quarter ended September 30, 1985.

        10.5    Agreement  dated as of January 1, 1990  between  the Company and
                Alpha  Risk  Management,  Inc.,  incorporated  by  reference  to
                Exhibit  10(k) of the  Company's  Annual Report on Form 10-K for
                the year ended December 31, 1990.


                                       25
<PAGE>

Exhibits (continued)

   Exhibit No.  Description of Exhibit
   -----------  ----------------------

        10.6    Agreement dated May 25, 1988 between British  Telecommunications
                plc and the Company,  incorporated by reference to Exhibit 19(a)
                of the Company's  Quarterly  Report on Form 10-Q for the quarter
                ended June 30, 1988.  Confidential  Treatment granted;  document
                filed separately with the SEC.

        10.6.1  Amendment to agreement of May 25, 1988, dated September 1, 1996,
                between   British   Telecommunications   plc  and  the  Company,
                incorporated  by  reference  to Exhibit  10.6.1 of the Company's
                annual report on Form 10-K for the year ended December 31, 1996.

        10.7    Lease  dated  December  17,  1990  between  the  Company and LBA
                properties,  Inc., incorporated by reference to Exhibit 10(d) of
                the  Company's  annual  report on Form  10-K for the year  ended
                December 31, 1990.

        10.8    Asset Purchase  Agreement dated as of March 6, 1996 by and among
                Augat Inc., Porta Systems Corp. and certain of its subsidiaries,
                incorporated  by  reference  to  Exhibit  10.8 of the  Company's
                Annual Report on Form 10K for the year ended December 31, 1995.

        10.9    Form of  Employment  Contract  dated October 2, 1995 between the
                Company and KPMG  BayMark  Strategies  LLC's  Crisis  Management
                Group,   incorporated  by  reference  to  Exhibit  10.9  of  the
                Company's  Annual Report on Form 10K for the year ended December
                31, 1995.

        10.9.1  Amendment  dated  December 18, 1996 between the Company and KPMG
                BayMark Strategies LLC's Crisis Management Group.

        10.10   Form of Employment  Contract  dated October 16, 1995 between the
                Company and Edward B.  Kornfeld,  incorporated  by  reference to
                Exhibit 10.10 of the Company's Annual Report on Form 10K for the
                year ended December 31, 1995.

        10.11   (Deleted)

        10.12   Form of Executive  Salary  Continuation  Agreement dated October
                16,  1995   between   the   Company  and  Edward  B.   Kornfeld,
                incorporated  by  reference  to Exhibit  10.12 of the  Company's
                Annual Report on Form 10K for the year ended December 31, 1995.

        10.13   Form of  Employment  Contract  dated October 9, 1996 between the
                Company and Seymour Joffe.

        10.14   1996 Stock Option Plan filed as Exhibit A to the Proxy Statement
                for the 1996 Annual  Meeting to  Stockholders  and  incorporated
                herein by reference.

        10.15   Form of subscription  agreement for Units, including the form of
                12% Note, Series B Warrant and Series C Warrant, incorporated by
                reference  to  Exhibit  10.15 of the  Company's  Form 8-K  dated
                January 2, 1998.


                                       26
<PAGE>

Exhibits (continued)

   Exhibit No.  Description of Exhibit
   -----------  ----------------------

        10.16   Agreement  dated January 26, 1998,  among the Company and Henley
                Group, Ltd.,  Woodstead  Associates,  L.P., Lake Trust and Smith
                Management  Company,  Inc.  incorporated by reference to Exhibit
                10.16 of the Company's Form 8-K dated January 2, 1998.

        22.1    Subsidiaries  of  the  Company,  incorporated  by  reference  to
                Exhibit 22.1 of the Company's  Annual Report on Form 10K for the
                year ended December 31, 1995.

        23      Consent of Independent Auditors.


                                       27
<PAGE>

SIGNATURES

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

                                                PORTA SYSTEMS CORP.

      Dated March 17, 1998                      By  /s/ William V. Carney
                                                    ----------------------------
                                                      William V. Carney
                                                      Chairman of the Board and
                                                      Chief Executive Officer

      Pursuant to the  requirements  of the Securities  Exchange Act of 1934, as
amended,  the report has been signed by the  following  persons on behalf of the
Registrant and in the capacities and on the dates  indicated.  Each person whose
signature  appears  below  hereby  authorizes  William  V.  Carney and Edward B.
Kornfeld or either of them acting in the absence of the others,  as his true and
lawful   attorney-in-fact  and  agent,  with  full  power  of  substitution  and
resubstitution  for  him  and in his  name,  place  and  stead,  in any  and all
capacities to sign any and all amendments to this report,  and to file the same,
with all exhibits thereto and other documents in connection therewith,  with the
Securities and Exchange Commission.

         Signature                         Title                       Date
         ---------                         -----                       ----

     /s/William V. Carney           Chairman of the Board,        March 17, 1998
------------------------------      Chief Executive Officer
        William V. Carney           and Director (Principal 
                                    Executive Officer)

     /s/Edward B. Kornfeld          Senior Vice President and     March 17, 1998
------------------------------      Chief Financial Officer
        Edward B. Kornfeld          (Principal Financial and 
                                    Accounting Officer)

     /s/Seymour Joffe               Director                      March 17, 1998
------------------------------
        Seymour Joffe

     /s/Michael A. Tancredi         Director                      March 17, 1998
------------------------------
        Michael A. Tancredi

     /s/Howard D. Brous             Director                      March 17, 1998
------------------------------
        Howard D. Brous

     /s/Warren H. Esanu             Director                      March 17, 1998
------------------------------
        Warren H. Esanu

     /s/Herbert H. Feldman          Director                      March 17, 1998
------------------------------
        Herbert H. Feldman

     /s/Stanley Kreitman            Director                      March 17, 1998
------------------------------
        Stanley Kreitman

     /s/Lloyd I. Miller, III        Director                      March 17, 1998
------------------------------
        Lloyd I. Miller, III

     /s/Robert Shreiber             Director                      March 17, 1998
------------------------------
        Robert Shreiber

                                       28
<PAGE>

Exhibit I

Item 8.  Financial Statements and Supplementary Data

Index                                                                       Page
-----                                                                       ----
Report of Independent Certified Public Accountants                          F-2

Consolidated Financial Statements and Notes:

     Consolidated Balance Sheets,
     December 31, 1997 and 1996                                             F-3

     Consolidated Statements of Operations,
     Years Ended December 31, 1997, 1996 and 1995                           F-4

     Consolidated Statements of Stockholders'
     Equity (Deficit), Years Ended
     December 31, 1997, 1996 and 1995                                       F-5

     Consolidated Statements of Cash Flows
     for the Years Ended December 31, 1997,
     1996 and 1995                                                          F-6

     Notes to Consolidated Financial Statements                             F-7


                                       F-1

<PAGE>

               Report of Independent Certified Public Accountants

The Board of Directors and
Stockholders of Porta Systems Corp.:

We have audited the  accompanying  consolidated  balance sheets of Porta Systems
Corp.  and  subsidiaries  as of  December  31,  1997 and 1996,  and the  related
consolidated statements of operations,  stockholders' equity (deficit), and cash
flows for each of the three years in the period ended  December 31, 1997.  These
consolidated  financial  statements  are  the  responsibility  of the  Company's
management.  Our  responsibility is to express an opinion on these  consolidated
financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material respects,  the financial position of Porta Systems Corp.
and  subsidiaries  as of December  31,  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.

                                                    /s/ BDO SEIDMAN, LLP
                                                    ---------------------------
                                                    BDO SEIDMAN, LLP

Mitchel Field, New York
March 9, 1998


                                       F-2

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
                           Consolidated Balance Sheets
                           December 31, 1997 and 1996
                             (Dollars in thousands)

                                 Assets                       1997        1996
                                                              ----        ----
Current assets:
    Cash and cash equivalents                               $  5,091      2,584
    Accounts receivable - trade, less allowance for 
    doubtful accounts of $1,058 in 1997 and $1,550 
    in 1996                                                   14,891     16,034
    Inventories                                                8,159      7,424
    Prepaid expenses and other current assets                  1,266        782
    Other receivables                                           --          531
                                                            --------     ------
                  Total current assets                        29,407     27,355
                                                            --------     ------

Property, plant and equipment, net                             4,667      5,457
Deferred computer software, net                                  543      1,676
Goodwill, net of amortization of $3,301 in 1997 and 
  $2,503 in 1996                                              12,059     12,522
Other assets                                                   4,324      4,650
                                                            --------     ------
                  Total assets                              $ 51,000     51,660
                                                            ========     ======

                 Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
    Convertible subordinated debentures                     $  1,758      2,096
    Current portion of senior debt                             1,900        750
    Accounts payable                                           5,796      6,056
    Accrued expenses                                           8,656      9,004
    Accrued interest payable                                     398        583
    Accrued commissions                                        2,444      2,708
    Accrued deferred compensation                              1,228      1,232
    Income taxes payable                                         853        780
    Short-term loans                                             120         31
                                                            --------     ------
                  Total current liabilities                   23,153     23,240
                                                            --------     ------

Senior debt                                                   12,978     16,835
Zero coupon senior subordinated convertible notes              2,796     25,885
Notes payable net of current maturities                        3,084      3,084
Income taxes payable                                             649        802
Other long-term liabilities                                      487        653
Minority interest                                              1,040        863
                                                            --------     ------
                  Total long-term liabilities                 21,034     48,122
                                                            --------     ------

Commitments and contingencies

Stockholders' equity (deficit):
    Preferred stock, no par value;  authorized  
    1,000,000 shares,  none issued                                --         --
    Common stock,  par value $.01; authorized 
    20,000,000 and 40,000,000 shares, issued 
    8,644,304 and 2,223,861 shares in 1997 and 
    1996, respectively                                            86         22
    Additional paid-in capital                                70,926     36,561
    Foreign currency translation adjustment                   (4,027)    (3,012)
    Accumulated deficit                                      (57,799)   (50,900)
                                                            --------     ------
                                                               9,186    (17,329)
    Treasury stock, at cost, 33,340 shares                    (2,066)    (2,066)
    Receivable for employee stock purchases                     (307)      (307)
                                                            --------     ------
                  Total stockholders' equity (deficit)         6,813    (19,702)
                                                            --------     ------
                  Total liabilities and stockholders' 
                    equity (deficit)                        $ 51,000     51,660
                                                            ========     ======

          See accompanying notes to consolidated financial statements.


