**United
      States**


**SECURITIES
      AND EXCHANGE COMMISSION**


Washington,
      DC 20549





**FORM
      10-K**


**(Mark
      One)**




**x ANNUAL
      REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF THE**


**SECURITIES
      EXCHANGE ACT OF 1934**


**For
      the fiscal year ended** **December
      31, 2007**





**o** **TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**


**SECURITIES
      EXCHANGE ACT OF 1934**


**Commission
      file number** **0-8460**




**PORTA
      SYSTEMS CORP** .


(Exact
      name of registrant as specified in its charter)





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





**6851
                Jericho Turnpike, 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: None


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




Common
      Stock, par value $.01 per share


(Title
      of
      Class)





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act. Yes o No x





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act. Yes o No x





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 o





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




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Check
      one:




Large
      accelerated filer o Accelerated
      filer o Non-accelerated
      filer o Smaller
      reporting company x





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Act).


o Yes x No





State
      aggregate market value of the voting stock held by non-affiliates of the
      registrant: $806,045 as of December 31, 2007.





Indicate
      the number of shares outstanding of each of the registrant's class of common
      stock, as of the latest practicable date: 10,053,617 shares of Common Stock,
      par
      value $.01 per share, as of March 12, 2008.





**DOCUMENTS
      INCORPORATED BY REFERENCE**


None












**PART
      I**




**Item
      1.** **** **Business**





Porta
      Systems Corp. develops, designs, manufactures and markets a range of standard
      and proprietary telecommunications equipment for sale domestically and
      internationally. Our core products, focused on ensuring communications for
      service providers worldwide, fall principally into two categories:




**Voice
      and Data Connection and Protection Equipment** **.** These
      products are used to connect copper wire lines, Automated Digital Subscriber
      Lines (“ADSL”), wireless networks, fiber connection/protection lines (“FTTX”),
      and security networks; and to protect equipment from voltage surges. We market
      our connection and protection products to telephone operating companies,
      customer premise providers and installers and security providers and installers
      throughout the world.




**Signal
      Processing Equipment** **.** Signal
      Processing products are sold principally for use in defense and aerospace
      applications, and support copper wire-based communications systems. Customers
      for signal processing equipment are major aircraft, naval ship and ground-based
      vehicle manufacturers, as well as their third party sub-tier
      partners.





Through
      2004, we offered a third category of products - operations support systems,
      which we called OSS. We began to scale back our OSS operations in 2003 and
      we
      scaled back these operations further through 2006, limiting our activity to
      the
      performance of contractual maintenance and warranty services. In June 2007,
      the
      contractual maintenance and warranty services agreements expired and we
      discontinued all operations for OSS. See Note 10 of Notes to Consolidated
      Financial Statements. The assets and liabilities and results of operations
      of
      the OSS division through June 30, 2007 are segregated and reported separately
      as
      discontinued operations on our consolidated financial statements.





We
      are a
      Delaware corporation incorporated in 1972 as the successor to a New York
      corporation of the same name incorporated in 1969. Our principal offices are
      located at 6851 Jericho Turnpike, Syosset, New York 11791; telephone number,
      516-364-9300. References to “we,” “us,” “our,” and words of like import refer to
      Porta Systems Corp. and its subsidiaries, unless the context indicates
      otherwise.


.


**Forward-Looking
      Statements**





Statements
      in this Form 10-K annual report may be “forward-looking statements” within the
      meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking
      statements include, but are not limited to, statements that express our
      intentions, beliefs, expectations, strategies, predictions or any other
      statements relating to our future activities or other future events or
      conditions. These statements are based on current expectations, estimates and
      projections about our business based, in part, on assumptions made by
      management. These statements are not guarantees of future performance and
      involve risks, uncertainties and assumptions that are difficult to predict.
      Therefore, actual outcomes and results may, and probably will, differ materially
      from what is expressed or forecasted in the forward-looking statements due
      to
      numerous factors, including those risks discussed from time to time in this
      Form
      10-K annual report, including the risks described under “Risk Factors” and the
      matters described under “Management’s Discussion and Analysis of Financial
      Condition and Results of Operations,” and in other documents which we file with
      the Securities and Exchange Commission. In addition, such statements could
      be
      affected by risks and uncertainties related to our financial conditions, our
      relationship with the holder of our senior debt, factors which affect the
      telecommunications industry, market and customer acceptance, including our
      relationship with our principal customer, competition, government regulations
      and requirements and pricing, as well as general industry and market conditions
      and growth rates, and general economic conditions. Any forward-looking
      statements speak only as of the date on which they are made, and we do not
      undertake any obligation to update any forward-looking statement to reflect
      events or circumstances after the date of this Form 10-K.




**Products**





**Telecommunications
      Connection and Protection Equipment** .





Our
      connection and protection equipment includes a variety of connector blocks,
      protector modules, building entrance terminals, category 5E **** and
      6
      cable connectors and protectors, frames used in telephone central switching
      offices, voice and data installations, multiple dwelling units and customer
      premises applications. The connector products are used by telephone companies
      and installers of voice and data transmission equipment to interconnect copper
      and fiber subscriber lines. The protector modules are used to protect from
      electrical surges the equipment and personnel of telephone companies, voice
      and
      data transmission providers and customer premises equipment providers. The
      need
      for protection products has increased as a result of the worldwide move to
      digital technology, wireless and broadband, which is extremely sensitive to
      damage by electrical overloads. Moreover, private owners of telecommunications
      equipment now have the responsibility to protect their equipment, personnel
      and
      buildings from damage caused by electrical surges.


Page
          1 of
          29





We
      also
      have developed a range of security products for use in Closed Circuit TV (CCTV)
      installations. Our CCTV video balun products allow full motion color or
      monochrome video transmission via cost-effective UTP CAT 3 or better cable
      eliminating expensive and bulky coax cable. Porta Systems’ CCTV surge protectors
      provide protection against voltage spikes and current surges that can disable
      and permanently damage expensive video equipment, including cameras and
      recorders, resulting in loss of important information and reduced
      security.





Our
      connection and protection products are used by international telephone service
      providers as well as many of the regional telecommunication service providers
      as
      well as independent telecommunication service providers in the United States,
      and by owners of private telecommunications equipment providing communications
      and data transmission facilities and equipment. These products are also
      purchased by equipment manufacturers for integration with their systems. In
      addition, our telecommunications connection products have been sold to telephone
      operating companies in various foreign countries. This equipment is compatible
      with existing telephone systems both within and outside the United States and
      can generally be used without modification, although we do custom-design
      modifications to accommodate the specific needs of our customers.





**Signal
      Processing Products** **.** The
      Signal Processing products include data bus components, cable assemblies and
      wideband transformers. Our data bus components provide network infrastructure
      that connects remote terminals used in military data transmission applications,
      where an extremely high level of reliability and performance is required. Our
      wideband video isolation transformers are used by the television and broadcast,
      medical imaging, in-flight entertainment and industrial process control
      industries to reduce ground noise, interference and improve picture quality.
      Our
      wideband products are also used by test and measurement engineers in the
      characterization of data transmission networks.





Sales
      by Product Category





The
      table
      below shows, for the last three fiscal years, the contribution to sales from
      continuing operations made by each of our major categories of the
      telecommunications industry:





Years
                Ended December 31,2007
            
            2006
            
            2005(Dollars
                in thousands)Line
                Connection/Protection Equipment
            
            $
            22,929
            
            
            82
            %
            $
            27,188
            
            
            83
            %
            $
            21,982
            
            
            79
            %Signal
                Processing
            
            
            4,891
            
            
            18
            %
            
            5,292
            
            
            16
            %
            
            5,710
            
            
            21
            %Other
            
            
            -
            
            
            -
            %
            
            338
            
            
            1
            %
            
            127
            
            
            -
            %Total
            
            $
            27,820
            
            
            100
            %
            $
            32,818
            
            
            100
            %
            $
            27,819
            
            
            100
            %





**Discontinued
      Operations**




Through
      2004, we sold our OSS systems primarily to telephone operating companies in
      established and developing countries in Asia, South and Central America and
      Europe. OSS systems focus on the access loop and are components of telephone
      companies’ service assurance and service delivery initiatives. These systems
      primarily focus on trouble management, line testing, network provisioning,
      inventory and assignment, and automatic activation, and most currently single
      ended line qualification for the delivery of xDSL high bandwidth services.
      Because of continuing losses in this division, combined with difficulties in
      marketing OSS products in view of our financial condition, commencing in 2003
      we
      began to scale down these activities and in 2006 we limited our OSS activities
      to the performance of maintenance and warranty services under existing
      agreements all of which expired by June 30, 2007 at which time we discontinued
      operations of OSS. Effective as of June 30, 2006, the assets and liabilities
      and
      results of operations of the OSS division were segregated and reported
      separately as discontinued operations on our consolidated financial statements
      through June 30, 2007. Sales of OSS products and related services were $100,000
      through June 30, 2007, $333,000 for 2006 and $785,000 for 2005.


Page
          2 of
          29


**Markets**




Our
      connection/protection equipment is used by domestic and international service
      providers, by owners of private telecommunications equipment, and by
      manufacturers and suppliers of telephone central office and customer premises
      equipment. Products of this type comprising our telecommunications connection
      equipment are included as an integral part of all domestic and foreign voice
      and
      data networks, ADSL services, FTTX and other telecommunications
      systems.





As
      a
      telephone company expands the number of its subscriber lines and additional
      services such as DSL, it may require additional connection equipment to
      interconnect and protect those lines in its central offices. We provide a line
      of copper connection equipment for this purpose. Recent trends towards the
      transmission of high frequency signals on copper lines are sustaining this
      market.




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





Connection
      and protection products accounted for approximately 82% of our sales in 2007,
      83% of our sales in 2006 and 79 % in 2005.




Our
      signal processing products are sold to customers in the military and aerospace
      industry as well as manufacturers of medical equipment and video systems. The
      primary communication standard in new military and aerospace systems is the
      MIL-STD-1553 Command Response Data Bus, an application which requires an
      extremely high level of reliability and performance. Our wideband transformers
      are required for ground noise elimination in video imaging systems and are
      used
      in the television and broadcast, medical imaging and industrial process control
      industries. If not eliminated, ground noise caused by poor electrical system
      wiring or power supplies, results in significant deterioration in system
      performance, including poor picture quality and process failures in
      instrumentation. The wideband transformers provide a cost-effective and quick
      solution to the problem without the need of redesign of the rest of the system.
      Products are designed to satisfy the specific requirements of each military
      or
      aerospace customer.





During
      2007, 2006 and 2005, signal processing equipment accounted for approximately
      18%, 16% and 21% of our sales, respectively.





**Marketing
      and Sales**





We
      operate principally through two business units, which are organized by product
      line, and with each having responsibility for the sales and marketing of its
      products.





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





In
      the
      United States and throughout the world, we use independent distributors in
      the
      marketing of all copper based products to the regional Bell operating companies
      and the customer premises equipment market. All distributors marketing
      copper-based products also market directly competing products. In addition,
      we
      continue to promote the direct marketing relationships we developed in the
      past
      with telephone operating companies.





British
      Telecommunications, PLC purchased line connecting/protecting products in the
      amount of $10,860,000 (39% of sales) in 2007, $9,614,000 (29% of sales) in
      2006,
      and $5,641,000 (20% of sales) in 2005. During these years, we also sold our
      products to unaffiliated suppliers for resale to British Telecommunications,
      the
      most significant of which was Fujitsu Telecommunications Europe LTD, a systems
      integrator for British Telecommunications, to whom we sold $896,000 (3% of
      sales) in 2007, $8,609,000 (26% of sales) in 2006, and $3,170,000 (11% of sales)
      in 2005.


Page
          3 of
          29


Our
      signal processing products are sold primarily to United States military and
      aerospace prime contractors, and domestic original equipment manufacturers
      and
      end users.





The
      following table sets forth, for the last three fiscal years, our sales to
      customers by geographic region:





Sales
      from Continuing Operations by Customers’ Geographic Region (1)





Year
                Ended December 31,2007
            
            2006
            
            2005(Dollars
                in thousands)North
                America
            
            $
            14,499
            
            
            52
            %
            $
            12,093
            
            
            37
            %
            $
            13,277
            
            
            48
            %United
                Kingdom
            
            
            13,321
            
            
            48
            %
            
            20,725
            
            
            63
            %
            
            14,542
            
            
            52
            %Total
                Sales
            
            $
            27,820
            
            
            100
            %
            $
            32,818
            
            
            100
            %
            $
            27,819
            
            
            100
            %





(1)
            For
                information regarding the amount of sales, operating profit or loss
                and
                identifiable assets attributable to each of our divisions and geographic
                areas, see Note 19 of Notes to the Consolidated Financial
                Statements.





In
      selling to customers in many foreign countries, we face inherent risks not
      normally present in the case of sales to United States customers, including
      risks associated with currency devaluation, inability to convert local currency
      into dollars, as well as local tax regulations and political
      instability.





**Manufacturing**





At
      present, our manufacturing and assembly operations are conducted at facilities
      located in Syosset, New York and Matamoros, Mexico. From time to time, we also
      use subcontractors to supplement our production activities and during 2007
      we
      commenced sourcing certain manufacturing to China in order to lower the cost
      of
      manufacturing.





**Source
      and Availability of Components**




We
      generally purchase the standard components used in the manufacture of our
      products from a number of suppliers. We attempt to assure ourselves that the
      components are available from more than one source.





Significant
      Customers




Our
      top
      five customers accounted for approximately 66% of sales in 2007, 71% in 2006,
      and 63% in 2005, of our total revenues. Total sales to British
      Telecommunications, consisting of direct sales and sales to systems integrators
      for British Telecommunications (including Fujitsu and Telent) were $12,504,000
      (45% of sales) for 2007, $20,313,000 (62%) of sales for 2006, and $14,046,000
      (50%) for 2005. Direct sales to British Telecommunications (exclusive of sales
      to systems integrators for British Telecommunications), our largest customer
      for
      2007, 2006 and 2005, were $ 10,860,000, (39% of sales) in 2007, $9,614,000
      (29%)
      of sales in 2006, and $5,641,000 (20%) of sales in 2005. All of these sales
      to
      British Telecommunications were sales of connection/protection products. Sales
      to Fujitsu were $896,000 (3% of sales) for 2007, $8,609,000 (26%) of sales
      for
      2006 and $3,170,000 of sales (11%) for 2005. Sales to Telent (formally Marconi)
      were $627,000 (2% of sales) in 2007, 1,633,000 (5% of sales) in 2006 and
      $3,550,000 (13% of sales) in 2005. Sales to Teléfonos de Mexico S.A. de C.V.
      (Telmex) were $4,585,000, (16 %) of sales for 2007, $2,435,000, (7%) of sales
      for 2006, and $3,157,000, (11%) of sales for 2005. No other customers account
      for 10% or more of our sales in 2007, 2006, or 2005.




Distributors
      of our customer premise equipment are the ultimate purchasers of a significant
      portion of our products sold in the United States, while sales to foreign
      telephone operating companies constitute the major portion of our foreign sales.
      Our contracts with these customers require no minimum purchases by such
      customers. Significant customers for the signal processing products include
      major United States aerospace companies, the Department of Defense and original
      equipment manufacturers in the medical imaging and process control equipment
      industries. We sell both catalog and custom designed products to these
      customers. Some contracts are multi-year procurements.


Page
          4 of
          29





**Backlog**





At
      December 31, 2007, our backlog was approximately $2,368,000 compared with,
      our
      backlog of approximately $4,050,000 as of December 31, 2006. Of the December
      31,
      2007 backlog, approximately $597,000 represented orders from British
      Telecommunications. We expect to ship substantially all of our December 31,
      2007
      backlog during 2008.





**Intellectual
      Property Rights**





We
      own a
      number of domestic utility and design patents and have pending patent
      applications for certain of our products. In addition, we have foreign patent
      protection for a number of our products.





From
      time
      to time we enter into licensing and technical information agreements under
      which
      we receive or grant rights to produce certain subcomponents used in our
      products. These agreements are for varying terms and provide for the payment
      or
      receipt of royalties or technical license fees. There are no such arrangements
      as of December 31, 2007.





While
      we
      consider patent protection important to the development of our business, we
      believe that our success depends primarily upon our engineering, manufacturing
      and marketing skills. Accordingly, we do not believe that a denial of any of
      our
      pending patent applications, expiration of any of our patents, a determination
      that any of the patents which have been granted to us are invalid or the
      cancellation of any of our existing license agreements would have a material
      adverse effect on our business.





**Competition**





The
      voice, data and security market in which we do business is characterized by
      intense competition, rapid technological change and the offering of triple
      play.
      In competing for SP 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 premise
      equipment market, we are functioning in a market characterized by distributors
      and installers of equipment and by price competition.





We
      compete directly with a number of large and small telephone equipment
      manufacturers in the United States, with Emerson, which acquired the business
      in
      2004 from Marconi Corporation, being our principal United States competitor.
      Emerson’s greater resources, extensive research and development facilities,
      long-standing equipment supply relationships with the operating companies of
      the
      regional holding companies and history of manufacturing and marketing products
      similar in function to those produced by us continue to be significant factors
      in our competitive environment. Currently, Emerson and a number of companies
      with greater financial resources than ours produce, or have the design and
      manufacturing capabilities to produce products competitive with our products.
      In
      meeting this competition, we rely primarily on the engineered performance and
      design characteristics of our products to achieve comparable performance and
      we
      endeavor to offer our products at prices that will make our products competitive
      worldwide. However, our ability to compete is hampered by our historical
      financial condition, our continuing working capital deficit and our reliance
      on
      the agreement of the holder of our senior debt to continue to defer the maturity
      of our senior debt.





In
      connection with overseas sales of our line connection and protection equipment,
      we have met with significant competition from United States and foreign
      manufacturers of comparable equipment and we expect this competition to
      continue. Tyco and a number of our other overseas competitors have significantly
      greater resources than we do.





**Research
      and Development Activities**





We
      spent
      approximately $2,000,000 in 2007, $1,500,000 in 2006, and $1,400,000 in 2005
      on
      research and development activities from continuing operations. Most of the
      research and development expenses in 2007 related to copper
      connection/protection products, and were oriented toward development of new
      products and the support of our current products. All research and
      development was Company-sponsored and is expensed as incurred. During 2007,
      we
      increased our research and development efforts in the connection/protection
      business.


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          5 of
          29


**Employees**





As
      of
      December 31, 2007 we had 412 employees, of which 53 were employed in the United
      States, 359 in Mexico, 3 in the United Kingdom. We believe that our relations
      with our employees are good, and we have never experienced a work
      stoppage. Our employees are not covered by collective bargaining agreements
      except for our hourly employees in Mexico who are covered by a collective
      bargaining agreement that expires on May 20, 2009.