                                       F-3

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
                      Consolidated Statements of Operations
                  Years ended December 31, 1997, 1996 and 1995
                    (in thousands, except per share amounts)

                                                     1997      1996       1995
                                                     ----      ----       ----
Sales                                             $ 62,230    57,987     61,181
Cost of sales                                       37,950    36,591     56,444
                                                  --------    ------     ------ 
     Gross profit                                   24,280    21,396      4,737
                                                  --------    ------     ------ 
Selling, general and administrative expenses        12,818    13,566     16,556
Research and development expenses                    5,361     3,848      6,103
Litigation settlement                                 --        --        1,100
Write-down of net assets held for sale to net 
  realizable value                                    --        --          862
                                                  --------    ------     ------ 
     Total expenses                                 18,179    17,414     24,621
                                                  --------    ------     ------ 
     Operating income (loss)                         6,101     3,982    (19,884)
Interest expense                                    (3,379)   (5,328)    (8,484)
Interest income                                        259       136         87
Gain on sale of assets                                --       2,264       --
Other income (expense), net                          1,047       402       (884)
Debt conversion expense                            (11,458)     --         --
                                                  --------    ------     ------ 
     Income (loss) from continuing operations
     before income taxes and minority interest      (7,430)    1,456    (29,165)
Income tax expense (benefit)                          (585)      100         30
Minority interest                                      176       104        102
                                                  --------    ------     ------ 
     Income (loss) before discontinued operations   (7,021)    1,252    (29,297)
Provision for loss on disposal of discontinued 
  operations                                          --        --       (3,500)
                                                  --------    ------     ------ 
     Income (loss) before extraordinary item        (7,021)    1,252    (32,797)
Extraordinary gain on early extinguishment
  of debt                                              122     3,922      1,756
                                                  --------    ------     ------ 
     Net income (loss)                            $ (6,899)    5,174    (31,041)
                                                  ========    ======     ======
Basic per share amounts:
   Continuing operations                          $  (2.26)     0.57     (20.05)
   Discontinued operations                            --        --        (2.40)
   Extraordinary item                                 0.04      1.80       1.20
                                                  --------    ------     ------ 
     Net income (loss) per share
     of common stock                              $  (2.22)     2.37     (21.25)
                                                  ========    ======     ======
   Weighted average shares of common stock
     outstanding                                     3,111     2,184      1,461
                                                  ========    ======     ======
Diluted per share amounts:
   Continuing operations                          $  (2.26)     0.23     (20.05)
   Discontinued operations                            --        --        (2.40)
   Extraordinary item                                 0.04      0.71       1.20
                                                  --------    ------     ------ 
     Net income (loss) per share
     of common stock                              $  (2.22)     0.94     (21.25)
                                                  ========    ======     ======
   Weighted average shares of common stock 
     outstanding                                     3,111     5,528      1,461
                                                  ========    ======     ======

          See accompanying notes to consolidated financial statements.


                                       F-4

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
            Consolidated Statements of Stockholders' Equity (Deficit)
                  Years ended December 31, 1997, 1996 and 1995
                                 (In thousands)
<TABLE>
<CAPTION>

                                                                                                       Receivable     Total
                                      Common Stock                   Foreign     Retained                  for       Stock-
                                   ------------------- Additional   Currency     Earnings               Employee     holders'
                                   No. of    Par Value   Paid-in   Translation (Accumulated  Treasury     Stock      Equity/
                                   Shares      Amount    Capital   Adjustment    Deficit)      Stock    Purchases   (Deficit)
                                   ------      ------    -------   ----------    --------      -----    ---------   ---------
<S>                                 <C>          <C>     <C>        <C>          <C>         <C>          <C>           <C>  
Balance at December 31, 1994        1,492        15      32,948     (4,031)      (25,033)    (1,938)      (436)         1,525

Net loss 1995                           -         -           -          -       (31,041)         -          -        (31,041)
Warrants issued                         -         -         360          -             -          -          -            360
Write off of receivable for
   employee stock purchases             -         -           -          -             -       (128)       129              1
Foreign currency translation
   adjustment                           -         -           -       (168)            -          -          -           (168)
                                    -----       ---     -------    -------      --------    -------      -----       --------
Balance at December 31, 1995        1,492        15      33,308     (4,199)      (56,074)    (2,066)      (307)       (29,323)

Net income 1996                         -         -           -          -         5,174          -          -          5,174
Stock issued                          732         7       2,873          -             -          -          -          2,880
Warrants issued                         -         -         380          -             -          -          -            380
Foreign currency translation
   adjustment                           -         -           -      1,187             -          -          -          1,187
                                    -----       ---     -------    -------      --------    -------      -----       --------
Balance at December 31, 1996        2,224       $22     $36,561    $(3,012)     $(50,900)   $(2,066)     $(307)      $(19,702)

Net loss 1997                           -         -           -          -        (6,899)         -          -         (6,899)
Stock issued                        6,420        64      34,001          -             -          -          -         34,065
Warrants issued                         -         -         364          -             -          -          -            364
Foreign currency translation
   adjustment                           -         -           -     (1,015)            -          -          -         (1,015)
                                    -----       ---     -------    -------      --------    -------      -----       --------
Balance at December 31, 1997        8,644       $86     $70,926    $(4,027)     $(57,799)   $(2,066)     $(307)      $  6,813
                                    =====       ===     =======    =======      ========    =======      =====       ========
</TABLE>

           See accompanying notes to consolidated financial statements


                                       F-5

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
                 Consolidated Statements of Cash Flows (Note 23)
                  Years ended December 31, 1997, 1996 and 1995
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                              1997        1996      1995
                                                                              ----        ----      ----
    <S>                                                                     <C>           <C>      <C>     
Cash flows from operating activities:
    Net income (loss)                                                       $ (6,899)     5,174    (31,041)
    Adjustments to reconcile net income (loss) to net cash
       provided by (used in) operating activities:
          Loss on disposal of discontinued operations                           --         --        3,500
          Gain on sale of assets                                                --       (2,264)      --
          Gain on extinguishment or refinancing of indebtedness                 (122)    (3,922)    (1,756)
          Non-cash debt conversion expense                                    10,646       --         --
          Non-cash financing costs                                               274      2,280      2,698
          Realized gain on litigation settlement                                (229)      (174)      --
          Depreciation and amortization                                        3,040      3,941      7,015
          Write off of employee notes receivable                                --         --            1
          Amortization of discount on convertible subordinated debentures         40        104        603
          Minority interest                                                     (176)       104        102
    Changes in operating assets and liabilities:
       Accounts receivable                                                     1,143     (3,408)     1,338
       Inventories                                                              (735)     1,555      9,700
       Prepaid expenses                                                         (484)      (123)      (773)
       Other receivables                                                          31       --         --
       Other assets                                                             (122)      (743)     1,916
       Accounts payable, accrued expenses and other liabilities                 (999)    (1,788)     4,167
                                                                               -----      -----     ------ 
                  Net cash provided by (used in) operating activities          5,408        736     (2,530)
                                                                               -----      -----      ----- 

Cash flows from investing activities:
    Proceeds from disposal of assets held for sale, net                          500      7,393       --
    Proceeds from sale of assets                                                --        3,456       --
    Capital expenditures, net                                                   (409)      (125)    (1,749)
                                                                                -----     -----      ----- 
                  Net cash provided by (used in) investing activities             91     10,724     (1,749)
                                                                                -----    ------      ----- 

Cash flows from financing activities:
    Proceeds from senior debt                                                    306      1,343      5,781
    Repayments of senior debt                                                 (3,013)   (10,403)    (2,500)
    Proceeds (Repayments) of notes payable/short-term loans                       89       (337)      --
                                                                               -----      -----      ----- 
                  Net cash provided by (used in) financing activities         (2,618)    (9,397)     3,281
                                                                               -----      -----      ----- 
Effect of exchange rate changes on cash                                         (374)      (588)      (225)
Increase (decrease) in cash and cash equivalents                               2,507      1,475     (1,223)
Cash and equivalents - beginning of year                                       2,584      1,109      2,332
                                                                               -----      -----      -----

Cash and equivalents - end of year                                          $  5,091      2,584      1,109
                                                                            ========      =====      =====
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       F-6

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1997 and 1996

(1) Summary of Significant Accounting Policies

    Nature of Operations and Principles of Consolidation

    Porta  Systems  Corp.  (the  "Company")  designs,  manufactures  and markets
      systems for the  connection,  protection,  testing and  administration  of
      public and private  telecommunications lines and networks. The Company has
      various  patents for copper and software  based  products and systems that
      support voice, data, image and video transmission. The Company's principal
      customers are the U.S. regional telephone  operating companies and foreign
      telephone companies.

    The accompanying  consolidated  financial statements include the accounts of
      Porta Systems Corp. (the "Company") and its  majority-owned  or controlled
      subsidiaries.  All significant intercompany transactions and balances have
      been eliminated in consolidation.

    Revenue Recognition

    Revenue, from other than contracts for specialized  products,  is recognized
      when a product is shipped.  Revenues  and  earnings  relating to long-term
      contracts    for    specialized    products   are    recognized   on   the
      percentage-of-completion  basis  primarily  measured by the  attainment of
      milestones.  Anticipated  losses,  if any, are recognized in the period in
      which they are identified.

    Concentration of Credit Risk

    Financial   instruments,   which   potentially   subject   the   Company  to
      concentrations  of credit risk,  consist  principally of cash and accounts
      receivable.  At  times  such  cash in  banks  are in  excess  of the  FDIC
      insurance limit.

    As discussed in note 19, substantial  portions of the Company's sales are to
      customers in foreign countries.  The Company's credit risk with respect to
      these  customers  is  mitigated  by  obtaining  letters  of  credit  for a
      substantial  portion  of the  contract  price,  and by  monitoring  credit
      exposure with each customer.

    Cash Equivalents

    The Company considers  investments with original  maturities of three months
      or less at the time of purchase to be cash  equivalents.  Cash equivalents
      consist of commercial paper.

    Inventories

    Inventories  are stated at the lower of cost (on the  average  or  first-in,
      first-out methods) or market.

                                                                     (Continued)


                                       F-7

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

    Property, Plant and Equipment

    Property,  plant and equipment are carried at cost.  Leasehold  improvements
      are amortized over the term of the lease.  Depreciation  is computed using
      the straight-line method over the related assets' estimated lives.

    Deferred Computer Software

    Software costs incurred for specific customer  contracts are charged to cost
      of sales at the time revenues on such contracts are  recognized.  Software
      development  costs  relating to products  the Company  offers for sale are
      deferred in accordance  with Statement of Financial  Accounting  Standards
      (SFAS) No. 86 "Accounting  for the Costs of Computer  Software to Be Sold,
      Leased, or Otherwise Marketed". These costs are amortized to cost of sales
      over the periods that the related product will be sold, up to a maximum of
      four years.  Amortization of computer software costs,  which all relate to
      products  the  Company   offers  for  sale,   amounted  to   approximately
      $1,133,000,   $1,551,000   and   $3,171,000  in  1997,   1996,  and  1995,
      respectively.

    Goodwill

    Goodwill  represents the difference  between the purchase price and the fair
      market value of net assets  acquired in business  combinations  treated as
      purchases.  Goodwill is amortized on a  straight-line  basis over 20 to 40
      years. At December 31, 1997, $9,892,000 of the goodwill is being amortized
      over  approximately  20 years and  $2,167,000 is being  amortized  over 40
      years. The Company  assesses the  recoverability  of unamortized  goodwill
      using the  undiscounted  projected  future  cash  flows  from the  related
      businesses.

    Income Taxes

    Deferred income taxes are recognized  based on the  differences  between the
      tax bases of assets  and  liabilities  and their  reported  amounts in the
      financial  statements that will result in taxable or deductible amounts in
      future years.  Further, the effects of enacted tax law or rate changes are
      included  in income as part of  deferred  tax  expense or benefit  for the
      period that includes the enactment date (note 15).

    Foreign Currency Translation

    Assets and  liabilities of foreign  subsidiaries  are translated at year-end
      rates of exchange, and revenues and expenses are translated at the average
      rates  of  exchange  for  the  year.   Gains  and  losses  resulting  from
      translation  are  accumulated  in a separate  component  of  stockholders'
      equity.  Gains and losses  resulting  from foreign  currency  transactions
      (transactions   denominated  in  a  currency  other  than  the  functional
      currency) are included in net income or loss.

                                                                     (Continued)


                                       F-8

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

    Earnings (Loss) Per Share

    In 1997 the  Company   adopted  the  FASB  issued   Statement  of  Financial
      Accounting  Standard No. 128,  "Earnings  Per Share."  This  pronouncement
      provides  for the  calculation  of Basic and Diluted  earnings  per share.
      Earnings  per share  presented  for 1996 and 1995 have  been  restated  to
      reflect the adoption of this pronouncement.

    Basic earnings (loss) per share are based on the weighted  average number of
      shares  outstanding.  Diluted  earnings  (loss) per share are based on the
      weighted  average  number of shares  outstanding  plus dilutive  potential
      shares of common stock, if such shares had been issued. The calculation of
      diluted earnings per shares for the year ended December 31, 1996,  assumes
      the conversion of the Zero coupon senior  subordinated  convertible  notes
      which are dilutive. For 1997 and 1995, no dilutive potential common shares
      were  added to  compute  diluted  loss per  share  because  the  effect is
      anti-dilutive.

    All share and per share information have been restated to give effect to the
      one for five reverse stock split effective August 2, 1996.

    Reclassifications

    Certain   reclassifications   have  been  made  to  conform   prior   years'
      consolidated financial statements to the 1997 presentation.

    Accounting for Stock-Based Compensation

    The Company follows the Statement of Financial  Accounting Standard No. 123,
      "Accounting for Stock-Based Compensation".  The Company has elected not to
      implement  the fair  value  based  accounting  method for  employee  stock
      options, but has elected to disclose the pro-forma net income and earnings
      per share as if such  method  had been  used to  account  for  stock-based
      compensation cost as described in the Statement.

    Accounting for the Impairment of Long-Lived Assets

    The Company follows the Statement of Financial  Accounting Standard No. 121,
      "Accounting  for the  Impairment of Long-Lived  Assets and for  Long-Lived
      Assets  to  be  Disposed  Of".  The  Company  believes  that  there  is no
      impairment of its long-lived assets.

    Use of Estimates

    The  preparation  of  financial  statements  in  accordance  with  generally
      accepted  accounting  principles requires management to make estimates and
      assumptions  that affect  reported  amounts of assets and  liabilities and
      disclosure  of  contingent  assets  and  liabilities  at the  date  of the
      financial  statements  and the  reported  amounts of revenues and expenses
      during the reporting period. Among the more significant estimates included
      in these consolidated financial statements are the estimated allowance for
      doubtful accounts receivable, inventory reserves, percentage of completion
      for long-term  contracts,  and the deferred tax asset valuation allowance.
      Actual results could differ from those and other estimates.

                                                                     (Continued)


                                       F-9

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

    New Accounting Standards

    In June 1997,  the  Financial  Accounting  Standards  Board  issued  two new
      disclosure standards. Results of operations and financial position will be
      unaffected by implementation of these new standards.

    Statement of Financial  Standards (SFAS) No. 130,  "Reporting  Comprehensive
      Income",  establishes standards for reporting and display of comprehensive
      income, its components and accumulated  balances.  Comprehensive income is
      defined to include  all  changes in equity  except  those  resulting  from
      investments   by  owners  and   distributions   to  owners.   Among  other
      disclosures,  SFAS No. 130 requires that all items that are required to be
      recognized   under   current   accounting   standards  as   components  of
      comprehensive  income  be  reported  in  a  financial  statement  that  is
      displayed with the same prominence as other financial statements.

    SFAS No. 131,  "Disclosures  About  Segments  of an  Enterprise  and Related
      Information",  which  supersedes  SFAS No. 14,  "Financial  Reporting  for
      Segments of a Business Enterprise", establishes standards for the way that
      public enterprises reports information about operating segments in interim
      financial  statements issued to the public. It also establishes  standards
      regarding  products and services,  geographic  areas and major  customers.
      SFAS No. 131 defines  operating  segments as  components  of an enterprise
      about which separate financial  information is available that is evaluated
      regularly  by the  chief  operating  decision  maker  in  deciding  how to
      allocate resources and in assessing performance.

    Both of these standards are effective for financial  statements  for periods
      beginning after December 15, 1997 and require comparative  information for
      earlier  years  to be  restated.  Due  to the  recent  issuance  of  these
      standards,  management  has been unable to fully  evaluate the impact,  if
      any, they may have on future financial statement disclosures.

(2) Accounts Receivable

    Accounts receivable  included  approximately $0 and $900,000 at December 31,
      1997 and 1996, respectively,  of revenues earned but not yet contractually
      billable  relating to long-term  contracts for specialized  products.  All
      such amounts at December 31, 1996 were billed in 1997.  The  allowance for
      doubtful accounts  receivable was $1,058,000 and $1,550,000 as of December
      31, 1997 and 1996,  respectively.  The allowance for doubtful accounts was
      increased by provisions of $107,000,  $553,000, and $864,000 and decreased
      by  write-offs  of  $599,000,  $254,000,  and $198,000 for the years ended
      December 31, 1997, 1996, and 1995, respectively.

                                                                     (Continued)

                                      F-10

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

(3) Inventories

    Inventories consist of the following:

                                                       December 31,
                                                 -----------------------
                                                 1997               1996
                                                 ----               ----
    Parts and components                      $5,349,000          4,557,000
    Work-in-process                            1,079,000            515,000
    Finished goods                             1,731,000          2,352,000
                                              ----------          ---------
                                              $8,159,000          7,424,000
                                              ==========          =========

(4) Assets Held for Sale

    On March 13, 1996,  the Company sold  certain  assets and the buyer  assumed
      certain liabilities and severance obligations related to the operations of
      the  Company's  fiber  optics   management  and  component   business  for
      $7,893,000,  subject to certain  adjustments.  As of December 31, 1995, in
      conjunction  with this  transaction,  the  Company  accrued  approximately
      $700,000 for certain  obligations  in  connection  with the closing of its
      fiber optics facility in Ireland.  These  obligations  were settled during
      1996,  along  with  other  adjustments  related  to the sale of the  fiber
      business.  The net proceeds  approximated the carrying value of the assets
      held for sale.  The  difference  was  recorded  as other  expenses  in the
      accompanying statement of operations.

    The Company received $6,793,000 at closing of the sale of the fiber business
      and the remainder was placed into two escrow funds to be released over the
      next year, subject to certain  conditions,  including a final valuation of
      the net assets  transferred.  As of  December  31,  1996,  the  remainder,
      $531,000,  has remained in escrow and is reported as an "Other receivable"
      in the accompanying consolidated balance sheet. The amount was received in
      1997.  The proceeds  were  primarily  used to repay  long-term  debt. As a
      result of the transaction,  the Company recorded a charge to operations in
      1995 of  $862,000  to write  down the net  assets  sold to net  realizable
      value.  Net sales of the fiber optics business  approximated  $447,000 and
      $6,513,000 for 1996 and 1995, respectively.