**Item
        1A.**  **Risk
        Factors**





**We
      require substantial financing to meet our working capital requirements and
      we
      have no access to such financing.**




We
      had a
      working capital deficit at December 31, 2007 of $34,513,000. As of December
      31,
      2007, our current liabilities included $24,373,000 due to the holder of our
      senior debt. We do not have sufficient resources to pay the senior debt, to
      pay
      principal and interest of $13,044,000 which was due at December 31, 2007 on
      the
      outstanding subordinated notes that became due on July 3, 2001, or to pay the
      outstanding subordinated debentures (including accrued interest) of
      approximately $568,000 which became due on July 1, 2002. The Company has not
      paid interest on these debt instruments since July 2000, and the holder of
      the
      senior debt prohibits us from making any payments of principal and interest
      (see
      Note 7). We do not expect to generate the necessary cash from our operations
      to
      enable us to make those payments. As of December 31, 2007 we had no other source
      of outside financing. The holder of our senior debt provided an additional
      $1
      million in October 2007, however there is no agreement for any further funding;
      and, at present our only source of funds is from operations. To the extent
      that
      either our operations do not generate sufficient funds to cover our expenses
      or
      the holders of our debt demand payments which we are unable to make, it may
      be
      necessary for us to seek protection under the Bankruptcy Code. See “Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations.”




**We
      may enter into an agreement to**  **restructure
      our debt which would significantly dilute the interest of the holder’s of our
      common stock.**




On
      February 7, 2007, Cheyne Special Situations Fund L.P.(“Cheyne”) purchased our
      senior debt of approximately $23,373,000 from SHF IX, LLC. In October 2007
      we
      borrowed an additional $1,000,000 from Cheyne to meet our current working
      capital needs. This loan along with the existing senior debt matures on May
      1,
      2008. If the senior debt holder does not extend the maturity of our senior
      debt
      beyond May 1, 2008, or if the senior debt holder demands payment of all or
      a
      significant portion of the senior debt when due, we will not be able to continue
      in business, and it is likely that we will seek protection under the Bankruptcy
      Code. We are engaged in negotiations with the senior debt holder with respect
      to
      a restructure of our senior and subordinated debt and we anticipate that any
      such restructure will result in a very significant dilution in the interests
      of
      the holders of our common stock and will require the approval of the holders
      of
      our common stock and subordinated debt. If we are unable to obtain the necessary
      consent, we may be unable to effect a restructure of our debt.





**We
      may not be able to replace the significant volume of sales to British
      Telecommunications which resulted in our loss for 2007**




Our
      sales
      to British Telecommunications, including sales to systems integrators for
      British Telecommunication, have declined significantly, from $20,313,000 in
      2006
      to $12,504,000 in 2007, a decline of approximately 38.4%. We were not able
      to
      offset this decline in sales, and, principally because of this decline in sales,
      we sustained a net loss from continuing operations of approximately $2,223,000
      in 2007, as compared with net income from continuing operations of approximately
      $2,511,000 in 2006. We are continuing to operate at a loss. We are still selling
      products to British Telecommunications at the reduced level. Further, the sales
      that we are making to British Telecommunication generate a lower gross margin
      than sales to this customer in 2006. Unless we are able to increase our sales
      to
      British Telecommunications or sell products to new customers, we will not be
      able to operate at a profit. We cannot assure you that we will be able to
      improve either our sales to British Telecommunications or our margins on those
      sales or find other customers for our products. **** If
      British Telecommunications and its systems integrators do not increase their
      purchases from us or if we are not able to increase our margins on sales to
      these customers, it may be necessary for us to seek protection under the
      Bankruptcy Code.


Page
          6 of
          29





**Our
      independent registered public accounting firm has included an explanatory
      paragraph relating to our ability to continue as a going concern in its report
      on our financial statements.**




Because
      of our stockholders’ deficit of $30,527,000, our working capital deficit of
      $34,513,000 as of December 31, 2007, our net loss for 2007, and our dependence
      upon the continued agreement of our senior debt holder to defer the maturity
      date of our senior debt, our accounting firm included in its report an
      explanatory paragraph about our ability to continue as a going
      concern.




**Our
      sales in our copper connection/protection segment are based on specific market
      factors and the requirements of British Telecommunications, which may not
      continue.**




Total
      sales to British Telecommunications, consisting of direct sales and sales to
      systems integrators for British Telecommunications (including Fujitsu
      Telecommunications Europe LTD), were $12,504,000 (45% of sales) for 2007,
      $20,313,000 (62% of sales) for 2006, and $14,046,000 (50% of sales) for 2005.
      These were sales of copper connection and protection products . To the extent
      that British Telecommunications no longer requires products from us, we may
      be
      unable to operate profitably, and it may be necessary for us to seek protection
      under the Bankruptcy Code.




**Our
      sales are dependent upon the requirements of the telecommunications
      industry.**




Our
      ability to operate profitably will be impaired by any factors which affect
      the
      telecommunications industry generally or to the extent that our customers’
needs, particularly British Telecommunications, change either as a result of
      regulatory conditions or changes in technology or the completion of projects
      which require our products. In the past, we have suffered losses following
      the
      overbuilding by the telecommunications industry and the subsequent reduced
      demand for telecommunications products generally and our products in particular.
      We cannot assure you that we will not be affected by similar or other
      industry-related factors in the future.





**We
      are heavily dependent on foreign sales.**




Approximately
      48% of our sales in 2007, 63% of our sales in 2006, and 52% of our sales in
      2005, were made to foreign telephone operating companies, particularly British
      Telecommunications and its systems integrators. In selling to customers in
      foreign countries, we are exposed to inherent risks not normally present in
      the
      case of our sales to United States customers, including risks relating to
      political and economic changes, including the decline in the value of the dollar
      against other major currencies. Furthermore, our historical financial condition
      has impaired and may continue to impair our ability to generate new business
      in
      the international market as potential customers express concern about our
      ability to perform.




**Because
      of our small size and our historical financial problems, we may have difficulty
      competing for business.**




We
      compete directly with a number of large and small domestic and foreign telephone
      equipment manufacturers, with Emerson, which acquired the business in 2004
      from
      Marconi Corporation, continuing to be our principal United States competitor.
      Our competitors have used our historical financial difficulties in successfully
      competing against us. We anticipate that our working capital deficit and our
      current and historical losses, combined with the absence of financing, may
      continue to place us in a competitive disadvantage.




**We
      require access to current technological developments.**




We
      rely
      primarily on the performance and design characteristics of our products in
      marketing our products, which requires access to state-of-the-art technology
      in
      order to be competitive. Our business could be adversely affected if we cannot
      develop or obtain licenses for state-of-the-art technology. Because of our
      historical financial problems, we were not able to devote a significant effort
      to research and development, which could increase our difficulties in making
      sales of our current products and introducing any significant new
      products.




**We
      rely on certain key employees.**




We
      are
      dependent upon the continued employment of certain key employees, including
      our
      chief executive officer and our operations and technical personnel. Our failure
      to retain such employees may have a material adverse effect upon our business.
      If we are unable to provide our customers with necessary service, our ability
      to
      operate profitably could be impaired.


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**Because
      our stock is subject to the penny stock rules, our stockholders may have
      difficulty in selling our stock.**




Because
      our stock is traded on the OTC Bulletin Board and our stock price is very low,
      our stock is subject to the Securities and Exchange Commission’s penny stock
      rules, which impose additional sales practice requirements on broker-dealers
      that sell our stock to persons other than established customers and
      institutional accredited investors. These rules may affect the ability of
      broker-dealers to sell our common stock and may affect the ability of our
      stockholders to sell any common stock they may own.




**We
      do not pay dividends on common stock.**




The
      holder of our senior debt has prohibited us from paying any dividends on our
      common stock.




**Item
        1B.**  **Unresolved
        Staff Comments**





None.


**Item
        2.**  **Properties**





We
      currently lease approximately 14,500 square feet of executive, sales, marketing
      and research and development space, 4,200 square feet of manufacturing space
      in
      Syosset, New York, and approximately 5,000 square feet of warehousing space
      in
      Brownsville, Texas. These facilities represent substantially all of our office,
      plant and warehouse space in the United States. The Syosset, New York leases
      expire February 2011. The annual rental payable under these leases is
      approximately $353,000 and is subject to customary escalation clauses. The
      space
      in Texas is currently leased on a month to month basis.





Our
      wholly-owned United Kingdom subsidiary leases an approximately 7,000 square
      foot
      facility in Northants, England, which facility comprises all of our office
      and
      warehouse space. The lease expires in 2017. The aggregate current annual rental
      is approximately $66,000 and is subject to customary escalation clauses.





Our
      wholly-owned Mexican subsidiary owns an approximately 40,000 square foot
      manufacturing facility, and approximately 50,000 square feet of adjacent land,
      in Matamoros, Mexico.





We
      believe our properties are adequate for our needs.




**Item
      3.**  **Legal
      Proceedings**





None




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





During
      the fourth quarter of 2007, no matters were submitted to a vote of our security
      holders.


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**PART
      II**




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




Our
      common stock is traded on the OTC Bulletin Board under the symbol PYTM. The
      following table sets forth, for 2006 and 2007, the quarterly high and low bid
      prices for our common stock on the OTC Bulletin Board as provided by the NASDAQ
      Stock Market, Inc. These prices represent inter-dealer quotations without retail
      markup, markdown, or commission and may not necessarily represent actual
      transactions.





2006
            
            2007High
            
            Low
            
            High
            
            LowFirst
                quarter
            
            $
            0.17
            
            $
            0.09
            
            $
            0.18
            
            $
            0.11Second
                quarter
            
            
            0.15
            
            
            0.09
            
            
            0.18
            
            
            0.11Third
                quarter
            
            
            0.15
            
            
            0.06
            
            
            0.16
            
            
            0.11Fourth
                quarter
            
            
            0.18
            
            
            0.11
            
            
            0.13
            
            
            0.06




The
      last
      reported bid price of our common stock on March 13, 2008 was $0.09 per
      share.




We
      did
      not declare or pay any cash dividends in 2007 or 2006, and we do not anticipate
      paying cash dividends in the foreseeable future. Our agreement with the holder
      of our senior debt prohibits us from paying cash dividends on our common stock.





We
      did
      not issue any unregistered securities during 2007.





**Equity
      Compensation Plan Information**





The
      following table summarizes the equity compensation plans under which our
      securities may be issued as of December 31, 2007.





Equity
      Compensation Plan Information as of December 31, 2007





Plan
                Category
            
            Number of securities
              to be issued upon
              exercise of
              outstanding options
              and
              warrants
            
            Weighted-average
              exercise price of
              outstanding options
              and warrants
            
            Number of securities
              remaining available
              for future issuance
              under equity
              compensation plansEquity
                compensation plans approved by security holders
            
            
            139,000
            
            $
            .49
            
            
            710,000Equity
                compensation plan not approved by security holders
            
            
            -0-
            
            
            -0-
            
            
            -0-139,000
            
            $
            .49
            
            
            710,000




**Item
      6.**  **Selected
      Financial Data**





The
      following selected consolidated financial data has been derived from the
      Company’s audited Consolidated Financial Statements for the five years ended
      December 31, 2007. See “Management’s Discussion and Analysis of Financial
      Condition and Results of Operations”, found in Item 7 of this report, for
      information regarding discontinued operations, critical accounting policies
      and
      items affecting comparability of the amounts below. The selected financial
      information should be read in conjunction with the Consolidated Financial
      Statements included in this report. All current and prior years financial data
      below has been restated to reflect the discontinued operations of our OSS
      business.


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Year
                Ended December 31,2007
            
            2006
            
            2005
            
            2004
            
            2003(In
                thousands, except per share data)Income
                Statement Data:Sales
            
            $
            27,820
            
            $
            32,818
            
            $
            27,819
            
            $
            27,165
            
            $
            16,341Income
                (loss) from continuing operations
            
            
            (2,223
            )
            
            2,511
            
            
            1,855
            
            
            4,336
            
            
            (284
            )Loss
                from discontinued operations, net of zero tax
            
            
            (521
            )
            
            (329
            )
            
            (1,045
            )
            
            (1,661
            )
            
            (3,073
            )Net
                income (loss)
            
            
            (2,744
            )
            
            2,182
            
            
            810
            
            
            2,675
            
            
            (3,357
            )Per
                share: Basic net income (loss) from continuing operations
            
            $
            (.22
            )
            $
            0.25
            
            $
            0.18
            
            $
            0.43
            
            $
            (0.08
            )Basic
                loss from discontinued operations
            
            
            (.05
            )
            
            (0.03
            )
            
            (0.10
            )
            
            (0.17
            )
            
            (0.31
            )Diluted
                income (loss) from continuing operations
            
            
            (.22
            )
            
            0.25
            
            
            0.18
            
            
            0.43
            
            
            (0.08
            )Diluted
                loss from discontinued operations
            
            
            (.05
            )
            
            (0.03
            )
            
            (0.10
            )
            
            (0.17
            )
            
            (0.31
            )Number
                of shares used in calculating net income (loss) per share:Basic
            
            
            10,054
            
            
            10,054
            
            
            10,054
            
            
            9,972
            
            
            9,972Diluted
            
            
            10,054
            
            
            10,103
            
            
            10,093
            
            
            9,988
            
            
            9,972





At
                December 31,2007
            
            2006
            
            2005
            
            2004
            
            2003(In
                thousands)Total
                assets
            
            $
            16,899
            
            $
            17,784
            
            $
            14,661
            
            $
            14,438
            
            $
            12,355Working
                capital (deficit)
            
            $
            (34,513
            )
            $
            (31,646
            )
            $
            (33,777
            )
            $
            (34,150
            )
            $
            (36,825
            )Current
                debt maturities, including accrued interest
            
            $
            38,641
            
            $
            36,169
            
            $
            36,384
            
            $
            36,736
            
            $
            35,479Long-term
                debt, excluding current maturities
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -Stockholders'
                deficit
            
            $
            (30,527
            )
            $
            (27,823
            )
            $
            (30,185
            )
            $
            (30,661
            )
            $
            (33,238
            )




In
      December 2003, we decided to scale down our OSS business because of continuing
      losses combined with difficulties in marketing OSS products in view of our
      financial condition. In 2006 we limited our OSS activities to the performance
      of
      maintenance and warranty services under existing agreements all of which expired
      by June 30, 2007. As of June 30, 2006, the assets and liabilities and results
      of
      operations of the OSS division have been segregated and reported separately
      as
      discontinued operations on our consolidated financial statements.


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





**Overview**





We
      design, manufacture and market systems for the connection, protection, testing
      and administration of public and private telecommunications lines and networks
      and products that provide network infrastructure. Our principal customers are
      foreign and domestic telephone companies. As a result, our business is dependent
      upon meeting the needs of the foreign and domestic telecommunications
      industry.




Dependence
      on British Telecommunications





From
      the
      fourth quarter of 2003 through 2006, we experienced an increase in our copper
      connection business primarily as a result of the requirements of British
      Telecommunications to provide increased service in the United Kingdom and,
      in
      2005, as a result of British Telecommunications’ implementation of the local
      loop unbundling (“LLU”) program, demanded by regulators to enable third party
      providers of telephone service to gain access to British
      Telecommunications’ systems. During 2007 we continued to supply LLU at a
      significant rate, but experienced a significant drop off of demand for DSL
      product from British Telecommunications. During the past three years, sales
      to
      British Telecommunications, consisting of both direct sales and sales to systems
      integrators for British Telecommunications, represented a substantial percentage
      of our total sales, accounting for 45% of sales for 2007, 62% of sales for
      2006,
      and 50% of sales for 2005. Such sales were sales of copper connection products. Our
      sales
      to British Telecommunications, including sales to its systems integrators,
      have
      declined significantly, from $20,313,000 in 2006 to $12,504,000 in 2007, a
      decline of approximately 38.4%. We were not able to offset this decline in
      sales, and, principally because of this decline in sales, we sustained a net
      loss from continuing operations of approximately $2,223,000 in 2007, as compared
      with net income from continuing operations of approximately $2,511,000 in 2006.
      We are continuing to operate at a loss. We are still selling products to British
      Telecommunications at a reduced level. Further, the sales that we are making
      to
      British Telecommunications generate a lower gross margin than sales to this
      customer in 2006. Unless we are able to increase our sales to British
      Telecommunications or sell products to new customers, we will not be able to
      operate at a profit. We cannot assure you that we will be able to improve either
      our sales to British Telecommunications or our margins on those sales or find
      other customers for our products. **** If
      British Telecommunications and its systems integrators do not increase their
      purchases from us or if we are not able to increase our margins on sales to
      these customers, it may be necessary for us to seek protection under the
      Bankruptcy Code.




Senior
      Debt




Our
      senior debt matures on May 1, 2008. On February 7, 2007, Cheyne Special
      Situations Fund L.P purchased our senior debt of approximately $23,373,000
      from
      SHF IX, LLC and subsequently extended the maturity of the senior debt. Pursuant
      to the most recent extension agreement, the senior debt matures on May 1,
      2008.  During 2007, the Company borrowed an additional $1,000,000 from
      Cheyne. If the senior debt is not extended beyond May 1, 2008, or if the senior
      debt holder demands payment of all or a significant portion of the loan when
      due, we will not be able to continue in business, and it is likely that we
      will
      seek protection under the Bankruptcy Code. We are negotiating a debt
      restructuring plan with the holders of our senior debt, subordinated notes
      and
      other creditors. This debt restructuring, which will require stockholder
      approval, among other things, would result in an exchange of debt for equity
      and
      a significant reduction in our senior and subordinated debt. We cannot assure
      you that we will be able to enter into a restructuring transaction, and if
      we
      are unable to do so, it is likely that we will seek protection under the
      Bankruptcy Code.




Interest




We
      do not
      accrue interest on the entire amount of the senior debt under the terms of
      our
      agreement with the holder of our senior debt. Interest has accrued from February
      7, 2007 on $10,000,000 of the senior debt at 12.5% as a result of the terms
      of
      the February 7, 2007 extension of the maturity of our senior debt. In addition,
      we accrue interest on the $1,000,000 lent to us by our senior lender in October
      2007 at a rate of LIBOR plus 10%, approximately 14.65% for
      2007.


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          11 of
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**Critical
      Accounting Policies and Estimates**





The
      discussion and analysis of our financial condition and results of operations
      are
      based on our consolidated financial statements, which have been prepared in
      conformity with accounting principles accepted in the United States. The
      preparation of these financial statements requires us to make estimates and
      assumptions that affect the reported amounts of assets, liabilities, revenues
      and expenses reported in those financial statements. These judgments can be
      complex and consequently actual results could differ from those estimates.
      Among
      the more significant estimates included in these consolidated financial
      statements are allowance for doubtful accounts receivable, inventory reserves,
      goodwill valuation and the deferred tax asset valuation allowance. At December
      31, 2007, we had outstanding senior debt of approximately $24,373,000 and
      subordinated debt in the principal amount of approximately $6,144,000 and
      subordinated debentures in the principal amount of approximately $385,000.
      Although we have received an extension on the maturity of the senior debt to
      May
      1, 2008, if the senior debt is called, we will be unable to pay the note and
      it
      would be necessary for us to seek protection under the Bankruptcy Code. Note
      2
      of Notes to Consolidated Financial Statements, included elsewhere in this annual
      report on Form 10-K, includes a summary of the significant accounting policies
      and methods used in the preparation of our consolidated financial statements.
      Because of our stockholders’ deficit of $30,527,000 and working capital deficit
      of $34,513,000 as of December 31, 2007, because we sustained a net loss from
      continuing operations of
      $2,223,000 for 2007, and because we are dependent upon our senior debt holder
      continuing to extend the maturity of our senior debt, our independent registered
      public accounting firm included in its report an explanatory paragraph about
      our
      ability to continue as a going concern.