                                                                     (Continued)


                                      F-11

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

(5) Property, Plant and Equipment

    Property, plant and equipment consists of the following:

                                                December 31   
                                            ------------------      Estimated
                                            1997          1996     useful lives
                                            ----          ----     ------------
Land                                   $   246,000       246,000        --
Buildings                                2,525,000     2,525,000   20-50 years
Machinery and equipment                  7,385,000     7,575,000    3-8 years
Furniture and fixtures                   3,424,000     4,332,000    5-10 years
Transportation equipment                   126,000       126,000     4 years
Tools and molds                          3,067,000     3,059,000     8 years
Leasehold improvements                     793,000       855,000   Term of lease
                                       -----------    ----------
                                        17,566,000    18,718,000
Less accumulated depreciation
   and amortization                     12,899,000    13,261,000
                                       -----------    ----------
                                       $ 4,667,000     5,457,000
                                       ===========    ==========

    Total depreciation and amortization expense for 1997, 1996 and 1995 amounted
      to approximately $1,468,000, $1,746,000 and $3,610,000, respectively.

(6) Notes Payable and Line of Credit

    The Company has  outstanding  $3,084,000 of  non-interest  bearing  deferred
      funding  fee notes  payable  with its  senior  lender,  included  in notes
      payable at December  31,  1997 and 1996,  which are due on August 31, 1999
      (note 7). The Company's  Korean  subsidiary  has a line of credit  bearing
      interest  at  11%.  At  December  31,  1997  and  1996  no  balances  were
      outstanding under this line of credit.

(7) Senior Debt

    On December 31, 1997 and 1996, the  Company's  long-term  debt  consisted of
      senior  debt under its credit  facility in the amount of  $14,878,000  and
      $17,585,000,   of  which  $1,900,000  and  $750,000,   respectively,   are
      classified as the current portion of senior debt. The facility consists of
      a combined revolving line of credit and letter of credit  availability not
      to exceed  $9,000,000.  The balance of the facility is comprised of a term
      loan. The credit facility is secured by substantially all of the Company's
      assets. All obligations except undrawn letters of credit, letter of credit
      guarantees  and the  deferred  fee notes will bear  interest  at 12%.  The
      Company will incur a fee of 2% on the average  balance of undrawn  letters
      of credit and letter of credit guarantees outstanding.

    On November 30, 1997 the Company extended  its Loan and  Security  Agreement
      with its senior  lender from  November  30, 1998 to August 31,  1999.  All
      other terms of the Agreement remain unchanged.

                                                                     (Continued)


                                      F-12

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

    The agreement (as revised) provides for loan principal  payments of $250,000
      on each of June 30, 1997,  September  30, 1997 and December 31, 1997,  and
      $325,000  commencing  March 31,  1998 and on the last day of each  quarter
      thereafter during the term of the agreement. Commencing June 30, 1997, the
      agreement also requires the Company to pay additional  principal  payments
      if its cash flow  exceeds  certain  amounts.  In addition,  the  agreement
      required that certain proceeds from the Company's sale of its fiber optics
      business (note 4),  including  $6,793,000  received at closing,  the first
      $100,000  disbursed  from escrow to the Company and 50% of any  additional
      amounts  disbursed  to the  Company,  be paid to the  senior  lender.  The
      $6,793,000  received at closing  was paid to the senior  lender to (i) pay
      accrued  interest  through March 31, 1996, (ii) repay a $3,000,000 line of
      credit and (iii) partially  repay the principal  balance of the term loan.
      Upon the  payment on March 13,  1996,  the lender  made  available  to the
      Company a  $2,000,000  revolving  line of credit.  Simultaneously,  and in
      accordance  with the  amended  agreement,  the  revolving  line of  credit
      maximum amount was reduced from  $10,000,000 to $2,000,000 and the maximum
      available for letters of credit or guarantees was reduced from  $8,000,000
      to $7,000,000. In addition, the Company repaid $3,456,000 of its term loan
      from the proceeds of the sale of assets  associated with its  discontinued
      Israeli operation (note 16).

    Through  December 31, 1997,  the Company  incurred the  following  fees,  in
      connection  with this  credit  facility:  In 1994,  a one-time  $2,474,000
      deferred  funding fee for the revolving  line and term loan evidenced by a
      non-interest bearing promissory note due and payable on November 30, 1998.
      The Company  incurred a $300,000 fee on February 13, 1995,  evidenced by a
      non-interest  bearing note due  November 30, 1998 and a $310,000  facility
      fee on November 30, 1995,  which amount has been added to the  outstanding
      principal  balance  of the  deferred  funding  fee  note  and is also  due
      November 30, 1998. The agreement  requires a monthly  facility fee payment
      of $50,000, commencing November 30, 1996, and continuing to the end of the
      agreement.  In  conjunction  with the  November 30, 1997 Loan and Security
      Agreement extension, all of the above fees have been extended to be due on
      August 31, 1999.

    In connection with the credit facility,  in November 1994 the Company issued
      warrants to its senior  lender to purchase  82,500 shares of common stock,
      exercisable  at  $17.20  per share  and  expiring  in  November  1999.  In
      connection with the extended  agreement in March 1996, the Company granted
      additional  warrants  to the lender to purchase  200,000  shares of common
      stock  at $5 per  share  that  expire  in  March  2001.  The  value of the
      warrants,  as issued in March 1996 of  $380,000,  was recorded as deferred
      financing expense and additional paid in capital in 1996.

                                                                     (Continued)


                                      F-13

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

    Pursuant to the November  30, 1997  extension  of the credit  facility,  the
      Company agreed to amend the terms of the warrants previously issued to its
      senior lender.  The 82,500 and 200,000 warrants,  after adjustment for the
      antidilution  provisions contained in the warrant agreement,  provides for
      the purchase of 164,627 and 295,441  shares of common stock,  respectively
      and are immediately  exercisable at $3.00 per share and expire on November
      30,  2002.  The value of the change in warrant  terms is  estimated  to be
      $45,000  and  has  been  recorded  as a  deferred  financing  expense  and
      additional paid in capital in 1997.

    Financial  debt  covenants  include  an  interest  coverage  ratio  measured
      quarterly with limitations on the incurrence of indebtedness,  limitations
      on capital  expenditures,  and prohibitions on declarations of any cash or
      stock  dividends or the repurchase of the Company's  stock. As of December
      31, 1997, the Company was in compliance with the above covenants.

    In connection with an amendment to the credit facility agreement on February
      13,  1995,  the Company  purchased  from the senior  lender  $3.9  million
      principal amount of its 6% Subordinated  Debentures for approximately $2.5
      million,  including accrued interest. Such payment was financed with funds
      received  from the  senior  lender as an  increase  in the term  loan.  In
      connection with this  transaction,  the Company  recorded an extraordinary
      gain on the early  extinguishment  of the debt of  $1,756,000,  which gain
      represented  the excess of the book  value  over the  market  value of the
      debt. Moreover, the $782,000 premium paid in excess of the market value of
      the debt was  reflected as additional  borrowing  costs over the remaining
      term of the facility.

    Maturities  of  the  Company's   long-term   debt,   including   convertible
      subordinated  debentures (exclusive of $1,785,000 which are in default and
      have not been  exchanged as described  in note 8 and are  classified  as a
      current  liability)  and notes payable net of current  maturities,  are as
      follows:

                      1998                       $    1,900,000
                      1999                           15,774,000
                                                 --------------
                                                 $   17,674,000
                                                 ==============

    Subsequent to December 31, 1997, the Company repaid  $2,950,000 of principal
      of senior  debt to reduce the  revolving  line of credit and the term loan
      from the proceeds of the 12% Subordinated Notes (note 9)

                                                                     (Continued)


                                      F-14

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

(8) 6% Convertible Subordinated Debentures and
    Zero Coupon Senior Subordinated Convertible Notes

    As of December 31, 1997 and 1996 the Company had outstanding  $1,758,000 and
      $2,096,000 of its 6% convertible  Subordinated Debentures due July 1, 2002
      (the Debentures), net of original issue discount of $137,000 and $209,000,
      respectively. The face amount of the outstanding Debentures was $1,895,000
      and $2,305,000 at December 31, 1997 and 1996, respectively. The Debentures
      are convertible at any time prior to maturity, unless previously redeemed,
      into Common Stock of the Company at a conversion  rate of 8.333 shares for
      each  $1,000  principal  amount at  maturity  of  Debentures,  subject  to
      adjustment under certain circumstances.

    The Debentures are redeemable at the option of the Company,  (a) in whole or
      in part, at redemption  prices ranging from 89.626% of principal amount at
      maturity  beginning  July 1, 1995 to 100% of principal  amount at maturity
      beginning  July 1, 2001 and  thereafter,  together with accrued and unpaid
      interest  to the  redemption  date,  and (b) in  whole at any  time,  at a
      redemption  price equal to the issue price plus  interest and that portion
      of the original  issue  discount and  interest  accrued to the  redemption
      date,  in the event of certain  changes in United  States  taxation or the
      imposition  of  certain  certification,  information  or  other  reporting
      requirements.

    Interest on the  Debentures is payable on July 1 of each year.  The interest
      accrued  as of  December  31,  1997  and 1996  amounted  to  $398,000  and
      $387,000,  respectively. As of December 31, 1997 the Company is in default
      under the interest payment provisions of the Debentures.

    On November 30, 1995, the Company  offered the holders of its  Debentures an
      exchange of such debt for common stock and Zero Coupon Senior Subordinated
      Convertible  Notes (the Notes) due January 2, 1998.  The exchange ratio is
      19.4 shares of common  stock and $767.22 of principal of Notes in exchange
      for each $1,000 principal amount of Debentures converted. Accrued interest
      on the Debentures would also be eliminated.

    The Notes are unsecured and do not bear interest.  There are no sinking fund
      requirements for the Notes.  Each Note is convertible into common stock at
      a conversion  price of $6.55 prior to the  amendment  as discussed  below.
      Accordingly,  in addition to the 699,855  maximum  common shares  issuable
      from the exchange of the  Debentures,  the maximum number of common shares
      that could be issued upon conversion,  if all Debentures are exchanged, is
      4,225,600. The Notes are redeemable at the option of the Company at 90.32%
      of the principal balance increasing  periodically to 100% of the principal
      balance on November 1, 1997.