**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,
      accrued expenses, goodwill valuation and the deferred tax asset valuation
      allowance. Actual results could differ from the estimates.





**Allowance
      for Doubtful Accounts Receivable**





We
      record
      an allowance for doubtful accounts receivable based on specifically identified
      amounts that we believe to be uncollectible. We also record additional
      allowances based on certain percentages of our aged receivables, which are
      determined based on historical experience and our assessment of the general
      financial conditions affecting our customer base. If our actual collections
      experience changes, revisions to our allowance may be required. We have a
      limited number of customers with individually large amounts due at any given
      balance sheet date. Any unanticipated change in one of those customers’
creditworthiness, or other matters affecting the collectability of amounts
      due
      from such customers, could have a material effect on our results of operations
      in the period in which such changes or events occur. After all attempts to
      collect a receivable have failed, the receivable is written off against the
      allowance.





**Inventory
      Reserves**





Inventories
      are stated at the lower of cost (on the average or first-in, first-out methods)
      or fair market value. Our stated inventory reflects an inventory obsolescence
      reserve that represents the difference between the cost of the inventory and
      its
      estimated market value. This reserve is calculated based on historical usage
      and
      forecasted sales. Actual results may differ from our estimates.





**Goodwill**





Goodwill
      represents the difference between the purchase price and the fair market value
      of net assets acquired in business combinations treated as purchases. On an
      annual basis, we test the goodwill for impairment. We determine the market
      value
      of the reporting unit by considering the projected cash flows generated from
      the
      reporting unit to which the goodwill relates. As of December 31, 2007 and 2006,
      all of our goodwill related to our signal processing division. We cannot give
      assurances that further write-downs will not be necessary, although management
      believes that no additional goodwill impairment charges are necessary at this
      time. We determined that there was no impairment of goodwill for
      2007.


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**Deferred
      Income Tax Valuation Allowance**





Deferred
      taxes result from temporary differences between the tax bases of assets and
      liabilities and their reported amounts in the financial statements. The
      temporary differences result from costs required to be capitalized for tax
      purposes by the United States Internal Revenue Code, and certain items accrued
      for financial reporting purposes in the year incurred but not deductible for
      tax
      purposes until paid. Due to our losses in previous years, a valuation allowance
      for the entire deferred tax asset was provided, which management believes is
      still appropriate, due to the uncertainty as to future realization and
      uncertainties associated with projections of future taxable income and the
      effects of a potential restructuring.





**Other
      Matters**




During
      the past several years we have, on a number of occasions, engaged in
      negotiations with respect to the sale of one or more of our divisions. None
      of
      our discussions resulted in an agreement. We may continue to engage in such
      negotiations in the future.





Discontinued
      Operations




In
      December 2003, we decided to scale down our OSS business because of continuing
      losses combined with difficulties in marketing OSS products in view of our
      financial condition. The OSS operating segment is reported as a discontinued
      operation in our consolidated financial statements for all periods presented.
      The OSS operating activities were limited to the performance of contractual
      maintenance and warranty services under contracts which expired by June 30,
      2007
      and at which time this business was discontinued.





**Results
      of Operations**




The
      following table sets forth our consolidated statements of operations for the
      three years ended December 31, 2007, 2006, and 2005, as a percentage of
      sales:





Years
                Ended December 31,2007
            
            2006
            
            2005Sales
            
            
            100
            %
            
            100
            %
            
            100
            %Cost
                of sales
            
            
            71
            %
            
            67
            %
            
            63
            %Gross
                profit
            
            
            29
            %
            
            33
            %
            
            37
            %Selling,
                general and administrative expenses
            
            
            22
            %
            
            16
            %
            
            18
            %Research
                and development expenses
            
            
            7
            %
            
            5
            %
            
            5
            %Reorganization
                expenses
            
            
            —
            
            
            —
            
            
            3
            %Operating
                income
            
            
            -
            %
            
            12
            %
            
            11
            %Interest
                expense (net)
            
            
            (8
            )%
            
            (3
            )%
            
            (3
            )%Income
                (loss) from continuing operations before income taxes
            
            
            (8
            )%
            
            9
            %
            
            8
            %Income
                tax expense
            
            
            (-
            )%
            
            (1
            )%
            
            (1
            )%Income
                (loss) from continuing operations before discontinued
                operations
            
            
            (8
            )%
            
            8
            %
            
            7
            %Loss
                from discontinued operations
            
            
            (2
            )%
            
            (1
            )%
            
            (4
            )%Net
                income (loss)
            
            
            (10
            )%
            
            7
            %
            
            3
            %




*Years
      Ended December 31, 2007 and 2006*





Our
      sales
      for 2007 were $27,820,000 compared to $32,818,000 in 2006, which is a decrease
      of $4,998,000 (15%).


Page
          13 of
          29


Line
      connection/protection equipment sales for 2007 decreased $4,259,000 (15.7%)
      from
      $27,188,000 in 2006 to $22,929,000 in 2007. The decrease in sales is due to
      a
      decline in orders from British Telecommunications systems integrators for DSL
      products that was partially offset by higher demand for connection and
      protection product from North America customers. During 2007, direct sales
      to
      British Telecommunications increased 12.9% from $9,614,000 to $10,860,000
      primarily from requirements for LLU products, while sales to systems integrators
      for British Telecommunications decreased from $10,699,000 to $ 1,644,000, or
      84.6%, for the same period. The direct sales to British Telecommunications
      do
      not include sales to Fujitsu and other systems integrators for British
      Telecommunications. Sales of connection and protection product to North America
      customers increased approximately $2,807,000 from $6,801,000 in 2006 to
      $9,608,000 in 2007.




A
      significant percentage of our revenues are derived from British
      Telecommunications and its systems integrators. Any continuation of the reduced
      level of sales to British Telecommunications and its systems integrators could
      continue to have a material adverse effect upon both our revenue, gross margin
      and operating income.




Signal
      sales for 2007 were $4,891,000 compared to $5,292,000 in the same period of
      2006, a decrease of 7.6%. The decline in Signal revenue was primarily due to
      the
      deferral of anticipated orders from the military sector resulting from Congress'
      failure to approve the U.S. military budget until late 2007.




Gross
      profit decreased from 33% in 2006 to 29% in 2007. The decrease is primarily
      related to a change in volume and product mix sold to British Telecommunications
      from the higher gross profit DSL products to the lower margin local loop
      unbundling products, less absorption of manufacturing overhead due to the lower
      level of revenue and set-up costs for new products at our assembly facility
      in
      Mexico.




Selling,
      general and administrative expenses increased by $671,000 (12.2%) from
      $5,515,000 in 2006 to $6,186,000 in 2007. The selling expense increase relates
      primarily to increased commission expenses on connection/protection sales to
      North American customers and increased promotional expenses. General and
      administrative costs increased primarily due to increased professional fees
      related to our debt restructuring efforts.




Research
      and development expenses increased by $450,000 (29.9%) from $1,505,000 in 2006
      to $1,955,000 in 2007. This increase resulted primarily from increased spending
      by both our Line connection/protection and signal divisions for the development
      of new products for the Europe and North America markets and to enhance our
      existing line products.




As
      a
      result of the above, we had an operating loss from continuing operations of
      $2,223,000 in 2007 versus an operating income from continuing operations of
      $2,511,000 in 2006.




Interest
      expense, net of interest income, for 2007 increased by $933,000 from $1,187,000
      in 2006 to $2,120,000 in 2007. This increase is primarily related to interest
      on
      our senior debt under the terms of our extension agreement with the senior
      debt
      holder. We do not accrue interest on the entire amount of the senior debt of
      $24,373,000 under the terms of our agreement with the holder of our senior
      debt.
      Interest has accrued from February 7, 2007 on $10,000,000 of the senior debt
      at
      12.5% as a result of the terms of extension of the maturity of our senior debt
      to May 1, 2008. In addition, we accrue interest on the $1,000,000 loan to us
      by
      our senior lender in October, 2007 at a rate of LIBOR plus 10% , approximately
      14.65% since October 2007.




The
      tax
      provisions for 2007 and 2006 were lower than the statutory tax rate principally
      as a result of a net loss in 2007 and the utilization of available net operating
      loss carryforwards in 2006 and reductions in the deferred tax reserves.




As
      the
      result of the foregoing, the 2007 net loss was $2,744,000, or ($0.27) per share
      (basic and diluted), compared with a net income of $2,182,000, $0.22 per share
      (basic and diluted) for 2006.




The
      increase in the loss from discontinued operations from $329,000 in 2006 to
      $521,000 in 2007 was a result of the reduction in the scope of these operations
      reflecting the scaling down of these operations which commenced in 2004 and
      by
      the write-off of inventory and other assets of $434,000.





If
      we are
      unable to operate profitably in the future it may be necessary for us to seek
      protection under the Bankruptcy Code.


Page
          14 of
          29





*Years
      Ended December 31, 2006 and 2005*





Our
      sales
      for 2006 were $32,818,000 compared to $27,819,000 in 2005, which is an increase
      of $4,999,000 (18%).




Line
      connection/protection equipment sales for 2006 increased $5,206,000 (24%) from
      $21,982,000 in 2005 to $27,188,000 in 2006. This increase resulted primarily
      from sales to British Telecommunications as a result of British
      Telecommunications’ continuing rollout of the availability of DSL lines, and its
      requirement to provide local loop unbundling service demanded by the regulatory
      authority in the United Kingdom. During 2006, direct sales to British
      Telecommunications increased 70% from $5,641,000 to $9,614,000, while sales
      to
      systems integrators for British Telecommunications increased from $8,406,000
      to
      $10,699,000, or 27%, for the same period. Both of these changes were due to
      a
      change in product mix from an increase in sales to British Telecommunications
      of
      local loop unbundling products and an increase in sales of DSL products to
      the
      systems integrators. The direct sales to British Telecommunications do not
      include sales to Fujitsu and other systems integrators for British
      Telecommunications.





Signal
      processing revenue for 2006 compared to 2005 decreased by $418,000 (7%) from
      $5,710,000 to $5,292,000. The decline in Signal revenue for 2006 resulted
      primarily from sluggish order rates from the military sector in the first six
      months of 2006. In addition, the revenue for 2005 was positively impacted by
      product shipments to customers whose 2004 backlogged orders were not shipped
      in
      2004 due to our cash constraints at that time. Sales for 2006 represent
      shipments of both current orders and backlog.





Gross
      profit decreased from 37% in 2005 to 33% in 2006. The decrease is primarily
      related to a change in products sold to British Telecommunications from the
      higher gross profit DSL products to the lower margin local loop unbundling
      products, short-term manufacturing inefficiencies at our assembly facility
      in
      Mexico during the second quarter, and additional freight costs associated with
      on-time deliveries to customers.





Selling,
      general and administrative expenses increased by $395,000 (8%) from $5,120,000
      in 2005 to $5,515,000 in 2006. These increases resulted primarily from increased
      expenses in our Line segment for salaries and advertising as our marketing
      activities for Line were increased during 2006. These increases in Line expenses
      were partially offset by a decrease in general and administrative expenses
      relating to a 2005 lease agreement in the United Kingdom which was settled
      in
      the fourth quarter of 2005.




Research
      and development expenses increased by $146,000 (11%) from $1,359,000 in 2005
      to
      $1,505,000 in 2006. This increase resulted primarily from increased spending
      by
      our Line connection/protection division of approximately $120,000 as well as
      increased spending by our Signal division of approximately $30,000 to enhance
      our existing products and develop new products.





As
      a
      result of the above, we had an operating income of $3,814,000 in 2006 versus
      an
      operating income of $3,066,000 in 2005.




Interest
      expense, net, for 2006 increased by $131,000 from $1,056,000 in 2005 to
      $1,187,000 in 2006 primarily because of imputed interest on the amortization
      of
      a long term liability in 2006. Such interest excludes interest on our old term
      loan, in the principal amount of approximately $23,500,000, as our related
      loan
      agreement provides that no interest is due commencing March 1, 2002 through
      December 31, 2006. At the time interest begins to accrue, the interest is due
      at
      a rate of 12% or, in the case of default, 14%.




The
      tax
      provisions for 2006 and 2005 were lower than the statutory tax rate principally
      as a result of the utilization of available net operating loss carryforwards
      and
      reductions in the deferred tax reserves.




As
      the
      result of the foregoing, the 2006 net income was $2,182,000, $0.22 per share
      (basic and diluted), compared with a net income of $810,000, $0.08 per share
      (basic and diluted) for 2005.




The
      loss
      from discontinued operations decreased from $1,045,000 in 2005 to $329,000
      in
      2006 as a result of the reduction in the scope of these operations reflecting
      the scaling down of these operations which commenced in 2004.


Page
          15 of
          29




**Liquidity
      and Capital Resources**




At
      December 31, 2007, we had cash and cash equivalents of $ 494,000 compared with
      $2,102,000 at December 31, 2006. Our working capital deficit was $34,513,000
      at
      December 31, 2007, compared to a working capital deficit of $31,646,000 at
      December 31, 2006. During 2007 our operations utilized net cash of
      $1,941,000 as compared with 2006 in which we generated cash from operations
      of
      $2,462,000. Of this amount, we made principal payments of $140,000 and
      $1,163,000 in 2007 and 2006, respectively, on our senior debt. Our cash flow
      from operations reflects interest payments of $493,000 on senior debt in 2007
      and $169,400 on our senior debt and $25,000 on account of the senior lender’s
      expenses in 2006. In October 2007 we borrowed $1,000,000 from Cheyne, our
      senior debt holder in order to meet current working capital requirements. The
      loan, along with the previously existing senior debt, matures on May 1, 2008.
      To
      the extent that we are not able to generate sufficient funds to cover our
      expenses, including payments required by the holder of our senior debt, we
      may
      have to consider protection under the Bankruptcy Code.





As
      of
      December 31, 2007, our debt includes $24,373,000 of senior debt which, as a
      result of an extension effective October 1, 2007, matures on May 1, 2008, and
      $6,144,000 principal amount of subordinated notes which became due on July
      3,
      2001. We were unable to pay the interest payment on the subordinated notes
      of
      approximately $6,900,000 which represents interest accrued from July 2000
      through December 2007. As of December 31, 2007, we also had $385,000 outstanding
      of 6% convertible debentures which matured July 2, 2002. The interest accrued
      on
      the 6% debentures at December 31, 2007 was approximately $183,000. At December
      31, 2007, we did not have sufficient resources to pay either the senior debt
      or
      the subordinated debt and it is unlikely that we can generate such cash from
      our
      operations in the foreseeable future. Further, the holder of our senior debt
      has
      precluded us from making payments on the subordinated debt.





We
      are
      addressing our working capital and liquidity problems by seeking a restructure
      of our senior and subordinated debts as well as a significant amount of
      unsecured debt. Any restructure of our Company is likely to result in very
      significant dilution to the holders of our common stock which will require
      the
      approval of the holders of our common stock and subordinated debt. If we do
      not
      restructure our debt and the senior lender does not extend the maturity of
      our
      senior debt beyond May 1, 2008 or if the holder of our senior debt demands
      payment of all or a significant portion of the senior debt when due, whether
      on
      May 1, 2008 or upon the expiration of a subsequent extension, we will not be
      able to continue in business, and it is likely that we will seek protection
      under the Bankruptcy Code. Furthermore, regardless of any restructure of our
      debt, if we are not able to increase our revenue and gross margins to enable
      us
      to operate profitably, it may be necessary for us to seek protection under
      the
      Bankruptcy Code.





Because
      of our present stock price, we cannot raise funds through the sales of our
      equity securities, and our financial condition prevents us from issuing debt
      securities. In the event that we are unable to extend our debt obligations
      or
      sell one or more of our remaining divisions, we cannot assure you that we will
      be able to continue in operations. Furthermore, we believe that our financial
      position is having, and will continue to have, an adverse effect upon our
      ability to develop new business as competitors and potential customers question
      our ability both to perform our obligations under any agreements we may enter
      and to continue in business.




As
      of
      December 31, 2007, we did not have any off-balance sheet arrangements that
      have
      or are reasonably likely to have a material effect on our current or future
      financial condition, results of operations, liquidity, or capital
      resources.




The
      following table summarizes our principal contractual obligations as of December
      31, 2007 and the effects such obligations are expected to have on our liquidity
      and cash flow in future periods.




Payments
                Due by Period(in thousands)Contractual
                Obligations
            
            
            1
                Year
            
            
            1-3
                Years
            
            
            3
                -5 Years
            
            
            More Than
              5 Years
            
            
            TotalTotal
                debt, including accrued interest
            
            $
            38,641
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            38,641Operating
                leases
            
            
            444
            
            
            896
            
            
            194
            
            
            314
            
            
            1,848Deferred
                compensation obligations
            
            
            109
            
            
            181
            
            
            144
            
            
            785
            
            
            1,219Purchase
                obligations
            
            
            443
            
            
            -
            
            
            -
            
            
            -
            
            
            443Total
            
            $
            39,637
            
            $
            1,077
            
            $
            338
            
            $
            1,099
            
            $
            42,151


Page
          16 of
          29


**Item
        7A.**  **Quantitative
        and Qualitative Disclosure About Market Risk.**





We
      conduct certain operations outside the United States. A substantial portion
      of
      our revenue and expenses from our United Kingdom operations are denominated
      in
      Sterling. Any Sterling-denominated receipts are promptly converted into United
      States dollars. We do not engage in any hedging or other currency transactions.
      For 2007 and 2006, the currency translation adjustment was not significant
      in
      relation to our total revenue.


**Item
        8.**  **Financial
        Statements**





The
      financial statements and supplementary data begin on Page F-1.


**Item
        9.**  **Changes
        in and Disagreements With Accountants on Accounting and Financial
        Disclosure.**





Not
      Applicable


**Item
        9A.**  **Controls
        and Procedures.**




(a) **Evaluation
      of disclosure controls and procedures**




Disclosure
      controls and procedures are controls and procedures that are designed to ensure
      that information required to be disclosed by us in reports that we file or
      submit under the Exchange Act is recorded, processed , summarized
      and timely reported as provided in SEC rules and forms. We periodically review
      the design and effectiveness of our disclosure controls and procedures,
      including compliance with various laws and regulations that apply to our
      operations. We make modifications to improve the design and effectiveness of
      our
      disclosure controls and procedures, and may take other corrective action, if
      our
      reviews identify a need for such modifications or actions. In designing and
      evaluating the disclosure controls and procedures, we recognize that any
      controls and procedures, no matter how well designed and operated, can provide
      only reasonable assurance of achieving the desired control objectives.