    As of December 31, 1996, the Company had exchanged approximately $33,770,000
      principal amount of the Debentures,  net of related  unamortized  discount
      and accrued interest expense,  for 655,000 shares of stock and $25,909,000
      of  Notes.  This  represents  94% of  the  outstanding  balance  of the 6%
      Debentures  prior to any  conversion  to the  Notes.  In  addition,  as of
      December 31, 1996,  $24,000 of Notes had been  converted into 3,600 shares
      of stock. As of December 31, 1996, $25,885,000 Notes were outstanding.

                                                                     (Continued)


                                      F-15

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

    During 1997, the company exchanged  approximately  $410,000 principal amount
      of the  Debentures,  net  of  related  unamortized  discount  and  accrued
      interest expense, for 8,000 shares of common stock and $315,000 of Notes.

    The exchange of the  Debentures for the Notes and common stock was accounted
      for as a troubled  debt  restructuring  in  accordance  with  Statement of
      Financial  Accounting  Standards  No. 15. Since the future  principal  and
      interest  payments  under the Notes is less than the carrying value of the
      Debentures,  the Notes were  recorded  for the  amount of the future  cash
      payments, and not discounted,  the common stock issued was recorded at the
      market  value  at the  time  of  issuance,  and an  extraordinary  gain on
      restructuring  was recorded of  approximately  $122,000,  $3,922,000,  and
      $1,756,000 in 1997, 1996 and 1995,  respectively.  Accordingly,  no future
      interest expense will be recorded on the Notes.

    Effective  November  13, 1997,  the Company  amended the terms of the Notes.
      Under the amended terms,  the conversion price of the Notes was reduced to
      $3.65 from $6.55.  As of December 31, 1997,  approximately  $23,400,000 of
      principal  amount of Notes were  converted  into  approximately  6,412,000
      shares of common  stock.  The  conversion  of the Notes for  common  stock
      reduced debt by $23,400,000,  increased equity by $34,049,000 and resulted
      in a primarily  non-cash  charge of  $11,458,000.  The non-cash charge was
      based on the  difference  between the shares  issuable  under the original
      terms and the shares  issued  with  respect to the Notes under the amended
      terms.   As  of  December  31,  1997,   $2,796,000  of  the  Notes  remain
      outstanding.

    Subsequent  to December  31,  1997,  the  Company  (i) repaid the  remaining
      balance of the Notes from the proceeds of the 12% Subordinated Notes (note
      9) (ii) exchanged $250,000  additional  principal amount of the Debentures
      for 5,000  shares of common  stock and  $192,000  of Notes which were then
      converted to 53,000  shares common stock based on the amended terms of the
      Notes as described above and (iii) issued approximately  330,000 shares of
      common stock in exchange for $1,260,000 principal amount of its Debentures
      and accrued interest. The Company will record a debt conversion expense of
      approximately  $850,000, net of interest forgiven, in the first quarter of
      1998.  After giving affect to these subsequent  transactions,  the Company
      will  have  no  Notes  and  $385,000   principal   amount  of   Debentures
      outstanding.

                                                                     (Continued)


                                      F-16

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

(9) 12% Subordinated Notes, Subsequent Event

    In January 1998, the Company raised $6,000,000 from the private placement of
      60 units at $100,000 per unit. Each unit consisted of (a) the Company's 12
      % Subordinated  Note due January 3, 2000 (a "12% Note"),  in the principal
      amount of $100,000,  and (b) a Series B Common Stock  Purchase  Warrant (a
      "Series B Warrant") to purchase 10,000 shares of Common Stock at $3.00 per
      share  through  December  31,  2002.  In the  event  that  any 12% Note is
      outstanding  one year from the date on which such 12% Note is issued  (the
      "Anniversary Date of the Note"),  the Company shall issue to the holder of
      such 12% Note on the  Anniversary  Date of the Note a Series C Warrant  to
      purchase 25 shares of Common Stock for each $1,000 principal amount of 12%
      Notes  outstanding  on the  Anniversary  Date of the  Note.  The  Series C
      Warrant will have an exercise price equal to the average closing prices of
      the  Common  Stock  on  each  of  the  five  trading  days  preceding  the
      Anniversary Date of the Note with respect to which the Series C Warrant is
      being issued and will expire on December 31, 2003.  The proceeds  from the
      sale of the  Units was used  principally  to pay the  remaining  principal
      amount of Zero Coupon Notes which had not been converted of  approximately
      $2,800,000   (note  8)  and  to  reduce  the  Company's   senior  debt  by
      approximately  $2,950,000 (note 7). The balance of such proceeds was added
      to working capital.

(10) Joint Venture

    The Company entered into a joint venture agreement as of April 24, 1986 with
      a Korean  partner  whereby  each  owns a 50%  interest.  Unless  otherwise
      terminated  in  accordance  with the joint  venture  agreement,  the joint
      venture will terminate on December 31, 2010. In addition,  the Company has
      entered  into an  agreement  with its joint  venture  partner  whereby the
      Company has obtained an option, exercisable for approximately $190,000, to
      purchase  an  additional  1% interest  in the joint  venture,  which would
      increase  the   Company's   ownership   percentage  to  51%.  The  Company
      consolidates  the  operations  of the joint  venture since the Company can
      obtain a  controlling  interest at its election  and the joint  venture is
      entirely  dependent  on the Company  for the  products it sells as well as
      receiving  management  assistance  from the  Company.  The interest in the
      joint venture not owned by the Company is shown as a minority interest.

(11) Stockholders' Equity

    On June 6, 1996, the  stockholders  of the Company  approved a  one-for-five
      reverse split (the "Reverse  Split") of the Company's  common stock.  As a
      result of the Reverse Split, each share of common stock outstanding at the
      effective date of the Reverse Split, without any action on the part of the
      holder thereof,  became  one-fifth share of common stock. The par value of
      the common stock was not  affected by the Reverse  Split.  In  conjunction
      with the Reverse Split, the Company has reclassified approximately $84,000
      from common stock to additional  paid-in capital.  All share and per share
      data have been restated to give effect to the Reverse Split.

                                                                     (Continued)

                                      F-17


<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

    During 1996, the Company settled its previously  disclosed class action. The
      settlement  included a cash payment by the Company's insurers and issuance
      by the Company of 220,000  shares of its common stock.  As of December 31,
      1997,  approximately  73,000  shares  have been  issued  pursuant  to such
      settlement.  The  remaining  liability  of $504,000 is included in accrued
      expenses. Subsequent to December 31, 1997, the remaining 147,000 shares of
      common stock have been issued.

    During 1994, the Company issued warrants to purchase 82,500 shares of common
      stock at an exercise  price of $17.20 per share to its senior  lender that
      expire in November,  1999. In March 1996, the Company,  in connection with
      an agreement to amend and extend certain senior debt,  issued  warrants to
      purchase  200,000 shares of common stock at an exercise price of $5.00 per
      share that expire March,  2001. In  consideration of the November 30, 1997
      extension of the credit facility, the Company agreed to amend the terms of
      the  warrants  previously  issued to its  senior  lender.  The  82,500 and
      200,000  warrants,   after  adjustment  for  the  antidilution  provisions
      contained in the warrant agreement,  allow for the purchase of 164,627 and
      295,441  shares  of  common  stock,   respectively   and  are  immediately
      exercisable  at $3.00 per  share  and  expire on  November  30,  2002.  In
      connection  with the change of the warrant  terms,  the  Company  recorded
      deferred financing costs of $45,000 (note 7).

    In 1997, as  remuneration  for advisory  services by an  investment  banking
      firm,  the Company  issued  warrants to purchase  400,000 shares of common
      stock of which 350,000 are immediately  exercisable at $1.56 per share and
      50,000 become  exercisable at $1.56 on May 1, 1998, which expire in April,
      2002. In addition,  as remuneration  for the advisory  services related to
      the private  placement,  the Company issued to its investment banking firm
      120,000 shares of common stock (note 9). In 1997, in connection with these
      services,  the Company  recorded  deferred  consulting and debt conversion
      expense of approximately $80,000 and $580,000, respectively.

    As of December  31,  1997,  the  Company  also had  outstanding  warrants to
      purchase (i) 25,000 shares of common stock at an exercise  price of $33.10
      per share expiring in August 1998, (ii) 4,000 shares of common stock at an
      exercise  price of $5.00 per share  expiring in August  1998,  (iii) 6,000
      shares of common at an  exercise  price of $30.625  per share  expiring in
      June 1998,  (iv) 600 shares of common stock at an exercise price of $50.00
      per  share  expiring  in  May  1998  to  certain  consultants  as  partial
      remuneration for services provided during 1995 and 1993. In addition,  the
      Company has outstanding warrants to purchase 53,000 shares of common stock
      at an exercise  price of $17.50 per share expiring in November 2001 to its
      former  lenders in return for a discount  with respect to the repayment of
      its debt in 1994.

                                                                     (Continued)


                                      F-18


<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

(12) Stockholder Rights Plan

    The Company has a Stockholder  Rights Plan in which preferred stock purchase
      rights were  distributed to  stockholders as a dividend at the rate of one
      right for each common  share.  Each right  entitles the holder to buy from
      the Company one  one-hundredth  of a newly issued share of Series A junior
      participating preferred stock at an exercise price of $175.00 per right.

    The rights will be exercisable only if a person or group acquires beneficial
      ownership  of 22.5  percent  or  more of the  Company's  Common  Stock  or
      commences  a tender or  exchange  offer  upon  consummation  of which such
      person or group would  beneficially own 22.5 percent or more of the Common
      Stock.

    If any person becomes the  beneficial  owner of 22.5  percent or more of the
      Company's  Common  Stock  other than  pursuant  to an offer for all shares
      which is fair to and  otherwise  in the best  interests of the Company and
      its  stockholders,  each right not owned by such person or related parties
      will enable its holders to purchase,  at the right's then current exercise
      price, shares of Common Stock of the Company (or, in certain circumstances
      as determined by the Board of Directors,  a combination of cash, property,
      common  stock or other  securities)  having a value of twice  the  right's
      exercise  price.  In  addition,  if the Company is involved in a merger or
      other business  combination  transaction  with another person in which its
      shares  are  changed  or  converted,  or sells more than 50 percent of its
      assets to another  person or persons,  each right that has not  previously
      been  exercised  will entitle its holder to purchase,  at the right's then
      current exercise price,  common shares of such other person having a value
      of twice the right's exercise price.