We
      have
      carried out an evaluation, under the supervision and the participation of our
      management, including our principal executive officer and principal financial
      officer, of the effectiveness of the design and operation of our disclosure
      controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
      Exchange Act), as of the year ended December 31, 2007. In light of the
      discussion of a material weakness set forth below in respect to Information
      Technology, the officer has concluded that our disclosure controls and
      procedures were not effective as of December 31, 2007. To address the material
      weakness, described below, we performed additional analysis and other post
      closing procedures to ensure our consolidated financial statements were prepared
      in accordance with generally accepted account principles. Based on the
      additional procedures performed management has determined that the consolidated
      financial statements fairly present, in all material respects, our financial
      condition, results of operations, and cash flows for the periods presented.





**(b)
      Management’s Annual Report on Internal Control over Financial
      Reporting**




Our
      management is responsible for establishing and maintaining adequate internal
      control over financial reporting as defined in Rule 13a-15(f) under the
      Exchange Act. Internal control over financial reporting is a process designed
      by, or under the supervision of, the Company’s principal executive and principal
      financial officer, and effected by the board of directors, management, and
      other
      personnel, to provide reasonable assurance regarding the reliability of
      financial reporting and the preparation of financial statements for external
      purposes in accordance with US GAAP including those policies and procedures
      that: (i) pertain to the maintenance of records that, in reasonable detail,
      accurately and fairly reflect the transactions and dispositions of the assets
      of
      the company, (ii) provide reasonable assurance that transactions are
      recorded as necessary to permit preparation of financial statements in
      accordance with US GAAP and that receipts and expenditures are being made only
      in accordance with authorizations of management and directors of the company,
      and (iii) provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the Company’s
      assets that could have a material effect on the financial statements.




Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with policies and procedures may deteriorate.


Page
          17 of
          29




Under
      the
      supervision and with the participation of our management, including our Chief
      Executive Officer and Chief Financial Officer, we have assessed the
      effectiveness of our internal control over financial reporting as of
      December 31, 2007. In making this assessment, our management used the
      criteria described in Internal Control — Integrated Framework issued by the
      Committee of Sponsoring Organizations of the Treadway Commission (COSO). Due
      to
      the inherent issue of segregation of duties in a small company, we have relied
      heavily on entity or management review controls to lessen the issue of
      segregation of duties. Based on this assessment and those criteria, our
      management concluded that the Company did not maintain effective internal
      control over financial reporting as of December 31, 2007 as a result of a
      material weakness relating to Information Technology, as described below.
      Notwithstanding the material weaknesses, management believes the consolidated
      financial statements included in this report fairly present in all material
      respects our financial condition, results of operations and cash flows for
      the
      periods presented.




The
      certification of our chief executive officer and chief financial officer, which
      is included as Exhibits 31.1 and 32.1 to this Annual Report on Form 10-K,
      include, in paragraph 4 of such certification, information concerning our
      disclosure controls and procedures and internal control over financial
      reporting. Such certifications should be read in conjunction with the
      information contained in this Item 9A - Controls and Procedures for a more
      complete understanding of the matters covered by such certification.




This
      annual report does not include an attestation report of the Company’s
      independent registered public accounting firm regarding internal control over
      financial reporting. Management’s report was not subject to attestation by the
      Company’s independent registered public accounting firm pursuant to temporary
      rules of the Securities and Exchange Commission that permits the Company to
      provide only management’s report in this annual report.




A
      material weakness is a deficiency, or combination of deficiencies, in internal
      control over financial reporting, such that there is a reasonable possibility
      that a material misstatement of the Company’s annual or interim financial
      statements will not be prevented or detected on a timely basis. Management
      identified the following material weaknesses as of December 31, 2007:




**Information
      Technology**




Management
      identified the following significant deficiencies that when aggregated may
      give
      rise to a material weakness. Management identified certain control procedures
      that were not sufficiently documented relating to a) program change management
      in the Company’s PROCOMM system, b) lack of integrated modules with the general
      ledger and c) excessive manual adjustments to the inventory module are
      required.




**Management’s
      Plan of Remediation**




Management
      plans to evaluate, select and install a new integrated ERP system that will
      include a complete general ledger and reporting package to eliminate the need
      for manual updates and significantly reduce the need for journal entries in
      the
      financial reporting process.




**Changes
      in Internal Control over Financial Reporting**




There
      have been no changes in our internal control over financial reporting during
      the
      most recently completed fiscal quarter that have materially affected, or are
      reasonably likely to materially affect, our internal control over financial
      reporting.


**Item
        9B.**  **Other
        Information.**




None


Page
          18 of
          29





**PART
      III**


**Item
        10.**  **Directors
        and Executive Officers**





Set
      forth
      below is information concerning our directors and executive
      officers:





Name
            
            Positions
            
            AgeEdward
                B. Kornfeld
            
            Chief
                executive officer and chief financial officer
            
            64William
                V. Carney1
            
            Chairman
                of the board and director
            
            71Michael
                A. Tancredi
            
            Senior
                vice president, secretary, treasurer and director
            
            78Warren
                H. Esanu1,2
            
            Director
            
            65Herbert
                H. Feldman1,2
            
            Director
            
            74Marco
                M. Elser2
            
            Director
            
            49





1
            Member
                of the executive committee


2
            Member
                of the audit and compensation committees.




Mr.
      Kornfeld has been an executive officer since 1995. Mr. Kornfeld has been our
      chief executive officer since April 2006, and president from April 2004 through
      April 2006 and chief financial officer since October 1995. He was chief
      operating officer from April 2004 until April **** 2006.
      He
      was senior vice president-operations from 1996 until April 2004 and vice
      president-finance from October 1995 until 1996. Since June 2002, Mr. Kornfeld
      has also been a partner of the firm of Tatum CFO Partners, which provides chief
      financial officer services to medium and large companies; however, he continues
      to devote full-time effort to our business.





Mr.
      Carney has been chairman of the board since October 1996, a director since
      1970
      and chief executive officer from October 1996 until March 2006, and a consultant
      from March 2006 until March 2007. As chairman of the board, Mr. Carney is not
      an
      executive officer. He was vice chairman from 1988 to October 1996, senior vice
      president from 1989 to October 1996, chief technical officer since 1990 and
      secretary from 1977 to October 1996. He also served as senior vice
      president-mechanical engineering from 1988 to 1989, senior vice
      president-connector products from 1985 to 1988, senior vice
      president-manufacturing from 1984 to 1985 and senior vice president-operations
      from 1977 to 1984. From December 2002 through March 13, 2006, Mr. Carney worked
      for us on a part-time basis.





Mr.
      Tancredi has been a director since 1970, senior vice president and secretary
      since 1997 and treasurer since 1978. He has been vice president-administration
      since 1995 having served as vice president-finance and administration from
      1989
      to 1995 and vice president-finance from 1984 to 1989.





Mr.
      Esanu
      has been a director since April 1997 and also served as a director from 1989
      to
      1996. He was also our chairman of the board from March 1996 to October 1996.
      He
      is senior counsel to Katsky Korins LLP, attorneys at law, and was counsel for
      such firm for more than the past five years. Mr. Esanu is also a senior officer
      and director of a number of privately held real estate investment and management
      companies.





Mr.
      Elser
      has been a director since 2000 and the managing director of Advicorp, PLC,
      an
      investment advisory firm, for more than the past five years. He has also been
      associated with Northeast Securities, a US-based broker dealer and is
      responsible for the Italian office, which he founded in 1994.





Mr.
      Feldman has been a director since 1989. He has been president of Alpha Risk
      Management, Inc., independent risk management consultants, for more than the
      past five years.





All
      of
      our officers serve at the pleasure of the board of directors. There is no family
      relationship between any of the executive officers listed above.





We
      maintain a code of ethics that applies to all of our executive officers,
      including our principal executive, financial and accounting officers, our
      directors, our financial managers and all employees. Any waiver of the code
      must
      be approved by the Audit Committee and must be disclosed in accordance with
      SEC
      rules. We also have a standard of conduct which is applicable to all
      employees.


Page
          19 of
          29


**The
      Board and Committees of the Board**




We
      are
      governed by a board of directors currently consisting of five members. The
      Board
      has established three committees: the executive committee, the audit committee,
      the compensation committee. The Board has adopted a written charter for the
      audit and compensation committee, copies of which are posted on our website
      at
      www.portasystems.com. ** Printed
      copies of these charters may be obtained, without charge, by contacting the
      corporate secretary, Mr. Michael A. Tancredi, at 6851 Jericho Turnpike, Syosset,
      New York 11791. Set forth below is a summary of each of the
      committees.




**Executive
      Committee**




The
      executive committee has all power to act between board meetings. As a result,
      any action that can be taken or approved by the board of directors can be taken
      or approved by the executive committee, except that the executive committee
      has
      no power or authority with respect to amending our certificate of incorporation
      (except with respect to a certificate of designation to the extent authorized
      by
      the board of directors, adopting an agreement of merger or consolidation,
      recommending to the stockholders a sale or lease of all or substantially all
      of
      its property, recommending a dissolution or amending our bylaws. In addition,
      unless our certificate of incorporation or by-laws or a board resolution
      expressly provides for it, the executive committee has no power to declare
      a
      dividend, or authorize the issuance of stock or merger a wholly-owned subsidiary
      into us.




The
      executive committee is presently comprised of Messrs. Carney, Esanu and Feldman.




**Audit
      Committee**




Our
      audit
      committee reviews our financial statements and accounting principles, the scope
      and results of the annual audit by the independent registered public accounting
      firm (the “independent auditors”), our internal audit process, and the
      effectiveness of our internal control over financial reporting. Prior to the
      filing of each quarterly report on Form 10-Q and annual report on Form 10-K,
      our
      audit committee holds a conference call meeting with representatives of our
      independent auditors and our chief financial officer.




Our
      audit
      committee also reviews the qualifications, independence and performance of
      our
      independent auditors. In this connection, the audit committee is directly
      responsible for the appointment, compensation, retention and oversight of the
      work of our registered public accounting firm engaged (including the resolution
      of disagreements between management and the auditor regarding financial
      reporting) for the purpose of preparing or issuing an audit report or performing
      other audit, review or attest services for us, and our registered public
      accounting firm reports directly to the audit committee.




Our
      audit
      committee is presently comprised of Messrs. Elser, Esanu and Feldman.




Our
      board
      of directors has determined that each member of the audit committee is an
      independent director, using the Nasdaq’s standard of independence. The board
      also has determined that Mr. Elser qualifies as an “audit committee financial
      expert” under the rules of the SEC.




No
      members of our audit committee serve on the audit committee of any other public
      companies.




**Compensation
      Committee**




Our
      compensation committee oversees the compensation of our chief executive officer
      and our other executive officers. The committee also serves as the granting
      and
      administrative committee under our equity compensation plans.  Our
      compensation committee is presently comprised of Messrs. Elser, Esanu and
      Feldman.


Page
          20 of
          29




**Board
      and Committee Attendance**




The
      Board
      and its committees held the following number of meetings during the
      2007:




Board
                of directors
            
            
            6Audit
                committee
            
            
            4Compensation
                committee
            
            
            3




The
      meetings include meetings that were held by means of a conference telephone
      call, but do not include actions taken by unanimous written
      consent.




Each
      director attended at least 75% of the total number of meetings of the board
      and
      those committees on which he served during the year. Our non-management
      directors did not meet in executive session during 2007.


**Item
        11.**  **Executive
        Compensation**




**SUMMARY
      COMPENSATION TABLES**




The
      following tables set forth below a summary of the dollar values of the total
      annual compensation provided to the only person who served as our chief
      executive officer and our chief financial officer during 2007. No other
      officer received compensation of $100,000 or more during 2007.




Name
            
            Year
            
            Salary
            
            Bonus
            
            Stock
              Awards
            
            Option
              Awards
            
            Non-Equity
                Incentive Plan Compensation
            
            All
                Other Compensation
            
            TotalEdward
                B. Kornfeld,
              chief
                executive
              officer
                and chief financial officer
            
            
            2007
              2006
              2005
            
            $
            271,250
              256,250
              237,000
            
            $
            -
              60,000
              50,000
            
            $
            -
              -
              -
            
            $
            -
              -
              -
            
            $
            -
              -
              -
            
            $
            6,939
              6,865
              6,714
            
            $
            278,189
              323,115
              293,714





Compensation
      to Mr. Kornfeld does not include fees of $12,000 paid in 2007, $48,000 paid
      in
      2006 and $36,000 in 2005 to Tatum CFO Partners, of which Mr. Kornfeld is a
      partner, for services rendered to us by Mr. Kornfeld. “All Other Compensation”
includes a payment to the executive’s account pursuant to our 401(k) Plan, group
      life insurance in amounts greater than that available to all employees and
      special long term disability coverage. All Other Compensation includes for
      Mr.
      Kornfeld 401(k) match ($3,375 ) and supplemental insurance ($ 3,564) for 2007, 401(k)
      match ($3,300) and supplemental insurance ($3,565) for
      2006, and 401(k) match ($3,150) and supplemental insurance ($3,564) for
      2005.





Internal
      Revenue Code Section 162(m)




Section
      162(m) of the Internal Revenue Code precludes a public corporation from taking
      a
      deduction for compensation in excess of $1 million for its chief executive
      officer or any of its four other highest paid executive officers, unless certain
      specific and detailed criteria are satisfied. We do not believe that this
      provision will effect the deductibility of our compensation to our chief
      executive officer under his employment agreement.


Page
          21 of
          29




**COMPENSATION
      DISCUSSION AND ANALYSIS**




Overview




Our
      philosophy is to provide a compensation package that attracts and retains
      executive talent and delivers higher rewards for superior performance and
      consequences for underperformance. We seek to offer a balanced mix of cash
      and
      equity-based compensation designed to align the short- and long-term interests
      of our executives with that of our stockholders and to encourage executives
      to
      act as and on behalf of our stockholders.   We seek to attract
      executive talent by offering competitive base salaries, annual performance
      incentive opportunities, and the potential for long-term rewards under our
      long-term incentive program. Achievement of short-term objectives is rewarded
      through base salary and annual performance incentives, while long-term
      equity-based incentive grants encourage executives to focus on our long-term
      goals as well. These incentives are based on financial objectives of importance
      to us, including revenue and earnings growth, return on invested capital, and
      creation of shareholder value. Our compensation program also accounts for
      individual performance, which enables the committee to differentiate among
      executives and emphasize the link between personal performance and compensation.
      Our compensation practices reflect our pay-for-performance
      philosophy.




The
      key
      elements of executive compensation are base salary, annual performance incentive
      awards, and long-term equity-based incentive grants. A table showing the value
      of total annual compensation provided to the named executive officers is set
      forth below under “Value of Total Compensation.”




We
      have
      been limited in the past on the incentives that we could make available to
      our
      executive officers and we did not grant options to any of our officers in 2006
      or 2007 nor are there any outstanding equity awards to any named officer as
      of
      December 31, 2007. We expect, however, that in 2008, equity incentives will
      represent an important aspect of our executive compensation
      program.




Elements
      of Executive Compensation




*Base
      Salary*




Our
      compensation committee annually reviews and determines the base salaries of
      the
      chief executive officer and other members of senior management, with its
      determination with respect to the chief executive officer being subject to
      approval by the entire board. In each case, the committee takes into account
      the
      results achieved by the executive, his or her future potential, scope of
      responsibilities and experience, and competitive salary practices.




*Performance-Based
      Annual Incentive Awards*




Annual
      performance incentives are tied to our overall performance, as well as the
      performance of each executive and of his or her area of responsibility or
      business unit. An annual bonus is awarded the chief executive officer by the
      committee based on its evaluation of the effectiveness of the executive for
      each
      year. In addition, management sets certain financial and operational objectives
      for each business unit manager that are designed to promote key company
      initiatives.







Incentive
      award payments are made to the heads of business units based on the business
      units’ performance, ranging from $0 for meeting the business units’ operating
      income goal to a maximum of $30,000 of the performance operating income target,
      pre-established by the committee, with the committee having discretion to grant
      additional awards based on other factors.




Performance
                Level
            
            Funding
                LevelMeet
                of target
            
            
            No
                fundingAt
                least 1%, but less than 10% above target
            
            $
            5,000At
                least 10%, but less than 15% above target
            
            
            7,500At
                least 15%, but less than 20% above target
            
            
            12,50020%
                or more above target
            
            
            30,000


Page
          22 of
          29





*Long-Term
      Incentive Awards*




We
      provide a stock award plan and two stock option plans to award officers and
      key
      managers, which are described under “Long-Term Incentive Plans.




REVIEW
      OF ALL COMPONENTS OF CEO COMPENSATION




The
      compensation committee has reviewed all components of the CEO's compensation,
      including salary, bonus, equity and long-term incentive compensation,
      accumulated realized and unrealized stock options, the dollar value to the
      executive and cost to us of all perquisites and other personal benefits, and
      under several potential severance and change-in-control scenarios.




**The
      Committee’s Conclusion**




Based
      on
      its review, the committee concluded that the CEO’s total compensation (and, in
      the case of the severance and change-in-control scenarios, the potential
      payouts) in the aggregate to be reasonable and not excessive. Since we sustained
      a significant loss in 2007, we did not award bonus compensation to our CEO
      or to
      any senior executive officer. It should be noted that when the committee
      considers any component of the CEO’s total compensation, the aggregate amounts
      and mix of all the components, including accumulated (realized and unrealized)
      options are taken into consideration in the committee’s decisions. At the
      committee meeting during the year, the CEO’s proposed compensation is presented,
      reviewed and analyzed in the context of all the components of his total
      compensation. Members then have additional time between meetings to ask for
      additional information and to raise and discuss further questions, after which
      a
      vote is taken.





REPORT
      OF
      THE COMPENSATION COMMITTEE  ON
      EXECUTIVE COMPENSATION




The
      compensation committee is composed exclusively of non-employee, independent
      directors. The committee reviews the compensation program for the chief
      executive officer and other members of senior management, including the
      executive officers listed on the Summary Compensation Table (the “named
      executives”), and determines their compensation. In the case of the chief
      executive officer, the compensation determination made by the committee is
      also
      subject to approval by the entire board. The committee also oversees the
      administration of our employee benefits and benefit plans.




**Compensation
      of the Chief Executive Officer**




The
      committee meets each year in executive session to evaluate the performance
      of
      the chief executive officer, the results of which are used to determine his
      compensation. The committee approved a 4% and 6% salary increase for Mr.
      Kornfeld in both 2007 and 2006, respectively. Effective April 1, 2006 Mr.
      Kornfeld’s salary was increased from $245,000 to $260,000, and was increase to
      $275,000 on April 1, 2007. These increases also recognized Mr. Kornfeld’s
      additional responsibilities as our chief executive officer while continuing
      to
      serve as our chief financial officer in 2006 and 2007.




The
      committee also awarded Mr. Kornfeld a $60,000 annual incentive payment in
      November 2006 based on our overall financial performance, as well as his
      leadership in advancing our strategies of increasing profitable revenue growth
      through innovation, improving operating effectiveness and strengthening our
      organizational capabilities. The committee also reviewed perquisites and
      other compensation paid to Mr. Kornfeld for fiscal 2005, during which he
      served as president, chief operating officer and chief financial officer, and
      found these amounts to be reasonable. The committee did not award bonus
      compensation in 2007 because we sustained a net loss for the year.




**Stock
      Incentive Plans**




We
      have
      two stock option plans pursuant to which we may grant options to key employees,
      including officers. Pursuant to these plans, at December 31, 2007, there were
      outstanding options to purchase 4,000 shares of common stock from the 1996
      plan
      and 135,000 shares of common stock from the 1999 plan, together with any
      outstanding options which expire or are terminated prior to the expiration
      of
      the applicable plan. Pursuant to these plans, each non-management director
      received the automatic grant of a five-year option to purchase 5,000 shares
      (or,
      if there are not sufficient shares available, the number of available shares
      divided by the number of non-management directors) of common stock a price
      per
      share equal to the average closing price of the common stock for the last ten
      trading days in April. During 2007 and 2006, we did not grant Mr. Kornfeld
      any
      options, and Mr. Kornfeld did not exercise any options to purchase shares of
      our
      common stock. As of December 31, 2007, Mr. Kornfeld did not have any outstanding
      options and no stock appreciation rights were granted.


Page
          23 of
          29


**Directors’
      Compensation**





At
      January 1, 2006, we paid directors’ fees to our non-management directors a fee
      of $6,250 per quarter and a meeting fee of $1,500 per meeting. On March 23,
      2006, the directors’ fee was increased to $6,875 per quarter and the meeting fee
      was increased to $1,650 per meeting. These rates continued through 2007. Each
      non-management director received the automatic grant of a five-year option
      to
      purchase 5,000 shares of common stock at a price per share equal to the average
      closing price of the common stock for the last ten trading days in
      April.





The
      table
      below summarized the compensation we paid to our non-employee directors for
      the
      year ended December 31, 2007:




Directors’
      Summary Compensation Table




Name
            
            Fees
                Paid in Cash
            
            Option
              Award(1)
            
            TotalHerbert
                H. Feldman
            
            $
            42,075
            
            $
            -
            
            $
            42,075Marco
                M. Elser
            
            $
            42,075
            
            $
            -
            
            $
            42,075William
                V. Carney
            
            $
            54,525(2
            )
            $
            -
            
            $
            54,525Warren
                H. Esanu
            
            $
            42,075
            
            $
            -
            
            $
            42,075





(1)
            Reflects
                the dollar amount recognized for financial statement reporting purposes
                for 2007 in accordance with FAS 123R. The fair value of the automatic
                grants are diminutive.




(2)
            Represents
                directors fees of $ 42,075 and consulting fees of $12,450 paid to
                Mr.
                Carney during 2007.




The
      option awards represent the options to purchase 5,000 shares of common stock
      which are automatically granted to each non-employee director on May 1 of each
      year. Prior to 2006, we issued to our non-employee directors shares of common
      stock in lieu of a portion of the cash compensation due to them for services
      as
      a director. All of such shares vested six months after the grant and therefore
      no awards were outstanding at December 31, 2007. The options are granted even
      if
      they are not exercisable. An option granted in May would become exercisable
      in
      November.




As
      of
      December 31, 2007, each director has the following outstanding options: Messrs.
      Esanu and Feldman, 47,000 each; Mr. Elser, 35,000; and Mr. Carney,
      10,000.





**Consulting
      Agreements**




On
      March
      14, 2006, Mr. Carney resigned as an officer but was engaged as a consultant
      to
      us in the area of product development through March 13, 2007, at which time
      his
      agreement terminated. His compensation was $50,000 during this period of which
      $37,550 was paid in 2006 and the balance in 2007.





**Employment
      Agreements**





We
      have
      an employment agreement and a salary continuation agreement with Mr. Kornfeld.
      The employment agreement has a term which expires March 31, 2010 **** and
      continues on a year-to-year basis thereafter unless terminated by either party
      on not less than 90 days’ prior written notice. Salary is determined by the
      board, except that the salary may not be reduced except as a part of a salary
      reduction program applicable to all executive officers and was increased to
      $270,000 on April 1, 2007. In March 2006, Mr. Kornfeld was elected as chief
      executive officer and his annual salary rate was increased from $245,000 to
      $260,000. Upon death or termination of employment as a result of a disability,
      Mr. Kornfeld or his estate is to receive a payment equal to three months salary.
      Upon a termination without cause, Mr. Kornfeld is entitled to receive his then
      current salary for twelve months plus one month for each full year of service
      up
      to a maximum aggregate of 36 months. In the event that Mr. Kornfeld is covered
      by an executive severance agreement, including the salary continuation
      agreements (as described below), which provides for payments upon termination
      subsequent to a “change of control,” Mr. Kornfeld would be entitled to the
      greater of the severance arrangements as described in this paragraph or the
      severance payments under the executive severance agreements. We also have a
      month-to-month agreement with Tatum CFO Partners of which Mr. Kornfeld is a
      partner, pursuant to which we pay Tatum CFO Partners $1,000 per month for Mr.
      Kornfeld’s services.


Page
          24 of
          29








The
      salary continuation agreement provides that, in the event that a change of
      control occurs and Mr. Kornfeld’s employment with us is subsequently terminated
      by us other than for cause, death or disability, or is terminated by Mr.
      Kornfeld as a result of a substantial alteration in his duties, compensation
      or
      other benefits, the executive shall be entitled to the payment of an amount
      equal to his monthly salary at the rate in effect as of the date of his
      termination (or, if higher, as in effect immediately prior to the change in
      control) plus the pro rata monthly amount of his most recent annual bonus paid
      immediately before the change of control multiplied by 36. For purposes of
      the
      salary continuation agreement, a change of control is defined as one which
      would
      be required to be reported in response to the proxy rules under the Securities
      Exchange Act of 1934, as amended, the acquisition of beneficial ownership,
      directly or indirectly, by a person or group of persons of our securities
      representing 25% or more of the combined voting power of our then outstanding
      securities, or, during any period of two consecutive years, if individuals
      who
      at the beginning of such period constituted the board cease for any reason
      to
      constitute at least a majority thereof unless the election of each new director
      was nominated or ratified by at least two-thirds of the directors then still
      in
      office who were directors at the beginning of the period. The change of control
      must occur during the term of the salary continuation agreement, which is
      currently through August 31, 2008 and is renewed automatically unless we give
      timely notice prior to January 1 of any year of our election not to renew the
      agreement. If such a change of control occurs during the effectiveness of the
      salary continuation agreement, any termination of Mr. Kornfeld during the 18
      months following the change of control will result in the payment of the
      compensation described above





We
      have
      an employment agreement with Mr.Tancredi, Senior Vice President, Treasurer
      and
      Secretary. The employment agreement has a term which expires July 31, 2008
      and
      continues on a year-to-year basis thereafter unless terminated by either party
      on not less than 90 days’ prior written notice. Salary is determined by the
      board, except that the salary may not be reduced except as a part of a salary
      reduction program
      applicable to all executive officers. Upon death or termination of employment
      as
      a result of a disability, Mr. Tancredi or his estate is to receive a payment
      equal to three months salary. Upon a termination without cause, Mr. Tancredi
      is
      entitled to receive his then current salary for twelve months plus one month
      for
      each full year of service up to a maximum aggregate of 36 months. Mr. Tancredi’s
      current annual salary is $100,000.





**Item
                12.**
            **Principal
                Holders of Securities and Security Holdings of
                Management**





The
      following table and discussion provides information as to the shares of common
      stock beneficially owned on March 15, 2008, by:





•
            each
                director;•
            each
                officer named in the summary compensation table;•
            each
                person owning of record or known by us, based on information provided
                to
                us by the persons named below, to own beneficially at least 5% of
                our
                common stock; and•
            all
                directors and executive officers as a group.




Name
              
              Shares of
                Common
                Stock
                Beneficially
                Owned
              
              Percentage of
                Outstanding
                Common
                StockWilliam
                  V. Carney
              
              
              133,022
              
              
              1.3
              %Michael
                  A. Tancredi
              
              
              39,238
              
              
              *Warren
                  H. Esanu
              
              
              47,000
              
              
              *Herbert
                  H. Feldman
              
              
              106,631
              
              
              1.1
              %Marco
                  M. Elser
              
              
              351,376
              
              
              3.5
              %Edward
                  B. Kornfeld
              
              
              26,317
              
              
              *All
                  directors and executive officers as a group (6
                  individuals)
              
              
              703,584
              
              
              6.98
              %





*
            Less
                than 1%




Page
          25 of
          29




Except
      as
      otherwise indicated, each person has the sole power to vote and dispose of
      all
      shares of common stock listed opposite his name.





The
      number of shares owned by our directors and officers named in the summary
      compensation table includes shares of common stock which are issuable upon
      exercise of options and warrants that are exercisable at March 15, 2008 or
      will
      become exercisable within 60 days after that date. Set forth below is the number
      of shares of common stock issuable upon exercise of those options and warrants
      for each of these directors and officers.


Name
              
              SharesWilliam
                  V. Carney
              
              
              10,000Michael
                  A. Tancredi
              
              
              -Warren
                  H. Esanu
              
              
              47,000Herbert
                  H. Feldman
              
              
              47,000Marco
                  M. Elser
              
              
              35,000Edward
                  B. Kornfeld
              
              
              -All
                  officers and directors as a group
              
              
              139,000


**Item
                  13.**
              **Certain
                  Relationships and Related
                  Transactions**





During
      2007 and 2006, Warren H. Esanu, a director, served as a member of our audit
      and
      compensation committees. During this period, the law firm of Katsky Korins
      LLP
      to which Mr. Esanu is senior counsel, provided legal services to us, for which
      it received fees of $390,000 and $310,000 for 2007 and 2006, respectively.
      Katsky Korins LLP is continuing to render legal services to us during
      2008.




**Item
                14.**
            **Principal
                Accountant Fees and Services.**





The
      following is a summary of the fees for professional services rendered by our
      independent registered public accountants, BDO Seidman, LLP, for the years
      ended
      December 31, 2007 and December 31, 2006:





FeesFee
                Category
            
            
            2007
            
            
            2006Audit
                fees
            
            $
            288,000
            
            $
            239,400Audit-related
                fees
            
            
            14,100
            
            
            12,500Tax
                fees
            
            
            32,000
            
            
            30,000Other
                fees
            
            
            42,000Total
                Fees
            
            $
            376,100
            
            $
            281,900





*Audit
      fees.* Audit
      fees represent fees for professional services performed by BDO Seidman, LLP
      for
      the audit of our annual financial statements and the review of our quarterly
      financial statements, as well as services that are normally provided in
      connection with statutory and regulatory filings or engagements.




*Audit-related
      fees.* Audit-related
      fees represent fees for assurance and related services performed by BDO Seidman,
      LLP that are reasonably related to the performance of the audit or review of
      our
      financial statements. The specific service was the audit of our retirement
      plan.




*Tax
      Fees.* Tax
      fees
      represent fees for tax compliance services performed by BDO Seidman,
      LLP.




Page
          26 of
          29


*All
      other fees.* BDO
      Seidman, LLP performed services related to the restructuring of the Company’s
      senior and subordinated debt described above.





Policy
      on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services
      of
      Independent Auditors




The
      Audit
      Committee’s policy is to pre-approve all audit and permissible non-audit
      services provided by the independent registered public accounting firm. These
      services may include audit services, audit-related services, tax services and
      other services. The independent registered public accounting firm and management
      are required to periodically report to the Audit Committee regarding the extent
      of services provided by the independent registered public accounting firm in
      accordance with this pre-approval, and the fees for the services performed
      to
      date. The Audit Committee may also pre-approve particular services on a
      case-by-case basis. All services were pre-approved by the Audit
      Committee.




**PART
      IV**





**Item
                15.**
            **Exhibits,
                Financial Statements
                Schedules.**





(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.





See
      Schedule II.





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.





(b)
            Exhibits




Exhibit No.
              
              Description
                  of Exhibit3.1
              
              Certificate
                  of Incorporation of the Company, as amended to date, incorporated
                  by
                  reference to Exhibit 4 (a) of the Company’s Annual Report on Form 10-K for
                  the year ended December 31, 1991.3.2
              
              By-laws
                  of the Company, as amended to date, incorporated by reference to
                  Exhibit
                  3.3 of the Company’s Annual Report on Form 10-K for the year ended
                  December 31, 1995.4.1
              
              Amended
                  and Restated Loan and Security Agreement dated as of November 28,
                  1994,
                  between the Company and Foothill ("Foothill") Capital Corporation,
                  incorporated by reference to Exhibit 2 to the Company’s Current Report on
                  Form 8-K dated November 30, 1994.4.2
              
              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, 1995.4.3
              
              Amendment
                  Number Twenty Seven to the Amended and Restated Loan and Security
                  Agreement between the Company and Cheyne Special Situations Fund
                  L.P.,
                  dated as of February 7, 2007.4.4
              
              Amendment
                  Number Twenty Nine to the Amended and Restated Loan and Security
                  Agreement
                  between the Company and Cheyne Special Situations Fund L.P., dated
                  as of
                  February 1, 2008.
  Page
            27 of
            29
  4.5
              
              Negotiable
                  Promissory Note for $1,000,000 between the Company and Cheyne Special
                  Situations Fund L.P., dated October 23, 2007.10.1
              
              Form
                  of Executive Salary Continuation Agreement, incorporated by reference
                  to
                  Exhibit 19 of the Company’s Quarterly Report on Form 10-Q for the quarter
                  ended September 30, 1985.10.2
              
              Lease
                  dated November 6, 2002 between the Company and Long Island Industrial
                  Group LLC., incorporated by reference to Exhibit 10.2 of the Company’s
                  Annual Report on Form 10K for the year ended December 31,
                  2002.10.3
              
              Lease
                  dated May 1, 2002 between the Company and Long Island Industrial
                  Group
                  LLC., incorporated by reference to Exhibit 10.3 of the Company’s Annual
                  Report on Form 10K for the year ended December 31,
                  2002.10.4
              
              Employment
                  Agreement between the Company and Edward B. Kornfeld dated August
                  1,
                  2006.10.5
              
              Employment
                  Agreement between the Company and Michael A.Tancredi dated August
                  1, 2006.14.1
              
              Code
                  of Ethics of the Company, dated March 23, 2004, incorporated by
                  reference
                  to Exhibit 14.1 of the Company’s Annual Report on Form 10K for the year
                  ended December 31, 2003.14.2
              
              Standard
                  of Conduct of the Company.22
              
              Subsidiaries
                  of the Company, incorporated by reference to Exhibit 22.1 of the
                  Company’s
                  Annual Report on Form 10K for the year ended December 31,
                  1995.23
              
              Consent
                  of Independent Registered Public Accounting Firm.31.1
              
              Certification
                  of chief executive officer and chief financial officer pursuant
                  to Section
                  302 of the Sarbanes-Oxley Act of 2002.32.1
              
              Certification
                  of chief executive officer and chief financial officer pursuant
                  to Section
                  906 of the Sarbanes-Oxley Act of
                  2002.




Page
          28 of
          29




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.




Dated: 
                March 28, 2008
            PORTA
                SYSTEMS CORP.By:
            /s/
                Edward B. KornfeldEdward
                B. KornfeldChief
                Executive Officer and Chief Financial
                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 Edward B. Kornfeld 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/Edward
                  B. Kornfeld
              
              Chief
                  Executive Officer and Chief Financial Officer
              
              March
                  28, 2008Edward
                  B. Kornfeld
              
              (Principal
                  Executive, Financial and Accounting Officer)/s/William
                  V. Carney
              
              Director
              
              March
                  28, 2008William
                  V. Carney/s/Warren
                  H. Esanu
              
              Director
              
              March
                  28, 2008Warren
                  H. Esanu/s/Michael
                  A. Tancredi
              
              Director
              
              March
                  28, 2008Michael
                  A. Tancredi/s/Herbert
                  H. Feldman
              
              Director
              
              March
                  28, 2008Herbert
                  H. Feldman/s/Marco
                  Elser
              
              Director
              
              March
                  28, 2008Marco
                  Elser


Page
            29 of
            29


**Exhibit
      I**





**Item
      8. Financial Statements and Supplementary Data**




Index
            
            PageConsolidated
                Financial Statements and Notes:Report
                of Independent Registered Public Accounting Firm
            
            F-2Consolidated
                Balance Sheets, December 31, 2007 and 2006
            
            F-3Consolidated
                Statements of Operations and Comprehensive Income/(Loss), Years Ended
                December 31, 2007, 2006 and 2005
            
            F-4Consolidated
                Statements of Stockholders’ Deficit, Years Ended December 31, 2007, 2006
                and 2005
            
            F-5Consolidated
                Statements of Cash Flows for the Years Ended December 31, 2007, 2006
                and
                2005
            
            F-6Notes
                to Consolidated Financial Statements
            
            F-7Financial
                Statement Schedule:Report
                of Independent Registered Public Accounting Firm
            
            F-25Financial
                Statement Schedule II - Valuation and Qualifying Accounts
            
            F-26




F-1




Report
      of Independent Registered Public Accounting Firm





The
      Board
      of Directors and Stockholders


Porta
      Systems Corp.


Syosset,
      New York





We
      have
      audited the accompanying consolidated balance sheets of Porta Systems Corp.
      and
      subsidiaries as of December 31, 2007 and 2006, and the related consolidated
      statements of operations and comprehensive income/(loss), stockholders’ deficit,
      and cash flows for each of the three years in the period ended December 31,
      2007. These consolidated financial statements and financial statement schedule
      are the responsibility of the Company’s management. Our responsibility is to
      express an opinion on these financial statements based on our
      audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. The Company is not required to
      have, nor were we engaged to perform, an audit of its internal control over
      financial reporting. Our audits included consideration of internal control
      over
      financial reporting as a basis for designing audit procedures that are
      appropriate in the circumstances, but not for the purpose of expressing an
      opinion on the effectiveness of the Company’s internal control over financial
      reporting. Accordingly, we express no such opinion. An audit also includes
      examining, on a test basis, evidence supporting the amounts and disclosures
      in
      the financial statements, assessing the accounting principles used and
      significant estimates made by management, 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, 2007 and 2006, and the results of its operations
      and its cash flows for each of the three years in the period ended December
      31,
      2007, in conformity with accounting principles generally accepted in the United
      States.