    The Company will generally be entitled to redeem the rights,  by action of a
      majority of the continuing  directors of the Company, at $.01 per right at
      any time until the tenth business day following public announcement that a
      22.5 percent position has been acquired.

(13) Employee Benefit Plans

    The Company has deferred  compensation  agreements with certain officers and
      employees,  with benefits  commencing  at  retirement  equal to 50% of the
      employee's base salary, as defined.  Payments under the agreements will be
      made for a period of fifteen years  following the earlier of attainment of
      age  65 or  death.  During  1997,  1996  and  1995,  the  Company  accrued
      approximately $203,000, $180,000 and $203,000,  respectively,  under these
      agreements.

    In 1986, the Company established the Porta Systems Corp. 401(k) Savings Plan
      (Savings  Plan) for the benefit of eligible  employees,  as defined in the
      Savings Plan. Participants contribute a specified percentage of their base
      salary up to a maximum of 15%.  The  Company  will  match a  participant's
      contribution  by  an  amount  equal  to  25%  of  the  first  six  percent
      contributed  by the  participant.  A  participant  is 100%  vested  in the
      balance to his credit.  For the years ended  December 31,  1997,  1996 and
      1995,  the  Company's  contribution  amounted  to  $96,000,   $90,000  and
      $379,000, respectively.

    The Company  does not provide any other  post-retirement  benefits to any of
      its employees.

                                                                     (Continued)


                                      F-19

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

(14) Incentive Plans

    Under the Company's 1984 Employee  Incentive  Plan, the Company  provided an
      opportunity  to acquire  subordinated  convertible  debentures  to certain
      employees  of the Company and its  subsidiaries.  This plan was  suspended
      when the Company's  stockholders  approved the Company's 1986 Stock Option
      Plan.  As of December 31, 1997,  there is $307,000 of employee  promissory
      notes receivable outstanding, of which the maturity date has been extended
      to April 1999.

    The Company's 1986 Stock Incentive Plan (1986 Plan),  expired in March 1996,
      although  options granted prior to the expiration date remain in effect in
      accordance  with their terms.  Options  granted under the 1986 Plan may be
      incentive  stock  options,  as defined in the Internal  Revenue  Code,  or
      options that are not incentive  stock options.  The exercise price for all
      options granted was equal to the fair market value at the date of grant.

    The Company's 1996 Stock  Incentive Plan (1996 Plan), is authorized to issue
      450,000 shares of Common Stock.  Incentive  stock options cannot be issued
      subsequent to ten years from the date the Plan was approved. Options under
      the 1996 Plan may be  granted to key  employees,  including  officers  and
      directors  of the Company and its  subsidiaries,  except that  members and
      alternate  members of the stock  option  committee  are not  eligible  for
      options  under the 1996  Plan.  In  addition,  the Plan  provides  for the
      automatic grant to  non-management  directors of non-qualified  options to
      purchase  2,000  shares on May 1st of each year  commencing  May 1,  1996,
      based upon the average closing price of the last ten trading days of April
      of each year.

    The  Company  applies  APB  Opinion  25,  "Accounting  for  Stock  Issued to
      Employees" and related Interpretations in accounting for the 1996 and 1986
      Plans.  Under APB 25,  no  compensation  cost is  recognized  for  options
      granted to employees at exercise  prices equal to fair market value of the
      underlying common stock at the date of grant.

    The Company has adopted the  disclosure  only  provisions  of  Statement  of
      Financial   Accounting  Standard  No.  123,  "Accounting  for  Stock-Based
      Compensation"  ("SFAS  No.123")  which  requires  the  Company to provide,
      beginning with 1995 grants, pro forma information regarding net income and
      net income per common share (basic and diluted) as compensation  costs for
      the Company's  stock option plans had been  determined in accordance  with
      the fair value  method  prescribed  in SFAS  No.123.  If the  Company  had
      elected to recognize compensation costs based on fair value of the options
      granted at grant date as prescribed by SFAS No. 123, net income (loss) and
      earnings  (loss) per  share(basic  and diluted) would have been reduced to
      the pro forma amounts indicated below:

           (Dollars in thousands, except per share data)

                                                                        1997
                                                                        ----
           Pro forma net loss                                        $(7,026)
           Pro forma loss per share (basic and diluted)               $(2.26)

    The  weighted-average  fair value of options  granted was $0.35 per share in
      1997.

                                                                     (Continued)


                                      F-20

<PAGE>
  
                      PORTA SYSTEMS CORP. AND SUBSIDIARIES

              Notes to Consolidated Financial Statements, Continued

    The fair value of each option  grant is estimated on the date of grant using
      the Black-Scholes  option-pricing model with the following assumptions for
      1997:

                 Dividends:                           $0.00 per share
                 Volatility:                          80.00%
                 Risk-free interest:                   6.40%
                 Expected term:                      5 years

    Such pro forma  information has not been presented for 1996 and 1995 because
      management has determined  that the  compensation  costs  associated  with
      options  granted in 1996 and 1995 are not material to net income (loss) or
      net income (loss) per share.

    A summary  of the  status of the  Company's  1986  stock  option  plan as of
      December 31, 1997,  1996, and 1995, and changes during the years ending on
      those dates is presented below:

<TABLE>
<CAPTION>
                                                1997                       1996                         1995
                                     -----------------------     ------------------------    -------------------------
                                     Shares      Weighted        Shares      Weighted        Shares       Weighted
                                     Under       Average         Under        Average         Under        Average
                                     Option   Exercise Price     Option    Exercise Price     Option    Exercise Price
                                     ------   --------------     ------    --------------     ------    --------------              
<S>                                  <C>           <C>           <C>            <C>           <C>            <C>
Outstanding beginning of year        16,397        $57           56,360         $58           80,775         $63
                                                                                                           
Granted                                --                          --                          6,000           5
Exercised                              --                                                                
Forfeited                                (5)         5          (39,963)         58          (30,415)         63
                                     ------                      ------                       ------      
Outstanding end of year              16,392         57           16,397          57           50,360          58     
                                     ======                      ======                       ======         
Options exercisable at year-end      16,392                      16,397                       50,360       
                                     ======                      ======                       ======       
</TABLE>

    The following table summarizes  information about stock options  outstanding
      under the 1986 Plan at December 31, 1997:

<TABLE>
<CAPTION>
                                Options Outstanding                          Options Exercisable
                   ------------------------------------------------    ------------------------------
  Range of         Outstanding      Remaining      Weighted-average    Exercisable   Weighted-Average
Exercise Prices    at 12/31/97  Contractual Life    Exercise Price     at 12/31/97    Exercise Price
---------------    -----------  ----------------    --------------     -----------    --------------
<S>                   <C>          <C>                   <C>              <C>              <C>
$ 5 to  25            2,995        4.8 years             $ 5              2,995            $ 5
 25 to  75           10,600        1.7                    65             10,600             65
 75 to 100            2,797        1.3                    86              2,797             86
                     ------                                              ------
$ 5 to 100           16,392        3.2                    58             16,392             58
                     ======                                              ======
</TABLE>

                                                                     (Continued)


                                      F-21


<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

    A summary  of the  status of the  Company's  1996  stock  option  plan as of
      December  31,  1997 and 1996,  and  changes  during the year is  presented
      below:

                                            1997                    1996       
                                    -------------------     --------------------
                                               Weighted                 Weighted
                                    Shares      Average     Shares       Average
                                    Under      Exercise     Under       Exercise
                                    Option       Price      Option        Price
                                    ------       -----      ------        -----
                                  
Outstanding beginning of year        79,448       2.45         -0-       $  0.00
Granted                             358,780       1.50       79,448         2.45
Exercised                              --                      --
Forfeited                              (240)      2.00         --
                                    -------       ----       ------   

Outstanding end of year             437,988       1.67       79,448         2.45
                                    =======                  ======

Options exercisable at year-end     333,488                  63,050
                                    =======                  ======

    The following table summarizes  information about stock options  outstanding
      under the 1996 Plan at December 31, 1997:

<TABLE>
<CAPTION>

                               Options Outstanding                    Options Exercisable                
                 ----------------------------------------------   ----------------------------  
Range of         Outstanding  Remaining         Weighted-average  Exercisable  Weighted-Average   
Exercise Prices  at 12/31/97  Contractual Life  Exercise Price    at 12/31/97  Exercise Price
---------------  -----------  ----------------  --------------    -----------  --------------

<S>                <C>           <C>                 <C>             <C>           <C>   
$1 to 5            437,988       8.5 years           $ 1.67         333,488        $ 1.72
                   =======                                          =======

</TABLE>

(15)  Income Taxes

    Included in income (loss) from  continuing  operations is income (loss) from
      foreign  operations of $2,641,000,  $(584,000) and  $1,272,000,  for 1997,
      1996 and 1995, respectively.