The
      accompanying financial statements have been prepared assuming that the Company
      will continue as a going concern. As discussed in Note 2 to the consolidated
      financial statements, the Company has suffered substantial losses from
      operations in previous years and, as of December 31, 2007, has a stockholders’
deficit of $30,527,000 and a working capital deficit of $34,513,000 and is
      dependent on the continued agreement of the holder of its senior debt to defer
      the maturity date of such debt. These factors raise substantial doubt about
      the
      Company’s ability to continue as a going concern. Management’s plans in regard
      to these matters are also described in Note 2. The financial statements do not
      include any adjustments that might result from the outcome of this
      uncertainty.





As
      discussed in Note 1 to the consolidated financial statements, effective January
      1, 2006, the Company adopted Statement of Financial Accounting Standards No.
      123R, “Share Based Payments” using the modified prospective transition method.





/s/
                BDO SEIDMAN, LLPBDO
                SEIDMAN, LLPMelville,
                New YorkMarch
                24, 2008


F-2




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Consolidated
      Balance Sheets


December
      31, 2007 and 2006


(in
      thousands, except shares and par value)


2007
              
              2006AssetsCurrent
                  assets:Cash
                  and cash equivalents
              
              $
              494
              
              $
              2,102Accounts
                  receivable - trade, less allowance for doubtful accounts of $ 50
                  in 2007
                  and $13 in 2006
              
              
              5,098
              
              
              5,417Inventories
              
              
              6,411
              
              
              4,591Prepaid
                  expenses and other current assets
              
              
              203
              
              
              697Current
                  assets of discontinued operations
              
              
              -
              
              
              383Total
                  current assets
              
              
              12,206
              
              
              13,190Property,
                  plant and equipment, net
              
              
              1,678
              
              
              1,571Goodwill
              
              
              2,961
              
              
              2,961Other
                  assets
              
              
              54
              
              
              51Long
                  term assets of discontinued operations
              
              
              -
              
              
              11Total
                  assets
              
              $
              16,899
              
              $
              17,784Liabilities
                  and Stockholders’ DeficitCurrent
                  liabilities:Senior
                  debt
              
              $
              24,373
              
              $
              23,513Subordinated
                  notes
              
              
              6,144
              
              
              6,1446%
                  Convertible subordinated debentures
              
              
              385
              
              
              385Accounts
                  payable
              
              
              5,523
              
              
              6,106Accrued
                  expenses and other
              
              
              2,555
              
              
              2,136Other
                  accrued interest payable
              
              
              7,739
              
              
              6,127Liabilities
                  of discontinued operations
              
              
              -
              
              
              425Total
                  current liabilities
              
              
              46,719
              
              
              44,836Deferred
                  compensation
              
              
              707
              
              
              771Total
                  liabilities
              
              
              47,426
              
              
              45,607Commitments
                  and contingenciesStockholders’
                  deficit:Preferred
                  stock, no par value; authorized 1,000,000 shares, none
                  issued
              
              
              -
              
              
              -Common
                  stock, par value $.01; authorized 20,000,000 shares, issued 10,084,557
                  shares in 2007 and 2006
              
              
              101
              
              
              101Additional
                  paid-in capital
              
              
              76,125
              
              
              76,125Accumulated
                  deficit
              
              
              (100,457
              )
              
              (97,713
              )Accumulated
                  other comprehensive loss:Foreign
                  currency translation adjustment
              
              
              (4,358
              )
              
              (4,398
              )(28,589
              )
              
              (25,885
              )Treasury
                  stock, at cost, 30,940 shares
              
              
              (1,938
              )
              
              (1,938
              )Total
                  stockholders’ deficit
              
              
              (30,527
              )
              
              (27,823
              )Total
                  liabilities and stockholders’ deficit
              
              $
              16,899
              
              $
              17,784




See
      accompanying notes to consolidated financial statements




F-3


PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Consolidated
      Statements of Operations and Comprehensive Income/(Loss)


Years
      ended December 31, 2007, 2006 and 2005


(in
      thousands, except per share amounts)


2007
              
              2006
              
              2005Sales
              
              $
              27,820
              
              $
              32,818
              
              $
              27,819Cost
                  of sales
              
              
              19,760
              
              
              21,984
              
              
              17,397Gross
                  profit
              
              
              8,060
              
              
              10,834
              
              
              10,422Selling,
                  general and administrative expenses
              
              
              6,186
              
              
              5,515
              
              
              5,120Research
                  and development expenses
              
              
              1,955
              
              
              1,505
              
              
              1,359Reorganization
                  expense
              
              
              
              
              
              —
              
              
              877Total
                  expenses
              
              
              8,141
              
              
              7,020
              
              
              7,356Operating
                  income (loss)
              
              
              (81
              )
              
              3,814
              
              
              3,066Interest
                  expense
              
              
              (2,139
              )
              
              (1,217
              )
              
              (1,080
              )Interest
                  income
              
              
              19
              
              
              30
              
              
              24Other
                  income, net
              
              
              54
              
              
              2
              
              
              5Income/(loss)
                  from continuing operations before income taxes
              
              
              (2,147
              )
              
              2,629
              
              
              2,015Income
                  tax expense
              
              
              (76
              )
              
              (118
              )
              
              (160
              )Income/(loss)
                  from continuing operations
              
              
              (2,223
              )
              
              2,511
              
              
              1,855Loss
                  from discontinued operations (net of zero tax)
              
              
              (521
              )
              
              (329
              )
              
              (1,045
              )Net
                  income/(loss)
              
              $
              (2,744
              )
              $
              2,182
              
              $
              810Other
                  comprehensive income:Foreign
                  currency translation adjustments
              
              
              40
              
              
              179
              
              
              (400
              )Net
                  comprehensive income/(loss)
              
              $
              (2,704
              )
              $
              2,361
              
              $
              410Basic
                  income (loss) per share of common stock:Continuing
                  operations
              
              $
              (0.22
              )
              $
              0.25
              
              $
              0.18Discontinuing
                  operations
              
              
              (0.05
              )
              
              (0.03
              )
              
              (0.10
              )$
              (0.27
              )
              $
              0.22
              
              $
              0.08Weighted
                  average of shares outstanding
              
              
              10,054
              
              
              10,054
              
              
              10,054Diluted
                  income (loss) per share of common stock:Continuing
                  operations
              
              $
              (0.22
              )
              $
              0.25
              
              $
              0.18Discontinuing
                  operations
              
              
              (0.05
              )
              
              (0.03
              )
              
              (0.10
              )$
              (0.27
              )
              $
              0.22
              
              $
              0.08Weighted
                  average shares of common stock outstanding
              
              
              10,054
              
              
              10,103
              
              
              10,093





See
      accompanying notes to consolidated financial statement




F-4




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Consolidated
      Statements of Stockholders’ Deficit


Years
      ended December 31, 2007, 2006 and 2005


(In
      thousands)





Accumulated
            
            
            
            
            
            
            
            TotalCommon Stock
            
            Additional
            
            Other
            
            
            
            
            
            
            
            Stock-No. of
            
            Par Value
            
            Paid-in
            
            Comprehensive
            
            Accumulated
            
            Treasury
            
            No. of
            
            holders’Shares
            
            Amount
            
            Capital
            
            (Loss)
            
            Deficit
            
            Stock
            
            Shares
            
            DeficitBalance
                at December 31, 2004
            
            
            10,004
            
            $
            100
            
            $
            76,059
            
            $
            (4,177
            )
            $
            (100,705
            )
            $
            (1,938
            )
            
            31
            
            $
            (30,661
            )Net
                income
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            810
            
            
            —
            
            
            —
            
            
            810Common
                stock issued
            
            
            81
            
            
            1
            
            
            65
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            66Foreign
                currency translation adjustment
            
            
            —
            
            
            —
            
            
            —
            
            
            (400
            )
            
            —
            
            
            —
            
            
            —
            
            
            (400
            )Balance
                at December 31, 2005
            
            
            10,085
            
            
            101
            
            
            76,124
            
            
            (4,577
            )
            
            (99,895
            )
            
            (1,938
            )
            
            31
            
            
            (30,185
            )Net
                income
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            2,182
            
            
            —
            
            
            —
            
            
            2,182Stock
                compensation expense
            
            
            —
            
            
            —
            
            
            1
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            1Foreign
                currency translation adjustment
            
            
            —
            
            
            —
            
            
            —
            
            
            179
            
            
            —
            
            
            —
            
            
            —
            
            
            179Balance
                at December 31, 2006
            
            
            10,085
            
            
            101
            
            
            76,125
            
            
            (4,398
            )
            
            (97,713
            )
            
            (1,938
            )
            
            31
            
            
            (27,823
            )Net
                Loss
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (2,744
            )
            
            —
            
            
            —
            
            
            (2,744
            )Foreign
                currency translation adjustment
            
            
            —
            
            
            —
            
            
            —
            
            
            40
            
            
            —
            
            
            —
            
            
            —
            
            
            40Balance
                at December 31, 2007
            
            
            10,085
            
            $
            101
            
            $
            76,125
            
            $
            (4,358
            )
            $
            (100,457
            )
            $
            (1,938
            )
            
            31
            
            $
            (30,527
            )




See
      accompanying notes to consolidated financial statements.


F-5


PORTA
      SYSTEMS CORP. AND SUBSIDIARIES




Consolidated
      Statements of Cash Flows (Note 18)


Years
      ended December 31, 2007, 2006 and 2005


(In
      thousands)





2007
            
            2006
            
            2005Cash
                flows from operating activities:Net
                income/(loss)
            
            $
            (2,744
            )
            $
            2,182
            
            $
            810Loss
                from discontinued operations
            
            
            521
            
            
            329
            
            
            1,045Stock
                compensation expense
            
            
            -
            
            
            1
            
            
            -Adjustments
                to reconcile net income to net cash provided by (used in) operating
                activities:Depreciation
                and amortization
            
            
            407
            
            
            414
            
            
            410Inventory
                reserves
            
            
            (404
            )
            
            (238
            )
            
            (43
            )Allowance
                for bad debt
            
            
            37
            
            
            **-**
            
            
            12Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            644
            
            
            (1,945
            )
            
            (623
            )Inventories
            
            
            (1,407
            )
            
            188
            
            
            (277
            )Prepaid
                expenses
            
            
            151
            
            
            (250
            )
            
            (118
            )Other
                assets
            
            
            (8
            )
            
            (3
            )
            
            20Accounts
                payable, accrued expenses and other liabilities
            
            
            949
            
            
            3,532
            
            
            1,164Net
                cash (used in) provided by continuing operations
            
            
            (1,854
            )
            
            4,210
            
            
            2,400Net
                cash used in operations of discontinued operations
            
            
            (87
            )
            
            (1,748
            )
            
            (1,303
            )Net
                cash (used in) provided by operations
            
            
            (1,941
            )
            
            2,462
            
            
            1,097Cash
                flows from investing activities:Capital
                expenditures, net
            
            
            (533
            )
            
            (585
            )
            
            (415
            )Net
                cash provided by (used in) investing of discontinued
                operations
            
            
            -
            
            
            5
            
            
            (172
            )Net
                cash used in investing activities
            
            
            (533
            )
            
            (580
            )
            
            (587
            )Cash
                flows from financing activities:Increase
                in senior debt
            
            
            1,000
            
            
            —
            
            
            337Repayments
                of senior debt
            
            
            (140
            )
            
            (1,163
            )
            
            (1,336
            )Net
                cash (used in) provided by financing activities
            
            
            860
            
            
            (1,163
            )
            
            (999
            )Effect
                of exchange rate changes on cash and cash equivalents
            
            
            6
            
            
            130
            
            
            (298
            )Increase
                (decrease) in cash and cash equivalents
            
            
            (1,608
            )
            
            849
            
            
            (787
            )Cash
                and equivalents - beginning of year
            
            
            2,102
            
            
            1,253
            
            
            2,040Cash
                and cash equivalents - end of year
            
            $
            494
            
            $
            2,102
            
            $
            1,253





See
      accompanying notes to consolidated financial statements.


F-6


PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements


December
      31, 2007 and 2006





**(1)**  **Summary
      of Significant Accounting Policies**





Nature
      of Operations and Principles of Consolidation





Porta
      Systems Corp. (“Porta” or the “Company”) designs, manufactures and markets
      systems for the connection, protection, testing and administration of public
      and
      private telecommunications lines and networks and products that provide network
      infrastructure that connects remote terminals used in military data transmission
      applications. The Company has various patents for copper and software based
      products and systems that support voice, data, image and video transmission.
      Porta’s principal customers are foreign and domestic telephone
      companies.




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




Revenue
      Recognition




Revenue
      is recognized when a product is shipped.




Concentration
      of Credit Risk




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




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.




Accounts
      Receivable




Accounts
      receivable are customer obligations due under normal trade terms. The Company
      sells its products directly to customers, to distributors and original equipment
      manufacturers involved in a variety of industries, principally
      telecommunications and military/aerospace. The Company performs continuing
      credit evaluations of its customers’ financial condition and although it
      generally does not require collateral, letters of credit may be required from
      customers in certain circumstances.





The
      Company records an allowance for doubtful accounts receivable based on
      specifically identified amounts that it believes to be uncollectible. The
      Company also records additional allowances based on certain percentages of
      its
      aged receivables, which are determined based on historical experience and its
      assessment of the general financial conditions affecting its customer base.
      If
      the Company’s actual collection experience changes, revisions to its allowance
      may be required. The Company has a limited number of customers with individually
      large amounts due at any given balance sheet date.




Inventories




Inventories
      are stated at the lower of cost (on the average or first-in, first-out methods)
      or fair market value. Our stated inventory reflects an inventory obsolescence
      reserve that represents the difference between the cost of the inventory and
      its
      estimated market value. This reserve is calculated based on historical usage
      and
      forecasted sales. Actual results may differ from our estimates.


F-7


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 shorter of the term of the lease or the estimated lives of the related
      assets. Depreciation is computed using the straight-line method over the related
      assets’ estimated lives.




Goodwill




Goodwill
      represents the difference between the purchase price and the fair market value
      of net assets acquired in business combinations. On an annual basis, or more
      frequently if certain events occur, the Company tests the goodwill for
      impairment. The Company determines the estimated fair value of the goodwill
      by
      considering the projected cash flows generated from the reporting unit to which
      the goodwill relates. Goodwill at December 31, 2007 and 2006, related only
      to
      the Company’s signal processing division. The Company determined that there was
      no goodwill impairment for 2007 or 2006.




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, and tax
      benefits of net operating loss carry forwards. Further, the effects of tax
      law
      or rate changes are included in income as part of deferred tax expense or
      benefit for the period that includes the enactment date. A valuation allowance
      is recorded to reduce net deferred tax assets to amounts that are more likely
      than not to be realized (See Note 13.)




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
      operations.




Research
      and Development




Costs
      for
      research and development activities are expensed as incurred.




Shipping
      and Handling Costs




Shipping
      and handling costs are included as a component of cost of sales.




Net
      Income/(Loss) Per Share




Basic
      net
      income/(loss) per share is based on the weighted average number of shares
      outstanding. Diluted net income per share is based on the weighted average
      number of shares outstanding plus the dilutive effect of potential shares of
      common stock, as if such shares had been issued.




Accounting
      for Stock Based Compensation




Prior
      to
      2006, the Company accounted for its stock-based employee compensation plans
      under the recognition and measurement principles of Accounting Principles Board
      (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related
      interpretations. No stock-based employee compensation cost was reflected in
      net
      income, as all options granted under those plans had an exercise price equal
      to
      the market value of the Common Stock on the date of grant. There were no options
      granted to employees during 2007. The only options granted in 2007 were as
      required under our automatic grant of options to non-employee
      directors.


F-8


PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued




In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS
      123R, “Share-Based Payment,” a revision of SFAS 123 which supersedes APB 25
“Accounting for Stock Issued to Employees”. As of January 1, 2006, the Company
      adopted SFAS 123R using the modified prospective transition method. Under that
      transition method, compensation cost recognized in fiscal 2006 includes (a)
      compensation cost for all share-based payments granted prior to, but not yet
      vested as of December 31, 2005, based on the grant-date fair value estimated,
      and (b) compensation cost for all share-based payments granted subsequent to
      December 31, 2005, based on the grant-date fair value estimate. Accordingly,
      the
      Company’s unaudited consolidated financial statements for the prior periods have
      not been restated to reflect the adoption of SFAS 123R. Because the Company
      previously adopted only the pro forma disclosure provisions of SFAS 123, it
      will
      recognize compensation cost relating to the unvested portion of awards granted
      prior to the date of adoption, using the same estimate of the grant-date fair
      value and the same attribution method used to determine the pro forma
      disclosures under SFAS 123, except that forfeiture rates will be estimated
      for
      all options, as required by SFAS 123R. The cumulative effect of applying the
      forfeiture rates is not material.




The
      Company used the Black-Scholes valuation model and straight-line amortization
      of
      compensation expense over the requisite service period of the grant. Based
      on
      the Black-Scholes valuation model there is no non-cash compensation attributable
      to stock options granted during 2007 and 2006, Stock compensation expense for
      all vested options to date is diminutive.





The
      following is a summary of the assumptions used in fiscal year ended December
      31,
      2007 and 2006:




Risk-free
                interest rate
            
            
            4.35
            %Expected
                dividend yield
            
            
            0
            %Expected
                term
            
            
            5
                yearsExpected
                volatility
            
            
            50
            %





The
      risk-free interest rate is based on the US Treasury yield curve at the time
      of
      the grant. The expected term of stock options granted is derived from historical
      data and represents the period of time that stock options are expected to be
      outstanding. The Company also uses historical data to estimate expected dividend
      yield and forfeiture rates. The expected volatility is based on historical
      volatility, implied volatility and other factors impacting the
      Company.




A
      summary
      of stock option transactions is as follows for the fiscal year ended December
      31, 2007:





Shares
            
            Weighted
              Average
              Exercise Price
              (per share)
            
            Weighted-
              Average
              Remaining
              Contractual
              Term
              (Years)
            
            Aggregate
              Intrinsic
              ValueOptions
                outstanding at beginning of period
            
            $
            322,280
            
            $
            1.33Granted
            
            
            20,000
            
            
            0.14Exercised
            
            
            —
            
            
            —Forfeited
            
            
            203,280
            
            
            1.50Options
                outstanding at end of period
            
            
            139,000
            
            
            .49
            
            
            5.70
            
            $
            990Options
                exercisable at end of period
            
            
            139,000
            
            
            .49
            
            
            5.70
            
            $
            990Options
                available for future grants
            
            
            710,000


F-9





PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued





The
      weighted average grant-date fair value of stock options granted during the
      period ended December 31, 2007 was $0.14 per share. As of December 31, 2007,
      there were no unrecognized stock-based compensation costs related to options
      granted under our plans as all options vested during the year.




Awards
      granted to employees prior to the adoption of FASB 123R were accounted for
      under
      the provisions of Accounting Principles Board Opinion No 25, “Accounting for
      Stock Issued to Employees” (APB 25”), and its related interpretations. Under
      this intrinsic value method there was no compensation expense recognized for
      the
      year ended December 31, 2005 because all the options had exercise prices equal
      to the market value of the underlying stock on the date of grant. The following
      table details the effect on net income and earnings per share if the Company
      had
      applied the fair value recognition provisions of Statement of Financial
      Accounting Statement (“SFAS”) No. 123, Accounting for Stock-Based Compensation,
      as amended by SFAS No. 148, to stock-based employee compensation.





Year
                EndedDecember 31, 2005Net
                Income (loss) reported
            
            $
            810Deduct:
                Total stock-based employee Compensation expense determined under
                Fair
                value based method
            
            
            (2
            )Pro-forma
                net income
            
            $
            808Earnings
                (loss) per share:Basic
                - as reported
            
            $
            0.08Basic
                pro-forma
            
            
            0.08Diluted
                - as reported
            
            $
            0.08Diluted
                - pro-forma
            
            
            0.08




The
      following weighted average assumptions were used in the Black-Scholes
      option-pricing model for grants during fiscal year ended December 31, 2005:
      term
      of 5 years, dividend yield of 0.00%, volatility of 50% and risk-free interest
      rate of 4.35%.




Accounting
      for the Impairment of Long-Lived Assets




The
      Company follows SFAS No. 144, “Accounting for the Impairment or Disposal of
      Long-Lived Assets.” Long-lived assets other than goodwill are evaluated for
      impairment when events or changes in circumstances indicate the carrying amount
      of the assets may not be recoverable through the estimated undiscounted future
      cash flows from the use of these assets.




Reorganization
      Expenses




Reorganization
      expenses in 2005 were $877,000. The expenses were for investment banking, legal
      and accounting, including payment of legal fees and other expenses of our senior
      debt holder, resulting from the requirement of our senior debt holder that
      we
      restructure our Company.


F-10


PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued


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, accrued expenses, goodwill
      valuation, and the deferred tax asset valuation allowance. Actual results could
      differ from the estimates.





Reclassification





Certain
      reclassifications have been made to the prior consolidated financial statements
      to conform to the current year presentation.





New
      Accounting Pronouncements




FIN 48




In
      June
      2006, the FASB issued Interpretation No. 48 (“FIN 48”), Accounting for
      Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109. The
      objective of this interpretation prescribes a recognition threshold and
      measurement attribute for the financial statement recognition and measurement
      of
      a tax position taken or expected to be taken in a tax return. FIN 48 is
      effective for the fiscal years beginning after December 15, 2006. The adoption
      of this statement did not have a material effect on the Company’s financial
      position or results of operations.




SFAS 157




In
      September 2006, FASB issued SFAS No. 157, “Fair Value Measurements,”
which provides enhanced guidance for using fair value to measure assets and
      liabilities. SFAS No. 157 establishes a common definition of fair value,
      provides a framework for measuring fair value under U.S. GAAP and expands
      disclosures requirements about fair value measurements. SFAS No. 157 is
      effective for financial statements issued in fiscal years beginning after
      November 15, 2007, and interim periods within those fiscal years. In
      February 2008, the FASB provided a one-year deferral for the implementation
      of
      SFAS No 157 for nonfinancial assets and liabilities recognized or disclosed
      at
      fair value in the financial statements on a nonrecurring bases. Management
      is
      currently assessing the effect of SFAS No 157 on its financial
      statements.




SFAS 159




In
      February 2007, the FASB issued Statement No. 159, “The Fair Value Option
      for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159
      allows entities the option to measure eligible financial instruments at fair
      value as of specified dates. Such election, which may be applied on an
      instrument by instrument basis, is typically irrevocable once elected.
      SFAS 159 is effective
      for fiscal years beginning after November 15, 2007, and early application
      is allowed under certain circumstances. The
      adoption of this statement is not expected to have a material effect on the
      Company’s financial position or results of operations.




EITF
      07-3




In
      June
      2007, the Emerging Issues Task Force issued EITF Issue No. 07-3,
“Accounting for Non Refundable Advance Payments for Goods or Services Received
      for Use in Future Research and Development Activities” (“EITF 07-3”). EITF 07-3
      requires that nonrefundable advance payments for goods or services that will
      be
      used or rendered for future research and development activities be deferred
      and
      capitalized and recognized as an expense as the goods are delivered or the
      related services are performed. EITF 07-3 is effective for fiscal years
      beginning after December 15, 2007 and will be adopted in the first quarter
      of 2008 and is not expected to have a material impact on the Company’s financial
      position or results of operations.




F-11




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued





**(2)**  **Going
      Concern**





As
      of
      December 31, 2007, the Company’s debt included (a) $24,373,000 of senior debt,
      as a result of a various extensions, which matures on May 1, 2008; (b)
      $6,144,000 principal amount of subordinated debt, which matured on July 3,
      2001;
      and (c) $385,000
      of 6% Debentures which matured on July 2, 2002. The Company was unable to pay
      the principal ($6,144,000) or accrued interest ($6,900,000) on the subordinated
      notes or the principal ($385,000) or interest ($183,000) on the 6% Debentures.
      Accordingly, the senior debt and subordinated debt are classified as current
      liabilities (Notes 7, 8 and 9).




The
      Company is impaired by both its working capital deficit, which was $34,513,000
      at December 31, 2007, and its loss from continuing operations of $2,223,000,
      as
      well as its dependence upon the willingness of the holder of its senior debt
      to
      continue to extend the maturity of the senior debt.




At
      December 31, 2007, the Company did not have sufficient resources to pay either
      the holder of the senior debt or the subordinated lenders; and it is unlikely
      that it can generate such cash from its operations, and the holder of the senior
      debt continues to preclude the Company from making payments on any subordinated
      indebtedness, other than accounts payable in the normal course of business.
      Accordingly, all senior and subordinated debts are classified as current
      liabilities (Notes 7, 8 and 9).




On
      February 7, 2007 Cheyne Special Situations Fund L.P (“Cheyne”) purchased the
      Company’s senior debt of approximately $23,373,000 from SHF IX, LLC and
      subsequently extended an additional $1,000,000 of debt in October 2007 to cover
      the Company’s working capital needs. Cheyne has extended the maturity of the
      senior debt to May 1, 2008. The Company can not give any assurance that the
      holder of its senior debt will extend the loan beyond May 1, 2008. The Company
      cannot determine whether the holder of the senior debt will continue to extend
      the loans. Any adverse event, including declines in business, could have an
      effect on the decision of the holder of the senior debt to extend or demand
      payment on the notes. If the holder of the senior debt does not extend the
      maturity of our senior debt beyond May 1, 2008 or if the holder of the senior
      debt demands payment of all or a significant portion of the senior debt when
      due, we will not be able to continue in business, and it is likely that we
      will
      seek protection under the Bankruptcy Code.




During
      the last several years, the Company has taken steps to reduce overhead,
      including a reduction in personnel, the hiring of lower wage personnel in its
      Mexico facility and the outsourcing of manufacturing to China. The Company
      will
      continue to look to reduce costs while it seeks additional business from new
      and
      existing customers. Furthermore, the Company believes that its current and
      historic financial position is having an adverse effect upon its ability to
      develop new business, as competitors and potential customers question its
      ability both to perform obligations under any agreements it may enter and to
      continue in business.




These
      financial statements have been prepared assuming that the Company will continue
      as a going concern and, accordingly, do not include any adjustments that might
      result from the outcome of the uncertainties described above.




**(3)**  **Accounts
      Receivable**





Accounts
      receivable are customer obligations due under normal trade terms. The Company
      sells its products directly to customers, to distributors and original equipment
      manufacturers involved in a variety of industries, principally
      telecommunications and military/aerospace. The Company performs continuing
      credit evaluations of its customers’ financial condition and although it
      generally does not require collateral, letters of credit may be required from
      customers in certain circumstances. Senior management reviews accounts
      receivable on a monthly basis to determine if any receivables will potentially
      be uncollectible. Included in the overall allowance for doubtful accounts are
      any accounts receivable balances that are determined to be uncollectible, along
      with a general reserve. After all attempts to collect a receivable have failed,
      the receivable is written off against the allowance. Based on the information
      available to the Company, it believes the allowance for doubtful accounts as
      of
      December 31, 2007 is adequate. However, actual write-offs may differ from the
      recorded allowance.


F-12





PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued





The
      allowance for doubtful accounts receivable was $50,000 and $13,000 as of
      December 31, 2007 and 2006, respectively. The net accounts receivable relating
      to the discontinued operations are included in assets of discontinued operations
      (See Note 10.) In 2006, the Company wrote off approximately $243,000 of fully
      reserved OSS accounts receivable.




**(4)**  **Inventories**





Inventories
      from continuing operations consist of the following (net of $1,952,000 in
      reserve for 2007 and $2,345,000 for 2006):




December
                31,2007
            
            2006Parts
                and component
            
            $
            3,669,000
            
            $
            3,637,000Work-in-process
            
            
            858,000
            
            
            543,000Finished
                goods
            
            
            1,884,000
            
            
            411,000$
            6,411,000
            
            $
            4,591,000





Inventories
      are stated at the lower of cost (on the average or first-in, first-out methods)
      or fair market value. Our stated inventory reflects an inventory obsolescence
      reserve that represents the difference between the cost of the inventory and
      its
      estimated market value. This reserve is calculated based on historical usage
      and
      forecasted sales. Actual results may differ from our estimates.





**(5)**  **Property,
      Plant and Equipment**





Property,
      plant and equipment from continuing operations consist of the
      following:





December
                31
            
            Estimated2007
            
            2006
            
            useful
                livesLand
            
            $
            132,000
            
            $
            132,000
            
            
            —Buildings
            
            
            876,000
            
            
            850,000
            
            
            20
                yearsMachinery
                and equipment
            
            
            1,695,000
            
            
            1,584,000
            
            
            3-8
                yearsFurniture
                and fixtures
            
            
            353,000
            
            
            307,000
            
            
            5-10
                yearsTransportation
                equipment
            
            
            48,000
            
            
            63,000
            
            
            4
                yearsTools
                and molds
            
            
            1,688,000
            
            
            1,353,000
            
            
            8
                yearsLeasehold
                improvements
            
            
            75,000
            
            
            251,000
            
            
            Lesser of term of
              lease or estimated
              useful life of asset4,867,000
            
            
            4,540,000Less
                accumulated depreciation and amortization
            
            
            3,189,000
            
            
            2,969,000$
            1,678,000
            
            $
            1,571,000




F-13




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued




Total
      depreciation and amortization expense for 2007, 2006, and 2005 amounted to
      approximately $407,000, $414,000, and $410,000 respectively.





During
      2007 the Company wrote off assets net of depreciation of $24,000 relating to
      leasehold improvements on property no longer leased in the UK and during 2006,
      the Company wrote off previously fully depreciated assets of approximately
      $69,000, which have been disposed of.





**(6)**  **Goodwill**





The
      Company measures the fair value of the goodwill at least annually, instead
      of
      amortizing goodwill over a fixed period of time, to determine if goodwill has
      been impaired.




As
      of
      December 31, 2007 and 2006, goodwill was $2,961,000. At such dates, all of
      the
      goodwill related to the Company’s Signal division. The Company cannot give
      assurances that future write-downs will not be necessary, although management
      believes that no goodwill impairment charges are necessary at this
      time.




**(7)**  **Senior
      Debt**





On
      December 31, 2007 and 2006, the Company’s senior debt consisted of debt in the
      amount of $24,373,000 and $23,513,000, respectively. Substantially all of the
      Company’s assets are pledged as collateral for the senior debt. The current
      agreement with the holder of the senior debt will expire on May 1, 2008 and,
      accordingly, the senior debt has been classified as a current liability. (See
      Note 2.) In October 2007 the Company borrowed an additional $1,000,000 from
      its
      senior debt holder to meet its current working capital needs. This loan along
      with the existing senior debt matures on May 1, 2008.




We
      do not
      accrue interest on the entire amount of the senior debt under the terms of
      our
      agreement with the holder of our senior debt. Interest has accrued from February
      7, 2007 on $10,000,000 of the senior debt at 12.5% as a result of the terms
      of
      the February 7, 2007 extension of the maturity of our senior debt. In addition,
      we accrue interest on the $1,000,000 lent to us by our senior lender in October
      2007 at a rate of LIBOR plus 10%, approximately 14.65% for 2007.




The
      holder of the senior debt prohibited the Company from making any payments on
      indebtedness to any subordinated creditors or from paying any dividends on
      common stock, but the Company is not prohibited from paying accounts payable
      in
      the ordinary course of business. Borrowings under this facility are included
      in
      senior debt as described in the preceding paragraph. The holder of the senior
      debt has no obligation to make any further loans to the Company.





**(8)**  **6%
      Convertible Subordinated Debentures**





As
      of
      December 31, 2007 and 2006, the Company had outstanding $385,000 of its 6%
      convertible subordinated debentures due July 1, 2002 (the “Debentures”). The
      Company has not paid interest on these Debentures since July 2000, and the
      holder of its senior debt prohibits it from making any payments of principal
      and
      interest (see Note 7). At December 31, 2007 and 2006, accrued interest on the
      debentures was $183,000 and $151,000, respectively. The trustee of the
      Debentures gave notice to the Company that the non-payment caused an event
      of
      default. The convertibility feature associated with the Debentures expired
      upon
      their stated maturity date, which was July 1, 2002.




**(9)**  **Subordinated
      Notes**





As
      of
      December 31, 2007 and 2006, subordinated notes in the principal amount of
      $6,144,000 were outstanding. As of December 31, 2007, $6,900,000 of accrued
      interest was also due and payable. However, the Company does not have the resources
      to pay either the $6,144,000 principal or the $6,900,000 interest due on the
      subordinated notes. In addition, the holder of its senior debt has precluded
      the
      Company from making payments on the subordinated debt (see Note
      7).




F-14




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued




**(10)**  **Discontinued
      operations**




Operating
      Support Systems (“OSS”)




In
      December 2003, the Company decided to wind down its OSS business because of
      continuing losses combined with difficulties in marketing OSS products in view
      of the Company’s financial condition. The OSS operating segment is reported in
      the consolidated financial statements as a discontinued operation for all
      periods presented. Its operating activities were limited to the performance
      of
      contractual maintenance and warranty services agreements which expired on June
      30, 2007, at which time the Company discontinued all OSS operations.
      Accordingly, the Company wrote off $434,000 of OSS assets.





The
      following amounts related to OSS have been segregated from the Company’s
      continuing operations and are reported as assets and liabilities of discontinued
      operations in the consolidated balance sheet:





December
                31,
              2007
            
            December
                31,
              2006Assets
                of discontinued operations:Prepaid
                expenses
            
            $
            —
            
            $
            13,000Accounts
                receivable
            
            
            —
            
            
            18,000Inventories
            
            
            —
            
            
            352,000Property,
                plant and equipment
            
            
            —
            
            
            11,000Other
                assets
            
            
            —
            
            
            —Total
                assets of discontinued operations
            
            $
            —
            
            $
            394,000Liabilities
                of discontinued operations:Accounts
                payable and accrued expenses
            
            $
            —
            
            $
            425,000Total
                liabilities of discontinued operations
            
            $
            —
            
            $
            425,000





Results
      of operations for OSS have been segregated from continuing operations and are
      reflected as discontinued operations approximately as follows:




December
                31,
              2007
            
            December
                31,
              2006
            
            December
                31,
              2005Revenues
            
            $
            100,000
            
            $
            333,000
            
            $
            785,000Loss
                from discontinued operations
            
            $
            (521,000
            )
            $
            (329,000
            )
            $
            (1,045,000
            )




F-15




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued




**(11)**  **Employee
      Benefit Plans**





The
      Company has unfunded deferred compensation agreements with certain present
      and
      former officers and employees, with benefits commencing at retirement equal
      to
      50% of the employee’s base salary, as defined. The amount of payments is based
      on a 2004 modification of the plan whereby the former officers and employees
      agreed to spread their payments over a longer period of time than the original
      plan, ranging from approximately 15 to approximately 25 years although they
      may
      be accelerated under certain conditions. Total deferred compensation obligations
      as of December 31, 2007 and 2006, before discounting at a rate of 6.5%, were
      $1,219,000 and $1,318,000, respectively.




The
      Company maintains the Porta Systems Corp. 401(k) Savings Plan for the benefit
      of
      eligible employees, as defined in the Savings Plan. Participants contribute
      a
      specified percentage of their base salary up to a maximum of 15%. Porta will
      match a participant’s contribution by an amount equal to 25% of the first 6%
      contributed by the participant. A participant is 100% vested in all balances
      credited to his account, including the Company’s contribution. For the years
      ended December 31, 2007, 2006 and 2005, the Company’s contribution amounted to $
      46,000, $44,000 and $41,000, respectively.





**(12)**  **Incentive
      Plans**





Incentive
      awards are provided to employees under the terms of our 1998 Non-Qualified
      Stock
      Option Plan and our 1999 Incentive and Non-Qualified Stock Option Plan (the
      “1998 Plan” and “1999 Plan,” respectively). Options under the 1998 Plan may be
      granted to key employees, including officers and directors of the Company and
      its subsidiaries. The exercise prices for all options granted under the 1998
      Plan are equal to the fair market value at the date of grant and vest as
      determined by the board of directors. Options under the 1999 Plan may be granted
      to key employees, including officers and directors of the Company and its
      subsidiaries, except that members and alternate members of the stock option
      committee are not eligible for options under the 1999 Plan. The exercise prices
      for all options granted are equal to the fair market value at the date of grant
      and vest as determined by the board of directors, which is historically
      determined as six months. In addition, the 1999 Plan provides for the automatic
      grant to non-management directors of non-qualified options to purchase 5,000
      shares on May 1st of each year commencing May 1, 1999, based upon the average
      closing price of the last ten trading days of April of each year. Options under
      both the 1998 and 1999 Plans have expiration terms between 5 and 10
      years.




During
      1999, the Company established an Employee Stock Bonus Plan whereby stock may
      be
      given to employees who are not officers or directors to recognize their
      contributions. A maximum of 95,750 shares of common stock is reserved for
      issuance pursuant to the Bonus Plan. No shares of common stock were issued
      pursuant to the Bonus Plan during 2007, 2006 or 2005.





The
      Company’s 1998 Non-Qualified Stock Option Plan (“1998 Plan”) covers 450,000
      shares of common stock. Options under the 1998 Plan may be granted to key
      employees, including officers and directors of the Company and its subsidiaries.
      Incentive stock options cannot be issued subsequent to ten years from the date
      the 1998 Plan was approved, however previously granted options are not affected.
      The exercise prices for all options granted were equal to the fair market value
      at the date of grant and vest as determined by the board of directors. Currently
      there are 445,000 options outstanding under this plan for future grants.