    The provision for income taxes consists of the following:

                             1997                1996               1995
                             ----                ----               ----
                      Current  Deferred    Current  Deferred   Current  Deferred
                      -------  --------    -------  --------   -------  --------

Federal              $ 40,000   (708,000)     --       --      (98,000)    --
State and foreign     177,000    (94,000)  100,000     --      128,000     --
                      -------    -------   -------  --------   -------  --------

             Total   $217,000   (802,000)  100,000     --       30,000     --
                     ========   ========   =======  ========    ======  ========

                                                                     (Continued)


                                      F-22

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

    A reconciliation  of the  Company's  income  tax  provision  and the  amount
      computed by applying the statutory U.S.  federal income tax rate of 34% to
      income  (loss)  from  continuing  operations  before  income  taxes  is as
      follows:

<TABLE>
<CAPTION>

                                                                    1997         1996          1995
                                                                    ----         ----          ----

<S>                                                            <C>               <C>       <C>        
Tax expense (benefit) at statutory rate                        $ (2,526,000)     495000    (9,916,000)
Increase (decrease) in income tax benefit resulting from:
   Increase (decrease) in valuation allowance                   (22,740,000)   (495,000)   10,103,000
   State and foreign taxes, less applicable federal benefits         83,000     100,000       132,000
   Debt conversion expense not deductible for tax                 3,620,000           -             -
   Other expenses not deductible for tax                            206,000           -             -
   Foreign income taxed at rates lower than U.S. statutory rate    (730,000)          -             -
   Utilization of net operating loss carryforward                  (669,000)          -             -
   Expiration of investment tax credit                              642,000           -             -
   NOL in excess of 382 limitation                               21,500,000           -             -
   Other                                                             29,000           -      (289,000)
                                                                -----------     -------       ------- 

                                                                $  (585,000)    100,000        30,000
                                                                ===========     =======        ======
</TABLE>

    The  Company  has  unused  United  States  tax  net  operating   loss  (NOL)
      carryforwards  of  approximately  $66,677,000  expiring  at various  dates
      between 2004 and 2011. No tax benefit or expense was apportioned to either
      the loss from discontinued  operations or the extraordinary gains, as such
      amounts are  immaterial.  In addition,  the Company has NOL  carryforwards
      arising from acquired companies of approximately $9,878,000. The effect of
      the sale of the Company's  fiber optics business (note 4) in March 1996 on
      the NOL carryforwards and acquired NOL carryforwards was not material. Due
      to the change in  ownership  which  resulted  from the  conversion  of the
      Company's Zero coupon subordinated  convertible notes to common stock, the
      Company's  usage of its NOL will be limited in  accordance  with  Internal
      Revenue Code section 382. The Company's  carryforward  utilization  of the
      NOL is limited to $  1,464,000  per year.  The  carryforward  amounts  are
      subject to review by the  Internal  Revenue  Service  (IRS).  In addition,
      there are capital loss  carryforwards  of  approximately  $11,396,000  and
      investment,  research and development and job tax credit  carryforwards of
      approximately $658,000 expiring at various dates between 1998 and 2001.

    The Company's  net  operating  loss  carryforwards,  limited by section 382,
      expire in the following years:

               2007                           $  11,503,000
               2008                               6,065,000
               2009                               1,464,000
               2010                               1,464,000
               2011                               1,464,000
                                              -------------

                                              $  21,960,000
                                              =============

                                                                     (Continued)


                                      F-23

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

    The components of the deferred tax assets and liabilities as of December 31,
      1997 and 1996 are as follows:

<TABLE>
<CAPTION>
     
                                                                  1997            1996
                                                                  ----            ----
<S>                                                          <C>                <C>      
 Deferred tax assets:
   Inventory                                                   $1,634,000       2,064,000
   Allowance for doubtful accounts receivable                     307,000         457,000
   Benefits of tax loss carryforwards                           7,525,000      27,233,000
   Benefit plans                                                1,007,000         869,000
   Accrued Commissions                                            941,000       1,043,000
   Other                                                          422,000         128,000
   Benefits of tax loss carryforwards of acquired business        930,000       3,479,000
   Benefit of investment tax credit carryforwards                 658,000       1,300,000
   Benefit of capital loss carryforwards                        4,387,000       4,387,000
                                                               ----------       ---------

                                                               17,811,000      40,960,000
   Valuation allowance                                        (16,704,000)    (39,444,000)
                                                               ----------      ---------- 
                                                                1,107,000       1,516,000
                                                               ----------      ----------
Deferred tax liabilities:
   Capitalized software costs                                    (240,000)     (1,479,000)
   Depreciation                                                   (65,000)        (37,000)
                                                               ----------       --------- 
                                                                 (305,000)     (1,516,000)
                                                               ----------       --------- 

                                                               $  802,000            --
                                                               ==========       =========       

</TABLE>

    Deferred taxes result from temporary  difference between tax basis of assets
      and  liabilities and their reported  amounts in the financial  statements.
      The temporary differences result from costs required to be capitalized for
      tax purposes by the US Internal  Revenue  Code,  and certain items accrued
      for financial  reporting  purposes in the year incurred but not deductible
      for tax purposes until paid.

    Because of the  Company's  US tax  losses  in 1995  and  1996,  a  valuation
      allowance  for the deferred tax asset was provided due to the  uncertainty
      as to future  realization.  During the year ended  December 31, 1997,  the
      valuation  allowance was reduced to reflect a net deferred tax asset equal
      to the  anticipated  tax benefit of the  temporary  differences  which are
      expected  to be  realized  within  one year  based on the  Company's  1998
      projected US taxable income.

    The income tax returns of the Company and its subsidiary operating in Puerto
      Rico were  examined by the IRS for the tax years ended  December  31, 1989
      and 1988.  As a result of this  examination,  the IRS increased the Puerto
      Rico subsidiary's taxable income resulting from intercompany transactions,
      with a corresponding  increase in the Company's net operating losses.  The
      settlement amounted to approximately $953,000. The Company is currently in
      a structured settlement with the IRS, which is reviewed annually,  whereby
      monthly  payments  will be made to  liquidate  the  settlement.  Aggregate
      annual amounts  payable by the Company,  including  interest on the unpaid
      amounts at a current  rate of 7%, is $240,000 in 1998.  As of December 31,
      1997,  the Company has made all the  required  payments  through that date
      under the settlement and approximately $920,000 remains outstanding.

                                                                     (Continued)


                                      F-24

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

(16)  Discontinued Operations

    In 1992 the Company sold its network communications business. As a result of
      an insolvency  procedure  involving the  purchaser of this  business,  the
      Company  reduced its  receivable  due from the  purchaser of $4,500,000 to
      $1,000,000  in 1995,  and  recorded an  additional  provision  for loss on
      disposal of discontinued operations of $3,500,000. Pursuant to the sale of
      the business out of receivership, the Company's receivable was represented
      shares of common  stock of the  entity  which  acquired  the  discontinued
      operation.  In 1996,  the  Company  sold such  shares for  $3,456,000  and
      recorded a gain of $2,264,000.  The gain  represented an adjustment in the
      estimated  value of the shares  previously  received and  accordingly  was
      reflected  in  continuing  operations.  As part of an  agreement  with the
      Company's  senior  lender,  the net proceeds from the sale were applied to
      reduce the  outstanding  principal  balance of the Company's term loan. In
      1997, the Company received $700,000 representing a final payment resulting
      from the insolvency procedure. Such payment is included in other income.

(17)  Leases

    AtDecember 31, 1997, the Company and its subsidiaries  leased  manufacturing
      and administrative facilities, equipment and automobiles under a number of
      operating leases.  The Company is required to pay increases in real estate
      taxes on the facilities in addition to minimum  rents.  Total rent expense
      for 1997, 1996, and 1995 amounted to approximately $827,000,  $871,000 and
      $1,277,000,  respectively. Minimum rental commitments, exclusive of future
      escalation charges, for each of the next five years are as follows:

                      1998                           488,000
                      1999                           388,000
                      2000                           289,000
                      2001                                 0
                      2002                                 0

(18)  Contingencies

    At December 31, 1997,  the Company was  contingently  liable for outstanding
      letters of credit aggregating approximately $6,800,000 as security for the
      performance of certain long-term contracts.

    The Company  is a party to  various  lawsuits  arising  out of the  ordinary
      conduct of its business.  Management believes that the settlement of these
      matters  will  not  have a  materially  adverse  effect  on the  financial
      position of the Company (note 22).

                                                                     (Continued)


                                      F-25

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

(19)  Major Customers

    During the years ended December 31, 1997,  1996 and 1995, the Company's five
      largest customers accounted for sales of $30,633,000, or approximately 49%
      of sales, $27,807,000, or approximately 48% of sales, and $ 31,517,000, or
      approximately 52% of sales,  respectively.  The Company's largest customer
      is BT. Sales to BT for the year ended  December  31,  1997,  1996 and 1995
      amounted to $13,876,000,  $11,308,000 and  $17,252,000,  respectively,  or
      approximately 22%, 20% and 28%,  respectively,  of the Company's sales for
      such years. Therefore, any significant interruption or decline in sales to
      BT may have a materially  adverse  effect upon the  Company's  operations.
      During  1996,  sales  to the  Philippines  Long  Distance  Telephone  were
      $7,034,000, or approximately 12% of sales. During 1995, sales to the Korea
      Telephone Company were $7,651,000, or approximately 13% of sales. No other
      customers  account  for 10% or more of the  Company's  sales for any year.
      Approximately  64% and 33% of the Company's  accounts  receivable  are due
      from the  five  largest  customers  as of  December  31,  1997  and  1996,
      respectively.

(20)  Fair Values of Financial Instruments

    Cash equivalents,  accounts receivable,  accounts and notes payable, accrued
      expenses and short-term loans are reflected in the consolidated  financial
      statements  at fair  value  because of the short  term  maturity  of these
      instruments.

    The carrying amount of the Company's  long-term debt approximates fair value
      as the extension of the Loan and Security  Agreement was  re-negotiated on
      November 30, 1997.

    The carrying  amount and estimated  fair value of the  Company's  additional
      financial instruments are summarized as follows:

                                     December 31, 1997        December 31, 1996
                                     -----------------        -----------------
                                  Carrying     Estimated    Carrying   Estimated
                                   amount     fair value     amount   fair value
                                   ------     ----------     ------   ----------
6% Convertible Subordinated
  Debentures                     $1,758,000    1,471,000    2,096,000    511,000
                                 ==========    =========   ==========    =======
Zero Coupon Subordinated      
  Convertible Notes              $2,796,000    2,796,000   25,885,000        (1)
                                 ==========    =========   ==========     
                           
    (1) As of December 31, 1996, due to the inherent uncertainty,  at that time,
      regarding the conversion of the Notes or their status at maturity,  it was
      impractical to estimate the fair value of this financial instrument.

    Management's  estimated fair value of the Debentures as of December 31, 1996
      is based on estimated market prices of the Company's common stock assuming
      conversion  as 94% of  the  holders  of the  Debentures  have  elected  to
      convert. Estimated fair value of the Debentures as of December 31, 1997 is
      based on market  prices of the  Company's  common  stock  price which were
      issued in January  1998 for the  conversion  of  $1,260,000  of  principal
      amount of the Debentures.