The
      Company’s 1999 Incentive and Non-Qualified Stock Option Plan (“1999 Plan”) cover
      400,000 shares of common stock. Incentive stock options cannot be issued
      subsequent to ten years from the date the 1999 Plan was approved, however
      previously granted options are not affected. Options under the 1999 Plan may
      be
      granted to key employees, including officers and directors of the Company and
      its subsidiaries, except that members and alternate members of the stock option
      committee are not eligible for options under the 1999 Plan. The exercise prices
      for all options granted were equal to the fair market value at the date of
      grant
      and vest as determined by the board of directors. In addition, the 1999 Plan
      provides for the automatic grant to non-management directors of non-qualified
      options to purchase 5,000 shares on May 1st of each year commencing May 1,
      1999,
      based upon the average closing price of the last ten trading days of April
      of
      each year. Currently there are 265,000 options outstanding for future
      grants.


F-16





PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued





The
      weighted-average fair values of options granted were $0.14 per share for options
      granted in 2005, $0.11 per share for options granted in 2006 and $0.14 per
      share
      for options granted in 2007. The only options granted under this plan during
      2005, 2006 and 2007 are the options granted to the independent directors
      pursuant to the automatic grant provisions. 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 2007, 2006 and 2005:





2007
            
            2006
            
            2005Dividends:
            
            $
            0.00 per share
            
            $
            0.00 per share
            
            $
            0.00 per shareVolatility:
            
            
            50
            %
            
            50
            %
            
            50
            %Risk-free
                interest:
            
            
            4.35
            %
            
            4.35
            %
            
            4.35
            %Expected
                term:
            
            
            5
                years
            
            
            5
                years
            
            
            5
                years





A
      summary
      of the status of the Company’s stock option plans as of December 31, 2007, 2006,
      and 2005, and changes during the years ending on those dates is presented below:





2007
            
            2006
            
            2005Shares
              Under
              Option
            
            Weighted
              Average
              Exercise
              Price
            
            Shares
              Under
              Option
            
            Weighted
              Average
              Exercise
              Price
            
            Shares
              Under
              Option
            
            Weighted
              Average
              Exercise
              PriceOutstanding
                beginning of year
            
            
            322,280
            
            $
            1.33
            
            
            337,780
            
            $
            1.39
            
            
            322,780
            
            $
            1.45Granted
            
            
            20,000
            
            
            0.14
            
            
            20,000
            
            
            0.11
            
            
            15,000
            
            
            0.14Exercised
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Forfeited
            
            
            203,280
            
            
            1.50
            
            
            35,500
            
            
            —
            
            
            —
            
            
            —Outstanding
                end of year
            
            
            139,000
            
            $
            .49
            
            
            322,280
            
            $
            1.33
            
            
            337,780
            
            $
            1.39Options
                exercisable at year-end
            
            
            139,000
            
            
            
            
            
            322,280
            
            
            
            
            
            337,780




**(13)**  **Income
      Taxes**





The
      provision for income taxes consists of the following:




2007
            
            2006
            
            2005Current
            
            Deferred
            
            Current
            
            Deferred
            
            Current
            
            DeferredFederal
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            32,000
            
            $
            —State
                and foreign
            
            
            76,000
            
            
            —
            
            
            118,000
            
            
            —
            
            
            128,000
            
            
            —Total
            
            $
            76,000
            
            $
            —
            
            $
            118,000
            
            $
            —
            
            $
            160,000
            
            $
            —




F-17





PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued




The
      domestic and foreign components of income (loss) from continuing operation
      before provision (benefit) for income taxes were as follows:





2007
            
            2006
            
            2005United
                States
            
            $
            (3,799,000
            )
            $
            1,146,000
            
            $
            783,000Foreign
            
            
            1,652,000
            
            
            1,483,000
            
            
            1,232,000Income/
                (loss) from continuing operations before discontinued operations
            
            $
            (2,147,000
            )
            $
            2,629,000
            
            $
            2,015,000





The
      Company’s tax provision consisted of current federal minimum taxes and state and
      foreign taxes.




Porta
      has
      unused United States tax net operating loss (NOL) carryforwards of approximately
      $50,907,000 expiring at various dates between 2008 and 2027. Due to the 1997
      change in ownership which resulted from the conversion of the Company’s
      Debentures 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 $1,767,000 per year with respect to
      approximately $23.9 million of the NOL, representing the portion that arose
      prior to the change in control. The carryforward amounts are subject to review
      by the Internal Revenue Service (IRS). In addition, Porta has foreign NOL
      carryforwards of approximately $5,279,000 with indefinite expiration
      dates.




The
      components of the deferred tax assets, the net balance of which total zero
      after
      the valuation allowance, as of December 31, 2007 and 2006 are as
      follows:





2007
            
            2006Deferred
                tax assets:Inventory
            
            $
            943,000
            
            $
            933,000Allowance
                for doubtful accounts receivable
            
            
            19,000
            
            
            5,000Benefits
                of tax loss carryforwards
            
            
            21,538,000
            
            
            20,568,000Benefit
                plans
            
            
            410,000
            
            
            412,000Accrued
                commissions
            
            
            111,000
            
            
            88,000Other
            
            
            3,255,000
            
            
            2,957,000Depreciation
            
            
            69,000
            
            
            253,00026,345,000
            
            
            25,216,000Valuation
                allowance
            
            $
            (26,345,000
            )
            $
            (25,216,000
            )$
            —
            
            $
            —




Because
      of the Company’s losses in previous years and uncertainties associated with
      projections of future taxable income and the possibility of a change in
      ownership, a valuation allowance for the entire deferred tax asset was provided
      and is still considered appropriate due to the uncertainty of future
      realization.





Effective
      January 1, 2007, we adopted Financial Accounting Standards Board Interpretation
      (“FIN” No. 48, Accounting for uncertainty in Income Taxes). Fin 48 prescribes a
      more-likely-than-not threshold for financial statement recognition and
      measurement of a tax position taken or expected to be taken in a tax return.
      As
      of such date, we did not have any unrecognized tax benefits, and there was
      no
      effect on our financial condition or results of operation as a result of
      implementing FIN 48.


F-18




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued





Fin
      48
      allows the Company to prospectively change its accounting policy as to where
      interest expense and penalties on income tax liabilities are classified. As
      of
      the date of adoption of FIN 48 we did not have any accrued interest or penalties
      associated with any unrecognized tax benefits, nor was any interest expense
      recognized during the respective quarters.





We
      file
      U.S. federal income tax returns as well as income tax returns in various states
      and foreign jurisdictions. We may be subject to examination by the Internal
      Revenue Service (‘IRS”) for calendar years 2003 through 2006 under the normal
      statute of limitations. Additionally, any net operating losses that were
      generated in prior years and utilized in these years may also be subject to
      examination by the IRS. Generally, for state tax purpose, the Company’s 2002
      though 2006 tax years remain open for examination by the tax authorities under
      a
      four year statute of limitations, however certain states may keep their stature
      open for six to ten years.




No
      provision was made for U.S. income taxes on the undistributed earnings of
      Porta’s foreign subsidiaries as it is management’s intention to utilize those
      earnings in the foreign operations for an indefinite period of time or
      repatriate such earnings only when tax effective to do so. **** At
      December 31, 2007, undistributed earnings of the foreign subsidiaries amounted
      to approximately $3,914,000. It is not practicable to determine the amount
      of
      income or withholding tax that would be payable upon the remittance of those
      earnings.





**(14)**  **Leases**





At
      December 31, 2007, the Company and its subsidiaries leased manufacturing and
      administrative facilities, equipment 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 2007, 2006, and 2005 amounted
      to approximately $ 491,000, $614,000 and $594,000, respectively. Minimum rental
      commitments, exclusive of future escalation charges, for each of the next five
      years are as follows:





2008
            
            $
            444,0002009
            
            
            448,0002010
            
            
            448,0002011
            
            
            128,0002012
            
            
            66,000Thereafter
            
            
            314,000$
            1,848,000





**(15)**  **Major
      Customers**





Porta’s
      five **** largest
      customers accounted for sales of $18,479,000, or approximately 66% of sales,
      for
      2007, $23,333,000 or approximately 71% of sales, for 2006 and $17,431,000 or
      approximately 63% of sales, for 2005. British Telecommunications PLC was Porta’s
      largest customer for 2007, accounting for sales of $10,860,000 or approximately
      39% of sales. For 2006 and 2005, British Telecommunications was also Porta’s
      largest customer accounting for sales of approximately $9,614,000 or 29%,and
      $5,641,000 or 20% of sales respectively.




**(16)**  **Fair
      Values of Financial Instruments**





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




The
      fair
      value of the Company’s senior and subordinated debt and related interest cannot
      be reasonably estimated due to the lack of marketability of such instruments.
      However, management believes, because of the Company’s financial position and,
      with respect to the senior debt, the sale of the senior debt by the Company’s
      former senior lender, that the fair value of these instruments is significantly
      less than their aggregate carrying amount.


F-19





PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued





**(17)**  **Net
      Income/(Loss) Per Share**





In
      2007 the weighted average shares of common stock did not take into effect the
      potential dilutive stock options as they would be anti-dilutive in the
      calculation of fully dilutive earnings per share. In 2006 and 2005, the weighted
      average shares of common stock outstanding for purposes of computing diluted
      net
      income per share include 65,000 dilutive potential shares of common stock
      related to stock options for which the options’ exercise price was less than the
      weighted average market price of the Company’s common stock for the year.
      Options to purchase 139,000, 257,280, and 272,780 shares of common stock for
      2007, 2006 and 2005, respectively, with exercise prices ranging from $0.07
      to
      $3.85, $0.32 to $3.85, and $0.30 to $3.85 for 2007, 2006 and 2005, respectively,
      were outstanding but not included in the computation of diluted net income
      per
      share, because the effect of doing so would be anti-dilutive.




**(18)**  **Cash
      Flow Information**





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





2007
            
            2006
            
            2005Cash
                paid for interest
            
            $
            604
            
            $
            169
            
            $
            1,130Cash
                paid for income taxes
            
            $
            0
            
            $
            0
            
            $
            115





During
      2005, the Company issued common stock amounting to $66,000 in lieu of payment
      of
      professional fees.




**(19)**  **Segment
      and Geographic Data**





Porta
      has
      two reportable segments: Line Connection and Protection Equipment (“Line”) whose
      products interconnect copper telephone lines to switching equipment and provides
      fuse elements that protect telephone equipment and personnel from electrical
      surges; and Signal Processing (“Signal”) whose products are used in data
      communication devices that employ high frequency transformer
      technology.


F-20




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued




The
      factors used to determine the above segments focused primarily on the types
      of
      products and services provided, and the type of customer served. Each of these
      segments is managed separately from the others, and management evaluates segment
      performance based on operating income.




2007
            
            2006
            
            2005**Revenue:**Line
            
            $
            22,929,000
            
            $
            27,188,000
            
            $
            21,982,000Signal
            
            
            4,891,000
            
            
            5,292,000
            
            
            5,710,000$
            27,820,000
            
            $
            32,480,000
            
            $
            27,692,000**Segment
                profit (loss):**Line
            
            $
            1,724,000
            
            
            4,688,000
            
            
            4,345,000Signal
            
            
            1,178,000
            
            
            1,640,000
            
            
            2,134,000$
            2,902,000
            
            $
            6,328,000
            
            $
            6,479,000**Depreciation
                and amortization:**Line
            
            $
            331,000
            
            
            315,000
            
            
            310,000Signal
            
            
            33,000
            
            
            34,000
            
            
            31,000$
            364,000
            
            
            349,000
            
            
            341,000**Total
                identifiable assets:**Line
            
            $
            11,032,000
            
            
            9,667,000
            
            
            7,626,000Signal
            
            
            5,022,000
            
            
            5,159,000
            
            
            4,775,000$
            16,054,000
            
            
            14,826,000
            
            
            12,401,000**Capital
                expenditures:**Line
            
            $
            492,000
            
            
            517,000
            
            
            357,000Signal
            
            
            12,000
            
            
            60,000
            
            
            37,000$
            504,000
            
            
            577,000
            
            
            394,000




F-21





PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued





The
      following table reconciles segment totals to consolidated totals:




2007
            
            2006
            
            2005**Revenue:**Total
                revenue for reportable segments
            
            $
            27,820,000
            
            $
            32,480,000
            
            $
            27,692,000Other
                revenue
            
            
            -0-
            
            
            338,000
            
            
            127,000Consolidated
                total revenue
            
            $
            27,820,000
            
            $
            32,818,000
            
            $
            27,819,000**Operating
                income/(loss) :**Total
                segment income for reportable segments
            
            $
            2,902,000
            
            $
            6,328,000
            
            $
            6,479,000Corporate
                and unallocated
            
            
            (2,983,000
            )
            
            (2,514,000
            )
            
            (3,413,000
            )Consolidated
                total operating income/(loss)
            
            $
            (81,000
            )
            $
            3,814,000
            
            $
            3,066,000**Depreciation
                and amortization:**Total
                for reportable segments
            
            $
            364,000
            
            $
            349,000
            
            $
            341,000Corporate
                and unallocated
            
            
            43,000
            
            
            65,000
            
            
            69,000Consolidated
                total deprecation and amortization
            
            $
            407,000
            
            $
            414,000
            
            $
            410,000**Total
                assets:**Total
                for reportable segments
            
            $
            16,054,000
            
            $
            14,826,000
            
            $
            12,401,000Corporate
                and unallocated
            
            
            845,000
            
            
            2,564,000
            
            
            1,672,000Assets
                of discontinued operations
            
            
            -0-
            
            
            394,000
            
            
            588,000Consolidated
                total assets
            
            $
            16,899,000
            
            $
            17,784,000
            
            $
            14,661,000**Capital
                expenditures:**Total
                for reportable segments
            
            $
            504,000
            
            $
            577,000
            
            $
            394,000Corporate
                and unallocated
            
            
            29,000
            
            
            8,000
            
            
            21,000Consolidated
                total capital expenditures
            
            $
            533,000
            
            $
            585,000
            
            $
            415,000




F-22




PORTA
      SYSTEMS CORP. AND SUBSIDIARIES


Notes
      to
      Consolidated Financial Statements, continued





The
      following table presents information about the Company by geographic
      area:





2007
            
            2006
            
            2005**Revenue:**United
                States
            
            $
            9,316,000
            
            $
            9,625,000
            
            $
            10,120,000United
                Kingdom
            
            
            13,321,000
            
            
            20,725,000
            
            
            14,542,000Mexico
            
            
            5,183,000
            
            
            2,468,000
            
            
            3,157,000Consolidated
                total revenue
            
            $
            27,820,000
            
            $
            32,818,000
            
            $
            27,819,000**Consolidated
                long-lived assets**:United
                States
            
            $
            4,334,000
            
            $
            4,241,000
            
            $
            4,055,000United
                Kingdom
            
            
            37,000
            
            
            44,000
            
            
            77,000Mexico
            
            
            328,000
            
            
            298,000
            
            
            288,0004,699,000
            
            
            4,583,000
            
            
            4,420,000Current
                and other assets
            
            
            12,200,000
            
            
            13,201,000
            
            
            10,241,000Consolidated
                total assets
            
            $
            16,899,000
            
            $
            17,784,000
            
            $
            14,661,000





**(20)**  **Quarterly
      Information (Unaudited)**





The
      following presents certain unaudited quarterly financial data:





Quarter
                EndedMarch 31, 2007
            
            June 30, 2007
            
            September
                30,
              2007
            
            December
                31,
              2007Net
                sales
            
            $
            8,202,000
            
            $
            7,069,000
            
            $
            6,651,000
            
            $
            5,898,000Gross
                profit
            
            
            2,620,000
            
            
            2,075,000
            
            
            2,088,000
            
            
            1,277,000Loss
                from discontinued operations
            
            
            (34,000
            )
            
            (487,000
            )
            
            -
            
            
            -Net
                income/ (loss)
            
            
            165,000
            
            
            (791,000
            )
            
            (424,000
            )
            
            (1,694,000
            )Income
                per share from continuing operations
            
            
            0.02
            
            
            (0.03
            )
            
            (0.04
            )
            
            (0.17
            )(Loss)
                per share from discontinued operations
            
            
            -
            
            
            (0.05
            )
            
            -
            
            
            -




Quarter
                EndedMarch 31, 2006
            
            June 30, 2006
            
            September
                30,
              2006
            
            December
                31,
              2006Net
                sales
            
            $
            7,937,000
            
            $
            8,084,000
            
            $
            9,018,000
            
            $
            7,779,000Gross
                profit
            
            
            2,713,000
            
            
            2,752,000
            
            
            2,984,000
            
            
            2,385,000Loss
                from discontinued operations
            
            
            (82,000
            )
            
            (76,000
            )
            
            (87,000
            )
            
            (84,000
            )Net
                income
            
            
            605,000
            
            
            587,000
            
            
            818,000
            
            
            172,000Income
                per share from continuing operations
            
            
            0.07
            
            
            0.07
            
            
            0.09
            
            
            0.03(Loss)
                per share from discontinued operations
            
            
            (0.01
            )
            
            (0.01
            )
            
            (0.01
            )
            
            (0.01
            )




F-23




REPORT
      OF
      INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




The
      Board
      of Directors and Stockholders


Porta
      Systems Corp.


Syosset,
      New York





The
      audits referred to in our report, dated March 24, 2008, relating to the
      consolidated financial statements of Porta Systems Corp., which are included
      in
      item 8 of this Form 10-K, included the audit of the financial statement Schedule
      II - Valuation and Qualifying Accounts for the three-year period ended December
      31, 2007. The financial statement schedule is the responsibility of the
      Company’s management. Our responsibility is to express an opinion on this
      financial statement schedule based on our audits.





In
      our
      opinion, such financial statement schedule presents fairly, in all material
      respects, the information set forth therein.





/s/
                BDO Seidman, LLPBDO
                Seidman, LLP




Melville,
      New York


March
      24,
      2008




F-24





Schedule
      II





**PORTA
      SYSTEMS CORP**


**VALUATION
      AND QUALIFYING ACCOUNTS**


(in
      thousands)





**Column
                A**
            
            **Column
                B**
            
            **Column
                C**
            
            **Column
                D**
            
            **Column
                E****Balance
                at**
            
            **Charged
                to**
            
            
            
            **Balance
                at****Beginning**
            
            **Costs
                and**
            
            
            
            **End
                of****Description**
            
            **of
                Period**
            
            **Expenses**
            
            **Deductions**
            
            **Period**Reserve
                and allowance deducted fromAsset
                accounts:YEAR
                ENDED DECEMBER 31, 2007Allowance
                for doubtful accounts
            
            $
            13
            
            $
            37
            
            $
            —
            
            $
            50Inventory
                reserve
            
            
            2,345
            
            
            —
            
            
            393
            
            
            1,952YEAR
                ENDED DECEMBER 31, 2006Allowance
                for doubtful accounts
            
            $
            13
            
            $
            —
            
            $
            —
            
            $
            13Inventory
                reserve
            
            
            2,583
            
            
            —
            
            
            238
            
            
            2,345YEAR
                ENDED DECEMBER 31, 2005Allowance
                for doubtful accounts
            
            $
            802
            
            $
            19
            
            $
            808
            
            $
            13Inventory
                reserve
            
            
            2,626
            
            
            626
            
            
            669
            
            
            2,583


F-25