                                                                     (Continued)


                                      F-26

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

 (21)     Earnings Per Share

    The following table sets forth the computation of basic and diluted earnings
      per share:

    Numerator-Basic and diluted earnings per share:

<TABLE>
<CAPTION>
                                                        1997           1996              1995
                                                        ----           ----              ----
<S>                                               <C>              <C>             <C>            
    Income (loss) from continuing operations      $  (7,021,000)   $ 1,252,000     $  (29,297,000)
    Discontinued operations                                --             --           (3,500,000)
    Extraordinary item                                  122,000      3,922,000          1,756,000
                                                  -------------    -----------     --------------
    Net income (loss)                             $  (6,899,000)   $ 5,174,000     $  (31,041,000)
                                                  =============    ===========     ============== 
Denominator:
    Denominator for basic earnings per share
       -weighted-average shares                       3,111,000      2,184,000          1,461,000
                                                  =============    ===========     ==============
    Effect of dilutive securities:
       Zero Coupon Senior Subordinated
       Convertible Notes                                   --        3,344,000               --  
                                                  -------------    -----------     -------------- 
    Denominator for diluted earnings per share-
       adjusted weighted-average shares and
       assumed conversions                            3,111,000      5,528,000          1,461,000
                                                  =============    ===========     ==============
   Basic per share amounts:
      Continuing operations                       $       (2.26)         $0.57            $(20.05)
      Discontinued operations                               --              --              (2.40)
      Extraordinary item                                   0.04           1.80               1.20
                                                  -------------    -----------     --------------
            Net income (loss) per share
            of common stock                       $       (2.22)    $     2.37     $       (21.25)
                                                  =============    ===========     ==============
   Diluted per share amounts:
      Continuing operations                       $       (2.26)    $     0.23     $       (20.05)
      Discontinued operations                               --             --               (2.40)
      Extraordinary item                                   0.04          40.71               1.20
                                                  -------------    -----------     --------------
            Net income (loss) per share
            of common stock                       $       (2.22)    $     0.94     $       (21.25)
                                                  =============    ===========     ==============

</TABLE>

    For additional  disclosure  regarding  the Zero Coupon  Senior  Subordinated
      Notes see note 8.

    In November 1997,  the Company  converted  approximately  23,400,000  of the
      Notes  to  approximately  6,412,000  shares  of  common  stock.  Had  this
      conversion  taken  place as of January 1, 1997,  the  denominator  for the
      basic  earnings  per share (the  weighted-average  shares) and the diluted
      earnings  per  share   (adjusted   weighted-average   shares  and  assumed
      conversion) would have been 8,639,000 for 1997.

                                                                     (Continued)


                                      F-27

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

(22)  Legal Matters

    In July 1996,  an action was  commenced  against  the  Company  and  certain
      present  and former  directors  in the  Supreme  Court of the State of New
      York, New York County by certain  stockholders  and warrant holders of the
      Company who acquired their  securities in connection  with the acquisition
      by the  Company of Aster  Corporation.  The  complaint  alleges  breach of
      contract  against  the Company and breach of  fiduciary  duty  against the
      directors arising out of an alleged failure to register certain restricted
      shares and warrants owned by the  plaintiffs.  The complaint seeks damages
      of $413,000;  however,  counsel for the plaintiff have advised the Company
      that  additional  plaintiffs may be added and, as a result,  the amount of
      damages  claimed may be  substantially  greater than the amount  presently
      claimed.  The Company  believes that the defendants have valid defenses to
      the claims. Discovery is proceeding.

    In July 1996, the Securities and Exchange  Commission  (the "SEC") issued an
      order (the "Order")  directing a private  investigation  of the Company to
      determine  whether there has been a violation of Federal  securities laws.
      The SEC  indicated  to  counsel  for the  Company  that the  investigation
      relates  to the  position  of the SEC staff that the  independence  of the
      Company's  auditors for 1995, KPMG Peat Marwick LLP ("Peat Marwick"),  was
      adversely impacted by certain relationships involving Peat Marwick, on one
      hand, and KPMG BayMark Strategies LLC ("BayMark") and Edward R. Olson, the
      President of BayMark and the Company's former interim  president and chief
      operating officer,  on the other hand. Although the Company does not agree
      with the  position of the SEC staff with  respect to the  independence  of
      Peat Marwick, the Company is cooperating with the SEC's investigation. The
      Company retained BDO Seidman,  LLP to reaudit the Company's 1995 financial
      statements,  which reaudit  resulted in no changes to the  Company's  1995
      financial  statements  as audited by Peat  Marwick.  The Company  does not
      believe that the  investigation  will result in any material  liability on
      the part of the  Company.  There has been no further  activity  respecting
      this investigation since November 1996.

(23)  Cash Flow Information

    (1) Supplemental  cash flow  information for the years ended December 31, is
      as follows:

                                                  1997     1996     1995
                                                  ----     ----     ----
         
         Cash paid for interest                 $2,844    2,751    2,915
                                                ======    =====    =====
         Cash paid for income taxes             $  117      105       73
                                                ======    =====    =====
     

                                                                     (Continued)


                                      F-28

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

    (2) Non cash transactions:

            (i)  During  1997 and  1996,  the  Company  exchanged  approximately
            $410,000 and $33,770,000 principal amount of its Debentures,  net of
            unamortized  discount  and accrued  interest,  for 8,000 and 655,000
            shares of Common  stock,  and  $315,000  and  $25,909,000  of Notes,
            respectively (note 8).

            (ii) During 1996, the Company issued 3,600 shares of common stock as
            a result of the  conversion of Notes under the original  terms (note
            8).

            (iii) During 1997,  the Company  issued  6,412,000  shares of common
            stock upon the conversion of Notes (note 8).

            (iv) During 1996,  the Company  issued 73,000 shares of common stock
            to  satisfy  a  portion  of the  final  settlement  of a  previously
            disclosed class action lawsuit (note 11).

            (v) In  connection  with the Company's  March 1996  amendment to its
            credit  facility,  the Company granted its senior lender warrants to
            purchase  200,000  shares of common stock (note 7). The value of the
            warrants was recorded as deferred  financing  expense and additional
            paid in capital.

            (vi) In connection with the November 1997 extension of the Company's
            credit  facility  with its senior  lender,  the Company  amended the
            terms of previously  issued warrants to purchase  common stock.  The
            value  of the  amendment,  approximately  $45,000  was  recorded  as
            deferred financing and additional paid in capital.

            (vii) In connection with advisory services provided by an investment
            banking firm,  the Company issued 120,000 shares of common stock and
            warrants to purchase  400,000  shares of common  stock  (notes 9 and
            11).

    (24) Segment Disclosure

          The Company  operates  almost  exclusively  in the  telecommunications
            industry. Customers include telephone operating companies and others
            within and outside the United States and its possessions.

          In the following table,  intercompany  sales are accounted for at cost
            plus a reasonable  profit.  Identifiable  assets for the  geographic
            areas are those assets  identified with the operations in each area.
            Corporate assets consist  principally of cash and cash  equivalents,
            debt issuance costs,  employee loans for debentures and patents. The
            Company does not allocate costs for product  development,  marketing
            or management  to each segment.  Thus,  the  information  may not be
            indicative of the extent to which  geographic  areas  contributed to
            the Company's consolidated results of operations.

                                                                     (Continued)


                                      F-29

<PAGE>

                      PORTA SYSTEMS CORP. AND SUBSIDIARIES
              Notes to Consolidated Financial Statements, Continued

    Geographic  area data for the years ended  December 31, 1997,  1996 and 1995
      are as follows:

<TABLE>
<CAPTION>
                                            1997            1996           1995
                                            ----            ----           ----
<S>                                    <C>               <C>             <C>    
Sales made from:
United States to: 
      U.S. customers                   $ 17,980,000      17,644,000      16,445,000
      Foreign customers                  13,684,000      18,418,000      12,875,000
      Intercompany                       14,906,000      16,726,000      14,849,000
                                       ------------      ----------      ----------
                                         46,570,000      52,788,000      44,169,000
                                       ------------      ----------      ----------
Korea-to customers                        4,881,000       4,749,000       7,651,000
                                       ------------      ----------      ----------
Europe-to customers                      24,396,000      17,176,000      24,174,000
Intercompany                              1,275,000       3,228,000       3,735,000
                                       ------------      ----------      ----------
                                         25,671,000      20,404,000      27,909,000

Other-to customers                        1,289,000            --            36,000
Intercompany                              1,951,000       1,878,000       2,410,000
                                       ------------      ----------      ----------
                                          3,240,000       1,878,000       2,446,000
                                       ------------      ----------      ----------
Intercompany eliminations               (18,132,000)    (21,832,000)    (20,994,000)
                                       ------------      ----------      ----------
Consolidated sales                     $ 62,230,000      57,987,000       61,181000
                                       ============      ==========      ==========  
Operating income (loss)
   United States                          3,312,000       4,310,000     (22,549,000)
   Europe                                 2,294,000        (666,000)      2,279,000
   Korea                                    363,000         236,000         288,000
   Other                                    132,000         102,000          98,000
                                       ------------      ----------      ----------
Consolidated operating income (loss)   $  6,101,000       3,982,000     (19,884,000)
                                       ============      ==========      ==========                                      
Identifiable assets:
   United States                         30,729,000      33,993,000      39,600,000
   Europe                                10,633,000      10,184,000      11,414,000
   Korea                                  1,300,000       2,324,000       2,540,000
   Other                                  1,325,000         544,000         623,000
                                       ------------      ----------      ----------
Consolidated identifiable assets         43,987,000      47,045,000      54,177,000

Corporate assets                          7,013,000       4,615,000       6,414,000
                                       ------------      ----------      ----------
Consolidated total assets              $ 51,000,000      51,660,000      60,591,000
                                       ============      ==========      ==========

</TABLE>


                                      F-30